J M Smucker Co (SJM) 2010 Q3 法說會逐字稿

Good morning and welcome to The J. M. Smucker Company's third quarter 2010 earnings conference. At this time, I'd like to inform everyone that today's conference is being recorded and that all participants are in a listen-only mode. At the request of the Company, we will open the conference up for questions and answers after the presentation. Please limit yourself to two initial questions during the Q&A session, and re-queue if you have additional questions. I will now turn the conference over to the Chief Financial Officer, Mr. Mark Belgya. Please go ahead, sir.

Good morning everyone, and welcome to our third quarter earnings conference call. Thank you for joining us. On the call from the Company are Tim Smucker, Chairman of the Board and Co-CEO, and Mark Smucker, President of Special Markets, who are joining us remotely. And with me this morning in Orrville are Richard Smucker, Executive Chairman and Co-CEO; Vince Byrd, President of our Coffee Business; Steve Oakland, President of Smucker's, Jiff and Hungry Jack; and Paul Wagstaff, President of Oils and Baking. 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 an overview of our outlook and closing remarks. At the conclusion of the comments we will be available to answer your questions. If you have not seen our press release it is available on our Web site at Smucker's.com. A replay of the call is available on the Web site. If you have any follow-up questions or comments after today's call, please feel free to contact me or Sonal Robinson, our Director of Investor Relations.

I would like to remind you that in both the prepared comments and during the question and answer period that follows we may make forward-looking statements that reflect the Company's current expectations about future plans and performance. The forward-looking statements rely on a number of assumptions and estimates, and actual results may differ materially due to risk and uncertainty. I invite you to read the full disclosure statements in the press release concerning such forward-looking statements.

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 on our press release and on our Web site.

Finally, as you know, the Folgers merger closed on November 6th, 2008, and as a result, this year's third quarter contains five additional days of operations from November 1st through November 5.

I'll now turn the call over to Richard.

Thank you, Mark. Good morning, everyone, and thank you for joining us. I would like to begin by summarizing the key financial highlights for the quarter. First we concluded a successful fall bake and holiday season in both the US and Canada. Our multibrand themed events took advantage of all elements of the marketing mix and generated a good response from our customers and our consumers. Second, volume was up 4% with gains in nearly all key brands in both the US and Canada. Third, margins were once again up with improvements across most of our businesses. Lower commodity costs and synergy benefits were the primary contributors. Fourth, non-GAAP earnings per share were up 34%. Fifth, these earnings resulted in cash from operations exceeding $320 million, a new record for the Company. And finally, our performance continues to confirm our strategy of owning leading brands sold in the center of the store.

Let me now provide some commentary on each of our four businesses, beginning with coffee. This quarter marked the first anniversary of the Folgers merger and a very successful first 12 months. We completed the integration and achieved our forecasted synergies, all in line with original expectations. The financial results exceeded all pro forma estimates and contributed to our overall strong performance. We're encouraged by our marketing initiatives, our new advertising and new products. For example, we will be shooting additional commercials for Folgers and Dunkin' Donuts coffee in the fourth quarter to add to those recently produced. We're also in the process of launching Dunkin' Turbo, which will build our presence and support our success in the growing gourmet coffee category. In addition, we expanded distribution and support of Folgers Black Silk which is receiving good consumer response.

Our pricing and promotion strategy, implemented in the first quarter, has been effective, offering consumers value on a daily basis while providing promotional support, as needed. This quarter, we continue to grow share as well as increase sales and profit in the coffee business. We are particularly pleased with our efforts to revitalize the core red can, our number one priority, and these are showing good results. The Folgers brand contributed most of the volume increase, while Dunkin' Donuts coffee realized double digit growth. Our sales of Dunkin' Donuts coffee have now exceeded $225 million on an annual basis.

Also, as you may have seen this morning, we are pleased to announce we have entered into a multi year manufacturing and distribution agreement with the Green Mountain Coffee Roaster Company. This agreement will enable Green Mountain to manufacture single-serve K cups using coffee beans roasted and blended by Smucker's for our Folgers Gourmet Selection and Millstone brands. This will enable us to participate in the fastest growing single-serve brewing system with Keurig single cup brewers. As the leader in the coffee category, our goal is to participate in all segments of the business. Although the single serve segment currently represents less than 5% of total at-home coffee, it is the fastest growing segment in the category. Our agreement with Green Mountain allows us to market and sell the Folgers Gourmet Selections and Millstone K cups to consumers in the US and Canada through grocery, mass retailers, drug stores and club channels.

Our initial plans are to provide a variety of six offerings nationally. These products will be available toward the end of this year. We are excited about this relationship and the opportunity to enter into this fast-growing segment.

Turning to the Consumer segment, marketing increased 14% in the quarter, with activities across all communication channels, including new advertising for our Smucker's and Jiff brands. Volume was up across most categories with gains in pancake mixes and syrups, peanut butter and fruit spreads. Net sales in consumer were impacted by increased promotional spending, mix of product sold and selective price declines.

Our Oils and Baking segment delivered volume growth led by the Crisco and Pillsbury brands. A combination of new products, merchandising programs and marketing investments contributed to a solid fall bake. Dollar sales for the segments were down as expected, primarily on price decreases taken last year in various categories and higher promotional spending.

Finally, sales in the Special Market segment increased 8% in part due to favorable foreign exchange and five additional days of Folgers. The Export and Food Service Coffee categories and the Natural Foods area all achieved volume growth. In addition, volume gains were realized in Canada, primarily in the baking and spreads categories. Canada's fall bake was very strong, the best in many years. During the quarter, Robin Hood, an iconic Canadian brand with a strong heritage, recognized its hundredth anniversary. In celebration, we set up several Robin Hood branded bake shops and invited families to prepare easy and fun recipes. This public relations effort received substantial media exposure and, more importantly, demonstrated our commitment in helping consumers create memorable meals and moments.

