Aaron Broholm - Director-Investor Relations Mark R. Belgya - Senior Vice President and Chief Financial Officer Richard K. Smucker - Chief Executive Officer David J. West - President, Big Heart Pet Food and Snacks Vincent C. Byrd - Vice Chairman Steven Oakland - President-Coffee & Food Services Mark T. Smucker - President, Consumer and Natural Foods.

Andrew Lazar - Barclays Capital, Inc. David Cristopher Driscoll - Citigroup Global Markets, Inc. (Broker) Robert Moskow - Credit Suisse Securities (USA) LLC (Broker) Alexia Jane Howard - Sanford C. Bernstein & Co. LLC Christopher R. Growe - Stifel, Nicolaus & Co., Inc. Jason M. English - Goldman Sachs & Co. Farha Aslam - Stephens, Inc. Jonathan P.

Feeney - Athlos Research John J. Baumgartner - Wells Fargo Securities LLC Rob Dickerson - Consumer Edge Research LLC Jon R. Andersen - William Blair & Co. LLC.

Good morning and welcome to The J.M. Smucker Company's first quarter 2016 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 for questions-and-answers after the presentation.

Please limit yourself to two initial questions during the Q&A session and re-queue if you then have additional questions. I will now turn the conference call over to Aaron Broholm, Director, Investor Relations. Please go ahead, sir..

Good morning, everyone. Thank you for joining us on our first quarter earnings conference call. With me today in presenting our prepared comments are Richard Smucker, Chief Executive Officer; and Mark Belgya, Chief Financial Officer.

Also joining us for the Q&A portion of the call is Vince Byrd, Vice Chairman; Steve Oakland, President, Coffee and Foodservice; Mark Smucker, President, Consumer and Natural Foods; Dave West, President, Pet Food; and Barry Dunaway, President, International.

During this conference call, we will make forward-looking statements that reflect the company's current expectations about future plans and performance. These 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 as detailed in our press release located on our corporate website, at jmsmucker.com.

A replay of this call will also be available on our website. On August 25, we filed a Form 8-K regarding a modification of our segment reporting structure. Effective this fiscal year, results for our Natural Foods business will now be included in the U.S. Retail Consumer Foods reportable segment.

International and Foodservice is now a combination of all remaining businesses. Modified prior-year results for fiscal 2015 and fiscal 2014 that reflect the realigned segments were included in the Form 8-K. Also as a reminder, we will be hosting our Investor Day at the New York Stock Exchange on October 20.

A live webcast of the event will be available through our Investor Relations website. If you would like to attend in person and have not yet received an invite or if you have any other questions after today's call, please contact me. I will now turn the call over to Richard. [002SK4-E Richard Smucker] Thank you, Aaron.

Good morning, everyone, and thank you for joining us. This continues to be an exciting time at Smucker's, as we have completed our first full quarter of owning the Pet Food business. Our teams remained focused on delivering synergies and ensuring we capitalize on the best capabilities of both organizations to position our company for continued growth.

At the same time, we delivered solid first quarter results. We are more confident than ever before that our decision to enter the growing pet food business was very timely. The more we learn, the more excited we've become in the potential of this sector and the combined positive impact with our existing business platforms.

Let me now provide a few highlights of our first quarter performance. First, net sales increased 47% to nearly $2 billion, driven by the addition of the Big Heart Pet Brands and a strong first quarter for coffee. Excluding acquisitions and foreign exchange, sales grew 6%. The May 1 launch of Dunkin' Donuts K-Cups in U.S.

retail channels has exceeded our initial expectations and drove a large portion of the increase. Second, non-GAAP operating income grew $81 million or 37% for the first quarter, also driven by the addition of the Pet Food business along with Coffee segment profit growth.

Third, with an increased interest expense and the higher tax rate and share count, non-GAAP earnings per share decreased 1% to $1.32. Excluding amortization, adjusted earnings per share were $1.60, an increase of 7% from the comparable measure in the prior year.

Lastly, free cash flow improved significantly from negative $57 million last year to positive $252 million this year, a portion of which was used during the quarter to reduce our net borrowed position. In addition, last month, we announced a 5% increase in our quarterly dividend rate. Overall, first quarter results were strong.

On a full year basis, we are on track to achieve our previously stated guidance as Mark will discuss in a moment. Let me first provide some brief comments on our U.S. Retail businesses. As I said, Dunkin' Donuts K-Cups got off to a great start.

During the quarter, we shipped over 100 million cups and had strong merchandising support, including nearly 40,000 retail displays. We are pleased that the brand already holds a 5% dollar share of the K-Cup market and a current ACV of 75% based on the latest 12-week scan period.

While some of the first quarter sales were pipeline filled, we are seeing distribution expand and we look forward to further our upcoming marketing support. As a result, we anticipate Dunkin' Donuts K-Cups will provide additional category growth and share gains for our K-Cup portfolio.

Mainstream coffee volume continued to be impacted by higher price points in the first quarter compared to a year ago. However, we experienced sequential improvement in volume trends from the fourth quarter. In July, we announced a 6% price decrease due to the anticipated declines in green coffee costs.

With this change and our transition to a reduced canister size for our large can Folgers' offering, which is proceeding as planned, consumers are now beginning to see lower price points on shelf.

In Consumer's Foods, which now includes our Natural Foods business under our new reporting structure, our Smucker's, Jif and Uncrustables brands have strong volume performance for the first quarter, including a 14th consecutive quarter of double digit volume growth for the Smucker's Uncrustables frozen sandwiches.

With new on-trend products and good merchandising support, we expect another successful back-to-school period for these brands. In the baking aisle, aggressive competitive activity impacted our results and we expect these dynamics to continue through the upcoming holidays.

