The Scotts Miracle-Gro Company (SMG) Q3 2013 Earnings Report, Transcript and Summary

Good day, everyone. Thank you for holding, and welcome to The Scotts Miracle-Gro 2013 Third Quarter Earnings Conference Call with your host, Jim King. [Operator Instructions] I would now like to turn the call over to Jim King. Please go ahead.

Thanks, Jimmy. Good morning, everyone, and welcome to our third quarter conference call. With me this morning are Jim Hagedorn, our Chairman and CEO; Barry Sanders, our President and Chief Operating Officer, who's calling in remotely; and Larry Hilsheimer, our CFO. Jim and Barry will provide an overview of the current state of the business, both in the context of our Q3 results as well as our overall progress, then Larry is going to walk through the financials and the implications of today's results on our full year outlook. After their prepared remarks, we'll open the call to your questions. [Operator Instructions] With that, I want to move on to the call and remind everyone that our comments this morning will contain forward-looking statements. As such, actual results may differ materially from what we state. And due do that risk, we encourage investors to review the risk factors outlined in our Form 10-K, which is filed with the Securities and Exchange Commission, or our most recent 10-Q. So with that, let's get over to business. And let me turn the call over to Jim Hagedorn to discuss our performance.

Thanks, Jim. Good morning, everyone. I hope that it's obvious why I'm pleased with the news we announced this morning. Our team has every reason to take pride in what we've accomplished this year. And the shareholders should take heart that we have a good handle on the state of the business and that we're executing according to our plan. Most importantly, the news we announced this morning makes good on the commitments we made to our shareholders a year ago. Let me quickly touch upon the headlines and then turn things over to Barry to more look deeply at the business. After a slow start to the season, we've had an extremely strong recovery. Entering Q3, consumer purchases of our products were down 28% from 2012 levels. As I sit here today, that deficit is almost entirely erased. On a year-to-date basis, POS is now essentially flat. After 2 years of gross margin declines, we've successfully reversed the trend, renewing our confidence in the long-term goal to get our margin rate to 40%. Year 1 of Project Max, our cost-out and productivity initiative, has been a success, allowing us to reduce SG&A at an even quicker pace than we first projected. Even with pricing increases and reductions in spending, we've maintained our aggregate market share. Speaking of our overall performance, we now see the business trending toward a midpoint of our full year guidance of $2.50 to $2.75 per share. As we've seen in recent years, hurricanes and other unforeseen events can negatively impact our fall business, so -- and for that reason, we're not changing the overall range. Regardless of where we land within the range, we also expect to exceed our cash flow guidance of $250 million. As a result of our performance, we've reduced our leverage ratio below of our internal goal of 2.5x. And so, as we began discussing during our Q3 call a year ago, we're in a position to start returning cash to shareholders. The 35% increase in the quarterly dividend that we announced this morning puts us solidly in the top quartile of our benchmark companies. As we said in the press release, we will also continue to consider other shareholder-friendly actions, the most likely of which will be, in the near term, to restart our share repurchase efforts. Later, we will provide more detail in a few minutes on how we arrived at this level of increase for the recurring dividend, but I want to stress that the increase should be viewed as a strong vote of confidence from both the management and the board in the underlying fundamentals of the business and our ability to continue generating significant levels of cash. I also want to stress that we have plenty of flexibility to fund the needs of the business, including acquisitions, while maintaining our targeted leverage ratio. So there's a lot of to feel good about right now, and I'm not afraid to say so. Our focus throughout the year was to improve the quality and strength of our financials. We've improved our margins. We've strengthened our balance sheet. We've put ourselves in a position to show even more improvement in 2014. Are we where I want us to be? Are we where we need to be? The answer to both those questions is no. And so while we've had a solid year, I don't want to get ahead of ourselves. Our #1 long-term goal has to be growth. We can't cut our way to success, and we know that. But as I said during this call a year ago, and based on our experiences in 2012, we're not going to struggle too hard against broader macroeconomic trends, and our outlook for the consumer hasn't really changed all that much. While our business had a solid year in the DIY and hardware channels, we've not fared as well on the mass merchant channels, where retailers got off to a slower start. Consumers in that channel also remain less engaged in our category, a trend that began in 2011. So until the broader consumer feels better and starts opening their wallet with more frequency no matter where they shop, then we still believe unit volume growth will be tough to get in the core business. That's not to say that we can't get growth in the overall business. We believe that low single-digit top line growth is achievable in 2014, but we see it mostly coming from pricing, a slight rebound in our international business, growth in Scotts LawnService and perhaps some modest acquisition in adjacent categories. We're not going to provide any further guidance today for next year, but I will say that we see the potential for another strong year of earnings growth in 2014, getting us closer to our near-term goal of returning to 2010 levels of profitability. But I want to stress, once again, our long-term focus is driving the category and achieving a higher level of sales growth. The combination of improved consumer insights, product innovation and smarter retailer programs will all play a role in reigniting our organic growth, and then we can supplement that growth with partnerships and small acquisitions. I believe that, that focus, combined with improved margins and a commitment to returning cash to shareholders, will allow us to deliver a higher level of total shareholder returns. Before I turn things over to Barry to discuss the execution and to Larry to run through the numbers, I want to take a step back and put the results we're seeing this year into perspective. I'm not going to blame weather for the shortfall, given the strong recovery we've seen in the third quarter, but the fact is that the delay we saw in March was clearly related to weather. When the weather broke, the season took off. Our retailers stayed engaged and helped drive the season, and I want to thank them for that commitment. But even with their full engagement, when you look at our year-to-date results by geography, you can see that the late-breaking markets never fully recovered. Personally, I believe our term (sic) [team] deserves a better result than we've seen this year because their execution this season was as good as I've seen in many years. When we designed our plans this year, we knew the results would be second half loaded, that March of 2012 represented a nearly impossible comp, and we knew the majority of our gross margin and SG&A benefit would not take hold until Q3 and Q4. So after a late start to the season, it would be understandable if our team entered Q3 with a bit of nervousness. But under Barry's leadership, the team exercised patience. They understood what was happening and didn't spend excessive money chasing the season. They didn't pull the trigger on unplanned promotions, and they didn't lose faith in the strength of our brands and the resilience of the category. I want to recognize the work done, not just by Barry, but also Mike Lukemire, Jim Lyski, Dave Swihart, as well as the thousands of people who work in their organizations. They maintained confidence in our plans, they stuck to their guns, and they executed as well as I ever recall seeing. They're not to the finish line yet, a point I want to continue reminding them. But the performance we've seen from our people this year is something that requires the attention of our shareholders, and I wanted to make sure that I gave them the credit they deserve. With that, let me throw things over to Barry to discuss some of the details.

