U.S. Markets closed

Edited Transcript of SJM earnings conference call or presentation 28-Nov-18 1:30pm GMT

Q2 2019 J M Smucker Co Earnings Call

ORRVILLE Dec 4, 2018 (Thomson StreetEvents) -- Edited Transcript of J M Smucker Co earnings conference call or presentation Wednesday, November 28, 2018 at 1:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Aaron Broholm

The J. M. Smucker Company - VP of IR

* David J. Lemmon

The J. M. Smucker Company - President of Pet Food and Snacks

* Joseph Stanziano

The J. M. Smucker Company - Senior VP & GM of Coffee

* Mark R. Belgya

The J. M. Smucker Company - Vice Chair & CFO

* Mark T. Smucker

The J. M. Smucker Company - CEO, President & Director

* Tina Floyd

The J. M. Smucker Company - Senior VP & GM of Consumer Foods

================================================================================

Conference Call Participants

================================================================================

* Akshay S. Jagdale

Jefferies LLC, Research Division - Equity Analyst

* Alexia Jane Burland Howard

Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst

* Andrew Lazar

Barclays Bank PLC, Research Division - MD & Senior Research Analyst

* Bryan Douglass Spillane

BofA Merrill Lynch, Research Division - MD of Equity Research

* Christopher Robert Growe

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Analyst

* David Christopher Driscoll

Citigroup Inc, Research Division - MD and Senior Research Analyst

* Jason M. English

Goldman Sachs Group Inc., Research Division - VP

* John Joseph Baumgartner

Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst

* Jon Robert Andersen

William Blair & Company L.L.C., Research Division - Partner

* Kenneth B. Goldman

JP Morgan Chase & Co, Research Division - Senior Analyst

* Pablo Ernesto Zuanic

Susquehanna Financial Group, LLLP, Research Division - Senior Analyst

* Pamela Kaufman

Morgan Stanley, Research Division - Senior Analyst

* Robert Bain Moskow

Crédit Suisse AG, Research Division - Research Analyst

* Robert Frederick Dickerson

Deutsche Bank AG, Research Division - Research Analyst

* Scott Andrew Mushkin

Wolfe Research, LLC - MD and Senior Retail & Staples Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning, and welcome to The J.M. Smucker Company's Fiscal 2019 Second Quarter Earnings Conference Call. This conference is being recorded. (Operator Instructions)

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

--------------------------------------------------------------------------------

Aaron Broholm, The J. M. Smucker Company - VP of IR [2]

--------------------------------------------------------------------------------

Good morning, and thank you for joining us for our fiscal 2019 second quarter earnings conference call.

Mark Smucker, President and CEO; and Mark Belgya, Vice Chair and CFO, will provide our prepared comments. Also participating in the Q&A are Tina Floyd, Senior Vice President and General Manager, Consumer Foods; Dave Lemmon, President, Pet Food and Pet Snacks; and Joe Stanziano, Senior Vice President and General Manager, Coffee.

During today's call, we will make forward-looking statements that reflect the company's current expectations about future plans and performance. These statements rely on assumptions and estimates, and actual results may differ materially due to risks and uncertainties. I encourage you to read the full disclosure concerning forward-looking statements in this morning's press release, which is located on our corporate website at jmsmucker.com.

Additionally, please note, the company uses non-GAAP results to evaluate performance internally, as detailed in the press release.

We have posted to our website a supplementary slide deck summarizing the quarterly results and fiscal 2019 full year outlook. The slides can be accessed through the link to the webcast of this call and will be archived on our website, along with the replay of this call. If you have additional questions after today's call, please contact me.

I will now turn the call over to Mark Smucker.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [3]

--------------------------------------------------------------------------------

Thank you, Aaron. Good morning, everyone, and thank you for joining us. It was a pleasure to see many of you in New York at our recent investor day, where we provided details on our strategy to achieve our long-term financial goals with a balanced portfolio of core and growth brands.

This morning, I will begin by discussing our second quarter results and then highlight the progress that we made this quarter in advancing our consumer-centric strategy.

We are pleased with the results for our business this quarter. While they were in line with our expectations, our efforts to support our balanced portfolio of brands continues to bear fruit. Our focus on adapting to consumer preferences was reflected in robust performance by key growth brands, which, in total, were up 12% this quarter. Sales for Nutrish premium pet food were up 23% over the prior year. Other growth brands, including Nature’s Recipe, Sahale Snacks, Smucker's Uncrustables and Café Bustelo, continued to deliver strong results, as all achieved double-digit sales growth.

Lower pricing and competitive activity across our broader coffee business impacted sales performance for the Folgers and Dunkin' Donuts brands, but did not impact margins. In pet food, solid 8% growth for the Meow Mix brand was offset by the planned discontinuation of certain Gravy Train products and weakness for Natural Balance in the pet specialty channel.

Factoring in all of this, and excluding the impact of the Ainsworth acquisition and prior year's sales attributed to the divested baking business, total company net sales were comparable with the prior year.

As detailed in our press release this morning, our adjusted earnings per share included a pretax gain on the sale of the U.S. baking business and income taxes related to the divestiture. However, the underlying business results, including the acquired Ainsworth business, were consistent with our expectations.

For the full fiscal year, we revised our sales forecast primarily due to competitive activity in coffee as lower green costs are being passed through to consumers, incremental promotional spend in peanut butter and fruit spreads and, in the pet segment, a shift in timing of shelf reset at key retailers that is delaying slightly the benefit of innovation launches.

Our adjusted EPS guidance reflects the impact of the revised sales forecast, a higher tax rate related to the baking divestiture, freight costs, unplanned legal expenses and a shift in timing of synergy realization.

The health of our businesses remain strong as we continue to make meaningful progress against our 3 consumer-centric growth priorities of leading in the best categories, building brands consumers love and being everywhere.

Let me provide a few examples of how we are executing against this framework, beginning with leading in the best categories.

Focusing on our growth brands in coffee, our Dunkin' Donuts K-Cup was recently recognized as a 2018 Nielsen Breakthrough Innovation, with year 1 sales exceeding $200 million. In addition to the #1 selling K-Cup SKU, the Dunkin' brand continues to be the #1 premium bag SKU offering and the #1 selling cold brew kit. 1850 brand coffee continues to perform as launch results confirm we are engaging with our target consumer. Velocities for 18 out of 19 SKUs increased this quarter, and total sales since launch are 90% incremental to the Folgers brand. The continued success of the 1850 brand will require us to fill out the product offerings in the coming years. This is a multiyear effort.

Double-digit sales growth for the Café Bustelo brand was fueled by 38% growth for Bustelo K-Cups this quarter. And in fact, consumer takeaway for our total K-Cup portfolio was more than double the category growth this quarter.

Further to our growth priority of leading in the best categories, we are well positioned for growth across all key segments of pet food and pet snacks, which is now the largest category in the center of store, growing at over 2x the total store average. Our dry cat food business, led by the iconic Meow Mix and 9Lives brands, had double-digit sales growth this quarter.

Sales for our widely available premium pet brands, Nature's Recipe and Nutrish, grew by 15% and 23%, respectively. While sales at pet snacks were down slightly compared to the prior year, we are excited about the upcoming snacks innovation. Retailer acceptance of our pet food and snacks innovation has been strong, with new points of distribution being 3% to 4% incremental to our current footprint for the total pet business.

Turning to our growth priority of building brands consumers love. We are following through on our commitment to increase marketing investment to support our innovation in growth brands. Our marketing expense increased $20 million this quarter compared to the prior year, driven by coffee and the addition of Ainsworth. A higher level of marketing support is critical to achieving our goal to grow our growth brands, which currently represents approximately $2 billion in total sales by high single digits over the next 5 years. We will also continue to invest in our core brands and anticipate flat to 1% growth for these brands over the same period.