However, with a combination of targeted innovation, pricing and merchandising, our brands are well-positioned to responsibly compete during the Fall Bake season. Within Pet Foods, strong performance for both our premium Pet Food and our Pet Snack brands continued to drive overall growth.

We had a well-executed launch of the Natural Balance brand into a large national pet specialty retailer during the quarter. Also, innovation across the Natural Balance, Milk-Bone and Meow Mix brands was a key contributor to first quarter results.

Our mainstream Pet Food business faced ongoing heightened competitive activity against a deflationary macro environment. We remain confident in the long-term health of our mainstream brands and the profitability of the category. Overall, we are very pleased with the performance of our Pet Food business to date.

Let me conclude my comments with an update on our Big Heart integration activities and the related synergy targets. Overall, we have made good progress on this front. We anticipate being in a position to share a broader update on these topics during our Investor Day in October. However, let me give you a brief overview today.

First, we have established the key integration milestone for our go-to-market organization, supply chain and migrating most of our core systems and processes to one platform, which will occur during the fourth quarter of this fiscal year.

As part of these activities, we are creating one combined sales organization to support our go-to-market approach. To that end, we have begun the process of consolidating a number of our sales offices.

Regarding our supply chain, the key initiatives include consolidating forecasting, procurement and our distribution network, leveraging our scale as an $8 billion organization. To support all of these efforts, we will transition key Big Heart administrative customer service and plant IT systems to our Oracle platform.

We will also establish a consolidated shared services footprint which will drive much of our planned G&A savings.

Second, work continues to progress on our project to benchmark and elevate our overall cost structure as we execute our integration plans, identifying best practices and focusing on enhancing our capabilities for growth across the entire company.

With the help of outside consultants, we have identified more synergy opportunities than the original $200 million target. At this time, we believe savings above this amount will be invested back in the business to drive future growth. Cost-cutting alone is not a long-term solution to creating shareholder value. We must drive the top line growth.

As to timing, we continue to expect to realize the first $25 million of benefit this fiscal year. There is still much work to be completed to ensure a seamless integration for our customers and consumers. We will then be positioned to achieve the bulk of the synergies in years two and three, as originally planned.

In general, we expect these savings to be somewhat equally split between supply chain opportunities and G&A. Lastly, we have also identified significant working capital opportunities as part of the consolidation project, which will further support our deleveraging objectives.

Based on work today, we believe a reduction of $200 million is achievable, primarily in the area of inventory. We recognize this may result in a P&L headwind during the transition period due to under-absorbed overhead, but we will look to ways to offset this impact.

Again, we are pleased with the progress we have made on our integration and synergy efforts and are confident that taking a phased approach remains wise to avoid disrupting our long-term plans, our growth, and our culture.

In summary, we're very pleased with the start for the year, with our new Pet business, and we are confident about the initiatives in place to support future growth. This continues to be a dynamic time for all of our employees, and we thank them for their continued dedication. With that, I'll turn the call over to Mark..

Thank you, Richard, and good morning, everyone. I will start by providing additional color on first quarter results and then conclude with our outlook for the full year. Net sales increased $628 million or 47% in the quarter. This largely reflects the addition of Big Heart.

On the legacy business, volume and mix combined to add four percentage points of growth, primarily attributable to K-Cups. The net sales impact of pricing and foreign exchange was essentially flat in the consolidated results.

GAAP earnings per share were $1.14 this quarter, in line with the prior year, reflecting the impact of higher interest expense and shares. Included in GAAP earnings were $26 million of special project costs, primarily related to merger integration activities, compared to $9 million of such costs in the prior year.

Also included were $10 million of unallocated derivative losses compared to a loss of $21 million last year. Excluding these items, non-GAAP EPS was $1.32, for a decrease of 1%. Further excluding amortization, adjusted EPS was $1.60, up 7%.

Non-GAAP gross profit grew slightly faster than sales, resulting in a 20 basis point increase in gross margins to 38%. Excluding Big Heart, the impact of commodity costs were unfavorable in the first quarter, driven by green coffee, but were fully offset by higher net pricing.

Big Heart's commodity costs were lower than the prior year during the quarter. SD&A increased 53%, as selling and marketing expenses grew at a slightly faster rate than net sales. Royalties associated with the Dunkin' Donuts business contributed to the higher selling cost.

Amortization expense increased $28 million as a result of the Pet Food acquisition. Factoring all of this in, non-GAAP operating income increased $81 million, while operating margin declined 130 basis points to 15.5%.

Longer term, we anticipate margins to improve as synergies from integration activities are realized, offsetting the operating income gains or higher interest expense and an increase in the number of shares outstanding related to the Big Heart acquisition.

In addition, a higher effective tax rate of 38.8% in the first quarter resulted from adjustments to deferred state taxes, including the impact of state tax law changes. We now expect the full-year effective tax rate to approximately 35%. Let me provide a brief overview of segment results.

And I'll start with Coffee, which achieved net sales growth of 12%. Sales for the Dunkin' Donuts brand increased 78% for the quarter, driven by the launch of Dunkin' Donuts K-Cups. Net sales for the Folgers brand increased 3%, reflecting higher net price realization and favorable mix. Folgers volume was down 9%.

This was anticipated, as first quarter promoted price points were higher compared to the prior year and as the reduced canister sizes began shipping in the latter part of the first quarter. Segment profit increased 13%, as coffee costs were higher compared to a year ago, but were more than offset by higher net pricing.

The Dunkin' Donuts K-Cup launch and lower marketing spend also contributed to segment profit growth. On July 1 we announced a 6% price decline on the majority of our Coffee portfolio excluding K-Cups. This was in anticipation of green coffee costs turning favorable on a year-over-year basis as we head through the second quarter.

Reflecting significant planned increases in marketing investments as we proceed through 2016, most notably in our second quarter, we continue to expect full-year segment profit growth in the mid-single-digit percent range for Coffee, somewhat equally weighted between the front and back halves for the fiscal year.