Thanks, Jim. Jim already gave you the headline regarding consumer purchases, but let me be more precise. POS in the quarter was up 15%, with year-over-year gains in every category. In our largest and most profitable business, Lawn Fertilizer, consumer purchases were up more than 40% for the quarter and now are up 1% on a year-to-date through last week. Within those numbers, we continue to see strong consumer acceptance of Snap. Purchases of Spreaders were up 31% in the quarter and are trending in line with what we saw during the introduction last year. Purchases of Snap-Pacs are higher than a year ago. Consumer excitement for the product remains high, and users of the product continue to feed their lawns at a significantly higher level than users of our traditional product. Mulch has been highly successful for the year again. POS was up 17% in the quarter and 9% year-to-date. More importantly, we have had great success in improving the profitability of this business. We told you during our Analyst Day meeting that we are moving to a more vertically integrated manufacturing process in this business. And that change has resulted in higher margins. While Mulch is still dilutive to our overall margins, the growth we're seeing is important, and we expect to see further margin improvement next year. I also want to talk to you about the performance of our gardens business. Consumer purchases of Miracle-Gro-branded soils and potting mixes were up nearly 10% in the quarter and 1% year-to-date. Overall, POS in soil was down slightly, but that's to do with the loss of some lower-margin private label listings. It's worth focusing on growing media for a reason. Many of you probably recall that this is a business that had a challenging year in 2012 and caught us off guard when the spring didn't materialize as we had expected. This year, however, even with the late spring, consumers are more engaged in the peak weeks of this year, not just in buying our products, but flowers, vegetables and other live goods as well. This is true with the rest of the business. We won't fully recover from the slow start, but we're satisfied with the result, given the circumstances. The same holds true in our controls portfolio. Recall that both Ortho and Roundup had strong performances in 2012, so they did not have an easy comp. And while both are still negative on a full year basis, both have been coming in strong in recent weeks. Roundup, in particular, has been doing well, posting increases of nearly 20% since June as consumers try to fight of the weeds that have been aided by high levels of rainfall in much of the U.S. Ortho has been about half that rate of growth over the past 2 months due to a need for both selective weed and insect control products. Switching gears a bit, retail inventory in the U.S. had been a bit of a roller coaster this season, but we're seeing inventory now that is pretty much in line with what we expected prior to selling them product for the fall season. As we get ready for fall, we continue to see strong retailer support, and we have a high degree of confidence in our marketing programs. The broad trends we've seen in the U.S., a slow start followed by consistent momentum, has also been the story in Europe. After a slow start, also delayed by weather, we've seen a strong recovery. The business there should come close to meeting the original plan for the year, and I'm pleased with their overall progress. The European team has fully embraced Project Max, and we've started the restructuring efforts we've discussed on previous calls. We expect to start seeing the payback from those efforts in the next year. Finally, let me touch upon Scotts LawnService. This business remains on track for mid-single-digit top line growth we expected, as well as another year of record profits and improved operating margin. Our customer count is now at an all-time high. So is our customer satisfaction scores. All of this is true despite the fact that significant Midwestern markets, like Chicago and Minneapolis, have struggled this year because of weather delays. On a separate note, the SLS team continues to get good learnings from the pest control test markets in Florida and remain confident that the long-term opportunity from such a product extension is both real and significant. We'll move cautiously, but I do see this as an important growth area as we look ahead. So I agree with Jim's assessment. Our performance in the third quarter was extremely solid, and I feel highly confident that we'll hit the bottom line targets that we've outlined back in December. The early discussions we've had with retailers regarding 2014 are encouraging. And once again, we expect Project Max to help drive leverage in the P&L next year. To be more specific about both, let me now turn the call over to Larry to discuss the numbers.

