J M Smucker Co
NYSE:SJM
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J M Smucker Co
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Good morning and welcome to The J. M. Smucker Company's Fiscal 2018 Fourth Quarter Earnings Conference Call. This conference is being recorded and all participants are in a listen-only mode. At the request of the Company, we will open the conference up for questions and answers after the prepared remarks. Please limit yourself to two questions during the Q&A session and re-queue if you have additional questions.
I will now turn the conference call over to Aaron Broholm, Vice President, Investor Relations. Please go ahead, sir.
Good morning and thank you for joining us on our fiscal 2018 fourth 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 Joe Stanziano, Senior Vice President and General Manager, Coffee; Tina Floyd, Senior Vice President and General Manager, Consumer Foods; Barry Dunaway, President, Pet Food and Pet Snacks; and Dave Lemmon, President, Canada, International and U.S. Away From Home. As previously announced, Dave will be assuming the role of President, Pet Food and Pet Snacks later this month in advance Barry’s retirement from the company in July.
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, our fiscal 2018 outlook, and information about recent new product launches. The slides can be accessed through the link to the webcast of this call and will be archived on our website along with a replay of this call. If you have additional questions after today's call, please contact me.
I will now turn the call over the Mark Smucker.
Thank you, Aaron. Good morning everyone and thank you for joining us. This morning, I will begin by discussing our fourth quarter results and then transition to an update on the progress we’ve made over the past year on our strategic road map which will segway into Mark Belgya’s discussion of our fiscal 2019 outlook.
We established our strategic road map to define a clear path to delivering on our three key financial priorities: Growing the top-line; Achieving significant cost savings; and delivering earnings per share growth in line with our stated long-term objective.
As we reported in our earnings release this morning, both industry wide factors and certain discrete events impacted progress in delivering against these financial priorities in the fourth quarter.
While performance under delivered for the quarter, we remain steadfast that the actions we are taking position us to deliver against each of these priorities and will create long-term shareholder value that outpaces our peers. In fact, we are seeing improved trends in the first quarter.
Fourth quarter net sales and adjusted earnings per share were below our projections, primarily driven by results in the coffee and pet businesses due to a few factors. First, trade spend in the quarter was higher than planned, most notably for Folgers' roast and ground coffee in response to competitive activity. While elevated trade support will continue as a lever to manage price, we are making progress toward aligning our coffee portfolio with the industry by increasing our presence in both premium and one-cup coffee. To this point, sales for both Dunkin' Donuts and Café Bustelo grew 11% this year as the brands crossed the $550 million and $150 million thresholds respectively in annual net sales.
Second, initial customer demand for our 1850 and Dunkin' Donuts canister launches was even stronger than expected. As a result, we incurred greater than forecasted operating and introductory costs in response to a broader than anticipated launch. While these incremental costs were incurred in the fourth quarter, the majority of initial customer shipments are occurring in this quarter, the first quarter of fiscal 2019.
Additional factors that impacted the quarter that were not in our most recent guidance included: pet food recall charges, and financing costs associated with the Ainsworth acquisition. Also freight expense, although anticipated to be higher, exceeded our projections by approximately $5 million. However, despite these headwinds, we delivered stronger than anticipated free cash flow for the quarter and the full year.
While not reflected in the fourth quarter financial performance the recent actions we've taken towards transforming our business are indicative of a new pace of change and sense of urgency within our company. They validate that we are focusing on those areas where we can win, realigning our portfolio to higher growth areas and on trend categories. Consider the following recent highlights. We appointed new leadership in all our strategic business areas, we created centers of excellence to ensure a relentless focus on consumer needs and improving our speed to market. We brought to market two of our most important innovations in recent years, 1850 premium coffee and Jif PowerUps snacks. We bolstered our premium pet food offerings with the acquisition of Ainsworth, which adds the fast-growing Rachael Ray Nutrish brand to the right segment of our portfolio. We moved forward aggressively with plans to explore a divestiture of a non-strategic asset our U.S. baking business. We've recently communicated with employees, our intention to consolidate our West Coast pet food offices into our Orville corporate location to manage our largest business seamlessly with our centers of excellence. We enhanced our partnership with Keurig to be more competitive in the market and open the door to expand the distribution and finally, we launched RIGHT SPEND, our zero-based budgeting program at the beginning of fiscal 2019.