Turning to Consumer Foods, net sales were comparable to the prior year, as favorable volume and mix was offset by list price declines taken during last fiscal year, most notably on peanut butter.

Volume gains included a 6% increase for Jif peanut butter and a 4% increase for Smucker's Fruit Spreads, with sales of our Natural offerings continuing to grow in both categories. In addition, Uncrustables frozen sandwich volume was up 27%. Conversely, Crisco oils and Pillsbury baking mixes experienced mid-single-digit declines.

Segment profit declined 1% for the first quarter from a strong prior-year comp when segment profit was up 15%. On a full-year basis, we continue to expect Consumer Foods segment profit to be down. This reflects an approximate $20 million headwind from incremental overhead related to the recently completed Memphis, Tennessee peanut butter facility.

Net sales for our U.S. Retail Pet Foods segment were $550 million in the first quarter, adding Canadian Pet Food sales reported in our International business results. This represents a mid-single-digit percent increase over Big Heart's reported sales for the comparable period a year ago.

Our top line momentum reflects the benefit of some of the marketing and other brand support investments made in the fourth quarter of last fiscal year. Pet Food segment profit was $90 million for the first quarter.

While profitability comparisons to Big Heart's previously reported results are not exact given acquisition accounting, we estimate this represents a mid-teen percent increase over the prior year. Items on the plus side included higher volume and mix along with lower marketing and commodity costs.

Partially offsetting this was lower net price realization, reflecting trade support in mainstream Pet Food due to the deflationary competitive environment and investments behind our product launches. In addition, the step-up in amortization expense significantly impacted segment profit.

Although, Pet Food results exceeded our expectations for the quarter, timing around marketing spend and other items contributed to the profit over performance. We anticipate a significant increase in marketing spend for Pet Food in the second quarter behind new item launches, which will impact year-over-year comparisons.

Overall, we expect Pet Food results for the first half of the year, as well as on a full-year basis, will be in line with our original projections. Lastly, net sales for International and Foodservice grew 7% in the quarter, reflecting the addition of the Pet Food business in Canada and higher volume and mix for the legacy businesses.

Volume growth was led by Robin Hood flour and Folgers Coffee in Canada, along with Smucker's branded spreads and Uncrustables offerings in Foodservice. Segment profit was in line with the prior year. As anticipated, foreign currency had an impact on top line and bottom line results.

While expected to remain a headwind in the coming quarters, we continue to pursue opportunities to offset much of this currency impact. Turning to cash flow, cash provided by operations was $305 million for the quarter compared to a use of cash of $8 million in the prior year.

Along with higher income, depreciation and amortization, this increase primarily reflects lower working capital needs driven by lower green coffee costs and the ending inventory compared to the prior year and a timing benefit of tax payments and refunds. Factoring in capital expenditures of $53 million, free cash flow was $252 million.

We ended the quarter with commercial paper borrowings at $303 million and long-term debt of $5.7 billion for a combined total debt of $6 billion. Based on our projected fiscal 2016 EBITDA of nearly $1.6 billion, our leverage stands at 3.8 times.

Our full year estimate for free cash flow has increased from $850 million to $900 million assuming CapEx of $200 million. Let me conclude with an update on our full year sales and earnings outlook which is unchanged from our previous guidance.

We continue to expect net sales to approximate $8 billion including the contributions of Pet Food along with legacy business growth of approximately 3%. Non-GAAP earnings per share are expected to be in the range of $5.65 to $5.80 for the year.

Excluding amortization expense of approximately $1.15 per share, this would result in adjusted earnings per share of between $6.80 and $6.95. We expect the year-over-year EPS growth to fall in the back half of the fiscal year.

As previously noted, this is primarily due to the timing of synergy recognition, anticipated lower green coffee costs being weighted toward the last six months and unfavorable FX impacts weighted toward the front half.

Further, we anticipate second quarter results to be slightly behind last year primarily due to planned significant increase in marketing expense in support of our brands.

We will provide further updates on our full year outlook following the second quarter, given better visibility into Fall Bake performance and as we progress on the Big Heart integration process. With that, we will open up the call to your questions.

Operator, could you please queue up the first question?.

Thank you. The question-and-answer session will begin at this time. Our first question comes from Andrew Lazar of Barclays. Please state your question..

Good morning, everybody..

Good morning, Andrew..

Good morning, Andrew..

Good morning, Andrew..

Hi. I think on Pet Food, you had mentioned that the majority of the synergies this fiscal year are likely to be back half weighted? As you mentioned, the profitability came in nicely this quarter.

So, just trying to get a sense of, were there some – I guess, really, the issue is, if you're looking for $2.4 billion, I think, in sales for the full year, but were below that level in the first quarter, I guess, despite some distribution gains, trying to get a sense of what drives the acceleration to hit the run rate, if you will, of the $2.4 billion for the full year?.

Okay, Andrew, this is Dave.

How are you doing?.

Hi, Dave..

Just let me take it into a – give you a couple of pieces. Remember that one thing is that the Canadian mainstream business was, in the modeling numbers, we would have given you when we bought the business. It's now in the International segment. So, there's a shift there.

That business is obviously still healthy but it's going to be running the Canadian business. So, you're going to see a slightly smaller number. This is also the seasonally lowest quarter. So you can't just take this quarter and multiply out by four.

This is because of the way merchandising in the category works and the timing in new item launches just tends to be the lowest quarter. So, I would look at it in a different way which would be to say, we only model 4% to 5% top line growth over time for this business. We're there in the first quarter.

Our Pet Snacks business grew high single digits; that's what we expected it to do, that's what it grew in the quarter. Our Pet Specialty business was above high single digits.

Some of that is pipeline filled as we've expanded the distribution footprint, but the core business is very healthy and offsetting that was, we were down in the mainstream business, particularly with some of the deflationary activity and promotional things that are going on in the market.