Thank you, Barry, and good morning, everyone. I have 3 objectives this morning. First, I want to recap our results for the quarter and, where relevant to the broader story, our year-to-date performance. Second, I want to help you better understand the implications of today's announcement on our full year guidance. And third, I want to build on Jim's comments regarding our dividend announcement this morning. I'll provide more comments on the strength of our balance sheet and our planned uses of cash going forward. With that, let me address our results. Sales in the quarter rose 9% year-over-year to $1.15 billion, driven primarily by the strength of the consumer business in the United States. Sales in the overall Global Consumer segment were up 10% to $1.05 billion. Within the segment, sales in the U.S. were up 8% during the quarter, while sales elsewhere increased 21%, excluding the impact of foreign exchange rates. As Jim said at the outset, weather had a big impact throughout the business in Q2, and that impact was most pronounced in Canada and Europe. Those businesses all rebounded well in Q3, leading to the strong sales I just outlined. Finally, Scotts LawnService increased 2% during the quarter. On a year-to-date basis, sales in the Global Consumer segment are still down 2%, while sales at SLS are up 4%. Company-wide year-to-date sales are minus 2%, but you'll recall that we adjusted our full year sales guidance in June and said we expected the result to range from plus 1% to minus 1%, and our 9-month performance is indicative of that outlook. In terms of the full year results, it seems most likely that we'll be flat to slightly down on the top line. However, as Jim already said, the team's performance with cost-out efforts and SG&A leverage provides more than enough support to make up that miss in the bottom line results. Let me do -- move down to gross margin, which, as we expected, was a very good story for us in the quarter. The adjusted gross margin rate in the third quarter improved 360 basis points compared to prior year, a result of improved leverage of our fixed manufacturing and warehousing costs in addition to favorable commodity cost, pricing and other cost efficiencies. We expect gross margin improvement will continue through the fourth quarter. You'll recall that we said, entering the year, we expected the gross margin rate to improve by up to 125 basis points. That top level of improvement is unlikely due to the volume miss we're going to see. Based on our updated sales guidance range, a full year improvement of 60 to 100 basis points is still achievable. Let's move on to SG&A, which has been a good story all year, especially so in the third quarter. During the quarter, SG&A decreased $8.1 million, a decline of 4% compared to a year ago. The year-over-year savings were primarily due to benefits of our Project Max initiative. Those decreases are partially offset by higher year-over-year costs for variable comp. With that said, variable pay, while still trending toward a targeted payout, will be less than what we had hoped. We had actually been accruing at higher levels earlier in the year in anticipation of hitting some stretch goals. So even though the variable pay will be lower than our original goals, we'll still see a targeted payout this year. And I agree with Jim's comments this morning: our team has done an outstanding job in executing our plan. Let me pause for a moment and try to help you with your models. When we updated our guidance in June, the biggest change was in SG&A. Our original target entering the year was to reduce SG&A by 1% to 3%. In June, we increased that target to a range of 3% to 5%. Now, with just 2 months left in the year, we expect to be on the high end of that range. Below the operating line, everything is in line with what we expected. Interest expense in the quarter was essentially flat at $16.8 million. The tax rate for adjusted earnings for the quarter was 36.5%. And we ended the quarter with a diluted share count of 62.6 million shares. All of that translated into adjusted income from continuing operations of $153.9 million or $2.46 per share during the quarter. That compares with $100.8 million for the same quarter last year or $1.62 per share. During the quarter, we had severance costs related to our European restructuring efforts of $8.5 million, which were adjusted out of earnings. We expect the last significant level of restructuring in Europe in the fourth quarter. When you include these onetime items, our GAAP earnings were $148.2 million or $2.30 per share compared with $96.4 million or $1.55 per share a year ago. So what does this mean for our full year earnings? Jim has already said we are trending to the midpoint of the range, and we hope to do slightly better. July was a good month for us, and August is relatively small but has started strong. So our September results and the kickoff to the start of the fall lawn and garden season will be important. Fortunately, our retail partners are engaged. So if the weather cooperates, we expect to have a strong finish to the year. If you move on to the balance sheet, 2 things stand out and are worth discussing. First, the change in accounts receivable is simply a function of the timing of shipments related to the higher sales volume. Secondly, and more importantly, we're really pleased with the year-over-year change in inventory levels. We said going into the year that managing inventory lower would be a priority for our supply chain for the next 2 years, and so far, they are doing even better than we expected. While I'm talking about supply chain, let me anticipate one of your questions related to the current commodity environment. I know that many of you have been calling in, in recent weeks to ask about the favorable trends in urea prices. We have been taking advantage of these trends and have locked in about half of our urea needs for 2014. We're not going to disclose our average price, but we do expect the amount to be lower than 2013. So I know that begs the next question, what is -- which is about pricing for 2014. As Barry said, we continue to move forward with modest price increases in our 2014 planning. Since we did not take any pricing in 2012, when urea moved sharply higher, the pricing we took in 2013, combined with our plans for 2014, now essentially offsets the margin gap. Finally, I want to talk about where we stand from a leverage perspective and also discuss our announcement today regarding the dividend and returning cash to shareholders. Entering Q4, our leverage ratio was 2.46, and we expect it to continue to improve slightly over the next few quarters. You will recall that we have said for the last several years that we view our optimal capital structure to be when our leverage ratio is within a range of 2x to 2.5x. That calculation is based on a 4-quarter average of net debt divided by trailing 12-month adjusted EBITDA. So we're back within the range, which allowed us to make the announcement about the dividend increase this morning. Let me help you understand the logic with our decision. We decided not to focus on a specific payout ratio or dividend yield. Instead, we looked at what level we felt comfortable with. We also looked at our peers and determined we wanted to stay within the top quartile benchmark companies from a payout ratio as long as we were comfortable. This increase puts us within that group. And as Jim said, it continues to give us plenty of flexibility to fund the business for the foreseeable future. We assessed our cash generation, considered risk, and we feel extremely comfortable with this recurring dividend level. In terms of near-term uses of cash, our philosophy of 2/3 to shareholders and 1/3 to the business still make sense for us. We've been studying some tuck-in acquisitions in adjacent categories for the U.S. consumer business that look attractive. Our LawnService business also continues to look at those type of deals as well. In all of those cases, we can meet the CapEx needs of our business, fund those acquisitions, return cash to shareholders and still stay within our 2x to 2.5x range. As we begin to look at next year, I believe the business has good momentum. I've been here for 4 months now, and I'm starting to better understand the rhythm of the business and the challenges and opportunities that we face. Like both Jim and Barry have said, we need to get the category growing at a faster rate. But I don't believe throwing money at the issue will get us very far. Our view of the consumer marketplace is mirroring what we continue to hear from peer companies and from our retail partners. So you can expect us to continue to manage the business prudently, to set reasonable expectations and to focus on driving solid shareholder returns. With that, I want to open the call to your questions.