In support of these objectives, we announced a transformation of our marketing model consistent with our aspiration of becoming a best-in-class marketing organization. The 3 key components to our new model are: one, overhauling our internal model to align marketing expertise to each business; two, adopting a new agency model and partner; and three, investing in resources in the areas of creative, consumer insights and data. Our new approach will yield increased productivity, cost savings that can be used to fund new investments, more breakthrough creative content and improved quality of our consumer engagement.

This leads us to our growth priority to be everywhere, as how and where consumers shop and consume products is more than ever on demand and multichannel. We think about both traditional and emerging retail channels, including the foodservice channel, as a single ecosystem where our brands must maintain an emotional bond with consumers. The fastest-growing part of this ecosystem is e-commerce. We have strategic advantages here as coffee and pet food are 2 of the fastest-growing categories online. These 2 categories drove a 40% increase in our e-commerce sales this quarter. Over 1/3 of our pet food and treats e-commerce sales, and approximately 25% of our coffee online sales, are on a subscription basis, and we anticipate continued growth.

As we look to expand both our partnerships with digital retailers and our own direct-to-consumer platforms, we will test new products and meet consumer demand for more customized offerings and variety with increased speed and minimal investment. Our new marketing model and capabilities will also help us capitalize on how, where and when our brands engage with consumers across digital platforms in targeted ways, ensuring our brands remain top of mind with relevant consumer segments.

Within our Away From Home business, we are consolidating our separate U.S. and Canadian operations into a single team. In addition, we transferred responsibility for the convenience channel to this team, which was previously included in our U.S. Retail businesses. Our focus on branded offerings in these channels, such as Smucker's Uncrustables and portion control Fruit Spreads, Sahale Snacks and the upcoming launch of 1850 coffee in foodservice channels, further supports our intent to be everywhere and have our brands available wherever consumers shop.

In closing, let me reiterate that our decisions around M&A, our investments in capabilities, brands and supply chain, supported by our cost savings efforts are all rooted in our consumer-led strategy focused on relevant growth categories. We have a balanced portfolio of core and high-growth brands. And we are committed to our increased investments, particularly in marketing, to strengthen our brands' purpose and connection to consumers. This strategy is our commitment to deliver total company growth and increased sustained shareholder value.

Lastly, we have a great team of dedicated employees to execute this strategy, and I would like to thank all of them for their continued dedication and efforts.

I will now turn the call over to Mark Belgya.

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [4]

--------------------------------------------------------------------------------

Thanks, Mark, and good morning, everyone. I will start with an overview of second quarter results and then shift to an update on our full year outlook.

Adjusted earnings per share was $2.17 compared to $2.02 in 2018, an increase of 7%. As Mark noted, there were a number of factors that occurred during the quarter that affected earnings per share. The contribution from the Ainsworth acquisition more than offset the lost sales and profits from the divested U.S. baking business. The resulting $27 million pretax gain from the divestiture was mostly offset by a higher than planned effective tax rate due to the income taxes applicable to the sale of the baking business.

Net sales increased 5% driven by the acquisition of Ainsworth. Excluding Ainsworth and the impact from the U.S. baking divestiture, net sales declined $12 million or 1%.

Lower net price realization was mostly offset by favorable volume/mix. Foreign exchange was a $5 million headwind during the quarter.

Adjusted gross margin showed sequential improvement, increasing from 36.8% in the first quarter to 38.2% in the second quarter. This was down 60 basis points compared to the prior year. The addition of the Ainsworth business impacted gross margins by 70 basis points. Margins are expected to improve upon realization of acquisition synergies and growth of the higher-margin Nutrish business. Excluding Ainsworth and the benefit of divesting the lower-margin baking business, our gross margin was down slightly as lower net price realization was not fully offset by favorable cost.

SD&A increased $23 million or 6% compared to 2018, primarily related to the addition of Ainsworth. Marketing expenses increased $20 million or 17%, driven by Ainsworth and support for our recent new product launches. G&A expenses declined $3.3 million or 3%, reflecting cost reductions from our RIGHT SPEND initiatives, which are pacing slightly ahead of our forecast. Factoring in all of this, adjusted operating income increased $31 million or 8% compared to the prior year.

Below operating income, interest expense increased $12 million, driven by borrowing cost associated with the Ainsworth acquisition. A $9 million unfavorable change in other income and expense was primarily driven by an increase in legal expenses. And an effective tax rate of 30% was above our previous guidance of 24.5%, reflecting the impact of taxes in connection with the divested baking business.

Let me now turn to segment results, beginning with coffee. Net sales declined 1% compared to the prior year. The decrease was primarily attributed to the timing of promotional activities for the Dunkin' Donuts brand compared to the prior year. Sales for the Folgers brand declined 1% due to lower green coffee cost being passed through to consumers as volume/mix was flat compared to the prior year, and Café Bustelo net sales increased 12%. Coffee segment profit increased 15%, reflecting the benefit of favorable green coffee cost and our lower contracted K-Cup cost, which were fully lapped this quarter. This segment profit growth was achieved despite a 40%-plus increase in marketing expense for the quarter, primarily in support of the 1850 brand.

In Consumer Foods, net sales increased 1%, excluding the non-comparable sales related to the divested U.S. baking business.

Looking at key brands, Smucker's and Crisco sales were both up compared to the prior year. Sales for the Smucker's brand was driven by Uncrustables, which increased 17%, more than offsetting declines in Fruit Spreads.

Net sales for Crisco increased 3% on strong volume growth in response to the price decrease we took earlier in the year.

Sales declined significantly for R.W. Knudsen brand juices due to a strong prior-year comp that included customers' building inventory of new pack sizes.

And Jif sales were flat, as the contribution from Power Ups snacks and volume/mix gains were offset by increased promotional spend due to private label pricing.

Segment profit increased 3% in the quarter, as the $27 million gain from the divestiture more than offset the loss of the prior year operating earnings related to the baking business. Excluding these items, segment profit declined 9%, reflecting lower net pricing, primarily for peanut butter and oils and higher peanut cost.

Turning to the pet food segment. Net sales increased 32%, reflecting the addition of Ainsworth. Without Ainsworth, net sales declined 1%, reflecting the planned discontinuation of certain Gravy Train and private label products that reduced sales by 2 percentage points.

Nutrish sales increased 23% compared to the prior year, with robust growth across all segments of dog food, cat food and snacks.

Gains in Meow Mix and Nature’s Recipe were partially offset by declines for Natural Balance and pet snacks. The softness in Natural Balance reflects ongoing softness in the pet specialty channel, which is not being offset by growth in e-commerce.

Pet food segment profit increased 1% compared to the prior year. The profit contribution from Ainsworth was mostly offset by the impact of higher commodity and freight cost across all pet categories.

And lastly, in the International & Away From Home segment, net sales declined 2% compared to the prior year, reflecting unfavorable foreign currency exchange and noncomparable sales in prior year from the divested baking business. Favorable volume/mix, most notably for Smucker's Uncrustables, contributed 2% of net sales and offset the impact of lower net price realization.

Segment profit increased 2%, as the decline in input cost, primarily for coffee, and a decrease in marketing offset the impact of lower pricing and the unfavorable exchange rate.

Looking at cash flow and debt. Second quarter free cash flow was $125 million. This represented a $55 million increase compared to the prior year, reflecting a decrease in working capital that more than offset a planned higher CapEx spending.

During the quarter, we paid down $440 million in debt, primarily funded by the proceeds from the divestiture of the baking business, resulting in a debt balance of $6.3 billion at October 31.

Based on a trailing 12-month EBITDA of approximately $1.6 billion, our leverage ratio stands at 3.9x.

Let me conclude my comments with an update on our full year outlook. As noted in this morning's press release, we've updated our full year guidance.

We now expect net sales to approximate $7.9 billion, in line with consensus estimates. This reflects continued lower net price realization on coffee and peanut butter, and the impact of delayed distribution for pet innovation.

We project full year gross margin will be approximately 38%. This compares to our previous forecast of 38.5%, which we based on our first quarter margin of 36.8% and an estimated 39% gross margin for the last 3 quarters.

