J M Smucker Co (SJM) 2017 Q2 法說會逐字稿

Good morning and welcome to The J.M. Smucker Company's fiscal 2017 second-quarter earnings call. This conference is being recorded and all participants are in a listen-only mode.

(Operator Instructions)

I will now turn the conference call over to Aaron Broholm, Vice President, Investor Relations. Please go ahead, sir.

Good morning everyone. Thank you for joining us for our second-quarter earnings conference call.

With me today and presenting our prepared comments are Mark Smucker, Chief Executive Officer, and Mark Belgya, Vice Chair and Chief Financial Officer. Also joining us for the Q&A portion of the call are Steve Oakland, Vice Chair and President, US Food and Beverage, and Barry Dunaway, President, Pet Food and Pet Snacks.

During this call we will make forward-looking statements that reflect the Company's current expectations about future plans and performance. These statements rely on a number of assumptions and estimates and actual results may differ materially due to risks and uncertainties. I encourage you to read the full disclosure concerning forward-looking statements in this morning's press release which is located on our corporate website at jmsmucker.com.

Additionally, please note the Company uses non-GAAP results for the purposes of evaluating performance internally as detailed in the press release.

We have also posted to our website a supplementary slide deck summarizing our second-quarter results which can be accessed through the link to the webcast of this call. These slides and a replay of this call will be archived on our website. If you have any questions after today's call please contact me.

I will now turn the call over to Mark Smucker.

Thank you, Aaron. Good morning, everyone, and thank you for joining us.

This continues to be an exciting and dynamic time at Smucker as we are delivering on both our current-year priorities and our long-term goals. This includes another quarter of record adjusted earnings per share as we continue to achieve our target for synergies and cost savings.

Second-quarter results also benefited from the strong performance of the Uncrustables, Dunkin' Donuts, Cafe Bustelo and Smucker's brands along with contributions from innovation as new products introduced in the past three years contributed 9% of our net sales in the quarter. In addition, we are investing in new capabilities to support the growth of our brands and on-trend platforms. We are making good progress on our journey to enhance innovation, e-commerce, our go-to-market skillset and revenue management capabilities.

One of the key initiatives that we are thrilled to share this morning is a decision to launch our Nature's Recipe premium pet food brand into the mainstream grocery and mass channels, which I will discuss in a moment. All of these efforts will position us to meet our long-term objectives for top- and bottom-line growth and deliver against our consumer-centric vision to engage, delight and inspire our consumers.

With that background let me provide a brief overview of our second-quarter results. Excluding the impact of divestitures and foreign exchange, net sales decreased 5% compared to 2016. This included a 2% impact from lower pricing, primarily reflecting a list price decline in coffee taken earlier in the fiscal year.

Lower pet food and peanut butter sales also contributed. With the anticipated impact of commodity inflation in certain categories and contributions from the launch of Nature's Recipe we continue to project full-year net sales to be in the range of flat to down 1% compared to 2016.

For the second quarter adjusted operating income was in line with the prior year as the decrease in net sales was more than offset by lower input costs and incremental synergies. Aided by a lower tax rate and a decrease in shares, adjusted earnings per share grew 7% to $2.05, exceeding our previous estimate for the quarter. This was mostly attributable to higher-than-planned segment profit for pet food and a continued focus on controlling administrative expenses.

For pets, the over-delivery reflected a decision to reallocate a portion of our planned second-quarter marketing spend to the fourth quarter to support the Nature's Recipe launch. For the full year, we remain on track to achieve our previously stated guidance for adjusted earnings per share.

As I turn to the U.S. Retail segment I would highlight that in each of our businesses not only do we compete in every segment of each category but are strategically focused on those segments where we can achieve the most long-term growth. Beginning with Coffee, profit was up 3% over the prior year despite the anticipated top-line impact of price declines.

In terms of the brands, volume for Folgers roasted ground coffee decreased 5%, reflecting a decline in our opening price point value offerings. However, Folgers K-Cup volume increased in the quarter, responding favorably to planned price investments.

For the Dunkin' Donuts brand bagged coffee volume was up 6% as lower prices supported by favorable input costs have improved the competitive position of the brand. In addition, Dunkin' K-Cups achieved double-digit volume growth in the quarter including contributions from new varieties and the brand continues to gain market share in the one cup segment.

Our Cafe Bustelo brand also realized double-digit growth in the second quarter for both its roast and ground and K-Cup offerings. And we anticipate this trend to carry into the back half of the year.

Turning briefly to the green coffee market, both arabica and robusta futures increased further lately. However, we continue to recognize lower green coffee costs in the second quarter. While we do not disclose our hedged position we remain confident in our ability to adjust pricing when warranted by our recognized costs as we have managed pricing in the past during periods of significantly higher green coffee markets.

Within our Consumer Food segment the second-quarter performance of peanut butter was weaker than last year with a high single-digit volume decline for the Jif brand. This was partially attributable to the timing of shipments as consumption and marketshare trends remain comparable to the prior year. With upcoming merchandising support and additional marketing investments we anticipate peanut butter sales to improve in the back half of the year.

The Smucker's brand delivered solid performance in the second quarter. As expected, volume rebounded in the quarter for a Uncrustables frozen sandwiches following a softer first quarter which was related to timing of customer shipments. Volume was up 13% in the second quarter and year to date Uncrustables volume is now up 6% in our retail business.

We expect double-digit growth for the full year. In addition, our snacking platform continues to gain traction beyond Uncrustables as Sahale Snacks and Jif Bars also delivered sales growth in the quarter and gained new points of distribution.

Lastly, as it relates to the Pillsbury brand aggressive competitive activities continue to influence the overall baking category and impact top-line performance, trends we expect to continue as we proceed through the Fall Bake period. However, Pillsbury and all our bake aisle brands remain key contributors to overall segment profit which we also expect to continue.

Turning to the Pet Food segment, we are excited to share up plans to offer premium dog food and grocery and mass outlets through the introduction of the Nature's Recipe brand in these channels. Nature's Recipe premium pet food has a long history of participating in the pet specialty channel and is uniquely positioned to meet the consumer's increasing desire for natural and wellness offerings at accessible price points. This launch allows us to participate in the fast-growing premium segment within traditional grocery outlets and leverage our scale in these channels.

