J M Smucker Co (SJM) 2018 Q2 法說會逐字稿

Good morning, and welcome to The J.M. Smucker Company's Fiscal 2018 Second Quarter Earnings Conference Call. This conference is being recorded. (Operator Instructions) I will now turn the conference call over to Aaron Broholm, Vice President of Investor Relations. Please go ahead, sir.

Good morning, everyone. Thank you for joining us on our Fiscal 2018 Second Quarter Earnings Conference Call. Mark Smucker, President and CEO; and Mark Belgya, Vice Chair and CFO, will provide our prepared comments.

Also participating in the Q&A are Steve Oakland, Vice Chair and President, U.S. Food and Beverage; Barry Dunaway, President, Pet Food and Pet Snacks; and Dave Lemmon, President, Canada and International and U.S. Away From Home.

During today's call, we will make forward-looking statements that reflect the company's current expectations about future plans and performance. These statements rely on 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 to evaluate performance internally, as detailed in the press release. We have posted to our website supplementary slide deck summarizing the quarterly results and our updated fiscal 2018 outlook, 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 additional 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. Our ongoing efforts to position our business for growth began to pay off this quarter. We achieved modest sales growth driven by key brands in every business and delivered earnings per share ahead of expectations. We will continue to deliver long-term top and bottom line growth by executing our strategy of supporting a balanced portfolio of leading and emerging brands guided by a deep focus on consumer and customer insights.

Central to our strategy is capitalizing on the strength of our leading brands, Folgers, Smucker's, Jif, Dunkin' Donuts and the Milk-Bone, including expanding their reach through the introduction of new platforms in high growth segments such as premium coffee and snacking.

At the same time, we are investing in emerging growth brands such as Café Bustelo, Smucker's Uncrustables, Nature's Recipe and Sahale Snacks. We are balancing our portfolio by placing emphasis and resources on these faster growth opportunities. This includes incremental marketing investments fueled by continued cost discipline, efforts to become more agile and the relentless focus on how best to engage and delight today's consumers.

As I mentioned, progress on these fronts is reflected in our second quarter results as we had strong performance for a number of our key brands. This included double-digit sales increases for Nature's Recipe, Dunkin' Donuts and Jif, and high single digit growth for the Uncrustables, Café Bustelo and R.W. Knudsen brands, demonstrating the ability of our brands to win in the rapidly changing retail environment. Sequential volume trends for Folgers Roast & Ground Coffee improved, with Folgers' volume down 6% in the second quarter compared to a decline of 13% in the first quarter. This was a result of actions we have taken to manage relative and absolute pricing gaps to competition. With price investments made in advance of lower green coffee cost expected later in the fiscal year, the Coffee segment profit decline was anticipated. These actions were necessary to protect competitive positioning in the near term as coffee profitability will improve significantly in the back half of the year. This includes a projected record fourth quarter segment profit for coffee, primarily resulting from lower green coffee cost and cost-savings initiatives.

During the second quarter, we continued to make progress on our strategic road map, which was introduced on our year-end call in June. As we have noted, the road map consists of 4 foundational pillars: Innovation, investment, cost savings and acquisitions, and is a multidimensional strategy that provides a path to sustainable, long-term sales and earnings growth. Let me provide a few updates from the quarter.

Starting with innovation, recent product launches including Dunkin' Donuts Cold Brew coffee and Natural Balance high-protein dog food offerings contributed -- both contributed to sales growth in the quarter.

In total, products introduced in the past 3 years contributed 6% of second quarter net sales. In addition, we remain on track for the upcoming launches of Dunkin' Donuts coffee canisters and Milk-Bone Puffs dog treats, both of which will be available later this fiscal year.

Our brand and innovation teams are preparing to launch new platforms that extend the reach of our iconic brands to meet consumer needs. This includes plans for Folgers coffee, Jif snacking and dog snacks that are all testing very positively with consumers and have already received fantastic customer feedback. We look forward to sharing more details at CAGNY as we get closer to the launch dates for these new platforms.

Turning to another key pillar of our strategic road map, investments. Our efforts to improve the competitive positioning of our dry dog food portfolio continue to pay off. We are now 9 months into the grocery and mass channel rollout of our Nature's Recipe brand and momentum is growing.

Net sales for the brand have exceeded our expectations, up 66% in the second quarter and 49% year-to-date, benefiting from a national advertising campaign, which is driving brand awareness and accelerating consumer takeaway.

In the latest 13-week period, Nature’s Recipe has achieved a 4% share of the $2.2 billion premium dog food segment in these channels and continues to grow despite increased competitive activity within the space. As retailers who have expanded their assortment to include additional pet specialty brands, Nature's Recipe continues to build momentum, as evidenced by unit velocity that is 2x that of competitive dog food brands based on the latest 13-week data. Kibbles 'n Bits and Gravy Train dog food also performed well in the quarter with net sales of 2% and 10%, respectively, reflecting the successful execution of our pricing strategies.

Combined with Nature's Recipe, our mainstream dog food net sales were up 17% in the quarter.

In addition, consumer takeaway was up over 25% for the latest 13-week period in measured channels.

We are also very pleased with the performance of Natural Balance, our super premium pet food brand that remains exclusive to the pet specialty and e-commerce channels. Net sales for Natural Balance were up mid-single digits in the quarter, including a 61% increase within e-commerce, which now accounts for 20% of total sales for this $300 million brand.

E-commerce remains a significant area of focus as we continue to place emphasis on this opportunity across our brands and businesses. Including Natural Balance, e-commerce sales for our pet food brands doubled in the quarter while Jif peanut butter sales improved by over 75% and coffee sales in the channel increased over 150%. These represent some of the fastest-growing categories in e-commerce as they are well suited for a subscription model.