Adjusted earnings per share is expected to be in the range of $8 to $8.20. Key factors that caused us to change our EPS guidance range include: the estimated earnings impact of reduced sales guidance; and increase in the effective tax rate to 25.5% to 26% to reflect the second quarter tax impact associated with the baking divestiture. This reflects a normalized tax rate of approximately 24.5% for the remainder of the fiscal year; an increase in freight cost; approximately $7 million of unplanned legal cost that we recorded in the second quarter; and a shift in timing of $5 million of synergy realization related to the Ainsworth acquisition from this fiscal year to next. While we still have a clear line of sight to the projected $55 million total synergies, we intentionally delayed some synergy capture related to headcount to protect business continuity purposes.

Regarding the earnings cadence for the remainder of the year, we anticipate third quarter EPS to decline approximately 20% from last year's third quarter. This is primarily due to an increase in marketing expense, higher input cost for the pet business, lost profits related to the divested baking business and higher interest expense. The prior year's third quarter also included a low effective tax rate, as the company recorded its initial benefit of the U.S. income tax reform. Fourth quarter EPS growth will be driven primarily by innovation launches within the U.S. pet food segment, distribution expansion for the Nutrish brand and the realization of acquisition synergies.

As it relates to free cash flow, we now project a range of $700 million to $750 million compared to our previous range of $770 million to $820 million. The reduction reflects income taxes associated with the divestiture and a decrease in earnings guidance, partially offset by a working capital benefit.

Our estimate for capital expenditures remain unchanged at $350 million to $370 million.

In addition to this free cash flow, we received net proceeds from the divestiture of $372 million.

As net proceeds were used to pay down debt, full year net interest expense will approximate $210 million to $215 million.

In closing, while we recognize there is still much to be done, we're confident in our ability to execute our strategy and deliver the sustainable, long-term growth that we outlined at our recent investor's day.

We thank you for your time this morning, and we will now open the call up to your questions. Operator, if you please queue up the first question.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And our first question comes from David Driscoll of Citi.

--------------------------------------------------------------------------------

David Christopher Driscoll, Citigroup Inc, Research Division - MD and Senior Research Analyst [2]

--------------------------------------------------------------------------------

My first question is just a fast one. I believe you said marketing expenses were up $20 million in the quarter. And I believe the full year previous expectation was for marketing to be up $80 million to $85 million. Can you confirm that you're still on track for that $80 million to $85 million increase in marketing?

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [3]

--------------------------------------------------------------------------------

David, this is Mark Belgya. So you're right. Marketing was up $20 million for the quarter, and that was mostly Ainsworth and in coffee. What I would say is that of that $80 million you referenced, $50 million of that was specifically for Power Ups and 1850. That is still on target. We are trimming our overall marketing spend back a little bit. But we're still -- the good news is, is that we expected about 7.3% to 7.4% marketing to net sales. And we're going to be at just about that same relationship. So obviously, we've had some favorable spending as we pushed our spending programs across all disciplines. So that's helping. And then just some selective where we feel comfortable that we weren't hurting any of the near-term growth.

--------------------------------------------------------------------------------

David Christopher Driscoll, Citigroup Inc, Research Division - MD and Senior Research Analyst [4]

--------------------------------------------------------------------------------

Okay. And then my second question just on the guidance. So your quarter comes out in line with expectations, Mark. And this is -- all my comments exclude anything related to the baking divestiture, so I'm trying to not talk about that. The core piece of it looks like it came out in line to your expectations, Mark. I think you said that in your script. But then you lowered the guidance. And so the question then is, there's a lot of pieces that you gave us here on coffee, peanut butter, delayed innovation. Can you just give us kind of a sense of magnitude where the real pressures are? It feels to me like it's more in coffee, but I don't really understand the delayed innovation comment as affecting the full year guidance. Any help and clarity would be appreciated.

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [5]

--------------------------------------------------------------------------------

David, this is Mark Belgya. I'll start and then I'll just look to Joe and to Dave and to Mark to add because I'd figured you'd have some -- there'd be some follow-ups there, particularly in some of the language we had. So in terms of just big buckets, we're lowering -- if you went from where our original guidance was of the $8.40 to $8.65, and I recognize that you exclude the gain, but I'll just -- if you don't mind, I'll include that in my conversation as I sort of reconcile down. So if you take the tax impact and call that -- depending on your rate anywhere from $0.17 to $0.19, and then we've mentioned litigation, freight cost and the delay in the synergies, that's all kind of about $0.12 roughly. And then the decline in the sales of -- depending what numbers, anywhere probably from $75 million to $100 million, depending on your rounding. So those are the key drivers that you look at the guidance in the aggregate are resulting if you -- again, if you take the low end going from $8.40 to $8. So in terms of the top line decline, we're going to obviously lose the margin from that sale, but we are seeing favorable -- continued favorable spend across the company in excess of our plan. That's helping to offset that softness a little bit. So that's big picture of how you kind of go from an $8.40 to an $8 and $8.65 to an $8.20. You guys want to jump on some of the specifics?

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [6]

--------------------------------------------------------------------------------

Just from the pet perspective, this is Dave Lemmon, David. So I would just say that the slow in getting our products to market is as a result of our key customers moving their mod date resets out about 6 weeks and the impact that has on projected sales.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [7]

--------------------------------------------------------------------------------

Yes, David, this is Joe Stanziano. Sorry, on coffee, yes, I mean, like, as we said earlier, the net price realization with just the competitive activity in the market, that's really reflecting the loss of that top line. But as Mark Smucker mentioned earlier in his script, not impacting our margin at all.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

And our next question comes from Ken Goldman of JPMorgan.

--------------------------------------------------------------------------------

Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [9]

--------------------------------------------------------------------------------

I had a couple questions on Ainsworth. Perhaps you said this, but I didn't hear. Are you still on pace for $800 million in sales this year because I think you did $184 million this quarter? It's not a very seasonal business. You're not quite on a run rate for that. But then you also talked about the distribution gain for Nutrish later this year. Just trying to get a sense of that distribution gain already part of the $800 million. Is that really how you get there and how you get the step-up in the sales rate? Any color there would be helpful.

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [10]

--------------------------------------------------------------------------------

Kevin -- Ken, this is Dave Lemmon. The distribution gains that we'll get from the innovation is in our number. We are confident that we'll hit the $800 million. There is timing associated with the back-end loading of innovation, but we still feel confident that we'll hit $800 million. If you look across the business, we've got a ton of innovation coming. We still got lots of white space opportunity in dog, cat and treats. And we feel confident that we'll hit the $800 million.

--------------------------------------------------------------------------------

Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [11]

--------------------------------------------------------------------------------

Okay. And -- but it sounds like that's really fourth quarter loaded. Is that right? We should really not expect a big ramp-up there until 4Q. Or did I not hear that right?

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [12]

--------------------------------------------------------------------------------

You'll see sales improvement in Q3 and Q4.

--------------------------------------------------------------------------------

Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [13]

--------------------------------------------------------------------------------

Okay. And then my second question is I wanted to dig in a little bit, Mark Belgya, on the income tax related to the gain on sale. Obviously, that tax hit came in greater than what you expected. Could you provide any more detail on that? I'm probably going to regret asking this because I won't clearly understand the answer. But any help you can give would be appreciated.