In summary, we delivered another record quarter with record financial results, affirming our strategy of owning the marketing center of the store, number-one food brands. This fall bake and holiday period marked the first time we were able to include the Folgers brand in our planning and execution, and we were pleased with the results. The addition of Folgers elevates our family of brands to a higher profile and positions us to meet the needs of both consumers and our retailers.

I would now like to turn the call back over to Mark and have him review the financial results for the quarter.

Thank you, Richard. Sales for the quarter increased $23 million or 2%. Excluding the additional coffee sales and the impact of foreign exchange, sales decreased 2% for the quarter. Overall, volume was up 4% but was more than offset by a 6% decline due to pricing mix with price, including promotional spending, the key driver. In certain instances we chose to increase trade spending in order to pass along decreases in commodity cost, which may not be sustained rather than taking a permanent price list reduction.

GAAP earnings per share were $1.14 this quarter and $0.68 in the third quarter of last year. Excluding charges, earnings per share were $1.17 this quarter and $0.87 in last year's third quarter, an increase of 34%. Last year's results include a number of factors which make quarter-over-quarter comparisons a bit more difficult. Items specifically related to Folgers included unfavorable inventory revaluation adjustment of $12 million, additional promotional expense and a difference in the recognition of marketing expense between the third and fourth quarter. Also included in the third quarter of last year and partially offsetting these negative amounts related to Folgers was the favorable impact from the reversal of mark-to-market charges related to non-qualifying commodity instruments. You may recall the mark-to-market charges were originally reported in the second quarter of last year.

Operating income increased $46 million for the quarter, excluding charges, an increase as a percent of sales from 14.3% to 17.8% . We realized noncash impairment charges of $10 million this quarter related to the write-down of certain intangible assets, primarily the Europe's Best trade name in Canada. This impacted margin by approximately 80 basis points. Gross profit increased $57 million to 38% of net sales from 33.9% last year. Much of the improvement is attributable to Folgers including the impact of lower green coffee cost and the extra five days of business. In addition, last year's gross margin was impacted by the inventory adjustments I noted earlier. Lower costs of raw material and freight across all of our businesses also favorably impacted this quarter's margin.

SG&A expenses increased approximately $3 million, but decreased slightly as a percent of net sales from 17.9% to 17.8 %. Marketing decreased in the quarter primarily due to the recognition of Folgers marketing expenses between the third and fourth quarters of last year. We expect marketing expenses for coffee and the total Company in the second half of the year to be higher than last year resulting in significantly higher marketing expenses in the fourth quarter. During last year's third quarter, the organization and shared service structures necessary to support the combined businesses was not yet complete. As a result, this year's general and administrative expenses are higher, reflecting the full model to support the coffee business and the larger company. In addition, pension and other employee-related benefit expenses increased.

And finally, the current year included approximately $2 million of cost associated with the pending closure in April of 2010 of our West Fargo, North Dakota plant. Another $2 million to $3 million is expected in the fourth quarter. This plant currently manufactures a small portion of our Uncrustables product, which will be transitioned to our Scottsdale, Kentucky facility. The effective income tax rate for the quarter was 31.3% reflecting the impact of reduced effective tax rates in Canada compared to 31.8% in last year's third quarter. This brings our year to date rate to 33.7%. We continue to anticipate a full-year tax rate of approximately 34%.

Let me now provide details on our four segments. As you may recall, last year's third quarter coffee results for Canada were included in the US retail coffee segment. We have reclassified last year's third and fourth quarter segment results so that coffee is accounted for in the US retail coffee and special market segments consistent with fiscal 2010. The reclassifications for both quarters are included in our press release. As reported, sales for the US retail coffee segment increased 9% in the quarter, including the five additional days. Volume increased approximately 4% compared to the same three-month period last year, that is, November 1st to January 31st for both years. Coffee segment profit increased 62% and margin improved from 21.3% to 31.5%. Last year's margin was lower due to the merger related inventory valuation adjustments and the recognition of marketing and promotional expenses between the third and fourth quarters, as previously noted.

This quarter's coffee margin again benefited from favorable green coffee costs, although to a lesser extent than the first two quarters of this year. This benefited is the primary reason coffee margins exceeded the long-term margin expectation of 30% plus this quarter.

In our US Retail Consumer Segment sales were up 1%. Volume was up 4% with gains in pancake mixes and syrups, peanut butter and fruit spreads. Volume gains were mostly offset by higher promotional spending, product mix and price declines on selected items, notably ethnic flour and red and black raspberry fruit spreads. Segment profit increased 6% mainly due to lower raw material and freight costs, which were partially offset by the higher marketing spending. Segment margin improved by 110 basis point compared to last year's third quarter.

In the US Retail Oils and Baking segment, sales declined 12% compared to last year, reflecting the impact of price decreases taken last calendar year and higher promotional spending across the segment. Volume was up 3% primarily led by the PIllsbury and Crisco brands. These gains were somewhat offset by modest declines in canned milk. Segment profit declined 17% mainly due to the inclusion last year of the reversal of mark-to-market charges for commodity instruments. In addition, a higher portion of sales sold on promotion in this year's quarter and product mix contributed to the decrease.

Sales in the Special Market segment increased 8%; but excluding the impact of foreign exchange in the additional Folgers sales declined 1%. Most categories in Canada achieved volume growth as did our natural foods and export businesses. Food service portion control volume declined, which is still generally attributable to the current economic environment. Overall, volume in the segment was up 6%. The impact of volume growth was more than offset by mix and increases in promotional spending. Profit in the Special Market segment was again strong, increasing 53% for the quarter primarily due to lower raw material costs and a higher percentage of coffee sales across the segment compared to last year. Margins improved from 12.6% to 17.8%.

Let me conclude with comments on other financial metrics. EBITDA, excluding merger related costs and adding back share-based compensation expenses as amortization was $267 million or 22.1% of net sales. Through the first nine months of the year, EBITDA was $790 million or 22.3% of net sales. Cash from operations in the third quarter was a record $323 million, bringing the year to date total to $509 million. With capital expenditures of $113 million, our nine-month free cash flow totals nearly $400 million.