But overall, we're right where we wanted to be on the model and as we project forward, I would still use that model to get to the number, just remembering it's a seasonally smaller quarter..

That's helpful. I appreciate that perspective. And then with respect to the margin in Pet, I know you had some favorability as you mentioned from commodities and marketing which will shift a little bit into second quarter from a marketing standpoint.

But the margin in Pet; is that something we should view as a sort of a reasonable, sustainable margin off of which to then layer on the synergies as we go through the back half of the year, or would you point out some discrete things in this quarter that wouldn't make that a base to work from?.

I think over time, you would expect the margins to improve for two reasons. If you think about where the growth is going to come from, Pet Snacks had the highest margin in the Pet portfolio. I think some of the highest margins in the entire portfolio of the company.

So, as we grow Pet Snacks high single digits over time, you get a very favorable mix effect in margins. And then the second thing is our Pet Specialty margins, we bought the business not too long ago with respect to Natural Balance, and we're just in the process now starting to put those margin improvement programs into place.

So our margins in Pet Specialty are probably lower than some of the bigger competitors that you might be tracking that give out public data. And over time, we think our operating margins will improve in the Pet Specialty segment as we grow as well..

All right..

Andrew, this is Vince Byrd. I would also just make sure we all understand that the synergies will not all be reflected in the Pet SG&A margin percentages. Those will basically affect all of our businesses or SG&A as we go forward..

Thanks for pointing that out, Vince. Thanks, everybody..

Thank you..

Thank you, Andrew..

Thanks..

Our next question comes from David Driscoll with Citigroup. Your line is now open..

Great, thank you and good morning..

Good morning, David..

Good morning, David..

Good morning..

I just wanted to go back to the savings. I think you said that the initial read here on looking at the savings program over the multi-years is that it's going to be higher than the $200 million. And that anything over that $200 million is going to be reinvested.

Number one, did I hear that correctly? And then number two, can you actually quantify how much reinvestment you would expect?.

This is Richard. You did hear that correctly. By doing the consolidating project we're doing, we've definitely confirmed that we can get above the $200 million but we really plan on investing that back into the business.

We are not at this point in time sharing those numbers, but it gives us real confidence in the $200 million and it gives us some sort of a cushion to invest back in our marketing programs and innovation..

Richard, I suppose what I'm really just trying to get at, even if you don't want to give a number is that it's materially higher. When you look at a $2.5 billion or $2.4 billion Pet Food business and the synergies, you get a number.

When you look at an $8 billion Smucker and you start to VBB [Value-Based Balance Sheet] and all these other tools, it's our expectation on the outside that you would get a materially higher number.

Is that at least a philosophically correct statement?.

It depends on how you define materially. It's a good number, but we're not doubling these savings. It's something like that. So just to let you know that it's a good number, but I don't want to put false expectations out..

David, this is Vince. And I would characterize it also as this. First of all, we are very pleased with the benchmarking that our consulting firm did and as both Richard stated and Mark in their formal remarks, they also identified a nice working capital opportunity for us.

But it really doesn't change what our teams are singly focused on over the next year, and that's all of the integration activities and achieving what we would probably call more combinational opportunities to achieve that $200 million.

As we look at other areas that our consultant challenges on, we would view that as the bucket of some transformational things, and we haven't made the decision yet at this point. That will be made over the next 12 months to 18 months how much further we go.

But again, I think the important thing is we were very pleased with the results and the benchmarking and there might be upside to those opportunities..

If I could sneak one last question then on Coffee. I believe you guys kind of reiterated a mid-single digit profit growth here.

But since the first quarter comes out, I think, better than your original guidance, certainly better than what we were modeling, kind of why wouldn't your expectations for the year have improved given the strong start in Coffee?.

Hi, Dave, it's Steve Oakland, a couple things.

We did have a great start in Coffee and that was driven by two things, as Mark talked about in his comments, both the Dunkin' Donuts K-Cup launch and better price cost relationship, even though we actually had a higher coffee prices this first quarter than we did a year ago, our promoted price in relation to that was better.

But if we look at the second quarter, we need to look back to the prior year and if we remember the results of the prior year caused us to be very aggressive at managing spending across that business. And so, we had significantly lower than average marketing costs in the second quarter last year. So, there's a lot of moving parts.

We feel great about our price cost relationship. In the comments, I think Richard mentioned that we downsized our canister. We did pass that savings along with that downsize. We also took a price decline.

So, if you think about we have the downsized canister and the pricing reflected there, the price decline, we think we're in a great place for great performance in our merchandising for the second quarter. Now, that's going to allow us to spend more normal marketing and that normal marketing is going to be spent on the launch of Perfect Measures.

So, we've got what we think is a very exciting innovation, one of the first innovations in roast and ground in some time, and we're pleased to be in a position to spend at a more normal level to support that launch. So, the marketing spend is probably the big difference. If you normalized marketing, you'd see much better year-over-year comparisons..

Thanks for the color..

Our next question comes from Robert Moskow of Credit Suisse. Please state your question..

Hi, thank you, good start to the year obviously. And as I talk to investors leading into the quarter, I think what I heard the most kind of concerns is on the top line guidance, not just for this year, 3% organic and then mid-single digit Pet.

But going forward, because I think the perception is that the world has changed, that the growth algorithm is lower, and Smucker doesn't appear to have adjusted its kind of top line outlook to that reality.

And I think you will get this question in future conferences to come but if you're – you have identified a bunch of savings, you've said on the call that your intention is to reinvest those savings to be able to hit those top line numbers.

Do you feel like that that is really the best use of those savings if overall growth outlooks have changed?.

I'll start. This is Richard. First of all, our growth outlooks – we're in two great categories, obviously Coffee and Pet. And then if you look at our Food side – and those are two great categories, but our third category is probably the base of our business, which is the Food side, which is Smucker's and peanut butter.