These actions are significant and directly aligned with our consumer led strategy to be a food and beverage leader focused on high growth on some categories. These actions are also proved that we are moving faster in order to deliver growth and strengthen our financial performance. Further, they deliver on the four pillars of our strategic roadmap, innovation, investments, cost savings, and acquisitions.
Let me briefly touch on each area. I'll start with innovation where products introduced in the past 3 years delivered nearly $500 million or 7% of fiscal 2018 net sales. As we began 2019, initial read on the introduction of our 1850 premium coffee brand are strong. The product which was developed through our new approach innovation tested well with not only traditional Folgers drinkers but also a younger generation of consumers who prefer Folgers Coffee blend Plan.
The initial 1850 launch spans 17 SKUs and retail interest has been strong with customer acceptance rate and a number of shell facing exceeding our expectations. To drive consumer awareness, we developed a comprehensive PR and marketing program, which is just getting underway. We are very encouraged with the reactions of the launch and initial product shipments will continue throughout the first quarter. We expect 1850 to be a growth platform for years to come.
We are similarly optimistic about Jif PowerUps, our new line snack bars and peanut butter clusters that began shipping in May. This on trend product extends the power of the Jif brand into the fast-growing snacking category, well tapping continued interest in protein-based snacks. Live 1850, we are supporting the launch of Jif PowerUps with significant retailer and consumer investment including an integrated PR and marketing campaign with a celebrating endorsement. We view these investments as essential to success for a launch of this magnitude.
In pet, recent product introductions include pepperoni jerky base and new varieties of Milo’s kitchen premium dog treats with real meat as the number one ingredient, these items expand our presence in a natural meat snack category, which has grown 15% over the past 52 weeks. Late this fiscal year, we look forward to new launches that will expand the reach of our iconic Milk-Bone brand into key pet snack segment. All of these innovations underscore our commitment to adapting to market trends. We recognize these efforts will be essential to compete in our dynamic industry.
Turning to the second pillar of the roadmap, which is investment. Momentum for the Smucker’s Uncrustables brand remain strong with company-wide sales up 15% this year marking the 4th consecutive year of double-digit growth. In 2018, the brand surpassed the $250 million level in annual net sales as we produce until more than 500 million sandwiches over the course of the year. With construction of our new facility in Longmont, Colorado on track for completion in fiscal 2020, this will provide capacity to further accelerate growth as we expect to double net sales for Uncrustables to more than $500 million over the next 5 years. We are now more than a year into the grocery and mass channel rollout of our Nature’s Recipe premium dog food brand and we continue to see a positive response and good momentum.
Net sales for the brand were up 20% in the fourth quarter, even while lapping the prior year launch and up 33% on a full year basis. In addition, consumer takeaway for our mainstream dog food brands continues to significantly outperform the overall dry dog food category. This growth occurred despite increased competitive activity in the mass premium space. We expect Nature’s Recipe will serve as a strong complement to the newly acquired Nutrish brand, which I will discuss in a moment. We are also a year into the launch of the Jif brand in Canada and the brand has quickly gained share in the peanut butter market. This contributed to company-wide sales for Jif growing 3% for the year.
Lastly on the topic of investment, e-commerce remained a significant area of strategic focus. While still a small base with just over 2% of 2018 US retail sales coming from the e-commerce channel, sales were up 71% this year with pet food brands up 64% and coffee sales in the channel more than doubling.
We continue to expect 5% of our net sales will come from the pure play e-commerce channel by fiscal 2020 and an even greater percentage when factoring in click and collect models. As you can see in addition to supporting innovation, we will also increase investment in several of our core brands. These investments are essential to support growth and the long-term health of our brands.
The third pillar of our strategic roadmap is generating cost savings to provide the fuel for investments in topline growth and margin protection and expansion. In 2018, we’ve realized our $200 million pet food synergy target while continuing to make progress on our other cost savings programs. This included our new K-Cup which has led to improved economics, increased distribution and additional SKUs.
