J M Smucker Co (SJM) 2007 Q3 法說會逐字稿

Good morning, everyone. I'd like to welcome you to the J.M. Smucker Company third quarter 2007 earnings conference call. [OPERATOR INSTRUCTIONS]

I will now turn the conference over to your host, Mr. Mark Belgya.

Thank you. Good morning, everyone. Welcome to the J.M. Smucker Company third quarter 2007 earnings conference call. I'm the Company's Chief Financial Officer and thank you for joining us this morning. Also on the call from the Company are Tim Smucker, Chairman, and Co-CEO; Richard Smucker, President and Co-CEO; Vince Byrd, Senior Vice President Consumer Markets; Steve Oakland, Vice President and General Manager of our Consumer Oils and Baking Business; Mark Smucker, Managing Director Canada, and Vice President International Markets; and Paul Smucker Wagstaff, Vice President, Foodservice and Beverage Market. Tim and Mark will be joining us remotely this morning.

After this brief introduction I will turn the call over to Richard for opening comments. I will then review the financial results for the quarter and Tim will provide closing remarks. At the conclusion of these comments we will be available to answer these questions. If you have not seen our press release it is available on our website at smuckers.Com. A replay is available on the website and downloadable MP 3 format. If you have any follow-up questions or comments after today's call please feel free to contact me.

I'd like to remind you that certain statements in this presentation and during the question and answer period that follows may relate to future events and expectations and as such, constitute forward-looking statements within the meaning of the Private Securities Legislation Reform Act of 1995. I invite you to read the full disclosure statement concerning such forward-looking statements in our press release. I also want to point out that the Company uses non-GAAP results for the purpose of evaluating performance internally. Additional discussion on non-GAAP information is also detailed in our press release. With that I'll turn the call over to Richard.

Thank you, Mark, and good morning, everyone, and thank you for joining us. Let me begin by summarizing the key points for the quarter.

First, we attribute much of our success this quarter to the focused execution of our strategy to achieve profitable growth in our icon brand. The recent divestiture of non-branded businesses and the exit of certain less profitable customers have improved our margins. In addition, we have acquired businesses such as White Lilly and five roses that complement our existing brands and contribute to our top line growth. Second, we achieved solid financial performance with sales and earnings per share of 6% excluding a one-time gain that was included in the last year's third quarter earnings per share increased by 16%. Third, despite ongoing cost pressures, operating margin improved significantly in the quarter and we were able to realize operating leverage. Fourth, we completed a successful fall bake period in both the U.S. and Canada realizing gains in sales, volume, and market share. We continue to promote our multi-brand event embracing the power of family meals. It is a powerful message that resonates with our consumers. And finally, we continue to focus on long term brand building.

At this point let me provide some specific comments on the quarter, starting with our consumer business area. Our Smuckers and Jif brands achieved good growth and record share with particular strength in peanut butter. Uncrustables again experienced strong growth demonstrating that consumer demand for the product remains high. We announced price increases this month on peanut butter and Uncrustables. In oils and Baking, our Crisco brand had a good fall bake, up in volume, sales, and share. The big event during the quarter was the launch of the zero grams trans fat per serving Crisco shortening. The reformulation reflects years of research by our dedicated Crisco team to develop a product with no compromise in quality while maintaining price parity.

The consumer has traditionally purchased Crisco for its performance, making the product trans fat free will enhance our reputation as the leader in this category. The launch has received a great deal of positive coverage and is drawing attention to the shortening category. In the three weeks since we announced the product, we have generated almost 90 million media impressions. We have had numerous responses from consumers and the press applauding this change. Across the Company in total, over 95% of our products contain zero grams trans fat per serving, meeting the needs of our consumers.

Turning to Baking, Baking sales for the quarter were up primarily on strong flour and frosting sales. The key to this very competitive category is to invest behind the brands and in new products. With escalating raw material cost and the competitive dynamic, margins have been and will continue to be pressured as pricing in this category has lagged the cost increases. In Canada, with the portfolio changes complete, we are realizing higher margins with the focus on our branded business. As in the U.S, we continue to experience raw material cost pressures; however, we have successfully implemented price increases in several categories. In addition, our recent consumer marketing initiatives, including advertising, are having a positive impact. We are pleased with the progress in building the Bicks and Robin Hood brands. We will continue to execute our strategy of taking advantage of opportunities for profitable growth that these icon brands present.

