J M Smucker Co (SJM) 2015 Q3 法說會逐字稿

Good morning and welcome to the J.M. Smucker Company's Third-Quarter 2015 earnings Conference Call.

At this time I would like to inform you that this conference is being recorded.

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

Good morning, everyone. Welcome to our third quarter earnings conference call. Thank you for joining us today.

Here with me on the call are Richard Smucker, Chief Executive Officer; Vince Byrd, President and Chief Operating Officer; Mark Belgya, Chief Financial Officer; Steve Oakland, President International Foodservice and Natural Foods; and Mark Smucker, President US Retail Coffee.

Our prepared comments this morning will be organized as follows. Richard will begin with an overview of our third quarter performance. 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 full year.

During this conference call, we will 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 risks and uncertainties. I encourage you to read the full disclosure statement in the Press Release concerning forward-looking statements.

Additionally, please note the Company uses non-GAAP results for the purpose of evaluating performance internally. Discussion on non-GAAP information is detailed in our Press Release located on our corporate website at jmsmucker.com. A replay of this call will also be available on the website. If you have any follow-up questions after today's call, please contact me.

I will now turn the call over to Richard.

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

As you know, last week we announced the signing of a definitive agreement to acquire Big Heart pet brands. We're excited to be adding this business to the Smucker portfolio as a third platform for growth, along with our existing food and coffee businesses. We look forward to sharing more on the transaction when we present at CAGNY next week.

As we work to close the acquisition by the end of the fourth quarter, we remain sharply focused on our existing businesses and will continue to execute on our plans and initiatives. To that end, the remainder of our prepared comments today will address the third quarter performance and the outlook for our current business.

Let me begin with an overview of the third quarter results. Our Coffee segment performance reflected many of the competitive dynamics that we discussed on our last call in November. While volume and sales trends showed improvement from the second quarter, coffee results fell slightly short of our expectations for the third quarter. However, we were pleased with the solid performance of all of our other businesses.

Total Company net sales declined 2% compared to the prior year reflecting modest declines in each of our three segments. In Coffee, lower volume for the Folgers brand was essentially offset by higher price realization. The Dunkin' Donuts brand performed well, with volume in line with a strong quarter in the prior year. Cafe Bustella volume was up 5%.

Within Consumer Foods, volume gains were achieved in a number of our key brands and categories following a successful holiday season. Most notably, volume was up in Jif peanut butter, Smuckers fruit spreads, Crisco oils and Uncrustables frozen sandwiches. The previously announced price decreases on Jif and Crisco drove the net sales decline compared to the prior year.

Lastly, the International Foodservice and Natural Food segment, excluding the impact of foreign currency and the foodservice business rationalization, net sales increased. We are encouraged to have fully lapsed the business rationalization impact in the quarter and look forward to improved top line trends for the segment as we move ahead.

Non-GAAP operating income was down $22 million, or 8%, which was entirely driven by a 17% decline in coffee segment profit. Consumer Foods and International Foodservice and Natural Foods achieved strong segment profit growth of 9% and 13% respectively for the quarter. Overall, this resulted in non-GAAP earnings per share of $1.54 compared to $1.61 in the prior year.

As Mark will discuss in a moment, we are adjusting our guidance approach for the rest of this year as we expect the Big Heart pet brands acquisition to close during the fourth quarter, which will have a significant impact on reported results. However, at a high level, we continue to anticipate the Consumer Foods and International Foodservice and Natural Food segments will deliver full-year results in line with our most recent guidance. Coffee results in the fourth quarter are now projected to fall slightly short of our previous expectations.

While we are disappointed with our Coffee business for this fourth quarter, we still firmly believe that it's a great category. We have grown segment profit in five out of the six years that we've owned it. While the category is evolving, we are participating in not just the traditional segment but also in the segments driving category growth. With anticipated stabilization in green coffee costs and our current initiatives, we expect to get coffee back on track for next fiscal year.

Finally, the organizational changes announced on Monday provide continued talented leadership across our Business. These changes were designed to continue to drive our core businesses of Consumer Foods and Coffee while allowing Vince, with 38 years of experience at Smuckers, to focus, along with Dave West, on a smooth integration of the pet food business and achieving our targeted $200 million in synergies. We look forward to welcoming Dave West to our team, which we believe is one of the best in the industry.

With that, I will now turn the call over to Vince for further comments on our business segments.

Thank you, Richard, and good morning, everyone.

Let me begin by summarizing the key points I would like to make today. First, we are pleased with the performance of our Consumer Foods and International Foodservice and Natural Foods segments. Most of the brands and categories in these segments performed well in the quarter reflecting one of the most successful holiday and return-to-school promotional periods in the Company's history.

Second, volume and sales performance from our Coffee segment improved from the second quarter; however, we now expect our Coffee results for the fourth quarter to be below our previous expectations as we anticipate current competitive dynamics to remain a head. Lastly, we are excited on the plans that will further strengthen our coffee business as we move forward and remain confident with our overall Coffee strategy.

With that, let me provide some additional color on our three segments beginning with US Retail Coffee. During our second quarter, we discussed the key dynamics that have impacted our recent coffee volume performance. Specifically, consumer response to higher promoted pricing on our core roasting ground offerings reduced promotional efficiency and competitive activities. As expected, volume trends improved this quarter as compared to our second quarter; however, promoted price gaps on shelf remain wider than anticipated, which we expect to continue in the fourth quarter.

Based upon recent consumption data for the last 52-week period, volume for the overall mainstream segment is down approximately 5%, driven by price elasticity on the Folgers brand. Our analysis indicates that half of this decline is the result of consumer purchasing less frequently. The remainder is due to consumer switching to other forms, as we anticipated.

Our volume was further impacted by consumers substituting lower priced competitive mainstream roast and ground offerings. The year-over-year decline in the third quarter segment profit remains similar to what we experienced in the second quarter. In addition to lower volume, the impact of higher recognized green coffee costs continued. Further, we increased price investments in our premium and K-Cup offerings in response to competitive activities resulting in a significant impact on near-term profitability.