As a result, net sales for our US K-Cup portfolio grew 11% for the year with Dunkin Doughnuts and Café Bustelo K-Cups both up over 20%. Due to the improved profitability of K-Cups, margins are now consistent across all of our coffee segments which is critical given our strategic focus on growing our premium and one cup segments. For fiscal 2019, we have implemented RIGHT SPEND to strengthen cost discipline throughout the organization and deliver a portion of the overall fiscal 2019 savings. By the end of the fiscal year, we will also relocate our pet food offices in both San Francisco and Burbank to our corporate offices in Orrville, furthering collaboration and enhanced agility while improving cost efficiency.
The final pillar of our strategic roadmap is acquisitions. Last month, we completed the Ainsworth transaction and welcomed a very talented team to the Smucker family. We are extremely excited to add Rachael Ray Nutrish, a high growth premium brand that has been a catalyst in transforming the dog food category in grocery and mass channels.
With distribution expansion opportunities and significant growth prospects in cat food and pet snacks, the addition of Nutrish will accelerate growth in our pet business. While the deal closed less than a month ago, we are already progressing towards a seamless integration of people, processes and systems into our pet business by the end of the fiscal year.
While growth through acquisitions plays a key role in our strategy, we have also demonstrated a willingness to divest businesses that are no longer consistent with our strategic focus and direction. Given our focus on growing our coffee, pet and snack food businesses in April of this year we announced our intent to explore our divestiture of our US baking brand and business. We are moving forward in the process and anticipate providing future updates in the coming months.
Fiscal 2019 will be a year of continued transformation and growth. As I mentioned, stepped up investments in our brands and innovation are imperative to adapting to market trends. Although for 2019, a significant portion is in support of our innovation launches, we expect to sustain these increased investments and consumer marketing in future years. Through cost savings programs and the benefit of U.S. tax reform, we have the resources to compete responsibly while at the same time increase fiscal 2019 adjusted earnings per share by 6% to 9%.
And wrapping up, here are a few thoughts, we hope you took away from my comments. While we are not satisfied with our fourth quarter performance, we are positioned for long-term success and some of the best food categories coffee, pet food, peanut butter, snacking. We have a strong mix of leading iconic brands and emerging on-trend brands as evidenced by full year 2018 sales growth for Smucker’s, Jif, Milk-Bone, Dunkin’ Donuts, Café Bustelo, Smucker’s Uncrustables and Nature’s Recipe, which underscores our ability to react to and capitalize on changing consumer needs.
We are taking and will continue to evaluate appropriate actions to align our portfolio to grow whether through innovation, acquisitions, divestitures or improving capabilities and execution in key areas.
And finally, our cost savings initiatives along with benefits of income tax reform allow us to mitigate headwinds in certain parts of our businesses and provide fuel to invest in our brands and our resources.
Let me close my comments by thanking all of our employees for their efforts this past year and their continued dedication as we move forward. We are confident we have the right team in place to deliver long-term growth and shareholder value. We recognize that there is still more work to do as part of our company transformation. We also know that we can’t stand still and we’ll continue to adapt to changes in our industry and consumer preferences. We look forward to providing future updates at an Investor Day in New York City on October 9th as our talented leadership team will share more details on the strategic roadmap for their respective businesses.
I will now turn the call over to Mark.
Thank you, Mark. Good morning everyone. I will start with an overview of fourth quarter results and 2018 cash flow performance and then shift to providing additional color on our outlook for fiscal 2019. GAAP earnings per share was $1.64 in the quarter, compared to $0.96 in the prior year. The increase primarily reflected a favorable change in unallocated derivative gains and losses in the current year along with the prior year including $0.34 impairment charge. Excluding these items and reflecting other non-GAAP adjustments summarized in this morning’s press release, fourth quarter adjusted earnings per share was $1.93 compared to a $1.80 in 2017 an increase of 7%. Included in this quarter’s adjusted EPS were combined cost of approximately $50 million or $0.10 per share associated with pet product recalls and acquisition financings which were not reflected in our most recent guidance.