I would now like to turn the call over

Thank you, Mark, and good morning, everyone. We're very pleased with our financial results for the first nine months of the fiscal year. And as a result, we are comfortable again raising our outlook for the year. We anticipate income per diluted share, excluding merger and integration costs, in the range of $4.02 to $4.07, an increase from our previous range of $3.95 to $4.05. Amortization of $0.40 is included in our forecast. Excluding the amortization, our new forecast is $4.42 to $4.47 per share. These earnings are based on a sales range of $4.5 billion to $4.6 billion.

Our forecast for the year includes the impairment charge of $10 million or $0.05 per share that we recorded this quarter. Based on the expanded guidance range, we anticipate our adjusted EBITDA, excluding merger and integration costs, will approximate $1 billion. Importantly, we remain committed to our long-term strategic objectives of 6% annual sales growth and greater than 8% earnings per share growth. Although we normally do not comment on quarters, our outlook for the year obviously forces a range of earnings for the fourth quarter. As we stressed in both our first and second quarter calls, this year's fourth quarter results will be less than last year, which was exceptionally strong. Mark has commented on a few of these items, but to summarize, last year's fourth quarter was higher than the third quarter, contributing 55% of the second half's earnings per share. We do not expect this weighting to recur.

The shift in marketing expenses between last year's third and fourth quarter will result in incremental marketing in this year's fourth quarter of approximately $20 million. Coffee margins in last year's fourth quarter and the first half of this year far exceeded our long-term target, primarily due to favorable green coffee costs. Although still favorable, the additional contribution from lower green coffee costs will be less. And finally, costs in the baking category are up significantly from the fourth quarter of last year, particularly sugar, cocoa and milk. In response, we have announced a price increase of private label milk which will become effective later in the fourth quarter and are considering other pricing actions. However, any future pricing actions are not expected to impact the fourth quarter.

So in summary, first the addition of Folgers contributed to a strong fall bake and holiday season. Second, we are pleased with our financial performance, including the significant generation of cash. Third, we have again raised our outlook for the year. And fourth, our performance continues to confirm our strategy of owning leading brands in North America in the center of the store. And finally, we want to thank our talented team of all of our employees throughout the Company for their tremendous efforts.

Thank you for your time today, and now we're happy to answer any of your questions.

Thank you. (Operator Instructions). And our first question will come from Eric Katzman from Deutsche Bank.

Good morning, everybody. The cash build here is pretty remarkable, and I've heard reports from some other companies that they -- somebody told me that Ralcorp, for example, had felt okay to buy back stock even within the two-year restriction. So I'm wondering if you can just comment on that, if that same approach could apply to you. And if not, where do you think the board goes with the dividend or the use of cash over the next couple of quarters?

Eric, this is Mark. I'll start, and then I'll have Richard answer the second part of the question. The rules under the Reverse Morris Trust do allow for repurchase. It's obviously situational. The way that our agreement was with Procter is such that we are holding to the two year window. Of course, that's only eight months out basically. I think we've commented before, we have a little under 4 million shares already authorized by the board. So if the situation is appropriate at the time we could enter the fourth quarter. I think have commented in the past, we were fairly active in the time leading up to the purchase of Folgers. So we certainly will reevaluate that, but not to expect to do anything from a repurchase until November.

And, Eric, this is Richard. On your second question regarding dividends, as you know, our board reviews our dividends each quarter, but it's historically our fourth quarter of the year that we look at increasing those, and that meeting's coming up in April.

Okay. And then just as my follow-up, maybe to Vince, you announced the single serve agreement with Green Mountain. Can you just give a sense as to what you think that means, and is that a margin accretive deal to the extent that you're already producing pretty high margins in coffee as it is?

Sure, Eric, let me back up. I think it's fair to say that we continue to get the question asked about how we think about the single-cup space, and I think our standard answer to date has been, as a market leader in any product category, we like to participate in all segments. We also are a company that likes to dot the i's and cross the t's. We took time over the past 12 months or so to really evaluate the landscape, both domestic and internationally. Several months ago basically concluded that we believe Green Mountain and Keurig was the right partnership for Smucker. I think you all know through their filings they are the leader in home brewers. Their growth rates have been significant. I believe they were public in their recent quarter that they sold about 650 million K cups, and they have a very, very high consumer appeal.

In terms of what we believe we can bring to the party, we believe that leveraging our marketing, selling, distribution and all of our brands will not only be good for Smucker, but more importantly, will help grow the overall category, and really provide a channel for consumers to purchase K cups because a significant amount of them are not purchased in what we would consider our traditional retail channels. And so long-term we hope that it will contribute to our strategic growth objectives. Given the fact that we will be launching later this fiscal year, and clearly, Eric we'll be investment-spending in the brand, there will be a margin hit as with launching any new product, but long term, I think it's fair so say that once the marketing normalizes it will not be dilutive to the Company.

Okay. I will pass it on. Thank you.

And next we'll hear from Ken Goldman with JPMorgan.

Good morning. Just a little more color, if I could, on Green Mountain, and forgive me if it's in the press release, but the exclusivity. It seems like you can't use another single-serve brewer if you wanted to, but I'm curious about the exclusivity in terms of whether Keurig is allowed to also use Maxwell House, for example, in its single-serve systems.

Hi Ken, Vince. I don't know that we want to go into those details, but I think you'll probably know that they have their own system that's been in the marketplace for a number of years. And maybe I'll just leave it at that.

Okay. And then my second question, it's always dangerous looking at AC Nielsen data, but I'll take that risk. According to AC Nelsen in measured channels your SKUs are down in Folger's some 10% to 15%, which is normal given the economy and what's happening. If this is accurate, when does this lap? Because if you look at your velocities and you look at your distribution, they've both been pretty impressive So it's possible and I'm curious what your comment is, that maybe sales are artificially low because you've taken some SKUs out and that when you lap that things will look even better. Is that a fair assessment, or not?

