J M Smucker Co (SJM) 2012 Q2 法說會逐字稿

Good day, and welcome to the J.M. Smucker Company's second-quarter 2012 earnings conference call. At this time, I would like to inform you that this 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 requeue if you then have additional questions.

I would now like to turn the conference over to Sonal Robinson, Vice president Of Investor Relations. Please go ahead.

Good morning, everyone, and welcome to our second-quarter earnings conference call. Thank you for joining us today. On the call with me are Richard Smucker, Chief Executive Officer; Vince Byrd, President and Chief Operating Officer; Mark Belgya, Senior Vice President and Chief Financial Officer; Steve Oakland, President, International, Foodservice and Natural Foods; Mark Smucker, President, US Retail Coffee; and Paul Smucker Wagstaff, President, US Retail Consumer Foods.

After this brief introduction, I will turn the call over to Richard for opening remarks. Vince will then provide an update on our business segments, and Mark will close with additional comments on our financial results for the quarter and our outlook for the year. We will then open up the call for questions.

During the call today, we may make forward-looking statements that reflect the Company's current expectations about future plans and performance. These forward-looking statements rely on a number of assumptions and estimates, and actual results may differ materially due to risk and uncertainties. I invite you to read the full disclosure statement in the press release concerning forward-looking statements.

Let me also remind you that the Company uses non-GAAP results for the purpose of evaluating performance internally. Additional discussion on non-GAAP information is detailed in our press release located on our website at Smuckers.com. A replay of this call will also be available on the website.

If you have any follow-up questions or comments after today's call, please contact me or Mark Belgya. I will now turn the call over to Richard.

Thank you, Sonal. Good morning, everyone, and thank you for joining us on the call. Let me begin by summarizing some of the key highlights for the quarter. First, as you have seen in our press release, we achieved sales growth of 18% over the prior year, reaching a record level for the second quarter. Pricing actions taken over the course of the past 12 months to offset significant commodity cost increases resulted in strong net price realization. Also, a positive mix of sales, notably increases in peanut butter and K-Cups, and the recently acquired Rowland Coffee business also contributed to sales growth.

Volume, while down 1% from last year's second quarter, showed growth in a number of categories and improved sequentially from the first quarter. As in previous quarters, innovation was a key driver of growth, as new products contributed significantly to the top-line gains. Incremental K-Cup sales for the quarter were $30 million, providing 2 percentage points of the sales increase. Sales of Folgers and Millstone-branded K-Cups, which marked their first anniversary during the quarter, now exceed $100 million on an annual basis, and we expect continued growth in this area.

Seasonal baking and coffee items also performed exceptionally well.

Second, the quarter's cost of goods sold hit the expected peak in our overall commodity cost curve for the fiscal year. And, although total cost of goods sold were up approximately $230 million, or 30%, our gross profit increased for the quarter.

Finally, non-GAAP earnings per share for the quarter were $1.29, down 9% from last year. Included in our results is a one-time loss of approximately $0.07 per share related to the divestiture of the Europe's Best business in Canada. Based on our desire to focus on categories that are more strategic to Canada's portfolio and prioritize resources to capitalize on key opportunities, we made the decision to exit this business.

Results for the second quarter were also impacted by a higher effective tax rate compared to the prior year.

Currently, we are in the midst of our important fall bake and holiday promotional period. Our team has excellent consumer and merchandising programs in place. We have seen an increase in the number of retail bake centers and in the number of the Smucker items included on these bake centers. This is supplemented with the strong consumer marketing program, including our multi-brand event that we launched earlier this month, as well as TV, print and digital advertising.

We feel good about our initiatives, and while we recognize that consumer takeaway will ultimately determine the success of our fall bake, we believe our business is very well-positioned.

Higher food prices have resulted in market data that shows consumers have decreased home pantry inventory levels across many categories throughout the food industry. This IRI data (technical difficulty) has actually increased, and thus represents a larger portion of total items.

Looking ahead, we are comforted that most commodity costs appear to have peaked in early fall and have retreated modestly in the past couple of months. As such, we believe our price to cost position is in good shape. Thus, the need for most price increases is behind us as we head into the remainder of the fiscal year.

Looking at the full year, we are revising our guidance range for non-GAAP income per diluted share to $4.90 to $5 a share. While this is down from our original estimate, most of the adjustment reflects the one-time loss associated with the Europe's Best sale and incremental interest expense related to our recent $750 million public note offering.

Although we are operating in a challenging environment, we remain confident in our long-term position, as our team continues to focus on balancing volume, market share and profitability.

Let me conclude by briefly commenting on last month's announcement regarding our plans to acquire the majority of Sara Lee's North American Foodservice Coffee business. We are extremely excited about this transaction, as it encompasses our definition of all three classes of acquisitions that we have spoken about in the past.

First, it is enabling, as it allows us to participate in the liquid coffee business, aligning with our desire to compete in all forms of coffee. Second, the acquisition transforms our Foodservice business by adding significant scale and nearly doubling its net sales. By providing liquid coffee technologies and adding a direct sales force to our team, it allows us to extend our reach within the foodservice coffee channels.

Third, it bolts on nicely to our existing North American coffee business and expands our overall coffee footprint.