In summary, although the cost environment continues to be challenging, we have good momentum in our brands and expect our strategy to result in long term profitable growth. I'd now like to turn the call back to Mark to have him review the quarter's financial results with you.

Thank you, Richard. Sales were up 6% for the quarter excluding divested businesses as defined in our release and again, up in all strategic business areas. The growth was led by volume and pricing gains in our Smuckers, Jif, and Crisco brands, but particularly strong performance in special markets and the contribution of previously acquired brands. GAAP earnings per share were $0.71 this quarter and $0.54 in the third quarter last year including restructuring and merger and integration costs detailed in our press release. Excluding these charges in both years, earnings per share were $0.72 this quarter and $0.68 in last year's quarter a 6% increase. Excluding the $0.06 gain on the sale of the Company's Salinas, California plant, earnings per share were $0.62 last year resulting in an overall 16% increase this quarter.

Operating margin for the quarter improved significantly over last year due to the divestiture of the lower margin Canadian business, favorable product mix, and price increases. These improvements were partially offset by higher raw material costs. Marketing expenses increased in total for the quarter and at a higher rate than sales as we allocated our spending more evenly between the second and third quarters this year compared to a heavier second quarter last year. The focus of that spending remains on longer term brand building activities.

Sales in our U.S. retail segment were $394 million in the third quarter, up 5% compared to last year. Sales in consumer business area were up 4% and sales in the oils and baking business were up 5%; however, if you exclude a decrease in sales of low margin industrial oils, sales in the U.S. retail segment were up 7% and sales in oils and baking were up 10% over last year. This increase was primarily due to growth in oils, sprays, frosting, and baking ingredients.

Uncrustables experienced another good quarter as sales across all channels increased by 31%. The level of growth this year continues to exceed our expectation as consumer demand remains high. We continue to make progress and our overall Uncrustables profitability has improved over the first nine months of this year as compared to last year. In the special market segment, sales were $129 million for the quarter, up 11% excluding divested businesses. The Foodservice business area was up 15% with gains in both the traditional and schools channel. Canada was up 10% driven primarily by the addition of the Five Roses flour brand earlier in the year, the impact of favorable exchange rates and growth in the pickles and relish category.

The beverage area continues to experience good sales growth in both its branded and non-branded businesses up 8% overall in the quarter. In the near term, the beverage business will be pressured by cost and availability of raw materials. In particular, the supply of key organic products remains constrained. Longer term, growth prospect in this business remains strong.

Let me now conclude my remarks with comments addressing items below operating income and our cash flow. Net interest was favorable, by $1.2 million primarily due to an increase in investable funds and a paydown of debt. Income taxes favorably impacted the quarter for results as well. We now expect the tax rate for the full year to be approximately 34.5%, a decrease from the 35% rate that we originally forecast. As a result, the tax rate for the third quarter was 33.1% reflecting an adjustment to the new full year rate. The reduction in rate benefited the third quarter by $0.02 as compared to our original forecasted rate and approximately $0.04 per share compared to last year when the tax rate for the quarter was 36.8%.

During the quarter we completed the repurchase of 1 million shares included in our previously announced 10-B 5-1 plan which commenced last quarter. In total we repurchased 322,000 shares at a cost of $15 million in the third quarter. This leaves approximately 1.7 million shares remaining available under the Board's authorization and we will continue to evaluate future actions against the authorization as appropriate. And finally, our cash from operations was very strong, generating $105 million during the quarter and $212 million year-to-date. I'd now like to turn the call over to Tim. Thank you, Mark, and good morning, everyone. We reported a very good quarter and the implementation of our strategy is responsible for generating these financial results. We are still operating in a difficult cost environment. We are experiencing cost increases on a number of raw materials including soybean oil, peanuts, corn, wheat, glass, sugar, potatoes and certain fruits unique to our beverage business. We do not expect cost pressure to let up in the near term and it appears that it may be necessary to implement additional price increases as we enter the new fiscal year. While the environment is challenging though, we are encouraged by the results we are seeing as we implement our strategy.