Retailer response to the introduction has been very enthusiastic and our teams are doing a fantastic job executing our launch plans. Initial shipments should occur near the beginning of the fourth quarter supported by strong marketing and merchandising efforts. We expect this launch will complement our actions to stabilize the Kibbles 'n Bits brand and will benefit our entire dog food portfolio, providing a strong presence in each segment of the mainstream dog food category.

Looking at the rest of the Pet Foods business top-line performance for Meow Mix cat food was soft in the second quarter as anticipated. As we transition out underperforming SKUs we are confident about driving future growth with new on-trend offerings such as our latest innovation Meow Mix Bistro along with investments in TV advertising and pricing support.

Sales for pet snacks were down mid single digits in the quarter against a strong prior-year comp. For the Milk-Bone brand sales were down low single digits with a portion of the decline being timing related, reflecting a shift in the promotional calendar. For the rest of the snacks portfolio, the exit of certain private label businesses and the impact of competitive activities, particularly on our Milo's Kitchen brand, also contributed.

With future innovation under way and an upcoming package redesign we anticipate growth of Milo's Kitchen over the long term as protein-based snacks increase in popularity. Within premium pet food sales for the Natural Balance brand were down slightly in the quarter, reflecting the recent slowdown in the overall pet superstore channel. However, we project a stronger back half of the year for natural balance supported by the ongoing national advertising campaign.

Finally, our synergy and cost savings activities remain on track as our diligence around customer management and a continuous improvement mindset is greater than ever. In the second quarter we realized $29 million of increment synergies, bringing our year-to-date total to approximately $60 million. We continue to anticipate $100 million of incremental synergies for the full fiscal year with the potential for some upside to this estimate.

Including the $37 million realized in fiscal 2016 this would bring our total to nearly $140 million of the $200 million anticipated by the end of fiscal 2018. In addition, we continue to target $50 million of additional annual cost savings to be realized over the next few years related to our previously announced organizational redesign program and plant closures. As we have indicated we expect to initially invest much of these incremental savings in several identified areas that I mentioned earlier that will ultimately support top-line growth.

In closing, I would like to thank our employees for their continued efforts towards delivering results in our core business, building on our product innovation activities and marketing support, expanding our capabilities to enhance future growth and achieving our synergy and cost savings goals. This strong execution continues to position the Company well for the remainder of this fiscal year and the longer term.

I will now turn the call over to Mark Belgya.

Thank you, Mark. Good morning everyone. I will begin by providing additional color on our second-quarter results and then conclude with our outlook for the full year.

Net sales decreased by $164 million or 8% in the quarter. The prior year's divestiture of the canned milk business detracted 3 percentage points as did volume/mix which was driven by pet food, coffee and peanut butter. Lower net price realization had a 2% impact and was mostly attributable to coffee. The impact of foreign exchange was immaterial.

GAAP earnings per share were $1.52 this quarter, 3% above the prior year. Factoring in non-GAAP adjustments for unallocated derivative gains and losses, amortization expense and special project costs, which are all summarized in this morning's press release, adjusted EPS was $2.05, an increase of 7%.

Adjusted gross profit declined at a significantly slower rate than sales, resulting in 190 basis point improvement in gross margin to 39.6%. Year-over-year gross margin expansion was realized as all three U.S. Retail segments, most significantly for coffee. Overall commodity costs were lower in the quarter driven by green coffee and offset the impact of lower net pricing.

Reduced manufacturing overhead cost and incremental synergies contributed to gross margin growth. SD&A decreased $27 million in the second quarter or 7% compared to 2016, mostly attributable to incremental synergies. Excluding the benefits of synergies marketing expense increased slightly for the quarter.

As Mark indicated a portion of the marketing spend originally planned for the second quarter is now being shifted to the fourth quarter to support the launch of Nature's Recipe brand in grocery and mass channels. For the full year we expect marketing spend to be up approximately $35 million or 8% across the Company.

Adjusted operating income for the second quarter was flat with the prior year while operating budget increased 170 basis points to 20.7%. Below the operating income line, lower interest and income tax expenses and a decrease in the number of shares outstanding contributed to the earnings per share growth. We now expect the full-year effective tax rate to be consistent with our year-to-date rate of approximately 33% compared to our previous guidance of 33.5%.

Let me expand on our segment results. Beginning with Coffee second-quarter net sales decreased 6%. Lower net price realization drove 5 percentage points of this decline, reflecting the full-quarter impact of the 6% list price decline taken in May of this year across most of the Coffee portfolio.

Negative volume/mix had a 1% impact in the quarter. Net sales for the Folgers brand declined 10% with lower net price realization and volume/mix contributing somewhat equally. For the Dunkin' Donuts brand sales were up 4% as lower pricing was offset by strong volume/mix growth for bagged and K-Cup offerings. Lastly, Cafe Bustelo sales were up 20% as the momentum for this brand continues.

Coffee segment profit grew 3% compared to the prior year with segment margin increasing 300 basis points to 33.8%. The net impact of lower pricing as compared to the recognition of lower cost was favorable to segment profit in the quarter and more than offset unfavorable volume/mix and a higher marketing spend.

Turning to Consumer Foods, net sales were down 4% excluding the canned milk divestiture mostly due to unfavorable volume/mix. Looking at the key brands, Jif was down 12%. For nut butters this reflected lower volume, partially attributed to the timing of shipments along with lower pricing while Jif Bars continue to have strong growth.

Sales for the Smucker brands were up 4%, driven by the return to double-digit growth for Uncrustable frozen sandwiches. In the bake aisle, sales for Crisco were down slightly as growth in oils was offset by a decline in shortening and Pillsbury brand sales deceased high single digits on lower volume.

Consumer Foods segment profit declined 7%, attributable to lapping $12 million of prior-year earnings related to the divested milk business. Excluding this impact segment profit was up 3% as reduced manufacturing costs offset lower volume/mix, a net price realization and an increase in marketing.

Net sales for our Pet Foods segment decreased 6%, primarily reflecting volume/mix. Lower sales were driven by high single-digit declines for our mainstream pet food brand including Meow Mix and Kibbles 'n Bits.

