The J. M. Smucker Company
Q2 2009 Earnings Call Transcript

Published: 21 Nov 2008

[Operator:]

(Operator Instructions) Welcome ladies and gentlemen to The J.M. Smucker Company Second Quarter 2009 Earnings Conference Call. I will now turn the conference over to Mr. Mark Belgya.

[Mark Belgya:]

Welcome to The J.M. Smucker Company Second Quarter 2009 Earnings Conference Call. I am the company’s Chief Financial Officer, thank you for joining us this morning. Also on the call from the company this morning are Tim Smucker, Chairman of the Board and Co-CEO, Richard Smucker, Executive Chairman and Co-CEO, Vince Byrd, President of our Coffee Business, Steve Oakland, President Consumer Business area, Mark Smucker, President of Special Markets and Paul Smucker Wagstaff, President Oils and Baking. After this brief introduction I will turn the call over to Tim for opening comments. I will then review the financial results for the quarter and Richard will provide closing remarks. At the conclusion of these comments we will be available to answer your questions. If you’ve not seen our press release it is available on our website at Smuckers.com. A replay of this call is available on the website in downloadable MP3 format. If you have any follow up questions or comments after today’s call please feel free to contact me or Sonal Robinson, Director of Corporate Finance and Investor Relations. I would like to remind you that certain statements in this presentation and during the question and answer period that follows may relate to future events and expectations and as such, constitute forward-looking statements within the meaning of the Private Securities Legislation Reform Act of 1995. I invite you to read the full disclosure statement concerning such forward-looking statements in the press release. I also want to point out that the company uses non-GAAP results for the purpose of evaluating performance internally. Additional discussion on non-GAAP information is also detailed in our press release. With that I’ll turn the call over to Tim.

[Tim Smucker:]

Before I discuss the quarter I’d like to take this opportunity to welcome the Folgers employees who joined us after the successful closing of the transaction earlier this month. I would also like to welcome our new shareholders who are joining us on this quarterly conference call for the first time. We thank you for your investment in Smucker. The Folgers and Millstone brands along with the Dunkin’ Donuts brand in retail have joined our widely recognized portfolio that includes Smucker’s, Jif, Crisco, Pillsbury, Eagle Brand, Hungry Jack, Robin Hood, and Bick’s. As the leading retail package coffee brand in the US Folgers is an excellent fit with our strategy to own and market number one food brands in North America. With the addition of Folgers we hold the number one position in nine categories in which we compete and we expect 75% of our sales will come from these number one brands. At Smucker our purpose is to help families share memorable meals and moments and we focus on our consumer with the theme, ‘Meals together, memories forever’. Folgers has a long tradition of being part of memorable meals, a perfect compliment to breakfast or dessert, two areas we know a lot about. There are many opportunities for leveraging our brands as our categories share similar core consumers. We look forward to many multi-branding events and are enthusiastic about the business and the opportunities ahead. Now let me summarize the key thoughts and highlights for the quarter. First, we delivered solid financial results, the quarters 19% sales growth was broad based as every business area was up double digit over last year. While pricing contributed much of the increase nearly all categories and brands experienced volume gains and non-GAAP earnings per share were up 12% led by increases in operating income and fewer shares outstanding. Second, we completed a successful back to school period. Finally, our performance in fall bake has been strong. Our portfolio of brands are considered by many families to be essential in their pantry and thus we are well positioned to meet the needs of those consumers looking to do more for their families by enjoying meals together at home. Recent data indicate that the number of meals prepared and consumed at home is trending upward in this challenging environment and is currently at levels not seen since the mid 90’s. Let me briefly comment on the performance of our brands during the quarter. In the consumer area the Smucker’s, Jif and Hungry Jack brands all contributed to sales growth. Virtually all categories in consumer experienced volume gains. Peanut butter volume rebounded from last quarter and was equal to last year despite ongoing competitive activity. During the recent back to school period we were once again fully promoting Jif and offering cross promotions with Smucker’s. As a result we are seeing the benefits in Jif’s performance along with strong growth in fruit spreads. Hungry Jack potatoes and pancake mixes both experienced double digit increases over the last year providing further evidence of peoples desire to enjoy comfort foods at home. In oils and baking, Crisco, Pillsbury, and Eagle Brand milk were all up for the quarter. In addition to the price increases taken during the last year the Crisco brand in both oils and shortening and Pillsbury brand also experienced volume growth. As we entered this years fall bake we felt our multi-brand marketing event was positioned to be the best in the four years we have been participating. Earlier this month our holiday coupon insert was delivered to millions of homes across the US in advance of the upcoming holiday baking season. Strong merchandising programs coupled with investments in marketing and new products provided a great start to the fall bake and should carry us through the remainder of the season. Once again, our special market segment contributed significantly to top line growth. The majority of the increase came in Canada where the Carnation and Europe’s Best acquisitions and pricing more than offset the negative impact of foreign exchange rates. While we did feel the impact of the economy on the traditional portion control business, pricing, and the addition of Knott’s Berry Farm helped deliver overall dollar growth in our food service business. Our beverage business also exhibited healthy top line growth. In summary, we delivered a strong quarter, continuing the success we experienced in the first quarter, with some relief in the commodity markets and a solid fall bake program we are optimistic about the prospects for the remainder of the fiscal year. Of course we look forward to opportunities Folgers provides going forward. I would now like to turn the call back to Mark to have him review the financial results.