First, we continue to see share growth across most of our brands. Second, both sales and earnings per share increased at levels ahead of our core growth objective and we were able to realize operating leverage. Third, our price increases have begun to offset some of the higher costs we have experienced and finally, our portfolio adjustments and our investments in supply chain initiatives are yielding results.

We understand that commodity costs tend to be cyclical and while we deal with the near term cost impacts, we will continue to manage for the long term and are confident our actions will provide future growth opportunities. Looking ahead, we confirm our long term sales growth goal of 8%, one half to come from our core business and new products and the remainder from acquisitions. Long term earnings per share growth would be in line with sales growth. We expect sales for the year to increase by approximately 4% over last year, excluding $100 million sale in sales related to the divestiture of our Canadian non-branded businesses. Despite the difficult cost environment, our goal remains to deliver earnings per share growth in line with our core growth objective of 4% over 2006 earnings of $2.65. The 2006 base excludes restructuring and merger and integration costs, the gain on the sale of Salinas, California plant and certain non-recurring tax benefits.

To summarize, first, we continue to execute our strategy to profitably grow our icon brands. Second, we achieved very good financial performance this quarter and third, although we remain cautious about the cost environment, we have developed good momentum and look forward to a successful completion of the remainder of the year. We thank you for your time today and now are happy to answer any of your questions.

Thank you, gentlemen. [OPERATOR INSTRUCTIONS] Our first question comes from John McMillin with Prudential Securities.

Good morning, everybody.

Good morning, John.

These gross margins were certainly better than I feared so it does look like you're dealing with the costs. I just want to get to the tax issue first because the tax rate did come in lower than what I was looking for and just in terms of your full year assumption, Mark, what is your full year tax rate assumption now?

John, the full year is 34.5.

Say that again?

34.5, which if you look at just the fourth quarter, it will probably be around 35% to deliver that number.

And before your tax rate guidance was a little bit higher than that; right?

Correct.

So to the extent, you're still estimating 4% growth for the year, I know Tim, when you said that, you said excluding some tax benefits. Are you talking about these tax benefits or are you talking about some other tax benefits?

No, John, we're actually talking about other benefits. Last year's results in specific to the fourth quarter, we had done a legal entity restructuring that resulted in a favorable tax rate so all we're doing is pulling, that was roughly $0.06 last year that we're pulling out.

Listen, I think the fact that you're doing your numbers even with a little lower tax rate is still a lot better than had you cut marketing and not had a quarter where selling, general, and administrative, you're supporting your business, so I don't want to make a big deal out of a couple cents, but it does look like you're maintaining your guidance with a little bit lower tax rate and I just wanted to kind of get that through. There was so much publicity yesterday tied to this competitors problem in peanut butter, I guess it's probably too early to assess the positives and negatives. I guess it can help you gain share, but it might hurt the category. Have you thought about it, what it means and do you make great value product, because ConAgra kind of acted like a lot of competitors make this great value product for Wal-Mart.

John, this is Richard and first of all as you pointed out this was not any of our brands. This was a plant-specific problem. We do not make any of the great value peanut butter. We just make our own brands which are Smuckers, Laura Scudder, Adams, and Jif, and it didn't affect any of those brands. We have thought of what this means. We never like anything to happen negative to the industry. In our case, our first concern is obviously the consumer, making sure we make safe products which we do, and how this affects us for the next quarter short-term is that it is affecting value. We've got a lot more orders from our customers wanting to fill the supply gap, but that will probably, hopefully that's at least for the industry short-term, and we don't know the exact impact of that, but we'll do our best to support the customers when they place their orders.

Thankfully things don't change much in Orville but around you things seem to change all the time, so now you're Duncan Hines baking competitor is changing hands, ConAgra's management has certainly changed hands. Just how would you describe the competitive environment versus a year or two ago? Is it more rational, less rational, or about the same or is it too early to kind of assess the pinnacle change?

Well, John, this is Tim. I'm off site, so I'm not in the room with the rest of the people, but clearly--.

I hope you're off site in a warmer place.

Well, clearly, we look at this from a long term perspective. We see these kind of changes all the time and we look for responsible marketers. As you know, our major focus is on our own business and being sure that we know our consumers and our customers, but I think it's too early to say anything significant here but I just think we're looking at the long term perspective of the business. I don't know if Vince or Richard have any other comments?