Those are all I guess three good categories that we're in. We think they all have opportunities for growth. Pet we talked about mid-single digits, which we still think that is true. Coffee, there are commodities oriented with all these products. And so just in dollars, you may not get the right quarter-to-quarter or year-to-year.

We have to price based upon where the commodities are. But we still see solid growth in all three of those businesses. Now in terms of absolute dollars, I think the industry is a little slower, but I think the categories that we're in still have solid mid-single growth rates. And I think that's what we still expect them to be..

Hey, Rob, this is Mark Belgya. I guess just to add to that, a couple of years ago we consciously increased the percentage of our organic growth to 3%. We moved our innovation from 1% to 2%. So it's tied to what Richard said, that innovation is clearly coming in those categories.

But if you look at just the portfolio of what we brought to market last year and what we're bringing to market this year, we're not basing a lot of that growth on what I would call the traditional slower stuff. I think that should help.

I think part of your question too, while I clearly aimed at organic, I too have heard similar commentary and I think a little bit challenges on the overall 6% as it relates to the M&A portion of the strategy, and I think it's a fair question.

But as we've talked about and we continue to talk about, that's why we focus so much on this deleveraging because I think if we get somewhere out three years or so, two to three years, we'll be in a much better place that as M&A opportunities do provide themselves. So I can see at this point why there's a little reservation.

Can we really get to the 6%? But I think if you give us a couple of years to delever, I think we'll be in a position to continue on the M&A side, which obviously has driven a lot of the top line, as we've hit our numbers over the last five years to 10 years, respectively..

And can I ask a follow-up regarding the synergies? You have an Analyst Day coming up. You don't have Analyst Days very often.

Richard, can you give us an update at that time as to how much of the new synergies you are willing to articulate and quantify at that time?.

I think what we'll do is we'll give you some more color. But we don't want to quantify at that point in time those extra synergies. But we'll probably give you some general directions in what we're doing.

And we'll also talk a lot about innovation, and that's where a lot of those synergies will be put behind because we have a lot of things in the pipeline in all three of our segments, and we're going to spend behind those innovations. And so that's where we'd like to spend the extra dollars..

Okay, I'll get back in the queue..

Thanks..

Our next question comes from Alexia Howard of Bernstein. Please state your question..

Good morning, everyone..

Hi, Alexia..

Good morning..

Good morning..

Can I ask about pricing dynamics with competitors on the Coffee side? If I remember correctly, you obviously led the price increase up a year ago, and I think Starbucks, some of the premium players didn't take pricing at that time.

Now that you're taking pricing down again, is the dynamic improving there in terms of price gaps? Just generally, what are you seeing in the pricing environment? And then I have a follow-up..

Sure. Hi, Alexia, Steve Oakland. You are correct. Last year in June, we took a 9% price up. And this year in July we took a 6% down. The delta there is a little bit of a price/cost mix. There's one month of difference there and then there's a couple percent difference just based on green.

Additionally, we passed on savings through the downsize of the canisters. So if you think about our mainstream business, we feel really good about that pricing. And we think that should – although the canister is down, we should see significant unit growth and hopefully modest volume growth because of the smaller canister.

The pricing dynamic with Starbucks though is more in our premium business. And you're right, I think we have had great share gains over the years. We took price up. Some of the other premium players did not follow, but the current pricing has allowed us to get those cost relationships more in line.

And we would hope that both the regular turns of those businesses because they sell a lot on regular turn and the promotional features will help. Specifically on Dunkin', the excitement around the K-Cup launch, we had about 40,000 or so displays, if you can believe that, out in the first quarter. And many of those displays had both bags and K-Cups.

So we're hoping that the excitement around K-Cup can also – and the media that we're going to do around K-Cup, which is just starting this last week or so, will help that whole Dunkin' franchise. So we feel good about pricing and about the excitement around the merchandising..

And so as the follow-up, are you able to share what the annualized run rate sales on K-Cups would be now if you were to take the last month or so, roughly how quickly it's ramping up?.

Mark?.

Hey, Alexia. This is Mark Belgya. We're using this opportunity to take a step back as far as how we're going to talk about our coffee brands. We really want to focus on the brands themselves. And I think we'd just reiterate what we said before.

Our current K-Cup business prior to Dunkin' was around $300 million, and we said a time or two that we think it can equal that. But we're trying to step away a little bit from the tracking that's pulling the brands up to that level of detail. So hopefully, we'll be consistent with that and everyone can get comfortable with that over time..

Okay, thank you very much. I'll pass it on..

Our next question comes from Chris Growe with Stifel. Please state your question..

Hi, good morning..

Hi, Chris..

Good morning..

Good morning. I have just two questions for you, if I could. The first would be as you look at the stronger than I had estimated underlying revenue growth from the quarter, it sounds like there was some benefit from the Pet Specialty channel building up some inventory there, Dunkin' K-Cups certainly.

And then also I'm curious about the smaller canister, if the underlying Folgers benefited from that. I'm just trying to get a sense of this quarter maybe if revenue growth was a little inflated, maybe there's a little bit coming off Q2. I just want to understand the dynamic between the two quarters and maybe what benefited this quarter..

Chris, Steve Oakland. I can speak to Coffee. I think we are really pleased with how the canister transitioned. It really transitioned seamlessly but I don't think that really impacted the quarter. Most of the promotional activity in the quarter was on the same canister you had a year ago. We should see the impact of that in the second quarter.

And I think it's both the ability to take price down. If you remember a year ago, we had taken a significant price increase. So, the year-versus-year, just absolute pricing difference makes both the retailer a little more excited about those features and hopefully, the consumer takeaway better..

Okay, and then....