[Mark Belgya:]

Our 19% sales growth during the quarter is broken down as follows

[Richard Smucker:]

As Tim mentioned we had a strong second quarter with solid sales and earnings growth. Fall bake is also strong with good momentum going into the second half of the year. Now that we have closed the Folgers transaction we are enthusiastic about our opportunities. Not only do we have the number one retail package coffee brand with Folgers but Dunkin’ Donuts has been a big winner in the gourmet coffee category with sales in excess of $150 million for the first full year. Last quarter we talked about our key milestones and priorities and I would like to provide an update on these. First, consistent with our basic belief of people we have made all the employee related matters our first priority. Prior to the close we identified the organization that would be in place on day one. As a result, the teams have hit the ground running. The majority of the previous Folgers organization has joined the Smucker Company including green coffee, procurement and supply chain, R&D, operations, finance, and information systems. Second, on day one of the merger we were selling products and going to market as one company through our sales team which includes Advantage Sales and Marketing, our national sales agent. This was a major accomplishment and one that will greatly benefit the integration process. Third, our primary objective is a seamless integration with our customers and consumers. Our integration teams have been working to accomplish this role. We expect Folgers products to be ordered, shipped, and invoiced alongside other Smucker products during the first quarter of 2009. Fourth, we have been meeting with our top 25 customers to share our vision for the broader portfolio of brands and to better understand their unique needs and expectations from the coffee category. Fifth, achieving the $80 million synergy level over the next 18 months is a key objective and we will be tracking success against the synergy target. Finally, we will continue to take advantage of opportunities to leverage the equity of the Folgers brand. In summary, we are pleased to have closed the Folgers transaction and welcome the Folgers brand and employees into the Smucker Company. Second, the integration process is off to a great start with the full support and focus of the organization. Finally, we delivered solid sales and earnings in the quarter with the strong back to school and fall bake program. In closing it seems appropriate to comment on the current economic crisis and its potential impact on our company. As evident by the numbers that we have just posted and the outlook that we shared we strongly believe that we are weathering the storm very well. This is not just the result of consumers tending to focus on the home and the value of preparing their own meals. Continuing to perform in these difficult times is dependent on our long held belief of focusing on the needs of the consumer and providing them with quality products that offer a real value. It is also the result of taking measured risk and at the same time maintaining a very strong balance sheet. These are fundamentals that have and will continue to allow us to achieve long-term performance for our shareholders. We truly believe that the best is yet to come. We thank you for your time today and now we’ll be happy to answer your questions.

[Operator:]

(Operator Instructions) Your first question comes from Eric Katzman - Deutsche Bank

[Eric Katzman:]

I’ve talked to a few investors already this morning and I was wondering if you could just kind of walk through the mark to market charge, what that means for the P&L going forward and how we should think about that for those who may be investing in the food industry for the first time given everything that’s going on in the world.

[Mark Belgya:]

Certainly it was a large number and let me walk through and I’ll go into some things assuming that you know a little bit around the accounting treatment. The biggest point is we’ve talked to all our investors is that Smuckers uses a hedging philosophy to basically align costs with our pricing. That’s the underlying point. In terms to what happened this quarter, as we entered into the quarter we saw a decline primarily in soybean oil and wheat in terms of the costs, a pretty significant decline and based on that and our positions we were required to write down to fair value the impact of that decline in those two specific commodities. The accounting rules require us to take that as a period charge in the second quarter, that’s different than what we would have done at certain times with other hedges where it’s matched in the future. What will happen is that we took this negative charge as a hedging charge this period but would expect that to reverse going forward. That will reverse, however, not as a gain from hedging but rather from the lower costs as we take physical delivery and use of those inventories. It will still affect cost of goods sold but you will not see us turn around with a favorable $24 million gain for example.