Net sales were flat compared to the prior year as higher net price realization contributing one percentage point to net sales growth was offset by lower volume mix. Adjusted gross profit increased $6 million or 1% as the net benefit of higher pricing and lower cost more than offset the profit impact of lower volume mix.
Adjusted gross margin was 37.9% in the fourth quarter, up 40 basis points compared to the prior year. However, this was below our projection due to less net price realization than anticipated and higher freight cost. While cost for the 1850 and Dunkin Doughnut cannister launches also exceeded our previous forecast, initial volume expectations have increased.
SG&A decreased $7 million in the fourth quarter or 2% compared to 2017 driven by lower corporate administrative expenses primarily reflecting a reduction in incentive compensation cost and ongoing budget management. This was partially offset by a charge related to pet food product recalls. For the year, corporate administrative expenses decreased $30 million or 9%. Factoring in all of this, adjusted operating income increased $10 million or 3% compared to the prior year which included a $4 million gain on divestiture.
Adjusted operating margin increased 60 basis points to 19.6%. Below low operating income interest expense increased primarily due to non-capitalized financing cost associated with the Ainsworth acquisition. The higher interest expense and a $3 million unfavorable change in other income were more than offset by a lower tax rate which decreased from 31.8% last year to 29.6% this quarter.
Lastly, the current quarter results benefitted from a 1% reduction in weighted average shares outstanding reflecting shares repurchased in the fourth quarter of fiscal 2017.
Let me turn to the segment specific results beginning with coffee. Net sales were flat in the prior year as the 4% increase from volume mix reflecting gains across all our coffee brands was offset by lower net price realization.
Sales for the Dunkin doughnuts brand increased 8% on strong K-Cup performance, an increase in promotional spending needed to improve competitive positioning for Folgers Roast & Ground Coffee drove a 2% net sales decline for that brand. Cafe Bustelo also declined 2% in the quarter primarily due to the timing of shipments to a large club customer.
Coffee segment profiting increased 4% due to favorable volume mix and lower input cost which more than offset the reduction in price realization and a significant increase in marketing expense in nearly 20% for the quarter. Segment profit margin of 30.7% represented 110 basis points increase over the prior year but was below our expectations for the fourth quarter due to the higher than planned levels of trade spend and product launch cost.
For 2019, we project full year coffee segment profit growth in the mid-single digits which will be heavily weighted towards the first half of fiscal year. This will be driven by the full year benefit of lower green coffee cost in our revised K-Cup contracts. These cost savings will be partially offset by an estimated $30 million investment to support our 1850 launch and an increase in marketing support behind Dunkin Doughnuts and Café Bustelo.
A consumer foods net sale were down 2% compared to the prior year, due to declines in the oils and baking categories. Excluding these two categories, net sales were up 1%. And overall volume mix decline of 8% in this segment reflected the impact of higher pricing in several categories with net price realization up 6%.
Sales for the Smucker’s brand were up 9% reflecting growth in both Uncrustables Frozen Sandwiches and Fruit Spreads. For the Jif brand, while consumer takeaway was up in the latest 12-week period net sales declined 3% due to the timing of peanut butter shipments in a strong prior year comp. Sales for the Crisco and Pillsbury brands also declined in the quarter.
As we move into fiscal 2019, we have taken strategic actions to improve the everyday price points for Crisco. Consumer Foods segment profit increased 5% compared to the prior year despite the profit impact associated with the lower volume mix and higher freight costs. Profit growth continues to reflect successful execution of our pricing strategies. For 2019, we project full year consumer foods segment profit to be flat to down slightly prior to any impact of potential divestiture of our baking business. This reflects an estimated $20 million investment to support Jif PowerUps launch and an incremental $7 million of cost associated with our Longmont facility.
Turning to the pet food segment, net sales were flat compared to the prior year, a slight increase in net price realization was offset by lower volume mix. Sales for our mainstream dog food brands were flat as 20% growth for Nature’s Recipe and 6% growth for Kibbles ’n Bits were offset by declines for Gravy Train due to the product recall and planned as SKU rationalization. Cat food sales increased 3% driven by growth for the 9Lives brand while pet snacks decreased 1%. Lastly within premium pet food sales for the Natural Balance brand decreased 5%, primarily due to softness in the pet specialty channel.