As we enter the fourth quarter, we expect continued softness driven by ongoing competitive activity, higher green coffee costs compared to the prior year and reduced promotional effectiveness. With that said, we are taking actions to address the current challenges while further positioning our Coffee business for long- term success and for a number of reasons we are optimistic as we look ahead.

First, we remain committed to strengthening the long-term health of our brands through a focus on brand support, innovation, responsible pricing and promotional activities and ensuring our coffee consistently provides the taste profile that consumers come to expect from our brands. Secondly, in the second quarter of FY16, we will begin to convert our core Folgers roast and ground items to a smaller canister. We look forward to providing consumers with a lower price point without compromising quality and improving our competitive positioning within mainstream coffee.

Third, given the current market conditions for green coffee, we anticipate improvements in our cost structure in FY16, which will also allow us to achieve lower promoted price points. Fourth, we are well positioned in the premium segment. Although we anticipate some volume softness in the near term, we are optimistic for the potential of the Dunkin' Donuts business, which continues to benefit from the strong coffee heritage of the Dunkin' Donuts brand. Our partnership with Dunkin' remains strong and we continue to explore opportunities for growth.

And lastly, we are capitalizing on the growing convenience trend. This includes an expanding K-Cup platform reflecting this year's strong launch of the Cafe Bustella K-Cups and the introduction of new offerings in the beginning of the next fiscal year. Overall we expect our innovation, packaging downsize and projected lower green coffee costs will allow us to grow our Coffee segment profit in FY16 at a higher rate than our overall long-term organic growth objective.

Turning to US Consumer Foods segment, our momentum continues and during the third quarter concluded one of the most successful holiday and return-to-school periods in the Company's history. Our spreads business had a strong quarter highlighted by volume growth of 2% for Smuckers fruit spreads and 7% for the Jif brand.

In addition, both volume and sales for Smucker Uncrustables frozen sandwiches were up 10%, representing the 12th consecutive quarter of double-digit growth in retail channels for the Uncrustable business. In the bake aisle, the Crisco brand continued its solid performance with base oil growing 4% against a strong 22% prior-year comp. In addition, we are encouraged that volume for the Pillsbury brand remains comparable to the prior year given the current softness in the baking category and increased competitive activities.

Looking across all of our consumer foods businesses for the last 12- week scan period, we are pleased to have maintained or grow our volume and dollar share in essentially every key category in which we compete. Segment profit for the third quarter was up 9% over the prior year, bringing the year-to-date increase to 15%, which was primarily driven by a more normal cost of price ratio along with the contributions of volume. While lower marketing expense also contributed to the segment profit growth, we expect our full year marketing spend in Consumer Foods segment to be in line with the prior year and remain confident in the level of brand support.

In the coming months, we look forward to a couple of key milestones in our consumer foods business. In the fourth quarter, we expect our new peanut butter facility in Memphis, Tennessee, to begin production in line with our planned timing. In addition, we are on track to complete the integration of the Sahale Snack acquisition by the end of the fourth quarter and remain excited about the growth opportunities for this business.

In the International Foodservice and Natural Foods segment, we expected segment profit growth to turn positive in the second half of our fiscal year and that has been the case. Third quarter segment profit was up 13% over the prior year, including the offsetting effects of foreign currency in the current year and the foodservice trade spending adjustment last year.

As we enter the fourth quarter and look ahead to FY6, the impact of foreign currency is expected to increase due to further weakening of the Canadian dollar; however, we have now lapped the other headwinds that had impacted the International Foodservice and Natural Food segment for the past couple of years. We are encouraged by the momentum developing across all of our businesses in this segment and look for this to continue as we remain focused on our key growth opportunities.

Our Canadian business also had a successful holiday bake season across nearly all brands. In addition, we look forward to capitalizing on the growth potential for the Big Heart pet brands business as they currently have a modest presence in Canada.

Within Foodservice, we had a strong Third Quarter for Smuckers branded portion control offerings, Folgers roast and ground coffee and Uncrustable frozen sandwiches and we look for these trends to continue. Specific to the Uncrustable business, we expect to see the initial benefits from reentering the USDA school programs in the fourth quarter as we anticipate regaining the exited businesses over the next few years.

And lastly, in Natural Foods we look to build on the strong performance of our branded beverage portfolio, participating in the continued growth in natural and organic offerings in both the traditional and natural food channels. In closing, let me reinforce that we're excited about our plans that we have in place to grow our businesses and remain optimistic as we look forward.

I will now turn the call over to Mark.

Thank you, Vince. Good morning, everyone.

I will start by briefly summarizing our third quarter results and then conclude with additional comments related to our outlook for the remainder of the year. Net sales decreased $26 million or 2% in the third quarter, reflecting lower overall volume primarily driven by Coffee. The combined impact of positive net price realization and unfavorable mix was immaterial.

GAAP earnings per share were $1.58 this quarter compared with $1.59 in the third quarter of last year. Included in this year's GAAP earnings were $13 million in unallocated derivative gains compared to a gain of $4 million in the prior year. Excluding these, and certain other items affecting comparability as described in our Press Release, non-GAAP EPS was $1.54, a decline of 6% from the prior year.

The quarter-over-quarter results were primarily impacted by a decline in non-GAAP gross profit which decreased $34 million or 6%. Gross margin declined 170 basis points to 35.4%. The net impact of changes in commodity cost to pricing, which includes both list price and promotional spending, was unfavorable, most notably for coffee and peanut butter.

In addition, lower coffee volume and the related impact on overall mix also contributed to the decline. Partially offsetting the lower gross profit was a 5% decrease in FD& A, driven by lower marketing expense.

A significant portion of the reduction this quarter and year-to-date was utilized to support price. Factoring in the lower SD& A, non-GAAP operating income decreased 8%. Factors below operating income that benefited year-over-year EPS comparisons were lower interest expense reflecting a reduction in the long term debt and a decrease in the number of average shares outstanding resulting from share repurchase activity in the prior fiscal year.