[Operator Instructions] First question is from Joe Altobello. Joseph Altobello - Oppenheimer & Co. Inc., Research Division: I guess, the first question, I just want to understand the gross margin guidance a bit better. I think in your prepared remarks, you mentioned that it had to do with volumes. And I was curious where volumes weren't in line with expectations and what kind of elasticity you saw in terms of the pricing that you took this year.

Let me start with just saying that, Joe, this is a pretty big focus for us. So we've been spending a lot of time sort of looking at the numbers and seeing what it means. I mean, I think that the biggest issue here was just an absorption issue based on a shortfall from our internal numbers that we had, which were probably a couple percent short of, overall, where we had wanted to be. So I think that's the only thing that's really moving. And I would say on sort of the pricing side that -- probably some puts and takes, but overall, we're not seeing any sort of major share change. And so we're comfortable with where we are, and we're very comfortable where the progress we're making on gross margins. And so -- I don't know. Barry and Larry, do you want to add anything to this?

Jim, what I would add, the most comparative category that we have is controls. So we're evaluating that, looking at what happened this year and evaluating our plans. But what I would say, Joe, is that it's right where we expected and we know what the actions that we can take. And Jim Lyski and his team know what the elasticities are so that we can make our pricing decisions. Joseph Altobello - Oppenheimer & Co. Inc., Research Division: Okay, that's helpful.

Yes, I would just add that it's primarily a volume issue relative to where we're shortfall and a little bit of mix. And other than that, we're really pleased with what we accomplished. Joseph Altobello - Oppenheimer & Co. Inc., Research Division: Okay. And then switching gears to SG&A, obviously you're calling it down 5%. This year looked better than what we had thought going in. Could you tell us how much of that decline this year is really sustainable through cost savings, et cetera, and how much of that is deferring, maybe, some investments from fiscal '13 into '14?

No, we believe that what we have taken out is very sustainable. These are fundamental changes in our business operating structure and really focused efforts on permanent takeout. The takeouts were actually even higher when you consider that we are now paying incentives at a higher rate than we were last year, and we believe that we will have additional takeouts next year that will offset what we anticipate to be incentive increases for next year.

And our next question is from Olivia Tong.

I wanted to start first on the top line guidance. I mean, even Larry had sort of said more flat to down 1% as opposed to the minus 1% to plus 1% range. So first, why keep the top end of that range if it seems sort of unlikely? And that's still implying a pretty wide range for Q4, so can you kind of give us a sense what gets you to the top of the -- even the flattish range versus the low end of the range?

Go ahead, Jim.

I would say you're thinking too hard, Olivia. I think what we're trying to do is saying that we still believe that the guidance we gave previously is correct and will be within that range. I think that's as much as you need to read through it. We're not -- we're not sending a message there except to say, which is kind of what I thought when Larry said it, that the range he gave before, we're still comfortable with. And I think that's the case. We weren't trying to sort of say we needed it except to say we'll be within it. One of the reasons that I wanted to see if we could get you pushed up in this was your comment on disappointment on the dividend, and I kind of wanted to deal with that, if you don't mind. You okay with that?

Okay.