Pet foods segment profit decreased 13% compared to the prior year. Nearly one half of this decline was attributable to the product recall costs in the quarter. In addition, higher commodity and freight costs were not fully offset by the higher price realization. While, we expect this price to cost relationship to continue in fiscal 2019 overall pet food segment profit is expected to increase approximately 20% compared to the prior year reflecting the addition of Ainsworth.
Lastly in the international and Away From Home segment net sales increased 2%, compared to the prior year driven by foreign currency exchange. Segment profit also increased 2% despite the prior year including a $4 million gain on the sale of our minority interest in Seamild. Excluding this item, segment profit increased 11% lower input costs, decrease in marketing expense and foreign currency exchange all contributing.
Let me now turn to an overview of cash and debt. Fourth quarter free cash flow is $203 million bringing the full year total to $896 million, a 3% increase compared to the prior year. This surpassed our fiscal 2018 updated guidance of $825 million as lower than projected working capital more than offset capital expenditures which came in at $322 million.
We ended the year with debt of $4.8 billion based on 2018 EBITDA of 1.6 billion, our leverage ratio stood at three times as of April 30th. On May 14th, we drew $1.5 billion on a new term loan and issued $400 million of commercial paper to fund the closing of the Ainsworth transaction. This increased our leverage to approximately four times.
The company has no required debt maturities coming due this fiscal year and we expect to focus on reducing leverage closer to three times over the next couple of years.
Let me now provide additional color on our outlook for fiscal 2019. This guidance includes projected contributions from the recently acquired Ainsworth business but excludes any impact from a potential divestiture of our US baking in business. Big picture, we expect net sales to increase approximately 13% to $8.3 million driven by the addition of the Ainsworth business. Excluding Ainsworth, sales are expected to be up 2% reflecting the launch of 1850 engine PowerUps.
There is a 1% negative impact due to planned SKU rationalization most notably in our pet segment. From an earnings perspective, we expect to deliver EPS growth of 6 to 9% as the benefit of continued cost savings and incremental tax reform more than offset a significant increase in brand support and cost inflation.
Overall commodity costs are projected to be higher with lower coffee cost expected to be offset by increases across a number of our key commodities and other raw materials including peanuts, protein and packaging. The pet segment will be most impacted with consumer foods also facing a net increase in cost. In addition, the freight headwind that impacted this in the last six months of fiscal 2018 is expected to continue into this year.
SG&A expenses are expected to increase over 20% compared to the prior year mostly attributable to the addition of Ainsworth. Excluding the acquisition, SG&A will be up mid to high single digits reflecting a substantial increase in marketing most notably approximately $50 million in support of 1850 and Jif PowerUps launches and also cost associated with the construction of our Uncrustables facility in Colorado.
With fixed incremental months of improved K-Cup manufacturing cost and additional cost reduction initiatives, we projected incremental $80 million will be realized in fiscal 2019 related to our $250 million cost management program. Along with the $100 million we achieved in 2018, this would bring our accumulative total to a $180 million in annual cost savings with the remaining expected to be realized in 2020.
Below operating income, we expect interest approximately $220 million with the year-over-year increase reflecting borrowings to finance the Ainsworth acquisition and an overall higher interest rate environment. We now project an effective tax rate of approximately 24.5%. This compares to our initial 2019 guidance of 23% primarily reflecting higher state income taxes. Lastly our guidance reflects weighted average share count of 113.6 million based on current shares outstanding.
As a result of all these factors, we’re projecting adjusted EPS to be in the range of $8.40 to $8.65. We project free cash flow will be approximately 800 to $850 million from CapEx expected to total somewhere between 350 million and 370 million including a $100 million related to the Uncrustables production facility. Other key assumptions effecting cash flow include depreciation and amortization expenses of approximately 220 and 250 million respectively including an estimate for Ainsworth amortizable intangible assets.