While sales for largest pet snack brands, Milk-Bone and Pupperoni, were comparable to a strong performance in the prior year, a decline for Milo's Kitchen and the exit of some private label businesses were key drivers with 6% decrease across our pet snacks portfolio. Sales for our premium Natural Balance brand declined 1%.

Pet Foods segment profit was consistent with the prior year as the sales shortfall was offset by reduced input cost, incremental synergy realization and a slight reduction in marketing for the quarter. Net sales for International and Foodservice declined 3% compared to the prior year. Excluding the impact of the canned milk divestiture net sales were down 1% as favorable volume/mix was offset by lower price realization.

Segment profit decreased 7% compared to a very strong second quarter in the prior year. Approximately half of this decline was due to lapping $2 million of prior-year profit related to the divested milk business. In addition, the net impact of pricing and cost was unfavorable and only partially offset by favorable volume/mix and lower marketing.

Turning to cash flow, cash provided by operations was $136 million for the quarter. This compares to $276 million in the prior year which included benefits related to our working capital initiative. Factoring in capital expenditures of $34 million, free cash flow was $103 million in the second quarter, bringing the first-half total to $291 million.

We continue to project full-year free cash flow of $1 billion assuming CapEx of $240 million. While this implies a significant acceleration of free cash flow in the back half of the year, this is consistent with our historical trends and our current working capital assumptions.

During the second quarter we paid down an additional $100 million on our term loan and ended the quarter with total debt of $5.35 billion. Based on trailing 12-month EBITDA of nearly $1.6 billion our leverage currently stands at just under 3.4 times. We continue to target a leverage ratio of 3.1 times by the end of this fiscal year.

Let me conclude with an update on our full-year sales and earnings outlook which remains unchanged from our most recent guidance. Excluding the 2 percentage point impact of the divested milk business we continue to expect net sales to be in the range of flat to down 1% compared to the prior year. This implies a return to organic sales growth for the back half of fiscal 2017 including the anticipated impact of commodity inflation in certain categories, contributions from the launch of Nature's Recipe and the continued strong growth of Uncrustables in both retail and the Foodservice channel.

In addition, we continue to project adjusted earnings per share to be in the range of $7.60 to $7.75 with a bias toward the middle to high end of this range. While this is unchanged from our previous guidance, there are a few puts and takes reflected in our outlook. Most notably, the benefit from the lower projected tax rate is expected to be offset by incremental investments in support of the Nature's Recipe launch.

In closing, while the challenges to revenue growth persist in certain categories, partially driven by the benefit of favorable commodity costs being passed on to our consumers, we remain pleased with our earnings performance. In addition, we continue to make meaningful progress executing on our key initiatives to improve top-line trends moving forward. Overall, we remain confident in our ability to achieve solid financial results this fiscal year and beyond.

We thank you for your time and we will now open up the call to your questions. Operator, if you would please queue up the first question.

(Operator Instructions) David Driscoll, Citi.

Great, thank you and good morning. So I'd like to talk a little bit about Retail Consumer.

What's happening here specifically on volume such that a mid-single-digit volume decline is still able to generate higher profits with increased marketing? Are you pruning unprofitable volumes?

And then could you just talk about volume expectations for the remaining portion of the year for this segment and the others, as well? Thank you.

Hi, David. Steve Oakland, I will start and then Mark or Barry can jump in.

You know, I think there's been a lot of work done on our portfolios, and if you think about how we've constructed our Coffee business and how it's performing it's doing just as it's been built. We have a large, profitable, mainstream business and that large mainstream business has provided a platform. And I think in Mark's comments we talked about 20% growth on the Cafe Bustelo, our Dunkin' K-Cup up 12%, our Dunkin' bag business up.

So I think it's allowed us to really manage the mix game, it's allowed us to manage where we are large and where we can scratch out those segments that are growing. You've got to dig into the details. In our Coffee business, I think in Mark's scripted comments the OPP item is down, our lowest priced item is down, but our mainstream 30.9 ounce classic roast item is up 2%.

So there's a lot of work going on within each one of these businesses and we are able to by managing mix bring both margin and the right things in. The same thing in Consumer Foods, we've got Sahale, we had good performance from Sahale in the quarter. The Jif Bars snacks, there is nice mix and margin opportunities within each one of these categories.

David, this is Mark Belgya. Just to add to on the Consumer Foods, which I think might have been a little more the focus of the question, so the other thing that we realize is that we are running, and this is probably a true comment candidly across our Coffee business as well, but from a manufacturing perspective we're seeing really good efficiencies. So that flowed through to earnings this quarter as well, which helped the profitability despite the softer volumes.

I'd go back and say those are all the supply chain work. We always talk about these things and supply chain opportunities. They are starting to drive better results across each one of the food and beverage businesses.

Can you guys just give a little bit of commentary on the volume expectations for the segments going forward? I think the street has been off on some of the expectations or I've been off on some of my volume expectations and we'd just like to understand how volumes are expected to flow in the segments in the remaining two quarters? Thank you.

This is Mark, David, again. Just maybe I will start and you guys can jump in.

I think that what you're going to see, because I understand or I'm guessing just based on some of the early feedback we've got on some of the reports that there's questioning whether or not we can hit the second-half sales. And I think there's a couple of things I would frame bigger, and again you guys can speak to volume. But we are seeing, expected a little bit of volume growth but really the growth I think in top line is going to come through what we say.

It's going to be some of the effect of inflation that will probably come through. It will be the Nature's Recipe rollout. It will be Uncrustables, but in some of the other businesses, for example Jif, I think you're going to see a turnaround there.

We've got some target merchandising programs that we are going to put into place that should address a little bit of what we the negative we experienced here in Q2. And I think that probably holds true for some of the other categories.

We've been in a long period, as you know, of commodity, low commodities. We did take a fruit spreads price increase at the end of the quarter. That's not one that we made a big press release around, but that is in and up across the categories and that's been receptive well.

I think given the fact that we have transparent pricing and we have credibility with the retailer we took our coffee pricing down when a lot of others didn't. That gives us the credibility when we have pricing and inflation in our commodities to take those prices back up. So I think it's fair to assume that there will be some of that in the back half.