In addition to all of these benefits, it provides a unique opportunity to establish a multiyear innovation partnership with Sara Lee's new coffee co. that will allow us to collaborate on new technologies in the liquid coffee category for the foodservice market.

True to form, our teams are actively working on steps necessary to close the transaction and seamlessly integrate it into our existing businesses. We expect the transaction to close in January, and look forward to welcoming nearly 450 employees to the Smucker family.

With that, I will now turn the call over to Vince for additional details on our businesses and our brands.

Thank you, Richard, and good morning, everyone. Let me begin by reinforcing that our team is successfully managing through this dynamic cost and pricing environment, and we believe our efforts to balance growing share, volume and profit continue to position us for the long term.

Turning to the segment results for the quarter, net sales increased 29% for the US Retail Coffee segment, primarily driven by price increases and strong contributions from innovation and acquisitions. Incremental K-Cup sales provided 6 percentage points of the sales growth, including the two new K-Cup varieties launched earlier this year. In addition, our Dunkin' Donuts seasonal items continue to perform exceptionally well, and our new filter packs and instant single-serve packets have been well-received by consumers.

The recently acquired Rowland Coffee brand also contributed 6 percentage points of the sales growth, and we remain excited about the opportunity to expand the Cafe Bustelo and Cafe Pilon brands in Hispanic markets.

During the quarter, we achieved a key integration milestone as we successfully completed the transaction of our customer-facing and distribution network activities with no interruption to the business. This is a testament to the hard work and dedication of our team. Overall, we were very pleased with this acquisition and its opportunities for continued growth.

Coffee segment volume, excluding acquisitions, decreased 4% for the quarter, with Folgers and Dunkin' Donuts brands experiencing volume declines of 4% and 3%, respectively, representing an improvement over the first quarter. We are pleased that our Folgers brand has continued to grow market share in the mainstream roast and ground segment in the most recent 12- and 52-week periods.

Coffee segment profit decreased for the quarter as a result of lower volume and the impact of significantly higher green coffee costs, which were more pronounced in the second quarter, as well as an unfavorable $7 million increase in unrealized mark-to-market adjustments on commodity contracts. As expected, the favorable pricing position that benefited the first quarter partially reversed in the second quarter.

Looking at the first two quarters combined, Coffee segment profit was up 7% over the prior year. We continue to expect higher green coffee costs to be recognized for the remainder of the year, although to a lesser extent than the second quarter. The higher costs will be reflected more in the third quarter, moderating in the fourth.

Also, from a comparison standpoint, keep in mind that the segment profit in last year's third quarter was at an all-time high. Overall, we remain encouraged with our Coffee business as we enter the back half of the year in our key promotional periods.

Turning now to the US Retail Consumer Foods segment, net sales increased 13%, reflecting significant pricing actions taken across all major categories to offset higher raw material costs, along with favorable sales mix. Overall volume was comparable to the prior year. Product innovation also added to the sales growth for the quarter, with contributions from our Pillsbury seasonal items, Jif To Go peanut butter and Orchard's Finest premium fruit spreads. Segment profit increased 2% from net price realization and favorable sales mix.

Let me now provide some additional commentary on the dynamics within the key categories. Peanut butter volume was up 11%, reflecting contributions from both Jif and our natural peanut butter brands. During the quarter we resumed promotional activities following a pullback in the first quarter to manage the peanut availability related to the 2010 peanut crop. This, combined with incremental consumer demand in advance of our previously announced November price increase, led to strong results for the quarter.

Jif Natural peanut butter continued its solid performance, with significant volume growth in the period.

Looking forward, we believe our prudent actions taken to manage challenges related to the 2011 peanut crop have positioned us well. We remain comfortable with our peanut supply heading into the remainder of the fiscal year. Our 30% price increase went into effect this month, with the exception of the holiday promotions, which have been price protected.

Similar price increases have been taken by all major peanut butter brands. The ultimate level of price elasticity associated with an increase of this magnitude will depend on a number of factors, but we expect the net price realization will fully offset our recognized costs and our peanut butter outlook for the full year remains positive.

Turning to Crisco, our base oils business was impacted significantly in the quarter by aggressive private-label price points at a few key retailers. As a result, volume for the Crisco brand was down 10% in the quarter. While we continue to manage this challenge, which we expect to continue in the near term, we are pleased with the performance of our base oil business at the majority of our customers. Further, our shortening business rebounded to post a slight volume gain in the second quarter.

Finally, volume in our baking category was up for the quarter. Although flour volume was down, baking mixes had yet another strong quarter, leading to market share gains. Our baking business continues to be driven by the success of product innovations in the Pillsbury brand, including a number of new seasonal items.

Overall, as Richard mentioned, we have in place exceptional quality merchandising programs as we continue through the fall bake and holiday period.

For the International Foodservice and Natural Foods segment, excluding the impact of acquisitions, divestitures and foreign exchange, net sales increased 6%, with price increases more than offsetting a 3% decline in volume and unfavorable mix. Volume gains were realized in Santa Cruz Organic beverages, Five Roses flours, Bick's pickles, but were offset by declines in nonbranded natural beverages and Folgers coffee.