Share based compensation expense of $20 million and lastly one-time cost of $60 million which are mostly cash related including approximately $30 million of cost associated with the Ainsworth acquisition and the remainder primarily associated with our organization optimization including the closure of certain offices.
As you can see the actions we’re taking to transform our company are enabling us to deliver against our financial priorities and growing the top-line, achieving significant cost savings and delivering earnings per share growth in line with our stated long-term objective.
We’re encouraged by the progress being made on our strategic roadmap but recognize, they’re still much to be done and we’re proceeding with the tens of urgency to deliver long-term growth and enhance shareholder value.
Thank you for your time and we’ll now open the call up to your questions. Operator, if you please queue up the first question.
Thank you. [Operator Instructions]. Our first question comes from Andrew Lazar with Barclays. Your line is now open.
So, two quick things. One would be, just first Mark, you mentioned your expectation for EPS growth in fiscal ’19, obviously given cost saves and the tax benefits and some deal accretion. Given all of the activity, you’ve got to this year around innovation and some of the big platforms that you are bringing to market. And I know you’re spending more against some as you’ve talked about. But I guess, is this a year, where you feel as though that’s enough or do you feel limited all I guess by the desire to show EPS growth in a year where maybe even more spending behind some of these platforms is better. So, I guess, I’m trying to get a sense of, I guess, do you feel like you’ve got enough behind these innovations or you’re limiting yourself, just, because of the desire to show obviously EPS growth? That will be the first one.
Andrew, I’ll start, this is Mark Belgya and actually Mark Smucker will finish. Good morning. So, a great question and we appreciate the question. Obviously, there is a lot going on, I think, one of points that we [want] have made and will continue to make throughout the course of the morning and into the future is that, we are very excited about these two particular innovation launches. There are two of them, the biggest that we had in the company’s history. We’ve learned over the years that if you don’t support launches of this size, they will not maximize the potential. So, and speaking on behalf of the team here I think we feel comfortable that the dollars we have behind those launches are adequate to achieve success in year one. And again reinforce, this is platform growth. So, there will be more to come behind these particular launches in coming years.
At the same time, we’re also comfortable that brands like, our growth [drinks] like Dunkin’ Uncrustables, Bustelo and we’ve also stepped up to spend behind those appropriately. And so, feel, that what is amounting to about $80 million to $85 million total marketing increase over last year on the business excluding Ainsworth is sufficient. We are fortunate to be a beneficiary of U.S. tax reform and the good work that our teams have done around cost savings that allow us to do that. So, there is a lot of headwinds out there, a lot of uncertainties. But we feel that, we’re adequately investing and our guidance range is capturing sort of all our thoughts around where costs are added, where pricing maybe headed, where tariffs might be headed and then the like
Got it. Okay. Thanks for that.
Yes. Andrew, if I could. This is Mark Smucker. Just a couple of things, I think, I repeated myself a lot in the script. But wanted to just 2 key points. The first is really want you guys to take away from the discussion today that’s we’ve made a lot of progress in terms of realigning our portfolio to the growth segments. As you know we’ve got more work to do and at the end of the day we are executing our strategy. But as it relates specifically to marketing, if you look at our marketing investment in our consumer marketing over the last decade or so, you will see that we have actually eroded our marketing spend to the tune of about $80 million and that is simply not acceptable. And so, as a result of that erosion and yes some of it is going to trade, but as a result of that erosion we have made choices in the particular years about supporting core brands versus innovation and we’ve got to ensure that we are supporting our brands for the long term where we will watch the health of those brands deteriorate. And so, if you think about the launch of Nature’s Recipe year and a half ago we’ve spent significantly behind that launch. Similarly, with these innovations and with any innovation we’ve got to commit to the support and then overtime that significant investment would shift to other innovations and we would see you know the second or third year after our launch we would see support come down to those launches at some maintenance level and that would continue to support.
So, we’ve got to make sure that if you look at our marketing as a percent of net sales, we need to be more in line with the rest of the industry in terms of what we’re supporting both our new products or new brands as well as our core business. So that really is a key message going forward.
Great. I’ll leave it there. Thanks very much.
Thank you. Our next question comes from Chris Growe with Stifel. Your line is now open.