[Eric Katzman:]

Over a given period of time the loss this quarter will reverse itself even though it won’t be as evident as a period item it will just be flowing through cost of goods is that we should take away?

[Mark Belgya:]

That is correct.

[Eric Katzman:]

On another subject you talked about the movement from out of home to in home those of us who are focused on the food industry are kind of aware of that but a lot of the questions I get also are the growth in private label in terms of at home consumption. Maybe you could discuss across some of your categories the tailwind you saw from out of home to in home versus maybe share losses from in home branded to him home private label.

[Tim Smucker:]

Private label is growing, we’ve seen that. That’s one of the reasons we have our strategy of owning number one brands still perform very well in the market. Most of the gain from private label growth has come from the three and four brand. As you saw in the numbers, that our actual volume growth is up for the three months.

[Steve Oakland:]

There are a couple key things. As you know we’re in the jam business, peanut butter business, we’re in pancake mix and mashed potatoes, all core comfort foods. The categories are up substantially, the pancake mix category is up 27% in the last four-week period. You’ve got categories like peanut butter up 10%. When you’ve got core categories where we have these kinds of positions growing that much there’s room for a little private label growth this period and there’s room frankly for us to grow.

[Eric Katzman:]

In terms of the outlook and your giving back on price it sounds like those are in some of the product lines that traditionally are more of a cost plus business, is that a fair description of your decision to lower pricing on oils and I think Folgers recently did the same thing in coffee.

[Paul Smucker Wagstaff:]

We did in fast yesterday just announce a price decline in our oil business, shortening business and flour. That’s more from a transparent perspective. That is going in effect in January.

[Eric Katzman:]

Does transparent mean cost plus, I don’t know what that means?

[Paul Wagstaff:]

Not exactly, its basically trying to match up our costs that we are having that we get with the rough raw ingredient.

[Eric Katzman:]

Did you say actually what the dollar amount of cost headwind was in this quarter?

[Mark Belgya:]

No, our overall cost outlook for the full year we had originally said $150 million, we’ve lowered that down a little bit to $140 million, but that’s for the full year.

[Eric Katzman:]

Can you give me a number as to how much you got hit in this quarter?

[Mark Belgya:]

What I would say is that we have taken probably about two thirds of the total during the first half of the year. We don’t specifically break it down by quarters but roughly two thirds of that $140 million.

[Operator:]

Your next question comes from Farha Aslam – Stephens

[Farha Aslam:]

Can you share with us your thoughts on Folgers volume pricing and sales going into the next six months of your fiscal ’09?

[Vince Byrd:]

As you know we’ve only owned the business for two weeks. I’ll address the pricing situation first and I was going to pick up on Eric’s comment. As I think you know historically P&G has been basically conditioned to trade that if the green coffee commodity reaches certain thresholds that basically will trigger an automatic price increase or decrease to the marketplace. As Eric pointed out there was in fact a price decline taken about two or three weeks right before we closed the transaction. Where the coffee sits today they have not hit an additional threshold but it may be trending in that same way and we’re obviously tracking that on a day-to-day basis. Secondly, as it relates to volume and projections, at this point we do not know really anything different than what the information used in Form 10 and that’s what we’re sticking to at this particular point. I will say there has been maybe a little bit of a shift. I think it’s fair to say that the Dunkin’ Donuts brand has probably exceeded expectations but that’s been offset by some of the Millstone and even some of the red can core volume.

[Farha Aslam:]

Could you share with us the price declines effective in January how much they are for oils, wheat, and Folgers?

[Paul Smucker Wagstaff:]

On oils we’re going down 13.6%, shortening 6.9%, and flour is 17.5%.

[Farha Aslam:]

Now that I understand that you’re in about the first two weeks of really key fall bake but could you share with us your retail volumes in oils and flour for the period?

[Paul Smucker Wagstaff:]

For the second quarter is that what you’re talking about?

[Farha Aslam:]

No, not the second quarter, kind of into the third quarter because we’re just right now starting fall bake how are your shipments looking and volume take away going into Thanksgiving?

[Paul Smucker Wagstaff:]

They’re very solid. We can’t give you specific numbers but we’re right on track in fact we’re doing better than track.

[Mark Belgya:]

To reiterate something I said in the scripted comments is I think going into the fall bake across the board we were very well positioned a year ago we had just bought Eagle, we obviously had another year of holding that. We’re very well going into it and as a result we’re seeing great performance.