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [14]

--------------------------------------------------------------------------------

Okay. I'll try to do this without taking the next hour. So let me just take the group back just a little bit on what we said publicly to just ground it, and I'll bring that conversation forward. So we consistently -- when we started talking about the disposition of the business even before we sold it -- and we sort of said this $25 million to $30 million pretax gain, which obviously that's where it landed, $27 million. When we were going through, I think that all of us, internally and externally, sort of just said we are very focused. These were the pretax gains that we just applied naturally what would have been our effective tax rate at that time, call it, 24% to 25%. And that's kind of how we landed at that EPS number that's been discussed. So we go through the actual sale and get the actual recognition of the gain. And as we're going through, what we call, the carve-out, just basically carving out the business for accounting purposes and zeroing out on accounts and so forth, it came to light that based on our tax gain, the taxes associated with that, our thinking was based upon prior transactions that, that would all sort of flow through deferred taxes, and there will be no effect to our effective tax rate. As it turns out, there was a portion of the taxes that were not covered, if you will, by the deferred tax. And the accounting rule would basically say that's different, which is the effect that you saw on the tax rate, needs to flow through our tax rate. So that's what caused it to go from to, call it, 25% to 30% for the quarter. A couple, I think, key takeaways for those on the phone are as follows. There were no incremental dollars to the actual cash taxes paid, so we were using sort of a $65 million to $70 million estimate all along, that hasn't changed. We had to take the entire effect of the income tax change, the rate through the quarter. In the days of old, we were able to sort of smooth that out over the year. We couldn't do that anymore. And perhaps, the most important thing is that, that we expect, all things being equal, that next year, we would expect it to go back to sort of our normalized rate of 24.5%. So hopefully, that helped. But obviously, I'll entertain any other question you might have on it.

--------------------------------------------------------------------------------

Operator [15]

--------------------------------------------------------------------------------

And our next question comes from Andrew Lazar of Barclays.

--------------------------------------------------------------------------------

Andrew Lazar, Barclays Bank PLC, Research Division - MD & Senior Research Analyst [16]

--------------------------------------------------------------------------------

Quick follow-up in pet for Dave and then just a broader question. Dave, I think, recently, a competitor in pet had talked a little bit about seeing somewhat of a slowdown in e-commerce for the overall pet category. I hadn't necessarily heard that before. And just wanted to get a sense from you whether that was something you were seeing for the category as a whole as well or not.

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [17]

--------------------------------------------------------------------------------

No. We're seeing -- e-com was up about 50% -- 45%, 50%, similar to last quarter, and we're keeping pace with that growth. So...

--------------------------------------------------------------------------------

Andrew Lazar, Barclays Bank PLC, Research Division - MD & Senior Research Analyst [18]

--------------------------------------------------------------------------------

Great. And then, I guess, just a broader question. A number of Smucker's sort of calendar reporting peers have already begun to, I think, more broadly acknowledge that the reinvestment process to jump-start the top line will be a multiyear process. And certainly, we understand that Smucker's is making sizable investment this year as well. But I guess, in light of -- I'm trying to, I guess, square that with some of the trimming of marketing spend this year that had been anticipated. Understanding that you like the returns so far that you're getting on the spending that you're doing, it just feels like this, Mark, had been described as a pretty significant reinvestment year on the part of the company and really expected to get Smucker back to a level of marketing maybe where you were several years ago before some of the declines. So I guess, I'm just trying to square that. And then thinking ahead, I know Smucker's is committed to supporting these new platforms consistently. Does that mean we've got another year or 2 of sort of significant incremental marketing as you think forward longer term?

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [19]

--------------------------------------------------------------------------------

Andrew, it's Mark Smucker. Thanks for the question. So as I said at investor day, we've got to stick to our gun. Obviously, we came out pretty strongly in support of this increase in marketing, getting back to historical levels, getting -- staying in that 6% to 8% of net sales range, which Mark earlier highlighted, that even with some modest trimming this year, we're still going to be right -- in terms of a percent of net sales, we'll be right where we expected to be. I would highlight, and I'm going to actually ask Tina to make a couple of comments, that, again, as Mark mentioned, where we felt that we could get some productivity gains, there may have been some opportunities where we didn't need to spend some dollars. On Uncrustables specifically, we -- that growth continues and we have not needed to accelerate some of the marketing spend that we thought we would. So I would submit to you that we have not cut any of the core marketing programs that we had intended to. It's more sort of trimming across a variety of areas, but not affecting any of our core programs.

--------------------------------------------------------------------------------

Tina Floyd, The J. M. Smucker Company - Senior VP & GM of Consumer Foods [20]

--------------------------------------------------------------------------------

Andrew, this is Tina. Just supporting Mark's comment quickly. We've seen 18 quarters of consecutive growth for Uncrustables. And again, we're starting to build household and knowing that Longmont is coming on next year, we just realized that we didn't need to spend the amount of marketing that we had in place. So that's some of the trimming that we did on the consumer side, but we're definitely still supporting, like the launch of Jif Power Ups. None of that has been touched up to this point.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

And our next question comes from Pablo Zuanic of SIG.

--------------------------------------------------------------------------------

Pablo Ernesto Zuanic, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [22]

--------------------------------------------------------------------------------

I'll stick to 2 questions. But the first one is maybe broader and, I guess, it can be answered by more than one more question. But Mark Belgya, when I try to think of the EBIT cut, I mean, tell me this spin is correct or incorrect. In the case of coffee, lower cost lead to lower prices, but there's nothing new there on the EBIT front. When coffee cost come down, prices come down. So coffee necessarily from an EBIT perspective doesn't -- did not worsen and is not the reason why the EBIT guidance was cut, ex the baking sale unit gain. In the case of pet, apparently, from what you're talking about, margin pressures freight, it's nothing new relative to what you had said in previous quarters. The pet issue is more about the delay on the innovation due to shelf resets, right? And then in the case of peanut butter, we have a situation where you have a higher cost, and prices are coming down. I assume that peanut butter, it's a bit of a pass-through category, so prices will adjust. So is that correct? Or what am I missing there? I understand that maybe Mark, Joe, Dave and Tina can answer on this. But it seems to me that the EBIT cut in that context of -- is not the end of the world. Can you comment on that?

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [23]

--------------------------------------------------------------------------------

Yes, Pablo, this is Mark. You're correct. In all those 3, I would say, of the 3, probably where there might be a little bit more EBIT than you've assumed in your model, it would be in the Consumer Foods, in Tina's area in peanut butter and that we are having to lean in, we are seeing low private label pricing. But you're right. In the coffee area, we've continued to see very favorable green coffee costs, which Joe has outlined, and then in Dave's area. The only other cost, I would say, that have increased -- or certainly haven't gone down is freight, and that has a predominant hit to both coffee -- or to consumer, I should say, and to pet. But generally, I think your thinking is right. But it's probably the freight cost and sort of the effect of peanut butter that are -- I'm guessing are negatively affecting a little bit more than what maybe you modeled.

--------------------------------------------------------------------------------

Pablo Ernesto Zuanic, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [24]

--------------------------------------------------------------------------------

And just a quick follow-up for Dave Lemmon. Dave, the trade press is talking about Petco making significant assortment changes starting next year, focusing on more natural products, making -- taking some brands off their shelves. I mean, can you talk about what your exposure to Petco? And how would your portfolio were affected there? By the same token, just comment how Nature’s Recipe in mass has been affected by the launch of NUTRO, and we all expect Blue Buffalo to enter Walmart at some point. So just give some context in terms of Nature’s Recipe has withstood the impact from a player, like NUTRO, on the premium side in mass.

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [25]

--------------------------------------------------------------------------------

Sure. Well, to answer your first question on Petco, the exposure that we see is in around 8%. 8% of Petco sales are done through brands that will no longer be supported by them. I would say that we are going to offset all of that and more through our innovation and new distribution launches that we have coming up later in the fiscal. And I would say that you can't discount our brand strength, and consumers will potentially leave the store and shop elsewhere for those brands that they know and love. So that's what I would say with regards to Petco. With regards to Nature’s Recipe, we're experiencing 15% growth on that brand. We see no impact from NUTRO. We've got True Treats coming to market as well as some innovation on food. So all looks good on Nature’s Recipe, and we see limited interaction with NUTRO.

--------------------------------------------------------------------------------

Operator [26]

--------------------------------------------------------------------------------

And our next question comes from Chris Growe of Stifel.