The channel is still relatively small with just over 2% of our U.S. Retail sales coming from e-commerce in the second quarter. However, we are confident this will increase to at least 5% of net sales by fiscal 2020.

In addition, we are working to improve margins by focusing on supply chain flexibility, customized products and packaging and establishing go-to-market guidelines for pricing.

Lastly, on the topic of investments, construction of our new Uncrustables Sandwich facility in Longmont, Colorado remains on track. When complete in fiscal 2020, we will have the capacity to double net sales from the $250 million level we project for the current fiscal year.

Another key component of our strategic road map is generating cost savings to provide the fuel for investments in top line growth and margin expansion.

We are pleased to report that in the second quarter, we completed the realization of our $200 million pet food synergy program.

In addition, this fiscal year, we expect to achieve $100 million of our $250 million cost management program, the majority of which will be realized in the back half of the year. This amount includes benefits related to our new K-Cup agreement with Keurig Green Mountain, which became effective during the second quarter.

We are encouraged by our enhanced partnership with KGM and the growth opportunities ahead. This includes improved economics, greater operating flexibility and KGM's renewed commitment to growing the platform. Specifically, a more competitive cost structure enables us to compete more effectively and gain a greater share of the K-Cup category, where we have under indexed while also improving the profitability of our K-Cup business.

In addition to lower cost, we can expand distribution of our brands in key channels and provide additional offerings for consumers through multiple pack sizes and new varieties.

Lastly, we are encouraged by the steps KGM is taking to reinvigorate system growth, including increased investment in advertising, bringing new innovation to market in the form of more affordable brewers and focusing on sustainability.

We also continue to progress on other cost-savings programs, including our initiative to strengthen cost discipline throughout the organization. While we will recognize some initial savings this year, we anticipate the benefits will have a greater impact in fiscal 2019 as we put the program in place during the upcoming budgeting season.

Finally, we recently completed the consolidation of our Harahan coffee facility into our New Orleans manufacturing footprint 2 months ahead of schedule.

Let me close my comments by reiterating that we are executing against the strategic road map that we set out to ensure a clear path to growth, and we'll continue to keep you posted on our progress. We remain focused on growing a balanced portfolio of brands in excellent categories as we capitalize on current consumer and retail trends. All of this ensures we deliver on our 3 key financial priorities of top line growth, achieving significant cost savings and delivering earnings per share growth in line with our stated long-term objective.

Lastly, I would like to thank all of our employees who have embraced a lot of change, understand our priorities and continue to drive our company forward everyday with their dedication.

I will now turn the call over to Mark.

Thank you, Mark, and good morning, everyone. Let me start by providing additional color on our second quarter results, and then conclude with our updated outlook for the full year.

GAAP earnings per share were $1.71 in the quarter compared to $1.52 in the prior year, an increase of 13%, primarily due to reduction in special project costs in the current year. Excluding these costs and reflecting other non-GAAP adjustments summarized in this morning's press release, adjusted earnings per share were $2.02 compared to $2.05 in the prior year, a decrease of 1%.

During our first quarter call in August, we guided toward a high single digit percent decline in second quarter adjusted earnings per share. The over delivery of earnings was attributed to increased net sales and a shift in certain marketing activities until later in the fiscal year.

Net sales increased $10 million, or 1%, compared to the prior year and improved sequentially from last quarter, where we were down 4% versus the first quarter of fiscal 2017. Net price realization was higher, adding 1% to the net sales driven by peanut butter and fruit spreads while foreign exchange also contributed slightly to sales growth.

Volume/mix had a negative 1 percentage point impact on net sales as declines in our oils and baking categories were partially offset by gains within mainstream dog food.

Moving down the P&L. Adjusted gross profit decreased $11 million or 1%, reflecting the impact of lower volume/mix. Commodity cost, notably green coffee, were higher in the quarter but were offset by the overall higher net pricing. Adjusted gross margin of 38.8% in the second quarter represented a decline of 80 basis points compared to the prior year, reflecting the anticipated increase in green coffee costs. However, gross margin improved sequentially from the first quarter, and we expect this trend to continue into the third and fourth quarters.

For the full year, we now project gross margin to increase approximately 50 basis points over 2017, reflecting anticipated cost savings and lower green coffee costs in the back half of the year. The reduction from our previous guidance of a 50 to 75 basis point improvement reflects higher-than-anticipated freight cost driven by industry-wide headwinds, which will mostly impact the last 6 months of 2018 and then continue into next fiscal year.

SD&A decreased $2 million in the second quarter or 1% compared to 2017, reflecting incremental synergies and cost savings. These items were partially offset by expenses associated with the construction of the new Uncrustables facility and start-up costs associated with upcoming coffee innovation. Factoring in all of this as well as the $4 million unfavorable change and other operating expense, adjusted operating income declined $13 million or 3% compared to the prior year.

Below operating income, moderately higher interest expense partially offset the benefit of a 3% reduction in shares outstanding, resulting from the company's share repurchase program executed in the fourth quarter of fiscal 2017.

Let me turn to the segment specific results, beginning with coffee. Net sales were flat to the prior year. The impact of the 6% list price increase in January this calendar year was mostly offset in the second quarter by increased trade investments on roast and ground coffee to improve competitive pricing. The net impact of volume/mix was also neutral in the quarter as declines for the Folgers brand were offset by gains for Dunkin' Donuts and Café Bustelo. Net sales for Folgers declined 6% driven by roast and ground coffee as Folgers K-Cups were in line with the prior year.

For the overall Folgers brand, this was an improvement from the 12% sales decline a quarter ago.

Sales for Dunkin' Donuts brand increased 17%, reflecting double-digit growth for both roast and ground and K-Cup offerings and for Café Bustelo, net sales increased 4% against a strong prior year comp of plus 20%.