Excluding the one-time loss on the divestitures of Europe's Best, segment profit was down approximately 2%, reflecting an increase in marketing expense over the prior year.

Before turning the call over to Mark, let me provide a brief update on our restructuring project. Activities continue to progress well, and the overall project remains on track, including the expansion of our New Orleans coffee operations and the construction of our new fruit spreads manufacturing facility in Orrville, Ohio. As planned, our Canadian pickle facility will close at the end of this month, with the production of these items successfully transitioned to contract manufacturers.

We would like to thank our employees for those efforts and their dedication during the transition.

In closing, we remain confident in the underlying fundamentals of our business, the strength of our brands and our ability to execute. I will now turn the call over to Mark to discuss our consolidated results and outlook for the year.

Thank you, Vince. Consolidated net sales increased $235 million, reflecting a 15% impact of net price realization, contributions from the Rowland Coffee brand, favorable sales mix and FX. Volume was down lightly.

GAAP earnings per share were $1.12 this quarter and $1.25 in the Second quarter of last year, including restructuring and merger and integration costs. Excluding these special project costs, earnings per share were $1.29 this quarter and $1.38 in last year's second quarter, a decrease of $0.09, or 7%.

As Richard noted, results in the current quarter included the $0.07 per share loss on Europe's Best and a higher effective tax rate compared to the prior year. These factors were partially offset by the benefit of a lower share count in the current year.

The cost of goods sold increase of 30% for the quarter was primarily due to higher recognized green coffee, oils and flour costs in the current year. Net price increases taken over the past year largely offset these higher costs, resulting in an increase in gross profit of $5 million. Included in the current year's results was a $10 million unfavorable adjustment from unrealized mark-to-market adjustments on derivative contracts compared to a $6 million unfavorable adjustment in the prior year.

SD&A expenses increased 6% for the quarter, reflecting higher selling and administrative expenses and the acquisition of Rowland Coffee. Total marketing expense was equal to the prior year. The increase in SD&A expenses and the loss on the Europe's Best divestiture were the primary causes of a $22 million decline in operating income, excluding special project costs. Excluding the loss on Europe's Best, operating income was down 4%.

The effective income tax rate was 34.1% in the second quarter compared to 32.5% in the prior year. The increase is primarily due to a higher Canadian effective tax rate and an increase in state income tax expense. We now anticipate a full-year effective tax rate between 33.5% and 34%, consistent with the rate for the first half of the year.

Capital expenditures were $68 million in the quarter, bringing the total to $136 million for the first half of the year. This level of spending puts us right on track with our full-year expectation of $250 million to $275 million.

Free cash flow of approximately $450 million is expected, contingent upon our year-end inventory balance and other changes in working capital.

During the quarter, we entered the public debt market for the first time in the Company's history, issuing $750 million in 10-year notes. The combination of the historically low rate environment, a strong interest in our initial issuance and a solid investment grade rating allowed us to issue the debt at a favorable 3.5% coupon rate. A portion of the proceeds were used to repay borrowings outstanding under our revolving credit facility. We also anticipate using a portion of the proceeds to fund the expected Sara Lee Foodservice beverage acquisition.

As a result of the additional debt, we now project full-year net interest expense of approximately $80 million. This increase reflects the incremental interest expense and the impact of terminating our interest rate swap. While we settled the swap and realized a significant net gain, the accounting rules require us to recognize the benefit over the remaining life of the underlining debt.

Lastly, during the quarter, we repurchased approximately 540,000 common shares that remained available under the 10b5-1 plan entered into in March of this year, utilizing nearly $40 million of cash. An additional 2.5 million shares remain available for repurchase under previous Board authorization. We will continue to evaluate the appropriate timing to execute any future buybacks.

Let me conclude by updating our outlook for the remainder of the fiscal year. Contributions from the expected Sara Lee Foodservice acquisitions are not reflected in this guidance.

Based on current estimates, the impact on earnings per share is not expected to be material in the current fiscal year. For the full year, we expect net sales percent growth in the mid-teens, driven primarily by net price realization. We anticipate a year-over-year cost increase in the low 20% range, excluding acquisitions.

Although the second quarter represented a peak in our commodity cost curve, we still expect significantly higher costs in the back half of the year, most notably for green coffee in the third quarter and peanuts in the fourth. While continuing to recover higher costs through pricing actions, this will further pressure gross margins.

We are aggressively managing administrative expenses and discretionary spending, and expect SD&A to come in below the 10% year-over-year increase included in our original guidance.

We are revising our guidance range for non-GAAP income per diluted share to $4.90 to $5, primarily to reflect the Europe's Best loss and the incremental interest expense. Placement in the range will depend on a number of factors, but most significantly, on volume in the back half of the year, which we expect to be down 2% to 3% from the prior year.

We would also like to point out that we expect to see swings in the performance of our Coffee and Consumer Food segments over the last two quarters. The impact of the higher green coffee costs will negatively impact the US Retail Coffee segment in the third quarter, with improvement expected in the fourth. Conversely, Consumer Foods should have a very strong third quarter, followed by a weaker fourth.