Thank you. I just want to ask in relation to your guidance you gave and we talked about fiscal ’19 we know really grow above your long-term growth algorithm with other cost, the cost savings coming through with the tax savings coming through. What is it that ultimately lead you to growth rate more in line with if you will, roughly in line with your long-term range. Is it the marketing, is it the trade promotion, I think you clearly contemplated some of these incremental launches? Just curious what could have led to a weaker outlook for fiscal ’19 EPS?
Well, Chris this is Mark Belgya. Let me just try to frame it in for those of you on the phone. So, if you kind of work off of where you guys are at TheStreet generally. I think the first thing is we’re obviously starting at lower base but beyond that as I noticed we’re taking our tax rate down to about 1.5 from original, most of that driven by state taxes, the Ainsworth acquisition, the footprint we have is driving a little bit of that. That’s about $0.15 of earnings and then if you, I guess if you just flip back to some of the commentary from CAGNY, I think that we had called out a market increase somewhere in the mid-teens which probably equated to around a mid-$65 million number as I just said we’re more in the 85 million. So that’s another 20 million if you would, our savings are, our cost programs are a little shy, we probably come in at closer to 100 million, we’re still going to go after but for now our guidance is reflecting around 80 million so there is another 20 million.
Clearly, we’ve got some additional cost in our construction of our Longmont facility. as I mentioned it's about 7 million and then we also have the incremental freight cost facing this year particularly in the first half of the year. So those four or five items are key drivers that take down sort of where the street sits down to the range that we’ve just discussed.
And just thank you for that Mark. So just one of the follow-up is Ainsworth is accretive in fiscal ’19. As you said how much accretion you expect from that transaction?
Yes. Chris, what we said is, we announced transaction we said about $0.25 accretive net of interest and so forth and basically, we’re right on that target.
Our next question comes from David Driscoll with Citi. Your line is now open.
So, Mark Smucker, this question is for you. It’s a little bit of a tough one, but your stock has indicated down quite substantially, so I’m going to be pretty straight forward. In the release, you say, you’re confident in delivering on the objectives. But you do have a big fourth quarter miss and guidance is well off versus the company’s CAGNY comments, which was just at the end of February. And this 8% EPS growth, you made I think some very compelling comments about what you’ve done to reshape the portfolio. But I honestly think the debate today is whether Smucker’s and the other CPG companies have the ability to take pricing to offset inflation and the fourth quarter results really call this in to question. So, kind of really directly Mark and really, you’re speaking all these investors now is given the way the stock is in act, why are you confident? And can’t Smucker’s take the necessary price actions?
So, thanks for the question David. So first of all, the first thing, I would remind everyone is that as you know, we’ve been in business for 121 years, we managed it for the long-term and we’ve over, although we haven’t done this over the last 3 years or so we have over delivered in terms of shareholder return. But in order to continue to do that in this environment as you know and as we’ve talked over the last year or so these changes are necessary in order to position ourselves for long-term growth. And so are confidence is bolstered by the fact that everywhere that we’ve invested in our portfolio, if you go back to my prepared comments, every brand that we’ve invested and has grown. Yes, we’ve had some drag from the oils and baking business part of that is because we consciously chose to back off on investment. And so, where we are focused, there is no question that we’re actually seeing results.
As it relates to pricing, we still feel confident and we’ve demonstrated that we can get pricing through particularly where we have leading brands, there are a few areas where we’re not the leading the brand, but we do tend to follow. But for the vast majority of our categories, we are able to lead. We used both, in the case of coffee, in the current environment, we have used trade to affect price versus taking a list price decline. So, we do use different levers to affect price. And then as I said in previous quarters as we go to our customers and we have justifiable price movements, we can’t and have been successful getting us through.
One of the questions you all have asked us, is it more difficult, I would tell you that it is taking a little bit longer, there is more discussion about pricing particularly increases. But I would say in almost every case we continue to be successful in getting that pricing through.