Coffee segment profit decreased 18%, consistent with the guidance we provided on our first quarter call. The decline was primarily due to an unfavorable price-to-cost relationship, reflecting significantly higher green coffee cost compared to the prior year. We remain confident that profit trends will improve sharply during the second half of the fiscal year, reflecting improved performance related to K-Cups and lower green coffee cost, which will mostly benefit the fourth quarter.

In Consumer Foods, second quarter net sales were down 5% compared to the prior year as lower volume/mix of 9% was only partially offset by higher pricing. Sales for the Jif and Smucker's brand increased 8% and 4%, respectively, benefiting from higher pricing.

For Jif, the sales increase further reflected the anticipated reversal of certain timing factors that negatively impacted peanut butter results in the first quarter.

Sales for the Crisco and Pillsbury brands each declined 20% for the quarter. For Crisco, the decline was largely anticipated due to loss distribution at a key retailer in the club channel that we will lap in the third quarter.

In addition, prior year results included a significant Crisco promotion that was not repeated in the current year. For Pillsbury, we chose not to match aggressive competitive price points during the quarter in anticipation of upcoming brand support during the key holiday season.

Consumer Foods segment profit increased 10% compared to the prior year despite the profit impact associated with the volume/mix decline of oils and baking. Segment profit margin improved 330 basis points. This continues to reflect successful execution of our pricing strategies an effective management of supply chain costs. A decrease in marketing expenses also contributed.

Turning to the pet food segment. Net sales increased 4% compared to the prior year as volume and mix contributed 5 percentage points. This was only partially offset by lower price realization. Sales for our mainstream pet food brands increased 6%, driven by the 17% increase in dry dog food that Mark discussed.

Within cat food, Meow Mix sales were up 2% in the quarter, but were offset by a 6% decline for the 9Lives brand. Within pet snacks, sales for Milk-Bone and the overall snacks portfolio were flat compared to the prior year. And lastly, for premium pet food, sales for the Natural Balance brand increased 6% in the quarter.

Pet food segment profit increased 7% compared to the prior year. This reflected the benefit of incremental synergies and cost-savings initiatives, partially offset by higher marketing expenses in support of Nature’s Recipe brand.

While pet marketing expense was up 8% in the quarter, it trailed our original projections due to a shift in timing for certain marketing activities to the back half of the fiscal year.

Lastly, in the International and Away From Home segment, net sales increased 5% compared to the prior year, with foreign currency translation, volume/mix and net price realization all contributing to sales growth. On a category basis, the higher sales were driven by gains across nearly all of our Away From Home categories as this business continues to outperform the broader industry. The segment profit increase was consistent with the sales growth for the quarter, up 4% compared to the prior year.

Turning to cash flow. Cash provided by operations was $130 million compared to $136 million in the prior year. Factoring in capital expenditures of $60 million, free cash flow was $70 million in the second quarter of 2018, bringing the first half total of the year to $305 million.

We continue to project full year free cash flow of $775 million assuming CapEx of $310 million. This is consistent with our historical pattern of stronger cash flow in the second half of the fiscal year.

Let me now conclude with an update for our full year sales and earnings outlook. Our guidance excludes any potential post-closing impacts from the previously announced agreement to acquire the Wesson brand. We now forecast full year net sales to be in the range of flat to down slightly compared to the prior year. This change in outlook primarily reflects the higher-than-anticipated sales in the second quarter.

With regard to earnings, as we progress through the year, we're narrowing our guidance range, reflecting both the improved sales outlook and the freight headwind I spoke to earlier. As a result, we're now guiding adjusted earnings per share to be in the range of $7.75 to $7.90.

Consistent with our commentary on our first quarter call, achievement of the middle to high end of this updated range is predicated on several factors, primarily related to our coffee business. These include: Continued improvement in volume trends for roast and ground coffee as a result of our pricing and merchandising activities; stronger performance of our Folgers K-Cups, reflecting improved economics in the back half of the year; initial contributions from new coffee products planned for the fourth quarter of the fiscal year; and meeting or exceeding our synergy and cost-savings targets for 2018.

Looking closer at the last 6 months of the fiscal year, lower green coffee cost will have a greater benefit in the fourth quarter while the third quarter will experience a sharp increase in marketing expense over the same quarter last year, reflecting our U.S. Olympics sponsorship.

As a result, we expect much of the year-over-year earnings growth to occur in the fourth quarter.

In closing, let me reiterate that we're pleased with this quarter's results and feel confident in delivering on our guidance for the fiscal year. We thank you for your time this morning. And we will now open the call up to your questions. Operator, if you would please queue up the first question.

(Operator Instructions) Our first question comes from the line of Andrew Lazar of Barclays.

Just one for me. I think it seems that each food category has a kind of one consumer problem or benefit that if it can be solved it sort of opens up a new avenue of growth. And I realized some categories are just on the wrong side of sort of where consumers want to go. But I guess, when it comes to roast and ground coffee, I know you -- I think you have more significant innovation plan for the end of the year and really into fiscal '19. But I guess, have you fully identified maybe what that key benefit is that roast and ground consumers are kind of looking for or the problem that you can sort of solve for them? And if so, I'm just curious what that is.

Andrew, Steve Oakland. I'll give that a shot. I think to suggest that there's one problem to solve in roast and ground coffee would--might be a little too easy. I think we've got so rich of consumer segmentation data today that we understand that there is a large business where Folgers flourishes frankly in the value channel, right? So if you think about the discount channel sort of growing and who's building stores today. So we want to provide that consumer with a rich coffee experience that's very affordable but it's branded. If you look at traditional grocery today, it's a convenience play, it's K-Cups, right? And if you look at who's merchandising K-Cups, it's the traditional grocery retailer across the country. And then there's the whole premium experience, and how do we make that authentic, how do we make it experiential, how do we bring more? And I would argue Café Bustelo does that, right? So if you think about the needs we're solving in Bustelo, the needs we're solving in other ones. So I think, obviously, there are things we need to solve in every category. The breadth and reach and size of the coffee category, the fun part about it is there a whole bunch of needs. It's fragmented, it's not as simple as it was 10 years ago that you could solve Folgers roast and ground. So the journey we're on, and we've talked a lot about that about improving our mainstream business, about positioning ourselves to participate significantly more in the premium business both with Dunkin' and Bustelo and then winning in K-Cups. And we make progress on all three of those in the quarter. We're excited as the innovation comes out later in the year to show you how we're solving in each one of those segments. But I just think we -- our view on it is, it's a complicated segment. There's a lot of opportunity, but they are uniquely different by customer and by consumer.