In summary, we achieved record sales in the quarter while successfully managing through the expected high point in our commodity cost curve for the year. We continue to realize strong contributions from our strategic growth drivers of product innovation and acquisitions. We have excellent merchandising programs in place for the holiday period, and we feel confident about the underlying fundamentals of our business as we head into the remainder of our fiscal year.

I would now like to turn the call back to Richard.

Before we move on to take your questions, I wanted to discuss one additional item. As you know, product quality and consumer safety have always been a priority for our Company, and we take pride in our track record in this area. When we do experience an issue on this front, we always approach it with an abundance of caution for consumers.

Working with the FDA and our retail customers, we have recalled a small quantity of Smucker's 16-ounce Natural Chunky Peanut Butter due to a quality issue. We are confident that this issue is isolated, and identified it as a result of the thorough testing methods that are in place at all of our manufacturing facilities. We have been successful in retrieving the majority of this product, but, as you may have seen, we issued a press release last evening in an effort to further ensure consumer safety.

Our team continues to work diligently to retrieve the remaining product, which is approximately 300 cases, and we thank them for their efforts. We do not expect any material financial impact on the Company.

We thank you for your time today, and now are happy to answer your questions.

(Operator Instructions) Eric Katzman, Deutsche Bank.

Good morning, everybody. Just some clarifications. First up, Mark, on what you said, just to be clear -- so your tax rate is a bit higher, so that is a hit to your annual guidance. And -- sorry -- I think you said $80 million of net interest expense over the year. That doesn't include the swap mentioned, of like $17 million or $18 million, does it?

No, it doesn't, Eric. What it includes is -- the swap actually is a favorable. It will reduce interest expense, but that will be over the next several years. So it is primarily the impact of the additional debt.

Okay, all right. And then I guess to a -- I don't know who will take this -- but the difference between the third quarter and the fourth quarter and reversal of what is happening with Coffee versus Consumer, can you go into that, not just from I guess a cost perspective, but is there also a top-line relevance to that comment?

Eric, this is Mark Belgya. I will just start. In terms of the cost side, we've called out obviously peanuts in the fourth quarter. But -- and I'll throw this to the guys if they want to add to it -- but there is really no top line. It is just driven more by the commodity costs of peanuts in the fourth and green coffee in the third.

I guess nobody else cares to comment.

I think everyone is in agreement with that.

Okay. I'll stick to your rules. I'll pass it on, and I'll get back in the queue.

Chuck Cerankosky, Northcoast Research.

Good morning, everyone, Richard and Mark and all the others, Vince. What are you judging right now is the consumer tolerance for shelf price increases?

This is Richard, (inaudible) and I will turn it over probably to Vince. But we have a lot of models that say if you take your prices up as much as we have taken them, and had to take them because of commodity price increases, that would have much significant -- more significant impact on volume than it has.

And so my gut feel -- and my feeling is that we've done a very good job of passing these on and making sure that we are competitive in the marketplace with our competition. So being down 1% in volume for the quarter with the size price increases that we've had to endure, we think is much better than the models would show, and I think is a benefit to our team for doing something what they've been able to do.

I really don't have much more to add. I think we are very, very pleased with where our volume is, given the pricing actions that we've taken. There are some categories that we mentioned that are being challenged, primarily from a competitive standpoint as opposed to a consumer takeaway perspective. So net-net we feel very, very good at this point.

That's my next question, is the competitive activity. What are you seeing there, especially on the private-label side and in areas where there is just a shortage of the raw products, such as peanuts? Can private label even respond well in that situation?

Hi, Chuck. This is Paul. First off, on oils, we are seeing an increase in some private-label discounting. And it is primarily at a few retailers; not across the board. And I think other than these key retailers, we are actually doing pretty well in the oils business. We know it is a challenge we will be facing probably for a little bit ongoing, but overall we feel pretty good about our business there.

On the peanut side, again, as you know, we feel very good about our peanut supply and our commitment going forward. I think there is going to be a challenge for other peanut butter producers. But I think in our case we are going to be in good shape.

This is Mark Smucker. Just on coffee, I echo Richard's comments. I think -- very succinct there. I would say just on the private label side, that private label has seen some good growth in the non-measured channels. But again, I think where our pricing is and the activities that we have in place, we have been doing a pretty good job of managing the business through that.

All right, thank you.

Scott Mushkin, Jefferies & Company.

Good morning, everyone. This is actually [Mike Otway] in for Scott. Thank you for taking the questions. First question we have was around K-Cups. We have seen Green Mountain K-Cups and Folgers at retail now at the same price. And with the Starbucks doing K-Cups and Dunkin' K-Cups available at the franchises, how should we be thinking about all of this vis-a-vis your K-Cup business, as well as your traditional ground coffee business?

This is Mark Smucker again. First of all, I would say our K-Cup sales continue to outperform our expectations, and we feel that there is tremendous upside continuing in the segment. And frankly, we think that the new entry by Starbucks will actually help grow the category. So we think that long term, it is probably good for the category, and we are very confident that we can continue to grow in that area.

Okay, that's helpful. Thank you. And then secondly, it sounds like some of the volume growth in peanut butter was due to you guys stepping back in on the promotional side, and as well maybe some folks buying ahead of the price increases. Any color on maybe what that split was? And I guess secondly, do you think you will be stepping up the promotional level with some of your other brands to try and drive volume? Thank you.