Look, we haven't changed anything. We spend a lot of time -- I ended up sort of in the process of getting a new CFO. I think he wanted to get regrounded with the banks and his advisers on how to do that. Cash flows are good and at or above what we expected. Our split that we have -- and I think consistent with over the last year or so of 2/3 to the shareholders, 1/3 for the use of the business, we are still good with. And it's just a question of the recurring dividend, where should it be, given that it's kind of hard to unwind, one. And we have spent a lot of time looking at other companies and what kind of -- I use the word, it's not precise, but what kind of "pop" you could sort of get in the equity. And the efficiency of that is as far as saying if you put too much into the recurring and there's not a lot of -- it doesn't do much to the equity, then what's sort of the perfect place for that to be? And I think that between Larry and the banks -- and I think really good work, by the way -- both the board and myself were convinced that this level is right. But it doesn't change anything. The amount of money we're planning to return is basically -- and my number on leverage is like more like 2.5x. But sort of at 2.5x leverage, 2/3 of our excess capacity will go to the shareholders, 1/3 used by the business. And so what's left then is specials and repurchases. So we have also renewed our authority that was existing but unused, this like $300 million that we have just -- it was already kind of on the books with the board. But we've worked with the board so we have an existing, now, $300 million repurchase availability. And so as we start moving into the next phase of returning cash to shareholders, it will be some combination of specials and/or buybacks, and we're just kind of trying to figure out what we think is best. But this was the first step of that process, and so we're absolutely committed to what we said before. And really, the level of recurring dividend was just basically saying what do we think the best place for it to show up in the equity, and the rest will happen through specials and buybacks. I don't know if that helped at all.

It does. By special, do you mean sort of onetime dividends? And then in terms of share repurchase, what kind of going run rate are you looking at going forward? Because from the press release, it sounds like you didn't really commit to any particular level. And 4 quarters now, we haven't seen any share repurchase. So can you give us a sense for what share repurchase would look like going forward?

Look, here's my issue with the question, which is I think that the math is not that hard. To say -- because the increase in the recurring dividend is not that high, okay? And it was designed for what it was, which is to say, "What level do you think we get the max return on the equity?" And then the rest will all happen through repurchases and specials. As soon as we have sort of visibility at year end on exactly what our availability and leverage is, we'll begin that process. And I think you'll see it sort of wholesale begin kind of for real in fiscal year '14. And I think it's purely doing the math, and I think probably my finance team can help on that. But it will be a consistently approached campaign to return cash in those 2 ways of doing it that will begin as soon as we're ready. And I'm saying that we're in that process, but we've still got to count our money, figure out what we got, what our availability is, what leverage is. And I think you'll see it in a big way in '14, consistent with what we've said. I don't know, Larry, do you want to add anything?

No, I think you said it as I would have, Jim. And it's just going to depend on our judgment of what we think is the appropriate mechanism to return money to our shareholders depending on where stock price is.

Anyway -- so I just wanted to sort of take the time to sort of advertise because we feel really good about it. I feel really good about it. And I think that when we took a look at the math on it, would I have liked to seen a higher recurring dividend, personally? When I say personally, meaning intellectually, I guess, the answer is yes. That said, I think there was a lot of evidence to say there's not a lot of bump in the stock to overpay and overcommit to a kind of recurring forever dividend. And so we kind of looked and said, "Where is the best point for that?" And then the rest will just happen.

Yes, the only thing I'd supplement that with is I did put our team through the paces of stressing, okay, give me all the worst things that could happen to us in the last whatever, and used that to help set a framework for me as to how much I would be willing. Because I don't want to lock into something that, black swan stuff happens, you're sitting here going, "Oh my gosh, why did we do that?" So we feel very, very comfortable at this level.

Got it. If I could just add -- ask one additional question. What was the change in compensation expense? What are you expecting now versus what you had expected going into the year?

I'm sorry. Oh, how -- make sure I have your question correct. Are you refracting -- or asking about how much we reduced from what we were accruing?

[indiscernible]

15.

And our next question is from Bill Chappell.

This is Sarah Miller on for Bill. I have a follow-up to Olivia's question and then one other question. On your variable comp for next year, is it going to kind of return to that level, 15 above this year? Or is it going to kind of build on top of what you expected for this year?

Well, let me just throw out there that we generally operate with a bunch of different sets of numbers. This is not to be sort of dishonest. It says that we have our own internal stretch numbers, we have numbers we sort of get the board to commit to, and that really sort of is our target comp, meaning the bonus is paid 100%, which is what we call target. And then there's the numbers we conservatively sort of transmit to the investment community. So I think what you can see here is that we're in that sort of middle range this year, which is sort of, we believe, at approximately target, okay? It's hard to say where we end up going forward in our budgeting process, because I think the idea of having a management team sort of operating the business toward more stretch goals is a good idea as long as we don't need it to sort of make sort of our investment thesis to you guys and our commitment to the board. So it would not be surprising to me if we started the budget year with more than 100% built into the incentive like we did this year. That does not mean that we're going to be committing, to either the board or the Street, sort of an exceptional year, if that makes any sense.

No, that's perfect. And then my second question is, can you kind of just talk around the -- give a little bit more color on the inventories at the end of the season and kind of going into the fall and how that sets you up for next year?

Barry, do you want take that?