Our next question comes from the line of David Driscoll of Citi Group.

Two questions for me. The first one is bigger picture on the cost-savings programs, the various programs. And just your sense today of the delivery of those savings to the EBIT line versus the need to reinvest. You know, Mark as you said in your script, the #1 point is getting that sales growth. So I'd just like you guys to talk a little bit about you've already achieved the $200 million from the Pet Brands acquisition. I believe there is $250 million remaining in your program. So can you go over a little bit about the timing and then really specifically whether or not much more of this needs to be reinvested back into the business to achieve your primary goal.

David, this is Mark Belgya. Thanks for the question. Let me start here. So you hit on all the points correctly. We did achieve the rest of the $200 million, and that leaves $250 million. And I think in our scripted comments, we said that we're going to have another $100 million and -- coming through this fiscal, which is probably skewed a little bit more towards the curry contract than the other components that we've spoken to. In terms of how we're going to spend that, it really kind of goes across the board. We were very explicit when we talked about -- if you'll recall we went from the $200 million, the original pet synergies to $250 million. That incremental $50 million, we were specific to say all $50 million of that was going to be reinvested in the business. And then as we look at the incremental $200 million, I would just say it's a blend. One of the things that we have spoken about is that to support the innovation platforms that are coming to market over the next several quarters, it's absolutely imperative that we support them both with the retailer and to the consumer. So we will be spending some of that behind each of the respective platforms that you'll see coming to market. At the same time, we also said the profitability on our K-Cup will improve. So there you will see a flow through the bottom line while we will certainly benefit from the price on Folgers K-Cups and see a volume pick up there, you will see margin improvement in the overall K-Cup category. And then I think just as we see the rest of it, it will be a blend of flowing through to help us achieve our strategic growth objectives there as it relates to earnings. What we're not in a position to do, and I just candidly don't see us doing this, it's just saying black-and-white of the $200 million, and the X amount will go to reinvestment and Y will go to the bottom line. I think we will prudently think about how we spend that in the coming couple of years. And then lastly, the timeframe is such that, that entire $450 million will be realized by the end of fiscal 2020.

Really appreciate that answer. One follow up on the coffee side. Just curious, how fast you can get moving on the benefit of the freedom to operate within the new K-Cup contract. It seems like a very significant event for you guys. But again, the speed of how fast you can take advantage of this new opportunity within the contract, I think is interesting. I would love to hear your thoughts and comments.

David. I think if you dug deep in the numbers or if you walked a club store, you'd see we sort of got a running start on that, okay? So even though the economics didn't make sense, we worked with KGM to start to build pack sizes to put ourselves in places where we knew we would benefit once the contract went into force. So I think it will be sequential, you'll see impact in the third quarter, and you'll see even more in the fourth quarter and I would expect it to be sequential into next year. I would remind you that we do about 20% -- 21% of our business in K-Cups. The category is 41% K-Cups. So the opportunity for us to grow significantly, we think, is real. We made a running start and part of that is reflected in the numbers. And we don't like negative numbers, but we felt investing and getting ahead of this K-Cup opportunity was important. And so we'll start to take advantage of that a little bit this quarter and more in the fourth quarter.

David, it's Mark Smucker. I think you heard both Mark and Steve's answers. I think it is good to point out that some of the flow through at the bottom line that Mark referenced is both a combination of improved economics and increased sales.

Our next question comes from the line of Ken Goldman of JPMorgan.

One quick one for me and then a more broad one if I can. I just wanted to get a sense, your pet sales came in I think a little bit better than most people were looking for. Was there any shipments ahead of consumption there that we should be aware of? I know you talked about mainstream dog food, I'm just trying to get a sense for overall.

Ken, this is Barry Dunaway. No, there were no anomalies as far as shipments this quarter. In fact, we had one retailer who shut shipments down just based on their year-end. And so we actually had fewer shipments because of that one retailer. So no. To answer your question specifically, no anomalies.

Okay. This is a broader one. There's obviously a bunch of areas of concern for investors in the food space, and indulge me for a second as I list a couple of them. But you have customer consolidation, the growth of private label, customers potentially not excepting higher prices as easily. I know you guys have talked a little bit about maybe some of the foot dragging that goes along with that, better terms, better fill rate, the customers were asking for. As you think about what of these -- which of these concerns is the most legitimate, and which is the most overstated, I'm just curious for your sense because you cover so much in the food industry in terms of your categories. How do we think about what's real and what's maybe imaginary, so to speak?

All right, Ken, it's Mark Smucker.

I'm putting you on the spot there Mark, sorry about that.

There are -- so there is -- we've talked about the foot dragging, there has been some pricing pressures. What we keep coming back to is our success in that area is really our ability to maintain strong customer relationships. We've always had very strong customer relationships, being a category captain certainly helps. So as we've said in a number of our recent investor meetings, in our case, it is more, I would say, delayed execution of pricing, but still successful execution of pricing. I think the private label comment, and I think we would tell you and again, we said this in investor meetings is that we have not seen, from a private label perspective, anything particularly different in this recent private label push versus ones in the past. And so, obviously, that's something that we will watch very carefully. We continue to point to the fact that U.S. consumers are particularly brand loyal, and that bodes well for our brands. And so, I guess, if I could comment on those, too. And then, I guess, I would reserve any commentary on customer consolidation. I don't know if anybody has anything to add around the table, but...