David, this is Mark Smucker. Just a couple of other comments around just to build on what Mark said.

First of all, the Nature's Recipe piece is important and we do expect a very healthy launch of that product. And then Steve's point, of course, around inflation, we already have taken actually a price increase on the Smucker's brand. And then I would also point to consumption data.

As we look at consumption data on most of our categories the share loss, if there is one, is very modest. And so we are seeing turns remain relatively strong. I would point to peanut butter as an example.

We had a very soft quarter in peanut butter but as we dug into those numbers we did see several customers adjusting inventories. We would expect some of that to come back and the consumption data around peanut butter remains reasonably strong, as well. So I think all of those things put together give us some confidence in the back half.

Thank you very much. I will pass it along.

Andrew Lazar, Barclays.

Morning, everybody. Just on the digging a little bit on the upcoming launch into mass premium, I guess Nature's Recipe has been a, call it, maybe low single-digit share brand or so in the pet specialty space for quite some time.

I know there's been a number of efforts against the brand over time, relaunches and such, and I don't know that it's necessarily moved the needle on that brand a ton. So I'm just trying to get a sense of a little bit more on the thinking behind choosing that as the brand, that was the right one for the mass premium launch, just a little bit more on your thinking into that.

And should we be concerned at all about any reaction on the Nature's Recipe brand from, let's say, retailers in the specialty channel as you take this brand into the mass space? Thank you.

Hey Andrew, it's Barry. Let me answer that question for you.

As you know, we've been giving a lot of thought to how to enter the premium segment and we explored a number of alternatives, including would we cross one of our brands? And as we looked in our portfolio we really believe the Nature's Recipe is the right brand. That brand has about 35 years of history and heritage in the pet specialty channel, and as we look at what the consumer is looking for in the mass and grocery channels we believe that is the right brand.

The acceptance from the retailers as we've taken that out as part of the launch has been -- has exceeded our expectations. So we definitely believe that's the right brand. Our retailers have confirmed with us it's the right brand, it's the right time and we are the right Company to bring that brand into the segment.

From a growth perspective we are developing a marketing communications plan. We will have marketing in place fourth quarter to support the launch and then we will have a national campaign next year really to speak to the attributes of the brand.

From a competitive or reaction from the pet specialty retailers we shared our decisions with them right up front when we made the decision to launch. And we anticipate that both of those retailers will continue to support the brand in their stores. And so, again, I think it speaks to the strength of the brand in both pet specialty as well as the potential that it has in mass and grocery.

Great, thanks very much.

Ken Goldman, JPMorgan.

Hi, thanks so much. I wanted to get a little bit more color on the mainstream pet business.

Barry, as you are getting more and more involved in this what are you learning about maybe what went wrong, what could have been done better, what help can you give us in terms of what's going to change? And I think, most importantly, maybe on the outside what markers maybe should we be looking for to get a sense of when some of these big brands that maybe have dragged you guys down a little bit improve a little bit from here?

Sure, let me just share with you some of our learnings in my own personal earnings. I think as we said last quarter price is paramount. And you have to be priced right in order to compete in mainstream dog.

And I think with our bonus bags in place we are certainly seeing the benefit of being priced right. Just to give some color there, if we think about our key, one of our major retailers, the number one retailer who overindexes on Kibbles 'n Bits, that brand was down, if you look at a 12-month period we were down 12%. If you look in the last quarter we are down just under 6%. So I think that speaks to the positive trends when you get price right.

You also have to market the brand and have communications directed at the consumer. So we will be back marketing that brand in 2018. We are refreshing packaging, we are bringing some innovation to the category.

So I think those -- it's just the fundamentals of marketing a brand, especially when you are up against major competitors like we are. So I think those are some of the learnings, and we are seeing some nice, positive trends. And based on the trends that we've seen we are now confident that we should be back in the marketplace in marketing that brand.

Thank you very much.

Chris Growe, Stifel.

Hi, good morning. I just had a question, first of all, on the marketing.

I think you have been talking about $40 million, now it's $35 million, not a significant change. But I was just curious, I've heard about some incremental trade spending in some categories. Is there any kind of shift in spending here or maybe you could also talk about your trade spending programs and if those are going up from here?

Hey Chris, it's Mark Belgya. So as you noted we did take down our marketing spend a little bit. But as you said it is $5 million is pretty insignificant on a over $400 million base.

So there's really been no significant changes from marketing to trade. It's just when you look at these programs you think about the number of brands we are supporting there's always going to be a little bit of flexibility. And so we feel good.

I think the one thing that I would like to maybe address here while we are on the subject of marketing, because it's probably on some folks' mind, but I'm sure everyone recalls at the end of Q1 we had indicated a part of the over-delivery against our first quarter was due to a timeshift in marketing spend. And we had anticipated that a fair amount of that which was pet related would slide into Q2 and guided to that.

As it turned out surely after we got into Q2 we had landed on our decision around Nature's Recipe, and just as I think, and Barry I won't speak for you, but I think the pet team stepped back and said how do we want to make sure that we have a successful launch? We really took pause and challenged some of our marketing spend in some of the other areas. So what's happened then as we shifted that once again, if you will, into Q4.

So I lot of those dollars we talked about in Q2 shifting are just moving to Q4. And that clearly contributed a little bit to the earnings for the quarter. So I don't know, guys, if you had any other comments around trade spend trend that you're seeing.

Yes, I guess I would comment back on both our coffee, our peanut butter, our big categories in our baking business. I would say our focus is on trade spend efficiency and is there the opportunity to cut some trade and I know the RGM, revenue growth management, term is the buzzword in a number of our peers' results and commentary.

I think we have great margins in our business and if we can drive top line with it, which as you know in our industry is not the easiest thing to do right now, that would be our first choice with our trade funds. Let's drive effective top line. There are places where we have the opportunity to trim it a little bit.

I would say we are not seeing surprises. Barry spoke to the competitive nature of mainstream pet, so if you come out of that, if you look at peanut butter, if you look at coffee, if you look at our baking businesses, our oils business, those are traditionally trade spend businesses. I don't think there are any surprises competitively across our Fall Bake merchandising or the merchandising into the third quarter.