I'll take that one. So inventory right now is down a little bit year-over-year. What we would expect for the balance of the quarter is around 10% POS increases, and that will drive roughly flat inventory to slightly up. As we look at last year, and you had to look at the business year-over-year and the decisions that were made with -- the retailers were conservative going into the fall. We had great comps in August and September, which had a lot of pull-through in October. This year, from a planning standpoint, we're planning on the fall being up. But operationally, we're going to ship most of the shipments about 2 weeks earlier. But we expect that, with the strong run we're having on POS right now, that it'll consume that. They'll end the inventory roughly flat to last year at the quarter, and we'll go into October in good shape.

Yes, just to clarify. Barry is talking about retailer inventories. Our inventories will be down in the target range that we identified.

And our next question is from David MacGregor.

This is Zoran in for David. I guess, first, I was just hoping to get your thoughts on market conditions in Western Europe. Clearly, had a very good revenue growth in that market this quarter. And a number of companies operating building products and consumer goods industries have indicated, during this earnings season, that market appears to be bottoming or even trending up. Understanding that your business is subject to seasonality, could you just talk a little bit about the environment there and maybe what your expectations might be for the region over the next 12 months?

This is -- Barry, let me just throw in my spin, just if I could. Look, I think that primarily what we're seeing in Europe is a rebound from just really sort of crap weather in the beginning of the season. I think they've ended up where it's been actually pretty nice in the kind of fall with the U.S. as far as warm. My forward view of Europe is possibly, I guess, that it's bottoming up. But I don't think that there, here in Marysville, there's a lot of view that there's a ton of upside on sort of consumer demand in Europe until, I'm going to say, these care economies start to feel a little better. And I don't personally see that. And talking to other senior executives of European-based businesses, I'm not sure they do either. So I think that for us, it was -- a lot of what happened was weather. But I think that the consumer has just not been a big help in Europe. And Barry, I don't know how you sort of take that and go with it, but good luck.

Well, I would say there's 3 things that affect it, as I look at macro things. Jim said some of them: the weather, the retailer sentiment and the consumer engagement. And similar to what you're saying, our point of view is we had better weather in the summer. The retailers stayed engaged. We had a couple of bankruptcies in the previous couple of years that had shifted things around a bit. I think that's normalized. And the consumer seems to be engaged. So where I would say we're at and where we're planning is, is that the business has stabilized at these levels. But as Jim has said, we're not planning on big growth from here. We're planning on consistent growth, and that's in line with what we said we were going to do to rightsize our cost structure to these levels. So we're planning on the business being relatively flat and rightsizing the business to those levels. And then as time goes on, we'll watch it. And we think there could be slightly some upturn next year based on exactly what we saw in the U.S. this year, which is weather, but we're going to plan for it at the modest levels.

That's helpful. And if I could throw one more in there. I was hoping you could expand your commentary with regard to potential acquisitions in both the consumer and lawn services segment. And specifically, we've seen in the past that you've entered new product categories like animal repellent on your own, just given strong brand awareness for your products. So should we interpret maybe your commentary as a change in strategy going forward, or would you still prefer to enter new categories on your own?

That's a really hard question because I think it's situational. I think we spent a lot of time looking at the repellent category, ultimately decided that the best way, for a whole slew of reasons, was to do it ourselves in the use of the Ortho brand. And I think that, that's going pretty well for us. I think there's other areas where we don't really believe we have the skills to do it. And if there's an opportunity this is priced properly, where we can either partner with someone or acquire them, I think we're willing to do that. And I think, based on the fact that we've reserved a pretty substantial amount of money relative to what we spent over the last few years, there is opportunities if it's properly priced and it's a category that we're interested in entering, particularly if we see that growth in our core categories is, to some extent, retarded. And I think this is an area where we are interested in, where we have availability and the price is right, to either enter it ourselves or acquire or partner. And I think that probably is different just because we haven't been in sort of that mode of acquisition. As you know, gross margin is something that we're focused on pretty hard. I wouldn't say excessively, meaning we're walking away from business because of margin, but I would say that this idea of sort of 40 points of gross margin is really important to us. And it's something that we're at or ahead of plan on getting to, especially if you take the absorption issues that happened in this year as a result of volume shortfalls. So that's -- so margin is a factor as we look at these categories of what we're interested and what we'd pass on. Within LawnService, this is a great growth margin category, both on "do-it-for-me" lawn service and pest control, where there's much higher margins than we see in our normal U.S. consumer business. And so this is an area where Brian Kura is competing for money. I was jousting with him a little this morning that he'd actually have to have a presentation that is capable of making the sale with me and Larry that -- and he says he's now ready for that presentation. So there is a little bit of competition for candidates within sort of the North American consumer business and the SLS business for -- which is more money than we've spent in recent past, but it's not unlimited in there based on 2/3 going back to the shareholders. So I think that there are opportunities, and we're chasing them, and we have a fairly well-populated, I would say, business development process happening right now, and that's a good thing.

And our next question is from Alice Longley.

My questions are mainly on gross margin. So you've got favorable urea prices for next year, but aren't maybe diesel costs going to be a headwind with rising oil prices? And also resin for your jugs, I'm hearing that, that's -- resin costs are going up a lot. So can you give us the puts and takes to convince us that your gross margins can be up next year in line with that 40 basis point goal that you've got?