I guess I would just say we have the ut most respect for the changes that have occurred in the management of those two companies.

Exactly.

Well thanks for all of that.

Next we'll move on to Farha Aslam with Stephens & Company.

Hi, good morning.

Hi, Farha.

Congratulations on a good fall bake.

Thank you.

Could we just get a little bit of detail regarding your consumer businesses and your baking businesses? How much in terms of percentage of sales do you think is strategic focus versus kind of areas that are industrial that you're looking to downsize? If you had to make a pie?

Farha, right?

Yes.

Farha, this is Vince. Well, all of the consumers our businesses strategic. There isn't anything that we're de-emphasizing in terms of that portfolio from spreads, whether it be fruit spreads, peanut butter, or the Hungry Jack business. We did divest a very small brand earlier in the fiscal year but it was very minor, so, all of them are strategic.

Okay, and--.

Farha, hi, Steve Oakland.

Hi, Steve.

The Crisco business when we acquired it from Proctor and Gamble, had a pretty substantial industrial oil business that was an ex-proctor business literally attached across the property and contractually, we are still supplying them, but we've been able to take that business to its old process business which really takes the volume and the sales dollars out of our top line and we should be through that by the end of this Fiscal Year, so we still benefit from the overhead and that relationship but we take the volatility of those industrial businesses out of our top line long term and that's really, we experienced a pretty significant, I think Mark detailed the difference in this quarter in the oils business, the top line did not impact us bottom line and hopefully by the end of next quarter that will be behind us.

And next quarter can we expect a similar type move or is it seasonal like the retail business?

It's smaller, it's much smaller next quarter.

Okay. And then you guys talked a bit about commodities and I know you have a very good commodity hedging team. Could you kind of detail for us your various commodities, how much they're up in the market and how much do you roughly anticipate it to impact your P&L this year and looking into next year as well?

Well, this is Richard. A couple of things.

Sure.

One is, we hope is as these costs increase that we can pass those cost increases on as we experience them, there's usually a little bit of lag in that in terms of when we can do it and how long it takes to get the price increases done, but unfortunately, most of the categories that we're in, we're experiencing cost increases -- the biggest is corn right now. Corn sweeteners are up almost 50% over last year, cost of corn and the other soy. Soy is up significantly, and peanuts are up, and wheat is up and sugar is up. All of these commodities that we use, and that may be a paradigm shift based upon biodiesel and ethanol and meaning that we don't necessarily see these coming down any time soon. A lot of it has to do with oil prices, if the price of oil comes down to $30 a barrel or something like that I think you'll see all of these change again but I don't think anyone is predicting that.

And when you look at these costs, about how much have you passed on in terms of pricing so far and looking forward, about how much of a lag is there? Is there sort of a three-month lag or more?

I would say that it varies by category and depending upon your position in the market, I think as you know typically we would lead in some categories and we would not in others.

Yes.

In the case of the spreads business, for example, we've been able to pretty --. --

Sure, and I think that's clearly the case in oils and baking. In the oils business, we have a great market to hedge in and there's no, there's not been much of a surprise that these commodities have been under pressure, so between the hedging activity and our pricing activity as the leader, we've been able to maintain margins for the most part. In the Baking category, we're not the leader. If you look at the IRI data, we have customers or competitors, excuse me, that are growing more in tonnage than dollars in a record high cost environment so I think we've taken what the we can take. We were positioned as best as I think we could have been. Those markets aren't as easy -- flour and those things aren't as easy to buy forward as soy is, so we, I think are trying to manage within that environment.

Farha, this is Mark again. Just one last comment on the subject.

Yes.

We would estimate that this year, we're probably seeing costs of about $20 million or basically 100 basis points on operating margin from the higher commodity and energy cost and looking into next year, we wouldn't be surprised to see a cost increase of -- similar in terms of dollars, so and then I think I've made this comment on prior calls, but this is the third year of our IMC synergies and while the business has changed and the ability to track it dollar for dollar is a little more difficult, we feel that those synergies were recognized and did help out some of these along with the price increases.