Turning to cash flow, cash provided by operations was $428 million for the quarter compared to $421 million in the prior year. As a reminder, the third quarter is our key cash generating period as the fall bake and holiday periods wind down. The quarter's cash from operations increases our year-to-date total to $512 million, compared to $589 million for the first three quarters of last fiscal year.

The decline for the year is primarily attributable to a greater current year use of cash for working capital needs, reflecting higher green coffee costs and ending inventory, as well as certain timing factors. These include a temporary increase in our days of inventory on hand as we prepare for our transition of coffee canister size and manage the industry-wide risks related to the increased demand for transportation providers.

Contributing to cash was $53 million received as a result of an early termination of interest rate swap. With capital expenditures of $48 million in the quarter, free cash flow was nearly $380 million for the quarter for a year-to-date total of $350 million. For the fiscal year, we are still projecting to spend approximately $240 million in CapEx. Finally, we ended the quarter with approximately $265 million in short-term borrowings.

Let me conclude with comments around our 2015 guidance. As Richard indicated, we are modifying our guidance approach for the rest of this year due to the pending acquisition of Big Heart pet brands, which is expected to close during the fourth quarter.

Let me begin by reviewing our net sales estimate. We now expect a modest decrease in net sales for the last three months of the fiscal year compared to the same period last year. This primarily reflects softer volume expectations for US Retail Coffee compared to our previous outlook, as we see competitive pricing in roast and ground coffee continuing through the fourth quarter. We expect this to result in volume in our segment being down low to midteens in the quarter. Much of this tonnage impact is expected to be offset by higher price realization and mix.

Net sales expectations in our two other segments have not changed significantly from the outlook provided last quarter. Consumer Food sales are anticipated to be down in the fourth quarter, resulting from price declines taken during the past year on peanut butter and oils and a solid prior-year volume comparison. Sahale Snack acquisition will have a modest contribution in the quarter.

In the International Food Service and Natural Foods segment, we expect sales to be up slightly, primarily driven by growth in our foodservice business. Based on these fourth quarter estimates, the Company now expects annual net sales to decrease by approximately 3% compared to the prior fiscal year.

In terms of non-GAAP earnings per share, we expect fourth quarter EPS to fall below analyst consensus estimates. As a result, full year earnings per share are expected to be below the midpoint of our previous $5.45 to $5.65 guidance range by approximately 3%. While we plan to decrease in the fourth quarter earnings from a year ago, our revised outlook for Coffee volume is the primary cause, as profit projections for our two other segments have not changed significantly.

In Consumer Foods, fourth quarter segment profit is expected to decline modestly versus the same period last year, consistent with our prior commentary as the segment's full-year profit growth would be front-half loaded. Conversely, within International Foodservice and Natural Foods, segment profit is expected to be up over the prior year in the fourth quarter, partially reflecting the lapping of the prior-year trade spending adjustment along with the anticipated growth in our Foodservice and Natural Food businesses.

However, given the further weakening of the Canadian dollar, fourth quarter segment profit for International Foodservice and Natural Foods will be slightly below the amount assumed in our previous guidance range. In addition, certain deal costs and employee-related expenses incurred in the third quarter were not reflected in the previous guidance.

As we consider the closing of the Big Heart pet brands transaction, it is important to point out key factors that will ultimately impact our reported EPS for the year, albeit for roughly one month or so. These include earnings contribution from Big Heart for the period from the closing date through April 30; incremental interest, amortization and tax expense; the impact of any financing related costs beyond interest expense; and the issuance of 17.9 million share, which will have a different impact on weighted average shares for the fourth quarter versus the full year.

In closing, we recognize the significance of the profit challenges in the fourth quarter, but remain confident in both our ability to address this in the near term and our long term Coffee strategy. Further, we are pleased with the performance of our other businesses and look forward to even more growth in the future. And finally, we are very excited to close the Big Heart pet brands acquisition, which will provide another platform for growth as we move ahead.

With that, we will open up the call to your questions. Operator, if you'd please queue up the first question.

Thank you.

(Operator Instructions) Our first question comes from Eric Katzman from Deutsche Bank.

Hi, good morning, everybody.

Good morning.

So it sounds like the Consumer and the International Foodservice, et cetera, divisions, those two are in pretty good shape. Coffee, for the fourth quarter, being so challenged, are you kind of letting some of the trade inventories that maybe have built up bleed through maybe also as part of the change to the size of the Folgers can? Or is there a big A&P spending boost or a combination thereof? Because if it's all Coffee, it seems like a pretty dramatic falloff from the third quarter to the fourth quarter.

Hey, Eric, it's Mark Smucker. In the fourth quarter what we're basically seeing is there's two key things. We expect that the promotional efficiencies that have been not as great as we would have liked are going to probably continue in the fourth quarter and there is a lot of competition.

We still have -- there's a competitive launch in the premium segment. But the other thing is is we're lapping our lowest green coffee costs from last year, so we've experienced the lowest green coffee costs in our fourth quarter last year and that's really what's driving it. So rather than invest more than we have, we feel that our pricing is right from where we need to be and we are going to weather it.

Okay. And then, Vince, you gave a couple of comments around the changes you're going to make so that hopefully FY16 Coffee is in better shape. Is there some kind of restructuring or significant cost reduction effort that's going to give some investors confidence that that's, in fact, going to be a tailwind?

Yes, Eric, this is obviously Vince, and I can turn it to Mark for more color and we'll provide a little more detail at CAGNY next week. But as we look forward, the reason we're confident that roast and ground can improve its trends, it's all about being more competitive on shelves and there's two main drivers that will help us do that. It's the canister downsize, where we will pass those savings on to our consumers. We believe green coffee costs probably as we go second quarter on will probably give us some relief.

Both of those things will make us more competitive either every day or in promotion. We have some great innovation that's in the pipeline that we're looking forward to and we'll expand more on that at CAGNY next week. But we do believe we'll be able to grow this business and get it back on track earlier into our second quarter of next year.