And, Chris, there's a little bit of pipeline in the Pet Specialty business as we expand the Natural Balance footprint. So the Natural Balance in the Pet Specialty segment was up certainly higher than high single digits in the quarter. We still see the overall year, still looking in that 4% to 5% range. There will be puts and takes as we go along.

We had a more difficult time in the dry dog food part of the market this quarter. We wouldn't expect that to continue all year. So there will be puts and takes as we go along, but there's a little bit of pipeline as we get the distribution expansion on Natural Balance.

But I think for the year, you can still look at that 4% to 5% and feel pretty good about it..

Okay, thank you for that. And just a quick follow-up if I could, you have, it sounds like, a pretty substantial increase in advertising coming in the second quarter.

Was it down in the first quarter and if we think about kind of first half versus second half, is it kind of balancing out here in the first half? Do we still expect it to be up double digits for the year?.

Marketing will certainly be up. It was down just a little bit. As we said, Dave's timing is more in the second quarter support, Pet Food, but you'll see. And as Steve said, particularly year-over-year in his business, it's going to be dramatically up.

So we're still tracking pretty much in line with what we said at the beginning of the year in terms of overall marketing. Now, as you know, as we move through the year, we use that a little bit as a lever. But right now, we feel pretty good where we are..

Okay, thanks for your time..

Our next question comes from Jason English of Goldman Sachs. Please state your question..

Hey, good morning, folks. Thank you for the question..

Good morning, Jason..

Good morning, Jason..

I apologize if I missed this in the prepared remarks, but I certainly missed it in the press release.

The volume price contribution to organic growth by segment, can you walk us through that?.

By segment, yes, we can do that. Well, obviously, in Coffee, we said our Folgers' volume was actually down 9%; why don't we pull that here and maybe cover that. If you've got another question and we can come back to that..

Sure. I've got another question. You're mentioning incremental savings with synergies.

Is it fair to say when you say synergies, you're really just bucketing in efficiency throughout the organization, some of it related to the acquisition, some of it related to just overall productivity? And then the second part of that question, reinvestment; can you give us some color on where you see opportunity for reinvestment? Is it M&A? Is it diversification of your portfolio organically? Is it just more marketing? A little more thought or a little more color just in philosophically how you're thinking about that..

Jason, this is Vince. I'll start. I would say our synergy targets, as we said, we're going to give a little more color during the Investment Day, but it's in the traditional areas of, quite frankly, head count, other SG&A and then total delivered cost.

And if you put SG&A versus total delivered, it's about 50%/50% in terms of where our current target is as Richard said in his prepared remarks. In terms of where we invest or where we choose to invest over the $200 million as Richard said earlier, time will tell. But it will be probably more in innovation in top line and probably marketing..

I'll just add a little color to that too because it's as we said.

We're going to get $25 million of the synergies hitting the bottom line this year, but we are doing a lot of work to integrate these businesses and we are doing it, I would say the right way, measured, making sure that the businesses are solid, that our customers don't see any differences in terms of how we go to market, in terms of making sure that we're in line.

And then, so most of that investment is going to come in the year two and year three against new products and innovation and that's where we would like to spend it. So, you're going to see that investment back at that time.

You probably won't see much reinvestment this year, with the exception, as we've mentioned, we started the year good, our marketing programs and our marketing expenses are fully funded this year. And as Mark said, those are levers that you could pull throughout the year if you need to.

But because we're off to a good start, we'd love to spend that money because that builds our brands for the long-term and we feel that we can do that this year and still hit the targets that we shared with the Street..

Hey, Jason, this is Mark. So, in our Coffee business volume mix would be about plus 4%, our Consumer Foods would be plus 3%, and our International and Foodservice would be around plus 6%..

Thank you. That's helpful, pretty good numbers across the board. Thanks for the color, guys. I'll pass it on..

Our next question comes from Farha Aslam with Stephens Inc. Please state your question..

Hi, good morning..

Good morning, Farha..

Good morning..

When you look at your 3% core growth target for this year, could you just share with us how much you anticipate that to be volume versus price/mix?.

Hey, Farha. Could you just repeat that? You were just a little low on our end, I'm sorry..

Sure.

How much of that 3% growth in the core business that you anticipate this year will be from volume/mix versus pricing?.

It's going to be primarily mix because on volume, you will recall we talked about with the downsizing of Coffee, we're going to lose it. We're measuring volume in tonnage, so we're going to have that as a drag.

In terms of the pricing, we've got the Coffee, the price decline that we just took this summer, and then, a little bit of effect you had at the carryover on the peanut butter side.

So, Dunkin', as we said, a lot of the 3% growth by can we use is coming in Coffee this year and it's being driven primarily by the K-Cup launch and then supplemented with the various innovations we've got across the organization..

Okay. And then a longer-term question, going back to what Rob was asking about really growth drivers in your business and what we can expect out of them.

So, are the three growth drivers Natural Food, Pet Food and Coffee?.

I think a different way to think about that is more of what we've called sort of the big ideas that we've talked about. We've talked about growing Jif and Smucker's, and a lot of that's through innovation, both specifically in sort of traditional, but also pushing the brand in different categories.

We've talked about Uncrustables, clearly, that continues to grow. In Coffee, really just that it continues to grow with the leader there and then, in Pet. So, yes, some of the stuff you said but it's somewhat embedded in those five areas or six areas as well..

Yes. And I guess, I'll add to that, peanut butter just itself, it's been, continues to be a great category. And Snacking, almost every single category that we're in, whether it's Pet Snacks or Human Snacks, we're pushing Snacking across all of our lines, I guess, with the exception of Coffee. And those are kind of the areas that we're focusing on.

Those are the big ideas..

And on that, just you're running baking for essentially cash flow.

Do you expect growth in baking? How should we think about that baking portfolio?.