--------------------------------------------------------------------------------

Christopher Robert Growe, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Analyst [27]

--------------------------------------------------------------------------------

Just want to ask if I could in relation to -- and forgive me if I missed this, but in terms of -- like, what was your overall inflation in the quarter? As I was thinking through some of the divisions, I guess, in coffee, your pricing net of cost was favorable, but maybe less so in consumer and pet. I want to make sure I have that right. Number one, if you can maybe better quantify the freight and the input cost inflation for the quarter that was affecting the gross margin.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [28]

--------------------------------------------------------------------------------

Chris, it's Mark Smucker. I'm just going to start real quick and then pass it over to Mark. But I think what is a little unique about our business versus some of the rest of the industry, as we are seeing inflation in many categories, we are starting to see some inflation in pet, as we've commented in the prepared comments. But you are correct that in coffee, and to a lesser degree and to some degree, in consumer, we are still seeing some deflation. And so, yes, I can turn it over to Mark to just comment, generally on the net effect, but I think that does make us a little unique. What I don't think has changed is that we will continue to pass along cost up or down to the end consumer, and so that has not changed. And that, again, we use multiple levers. I think what you've seen in both coffee and peanut butter of late and then probably for the back half is that we will be using the trade lever, to a degree. And so that's just -- that's one way we manage it.

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [29]

--------------------------------------------------------------------------------

Yes. Chris, it's Mark Belgya. In terms of the net inflation, it's probably pretty modest because, as Mark suggested, we have had -- and then we've said this since the beginning of the year, we expected cost increases across a whole variety of spend in -- on the input side and on freight, and those have continued to come to pass. And I guess, there's probably a couple percentage points. But offsetting that has been the coffee. And of course, we get an additional benefit. As we reported, this was our fourth quarter of our K-Cup contract benefit, so that also just -- if you look at it for total cost, it's offsetting that. So it is pretty much a wash when you come to a net inflation, deflation percentage, but it definitely skews unfavorable to consumer foods and to pet and positive to the coffee side.

--------------------------------------------------------------------------------

Christopher Robert Growe, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Analyst [30]

--------------------------------------------------------------------------------

Okay. And I just have one quick follow-up for you, Mark Belgya, in relation to the receivables balance, which was up quite strongly, again, like it was last quarter. I think, last quarter, you talked about some late in the quarter sales coming in through. Can you get a good idea of what happened this quarter and how that affects your receivables balance and potentially sales going forward?

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [31]

--------------------------------------------------------------------------------

Yes. So there's 2 things. One is just the absolute increase that came over from the Ainsworth acquisitions, so that's a component of it. The second thing, and I'm guessing, I'm not sure exactly what your point of comparison, but you compare it back to the end of the fiscal year, you have to look at the last month of each quarter. So the last month of the second quarter, our October is a big sales month. If you look at the end of, obviously, the fourth quarter of last year, April is a smaller, so it should -- the incremental increase in sales dollars, most of those receivables are still outstanding at the end of the month.

--------------------------------------------------------------------------------

Operator [32]

--------------------------------------------------------------------------------

And our next question comes from Bryan Spillane of Bank of America.

--------------------------------------------------------------------------------

Bryan Douglass Spillane, BofA Merrill Lynch, Research Division - MD of Equity Research [33]

--------------------------------------------------------------------------------

So I guess, first question just related to -- just want to tie a couple things together with some of the questions related to pet food. I guess, stepping back and listening to what's happening, you've got some investment going on in launching some new products. There's a channel shift happening as e-commerce grows. I guess, there's some potential disruption at -- in the specialty channel with -- that's happening at Petco. So it just sounds -- it seems to me that, like, will there be margin pressure that we should expect to see in that pet food division, the net of all these things that maybe goes on for a year or 2? Just trying to get a sense for -- with all this changing -- all these dynamics, does it put some margin pressure on that business in the medium term?

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [34]

--------------------------------------------------------------------------------

No. We don't see there's any margin pressure coming in pet. Yes, there's channel shifting going on, and that's sort of common. I would say that we have major levers that we will pull, as we continue on the business, both -- synergies being the first one, which will deliver margin. Our pricing, we led on snacks. We will follow on food quickly if we see it take place in the marketplace. And then we've got a bunch of sort of levers that we're pulling from a supply chain network optimization, making sure that we have the most efficient network. We're doing some design to value and value engineering work from a formula perspective. And then RIGHT SPEND, obviously, continues on the business. And we expect to yield better margins from that moving forward.

--------------------------------------------------------------------------------

Bryan Douglass Spillane, BofA Merrill Lynch, Research Division - MD of Equity Research [35]

--------------------------------------------------------------------------------

Okay. And Mark Belgya, I'm not sure if I missed this, but you've talked a little bit about gross margin expectations for the year. Did you talk -- could you just talk a little bit about phasing? Is there anything that we should be thinking about 3Q versus 4Q in terms of the phasing of gross margins year-over-year?

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [36]

--------------------------------------------------------------------------------

Yes, Bryan, I think you're going to see a -- an enhancement more in the fourth quarter than in Q3.

--------------------------------------------------------------------------------

Bryan Douglass Spillane, BofA Merrill Lynch, Research Division - MD of Equity Research [37]

--------------------------------------------------------------------------------

Okay. And that's just timing of, like, price increases and actions you're taking or year-over-year differences. Just what's driving the difference?

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [38]

--------------------------------------------------------------------------------

Yes. It is timing, but it certainly -- there's some synergies that Dave mentioned. Those are both G&A and COGS impacted, just the way some of the cost are hitting and, again, the way we priced just more in Q4.

--------------------------------------------------------------------------------

Operator [39]

--------------------------------------------------------------------------------

And our next question comes from Rob Dickerson of Deutsche Bank.

--------------------------------------------------------------------------------

Robert Frederick Dickerson, Deutsche Bank AG, Research Division - Research Analyst [40]

--------------------------------------------------------------------------------

So just to step back for a minute in terms of the pricing conversation. I know, it sounded like earlier this year, as we kind of look forward into full fiscal '19, we saw there might be some elevated promotional spending coming, especially given just where the commodity basket was. But what we're hearing now is, yes, that did happen, but also kind of given where the passthrough has occurred mainly let's say on the private label side that, overall, the pricing environment just remains obviously very challenged and very competitive, which is essentially the case for all of U.S. food. So I'm just curious, like, in terms of the innovation that comes, as you think about how your organic sales growth trajectory kind of flows in the back half of this year and next year, do you say, "Okay. While on the core, we -- we're in the center of the store." And there is a private label push. And because it come -- because of the commodity complex, there is incremental pricing pressure, so we need to continue to manage those price gaps, one. And then hopefully, we can offset, with some price/mix on the innovation, to get us to kind of a normalized flattish pricing outlook overall. Or is it, a, look, in general, we need to support our growth brands and increase our marketing spend and become more nimble to be more in tune with consumer demand and then -- but at the same time, we are going to have to defend our core. And part of that is going to come in the form of, pretty much, pricing. We might not be announcing price list declines, but we do foresee the pricing environment continuing to be a bit challenged as we go through the back half of the year.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [41]

--------------------------------------------------------------------------------

Rob, it's Mark Smucker. I'll start, and then ask the team if they have any color commentary. So you are correct, it is a competitive environment. You are also correct that as we manage through those environment, making sure that our price gaps are right, that our goal is to protect profit, dollar profit. Obviously, margins are important too, but we really are focused on dollar profit. And as you've seen so far this year, we've been successful in doing that. We do -- we continue to believe philosophically that the right thing to do is to not only be competitive, but to pass through up or down cost to the end consumer, and so that will continue to be our focus. But I do think at the end of the day, we are focused, again, on making sure that we can sustain and ultimately grow our dollar profit.