This is Paul. On the peanut butter side, we did experience a little bit of the volume in the second quarter. But we have implemented and mandated an allocation process by customer, and that really mitigated a lot of that buy-in. So we did see a little bit of the consumer hoarding, you could say, but it really wasn't that significant. And we would anticipate some good growth going forward on peanut butter.

As far as some of the other brands are concerned, again, we feel going through this fall bake time period we are well-positioned and feel good about where we are.

Great. Thank you.

David Driscoll, Citi Investment Research.

Hi, good morning. This is Alexis Borden in for David this morning. We were wondering if you could talk a little bit about the decline in green coffee costs, and specifically the effect on the business, and specifically focusing on two issues. One, a year ago you guys, if we remember correctly, had gains from -- we believe you had favorable gains from hedges. And two, given that the green cost -- the cost of coffee has gone down, do you feel pressure now to lower prices on coffee?

This is Mark Smucker again. Thanks for the question. I think it really goes back to precisely what was in the script. As you know, we experienced very favorable margins in the first quarter, expected our highest costs in the second quarter, and fortunately, costs have tapered off more or less as we expected. And we have reflected much of that in our August price increase.

So going forward, just to reiterate, I think, what has been said before, costs will continue to moderate, but they will continue to be higher than last year in the third quarter and begin to continue that tapering effect in the fourth.

I would just add that the pricing action that we took in August, the price decrease, is in good position relative to our coffee costs for the balance of the year. So we would not anticipate any further action at this point.

Okay, so even though prices are going down, you're not expecting at this point to lower the price (multiple speakers).

But again, we took that into account in the pricing action we took in August, given our position at that time.

Okay, thank you.

Ed Aaron, RBC Capital Markets.

Hi, thanks for taking the question. So your sales guidance changed a little bit for the full year, but it doesn't sound like your cost outlook really came down. So wondering if you could just tell us, the sale guidance change, is that a reflection of different volume expectations or different levels of pricing?

This is Mark Belgya. It really was pretty much reflective of the volume. As I mentioned in my scripted comments, we expect the back half to be pretty close to the first-half performance in terms of overall volumes, down 2 to 3 percentage points. But it was rudely that as opposed to pricing.

And from a category perspective, the volume change versus expectations, how would you kind of break that down?

I think mix will continue to be favorable.

Mix will be favorable. We'll see some declines on the oil side. Flour obviously is probably going to be down. Peanut butter should be up.

Thanks, and just one quick follow-up question. In the back half of the year from an inflation perspective, I know you have higher coffee costs in Q3 and then moderating from there. But then peanuts are kind of the inverse of that. Do you expect your overall inflation levels to be higher in Q3 or Q4, or should they be about the same by quarter?

I would estimate them to be pretty much in line quarter to quarter. Overall, I think our COGS, as we said, are going to be 20%. So I mean it could swing a couple percentage points up or down from that.

Okay. Thank you very much.

Ken Goldman, JPMorgan.

Good morning. I just wanted to clarify your core operating guidance a bit better. If there were no loss on sale, if there were no mark to market --

Excuse me, Ken, this is Mark. (multiple speakers) Ken?

-- issues, no changes to tax rates, none of that, would you have adjusted your guidance at all?

This is Mark Belgya. I'm sorry, but the volume -- we just couldn't hear your question.

Is this better?

A little.

Can you hear me now?

It's a little better. Go ahead.

Okay. I'll try again. I'm on the road. I just wanted to clarify your core operating guidance a bit better. If there were no loss on sale, if there were no mark to market charges, none of these other gains or hedging issues, and really if your tax rate had come in in line, would you have adjusted your guidance at all?

Yes, we would have, because, again, if you look at -- between the Europe's Best and the interest, that is about $0.14 to $0.15 in total. So yes, we would have.

And I know that everyone kind of looks at the loss differently, but we felt it was appropriate to reduce our guidance by that $0.07, and then also the interest. So yes, we would have. (multiple speakers)

If your question is is our base business is still solid and still within original plans, the answer is yes, it is. So those adjustments (multiple speakers). Then that's the answer.

Okay, and then one more. One of your largest customers said yesterday it was not taking its food retail prices up nearly as quickly as its costs were rising. And then privately, speaking with some of that competitor's -- or that customer's competitors, they said these claims were overstated, that really no retailers were being particularly irrational now, that pricing across all the retailers was up.

Without naming names, of course, have you seen rational retail pricing behavior from all of your primary customers? Or are any of them purposely eating some margin, in your opinion, to attract more volume? I guess to me this is important because if retailers are willing to eat more margin, you and other manufacturers, they can take pricing, and maybe not experience quite as much elasticity as you might have thought. I'm just curious how you are seeing that right now.

Ken, this is Vince. I think it is fair to say if you look over the past 12 to 18 months, when prices were escalating across all manufacturers, that there were some key categories, including some of ours, where pricing was not being fully reflected, up or down.

And I think that is fair when you even look at their results and in terms of their margin expectations. So I think that is a fair comment.