Your first comment is the most important one. It's risky looking at the data you have available to us. I would not say that our SKUs are down significantly. We have clearly shifted some emphasis to within the category; but if you look at the O&B period or the last quarter, clearly the category is up. We grew share during that category in both our core red can and led by Dunkin'. As you know the challenge that we have there is Millstone, so maybe that's being driven by Millstone. I'm not exactly sure. So overall we feel very good in where we're positioned right now, Ken.

Okay. Thanks very much.

And next we'll move on to Farha Aslam with Stephens.

Good morning. Can you comment on the mix changes that you spoke about? Do you see that continuing? Comment on the consumer and how the consumer is feeling regarding trading down to more basic products? And what will cause them to trade up again?

Hi Farha, Steve Oakland. I can comment about mix change in consumer. There's two things. Earlier in the year we did see in the fruit spread business particularly the consumer trade from our more premium items, the Simply Fruit or low sugar or sugar free into traditional fruit spreads. We were frankly pleased that we saw some of those segments come back in the quarter. I don't know that we can say that's an economic indicator, but we saw people come back to those better for you segments or higher cost per ounce segments.

Frankly in consumer we had a great period in pancakes and syrup. Given the seasonal time and the promotional strategy behind it, the tie-ins with coffee, we had a great Hungry Jack period. That did drive some of our mix change. And what happens there is that, as you can imagine a box of pancake mix on promotion is $1.99, but it's a lot of tonnage. So although the margins are good, and you can see that in our segment reporting, we did move a lot of tonnage in those categories, which causes the impact of high tonnage and lower net sales.

Farha, this is Paul. On the Oils and Baking side, I'd point out one mix change that we saw and that's really on the flour side of the business. We saw significant growth in flour over the O&B time period, and that's a little less margin item than some of our other items.

And maybe as a follow-up, could you just share with us promotional trends as they went through the quarters versus what you're seeing today? Have you seen any mitigation of promotional pressure as the quarter continued?

Let me start, and then I'll turn it over to Paul and Steve. From a pure coffee perspective, the strategy that we implemented in our first quarter, reducing our trade spend and putting that into everyday price I think we would deem as a success at this point. We clearly got some very good merchandising during the holiday bake period. But net-net we're very comfortable with where our pricing is. The second comment I would make, though, is that many of us just came off a recent retail industry event, and clearly our customers are driving price points on leading brands that are not necessarily funded by manufacturers, and using them to increase the foot traffic, and so they may be taking little or no margin on our brands. So I would just make that comment from a macro perspective, and then I'll turn it to Paul and Steve.

Hi. Paul here again. On the oils and baking side, on the Crisco oil part of the business, we did not take our price down, our list price down starting in the first quarter of this year. Instead what we did is we chose to spend those additional dollars and basically give that funding back to the retailer in the form of promotional spending instead of price declines. So that's what we have been experiencing this whole year so far.

Farha, Steve. And then in the consumer business, the trends that Vince talked about, the retailer wanting some hot price points on their front page, and if you think about a year ago is when peanut butter experienced the tough times with the PCA recalls. Peanut butter was a very competitive quarter. I think everybody saw opportunities to lap pretty soft numbers in the previous quarter. There was a lot of peanut butter promotion activity during the quarter driven by the manufacturing community and I would argue driven by the retailer.

That's very helpful. Thank you.

Your next is from the line of [Jane Galfon] with Barclays Capital.

Good morning. As we look at your margins in the quarter, they were approaching 19% on a clean basis once you take out the impairment, and looking across the group that's certainly at the top end from a benchmarking standpoint, well above that 15% target you laid out a couple of year ago. And I know you've mentioned in the past that you're working through the core to find out where more opportunity may lie from here, and perhaps you'll talk about that more as the fiscal year comes to an end, but for now we'd be curious to hear your thinking in how you strike that balance between keeping the margins high at the attractive levels they are currently versus making sure there's enough flexibility there to fund the core and keep it growing?

It's Mark. It's a good question, and I think that what I would say -- and I think it would be reinforced by everybody in the room is that being in the game for the long term, we will take opportunities to reinvest to the brands. We've obviously this year had the luxury of the profitability of coffee and the overall lower commodity costs to do that pretty significantly across all of the businesses. But at some point our view is that commodity costs will tick back up, and as a result, we'll have to continuously look across the organization to find productivity gains and the like. I know we say this every time, but it is the way we operate, is that our businesses, our presence are all charged with identifying those opportunities. Again, now that the Folgers integration is basically complete and as we head into fiscal '11 that's what we're going to focus on. It doesn't mean we're not going to look for acquisitions or do anything differently, but we can focus our attention on those areas and that can cross production, it can cross the administrative functions and all the way across supply chain.

Thanks. Maybe as a quick follow-up and a little closer in, even though you may be working on the longer-term opportunities on productivity, we know that margin expansion is never a straight line. The environment is clearly challenging economically. Everyone across the industry is starting to spend back more in promotions. Obviously the commodities have bounced off recent troughs. So maybe as we look out over the next four quarters, I know you don't have a crystal ball, but how do you think about how margins are likely to trend more near term versus the longer-term vision you may have?

I guess what I would say just to your opening comment, clearly our margins are high in the industry, but we believe a lot of that comes from the acquisition strategy we followed and the strength of the brands and the interaction the brands play. Cost we think, if you look across, are ticking up a bit. So we will evaluate that, and if necessary, take pricing actions to try to maintain that. But in the short term, and we'll have more to say on this in June when we talk about FY11, but in the short term we'll continue to try to guard the margins, but, at the same time, for example, in the K cup space, we'll invest as necessary.

Thanks very much.

And next we'll hear from Chuck Cerankosky from Northcoast Research.

Good morning, everyone. Alex Bisson and I are both here, and we've got some questions.

A couple questions for you. In the press release, you indicated you're looking forward to additional opportunities. I suspect one of those was K cups. But what else is behind that? does that mean innovation, acquisitions, or something else?