Hey, Farha, it's Mark Smucker. So, in the baking area, let me talk about last year. We had a great year last year. We won Fall Bake last year, and oils benefited significantly from a major customer of sort of having an outage in private label so that really helped. In addition to having a good Fall Bake, we had a great Fall Bake because of that.

We are, as you recall, managing all of our categories, balancing volume, top line as well as profit and share. So, this year as you know or you may know, one of our major competitors took a price decline in core baking mixes, which we followed. And we expect them to be very aggressive through the period.

So to my earlier comment just about balancing top line and bottom line, we will be competitive at targeted locations in both of those categories. But we think we'll have a decent Fall Bake, but will clearly be down from last year, just making sure again that we balance both top line and bottom line..

I think, too, just to the point about managing cash. So you've got the profitability side of that contribution in cash, but it's not a big CapEx demand as we've invested previously in it. And I think as we've talked about earlier on the working capital program, I suspect there'll be some benefits from cash generation there too.

So I don't want to say we're just managing for cash, but I think we will see cash generation at or better levels as we move forward on that particular part of the business..

That's helpful. Thank you..

Our next question comes from Jonathan Feeney with Athlos Research. Please state your question..

Good morning. Thanks for the question..

Hi, Jon..

Good morning..

Just a couple on the Dunkin' Cup launch actually. First, there has been a lot of talk about some of the competitive activity within the single-serve market. And I know you're not calling out your metrics in that market, the single-serve versus cans specifically. But can you tell me – it sounds like you're happy with your launch.

Was the price positioning of these Dunkin' K-Cups above average for your single-serve cups that are in the market today? It's my first question. My second question is would the contribution of those 100 million cups this quarter be profit contribution, be above the segment average which looks like 27.5%. Thanks very much..

Hi, Jonathan, Steve Oakland. Couple of things; yes. Dunkin' is in that premium segment, right. So, it's slightly above where Folgers is priced. And so, I mean it was an amazing launch quite frankly. If you think about it, you take one of, if not the largest, liquid coffee brands into mainstream K-Cup in the grocery store.

So, the retailers, not just in the Northeast, but across the country were very excited about that. So, for the most part, we had trucks lined up at midnight the day we started shipping it, right. So, that kind of thing. So, we had great support there.

The consumer has responded and it was not a – the whole segment really isn't driven by price points yet. So, let's hope we keep it that way. So, we gained share, but after one quarter, it's really hard given all of the shipments and all the channel things. It's hard to make a bet on the whole share gain for the year.

But the early result share numbers were good as well. So I think you'll see that. I think you can expect that in the back half. Is it a higher margin item? No.

And in fact, it performed reasonably well given the fact as early as it was in our launch, but like any launch, you've got all the cost, the marketing cost, the other things we invest in to put that product on the shelf. So....

Yes, Hey, Jon, this is Mark Belgya again. Just to add one more thing to that. I think maybe a little longer-term bigger picture here is you got to remember that the arrangement is a three-party arrangement. So it naturally will have a slightly lower margin than existing the K-Cup business and clearly lower than the overall segment, yes..

Okay, thanks very much..

Our next question comes from John Baumgartner with Wells Fargo. Please state your question..

Thanks for the question, good morning. Dave, I wonder if you could maybe come back to the dry dog softness. And I think if I heard it clearly, your view is the past weakness won't continue? And I guess maybe aside from the deflationary inputs there, it seems there's some share loss or share migration to smaller, natural organic brands.

What gives you the confidence that dry dog improves going forward?.

I think what you're seeing right now – and again, I think when you buy the syndicated data, I think you get a number that's dog and cat, and we look at it as dry and wet, so I think you don't see the full picture. If you look at it over 52 weeks of a brand like Kibbles 'n Bits, we're down 10 basis points in share over 52 weeks.

If you look at the last quarter, that's been accelerated, but that's really all about price points and opening price points, and we took our price up in the quarter and we lost some share. So what we're doing in that business over time is managing it for profit as well as for share.

So we're pleased with the profitability of our dry cat and dog businesses. Soybean meal and corn are the largest inputs in the dry food business. They're at lows and are much lower than prior years. So you're going to see some of that reflected in price points at the shelf, but it is not a pass-through category.

So over time, as you see commodities come back up, you also won't see all of it passed back through in terms of prices going up and down. So it's a little different than the categories. This is a big, big, big category over time. It's been relatively flat over time. Right now we're deflationary.

So I think we're managing it for a combination of share and profits. So I'm not all that concerned about it. On a long-term basis, people still will feed, and this will be a relatively flat tonnage part of the business. You do see a significant migration away into Pet Specialty over time. We have two great brands in Pet Specialty.

We have Nature's Recipe, which is a gateway brand into Pet Specialty. And then we have the Natural Balance business, which we're rolling out our distribution footprint. So as that migration occurs, we're well positioned to take advantage of it. We've got a great brand in Kibbles 'n Bits and a very good brand in Gravy Train as well in dry dog.

So I think you can't overreact to something in a deflationary period. The business was a little softer than we'd like it to be, but we also hit the profit targets for the dry business overall..

Thanks, Dave. And then just maybe, just for the company conceptually in totality, coming back to the framework for the top line outlook and relating specifically to the Natural Foods business, it is a smaller part of your business now.

But is this an area where you feel you can lean a bit harder going forward, either organically with truRoots or through M&A as you delever from Big Heart? It would seem that Natural Foods is an area where there's untapped potential.

Is that a fair statement?.

Mark?.

Yes, sure. This is Mark Smucker. That is a great business, and it's actually off to a very good start this year. Our core, we have a reasonably large beverage business in that we recently restaged the Santa Cruz Organic brand, and we are seeing some very nice growth in that core business, if you will.

And like some of even the mainstream businesses, just pushing out in all the brands, whether it be truRoots, R.W. Knudsen, Santa Cruz Organic, all of those brands have some good runway. And so we would expect the total Natural Foods business, albeit still relatively small, to grow probably greater than our core businesses for sure..