[Operator:]

Your next question comes from Jon Andersen - William Blair

[Jon Andersen:]

I wanted to come back for a minute to the price reductions that you recently announced. Did I hear your correctly that those are effective in January and then second, was that something that retailers came to you for or how did you arrive at the decision to take those decreases and was it more of a decision that your major retailers coming to you and saying we’re looking at what’s happening in the commodity market and looking for some type of relief at a consumer level?

[Paul Smucker Wagstaff:]

To answer your first question, yes, you heard that correctly. They are effective in middle January. We actually look at the market and watch it very closely and we made the decision to take the prices down primarily based on the market conditions. Obviously we do hear from our retailers and listen to what they have to say but we did do this based on market conditions.

[Jon Andersen:]

Based on what you’re seeing right now are there other categories or other businesses where there may be similar types of moves, maybe not in magnitude but in terms of timeframes in other businesses?

[Vince Byrd:]

I think coffee is one as I mentioned earlier we’re going to monitor.

[Paul Smucker Wagstaff:]

In the consumer businesses we really don’t face the same commodity fluctuations, fruit, glass, sweetener; those things are on longer term contracts or bought annually.

[Jon Andersen:]

On hedging obviously with the mark to market in the current quarter related to flour and soybean oil, with Folgers coming over now do you inherit a similar hedging strategy on green coffee beans and is that something the capability came over and the approach would be similar on that piece of the business?

[Vince Byrd:]

The answer is yes. First of all as I think Richard made in his comments we’re very fortunate that we got the entire green coffee buying group as part of the merger. That entire organization is in place. Probably the one difference in terms of the strategy is we tend to be a little shorter positioned on coffee. Again, given the amount of time it takes to react and how the trades been conditioned with pricing movements within the industry.

[Jon Andersen:]

It sounds like you’re making nice progress with Crisco Olive Oil. Can you provide a little more color on your level of distribution there or ACV and some of your plans it sounds like you have a new marketing campaign you’re getting ready to launch.

[Paul Smucker Wagstaff:]

The olive oil business is going very well right now, it’s on track with where we’re trending, where we want to trend. The ACV I would say is mostly 100% US its not 100% but we’re pretty much every market, a few markets in the Northeast we’re not in at this point.

[Richard Smucker:]

We’re nationwide but we’re about 30%, 35% ACV. So we have some opportunities.

[Paul Smucker Wagstaff:]

Absolutely, that is correct but we are very pleased with where we’re headed.

[Operator:]

Your next question comes from Chuck Cerankosky – FTN Midwest

[Chuck Cerankosky:]

If we look at Folgers for a bit is there any unfilled private label production capacity you’d like to utilize there since I think you lost some Safeway business a while ago?

[Vince Byrd:]

No. Are you asking would we like to do private label?

[Chuck Cerankosky:]

Yes, given that Folgers had been in that business?

[Vince Byrd:]

No, I think you know our primary business is brand. Our number one charge is focus on growing the Folgers and the Dunkin’ Donuts and Millstone brands that’s where we’ll focus the efforts.

[Chuck Cerankosky:]

Could you give us some idea as how integration charges related to the Folgers business will track over the next few quarters?

[Mark Belgya:]

I think that you’re going to see it spread over the next 18 months to two years. We’ll see charges here in the third quarter obviously closing the transaction there will be people related charges and as we start relocating things and training the like. Then I think it will be just spread out over the rest of the next four to eight quarters but you will see a little bit of blip here in the third quarter.

[Chuck Cerankosky:]

To put on an index number 100 there’d be a bulge in the third quarter and then over the next maybe eight quarters it would be pretty level?

[Mark Belgya:]

Yes, there will be some spikes as we go along. The way we’re managing the integration is we’re using the term milestone. For example we talked about what we call customer facing that will occur in the first calendar quarter of ’09 that would be a milestone. For example when we convert to Smucker’s systems for our plant and finances later next year that would be a spike. There will be some spikes but I think generally your comment is correct.

[Chuck Cerankosky:]

How about the synergies, will they track in any type of pattern against those?

[Mark Belgya:]

I don’t think there’s a real correlation there. There will be some but I would say that we’ll see it spread out probably a little more into next year than this year.

[Chuck Cerankosky:]

Next year being fiscal ’10?

[Mark Belgya:]

Yes.

[Chuck Cerankosky:]

With the volume decline in industrial oils is that mainly related to food service customers?

[Paul Smucker Wagstaff:]

No that was primarily a timing situation.