Yes. Ken, this is Steve. We saw the consolidation, the national -- when Kroger went national, when a number of these things happened. I think it is a tough retail environment. I think there's a lot of question on the role of e-commerce. There's click-and-collect. A couple of our retailers are just super successful with click-and-collect. So I think there's a lot of question on how to serve the consumer today as we transition to a consumer that's much more digitally connected. I would tell you some of the meetings we're having, the level of dialogue is very rich. Those places where you're category captain, where you're important to the retailer and in most of our big brands that we are in that situation. The dialogue is very rich. I think there's going to be a lot of test-and-learn in the interim, but I would tell you, I think we're encouraged by the recent results by some of our biggest customers and how strong their business is. I think you can look at our results, and you can say, well that's a mirror of those results. So obviously I think that dialogue is working. So I think it's hard for us to comment on any one of those things. I think they all exist differently depending on the category and the impact on that category depending on your position in the category. If you're a #2 or 3 brand, I think it's a tough place to be right now.

Ken, it's Mark, again. Just a couple of things. We continue to preach big brands are not dead and there is a continued role for those, both in e-commerce and in traditional brick-and-mortar. What we are very pleased with in this quarter is in virtually every one of our businesses, the brands that we intended to grow, did grow. And so I think from our perspective that speaks to the fact that our strategy is working.

Our next question comes from the line of Pablo Zuanic of SIG.

This is actually Aatish Shah for Pablo. Just 2 quick questions. First, related to coffee, and then the second, on pet food. On the coffee front, as K-Cups become a larger part of the coffee market and of your own Coffee segment, does that mean the Coffee segment become less of a pass through category? And as such, should we expect more margin volatility in the future? Also, is roast and ground becoming less of a pass-through category? We ask this because you're guiding for a record 4Q coffee margins, but given the lower coffee cost, we would imagine that will get passed on. Any color on this and the coffee margin bridge for 2Q in the second half would be helpful.

Sure. I do think, as we talked about earlier, K-Cups are 40% of the business today. I think the good news on your question there when it comes to green coffee volatility, green coffee quite frankly, is a small part of the cost of a K-Cup. So if you think about what's going on in the K-Cup, it's really packaging distribution technology co-pack agreement. So green coffee has a much smaller role in the margin structure. So I think by nature, you're going to have less volatility, right? Unless we get coffee at extreme, extreme prices. So I actually think that would be good for us all long term, I think you'll see some more stable margins because green coffee frankly, is a bigger deal. With regards to pass-through categories, I think Ken touched this in the last question. I think pass-through is a little bit more difficult now. I think we have to look at our green coffee purchasing organization and our strategy. We have great results when we are priced at certain price points. And so we need to make sure we hit those price points as often as we can. I'm not suggesting we can't price -- push price through, but I'm just suggesting we understand better how the Folgers brand performs, where it performs and what channels, and we just have to have that pricing right. And that pricing right means not just absolute price point, but gap with our major competitor. The other thing I would say is going on is the growth of premium. And premium, historically, has had less price volatility in it because all the players don't pass price at the same time, part of that is driven by the length of the supply chain of premium coffees, et cetera. So I would argue the fragmentation of the category in general, I guess, to bring us all together will make it less volatile versus more volatile long term. K-Cup is being the biggest impact on that.

That's great. And if I can squeeze one in on pet food. Is there an imperative to increase exposure to the faster-growing natural pet food segment? And if so, would this be through maybe taking Natural Balance to FDM and/or acquiring other natural pet food brands?

Aatish, this is Barry. Let me add some color to that. We had stated previously that we are committed to keeping Natural Balance in the pet specialty channel. We believe that we continue to be consumer led as we think about that brand, and we think those consumers are looking for that brand specifically within the pet specialty channel. Based on the performance of Nature’s Recipe, which you saw the numbers, we think that is the right brand for grocery and mass and I think the performance is playing out as we expected. So no, Natural Balance will continue to be focused in pet specialty. M&A acquisitions of other brands will be part of our growth strategy and clearly, we'll look for brands in pet specialty just like we would across grocery, grocery and mass.

That's great. If I could, just one more quick one going back to coffee. Is there a negative mix issue since Dunkin' is growing faster than Folgers especially in the K-Cup category and if there's any kind of color in terms of the margin difference between the 2?

In general, no. The premium coffee margins are at or above our segment margins. And now that we've sold the K-Cup issue, I think we're in much better shape there. So previously, I would have said yes on K-Cups only, but not now.

Our next question comes from the line of John Baumgartner of Wells Fargo.

Question for Mark, maybe Belgya. As part of your savings initiatives, you've really been focused on trade spend and getting the efficiencies there. And we've seen a pretty significant improvement in your subsidized volumes over the past few quarters. And it's really across the board. Spending on dog foods, spreads, peanut butter, coffee, right on down the line. And the magnitude really seems unique across the industry. So can you speak to a little bit to the execution there? I mean, what's maybe changed in your approach to trade promotion? What inning are you in, in terms of the improvement there? Any comments would be appreciated.

Okay I'll start and then maybe look to Steve. As we talked -- whatever 6 months or a year ago when we first came out with our cost-savings program and then we had I think just 6 items or 6 categories. Certainly, trade was one of those revenue growth management. And so we have just been actively -- we used the term just blocking and tackling, but we've been actively trying to address it. We've got a dedicated team following the pet acquisition that is spending more time on that. We're adding analytics capabilities and again, there's just making sure that each dollar spent, is we're getting the maximum efficiency out of each of that. And then I think just the fact that we've elevated the importance both through the savings programs and just to the respected individuals that are responsible for managing the efficiency that I think it's a combination. I don't know, Steve, if I would say anything dramatically or specifically we would say we're doing differently, although we're continuing to look at ways.