Okay, and then just last follow-up to Richard. One of the questions I've gotten since the pet food acquisition was announced was I think most investors expected Coffee to be problematic. Do you feel like the organization is in enough shape -- obviously Paul left, but is the organization in good-enough shape that with all the coffee problems that the integration of pet, along with the leverage that you're going to be adding, will be okay?

Yes, first of all, we feel very strong about our team. We've got, as I said, confidence in our team and the best team in the industry, we believe. And we've made some obviously significant changes just recently which we announced earlier this week, aligning the right people to head the right businesses to make that happen. And then bringing Dave West on board, whose got tremendous experience, and Dave and Vince working hand in hand to make sure the integration goes well and that we hit the synergies. And Mark and Steve driving the base businesses.

We really feel good about the team and the excitement around here is palpable. Our team is very, very excited to get into the pet food business, so we're very confident in the team that we've got and very excited about the talent that we're getting from Big Heart pet food business and combined with our talent, we're very confident.

Okay, thanks, see you next week.

We'll go next to Andrew Lazar from Barclays.

Good morning, everybody.

Good morning, Andrew.

I think in the remarks in the Press Release this morning you talk a bit about not having fully covered the higher coffee costs yet with pricing, but also having peanut butter pricing drop ahead of you getting the benefit of lower costs in your P & L? So it seems like it's a getting hit on the way up and the way down situation, which I guess is typically not the way I've remembered the pass-through model more generally working.

I think companies like yours usually at least got an outsized or disproportionate benefit on the way down. And so I guess I'm just trying to get a sense, has something changed more structurally here in the way that pass-through model works, do you think? Or is there really something more transatory with either the way consumers or retailers are behaving in the current environment, which is admittedly difficult?

Andrew, this is Vince. I would say, in a general sense, we've always said that we'd try to be as transparent as we can with our pricing and pass it on, up or down, as we need to to maintain our margins.

You may recall in peanut butter, we did get sort of upside down with peanut costs a couple of years ago because we had to incentify growers to grow peanuts that ended up being a very large bumper crop. And at the end of the day our competitors were in a better position to benefit from that than we were because of the commitment we had to make being the largest procurer of peanuts in the United States.

Accordingly then we had to be more competitive on shelves so we did some pricing and promotional activities ahead of when our costs were actually realized. We are now, and it's one of the reasons our Consumer Foods segment has had a nice run, is that price cost ratio is where it needs to be.

As it relates to Coffee, I would say that fundamentally nothing has changed except that the competitive level of promotional activity and depth caused us to go deeper and more frequent than we would have otherwise. As Mark articulated earlier, we try to balance all those indications. But clearly, where Coffee costs are, it's had an impact on our volume. But structurally, we still think the same way about our pricing mechanisms.

That's helpful. And just quickly, a follow-up on Coffee which would be the canister-size change. Is that basically being changed to be sort of in line with where the competitive set is or are you setting a different standard out there?

No, basically in line. This is Mark.

Thanks very much. See you all next week.

Thanks.

We'll go next to Ken Goldman from JP Morgan.

Hi, thank you for the question. Can you walk us a bit through a little more of the reasoning behind the Management changes you made earlier this week? I think it feels like a month ago, but it was just a few days ago.

Were some of the moves being contemplated maybe prior to Paul's resignation or did that really necessitate some of the switches that are happening? And, Mark, since you're on the call, I guess I'll ask you directly. How do you personally feel about that shift for you and how favorable were you to it?

This is Richard. I'll start. Obviously we had two significant changes in the past several months. The first was Paul's departure and then second was the addition of Big Heart Pet Brands.

Either one of those required us to relook at our organization structure and combined, obviously gave us the need and opportunity to restructure. So those were the drivers. And, as I said earlier, I think the team that we have in place and where we put them in terms of their new responsibilities really plays upon their strengths.

Steve Oakland has been here 32 years and has run most of our key businesses over the years and was our General Manager and established our whole Canadian business years ago. So he's got great capabilities and skills to run the Coffee business. Mark has run everything except for the Consumer businesses, so we have the opportunity to put Mark in that role to run the Consumer side of the business, food side. And then Vince, as I mentioned, has 38 years of experience and knows where all the bones are buried, and so his combination, along with Dave West, will have real opportunities to drive that integration so it's very successful.

And then again, we're going to get a lot of talent from the Big Heart team and Dave West's group. So those are what drove it. That's why we made the changes and that's why I think we're very confident that we've got the right leadership team in place.

So, Ken, this is Mark. Just answering your question. I'm actually really excited about the change because, as Richard said, I haven't run these businesses. There's a lot of brands in there. The namesake business, of course, but obviously peanut butter being critical. And so it's exciting and having the opportunity to allow the natural foods piece to run autonomously, but yet sit in the same organizational structure, allows for us to make sure that we're meeting the needs of both of those customers.

So, yes, I'm very excited. Do I miss Paul on a personal level? Sure, but I think that the changes that were announced were quite logical.

And, Ken, Steve Oakland. Mark touched on one of the things that maybe we didn't discuss enough in some of the public data. We put some different segments together, putting Natural Foods in the Consumer group. The consumer doesn't know where natural begins and where natural ends, and so that allows us to really reach that constituent better.

And within Coffee as well, the consumers' coffee experience at home and away from home and the innovation and the research and the new products that we're doing in the Coffee business really need to apply both away from home and at home. So we think those are subtleties that maybe weren't seen in the release that are going to drive results on across all those different businesses.

And regardless of -- many of you have been here -- regardless of which business your name's on top of, we're a pretty close team and we work together very closely and have been together for so long that the teams know each other well and it should be seamless.

Thank you very much.

We'll go next to Farha Aslam from Stephens.

Hi, good morning.

Good morning.

My question's on coffee. In 2011, 2012, you earned around $540 million in Coffee and then your profitability surged almost $100 million into 2014 with green coffee and K-Cups. Now it seems like you're back in that $540 million-ish area.

Do you think the long term level is back at sort of that $640 million, or is it here kind of closer to current levels and this is the new base that we should work off of given greater competition in the coffee category?