Great. That's helpful. And my final question is kind of when you look longer term at this Company, what kind of margins are you looking for on the operating line and kind of what's your time horizon for those targets?

Well, I think that in terms of percentages they're probably consistent of what we talked about in the first. We feel the first objective is to get toward a pre-IMC level which is in the 13 range. Longer term -- and we really haven't put a specific time line on it but longer term as a medium-size to larger size food company, we think we should be in a 15% midteen range which is well below the large cap because we don't have that critical mass but much improved over where we are but that will come over time and as the business builds and we continue to see particularly a reduction in some of the raw material costs over time.

Great. Thank you very much.

Thanks. Next we will hear from George Askew with Stifel Nicolaus.

Yes, good morning.

Hi, George.

Hi. Let's see here. A couple of the questions are already covered certainly. You mentioned the organic supply constraint issue. Is that a short-term kind of weather related issue or are you simply seeing demand outstrip supply?

Hi, George, this is Paul Wagstaff and we're actually seeing demand out strip supply for the most part and again that's in our beverage business. I'll give you an example on Pomegranates and blueberries those items are very hot items right now and we're having a difficult time getting those products as well as organic apple juice, for example, and we think that's going to continue for a little while.

George to give you an example, organic apples used for juice stock cost us $350 per ton and for a regular juice apple, it's about $60 a ton. So the cost of organic is significantly greater.

Right. As you look at sort of the pipeline, I mean you mentioned that you think it will last for awhile, Paul, as you look at the pipeline of sort of in this case apple, organic apple trees coming along, can you one, convert existing apple grove, apple tree groves I guess into organic, or two, do you see a pipeline of supply coming?

Well, in order to convert a field to organic, it takes three years for that field to be basically be fallow, so the time horizon on bringing new stock online it just takes years, it takes time. We know that's being done in certain fruits and varieties, but again, it's going to be a few years before we go deep in supply.

Okay, and do you have, is there a market clearing price at which you can get the supply you need or is some of that supply locked up to others perhaps and you're just going to have to put customers on allocation?

For the most part, we're able to get the supply that we need. The challenge is at what cost and it is a significantly higher cost. All of our competitors that we're aware of are feeling the same pressure.

Right. This is kind of asking John's question a little differently or another bite at it but you're clearly, tax rate is more favorable this year than expected, so something has got to be offsetting that to give you kind of to maintain the same guidance. Is there something you can point to that's unfavorable versus a plan that's making you keep your guidance or are you just being conservative?

Well, I think, George, like I said, we looked at the cost increases for the year and you go back to last June when we gave our outlook for the year and these costs we're talking about are in addition, so as we said over the last two quarters, for the most part we've been able to deliver the result by raising prices and watching our administrative spend, but it really is the cost side, the commodity cost side that despite that and yes, we are having a little lower tax rate, we are still delivering our initial outlook.

And then just last thing, what was the sales contribution from the acquired brands, Five Roses and White Lilly?

In terms of dollars or percent?

Either one. Dollars would be good.

It's about 2.5% of the growth and for the quarter, it was -- bear with me just one second here.

Yes.

It's about $13 million.

Okay, great. And then I guess last question, are there any other sort of non-core businesses that we could see leave your portfolio over the next say year that would have a mix, a margin improvement due to mix shift?

George, this is Richard. I think we're pretty clean now. We've done a lot divestitures, probably six or seven in the last three years and we feel that what's in our portfolio now is our brands that we want to keep so I think we're in pretty good shape.

All right, Richard. Thank you very much.

Thanks. Next we will hear from Christina McGlone with Deutsche Bank.

Good morning.

Good morning.

Mark, I just wanted to clarify one of your answers to Farha's question. When you talked about cost next year increase, did you say they would be basically maintained at this level or they are going to increase another $20 million from what we've seen this year?

No. We're expecting an increase and $20 million wouldn't surprise us.

Okay. And I guess going back to the full year guidance, even on the top line, you say 4% for the year but year-to-date, we've had 5%. Does that -- are you expecting a slowdown in the fourth quarter or was that guidance just kind of maintained and you're being, again, conservative?