At this particular point, net-net, I think we feel that our pricing is probably where it should be. There are a couple of exceptions to that, but it is a fair comment, your point you've tried to make.

Thank you. I apologize for the phone issues.

Farha Aslam, Stephens.

Good morning. First, just a modeling question. Mark, you had said that $17 million to $18 million interest rate hit swap benefit is going to come in the next several years. Could you just give us some color -- is it three years, five years, seven years?

Yes, it is actually attributed to two underlying debt issuances. The first one, I believe expires -- or matures in 2018. And then the second piece applies to debt we just issued. So ballparkish, I would say sort of $3 million to $4 million between 2012 and 2017, 2018. And then you will actually see some interest -- or some additional interest expense in those last couple years that relate to the most recent issue.

Okay. And then could you just share with us the synergies you anticipate from your acquisitions going into next year, particularly with Rowland and Sara Lee? Did Rowland help you launch those individual sticks this quarter, and what the synergies were? And kind of how you are thinking about earnings. Of course the first year of Sara Lee is going to be neutral, but how you expect that growth and cost synergies to flow through the P&L in future periods.

This is Mark Smucker. First of all, I think your question was around the instant sticks. That is not a Rowland-related -- that is strictly a Folgers' branded product; that is essentially our Folgers instant in an individual serving.

And in terms of the synergies, we would expect that they will be on track. The integration of the business has gone well. But really those synergies will happen once we transition the operations to New Orleans from Miami. And as we've said, that is on a two- to four-year time frame from the time of the acquisition.

It's Steve. With regard to Sara Lee, we anticipate closing early in the calendar year. And the synergies for that will start to happen similar to Rowland, when we can, number one, put it on our systems, and number two, integrate the operations into New Orleans.

We think the first will happen sort of midway through next fiscal year. And then the operations will happen some time 12 to 36 months later. We will have some detail on that later in -- probably in this fiscal year, we will have better plans that we can announce on that.

Okay, that's helpful. Thank you.

Alexia Howard, Sanford Bernstein.

Good morning, everyone. Just following up on Ken Goldman's question, you've effectively reiterated profit guidance for the year despite the new challenges that have come up in the peanut butter category. Are there other parts of the business that are coming through better than expected at the beginning of the year? And what do you see is the key uncertainties that are going to shape the outcome in the second half, because there is a lot of moving pieces here?

It's Mark Belgya. In terms of managing, really, the couple percentage points of volume decline we see, I think you are aware that we have actually delivered SD&A below our expectations for the first half of the year. I think early on in June, we said we were going to be up about 10%. That average is probably closer to 6% right now.

We will probably be able to continue that trend of 6% to 7% year-over-year SD&A growth. We are really spending a lot of time focusing on discretionary spending and identifying opportunities to help to manage that a bit, and that is where a good portion of it will come for the last six months.

And then in terms of uncertainties for the second half, I am thinking more on the operational side within the segment.

This is Richard. In general, I think we feel really pretty good. Because we feel that from a pricing standpoint, we are well-positioned versus where the commodity costs are. We have our plans in place certainly for fall bake; those are all -- and we are really just waiting for the sell-through, which seems to be going very well. Our indication is it's doing well.

And then the back half of the year, we have a number of programs that are already in place and in line with our customers. So I guess we are feeling pretty good about that it's going to be pretty stable business for the remainder of the year and right in line with our expectations. And again our base business is very solid and really no changes to those forecasts.

Great. Thank you very much. I'll pass it on.

(Operator Instructions) Rob Dickerson, ConsumerEdge Research.

Thank you very much. I just had a couple quick questions, clarification. And I don't mean to beat the dead horse, as people always say, on guidance. But I do want to be clear here, that I guess guidance comes down basically by $0.10, $0.15. $0.15, $0.07 of that is from a one-time charge from the loss, from the business that you bought in 2008, sold to Hain. But there is no commentary around loss of run rate profitability for the rest of this year, or there is no readjustment of last year of taking that out; it is just the loss. That is kind of I'm hearing from the $0.07.

And so then I guess the question is, is there any additional color around any other effect from last year or this year from the asset sale, one? And then two is could you provide any color of when we could see some benefit in EPS potentially, just via buyback, what have you, from the increase in credit and therefore interest?

It's Mark Belgya. A couple comments around Europe's Best. Just to frame it, and I know you guys most know most of this. But last year, we had impairment charge in the third quarter and then the loss this quarter. In terms of impact on run rate, it really is not a material. The sales for the business had decreased over the last year or two, and so the sale takeout for the back half of the year will just not be material and we will cover that through growth in the existing Canadian business. So you will see no additional commentary or impact.

In terms of ways to potentially drive a little more EPS growth, in the scripted comments we talked about, we still have 2.5 million shares available under authorization. And I think we've been pretty true to our word that, when appropriate, we will go into the market and repurchase shares to help support the EPS. We have those shares there and we will continue to look at opportunities to do that.

And then again, as I mentioned, we will continue to look at the SD&A side. We feel comfortable about being able to reduce the overall -- or to grow it a slower rate, I should say. And we will just continue to challenge the team to find opportunities to do that. But I think those are the two or three triggers that may offer up some additional EPS, outside of the normal business units.