Yes, same for pet. Nothing to add other than what you and Steve have commented on.

Okay, thank you. And I just had one quick follow-up for Mark Belgya.

You mentioned inflation in some categories. Is that the absence of or, if you will, deflation moving back more toward stabilization? Or is that actual inflation that maybe requires some pricing in the future?

It is the latter, Chris. And, again, I think everyone probably tracks the commodities particularly close and we are and have been seeing a shift from the low period we've had for the last couple of years.

And several of our categories are moving, some more than others, and as you know as category pricing leaders in each of our categories we will take action. So some of that has clearly been built into our back-half top-line assumption.

Great, thanks for the help there.

Mario Contreras, Deutsche Bank.

Hi, good morning. So I wanted to follow up again on the launch of Nature's Recipe into the mass premium -- into mass the channel. Can you just remind us how big is Nature's Recipe of your current pet business?

Currently it's about $100 million brand.

Okay. And then have you from your conversations with retailers are you getting the sense that that's purely incremental space? Or is there any shift away from some of the mainstream brands to accommodate these new products?

I think there will be some shift but we believe it will be significantly incremental to the category.

Okay, and then just I guess one last one on this same topic, is there any differentiation in terms of pricing, packaging size, labels versus what consumers might see in the pet specialty channel versus what they might see in the mass and grocery? Thanks.

There may be some changes over time, but as we thought about this decision it really was about speed to market. So we are taking existing product in packaging that currently exists in the specialty channel, and that's what will support our initial launch. But as we continue to refine the line in packaging you may see some changes, but the initial launch will be identical to what's in the market.

Mario, this is Mark Smucker. Just on the pet business, both Nature's Recipe and Natural Balance, if you take just it strategically take a step back, obviously you guys all know that we got in the pet business for, obviously, a great category. It's a predominantly a branded category across multiple segments, obviously snacks and this premium segment are very important.

So if you think about similarly to other businesses that we are in, our strategy is always to play in all of the segments if we can and then make sure that when we are thinking about growth and incrementality we really want to make sure we are focusing on those areas where we can achieve the most growth. So, obviously, snacks we will continue to focus on, but if you think about premium pet whether it is pet specialty, which is a very important channel for us, as well as the mass channel our goal is really to have a stronger presence in both.

So we, obviously, went into, we expanded our presence with Natural Balance early on after we acquired the business which was, obviously, a good thing and we are going to continue to support that brand. There is national advertising as well as just leveraging our scale in the mainstream channels.

And, again, going back to just the fact that we really believe this Nature's Recipe because it's an existing brand and because even though it is a smaller brand in that channel it is known as a premium, a more premium brand at an affordable price. So that's why we think it fits nicely in that channel. So just really it is about strategy and making sure we are in the growth segments.

That's very helpful. Thanks everyone.

Alexia Howard, Bernstein.

Good morning everyone. Okay so two quick questions.

First one on the pet business, it looks how worried are you that the treat sales seem to be slowing fairly substantially in the mainstream measured channels? Is there something that's offsetting that to make it up elsewhere?

Alexia, this is Barry. I'm sorry, could you just repeat the first part of that question?

The treats part, the pet treats part, that's obviously high margin, it's historically been the growth piece of the business. It seems to be slowing in measured channels.

That's a fair point. One of the things that Mark commented is we have seen some of the shift as far as our sales this quarter where we have some promotional activity is shifted into the third quarter. The snack category is still growing.

There has been a slight decline in that growth. Milk-Bone, though, is still growing. We have a 60% share of the biscuit category.

We just took number one position with Pupperoni in the soft and chewy category. So we still have some great momentum with our brands and some innovation in the pipeline that we think will recharge the growth of that category. So overall brands are healthy, the category is growing and we still have a lot of upside in that segment of our business.

Great. And as a follow-up, can I ask about your appetite for acquisitions? Has leverage now come down to a point where you can start to consider medium to large scale acquisitions again?

What are your criteria there and how much incremental leverage would you be prepared to take on at this point if there was something out there that you really wanted? Thank you, and I will pass it on.

Hi, Alexia, Mark Belgya. Great question.

As we have consistently said probably the better part of over a year now, the closer we get to a three time or underlevered it opens up the doors to some of the strategic things we can do. It is not a hard and fast we need to get there. If there is an opportunity that comes along we are comfortable of levering up.

I think in terms, and maybe I will ask for Mark to comment on this in a moment, but just in terms of what we are looking for and what is out there, there are a number of assets that you can imagine that I would call more of the small to midsize bolt-on opportunities, a lot around the trends whether its convenience, good and good-for-you type products, clean label products, lots of natural space. So we have been looking and have not necessarily limited ourselves just because where we are from a leverage position, particularly as it relates to bolt-ons and we will continue to do that.

In terms of where we would lever, we went over 4 times with the transaction of Big Heart. And what I would frame in is to say that we were comfortable there, and the reason we were comfortable is the cash generation that came out of that transaction, both from the business itself and the synergy opportunities and the quickness of the paydown made it comfortable.

So is that a hard and fast target? Maybe, maybe not. But certainly we've proven that we are willing to go up there as long as there is a good sense of the cash generation out of that.

Great, thank you very much. I will pass it on.

Mark Smucker. Just to add that strategically acquisitions for us are clearly still part of our strategy.

We've deemphasized them for our long-term growth rates because as we talked to our investors and you folks we wanted to make sure that we are focusing on the growth that we can deliver out of our existing business. But it certainly is still part of our strategy. We always say we keep our lines in the water, and as things come up whether they be large, iconic leading brands or businesses like that, but also as Mark mentioned the smaller, more on-trend things are clearly part of the strategy as well and getting that balance right is key.

Thank you.

Robert Moskow, Credit Suisse.

Hi, thank you. I was just trying to go back to recent history.

I think the last time you took an increase on pricing in coffee was fiscal 2015 and that led to a pretty substantial decline in profits for the division. So my question is do you think you are in better shape this time once you have to start raising coffee prices to manage your portion of the profit pool and still grow profits? Or do you think there's a risk to that?