Yes. You said it well, Alice. I mean, there are ups and downs. On an overall basis, it's -- we'd view it as being relatively down. We've locked in about half of our cost, so we feel very comfortable. We've been working well with our retailers, and we feel comfortable with where we're at in our discussions on pricing with them. We are not taking as much pricing as we would have taken or would have thought we would 5 or 6 months ago related to that. But we're very comfortable with our trend on gross margin and feel confident that we're going to, over time, get to our 40% gross margin. Probably not going to get to the level that we'd hope by the end of next year related to being back at that fiscal '10 level, just because we don't see volume and leveraging of our fixed cost by that point, but we will make significant strides.

A couple of follow-ups to that. So you've locked in half of your urea costs. Have you locked in half of your resin and other costs as well?

Yes. And if I wasn't clear, it wasn't 50% of our urea. It's 50% of our total hedged commodity portfolio.

Of the total hedged. And do you hedge resin and transportation costs?

Yes, we hedge across the board.

Okay. And I misheard you earlier, what is your target for annual growth margin expansion?

We haven't locked down our target for next year yet. We're still in the budgeting process.

But Alice, what I would say on that is we are at or above the trends. As I said, the way that I'm going to say Barry and Dave and myself, now Larry, is the path now for me is, within our strategic plan, where we want to get to. I told you our goal there is, call it, 40-ish. In the journey down the road toward the gross margin we're looking for, we are on or ahead of plan, okay? It's a little bit hidden in this year because of March -- of a volume shortfall, which drove an absorption issue. If you would exclude that, we're at or above plan. The approach for next year, we are very positive on our costs compared to where we thought we were going to be, enough so that we've been somewhat more flexible in our pricing than we would have been, had that not been the case. So I think that the guys can take you offline through sort of more of the details on cost, but the bottom line is we're favorable based on the commodity market to where we thought we were going to be. And so I don't there'll be any issue convincing you that our gross margin targets are achievable.

Okay. And then I might have missed this earlier, but in your guidance for, let's say, flattish sales for this year, what would be the components in fiscal '13 of volume, price and mix?

I think I mentioned that. And as far as the fractions, I'm not going to get into that. And if other people decide they want to do that offline, that's up to them. But I think what we've said is recovery in Europe, continued growth in LawnService and modest sort of low single-digit pricing in the U.S. consumer business. Those are the components of...

And that means 1 to 2?

That's fair.

Okay. And could you -- what's your ad ratio doing this year?

Advertising ratio is -- in comparison to last year, is that what...

Right, yes.

We're down about a point on ratio. But we're in the, call it, the 5.5 A-to-S ratio area.

And is that something that you cut because volume was a little weak, or did you plan that at the beginning of the year?

Yes, we are on plan throughout this entire year. So it wasn't really volume-driven at all. It's really a matter of promoting our highest-margin products and our innovation coming out the door.

So this is consistent with a 50% increase and then backing that down to sort of a 25% increase from '11.

And our next question is from Jon Andersen. Jon Andersen - William Blair & Company L.L.C., Research Division: I just had a follow-up on the commodity question and how it relates to gross margin. With, I guess, the net commodity basket favorable relative to your expectations at this point and the forward purchasing that you've done -- or hedging, how does that roll out as you look into '14 and into '15? Because my understanding is there's some carryover effect that would not only benefit '14 but potentially '15. So I'm trying to get an understanding for the timing when we might see substantial benefit from lower urea prices. And then also, if you can just provide a little more clarification on your pricing commentary. Are you now kind of deviating from your plan to take about 2% of price a year, given the changing cost environment? Or is that something that's still kind of your long-term plan and objective?

Look, let me just take the second part and then leave to other smarter people than me when the benefits of lower commodities, how long it takes before it rolls out into the P&L. Yes, I would say it's a -- was a very slight deviation is that -- we talked earlier about -- I like an environment where everybody is taking pricing. And when not everyone's taking pricing and we take a look at what's happening, especially in competitive categories like our controls business, this would be Ortho, I think that this is an area where what the consumer is willing to bear relative to how other people are pricing does matter, where it's a more competitive set. And therefore, we have basically shown some flexibility in the negotiations with the retailers where we're still making our margin goals happen. And so I would say this is a very small deviation, but it's meaningful within sort of the negotiations as far as the retailers being clear that we're making our margin targets, which are a pretty significant expansion from where we were, call it, the end of last year, that when the commodity news is good, there's some more flexible view of it as long as we're making our goals. And those are important to me. In regard to sort of rolling it out over time, when that happens, Larry?

So Jon, a couple of pieces of information. I mean, when you look at our inventory cost and our cost of sales, raw materials is basically 19% on commodity-sensitive stuff. And on packaging, it's 6%. And you got a little bit, 3% in transportation. So all in, that's just 28% of our cost of sales. In terms of when it will roll through, I mean, with our inventory turns, basically, all of that's going to go through 1 year. In terms of what quarters, I don't have all that at the top of my -- tip of my tongue. We'll make our standard cost adjustment beginning of the year. That will roll through the first 6 months of the year, just as it did this year. But everything will play through in '14.

Well, it's also positive. If we start '15 with lower-cost product than we had anticipated in our strategic plan, it's got to be a positive for us.