Hi, Farha, this is Mark Smucker. Great question. Obviously, that's one that we've been discussing here internally. So the short answer is yes, we do think, as the business grows, we can get back to the levels that we had previously seen.

I would remind you that we did have some very significant supply chain restructurings that helped deliver some of that growth. Clearly, the results this year are largely volume driven. So I think over the next two to three years, we should start to see a lot of those dollars come back.

We actually are very confident in these last several months that we're making the right decisions on this business to return much of that profitability over the next couple, three years. And so we think as we transition organizationally, we'll be leaving the business in good hands with Steve, but in a direction that should help to deliver those results.

I guess if I could just take one minute and just talk about some of the why -- Vince touched on it in the first question, why we're optimistic. I put it in three buckets: consumer, brand, and consumption trends.

So on the consumer, we are seeing consumers come back into the category slower than we thought, slowly increasing the purchase frequency. We've confirmed that there's been no consumer demographic shift. Then on the brand, we still outpace our competition on the Folgers brand and we know that the Dunkin' brand has very strong coffee equity versus some of the other cafe offerings out there. And then finally, just on the consumption trends, we also know that over 80% of cups consumed at home are still traditional roast and ground. So the fact all of those dynamics and the fact that we're still participating in every segment, we feel confident that we can gain growth.

That's helpful. And then just turning in to your consumer business. Should we be concerned about the weather issues we've seen out West and how that relates to your nut food spreads and your natural drinks business?

Farha, this is Vince. No. I mean, obviously, we are watching all those impacts but I would say as we look into our FY16 we see a tailwind in our overall cost structure. Coffee is obviously to be determined, although we believe it too will be favorable. But if you look across our entire portfolio of raw materials, we believe that our raw material costs will be a tailwind as we go into next year. Some of that, of course, or most of it, will be passed on in pricing as we spoke to you earlier, so it could affect our bottom line. But we believe we are in overall pretty good position.

Great, thank you.

We'll take our next call from David Driscoll from Citi.

Great, thank you, and good morning.

Hi, David.

Good morning.

One little quick detail here. Do you guys exclude the deal-related costs from your outlook? So in this reduction, the 3% reduction from the [555] mid-point, is that reduction just all coffee or is there some deal-related stuff in that fourth-quarter reduction?

David, this is Mark Belgya. There's no deal cost in the fourth quarter guidance reduction. It's all based in the full year and it's the $4.5 million roughly that we incurred this quarter.

Just to be clear on kind of how all this will flow through going forward, these costs we treat as normal GAAP charges, but now that the deal has been signed and similar as we've done in prior deals, you'll see on our P & L the merge integration lines. And we spoke to these costs when we announced the deal at $225 million. Those will flow through over the course of the next three years. Those will be excluded from our non-GAAP earnings, so there's no additional deal costs expected in Q4.

Okay, Mark, just to follow up on Coffee. So what I'd love to hear is just why did this situation just reach a real tipping point in the second fiscal quarter? The canister-size issue has been there for a while, but it seems like this price increase that you guys tried to put into effect just really exacerbated, I guess, this can-size issue in your on-shelf comparison to your major competitor.

And I guess the whole point of this question is to look forward into second quarter of 2016 when we're lapping the 18% volume decline. Is it reasonable to think that the volumes come back if, in fact, you put the product on a historic basis back in line with the price gaps that it used to be at?

David, it's Mark here. So I think it is reasonable to expect that we will get some of the volume back. Given the downsize, it probably will not all come back, but there will be -- from a unit perspective, we do expect unit growth.

And then the first part of your question just around the second quarter, I think we said last quarter we were surprised by the elasticity. The elasticity we've seen mirrors the elasticity when we had even higher [revica] costs a few years ago. And so having a promoted on-shelf price that was significantly higher than our competition was clearly a reason for that. But again, the speed at which we went up, basically overnight from a $6.99 to sort of an $8.99 level, we saw the consumer react to that.

So when you look back over these past four, five, six months, you'll see that the winner was store brand and to a lesser degree, we've experienced some large growth on our opening price point offerings. And so the dynamics did surprise us a little bit. But going back to my previous answer about why we're optimistic, I think that we have a lot of the right things in place, the ability to sharpen our price points in the next fiscal year, this should help to bring a lot of that growth back.

Did you lose shelf space?

No, in fact, I think we talked this last quarter. We actually have seen, in a few select retailers, not sizeable ones, that perhaps have over skewed on the single-serve section and are actually now returning some of the shelf space to us. But to answer your question, in the last six months, we have not lost.

Okay, thank you so much. I'll pass it along.

We'll go next to Alexia Howard from Sanford Bernstein.

Good morning, everyone.

Good morning.

Can I ask about the profitability and pricing on the K-Cup side? There's been a lot of discussion about how pricing on K-Cups has come down even as the input costs on coffee have gone up. And I know that's to do with packaging and so on, but the commentary always used to be that the profits on K-Cups were broadly in line with the margins on your coffee business overall. Is that still true or has that come down quite a bit? And then I have a follow-up.

Alexia, it's Mark Smucker. So we did talk last time also about the margin compression and so we have seen our K-Cup margins below the segment average and so we did invest in the first couple quarters of this year. However, we took the price increase in January and we do expect that margins will improve, at least in the near term, but we may see a little softness in volume.

Okay, great. And then secondly, on the mainstream roast and ground coffee dynamic, your main competitor seemed to be talking about how they'd overpromoted in some of their own segments yesterday. Are you seeing any pullback or improvement in the competitive dynamic there or is it just too early to tell? Thank you, and I'll pass it on.

Thanks, Alexia. The mainstream, not a lot of pullback. I would say there is some of that. If you look at the share numbers or the consumption numbers again, private label or store brand tended to win. And even though our main competitor fared a little better than us, their consumption trends were also down.

Despite their investment levels.

Right; despite their investment levels.

Very helpful. Thank you very much. I'll pass it on.

We'll take our next question from Akshay Jagdale from KeyBanc Capital Markets.

Good morning.

Good morning.