This is Richard. I think it probably means all of those. We're always looking for more opportunities, but primarily I think it was the K cup in the short term. But we're also looking for new products, and we have a number of new products that are being launched and about to be launched, so that's what that meant.

Okay. Given the inclusion of K cups, does that help or alter your go to market strategy for institutional coffee sales?

No, it does not, because we actually only have the rights for the product in what we would consider to be our traditional grocery, retail, club mass channels and not in the food service or office/home space.

All right. And then maybe one more from me. Could you talk about Europe's Best and why the impairment charge?.

Yes, I can take. This is Mark Smucker. Basically I think Mark alluded to there was a $10 million number. It's somewhat less than that, it's probably in the $8 million range in terms we had a large -- one of our key customers in Canada that basically went out and bid their private label business, bundling that with some of the branded products. And the competitor was awarded that, and so although we had lost some of the items in that customer, we were able to retain and expand our frozen vegetable business, because the losses there on the SKUs were mainly on fruit. But we do believe, going forward, that we have an opportunity in the future to recapture at least a decent portion of that frozen fruit business. I don't know, Mark, if you want to elaborate.

Just to close the accounting loop on that, that event where that loss of business, in our opinion, it triggered what's called a potential indicator of impairment. So we went through the accounting requirements and basically valued the business, and when we looked at the fair value of that trademark versus what it was on the books for that's what caused the impairment charge. So right now, we don't think there's anything, based on the current business environment, that would require us to take an additional charge, but that's how the accounting was taken care of.

And then finally, if we look at the Uncrustables business, how are trends there shaping up, and what's that telling you about the consumer?

This is Mark Smucker again. Just overall I think the business, we still feel very good about that business, and the food service side, anyway, we are seeing that our business versus last year in the quarter is up in schools. And part of that is driven by the launch of our waffle product, so with a combination of both the sandwiches and the waffles, we're seeing good trends, and more importantly as well, the profitability of the business continues to inch up. We're pleased with that.

Profitability as measured in return on sales, or in dollar operating profits?

Mostly dollar operating profits.

All right. Thank you.

And if we look at uncrustables in retail, I spoke earlier about the PCA recall a year ago. If you remember, a lot of the media on that was about it being ingredient peanut butters that were problems, and although our items were not involved in any way, we think it did hurt Uncrustables a year ago. So we're pleased to see Uncrustables volume actually up in the third quarter. So we think we've got that behind us, hopefully the economic conditions behind us a little bit, and feel good about it going forward.

Next we'll hear from Alexia Howard from Sanford Bernstein.

Good morning, everyone. Just a couple of quick ones. Am I right in thinking promotional activity was up fair significantly in coffee this quarter? Is the plan to continue that into the fourth quarter, or do you expect to see some moderation there?

Again, I would not say that coffee promotional activity was up significantly in the third quarter. You have to take into account the pricing and promotional strategy that we put in, implemented in the first of the year. There's a lot of noise going on because of price decreases primarily and then, of course, we increased Columbia early in the year. But net-net our trade spend was not up during that period. And then, as you dial that forward to the fourth quarter, it will not be as deep as it was last year, because again, we hadn't enacted what we call our pricing promotional strategy that we implement in the first quarter. But I would say we got better quality merchandising during the third quarter than maybe was done last year.

Great. And then just one quick follow-up. You quantified the marketing spending increase in the fourth quarter as $20 million. Are you able to quantify the reduction year-on-year that happened in the third quarter in dollar terms?

It would be, to the total Company, about $10 million.

All right. Thank you very much. I'll pass it on.

We'll move on to Mitch Pinheiro with Janney Montgomery, Scott.

Good morning. Two questions. First around the Green Mountain news. So when you studied the single cut market over the last year, how big do you think single cup could be in the at home channel, say, in three years or five years?

That's a very good question, and I really wouldn't offer a guess at this point. I think, if you look at the growth that Green Mountain is public with, it's probably a good indication, but as you know it's grown very very significantly over the last several years. But it's currently a relatively small category when you compare it to the overall category, particularly at traditional grocery or mass. But again, we believe we can help fuel that growth and provide another avenue for the consumer.

Okay. And then curiously Dunkin' Donuts was not included in this agreement at the moment, if you could comment as to why. Is it perhaps because you don't own the brand, or I'd love to understand that, and also understand, I guess it's not your red can business. Is that a demographic issue?

Yes. I think it's, we just have to start somewhere and we chose to focus on our two gourmet brands of Folgers Gourmet Select and Millstone. Obviously we have a very, very solid relationship with our friends at Dunkin' Donuts and our business continues to flourish there, but our initial offerings are going to focus on our two brands.

So it's not out of the question that you could have Dunkin' Donuts in K cups at some point.

Our initial focus will be on our two brands.

Okay. And finally just relating to guidance, if you look at your sales guidance, that would imply a fourth quarter range of flat to maybe down 10%. I'm just not sure why the down, if you could talk about the down 10% part of the range.

Yes. This is Mark. I think, first of all, last year in the fourth quarter, I know some of you guys are new to us so you may not be as familiar with this, but last year's fourth quarter was an extremely strong coffee quarter. The business overall did well but coffee did extremely well. It was our first promotion around the Easter holiday. We just had a blowout quarter. So we expected to be down. I think probably if you just do the math, which it sounds like you're doing on the 10%, it would be a volume decline, but probably incremental spending to get to that point would push it down to that, although that would not be our expectation to be negative 10.

Okay. And on the earnings per share, the implied, just backing out the three quarters, I hope my math is correct, but $0.88 to $0.95 would be the range for the fourth quarter? Am I doing the math correctly there?

That seems too high. We were at $3.30 for the year to date. So it would be more in the mid to upper 70s.

Excluding the $0.17 to $0.19?

Yes.

So if I add that back in --

Yes.

Mid 70s.

Yes. If we just talk about what we call non-GAAP earnings we're at $3.30 through the first nine months and then the high end would be $0.77 to get to the $4.07.

Okay. Thank you very much.

We'll hear from Scott Mushkin with Jefferies.