Okay, perfect. And then one quick one. I know before you've targeted $450 million, I believe, in free cash flow for the year. It looks like so far for six months you are negative.

So I guess one is, if the expectation is that there will be a sizable ramp in free cash flow or cash from ops in the back half. And then also, if you could provide any color update as to what could cause free cash flow to ramp in next fiscal year. Thanks.

Yes, in terms of the free cash flow, you are basically seeing a trend that is pretty much the norm the last couple. Our first half of the year, as you know, we have to build inventories in advance of a couple things. One is our fall break and holiday. One is in advance of the Atlantic hurricane season as it relates to coffee.

Add to that we are in the transition, as we've talked about, with the facilities in New Orleans. So we've actually built a little bit more coffee inventory to make that move smooth.

Layer on top of all of that the cost environment that we are dealing in. So that is why our inventory and our working capital use in the first half has been significant. That will turn just through the normal sell-through of fall bake. And as well. we are going to actively try to manage down some of that inventory. Lower costs will certainly help as well.

So you will see a big increase in cash from operations in the back half, particularly probably in the third quarter. You will have seen the same trend last year.

And then again, I think looking at what we can do from an inventory perspective is the best way that we can sort of ramp up working capital and cash generation. And again, lower commodity costs will go a long way in helping that. But you will see a turn, and thus we feel good about the free cash flow number.

Okay, perfect. Thanks for that. I'll pass it on.

Andrew Lazar, Barclays.

Good morning, everyone. I know you all try and match, to the best you can, in businesses like coffee, your pricing and cost dynamics to try and at least protect sort of the profit dollars piece of it. And I guess that is what was toughest to do in coffee this quarter, and it didn't happen that way.

As you think forward into the third quarter, I know costs in coffee have peaked; they will still be high in the fiscal third quarter. Can you get to a place where the profit dollars are at least protected in up year-over-year in coffee in the third quarter? The reason I ask is because, if not, I guess that would be two quarters in a row where that didn't happen and that just seems to be, I guess, a longer period of time than you typically like to have when you are trying to match those two things in that business.

Andrew, this is Vince. In a broad sense, yes, we do try -- first of all, we manage the business for the long term and to grow gross profit dollars for the year. We know that from time to time, we are going to have a quarter based upon our position and what our pricing strategy is, those margins may fluctuate.

As we look at -- as Mark said and as we said formally in the script, we feel very good that we will be able to grow the gross profit dollars by the end of the fiscal year, and we are not coming off of that. We will have some quarter fluctuations and last year's third quarter was a record quarter that we need to keep in mind.

The other thing is, as we said in the formal remarks in the second quarter, we had a $7 million hit on mark-to-market adjustment. So a lot of things going on and a lot of play. At the end of the day, we are managing towards the business for the long term to grow those gross profit dollars.

Andrew, I'd like to just comment -- this is Richard -- as you know, these commodity costs have been more volatile, not just on coffee, but on every commodity that we purchase than they have been historically. Managing that is tough, and I think our teams and the positions we take, both hedging and puts and calls, have done a pretty good job of doing that. But to do it quarter by quarter, it is difficult because we really do take a long-term perspective.

So I guess my feeling is we've done a good job in the very volatile markets that we have. Fortunately, at least the last couple of months, the volatility seems to have dropped a little bit, but not where we'd all like to see it. But again, we manage for the long term.

I appreciate that. And the cost dynamic clearly has been truly extreme, so I appreciate the perspective. One quick follow-up would just be -- does the innovation agreement or partnership that you have with Sara Lee going forward, can that ultimately extend beyond just sort of the foodservice piece or just the liquid food service piece or is it just a matter of let's see how it goes and we will kind of take it year-by-year?

Hi, Andrew. It is Steve. The innovation agreement with Sara Lee is focused on Foodservice. And we are excited about that because there is a pipeline of some great new equipment for us to bring to market in North America.

But it is not limited. Obviously, no agreement is limited for the long-term. But we are going to focus on foodservice, we are going to get to know each other. And then if opportunities come up as we go forward, we are going to take a look at those together. There is a commitment on both sides to do that. But we are going to try to get it focused on getting this liquid business, achieving the opportunities that we see in front of us with liquid.

Andrew, this is Richard again. Just -- but this is a partnership. And we see it -- regardless of what is on paper, we see this as a real partnership going forward. And the great thing is they are in markets that we are not in geographically. They are in Europe and South America, and we are in North America. So it does provide us a good partnership

Yes, very complementary. Okay. Thanks very much.

Brian Holland, Janney Capital Markets.

Good morning, everyone. This is Brian stepping in for Mitch this morning. Just a couple questions on the coffee side here. First of all, can you talk at all about any impact that the Dunkin' Donuts K-Cup launch on the franchisee side, what impact that might have had on the bag business in the quarter in volume, if you are seeing any?

Very little, if any. I think going back to what we've said previously, the Dunkin' K-Cups that are being sold in their coffee shops, again, will help to grow the category. And we have not seen any impact on bag coffee sales.

Okay. And then if you could talk at all about some of the recent acquisitions you've had within the Coffee business, any opportunity to roll out any of those brands out into the K-Cup platform, the Keurig platform at all, going -- in the future?