Yes. I think it's a much more effective group, we have a new system application that we're in the middle of installing to help them to give them even more data. I would say it also goes back to we're having some very rich customer dialogue. It no longer is that the customer is just trying to collect trade funds, the customer wants us to grow the business as well. So the dialogue with the customer if you have the right information, and you're the category captain, the dialogue can be very rich and I would argue that's happening across pet, it's happening across our food businesses and our coffee business.

Great. And are there -- just in terms of thinking forward, are there any certain categories where you feel like you can still maybe do a better job overall? Or just some sort of basis of innings where you are in terms of the progress there going forward?

You know, we haven't had the question on our food business yet today, but we might get one. And if you look at some of the -- and there will be some sequential lumpiness in our food businesses because we spend trade on Crisco, we spend trade on baking. That team has decided and brought us a model, which suggest it's much better to spend that trade during the periods when the consumer is really in the category, okay? And so you saw our oils business and our baking business down substantially in the summer. You'll see those trends improve dramatically here in the fall baking period. So I think what we're learning is there's an opportunity for us to be much more targeted to align our promotional spending with one that consumers really in the aisle or really online really looking for recipes so they react to both our trade and our shopper marketing, those other things we do. So as we work on those, you might see some sequential changes in business and I would argue the food business is one of those right now. We took some of the spending that we would have normally spent in summer, spent in our other growth brands, on peanut butter and Fruit Spreads, Uncrustables, and we are turning on the promotional spend on those baking categories now. So I think as we get better as we learn how to target this to both the retailers needs and the consumer's needs, it will just become more effective, right? Less is great, effective is better. So I mean we're happy to spend trade dollars if we get a return. When you don't get a return, that's a wrong time to spend.

Yes, John, this is Mark Smucker. I think Steve painted a picture extremely well. I would only add that I would -- to answer your question specifically, I don't view that our capabilities are really any different by category. Our -- we have a centralized team that really manages the deployment of trade funds, but our individual sales folks are responsible for managing them at the customer level. But specifically, your question about innings, we're doing a much better job right now of managing category by category so the capabilities are consistent across. But as Steve mentioned, we are in the midst of upgrading our systems, and that is basically a 1.5-year to 2-year process. So as we go forward, we will continue to gain benefit, and it will probably be, I think, in fiscal 2020 that we get sort of the full benefit and even enhanced capabilities to manage that trade more effectively.

Our next question comes from the line of Akshay Jagdale with Jefferies.

I want to start with coffee so -- and K-Cup specifically, if I may. So help me understand the big picture here. I've noticed that the machine sales have skyrocketed. Is that the best characterization over the last few months? And if I remember correctly, maybe a year or 2 years ago, you were of the view that maybe household penetration and K-Cups or single service flattening, but it seems like there is a big replacement cycle that hasn't yet taken place because of all the confusion, I guess, that 2.0 had caused. So that's what I'm seeing. So I'm just wondering high level, what your view is on penetration of the category. And then as it relates to your own business within K-Cups, I mean, just the rough math is, if the rest of your business stays flat, you get a 40% penetration and actually double the K-Cup business, right? So can you give us some sense as to how this new partnership sort of fits into that implied sort of ambitious goal? Like getting distribution, getting into larger club packs, I get that. But I don't see how that would double your business. So maybe there's an innovation sort of pathway that gets you there. So help me understand like what is the dream for this K-Cup business now that you have more flexibility? And what's the view on household penetration, has that changed?

Okay. I'm going to try to catch those. There's a number of questions embedded in there actually, so I'll try to get them for you. First of all, I would say, yes, there is a replacement cycle and I don't know that we're really the right people to comment on that. I will comment on the fact that they've brought the first real, what I would consider, innovation to that. And that is a price point. We see that new brewer promoted under $50, right? In our largest retailer, we see it online at that number. So the fact that they're adding new price point is going -- just by definition we'll bring a new consumer base into this, right? So for the first time in a number of years, I think we have confidence that we will have a household penetration gains. And we have confidence they're doing 2 things: They're investing in marketing; and they're investing in equipment, right? And so both of those things, we view as very positive for the segment and I would hope will drive household penetration. I think certainly it's fair to assume that this lower price point machine will bring new consumers into the marketplace. And quite frankly, they're doing as retailers where we are very successful or we have great share. So that also intrigues us. Your comments on the category are correct, we think there's an opportunity to as much as double our K-Cup business over time. That has to happen by very, very different mechanics depending on the brand. The Bustelo business, right? We have to continue to expand reach. That business is small but growing very, very quickly. Dunkin' has a great opportunity as we get into flavors, as we get into pack sizes, we have the shackles taken off of us for channels and distribution. So Dunkin' is growing -- Dunkin' is our -- Dunkin' next to dog food, Dunkin' K-Cup is our best online item and a tremendous item at the largest online retailers. And then Folgers is really about competing in that lower price point, that mainstream price point. And we're now positioned with a cost structure that allows us to bring Folgers back to those price points that we needed to be. So I think the work will be different across brands and then I think the innovation that we'll show you at CAGNY will have another look at K-Cup opportunity. So for us to make that ambition of doubling our K-Cup business, we will need to add SKUs, we will need to add brands, and we'll need to add distribution. And I think hopefully, you'll start to see us do that.

That's very helpful. And one for Mark. So in terms -- Mark Smucker. In terms of the longer-term initiatives, M&A has really been the major sort of value unlock for investors in Smucker's over time, right? So recently, you've seen a big correction in valuations in the public market, rates are starting to move up. Can you just give us your view of what's happening in sort of your world? Are you seeing more reasonable valuations? What does the pipeline look like? And is the probability of a larger deal greater now than it has been? Or like just give us a high-level view of what's happening on the M&A side if anything, has changed.