There's a second question, I dug a little deeper into Meow Mix, I saw the declines in the retail sales and I remember you said that the advertising campaign had actually started in August like you were on air in August. Did you have to take that ad campaign off air and is the part of the reason why the sales on Meow Mix declined? Thanks.

Hi Rob, Steve. I will start with the coffee price increase dialogue and then Barry you can follow up on the cat food. Rob, I think there's a couple of things we need to think about today versus then.

Obviously, we took coffee pricing down because we had coffee costs that could support that. Coffee costs were relatively low even compared to any kind of averages. So it would be reasonable to think that in that kind of environment we would have been longer than normal.

So as we've seen coffee costs go up, yes, they are up but they were only up if you think about $1.70 arabica, it's not that much over the five- or 10-year average. So those are not high coffee costs if you think about what we've seen in past years in the $2, $2.52, $2.70 type of thing. So we don't think arabica is in anywhere near those kinds of price points. We've also learned a lot from that one instance where we took price up and we crossed two deciles.

If you remember we took two deciles on our key promoted sizes and we would have coverage in place that would not cause us to have to do that. So if there is pricing in coffee we think it will be much more measured.

And then the last thing I would remind you of is the downsize we did in the container. And so if you remember in that time frame our competitor was promoting an 11% smaller container than we were, and now that our containers are similar. So I think there's a couple of dynamics that would suggest the coffee pricing that we would see today or project certainly through this fiscal year but well into next year is not going to put us in the position that we were in when it impacted our margins. So we feel good about it.

Steve, the only other thing I would add, and I just kind of thought this, I'm not sure how material it is, but the other thing is if you look since that time we had the addition of the Dunkin' K-Cup. So we've got another couple hundred million dollars of sales that are in a category that's not as impacted as much by pricing changes.

Okay, and then the Meow Mix?

Sure, this is Barry. Happy to answer that for you, as well.

As far as Meow Mix is concerned we have had some of the most significant innovation against that brand this past year in the form of our Bistro launch with a strategy of how do we leverage our strength in dry across wet and treats. That launch where we have that product place has gone very well, we've seen trial and repeat strong and we have advertising in place supporting that brand and that launch.

So we are not off the air, we are actually on air advertising. Sorry if you haven't seen that. But we are supporting that launch.

And we are starting to see some nice momentum behind our total Meow Mix brand as a result of that launch. And we will continue to fill distribution gaps with Bistro based on its performance in-market.

So we think that was the right decision across what we are calling our Meow Mix total solution across each segment in cat. So innovation is performing well and we think that has strengthened our position across the cat food category.

Okay, I will see if I can find it in the Nielsen data. I did not see it come up. Thank you.

Jason English, Goldman Sachs.

Good morning, guys. Thank you for the question.

I wanted to come back to the Nature's Recipe line of questioning. Are you planning for declines in pet specialty going forward across the portfolio?

Yes, there will be some declines in pet specialty on that brand. So I think we will probably see some reduced SKUs and assortment in pet specialty. So, yes, there will be some decline in that channel.

But what it allows us to do is focus on Natural Balance. We've said that's our flagship brand in that channel. And what it does allow is our team to really focus and get behind that brand because that will be the main driver of growth in that channel.

This is a long time ago, but I think P&G did something similar 15, 20 years ago, somewhere in that time frame. And it impacted their whole portfolio in terms of retailer backlash.

I'm sure you guys have studied that case study. It sounds like from a planning perspective you are not really viewing that as the appropriate precedent since you are expecting the rest of your portfolio to do better. So can you help us understand maybe why that isn't the appropriate precedent?

We are certainly aware of what took place. But I think, as I stated earlier I think there's no question that the consumer demand for this type of product in the mass and grocery channels is there and our retailers have confirmed that with us.

So we've given this a lot of thought, Jason, just based on precedent and understanding channel impact. But we are confident based on the launch both in specialty and in mass and grocery that this was the right decision and the marketing investment we are going to put behind this brand to make sure that it turns and is successful with the consumer, as well.

Jason, it's Mark Smucker. I would add that we are in different times.

As Barry said I think the demand in the mass premium segment is strong, but I actually think a lot of the credit goes to our team and our sales team and Barry's team as you think about how good our relationships are with our customers. They go all the way up to the very top of the organization, and that really does make a difference. And even just thinking about what we're bringing to the table in the pet specialty channel and we are able to support the Natural Balance brand as well, and so bringing those additional, that additional support to the table helps with that relationship, as well, and helps offset some of what might be maybe a reduced SKU count.

Okay got it. Thanks guys. I will pass it on.

John Baumgartner, Wells Fargo.

Hi, good morning. Thanks for the question.

Barry I wanted to come back to your comments on mainstream pet. So I can appreciate the magnitude of volume declines have moderated, but the depth of decline it is still pretty meaningful, even after you went and reduced prices. So can you speak to what comes next?

What really gets you back to flat volumes in that mainstream price point and ideally back to growth? Is it something of a hybrid approach where you can go and renovate around ingredients but more of a mass price point, would you accept margin pressure to do that? Just how much heavy lifting really remains in that price point? Thank you.

Sure John, this is Barry. Let me add some color to that.

First, we have recently seen even expanded distribution on the bonus bag. So we continue to make sure we get that distribution more broadly across the channel.

And then as we think about support behind the brand, we have to bring some news to the Kibbles 'n Bits brand, go back to the taste equity. There's a consumer segment that is looking for taste not at the expense of quality or healthful product for their dog. So as we are thinking about that brand how do we get back to the taste equity offer at a price that makes sense.

And then have some meaningful marketing support behind the brand to drive the growth of the Kibbles 'n Bits brand. So that is our plan and we are confident that we are seeing enough stabilization that with that marketing investment we will get that brand back to slow growth.

Great, thanks, Barry.

Farha Aslam, Stephens.

Hi, good morning. My first question is on Folgers.

The volumes on that core business were down 10% in the quarter. Is there something to do with timing? Will that turn around next quarter?