I'll continue with the coffee questions. So it would be helpful if you could talk about maybe help us quantify roughly how much of this overall 9.5%, 10% volume decline this fiscal year really do you think went to private label basically? And then maybe just give us an order of magnitude on how much of the decline in volumes you are expecting this year went to which pieces so that we can better understand the sustainability of this headwind?

So it's Mark again. We touched on this in the script in the prepared comments. And, essentially, about half of the decline -- and this is back again to last quarter -- about half of the decline had to do with this sort of the sticker shock, the reduced purchase frequency, consumers taking pause, maybe using less coffee, so that was probably about half.

And then of the remainder, the shift to single-serve was basically where it has been, so we didn't see an acceleration of that shift. In fact, if you look at the share trends between the segments, you'll see that the growth in single-serve is decelerating and there seems to be some sort of stabilization that might come out of this in the next couple years.

That said, so you have half -- in a nutshell, half to purchasing less coffee, just the frequency, and then the other half is a combination of a normal shift to single-serve, and then the rest would be shifting to our competitors. And then in this case it would be private label and some premium.

Okay. So in other words the shift to private label -- and we've seen this in years past and from talking to some of your private label competitors, it's really a cost of price relationship and there's a lot of blending and stuff that plays into that, but that's not sustainable, right? They don't have a cost advantage longer term relative to you, so those share shifts have happened before and that should presumably come back to you eventually, right? That's a good way to think about it?

Yes, it is. I would say that the trends are very typical from a store brand standpoint and those brands tend to run short in their coverage from what we understand.

Okay. And then to talk to this frequency issue, I mean, I'm not sure I really understand it well enough. So what -- people went to stores less and purchased less coffee? We aren't seeing that in the cup consumption data, per se, but can you give us some sense of what happened there and how do you think that's going to play out? How do you address that?

Akshay, I can't break it down between purchase frequency, dosing the brewer less. We don't have that granularity. But when we've seen declines in the past, it typically is partly driven by consumers making maybe eight cups instead of ten in the home; maybe putting one less scoop in. So there typically could be less usage which, in turn, could drive not -- instead of an 85-day purchase cycle, for example, maybe they're buying their next round of coffee in 95 days. It's hard to get that level of granularity, but that's how we think about it.

And so the canister downsize and lower price point is going to address that issue; correct?

Yes, we believe it will.

Okay, great. I'll pass it on, thank you.

We'll take our next question from Chris Growe from Stifel.

Hi, good morning.

Good morning.

I just had two quick questions. I guess a bit of a follow-up and both on coffee, unfortunately. So just a question for you on there was a comment in the release about reduced promotional efficiency. And I know that the canister downsize and pets and all is not necessarily incremental promotion, but I just want to get a sense of across the different segments, is your promotional spending coming down with less efficiency or are you reducing promotional spending? Does that have a knock-on effect of prices? I'm just curious how you're going to address that.

Well, I think, yes, it has to do with responsible pricing. We have pulled back a little bit on frequency and as we get into the next fiscal year, we do expect both our promotional activities as well as the efficiencies to return to more normalized levels.

Okay. And then just a question for you on Dunkin' and that premium segment in general. You obviously have a big competitor entering that category or at least a big brand in McCafe. I'm just curious how, again, you're positioning Dunkin' in front of that? Again, more promotional or what are you trying to do to try and be more competitive in front of that launch?

Well, first of all, it's about supporting the brand. We have to continue to support the brand. We have a great relationship with Dunkin'. We enjoy the halo effect of their advertising as well.

There will be a short-term impact. We've seen plenty of trial on the competitor, but we think from a brand standpoint, Dunkin' has a very strong coffee equity and that that should help carry its weight as we move into the next fiscal year. And then we continue to focus, of course, on innovation. And so every year we've got new products, new flavors, all of those things that help support the brand as well. So we think we can weather it.

Okay, thank you for the time. See you at CAGNY.

Thanks, Chris.

We'll go next to Jonathan Feeney from Athlos Research.

Good morning, thanks very much.

Hi, John.

Have you done any work on your demographics of maybe some of the slowdown or any customer segments in particular within Coffee? I always thought of Folgers as within roast and ground as the premium player. And I'm not sure if it's possible some migration to single-serve within Folgers has maybe changed that and made people more price sensitive? But I'd love any insight you have as to is it middle income, low income, consumers who are a little bit more price sensitive would be appreciated.

Jonathan, that is exactly the question we've been asking ourselves. And we've done some work on that and my earlier comment was we haven't, fortunately, seen a shift in the demographic base and that does refer to the different socioeconomic levels. The concern might have been that we were learning losing the most, the least price sensitive consumers to other segments. And when we look at the ratios, it looks like it's pretty much the same consumer base that we've always had.

We do view Folgers within the mainstream segment as the premium, the leader, the price leader, all of those things, so we feel good about who our consumer is. And then in addition to that, we're doing a lot of very deep consumer segmentation work to make sure that our own views of who our consumer is have not changed, or maybe they have. So over the next several months, we'll also be updating those data points.

And just one other question. Eric asked earlier in the call, and I'm sorry if somebody else asked this, but Eric asked earlier in the call about retailer inventories maybe having an impact on the fourth quarter. I'm curious about your insights about consumer level inventories. I know that's been a big issue for Green Mountain and their change over, but even in the roast and ground business you talk about less purchasing.

Yes, this is Richard. Just in general in terms of the economic impact of the economy, we still look at the consumer based in three buckets. The top third is doing well, the lower third is still challenged in terms of consumer, and the middle third actually starting to do a little bit better, especially with gas prices coming down and I think we've seen a little bit of that.

Forget coffee for just a minute. But just in general, we've seen a little tick up in our business in the month of December and January in terms of the consumers being willing to loosen up their pocketbook a little bit. We think that has a lot to do with the gas prices coming down and just some optimism. So consumer confidence is up. You've seen the numbers, so we think that is going to bode well for our business overall next year. And actually we've seen it a little bit this year, but that's from a macro sense how we view it. I don't know if any of the other guys want to --

I think that covers it.

Yes, thanks. Any insight on the consumer level inventory of coffee?