So Akshay, thanks for the question. I think from a macro perspective, obviously, we're all very aware of the adjustment that occurred from our -- in our entire industry, in our peer group, largely driven by news around what's happening in the e-commerce space. I think you can point to, particularly in the last few days some decent performance by 2 of our largest customers that are historically brick-and-mortar retailers. And so from our view, we think the correction, if you will, may have been -- our opinion would be there was an over correction, and that is, we believe, substantiated both by some of the results of some of our larger customers as well as our performance this quarter and our outlook. From an M&A perspective, we can't talk about specifics. We do still believe that M&A is very important and it's 1 of the 4 key pillars of our strategic road map. And it goes without saying that we continue to keep our lines in the water and look at a number of opportunities. But as always, we are prudent and diligent, and we want to make the right acquisitions at the right price so that we can generate a return for our investors. And so at the end of the day, we still have a responsibility to our shareholders to deliver returns. And then as it relates to large or small lines in the water for both of those opportunities. But again, it's one of the things where we just can't control timing. Thanks for the question.

Yes. And just one last one again for you, Mark. If you leave M&A aside, you got the 3 other initiatives. What do you feel the best about in terms of which of those initiatives are most likely to have the most meaningful impact on your P&L and shareholder value over the next whatever, 5 years like long-term, what do you feel best about of those 3 initiatives in terms of where you'll see the biggest unlock for investors? I'll pass it on.

Akshay, this is Mark Belgya. I want to comment on something related to that, and then I'll turn it to Mark, he's agreed he wants to comment on the platform that we haven't exposed to the rest of you, so that's a little difficult. But -- and I've made this point to some investors over the past few months. If you want to look at near term absolute best opportunities, I would say, it's our Uncrustables and its our Café Bustelo. If you think about what we've said publicly over the last 2, 3, 4 months, the construction of Longmont provides us the opportunity to double the capacity of our current sales, which are $250 million. Our Bustelo business is about $125 million, which we feel also can be doubled over the next several years. So just those 2 pieces alone, are $350 million to $400 million worth of top line growth. So that's the near end. Mark, I don't know if you want to comment specifically on the platforms because again, we haven't really -- we've talked about, but we haven't scaled them in so I'm not sure that you have a preference over which one of the 3 is the best opportunity, going forward.

No, I agree with Mark. I think both of the opportunities that he mentioned are not only we have the ability to double, but we have the ability to double them profitably. And they both contain to generate at least or right around corporate average profitability. So those are both very important. And then just -- we will continue to have to be disciplined on our cost management programs. Those are very important for our ability to support our growth.

Our next question comes from the line of Farha Aslam of Stephens.

This is Greg Nep on for Farha. I wanted to drill into the pet food business a little bit. You mentioned that there was marketing expenses that got pushed out into the second half of the year. Can you help us understand what -- kind of quantify the impact of that? And then revenues there were strong despite that marketing push out. Will that marketing kind of as it hits in the second half, sort of help to accelerate that top line? Hello? Do you hear me?

Yes, I'm sorry. Greg, this is Barry. So you wanted to -- some color on the marketing shift?

Yes, yes as kind of the marketing shifts out in the pet food into the second of the year, I just wanted to understand the impact on margins that had in the second quarter.

It wasn't -- really it wasn't significant, to be honest. It was not a material impact on our segment profit. And just as we plan the year and now that we're actually executing our marketing plans, it's really just modest shifting and specific executions of marketing activity. So not a material impact on Q2, and we wouldn't expect it in the balance of the year.

Got it. And then if I can sort of drill into cash flow a little bit. I noticed that the sort of expectations for full year cash flow is maintained despite the slightly lower EPS guide, are there any offsetting factors in working capital that we should be thinking about in the second half of the year?

Yes, right now, I think that obviously, we kept our CapEx. We just -- we think that there's some opportunities just generally as we move into the last couple months of the year, both from the inventory and just the payable receivables that we'll try to cover that shortfall that's coming from the earnings. But we still feel confident that we can even get to $7.75.

Our next question comes from the line of Robert Moskow of Crédit Suisse.

Very specifically, I had seen coffee futures starting to rise because of bad weather conditions in Vietnam and then perhaps even some concerns about South America. Are you seeing that as well in your forward outlook heading into fiscal '19? Should we start to worry about that? And then also your comments about freight, can I assume that, that's not a cost that you can pass on to your customers because they're experiencing higher freight as well?

Rob. I would suggest that our opinion is there's going to be a lot of arabica coffee in the world next year. I think near-term volatility on these things based on one week's weather forecast or 2 weeks' weather forecast is -- it will drive you crazy if chase it on a day to day basis as you can imagine, we look at it day-to-day, so we know that for sure. But you can't let that happen. The macro environment of an on-cycle crop and where we are in the process would suggest that we think coffee futures will be fine. Remember in the first quarter of last year, coffee was like $1.55, right? And so you've got -- we're talking about moving from $1.25 to $1.30 type of thing now so significantly better coffee costs as we roll forward. We think it's going to be a good quality and size crop, which we think is good for all of us. With regard to freight, I think yes, I think passing freight on right now will be difficult for all of us. The challenge in front of us is to work with our customer to get absolutely as much pickup and to make our freight system the most effective it can be and I know our team is doing that. But I think we all understand what's going on in the macro freight world, what's happened because of the storms this year, the new driver logbook issues, all of those things are going to drive tightness in the freight market for the near term.

Our next question comes from the line of Jason English of Goldman Sachs.

A couple of questions. First, the hurricane, was there any benefit in results this past quarter?