I think if you look at it dollars were down 10%, volume was down 5% and if you look at that most of that volume, and again this is a deep dive into IRI or Nielsen, but virtually all of that was in our opening price point SKUs, what we call customers, those are items that we promote when coffee prices are very high. When coffee prices are low they tend to struggle because there is very little gap between the two. So I think we can provide that detail but no, our classic roast item is actually up 2% in volume if you go through the numbers.

Yes, it's Mark Smucker. Remember when you see commodity cost, coffee cost as low as they have been and you get price compression in the category, our opening price point SKUs don't do as well because people trade up to classic roast. And that's what we've seen.

And that's good for you if people trade up to classic roast?

Yes, when you see coffee prices as low as they have been people will trade up to classic roast. When we see excessively high commodity cost, the elasticity will drive people down to the opening price point SKUs.

You will recall a couple of years ago, actually a couple of times over the last three or four years, when we talked about the $10 price point. This is a good case where that, obviously, has come down and narrowed that price gap between opening price points in our classic line.

The price point, promoted price point on our 30.9 ounce canister has been in the $6.99 realm. So we are well below those thresholds.

And then for Barry, if you think about Natural Balance and Natural Recipe, what kind of growth can we expect on those two brands in 2017 and then if we think longer-term 2018 and beyond how should we think about the growth of those two brands?

We're actually not putting out specific numbers on Nature's Recipe. We are just in the stage of launching that brand. What I would share with you is we would expect to have shelf space similar to our competitors in the mass and grocery channel, so just would frame it in terms of shelf space based on our initial distribution.

As far as Natural Balance growth the balance of this year for this fiscal year, remember we are lapping last year's incremental distribution within with a major retailer in that channel. I would say year over year if you take that out we would expect to see growth low single digits.

And then long term is that the growth rate we can expect?

Next year I think, again, with the focus of our team on Natural Balance in the specialty channel I think we will see growth accelerate and we are also seeing some fantastic growth within e-commerce. We are seeing double-digit growth in that channel and a significant amount of the Natural Balance brand is similar to what we've seen with other brands in pet specialty is that shift into e-commerce, we are experiencing the same thing. And that is what we are experienced and seeing double-digit growth and would expect that to continue in that channel.

Okay, thank you very much.

Pablo Zuanic, SIG.

Hi, good morning, this is Aatish Shah in for Pablo. Just two quick questions.

One regarding pet food, again, I want to see if you can break down sales growth for the mass grocery versus specialty? It seemed like there might be a similar decline in both. And then two, regarding coffee, is it fair to say that K-Cup sales growth were flat for the quarter with Folgers offsetting Dunkin' growth?

So on the question on the growth rates for was it specialty channel and for mass, I'd just clarify that?

Yes, just mass and grocery versus the specialty growth for pet food specifically.

Yes, so I guess what I would say is we haven't changed much from what we said previously. Mass right now has always been sort of a flat to just modestly above. We clearly have been running below that, but that's where we see that category.

It's a little preliminary, quite candidly, to give you a really good number on the traditional growth rate in mass channels just because we need to see the effect of Nature's Recipe. I think Barry's comment about what we expect from the distribution capability of that Nature's Recipe and there is enough out there that you can do some comparables to see where the expectation is there.

And then in specialty, I know we commented previously that channel has slowed some. I think other competitors have noted similarities. But Barry's point, albeit somewhat still small but growing, the e-commerce cannot be taken lightly and we still think there's a lot of opportunity in that channel.

I think the other thing I'd reinforce in the natural or the specialty area for us, in particular, is there is still profitability opportunity, and we've seen that start to turn. We've talked about that, that was certainly an underindexed category for us in pet that related to our segment profit, we are seeing turns on that. So we still feel good about those channels and, again, I think with e-commerce and the Natural Balance focus we will see good growth.

And let me comment on K-Cups, and I think it depends on if you are looking at dollars or units because I'm sure we've guided too that there has been price compression in mainstream K-Cups or across all of K-Cups. I think you've heard that talked about in our peers' or competitors' releases. And so our K-Cups in actual units and equivalent volume are all both in Folgers, in Dunkin' and up dramatically, quite frankly, in Bustelo, although a small business.

That volume gain translates into dollar gains in Bustelo and in Dunkin'. The dollars are down a little bit in Folgers only because of the pricing that we have taken to support that, but the total K-Cup business is up nicely.

So we feel really good the fact that our legacy K-Cup business grew in units, our Dunkin' business is up dramatically and our Bustelo business, frankly, is on fire. So those segments, all three, are what are helping drive the mix in our Coffee business.

Great, thank you.

Akshay Jagdale, Jefferies.

Good morning. Thanks for the question. I just want to follow up quickly on specific to K-Cups but related.

So it's a coffee question, so you mentioned when coffee prices are low your opening price points and lower-priced items struggle a bit and the premium items do better. Can you give us a rough estimate of the overall portfolio, like how much you'd consider OPP, how much mainstream versus premium?

And as prices go up next year I'm guessing that this phenomenon is going to reverse. So net-net I think it's better for your Company to have lower coffee costs, so just help me understand that dynamic. I'm just trying to think about next year with prices going up it looks like the environment to produce growth is a little bit worse than it was this year.

Let me attempt to do that. Our OPP business is relatively small in the mix and it's concentrated in the retailers you would expect to be concentrated in. It's a big business at the value retailers whether that be the dollar channel, mass retail channel, the club channel.

So those SKUs exist in those environments where the consumer goes for value. When you are promoting our 30.9 ounce canister at $6.99 a small difference in the everyday price of OPP is not that exciting to the consumer.

So, yes, that will be a backstop for those consumers as coffee pricing moves up. But moving coffee price from say $6.99 to $7.99 doesn't scare me there. I think Mark mentioned this in his opening, when OPP becomes very attractive is when you get to those $9.99, $10.99 price points.

We have seen that in history. Remember we downsized the canister, so I think we are insulated from some of that. So I don't want us to think that $1.70 arabica takes us into any price point that we should all be afraid of.

We, obviously, still think this is relatively moderately priced arabica. So I think we are some way away from us having a discussion where we would be concerned about the absolute price points having some kind of dramatic effect and swinging our volume within our mix.