Hi, guys. Thanks. I have a few questions here. So just quickly on the fourth quarter, and I know there's a lot of noise and it was a blowout fourth quarter last year, but one of the things that struck me was volume growth in the third quarter accelerated a little bit. Are trends the same in the fourth quarter so far? Could you maybe speak to that just so we know how the base business is doing.

No, they would not be the same. Clearly we're projecting to have a volume decline in the quarter. Again, part of it driven by the coffee. But no, we are seeing, as expected a planned decline.

Okay. So that's expected. And you attribute that, Mark, to some great numbers that came out of the first promotional activity in Easter? Did I get that correctly?

That's exactly right. Just to be clear, when I say "down," down to last year's fourth quarter.

And that's specifically in coffee? The other business you're not expecting that, or you're expecting that through all the businesses?

Generally we expect Oils and baking will probably be down some, but I think, otherwise we're expecting to be reasonably flat.

This is Richard. Our business is still sold. There's not a change in how our consumers are buying or spending. Our business is still very solid. It's just the fact that last year's fourth quarter was abnormally strong. So we don't see any change in the general economic conditions.

Just to frame things in, for what it's worth, is that one of the comments we made, I believe it was our lead-in to the fiscal '10 last June, is that we categorized our sales and we said about 55% to 60% of our sales for the total year would fall in the second and third quarters and the remainder obviously in the first and fourth quarter. Based upon our projections that we have provided as part of our outlook, we're basically seeing that 55% of our sales are falling in those two quarters. So we're pretty much in line with what we expected from a dollar sales perspective.

So you're not seeing a big change in competitive activity or anything that's driving lower volume expectations? It's purely because of this looking at your own numbers year over year.

That is correct.

Okay. I want to dive into something that Kraft said and understand coffee as we move forward. Kraft said we had a tough quarter in coffee, and they actually threw it all at you guys. Getting promotional. I guess what I would say -- my question to you is, number one, you seem to be gaining a lot of market share. It doesn't seem to be coming because a lot of promotional or unsustainable promotional activity so what do you guys attribute the market share gains to, the number one reason, and is it sustainable?

Let me reinforce a couple of things, and yes, we obviously did hear that comment. It was brought to our attention. I think, in a macro sense, you can say that period, we had basically owned the business for still less than a year, but it's the ability for our sales and marketing team to leverage the Folgers and Dunkin' brands with our other iconic brands. And as we said previously, it gives us the opportunity to maybe get on the front page of the ad or it might get us display activity that we might not have been able to historically. We're honestly a little perplexed as to the comment, because even though, when our team looked at the numbers, our quality merchandising was clearly up, and our competitors' price points were not as low as they may have been last year, but for the most part, they were slightly to significantly below our price points. And so we're not sure that we understand the comment.

As I mentioned earlier, there were instances where we did not fund the pricing as our retailers chose to use Folgers, or in the case they have used our competitors' brands to drive foot traffic to their stores to make sure they're competitive within their respective marketplace. But net-net, we're very pleased that our promotion and pricing was executed within our guidelines and with very, very few exceptions. We obviously will have learnings, but we feel we're in a good place, and it is our objective to grow share long term.

And do you think you're gaining shelf space at key retailers? Is that something that's happening and can be sustained?

There's always opportunities. Probably the biggest one is that with the Dunkin' brand, we have less than a third of SKUs of the main competitor, and yet we have the number one, and three of the top five SKUs turning in there, and so we believe there's opportunities for incremental shelving or facings, I should say, of particularly Dunkin'. And also, I would just add Black Silk, which was referred to earlier, was a major emphasis of ours. We think it's a great product. We've put a lot of marketing behind it and we grew ACV of it, as well.

Getting back to the dividend question on the cash build you guys are seeing, I do think you have said a 40% payout ratio is what you're targeting. When you look at that ratio given the big spread between cash earnings and GAAP earnings what's the number we should be focused in on there. And then I had one more with the K cup, if I could, a half a one.

Yes. I would say we have typically paid 40% of our GAAP earnings over time. For the longest time there really wasn't a difference, and I think this is one of the discussion points we'll probably go through with the board, because, as you suggested, the difference between particularly a GAAP number and something more that represents a free cash flow or earnings per share. I think it's more likely than not, though, that it would be probably around our non-GAAP earnings per share. That's what we report to the street. But it will be something we will take under advisement with the board.

As far as looking at this K cup investment is it going to be so substantial that we could get flat earnings as that happens or is it not going to be to that level?

No, no, absolutely not.

Okay. Thanks for letting me ask so many questions.

We'll hear from Ed Aaron from RBC Capital Markets.

Good morning, everybody. I wanted to go back to Scott's question on the competitive landscape in coffee and the comments from Kraft. Have you seen any meaningful change more recently? The January retail data, looked like some of the share had shifted a little bit more in their direction, and just wondering if you're seeing any type of competitive response from your main competitor there that has you at all concerned?

As we all know, month to month there's going to be activity from all of us in the category. Probably the biggest news is that I think you're all aware they chose to follow us on our promotional pricing strategy that we implemented in the first quarter. So that was implemented, or is being implemented in the January time frame. If you look at a major customer, they're back on deal at a level that they were pre-holiday, and so there's a cycle there, and I would just again say that it's below our pricing promotional guideline points. But any one month we can always point to each other and comment about who's on deal and who's not on deal, but we feel comfortable where we are.

Thanks, and my follow-up just on the K cup opportunity, I was just hoping you could help me understand the brand positioning around that. I know you're using Gourmet Select, which is your premium product within Folgers, but K cups are generally $0.50 a serving. Folger's as a brand on average is something closer to $0.05. So even using a premium product it seems like the brand price point, that proposition is a bit different from what you're accustomed to. Just curious to get your thoughts around how you're managing the positioning around that so that the consumer has a clear message of what Folgers stands for from a price/value perspective.