Let me explain. You're correct. We are at 5% once you exclude the divested businesses, but in our guidance we're addressing the $100 million of just the Canadian non-grain business that we sold. We actually, if you strip out the effects of the U.S. Industrial business between the two years, we're actually at 4% increase on a year-to-date basis, so our fourth quarter to hit the numbers will basically be inline with where we are through nine months.

Oh, okay. I see. And I guess going back, you're getting operating leverage. I'm wondering if marketing, if your plan for marketing spend for the year had increased relative to what you were forecasting when the second quarter closed?

No. I think last quarter what we said, Christina, was that we expected our marketing spend for the year to be relatively flat with last year. Having said that, if you look at it on the back half for this fiscal, we'll be up approximately 10% for the back half of the year over last year.

Just because of timing differences?

Correct.

And then if I look at cost of goods as a percent of sales, it was significantly lower than I thought so I'm thinking, if this is now a structural change because of that divestiture of the Canadian business, should we look at this that okay, there's cost pressures here but you're also, the price realization should accelerate so we should use this as a base to grow going forward that this is our new base?

Well, from a gross profit standpoint, I think what you're seeing now, whether or not it's the absolute one to forecast , I can't say that, but clearly, you're going to see this kind of improvement. Being a non-branded business as you can imagine, most of the cost was in the gross profit side numbers so again, I'm not going to quote a specific gross profit number but you will see improvement over historical numbers.

Okay and then I guess last question for Steve. It's not just the, I think, the increase in prices that is a concern but it just seems that we're in so much more of a volatile world now and I wonder if that impacts your hedging in any of the commodities, particularly soybean oil but any of them, because it just, things don't make sense. I mean at harvest time we had $1 per bushel increase in corn and that never happens, so I'm wondering if that has an impact on your hedging.

Yes. It -- clearly, it does. You can't use some of the historical models. The demand component of the model has changed. In most commodities, wheat happens to be a supply component issue. We had a bad wheat crop globally last year but in the energy related crops, corn and soy, you have to factor a new demand component and you really have to look at when are those plants coming online. We've got new Canola processing plants that can make biodiesel coming online next year so you really have to look at those variables as well as the typical supply demand, weather, et cetera, And the other issue is is theres so much managed money in these things. The bulk of the contracts are not held by people like us who take title and take delivery, so it's a different environment.

Okay, and actually I have one more question. When you, Richard, I think you said that corn sweeteners were up 50%. Did you mean corn or corn sweetener pricing?

Corn.

Just want to make sure. Thank you.

[OPERATOR INSTRUCTIONS] We'll move right along to Chuck Cerankosky with FTN Midwest Securities.

Good morning, everyone.

Hi, Chuck.

A question about private label. How are some of these higher costs putting pressure on some private label competitors? I guess especially in the organics they're just choosing not to play because it was supply but where -- can you kind of us a review where private label is having an effect and where they are just losing share as you strengthen the brands and improve the marketing spend?

Well, one area where private label has struggled historically is in baking. It's been so competitive with the three main brands with Duncan Hines, Betty Crocker, and Pillsbury and in that area, we have seen it even decline more over the last year. Candidly, we're surprised we haven't seen more pricing from private label in oils. It's probably to come. We just can only have to assume that. Does that help?

Yes.

Okay.

Thank you.

Next we'll hear from Ann Gurkin with Davenport.

Good morning.

Hi.

I think I heard you say you took a price increase on peanut butter and Uncrustables. Can you tell me what that price increase was?

Sure. Peanut butter is about 4% and Uncrustables was significantly more than that, 8 to 10%.

Okay, and then with respect to Uncrustables, is it still the expectation that that product line should be profitable in calendar 2007?

Ann, this is Paul and the answer to that is yes. Again, we're continuing to improve our profitability of the Scottsville in the overall venture and we would expect it to be profitable in 2007.

Great. That's all I have. Thanks.

Thank you.

And gentlemen, I will now turn the conference back over to you to conclude.

Thank you. Again, today, for your time and interest and have a great day.

Thank you.

Ladies and gentlemen, if you wish to access the re broadcast after this live call, you may do so by dialing 1- 888-203-1112, or 1-719-457-0820 with a passcode of 6495745 or by accessing the website for a downloadable MP3 format. This concludes our conference call for today. Thank you, all for participating and have a nice day. All parties may now disconnect.