[Operator:]

Your next question comes from Eric Serotta - Merrill Lynch

[Eric Serotta:]

I wanted to clarify something in terms of the $3.45 to $3.50 guidance for the year. Does that include the charge or the additional expense from the write up of acquired Folgers inventory and what sort of order of magnitude is that? Some companies call that out as a special item do you plan to?

[Mark Belgya:]

The range is probably I’m guessing $10 to $15 million right now. I will say it’s a little bit higher than we thought it would be when we first announced the transaction. As you probably know that is driven by inventory levels and since we acquired the business at the peak of the coffee inventory that number is higher. That will run through our cost of goods sold and our earnings. We probably will at a minimum speak to it and call it out. We’re evaluating the actual treatment of accounting during the quarter.

[Eric Serotta:]

Is that in your $3.45 to $3.50 guidance?

[Mark Belgya:]

Yes.

[Eric Serotta:]

You could argue that, certainly if it’s in the guidance if you pull it out the number would be above the guidance. Moving on, could you guys speak to the month-to-month trends that you saw as the quarter unfolded if you strip out some of the seasonal factors as the economy and financial markets got worse from August to September and September to October. Did you see a pick up in your business; did you see a slowdown, what were the overall trends there?

[Richard Smucker:]

It is true that I think in the last 60 days or so we’ve seen more cocooning, more people staying at home, more meals prepared at home. There’s no doubt about it that the economy is affecting that trend.

[Eric Serotta:]

More people cocooning at home are you talking about purchasing food at the grocery store and eating at home or are you talking about pantry de-loading?

[Richard Smucker:]

We saw some nice trends in October, it’s hard to project. Quite frankly you’ve got retailers cautious with their inventories; you’ve got an awful lot of variables here. We did see in the category numbers I talked to you about earlier our delay is four weeks so October looked pretty solid.

[Operator:]

Your next question comes from Michael Prober – Clovis

[Michael Prober:]

How big is the red can business to Folgers?

[Vince Byrd:]

It’s the majority of it to be honest with you. It’s 80% to 90% depending on whether you’re measuring it on volume or dollars.

[Michael Prober:]

If you look at the last six months or so you commented that you have seen a slight decline in the red can. Can you talk about what’s happening in the category first between the red can and your competitor and then within private label and talk a little bit about what’s happening there?

[Vince Byrd:]

Obviously those were results tat were provided by Proctor and Gamble previously. Basically you have a category that’s pretty much flat in volume over that time period. There clearly has been some incremental competitive activity by the main competitor during that period. Thirdly, you have a major product innovation that was introduced during that timeframe by Proctor and Gamble on a volume weight conversion and a higher quality consistent offering during that period. I’ll say a lot of noise going on during that timeframe. Again, it’s our charge to invest in this brand in the long term and grow the red can for the future.

[Michael Prober:]

You lost share because the competitor was more aggressive you lost share because the new product?

[Vince Byrd:]

I would say its been price competitiveness during that timeframe.

[Michael Prober:]

The affect of private label on the category has private label been taking share from the category?

[Vince Byrd:]

It has been growing, yes.

[Michael Prober:]

Can you discuss two or three of your plans or even Folgers plans by itself to grow the brand? I know promoting coffee with my biscuits in the morning was clearly you put that in your slide show but can you just be a little bit more specific what you’re going to do to grow the brand?

[Vince Byrd:]

Absolutely, first of all we’re going to continue to leverage the growth of the Dunkin’ brand and that’s being supported with significant amount of consumer support including advertising. We want to continue to leverage that. Secondly, as we’ve talked many times before we are a food company and believe that we’ll be able to bring maybe a greater focus to it than the previous owners. Thirdly, as evidenced by what Paul has indicated with our multi-brand and merchandising events that we do around the fall bake period we clearly believe that Folgers fits very, very nicely into those same themes whether it be around a breakfast theme or whether it be around an evening dinner, dessert type theme. Fourthly, I would say it is about leveraging our go to market strategy and our sales and distribution network. I believe Richard commented that literally on day one we’ve hit the ground running. Our sales team including Advantage is selling that product as we speak. We believe that will provide incremental focus to the business as well. Again, we’re very, very excited but we’ve only owned it for two weeks.

[Operator:]

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

[Tim Smucker:]

Thank you very much and we certainly again thank our new investors and welcome the new Folgers employees to the Smucker team. Thank you very much and have a wonderful Thanksgiving

[Operator:]

(Operator Instructions) This concludes our conference call for today thank you all for participating and have a nice day. All parties may now disconnect.