Just from a pantry perspective?

Yes, pantry perspective. You say people are shopping less. You said maybe they're drinking a little bit less coffee. I don't know if you have any way of really knowing. You said making eight cups instead of 10 or something like that. Do you have any way of knowing what you're sort of pantries look like for dedicated Folgers households right now?

Yes, sure, there's some research that we do and it does look like consumers may have less coffee in total in their pantry, but I can't quantify that.

Okay, fair enough, guys. Thanks very much. See you at CAGNY.

Thank you.

We'll go next to Chuck Cerankosky from North Coast Research.

Good morning, everyone. I'd like to ask more of a macro question with regard to the demand for the center store products you sell. In looking at a customer that is feeling a little bit better about things, it looks like just spending more in the fresh food categories. And do you think that makes them more sensitive to price and promotion in the products you sell and perhaps maybe even skipping some of those items to make room for fresh products, some of which have significant inflation attached to them.

Hi, Chuck, it's Vince. I'm not sure that -- that may be going on, but let me just maybe frame in what we have seen on the last 12 weeks. If you look at total retail sales, dollars are up about 2.5%, tonnage is down a little over 1%. If you look at the categories that we participate in, dollar sales are only up about 1.7% and tonnage is actually down a little more about 2.5%.

But if you look at us as a manufacturer, including coffee and including the downsize on our peanut butter business, our sales are down but that's because we have more deflation, but our tonnage is down less than either the overall grocery store or the categories we're participating in. So we're gaining share.

And probably more comforting is if you compare to our number one competitor across all of that same landscape, they're down 7%. So I think it gets back to, one, Richard's comment, center of the store is flat to down one kind of number and we're faring pretty good relative to our competitive set.

I would just add to that. I think you are right, Chuck. Perimeter of the store is growing and as people have a little more money in their pocket they are willing to spend more on fresh products in the perimeter of the store and that certainly has an impact on the center of the store. But, as we know, the retailers still make the majority of their money on the center of the store and we're doing -- with the exception of coffee which we talked about, we're doing very well in the center of the store.

Chuck, this is Mark Belgya. I guess the only other thing I'd add from an innovation standpoint is the thought process is how do you take the popularity of the perimeter and bring it into the center? So if you look at a lot of where our innovation is, clean labels, good and good-for-you-type products, snacking is a real focus. And you've seen some and you'll see more and we'll chat about that next week at CAGNY a bit. So we are trying to capitalize at least on the trends that you are seeing in the outside.

All right, thank you very much.

We'll take our next question from Jason English from Goldman Sachs.

Good morning, folks. Thanks for squeezing me in.

Good morning, Jason.

First a very quick housekeeping item. I think there's some confusion related to at the last conference call you hosted regards to Big Heart, on exactly what the incremental amortization step-up is going to be. A lot of us will anchor to the $125 million. It sounds like that's all-in. Can you clarify what the incremental portion of that is?

Jason, this is Mark Belgya. It is the $125 million. In total, it's $225 million. That includes the existing $100 million Smucker today. Where there might be some confusion, depending upon what research you might have done, is they obviously had some of their own amortization, so we're just looking at it as all incremental, so that would be $125 million.

And the $125 million includes what's already embedded; the amortization that's already embedded in their D & A?

It does. Obviously we have to revalue all of the assets, so you flush their number and add our $125 million in.

Got it; that's helpful. Back to the business at hand. Lots of different sort of story lines of that what's happening in coffee. We're cutting some data this morning looking at household penetration for the Folgers brand, and we see household penetration having fallen in 2009 from 35% to 31.6% in 2014, about a 10% drop with sort of accelerating erosion on household penetration just this past year, down 6%.

This seems more concerning that just less households buying the brand. And maybe we've reached a tipping point where this sort of craft mentality fragmentation has accelerated and it begs a question of whether or not there's true secular issues at foot here. Can you comment on that, why we shouldn't be concerned about this data and maybe what you see in terms of your own penetration data?

Jason, it's Mark Smucker. You're right. Some household penetration is down on the Folgers brand, but that's why we are participating in all these other segments. So the fragmentation model, I think there's some truth to that. So on one hand, we're in all the other segments, we're getting growth, we've done real well in our Folgers K-Cups.

And then, just as you think about what some of the things you're going to hear next week when Vince presents at CAGNY about some of the mainstream innovation that we've got coming onstream in the fall in a small scale, but more broadly after that, we believe should still be able to shore up our business in the mainstream, if not the segment itself.

Okay, thanks. I look forward to seeing some of those initiatives.

Thanks.

We'll take our next question from Rob Dickerson from Consumer Edge Research.

Thank you very much. I just had two questions, I guess one more strategic around Big Heart Pet Brands and the other one just housekeeping. I guess the first question is on the strategic side with Big Heart, I'm just curious and I'm not sure how much you could actually comment on this, but any additional color would be great.

So I guess just considering Jim Kilts who, obviously has had a quite successful career on the CPG side and he's Chairman of Big Heart Pet Brands and currently a partner at Centerview. Is the expectation as you bring in David West and you've also have the Board advisors on the private equity side, that someone like Jim Kilts would actually be an integral part of the strategy going forward?

Well, Tim and I know Jim very well and I've known him for years and have a lot of respect for Jim. And, as we said, we're great that Dave West is joining the team. And our observers that are going to be part of our Board activity, they're all -- got good backgrounds in CPG. So hopefully we gain from their experience and we think that will be very helpful as we look at our business down the road. So we're looking forward to that.

Right. And on the advisor side then it's fair to assume, obviously, just considering the equity sake from the private equity side, that the comments and any additional help they can provide on the total business will be there. It's more comprehensive versus just Big Heart Pet Brands?

It's more strategic, you're correct.

Fair enough. And then secondly, just housekeeping. I know in the past you've said that transactions you do you hope that not only would they be EPS and free cash flow per share accretive but also accretive to returnable capital. I'm assuming the expectation is Big Heart will be that as well?

Yes, Rob, this is Mark. Of course, that is our expectation. And with the new capital structure out there, our weighted average cost of capital changes a bit to our favor. But, yes, this business would also deliver on that target.