--------------------------------------------------------------------------------

Robert Frederick Dickerson, Deutsche Bank AG, Research Division - Research Analyst [42]

--------------------------------------------------------------------------------

Okay, great. And then just one question on shelf resets, right? We're kind of entering the zone, you have anticipation of resets that occur at some large retailers earlier in the year. Likely those conversations I would think have been had, and kind of maybe where you foresee yourself playing out. So I'm just -- I'm curious, namely not so much in consumer, not so much in pet, but more so on coffee, do you foresee yourself come early part of calendar '19, you're holding space for Smucker within coffee at retail, it just might be a bit of a shift, let's say, a little less Folgers, a little bit more 1850, et cetera? That's it.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [43]

--------------------------------------------------------------------------------

Rob, it's Joe. Yes. I mean, I would say we're always ensuring whenever we go in for a reset with a customer that we're bringing our thoughts on what's good for the category, what's good for the consumer, what's good for our portfolio. So there always are puts and takes. Those -- some of those timings depending on key customers, some had happened maybe earlier in the summer. As we go into next year, we'll continue to bring the same mindset to every customer, and I think that's what they rely on us for is to be coming in with a very category-specific mindset and recommendations that are going to help absolutely our business, but help the whole category, grow the category.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [44]

--------------------------------------------------------------------------------

I would add.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [45]

--------------------------------------------------------------------------------

Okay.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [46]

--------------------------------------------------------------------------------

Rob, this is Mark Smucker again. Just as an example without naming any specific customer, we do have one of our largest customers that is in the process going through resets and actually our core Folgers business is more than likely going to regain some lost shelf space that they had previously lost. And I think the customer recognized that it probably wasn't the right decision, and so we're actually going to be regaining some space on the core of Red Can, that particular customer. So to Joe's point, we have to go in taking an approach that we're doing what's right for the entire category. And to the extent that we can do that, we feel that both the customer and our business will ultimately benefit.

--------------------------------------------------------------------------------

Operator [47]

--------------------------------------------------------------------------------

And our next question comes from Alexia Howard of Bernstein.

--------------------------------------------------------------------------------

Alexia Jane Burland Howard, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [48]

--------------------------------------------------------------------------------

Can I -- coming back to the question of pricing, I'm looking at the measured channel data, and it's showing that the pricing on shelf across the portfolio is actually up about 1%. And obviously, that's the pricing from the retailer to the consumer. And yet across many of your segments, the pricing is down. Is that just a delay of some sort? Maybe the retailers aren't passing through those price decreases that they're giving them, but will eventually? Or is there another explanation? And then my follow-up question just really quickly is the unplanned legal expenses, what were they for? And will they continue? I'll pass it on.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [49]

--------------------------------------------------------------------------------

Yes, Alexia, this is Joe. I'll start. I mean, I don't want to speak for all the categories, but I would just say I'm not -- I don't have what you're looking at maybe right in front of me. But I think some of the way that pricing measurement is reported could be depending on whether that's kind of everyday versus promotional. Some of our investment maybe is going more toward the promotion. So again, I think, overall, there is some lag there. But depending how the retailer reflect that on shelf and how IRI picks that up, that could be the differences there.

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [50]

--------------------------------------------------------------------------------

And then, Alexia, this is Mark Belgya. In terms of the legal expenses, I can't go into a lot on pending litigation, litigation claims and settlements. As far as the amount, that's our best estimate right now. I'm sure you're aware of sort of the contingent liability accounting rules, but that's our best estimate of what's probable and estimateable, so I think we booked about $7 million currently.

--------------------------------------------------------------------------------

Operator [51]

--------------------------------------------------------------------------------

And our next question comes from Akshay Jagdale of Jefferies.

--------------------------------------------------------------------------------

Akshay S. Jagdale, Jefferies LLC, Research Division - Equity Analyst [52]

--------------------------------------------------------------------------------

It might be more for Mark Smucker. It's a high-level question on the step up in brand support. And really, what I'm trying to get a sense from you on is, is this offensive or defensive, right? So if it's offensive to me, it means it should result in better market share performance for the company relative to what we've seen historically and that's, I think, exactly what you're planning. So, of course, is that a correct interpretation of what the company strategy intends to do? And then secondly, as we think about the likelihood of success, there is some confusion on our end because several large companies have made similar incremental brand investments, which makes these step ups sort of feel defensive, right? But I think what we might be missing in the big picture is a whole set of bunch of private companies, smaller companies that we don't hear from who you compete against. And I don't think they're making at least this level of step-up in marketing and brand investments, and this is probably the cohort where majority of the share gains are likely to come from. So hopefully, it's not too dense of a question, but I would love to get your perspective on that.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [53]

--------------------------------------------------------------------------------

Akshay, thank you for the question. You're right. It absolutely is offensive. At the end of the day, we've got to do what's right for our brands and making sure that the long-term health of the brands is there, is really what it's all about. And so I would submit to you that we were one of the very first companies to publicly talk about a step-up in marketing and whether or not some of our peers or competitors are doing the same thing. I think it points to the fact that it's probably the right thing to do across the board. As you know, there has been some erosion of brand equity, just generally speaking, in the industry. But in our own case, that is also true, and so we need to make sure that we're fully engaged with the consumer as we've said at Investor Day, and so the step-up in marketing is absolutely offensive. If you think about when you look at traditional MMA analysis, $1 spent on marketing typically has a markedly higher return over than $1 spent on trade, yet that return tends to be a longer burn, so the return time frame may be longer, it's not an instant hit. But that's the reason why we have to stick to our guns and continue to support our brands over the long term, and we should see our equities, our awarenesses and all of those measures similarly rise.

--------------------------------------------------------------------------------

Akshay S. Jagdale, Jefferies LLC, Research Division - Equity Analyst [54]

--------------------------------------------------------------------------------

And just to follow up on that , so to be clear, the reason you feel comfortable it's offensive is you feel good that you'll gain share because you're doing something more than most of your competitors in the categories that you compete, right? And as a follow-up just to that is as you've gone through this new marketing model at a high level, I mean, is the cost of incremental sales today higher or lower than historically? Because from what I can tell, the tools and the new sort of innovative partnerships that we're seeing from companies like yourself on go to market seem to be a lot more productive than the traditional sort of media spending, right? So there is this view out there that it just costs more to get growth. And I actually think that the tools available today make it a lot more efficient to get growth if you execute properly.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [55]

--------------------------------------------------------------------------------

The latter part of your question, we believe that as well that if done right, the cost of growth over time should be more efficient. As it relates to the offensive comment, Akshay, these investments in our brands are ultimately aimed at building loyalty. And that when you can build loyalty, you build repeat purchase. And when you build repeat purchase, ultimately, you're going to improve share. So absolutely. And then the cost of incremental sales part of your question, that has been true over the last few years in terms of trade dollars that there has been more trade in certain categories you have seen, trade dollars aren't getting the incremental lift that they say previously had. Therefore, justifying a return to investing in our brands.

--------------------------------------------------------------------------------

Operator [56]

--------------------------------------------------------------------------------

And our next question comes from Jason English of Goldman Sachs.

--------------------------------------------------------------------------------

Jason M. English, Goldman Sachs Group Inc., Research Division - VP [57]

--------------------------------------------------------------------------------

I have 2 just housekeeping items, and I'm sorry if I missed this in some of the prepared remarks. But could you help me understand the drivers of the quarterly cadence over the next 2 quarters? I think you said that third quarter EPS will be down around 20%, which implies at the midpoint that you'll bounce back to around 11% growth in the fourth quarter. Help me understand kind of what drives the softness in the third quarter and the robust bounce back in the fourth.

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [58]

--------------------------------------------------------------------------------

Jason, it's Mark Belgya. So the 20% reduction in Q3, there is probably 3 or 4 things. So one is there is a significant step-up in marketing in Q3. There is a step-up in Q4 too, but significantly in Q3. Because the third quarter is our heaviest baking period, we're losing a significant amount of profits from last year that obviously aren't going to repeat this year. And then we're also seeing the impact of both the freight cost and just cost -- higher cost in general. And then last year, the tax rate was abnormally low because that's when we booked our initial tax reform, so I think it was, if I recall, was even under 20%, so that's sort of the key drivers. As you flip it into Q4, what we're going to see, although the marketing spend is still going to be up. I think, to Dave's point, we're going to see a lot of his innovation come to market, and in Q4, we'll benefit from that. Some of the other innovations, obviously, are picking up some ramp-up Power-Ups, 1850s, are probably the key drivers there. I think the costs sort of settle out, I think I sad earlier in the margins that's the heaviest costs hit is more Q3 year-over-year versus Q4 year-over-year.