Akshay, it's is Mark Belgya. I guess as I think back about what we talked about over the years in terms of a breakdown, broadbrush I'd say about two-thirds of our total U.S. Retail Coffee sales would be considered mainstream. So that would include everything we've talked about: complements, classic, OPP and then the other third obviously would fall between K-Cups and premium.

That's helpful. Just one quick follow-up on synergies.

So this quarter it seems like the synergy capture was certainly, it was better than we expected. Was it better than what you had expected and I don't think you changed your synergy guidance for the year, so can you help me bridge the two? Thanks.

Yes, again it's Mark. Our performance on synergies did exceed our expectations for Q2 and you are right, we haven't adjusted, I think we would like to get a little bit more time, but there's no indications that we will not continue down our synergy path.

I think one way to think about our synergy number is we are talking about $100 million incremental through this year and $140 million capture through the end of this fiscal. But with programs in place, I would say that we are probably on a run rate right now at $180 million to $185 million. Said differently, we have got about $15 million to $20 million to tie down here in the next several months and we will have that $200 million locked in as we head into fiscal 2018. So we are in really good shape.

And the other comment I would say about synergies is on the SD&A, one of the things, we talked about marketing, I know there is probably some discussion about the marketing shift being a major contributor to the earnings, but we did deliver pretty significant reductions in our, what I would call, our administrative costs. So that combination of synergy recognition with some of the additional synergies we are following there and some of it, quite candidly, is just very strong cost management across those organization. So some of those dollars are just incremental savings program that people have put in place above and beyond the $200 million synergy target.

Thank you. I will pass it on.

Matthew Grainger, Morgan Stanley.

Great, hi everyone. Thanks for the question. I just had two.

One, coming back to pet, I was hoping you could elaborate a little bit more on the strategy within e-commerce because you've pointed out a number of times that it's growing well off a small base and that it's important. I don't have a strong sense yet for what you are doing to build out that channel more aggressively and ensure that you don't end up in an underindexed position 12, 18 months from now.

Matthew, this is Mark Smucker, I will start and if Barry has anything to add he certainly can chime in. So, first of all, as you know our industry is a generally speaking underdeveloped in the e-commerce channel and it, obviously, is a focus for all of us. Where I think we clearly have an e-commerce business, we are serving the e-commerce channels and the different customers there.

We do have plans to continue to strengthen our e-commerce organization as well as meet the needs of the unique needs of each of our e-commerce customers, and it is a journey but it is something that is one of our key priorities. As it relates to the pet specifically, one of the reasons why those products are uniquely qualified to grow in that channel is because typically they are a recurring purchase and they are very heavy. And so it's helpful to the consumer to actually have, many folks have that stuff delivered to their front doorstep, and so really it is the nature of the business that is helping to drive growth there.

That's great, Mark. And what I would also add from a pet perspective is we deal directly with the major e-commerce retailers. And so that has really attributed to a lot of our growth, and so that direct relationship is how we build our business together.

Okay, understood. Thanks.

And then just last question, the price increase you mentioned in fruit spreads, if you could just talk about the competitive dynamic at the moment. It seemed fairly rational recently, just whether there's any sensitivity right now to the risk of widening price gaps with your key competitor there and whether you would have any news or innovation plan that would help support the pricing that you have announced?

I think we've built so much credibility with the retailer that and they understand that we wouldn't take that pricing if it wasn't ingredient-based and commodity-based. And so you see it reflected on the shelf. It went into effect the end of last quarter and we see it at all major retailers and in place.

And the initial look and volume is very encouraging. So that's a relatively small category for us, but important. And I think the dynamics that we faced I would imagine the industry faces, so I would expect that both the private label and our competitors to be in the same situation.

Okay great. Thanks again.

Jon Andersen, William Blair.

Thanks so much for squeezing me in here. So at the top of the call there was some discussion around new capabilities. We've, obviously, talked a lot about innovation here, e-commerce.

One of the items that was discussed was revenue management. And I was just wondering if you could talk a little bit more about what that encompasses, what your plans and expectations around that revenue management initiative are so that we can start thinking about maybe benefits of that effort and the timing of those benefits? Thank you.

Jon, it's Mark Smucker. I will start and maybe ask Steve if he has anything to add. But, first of all, a couple of things.

As it relates to everybody thinks about revenue management a lot of the time as trade. As we all know it is the combination of trade, pricing, all of those and the strategies behind them that encompass revenue growth management.

And so as it relates to our trade practices we are pretty good at doing that. We have had a very good track record with our customers at providing the right programs and efficiencies there.

I think what you will see changing over time, and this is a Smucker comment and probably an industry comment, as well, is as Steve mentioned earlier the need to get more dialed in and precise. So as we think about being more strategic, as it relates to the total revenue growth management our goal over time through the development of skills, potentially new systems, better analytics, more centralized data, those types of things over time should provide us with the capability to become more strategic in revenue management and more focused as we think about how we deploy pricing and trade across our respective customer base.

The only thing I would add is maybe an example on the fruit spreads price increase that we have discussed today. If you think about the fruit spread category it includes a number of segments, a number of sizes and a number of different retail environments. It's in everything from the EDLP retailer to the high or low retailer.

We've got a 10 ounce small specialty jar and a 32 ounce promoted grape jelly. So in order to understand each one of the slopes in order to better understand it is a pennies business. So if we can get a couple of pennies right on each one of those slopes if our slope between 18 ounce and 32 ounce is right on what's going to drive the most volume at the best price point.

We can make some headway on that and I think the technology is there today and I think us as well as many of our peers have invested in the human capital to leverage that technology to get some of those details right. So we are hoping to scrape a couple of margin points out of it across different businesses over time and that money will be invested in our businesses or brought back to the bottom line. We will make those decisions depending on the category, the size, the magnitude, etc.

Thanks, really helpful. Thank you.

Thank you. I will now turn the call back to management to conclude.

Well again, this is Mark Smucker, I just wanted to thank all of you for taking the time this morning to join the call and, again, thank you very much for your interest in our Company. Have a great day.

Ladies and gentlemen, if you wish to access the rebroadcast after this live call you may do so by dialing 855-859-2056 or 404-537-3406 with a passcode of 97711320. This concludes our conference call for today.

Thank you all for participating and have a nice day. All parties may now disconnect.