May just add to that. When we talked about the amortization in our cash flow per share, we're going to start focusing more on that and sharing more information about our cash flow per share going forward, because our earnings per share really doesn't tell the whole story of this Company and how much cash we generate. And we've got probably more cash flow per share versus earnings per share than most people in the CPG industry and so we need to get that message out.

Richard, to that, and playing off the question that was just asked a little while ago on the amortization, if you look at once the deals close, if you take that $225 million in amortization and dollarize that, that's about $1.25 a share. So we know several of you think of value in our Company that way. So you take whatever guidance range and you put another $1.25 on it and that gives you a little better number to value us off of.

Fair enough, all right, thank you.

We'll go next to John Baumgartner from Wells Fargo.

Thank you, good morning.

Good morning.

Just wanted to ask big picture about consumer foods for a moment. And at the pricing contribution is weak there, presuming how commodities are tracking, there may not be positive pricing for some time still? So what are your expectations for the competitive dynamics and pricing in center store going forward? Do you see more or deeper discounting? Do manufacturers choose to hold the line here or maybe promote back a little bit less if consumers are feeling better? How are you thinking about that?

This is Vince. I mentioned earlier a couple of things. We took some price decreases this year on peanut butter and Crisco and we'll have those going into next year. As we look at our input costs across our consumer foods, most of those tend to be tailwinds and so from our topline perspective, we will have a negative dollar impact on net sales.

In terms of our industry, it's fair to say that I think everyone is saying that our promotional dollars are not as effective as they have been historically and there's a lot of money into the trade right now. We're very comfortable with our promotional strategy. If you look across our brands, most of our brands tend to do better everyday shelf price versus, I'll say, promotionally driven on the consumer side. And so whenever we can, our desire would be to get the everyday shelf price right and then tactically promote from off of that and not necessarily a higher frequency or a higher deal level. And so I guess I'll leave it there.

I might just add to that, Vince. Our strategy is the number one brands and the respective categories we participate in. And by that we take the leading position in terms of going up or down in price and recognizing in the short-terms such as, example, peanut butter, we got upside down on that for awhile. But we were willing to hang in there and do what was right for the brand and do brand building, the right pricing. And it took us probably 18 months to get our cost price relationship back, but we were responsible as the leaders in the category. And over time, that has still proven as the best strategy.

We don't think that strategy should change for the leaders in each of the categories that certainly that we participate in. And over time that's the right strategy. We also believe that this is a great time to be in the consumer foods business, believe it or not, although we know it's extremely competitive right now, brands are still extremely important to consumers, and if you treat them right, they will do well in the long term.

John, this is Mark Belgya. I'd add one other thing, because I agree with everything we've said and I think sometimes you throw the pass-through categorically across all our businesses. And I think it's important to think about everything we said, how we're managing the price and you think of peanut butter and cake mixes and things like that. But when you think about innovation as well, you've got to think -- take Sahale for example.

So while we're continuing to do the right thing in pricing, we added Sahale that brings growth into our Consumer Foods segment, or we're introducing products under the Jif or Smuckers brand that probably, longer term, once they're in the run-model mode, are going to be a positive mix. So we'll manage the price; we'll grow that; but we'll add on with innovation and acquisition to build that overall Consumer Food segment growth algorithm in the long term.

Okay. Thanks very much for that.

We'll go next to Robert Moscow from Credit Suisse.

One of the reasons I started covering your stock is that someone told me that it was undercovered by the sell side. (laughter)

Rob, you lost the lottery draw names on that; sorry.

Yes, I think we're probably past that as being an issue. So all right, Coffee question, just asked a different way. You said that mainstream category volume down 5%, half of it due to switching. So I guess my concern is 70% of your sales are Folgers in Coffee, and you're in a mainstream category that's probably going to decline another 2.5% in volume if that switching still occurs. Maybe 5% if the switching still occurs.

So how can we feel comfortable that Folgers can get back to volume growth aside from just taking market share? Because it seems like you're facing an uphill battle and the other 30% of the business is having trouble generating enough profit growth to make up for what Folgers is giving up.

Robert, let me start and then I'll turn it over to Mark. But these are the same issues and concerns we heard when the day that we acquired this business; that we're facing this growing premium segment and how were we going to compete on our Folgers mainstream, and we've demonstrated that we took a brand that was supposed to be $50 million to over $350 million.

We had this growing concern of single-serve and how were we going to compete and we were the first national brand to participate. And so clearly this past year we've had an issue with our mainstream roast and ground, but I think if you look at our history of our innovation, our Supply Chain initiatives that we've done, we've navigated our way through some pretty significant category and consumer trends and very significant changes in our cost of our green coffee.

Clearly as Richard and I said in our prepared remarks and as Mark has articulated, we're not happy with where it is today but we still think the Folgers brand is great. We still believe there are growth opportunities and there are other opportunities for us that we believe will come to fruition down the pike. So I would like to frame it in in that manner and trust us.

Okay. I'll say one thing, though. I think you're at a more reasonable base of profit for coffee this time around for FY15, so I guess that's the good thing. And for profit growth in FY16, you're saying you're going to grow above your normal organic growth rate. Is it fair to say that that organic growth rate is about 5% for profit?

I'd even say a tad below that. We typically talk about organic growth rate more like a 3% growth rate; 3% to 4%.

Okay, so organic 3% to 4% on the sales or profit line?

Sales would be more in the sort of 3% and then you pick up one or two points on profit.

Okay, so coffee profit is expected to grow a little faster than that in FY16?

That's right.

Okay, thank you.

There are no other questions in the queue at this time. I will now turn the conference back to Management to conclude.

We'd like to thank everybody for being on today. We're looking forward to seeing everybody at CAGNY next week. We've got more to talk about with Big Heart Pet Food next week and also talk about our strategy moving forward. So thank you all for being on and we'll see you next week.

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 a passcode of 1727919. This concludes our conference call for today. Thank you all for participating and have a nice day. All parties may now disconnect.