--------------------------------------------------------------------------------

Jason M. English, Goldman Sachs Group Inc., Research Division - VP [59]

--------------------------------------------------------------------------------

That's helpful. And then one more clean-up question on the guidance. I'm looking at your free cash flow guidance, the trim, it looks like around 9% at the midpoint. But at EPS, you trimmed EPS by 5%, and it looks like maybe 1.5 points or so is due to noncash step-up in tax rate, so sort of a cash EPS trim of around 3.5%. How does that amplify to almost to 9% decline in your free cash flow outlook, particularly in context to the positive comments you had on working capital this quarter?

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [60]

--------------------------------------------------------------------------------

Let me spin it in a little different way and see if this answers your question. So we took -- if you just go from the low end to low end, we went from $770 million to $700 million. We are paying about $70 million in cash taxes. And just bear with me here a second, when we talked about free cash flow last quarter, we obviously hadn't closed the transaction yet. So what we reported to you on that $775 million to $825 million did not have cash taxes coming out. What we did do is we deducted that from the proceeds, and if you go back and look at what we have said, the proceeds are about $310 million. As we went ahead and the way we ultimately play out on our financial statements, that taxes will actually flow through cash from operations which affects free cash flow. So that's the key driver is the $70 million. If you layer in the decline in earnings guidance, that takes you down, I don't know, call it another $20 million or $30 million, and then we are seeing positive benefit of working capital that brings us back up to get down to that roughly net $70 million reduction. So I hope that helped you.

--------------------------------------------------------------------------------

Jason M. English, Goldman Sachs Group Inc., Research Division - VP [61]

--------------------------------------------------------------------------------

That helps a tremendous amount.

--------------------------------------------------------------------------------

Operator [62]

--------------------------------------------------------------------------------

And our next question comes from Robert Moskow of Crédit Suisse.

--------------------------------------------------------------------------------

Robert Bain Moskow, Crédit Suisse AG, Research Division - Research Analyst [63]

--------------------------------------------------------------------------------

Just 2 quick questions. I'm a little unclear on the coffee outlook for the back half of this year. Joe, are you lowering your coffee outlook for the back half, but for the year, it's pretty much as you figured? And then secondly, also on the question about the reformulation potential at Petco. Dave, I thought the concern would be, what if other retailers follow Petco's lead and reduce shelf space for artificials or products with artificials or remove those products from the shelves? Do you think that's a concern? And if so, would you need to make broader reformulations across your line?

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [64]

--------------------------------------------------------------------------------

Hey, Rob, it's Joe. I'll start. On the coffee outlook, I would say, we're where we thought we would be at this point and the year doesn't change. I mean, I think we talked about it. The coffee margin was front-loaded in first and second quarter, and you can see that. As we sit here today, we're still confident with where we're going to end up the year where we thought. Again, I think it's just the net sales realization due to adjustments on our investment in trade based on competitive pricing has impacted that top line a little bit. We still hope to come in slightly above where we were last year from a net sales perspective.

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [65]

--------------------------------------------------------------------------------

Yes, and just on the Petco situation, I think that other retailers will take a wait-and-see sort of approach with Petco. We're already seeing it in some indie pet stores taking a similar approach or Petco is following them actually. And I would just say that there is a large consumer base out there that is buying many products that are not meeting Petco's standard, and they will decide -- not the stores will decide where and what they buy.

--------------------------------------------------------------------------------

Robert Bain Moskow, Crédit Suisse AG, Research Division - Research Analyst [66]

--------------------------------------------------------------------------------

Have you evaluated, Dave, what the cost would be if you needed to reformulate?

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [67]

--------------------------------------------------------------------------------

No, because I don't think that we need to reformulate.

--------------------------------------------------------------------------------

Operator [68]

--------------------------------------------------------------------------------

And our next question comes from John Baumgartner of Wells Fargo.

--------------------------------------------------------------------------------

John Joseph Baumgartner, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [69]

--------------------------------------------------------------------------------

Joe, I wanted to go back to single-serve coffee and the private-label pricing there. Because it's still deflationary, it's really not getting any better. So are you just more or less waiting for commodity inflation to induce more rational pricing from here? Or, I guess, is excess capacity such that pricing pressure may still persist even with commodity inflation? How are you thinking about the environment there and the structure?

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [70]

--------------------------------------------------------------------------------

John, one cup, I think we've talked about it, you could see what we're -- our brands are doing, and we feel very confident about how our growth looks across all of our K-Cup brands. From our perspective, that Keurig contract really helped us reset our pricing and has given us the ability to continue to drive growth at more category or consistent margins with the rest of the portfolio. Clearly, private label continues to grow. We're seeing growth especially from a price per unit with some upsizing in the segment, and I would expect to continue to see that happen. But obviously, as we've talked about the coffee commodity cost impacting one cup is very -- is minor compared to the other forms in the category.

--------------------------------------------------------------------------------

John Joseph Baumgartner, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [71]

--------------------------------------------------------------------------------

But I guess, if you look at single-serve as being a growth area for you, as the category shifts more and more to single-serve, it feels like it's opening up a new vulnerability because you've got -- it feels like just more irrational price competition in private label and single-serve than you had in roast and ground over the years. So I mean, can you comment a little bit in terms of what's in your expectations going forward or your model? I'm just trying to get some comfort in terms of what the competitive dynamics looks like going forward?

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [72]

--------------------------------------------------------------------------------

I don't know. I wouldn't agree with that. There is more irrational pricing in one cup. I mean, over the years, we've seen some irrational pricing in all segments. I would say, actually, there has been sharper pricing in one cup, but I wouldn't call it irrational. I don't expect that to get more irrational going forward.

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [73]

--------------------------------------------------------------------------------

John, this is Mark Belgya. Just one other thing to add to Joe's comments, I agree with what Joe's saying is that where we've seen over the years as we've been in coffee for the last decade, irrational is where green was and green is just such a much smaller percentage of the input cost on K-Cups and single-serve. So the availability and the ability to do that type of pricing just certainly not for an extended period of time.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [74]

--------------------------------------------------------------------------------

Right.

--------------------------------------------------------------------------------

John Joseph Baumgartner, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [75]

--------------------------------------------------------------------------------

Okay. And just a follow-up for Dave real quick. Just in terms of the clarification on pet, did you say that 8% of your Petco business was being rationalized?

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [76]

--------------------------------------------------------------------------------

Yes. No, not that it was. There could be.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [77]

--------------------------------------------------------------------------------

That's right.

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [78]

--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------

John Joseph Baumgartner, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [79]

--------------------------------------------------------------------------------

Right. And then you have a number on what Natural Balance sales were in the quarter?

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [80]

--------------------------------------------------------------------------------

Pardon me?

--------------------------------------------------------------------------------

John Joseph Baumgartner, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [81]

--------------------------------------------------------------------------------

You have a number for what Natural Balance sales did? You know, the growth in the quarter?

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [82]

--------------------------------------------------------------------------------

It did about $75 million.

--------------------------------------------------------------------------------

John Joseph Baumgartner, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [83]

--------------------------------------------------------------------------------

Okay, now that's obviously down double digits year-on-year?

--------------------------------------------------------------------------------

David J. Lemmon, The J. M. Smucker Company - President of Pet Food and Snacks [84]

--------------------------------------------------------------------------------

No, it's not down double digits, no. They're up 4%.

--------------------------------------------------------------------------------

Operator [85]

--------------------------------------------------------------------------------

And our next question comes from Pamela Kaufman of Morgan Stanley.

--------------------------------------------------------------------------------

Pamela Kaufman, Morgan Stanley, Research Division - Senior Analyst [86]

--------------------------------------------------------------------------------

I just wanted to follow up on the coffee outlook for the remainder of the year and what you're anticipating from the competitive and promotional environment. And given that the coffee margin, you mentioned it was front half loaded, should we expect EBIT margins to decline in the second half given the competitive environment and since you fully lapped the renegotiated K-Cup contract?