As we've said, I think, in the past, we obviously value our partnership with Green Mountain. And at this point -- we look at all of our opportunities, but at this point, we are holding firm with the brands that we currently are selling in the marketplace.

Okay, great. All of my other questions have been answered. Thanks for your time.

Eric Katzman.

Thanks for taking the follow-up. I guess this goes to maybe Richard and Steve. I guess -- I understand the technology associated with the Sara Lee agreement, et cetera. But I kind of question the interest in the foodservice side. I know Proctor really didn't care about that, so it is, to a certain extent, wide open. But historically, hasn't that been a much, much lower margin business? How does that jive with kind of the retail side of things, and how does that kind of come together from a profit perspective over time?

Hi, Eric. Steve. Let me try to address that, and Richard, if you have some thoughts.

A couple key. If you look at it in macro, okay, two thirds of the coffee consumed in America and in North America is consumed away from home. Okay? So it is a big universe. And we think it is important as the leader in North America to have our brands in those key segments. And if you look at all the major competitors, they've got brands away from home, at the office, at home.

So if you look at that, the Sara Lee piece, we didn't buy the whole thing. We just bought a slice of that. We bought primarily their liquid coffee technology, which is -- that is where Douwe Egberts and the brands we got there are clearly the leaders. Right?

So there are segments of foodservice, candidly, that are very attractive. This deal gives us not just that technology, but it gives us a direct sales force, an E&S, an equipment and service organization, who allow us to pick and choose where we play. What they didn't have and a lot of the foodservice folks don't have is a big brand.

So we think those things combined will allow us to pick our spots. It's not an all-inclusive. We are not going after everything. We did not take the operations, so we are not saddled with capacity we have to fill like they had. We think it gives us a nice opportunity to pick those profitable segments and do it with technology, do it with brand.

Steve said it very well, but one operations we did take was their Suffolk plant in Virginia, which is a state-of-the-art facility. It is one of the best plants I've seen anywhere.

And then I would also just add that the good thing about liquid coffee technology is it reminds me very much of Coke syrup and Coke concentrate, and that has been pretty successful for them over the last 100 years or so. So in a small way, we are participating in something similar technologically.

The plants that we did not take are the roast and ground plants. We took their state-of-the-art liquid coffee extract plant.

Richard, maybe in 50 years, we can kind of discuss that (laughter).

Maybe 40, Eric.

Yes, we may not (multiple speakers).

So with the protest going on outside my office, it may only be a couple of days, so I don't know.

But so do you intend to -- so basically, you are not taking the Douwe Egberts brand. You are going to -- are you going to put the Folgers brand on their machines, and that is going to be kind of your approach within that market?

You know, Eric, we think -- two things. We have a license agreement for Douwe Egberts that gives us plenty of room to transition the right brands. And as you know, we have the Folgers brand, the Millstone brand, the Bustelo brand. We've got brands that play in different segments. And they've got equipment that makes everything from a cappuccino and a latte to an iced coffee to a traditional long cup of coffee. So depending on where they are -- if it is front of house in limited lodging, if it is back of house in an upscale, white tablecloth restaurant -- we've got brands that fit those different segments.

So I think it will be a variety of brands, and it will be the formula and the taste profile that meets the operators' needs and best reaches the consumer. So it will be all of those brands.

Just as a quick follow-up, to Richard, on the M&A front, you've obviously been pretty active, with Rowland and now the Sara Lee. Do you think -- are you pausing for a bit, or do we -- do you think the organization is ready for even additional M&A if it presents itself?

You really can never pause in M&A in the sense that if there is a brand out there or a relationship that you want to have, that is time sensitive most of the time. And so I think everybody would like to take a pause a little bit while we integrate these, but if the right thing comes around, we have a great team, and I have 100% confidence that they could execute.

Okay. Thank you.

Ken Goldman.

Good morning, everyone, again. Not to have all grocery-oriented questions here, but I did a bunch of supermarket store tours recently, and looking at some of the peanut butter shelves, they were cleaned out a bit. And a couple of the CEOs told the literally couldn't get enough peanut butter, that Smucker, Unilever and ConAgra all are putting some items on allocation. Maybe this isn't a national issue. Maybe it's not even accurate. I realize you cut out a few SKUs months ago.

But on those items you are making, are you able to supply right now 100% of the peanut butter that I guess your customers are asking for?

Ken, this is Paul. I think the answer to that question is, again, we are in a mandatory allocation situation. That being said, we are able to supply the demand that we are primarily being requested on from a customer perspective. There are some customers that would like to have more always because of the current situation. But again, we feel very good with our position and what we've been able to supply; and our supply going forward through the rest of this fiscal year, we feel very good about.

And as far as you can tell, are your competitors in -- anyone in a particularly worse or better situation than you are in -- without naming names again? But just I'm curious as you get into the situation more and more what you're seeing there.

I would, again, just say from our perspective, I think we are in very good shape, and our relationships we have with our peanut shellers are very good. So I'd just comment that our supply is sound.

Okay, thank you.

I will now turn the conference back to management to conclude.

We wanted to thank everybody for their attention today, and we are confident that the year is going to be solid, and we appreciate your time.

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