Again I think between Folgers gourmet Select and our Millstone, which is premium coffees, we feel it fits very nicely with the category. And again, what we're bringing to the party is not only the leading brand. You can debate whether a consumer distinguishes between Folgers and Folgers Gourmet Selection. We are bringing a leading brand to this category, the first national brand to be involved, and we're bringing choice, we're bringing another opportunity for a consumer to fulfill their needs and hopefully grow this category working with Green Mountain. And we believe that this is a segment that we need to participate in, and feel very comfortable with where our initial efforts are.

Thank you.

Next we'll hear from Ian Vicino with Oppenheimer.

Hi. Thank you. Just as far as the Green Mountain deal and the Dunkin' agreement, do you have the right to go out and use Dunkin' in a K cup format, or do you need Dunkin's permission to do so? And on the other side of it, does the agreement you just struck permit you to begin to use Dunkin' in K cups, as well, or do you have to strike another deal with Green Mountain?

As I commented earlier, we prefer not to get into those details at this point. I think, again, we're very excited about being able to enter the relationship and, again, the initial effort will be against our two brands that we own, but we prefer not to get into the details of either agreement.

Okay. And then just on a different angle on the agreement, it looks like both you and Green Mountain will be distributing and marketing these products. Is there a certain area where you're going to be doing it in, where you have the grocery stores, they have the food service? Or, how do the economics vary between the two?

Let me be clear. We will be marketing and selling the products, our products, in traditional grocery, club mass channels. They will not be marketing our products in those channels. They will have the right to sell them online through their Web site, et cetera, but for the most part, you need to think about it is we are the ones who will be marketing those brands, our brands.

And it is our coffee.

It is our coffee.

We supply the coffee, the roasts, the blends, so it's our coffee, they put it in the cups for us.

They're manufacturing it for us and then we'll distribute it.

Given your history of really staying in the traditional channels versus food service, and (inaudible) to be much more food service oriented, how do you plan on going about attacking this new area for you?

First of all, I'm not sure I would say it's primarily a food service opportunity. But again, our agreement does not contemplate the food service or office channel. We do not have those rights.

Okay. All right. Thank you very much.

Next we'll hear from Eric Serotta from Consumer Edge Research.

Good morning. You guys have made pretty clear in the past that you expect acquisitions to account for over time on average about half of your long-term top line and EPS growth goals. Just wondering with you having not announced any acquisitions recently, and I realize it may be a little bit early for 2011 guidance, but you made a comment in the press release that you reaffirmed your long-term guidance. Do you think you'd be able to hit that in 2011 without any acquisition activity?

Eric, I think the purpose of that statement is, as we've reinforced over time, is that really is our strategic objective over a time frame, and although I understand the question and the natural tendency to just want to extend that to the next year, I think we really do want folks to focus on that. And then specific to FY11, I think we would just defer to June when we'll have much more details to go through from both a top line and earnings outlook.

Okay. And then in terms of the acquisition environment, any comments on how the pipeline looks? And how, whether the organization, having now digested Folgers, or had Folgers within the fold for about a year, whether you think the organization is ready for another acquisition yet or whether you need a bit more digestion time, because it certainly looks like the balance sheet is in shape, given the debt pay-down over the past quarter or so.

Eric, this is Richard. Acquisitions, as you know, are kind of lumpy. The way we describe it, we have our lines in the water all the time, and we're just not exactly sure when the fish are going to hit. I think your second question is are we acquisition-ready. I would say it's been 12 months. I'm looking around here. Everybody is finally catching their breath. So I think if we found the right thing, we could do it now.

Okay. And then, lastly, turning back to a comment in the press release and in your commentary about lower green coffee costs in the quarter, maybe I'm looking at the wrong thing, but when I look at just average near quarter trade green coffee costs for Arabicas, it looks like they're actually up year on year for the quarter on average. So wondering, maybe I'm looking at the wrong pricing series versus what you would be buying, but if I'm not, if that would be the benchmark, what accounts for the difference, and why were your coffee costs down year on year? Was that largely hedging, or was that related to the inventory valuation adjustment in the year-ago period?

I think what we're trying to comment on is, is that if you say where we were priced to in our first and seconds quarters versus where green was versus, say, our third and now going into our fourth quarter, clearly Arabica coffees have increased over that time frame. And then also you have to keep in mind that we, as you look across all of our offerings, we use a combination of Arabica and Robustas. In our case, you can't just look at Arabica coffee. But as we look out, and based on our current positions, we know that our green coffee costs have increased versus where they rested in the fourth quarter of last year and the first half of this year.

Okay. And am correct that the green coffee, that your Arabica prices, excluding hedging or spot Arabica you would use as your benchmark? I realize you're not using all of Arabicas, but those were up pretty substantially in the fiscal third quarter year on year for the quarter on average.

Yes.

Eric, just to underscore Vince's comment, I think we've tried to be clear on this, but when we talk about this favorable benefit of coffee across all of the quarters, it is always to this price-to. We've been talking about lower cost on some other raw materials, and that's period over period lower costs, but in this event we are being a little more specific to the benefit versus the price-to position.

Okay. Great. Thanks a lot. I'll pass it on.

Next we'll hear from John McMillan with Lord Abbett.

Good morning, everybody. When you talk about your investments in K cups, basically, you're doing distribution. You're providing the beans. There's really no major investment, correct?

Sure there is. We're going to support the product through promotional spending, marketing support, demonstrations, all kind of things. So we will be investment spending in it.

Can you quantify it at all?

Not at this point.

What kind of returns you expect?

Again, I think, as I mentioned earlier, long-term, we do not believe it will be dilutive. I think, on an initial basis, it will clearly be an investment if you would just evaluate it as a segment, but that's like any new product when we launch it.

You may look at it like when we first came out and did Dunkin'. We had marketing programs behind Dunkin' when we came out with that, and this is very similar to that.

And I think, too, we'll look at in the context of the overall marketing support for coffee, not just that is a sector of that that will come into consideration, as we look at the overall spend next year.

If it works half as well as Dunkin'I think we'll be okay. Thanks a lot.