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [87]

--------------------------------------------------------------------------------

Yes, Pamela, it's Joe. I would say consistent with what we've seen the rest of the year, we know that coffee futures continue to be volatile. We've seen competitors make investments. We've made investments. We would expect that, but again, we feel very confident with where we are today with our price and promotion strategy for the rest of the year. And yes, as I reiterated earlier, our plan from a margin perspective was front-loaded this year, so the back half I think would be down slightly.

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [88]

--------------------------------------------------------------------------------

Yes, but I think -- Pamela, this is Mark Belgya again. I think when we made the commentary about front-end loaded, that was sort of a year-over-year commentary. I think the margins that Joe and the team are showing, I mean, we consistently say we're going to over -- beat the 30%-plus segment profit and I think that's still the intention for the rest of the year.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [89]

--------------------------------------------------------------------------------

That's right.

--------------------------------------------------------------------------------

Pamela Kaufman, Morgan Stanley, Research Division - Senior Analyst [90]

--------------------------------------------------------------------------------

Okay. Great. That's helpful. And just a question on your cost savings program. Are you still on track to generate $80 million in savings from RIGHT SPEND this year?

--------------------------------------------------------------------------------

Mark R. Belgya, The J. M. Smucker Company - Vice Chair & CFO [91]

--------------------------------------------------------------------------------

Yes. This is Mark again. We're on track for the $80 million. Just to be clear, that was not all RIGHT SPEND, that was a series of projects. RIGHT SPEND is probably the largest single component of that, and I think it was in one of our scripted comments that we're actually trending above or favorable to that RIGHT SPEND portion.

--------------------------------------------------------------------------------

Operator [92]

--------------------------------------------------------------------------------

And our next question comes from Scott Mushkin of Wolfe Research.

--------------------------------------------------------------------------------

Scott Andrew Mushkin, Wolfe Research, LLC - MD and Senior Retail & Staples Analyst [93]

--------------------------------------------------------------------------------

So I want to go back to what Andrew Lazar was talking about a little bit earlier and really focus more on the medium to longer term. I guess, what I'm doing, I'm looking at your 3 segments, and I'm just trying to understand -- I mean, obviously, you've made an acquisition in pet and you're going to try to grow that, but there is a lot of pressures we talked about on this conference call. If you look at peanut butter and jelly, again, pressures private label and then if we go to coffee, it seems -- taking you guys a lot of money to get 1850 off the ground. So that project out a year or 2 or 3, just trying to understand how the business changes? And how I'm not going to have to spend more to stabilize things and grow things over time? And those are my only questions.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [94]

--------------------------------------------------------------------------------

Okay, Scott, this is Mark Smucker. So first of all, we are wholeheartedly committed to our strategy. And one of the reasons why Uncrustables has been performing as well as it has, is some of the consumption that peanut butter and jelly has or is shifting to ready premade sandwiches. And so we can consider ourselves lucky and smart that we are in that business because clearly, as a consumer doesn't make a PB and J in the morning, they might default to that. So clearly that is on strategy. As it relates to coffee, same thing, where we accelerated the growth of our one cup business, that has overdelivered this quarter and then Pet as well, making in every category, shifting our portfolio to where the growth is. And I would point to the fact that we had some questions in the last few quarters about Nutrish and its ability to coexist with Nature's Recipe. And as you've seen from the results, they're doing -- they're both doing very well, and they both serve a unique need. And so in each category, we are executing our strategy, making sure that we're supporting where the growth is and consistently following through. As it relates to innovation, as I mentioned in my prepared remarks, these are multiyear efforts. We talked a year or 2 ago about fewer bigger best. This is the beginning of that. You're seeing those efforts come to fruition. But as we're launching platforms, I would submit to you as you look across the industry, the amount of investment that we're making against the new platform is not unusual or significantly higher than you might see elsewhere in the industry. So we think we're pretty consistent there. But it does require us to maintain that investment for some period to flesh out, to fill out those product lines so that they continue to gain a presence on shelf. And so we've got to continue to do those things. So to the extent that we can continue to follow through on our strategy, we have a tremendous amount of confidence that we'll be successful.

--------------------------------------------------------------------------------

Operator [95]

--------------------------------------------------------------------------------

And our next question comes from Jon Andersen of William Blair.

--------------------------------------------------------------------------------

Jon Robert Andersen, William Blair & Company L.L.C., Research Division - Partner [96]

--------------------------------------------------------------------------------

I'll keep it brief. I was wondering if you could provide a little bit more color on the performance of 1840 and Power-Ups so far. I know it's early. These are platform innovations for you, and as you've said, Mark, it's a multiyear effort. But if you could talk a little bit about what you're seeing with respect to distribution, initial velocities, and what some of the next steps are or milestones are for those platform expansions.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [97]

--------------------------------------------------------------------------------

Jon, it's Joe. I'll start. You're 10 years too early, we were -- it's 1850...

--------------------------------------------------------------------------------

Jon Robert Andersen, William Blair & Company L.L.C., Research Division - Partner [98]

--------------------------------------------------------------------------------

Yes, I'm always early.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [99]

--------------------------------------------------------------------------------

We need to spend more marketing, obviously, you're not getting our targeted ad.

--------------------------------------------------------------------------------

Jon Robert Andersen, William Blair & Company L.L.C., Research Division - Partner [100]

--------------------------------------------------------------------------------

I'm always early.

--------------------------------------------------------------------------------

Joseph Stanziano, The J. M. Smucker Company - Senior VP & GM of Coffee [101]

--------------------------------------------------------------------------------

No, I'm kidding. As Mark said in his opening comments, we continue to be very pleased. We saw velocities improve this quarter with continued efforts. We saw both trial and repeat rates improve. Our consumption run rate is now above $1 million per week at retail, so again, all the key metrics we're watching very closely continue to improve. We've said it once, we'll say it again, this is a long-term project. We're going to continue to stay in it. We have continued support for the back half of the year. We've got some good merchandising even over the next couple of months that we're excited about as we're in the highest coffee consumption time period. And the incrementality continues to be better than what we expected before the launch. So we're pleased. We'll continue to support it. We'll continue to learn and adjust as we need, both for our customers at retail and our consumers.

--------------------------------------------------------------------------------

Tina Floyd, The J. M. Smucker Company - Senior VP & GM of Consumer Foods [102]

--------------------------------------------------------------------------------

Jon, it's Tina. Just on Jif Power-Ups, again, I'm saying very similar metrics to Joe. Our ACV is up. Our trial and repeat is up. Velocities continue to improve. Again it's great as Power-Ups is bringing new users into the Jif franchise, which we're really excited about. As we look to back half of the year, we have a lot of marketing and merchandising in place as we look to Q3 and Q4. And we've also added some incremental capacity for clusters. So, so far, we're really pleased with the platform and look forward to the balance of the year and continued growth.

--------------------------------------------------------------------------------

Operator [103]

--------------------------------------------------------------------------------

And that concludes our question-and-answer session. I'd like to turn the conference back over to Mark Smucker for closing remarks.

--------------------------------------------------------------------------------

Mark T. Smucker, The J. M. Smucker Company - CEO, President & Director [104]

--------------------------------------------------------------------------------

Thank you. Just want to reiterate. First of all, thank you to all of you for taking the time today to listen in. Wanted to just comment despite some of the unforeseen this quarter, the businesses are performing as expected. We see, from our lens, our strategy is working. I commented on Nature's Recipe and Nutrish coexisting. The fact that our Folgers brand, the decline was very modest. Our innovation is performing. Our growth brands are growing. So from our perspective, it is about sticking to our guns, making sure that we continue to support those things. And again, just thank you, our investors, for the questions today. I personally felt like it was a productive dialogue. Your questions were welcome, and it felt like a continuation of our Investor Day from a couple months ago. So I just wanted to thank you all for that. And then, of course, just thank our employees because they are the company, they are the people that make this happen every day, and so just wanted to acknowledge their support and dedication. And all of you, have a great day and a happy holiday.

--------------------------------------------------------------------------------

Operator [105]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.