Yes..

Thanks, Mark..

If I can add to that, just like the Snacking business, as we're looking at simpler ingredient labeling for all of our brands and more natural, so we have a Natural Smucker's jam and jelly, which we came up with a few years ago and is doing extremely well. We have Smucker's now made sweetened with honey, and actually it's doing very well again though.

And it's growing faster than the core brands, but they're very small. So we're trying to do that across every single category that we're in and even Pet, more natural, simple ingredients in Pet. So it's where the consumer wants to go. It's where we're headed.

And as I talked about earlier with innovation, all of our brands, all of our categories are pushing both snacks, natural, simple ingredients. And we're seeing a lot of growth in all of those areas..

Thank you, Vince..

Our next question comes from Rob Dickerson of Consumer Edge. Please state your question..

Okay, thanks. Just quickly, I know there's a lot of discussion obviously around Pet right now, in Coffee, and I think Farha touched on the baking business. Over a longer period of time, I think we've seen pressure in the baking business for a lot of obvious reasons. You say it's capital intensive, it's definitively generating cash; it's all positive.

But going forward, if we continue to see the volume declines in that business, would you ever consider thinking about divestment such that you could accelerate deleverage on Big Heart and improve top line growth? Thanks..

This is Richard. It's a very solid business. It gives up good cash flow every year. Some years it's up more than down, some years up more than others, some years down more than others. But we always do look at our portfolio.

And so we never say as long as it's – we're not changing the values upon which the company was founded, we definitely say we look at our portfolio and we will make changes and see if it fits long term. But right now, we are satisfied with most of the brands that we've got, but from time to time we look at that..

Okay, fair enough. And then just quickly, Mark, just housekeeping. Tax rate obviously in Q1 was a headwind, much higher than annual guidance. I guess the assumption if you're not changing that guidance is that it will be lower as we go through the year..

Yes, we'll average back down to the 35% I mentioned, pretty much to say I think you can use that lower down in each of the three quarters as well. It's not a phase down for Q4..

Okay, great. Thank you..

Our next question comes from Jon Andersen of William Blair. Please state your question..

Good morning. Thanks for the question, everybody..

Hey, Jon, good morning..

Good morning..

Hi. I guess maybe a little bit of an odd question. But you were talking earlier, I think, Richard, thinking about where the consumer is going and some of the megatrends out there around health and wellness in Snacking.

And so, I guess my question relates more to e-commerce and is there a role or maybe how big a role for e-commerce is kind of a go-to market channel is there in your business, where you see some of the opportunities and what initiatives you may have kind of underway to pursue that? And then the second part of that question is just kind of bigger picture for the industry for CPG manufacturers.

Do you see that kind of a net positive or is it more of a challenge? And one of the things that I think about is and there's probably a big business in building the basket via in-store merchandising and as things maybe moved away from in-store more to online, you lose that kind of ability to generate that impulse purchase.

I know there's a lot there but any thoughts you have around that would be instructive? Thanks..

I'm going to ask the team to comment on that. I'll just make a first comment that e-commerce this year we're actively involved in it. We think, however the consumer gets their products, we want to make sure that we can deliver it to them.

Some of that will be through our traditional customers who have e-commerce initiatives which most of them now have and some will be through strictly e-commerce providers. But we think that's where a lot of consumers want to get their products. And so it depends upon the product that we have.

I mean some products are certainly easier copies, very easy to ship by e-commerce. Pet Food is probably pretty easy to do by e-commerce. And some of our other products with less likely but we're looking at all opportunities. Dave, you might have a comment on that..

I only have good comments about this. I think as Richard said, Pet Food is one of the categories where you've got a number of retailers who are moving and have their own omni-channel businesses and we've been participating with that for years.

And one of the areas that we talked about, when we talk about reinvesting any amount of the savings above the $200 million, building capabilities in this area is something that we're already doing. We're channel agnostic in terms of the better consumer. We want to reach the consumer.

That becomes more and more important at that digital, so we are building digital capabilities and a digital ecosystem. Shopper marketing and the ability to use the big data that we all have to do better targeting and better shopper marketing program is an area that we're building out capability.

And then merchandising and go-to-market activities, particularly around launching innovation and how you get innovation to the right consumer in the trial period when you have your marketing; all of those things are capabilities that we have – both companies have in some form.

And we will continue to build out and we're pretty excited about those platforms. I think when we get to the Investor Day in October, when you see some of our brand and category presentations, you'll be able to see what we're doing in the digital, social and shopper marketing areas.

It's pretty exciting, but I think the reality of it is we need to own the relationship with our consumer because they're going to shop in more and more places over time. And so, we're really focused on owning that relationship and then meeting them when they want their information and where they want it.

And that's going to be more and more on their mobile device. So, more to come on it. I think the whole industry is moving. We're excited about where we are because we think they have categories that lend themselves to really great consumer interaction..

This is Vince maybe just to add just one other dimension to it. The other thing that we're doing is looking at how our consumer gets information about our brands and products through their mobile devices and we're very close working with our industry on that front as well.

So, it's all about consumer transparency in terms of information and our teams are working hard to fulfill that void as well..

So, Jon, hopefully you see we're excited about this area and we're invested in it..

No, that's really helpful. I appreciate all the commentary around that. Thanks..

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

We want to thank everybody for being on today. We look forward to seeing all of you, if possible, in New York in a month or so. And so have a great week, and holiday weekend coming up. Thanks a lot..

Ladies and gentlemen, if you wish to access the re-broadcast after this live call, you may do so by dialing 888-203-1112 or 719-457-0820, with a pass code of 2880183. This concludes our conference call for today. Thank you, all, for participating and have a nice day. All parties may now disconnect..