And we'll now take a follow-up question from Eric Katzman.

Thanks for taking the follow-up, everybody. I was, one, curious, I think you said the organic or natural business was up, and most of what we hear is that that segment is quite weak, so could you just comment a little bit on that.

Mark, want to take that?

Sorry, what was the question?

The question was about the natural category, why it was up.

The natural category, it was up basically we had seen, several of our customers had, as you know, the whole industry has been down, and we saw that there was some lag in some of the off-take in the first couple quarters. And essentially we just recovered a lot of the volume that we had seen go down the first couple quarters. We do believe that that industry is going to continue to be challenged, and so we will, strategically, we're looking at bolstering our core business, but also looking at how we might start to participate in some parallel categories.

Eric, if I might, just one additional point is that in that, in the natural, our growth income was from the branded side, so, just to underscore Mark's comments, both from our RW Knudsen brand and Santa Cruz Organic, we're very pleased to see the branded side of that business return back.

And the other thing I would comment there also is that as we look at the business, and it's hard to know because there really isn't good data in the industry, but our feeling is that the organic side of the business tends to be more consistently strong than, say, the natural side, if that makes sense. There seems to be a core die-hard organic consumer that is true to that category, and does not leave that category even though it is a higher priced area.

Yes. I'm very familiar with that at home. Okay. Then, just as a follow-up to Mark, and I think there was a question earlier. I loathe to focus on the quarter, but the 407 that you were talking about, on the high end, you're including the $0.05 impairment, right in that number?

Yes.

And then there is also you said about $0.11 year over year increase in the fourth quarter in the AMP spending, the $20 million.

Yes.

And what was the, I can't remember, but the peanut butter hit a year ago, that was in the fourth quarter, right?

It was.

And how much was that?

I think, early on, the whole category was down 20%. We tracked better than that, and for the full quarter -- Steven?

We were of about half that much. But the key here, we think the peanut butter is our toughest one to call, where is it going to shake out in the quarter. And that's because a year ago, if you remember, we went out with national media, we partnered with a number of customers and had front-page ads. So we had a lot of business in the Jiff brand in the last two months of the quarter. And although we've got great promotional support, it's difficult for us to really tell you how we're going to shake out versus a year ago, will we be up, will we be flat. We don't think we'll be anything worse than flat. We hope we'll be up a little bit. Early indications are great, but there's a lot of noise in the last two months in peanut butter, and I look forward to commenting on it in the next meeting. The business is very solid, but the comparables are difficult in the last two months, is what I'm saying.

And lastly, historically it seems like, to a certain extent, you've won full bake on the oils business, and then ConAgra has pushed it around Easter. So is that how you see it shaping up again this year?

Hi, John. Paul here. I would say we've pretty much won the O&B time period. We felt very good about that. It's clearly going to be competitive coming into the fourth quarter. That being said, we feel pretty confident we have some good promotions lined up.

Okay. All right. Thank you.

We'll now hear from Jon Andersen from William Blair.

Good morning, everyone, this is actually Ron filling in for Jon. Congratulations on the quarter. Just a quick one for you. After the $550 million paydown in debt this quarter, it doesn't look like you have anything due for quite a while. Do you have any restrictions or prepayment penalties that prevent you from repaying that debt going forward?

There are actually. In all of our notes there is a prepayment penalty and obviously based on the market conditions that can be very sizable. We look at that periodically, but we do have that out there.

And next we'll hear from Jane Galfon.

Thanks for taking the follow-up. Just a quick question on spreads. You mentioned some targeted price declines. Just wanted to get a little bit more color on whether or not that's part of a strategy, whether it's more tactical in relation to something you're seeing out there in the market, and more importantly are you seeing results as you adjust some of those price gaps. Sure.

I'll comment on fruit spreads and peanut butter. First of all, a year ago we had an anomaly in the fruit spread business. We had a short crop on certain of the premium cane berries, blackberries, raspberries, et cetera, and we took a 30% price increase. So obviously that had a big effect on that whole business. We have since rolled a big portion of that back. So those are material varieties during the third quarter, so that's some of the price decline in the fruit spread business.

As far as peanut butter, we're between crops right now. There have been some favorable costs in the peanut butter industry. When you compare that to the fact that the retailers, as Vince mentioned earlier, are looking for those front-page items, and we all as an industry have soft comparables. some of that favored peanut butter cost has been spent back on the peanut butter business. We tried to balance that. I think we've been able to increase our margins, been able to increase our tonnage. The segments, there's even another compound to that, some of the segments, like club and the consumer is looking at, there is tremendous value in some of those segments right now. So we're even seeing larger sizes very effective right now. So there's a lot of variables, but we're looking closely at the peanut butter, if we think those things are sustainable, we'll roll them into price as we always have. If not, they'll probably just be short term promotions.

Thanks very much. And just one more quick one. As we think about spreads, as you look at the business, how comfortable with where some of those core item price gaps are relative to private label, or do you see more opportunity over time to adjust it a little bit more?

We have to be careful there. Obviously our advertising, our brand scores, the brand health measures in the business are as high as they've ever been. We feel great about our connection with the consumer right now. But we are the largest strawberry preserve producer in the world, and we have to leverage that scale, we have to provide value to the consumer. To short-term let that gap get too large and take that margin gain and allow consumers the opportunity to try to private label we just think is the wrong decision. So we may give up some of those short term margin opportunities and keep the pressure on continuing to give them value on an everyday basis with thos items. So we'll try to continue to leverage out scale, keep that gap close to where it is right now.

Thank you again.

And there are no additional questions at this time. I'll turn the conference back to you.

Thank you very much for your attention today, and great questions, and again, thanks to our team for great results. Have a good day. Mark will be taking a number a questions. So thanks.

And ladies and gentlemen, if you wish to access the rebroadcast after this live call, you may do so by dialing 1-888-203-1112 or 719-457-0820 with pass code 7290467 or accessing the Web site for a downloadable format. Thank you for participating. And have a nice format