Yes, and to the extent that [indiscernible]. Jon Andersen - William Blair & Company L.L.C., Research Division: Okay. One quick follow-up. Jim, you mentioned the -- called out kind of the mass channel as somewhat soft, at least in the context of stronger performance in DIY and hardware. As you think about that channel going forward, is it just a matter of kind of waiting for a potential recovery in that middle -- lower middle-income consumer? Or are there some deliberate things that you're doing internally to try and turn that part of the business onto a better trajectory?

It's a really good question, by the way. And I think the answer is probably both. I'm not going to focus too much on the consumer recovery, but I think it matters, especially in a category where people are more sensitive to pricing. We opened up our option with cheaper SKUs that are lower priced. That's done real well in the food channel. I think it's had a little less merchandising support in mass. But hopefully, we'll get more listings there, because it's working pretty well in food. I think that if we look and basically said that the mass channel, so we're kind of avoiding these names, but it's a retailer, I think they got into the business late this season. And you show up in sort of middle of April on sort of tax day and you see stores in the Northeast not set, that's a big problem. And so I think that the issues in Bentonville are pretty well known. I don't think we're the only consumer products company that has talked about the sort of issues executing the year. Now to be fair and positive, Barry and the sales team have done a superb job of working very closely at senior levels within Walmart to rectify that. And if you look at their summer business, their summer business, while it's relatively small numbers are, I think, exceeding the sort of rate of increase we're seeing at DIY. So once the merchandising plans are being executed at the retail level, I think we do okay. But I think they got in late. The peak of the season was kind of, I think, a problem. So I think it's 2 issues. It's both continued weakness at the bottom end of the consumer sort of marketplace, meaning that demographic, and a sort of failure to execute on time, which is probably our fault, too. But I'll take that just as a matter of being fair. And Barry and his team have done, I think, a really good job of working about as well as you can with a retailer to sort of say, "Hey, we got to fix this, and let's get on it." And I think both sides, both Bentonville and Marysville, have really worked hard to sort of solve that problem. And I want to give Walmart credit for sort of getting on it and tell them that we appreciate it, not only for our own selfish reasons, but it says something good about Walmart.

And our final question is from Patrick Trucchio.

Just a follow-up on the mass market versus the home centers. How much were sales up in DIY and home centers? And did they decline in the mass market? And if so, how much did they decline?

Listen, from my point of view, I ain't saying. But I think it's fair to say they were better at DIY and what we call channel business, meaning sort of non-mass but smaller regional players and hardware, than they were at mass. I think you'd probably run the numbers and say, if anything, they're down at mass. That's fair enough, and I would say up everywhere else. But it is what it is, and I think I commented on it before and I want to -- I view this as, like I said before, in part just economic issues and in part merchandising execution and retail execution, and on both sides, ours as well. So I think everybody's on top of that, and the sales for the summer have looked actually really good there. But I think probably, for sure, I can easily say down compared to a year ago.

And then just on the share repurchase. How much of the buyback is anticipated for fiscal '14? And then separately from that, why have we been seeing so many -- so much more insider selling recently? And will the share repurchase bring the family's percentage ownership of the shares, or will it restore it?

So I'll go with the back part of that again. So I'm like 58, and there's 4 of us, 2 sets of twins, so everybody sort of 55-plus. My older brother and sister are like 10 and 12 years older, respectively. Within the family, there's a liquidity plan that gives people authority to sell a certain amount of shares. I think some people are kind of setting themselves up for their future, and they're doing that. It does not indicate a lack of commitment to our family business or what we see as our family business. So I wouldn't read anything into that, except that -- had a family meeting over the late spring, people sort of said what they wanted to do. We, as a group, said, "Well, do what you've got to do," and that's what you're seeing. But it's really just people operating within what we call liquidity plan. I think that on the repurchase side -- and I probably can speak for not only the Hagedorn family, but for other significant shareholders, too, who believe that, if the stock is undervalued relative to what we think its sort of intrinsic value is, that using the repurchasing method is a good one and that it will make all of us, finance-wise, [ph] larger shareholders sort of [indiscernible] at the people who are sellers. I think [indiscernible] Sort of for my sister or the other family members but to say that I think it's probably some mix. I think we would anticipate some accretion of our ownership through the repurchase, but it would not be fair to say, I don't think, that the family will not be participating at all in a repurchase. Larry, maybe you want to talk about what your view of timing is.

Yes. I mean, in terms of timing, I mean, as we've said before, our plan is to take advantage of the share repurchase authorization that we have that -- and execute on that to the extent that the value would support that over the next year, and we'll also be looking for a supplemental return of the up to 2/3 of our cash flow that we've talked about, which would, again, align to next fiscal year.

And at this time, we have no further questions in the queue. Mr. King, we'll set it back to you.

Okay, thanks, Jimmy. If there are other follow-up questions or people that we didn't get to, just give me a call directly today, (937) 578-5622. One other item before we close. Barry Sanders and I will be attending the CL King Best Ideas Conference in New York on September 12. As usual, that call will be webcast on our IR website. So if you're not there in person, you can listen in. And other than that, we will be reporting our Q4 results and year-end results early in November, and we'll talk to you than. Thanks for calling and joining us. Have a great day.