Jason, this is Mark Smucker. We saw some elevated shipments at the beginning of the quarter. But given the fact that it was early on in the quarter, we do -- and that was in advance of the one that hit Texas. Given the timing of it, we do think we saw some reversal of that later in the quarter, so we actually think that sort of the impact was all contained within the quarter, so we don't expect any blowback in the next quarter.

Got it, that's helpful. And on your pet performance, can you give us your assessment of how your portfolio is performing in accounts where Blue Buffalo has distribution?

Sure, Jason. This is Barry. The comments actually that Mark made in his prepared remarks reflected that performance. So where we have a presence in the same retailers where that competitive brand also has a presence, we are seeing our velocities at 2x what that brand's performance has been at least since they've been in the market. So our velocities are growing. They're 2x based on points of distribution. And we see velocities increasing. So again, we have a unique value proposition for the consumer. We have national distribution. You know that was a lift in place with that brand when we took it from pet specialty, we're going to be bringing out some refreshed packaging. We also are going to be adding some new items where we're going to be replacing some of the lower-performing items. So overall, performance outstanding year-to-date, especially including those retailers where we both have a presence and momentum growing.

And great news. Sorry, I missed the prepared remarks. Last question and then I'll pass it on. I heard comments on in terms of sort of the cadence of cost relief fourth quarter, heavy cadence of cost saves kind of tilting fourth quarter and cadence of marketing spend, a bit 3 quarter heavy. It sounds like you're talking or sort of suggesting muted earnings growth in the third quarter. Is there any way you can sort of contextualize that for us?

Jason, this is Mark. What I would say is just that from our, I guess, just more from our top line growth perspective is that we see growth in the back half, we tweaked up our top line guidance, and would see the volume growth come from particularly in coffee as we see -- both on the KGM passthrough K-Cup and then the price support on roast and ground. So I'm not sure really is there too much more to add to that.

Our next question comes from the line of Matthew Grainger of Morgan Stanley.

Just 2 follow ups on coffee, one follow-up and one quick clarification. You mentioned in the guidance comments that getting toward the higher end of the range was going to be dependent on continued roast and ground improvement and then the outcome in K-Cups as you move into the back half. We have seen scanner data, consumption data improve for roast and ground versus Q1, but it's still been a little bit choppy, low single digits, some months down high single digits than other. So just curious how consistent the improvement has been and if you could just give us a little bit of color on the current competitive pricing dynamic in the category.

Well, I think what you've seen in the data just reflects the 4-week nature of the data and the 4-week nature of the competitive set. So it will be lumpy on that. I think if you look at 12-week data, it's a little bit better way to look at it. I think we are priced where we need to be. I think we have support from our retail partners on core roast and ground that we're excited about, and that would be against, both our Folgers business and our Dunkin' business. So we think that -- we think you may still see monthly choppiness. I mean, that's going to happen in this business always, right? But we think as you roll it up from quarter-to-quarter, we think we're in good shape. I think it's too early to talk about next year. Will some of the coffee cost that we're talking about be passed on or not? I think that's something we'll see as we get into the fourth quarter. But I feel good about it, right? And in the K-Cup business as we spoke earlier, we understand what price points need to be on K-Cups. So that promotional volume, I think, is pretty easy to project for us. So those things are set, the big events on roast and ground are set, and I think as we get through, at least through third quarter and into fourth quarter, we have pretty good visibility.

And Matthew, this is Mark Smucker. I would just -- I think Steve said it well. I think I would just characterize the headlines are on K-Cup, we're executing it, and we feel very confident that the new agreement and our actions are going to deliver, particularly in the back half and beyond. And then the headline on roast and ground is the activities we have in place with our key retail partners are very strong, and that's what gives us sort of the confidence going forward through the next 6 months.

Okay. And then just to clarify, the comment around, I think, reaching all-time high levels of profitability in the Coffee segment in Q4, is that meant to be just in terms of absolute EBIT dollars or percentage margin as well?

It's dollars and it's a fourth quarter comment, as we clear it, the record for a fourth quarter, not a record for any quarter, but it's dollars, which may actually probably translate into margin percent as well.

Yes. And it's just where all of this is going to fall, right? And so we manage this on a full year basis, right? The plans we gave our team are for the year. We speak to you all quarterly obviously, but we run the business hopefully on a much longer-term basis than that. So we will have times when we have great quarters fall through and it looks like the fourth will be one of those.

Yes, Matt, this is Mark Belgya and just to add a little bit to Steve's point and maybe just to call out why we're a little bit -- that specific to that candidly that's a little out of character for us to call something like that out. There's been a lot of questions as we've met with investors over the course of the fall and they come out the first quarter, we basically talked about what was going to drive the back half in coffee and then there was just a conversation on how to shake up between Q3 and 4. And I think just in an effort to try give a little clarity to the investor as to dollarize it without being black-and-white, that was just another data point that we wanted to provide.

Okay. And then the full year expectation would still be I think you said on the first quarter call that full year margins would be roughly in that 31% to 32% range?

Yes. I think we've said it would be in the low-30s, which is sort of the historical so...

Our next question comes from the line of Chuck Cerankosky of Northcoast Research.

If possible, could you give us an update on where the Wesson oil acquisition is and if you're confidence about closing it has changed at all?

Chuck, Steve. No our confidence hasn't changed. Unfortunately, these things are cumbersome and so we're in the process of all of the documents going to them. We feel comfortable that shortly after that, we'll announce the close. But unfortunately, just the nature of that process, where that agency is right now, it's taking a little longer than we'd hoped. But it's not -- it does not affect our confidence. It's more a mechanical thing than anything else.

I'll now turn the conference back to management to conclude.

Well, we want to thank everyone for your time today and taking the time to listen. Again, we always want to thank our employees because they are the ones that make it all happen. And we will talk to you all soon. Thank you.

Ladies and gentlemen, this concludes our conference for today. Thank you all for participating, and have a nice day. All parties may now disconnect.