Maybe if I could just follow up on coffee, I just like to ask a little bit more about kind of what happened in the quarter, there was -- the team had a lot of confidence here that the lower green coffee was going to benefit profitability relative to our estimates this was the biggest miss on the P&L in the fourth quarter versus what we expected and I think what you guys expected. So, can you talk a little bit about kind of why it happened, why did you need the more trade promotion and what’s happening within the coffee segment in the industry to drive these prices down?
Good morning David, this is Joe. I’ll start there; I referenced Mark’s comments earlier, our cost to support the launch of 1850 and Dunkin canister were up in the fourth quarter along with that increased trade. While we’re disappointed with those results and we wish they were better we did grow both volume and segment profit in the quarter and we saw continued momentum in strategic areas. So, our K-Cup business was up 11% we are outperforming the one cup segment in the 4, 12 and 52-week scan data. Sales of Dunkin Doughnuts and Cafe Bustelo both grew double digit this year and our launch of 1850 is off to a fast start, great retailer acceptance and execution. As Mark said we have significant investment behind that platform and our marketing programs which have started will continue to ramp up over the next few weeks.
And finally, we’ve been working to better align our cost price relationship and we feel it's in a much better position going into fiscal ’19. I think you recall where we were last year at this time and we’ve made tremendous improvements, so I would say yes pricing is still competitive but where we have made those trade investments, we are seeing results and we’re seeing volume move in the right direction.
Thank you.
Thank you. Our next question comes from Ken Goldman with JPMorgan. Your line is now open.
Hi, thank you very much and good morning. Two questions from me, my first question is I wanted to make sure that my back of the envelope math is right. If you’re looking for about 800 million from Ainsworth, it seems to imply that organic sales growth to hit your target of 8.3 billion has to be around 2 to 3% and that’s in a year when you are taking prices down in coffee and you’re reducing your SKUs by 1%.
It honestly feels to me a little bit aggressive and I just wanted to make sure A is my math right there and B if you can walk us a little bit through obviously there is some innovation and so forth but maybe that innovation wouldn't be quite as much to get us there or quite enough, if you could walk us through a little bit sort of those drivers in more detail to get that would be great?
Your math is correct, we are expecting about, depending on how you’re rounding about 2% topline growth [indiscernible] organic which is ex-Ainsworth, most of that candidly is coming from innovation in particular 1850 and PowerUps along with some pet innovation coming. And then I just want to clarify a little bit on the price decline in cost, you’re correct in this fact that we’ve got one more quarter to lap that the price increase that we offset with trade beginning again in Q1 early Q2 last year. So, there is that but after that there is really no price decline built in anywhere across the portfolio.
So, it is primarily innovation, there is some growth continue obviously in Uncrustables, Bustelo all our growth brands are still projecting up, Natures is still expected to grow even though we had a great year last year. But the key driver is our innovation.
Maybe I didn’t understand that. There is only one more quarter of coffee pricing to be down but your cost have only been down for one quarter. How is that the case that it won’t flow through the, most of the rest of the year.
No. I guess, what we’re saying is that, we’re going to lap that trade adjustment that we had to take. Because remember, we took price up going into, I guess January 17th, and then had it taken back down. We still have a quarter of exposure on that.
Okay. I’ll follow up with you off-line on that one. And my other question is you’re moving your pet food offices from some big cities to Orrville. And Orrville is a great town, but I’m just wondering, I harken back to [coffee] right. And I think back to what happened with that brand, not to pick on Kellogg’s, but when a brand that was run very well sort of independently was taken from a big -- not really a big city, but it was in the West Coast in a very attractive area to something different. And I’m just worried about the potential for losing people, the potential for integrating a business that has had some struggles. So maybe, this is the right thing to do. But how are you factoring in some of those risks into your thinking for this year and your guidance.
I’ll start, Ken and this is Mark Smucker. And thanks actually for that question. So, you are absolutely right, the risks that you highlighted are risks that we have very carefully considered. And I want to say that the team, particularly San Francisco being the largest, of the pet offices, we have a fantastic team. And they are great people, they’re passionate about the business. I don’t think this is similar to [indiscernible], because this is our largest business. It is predominantly a mainstream business that resides in more or less similar channels, yes there is, had specialty, which are unique channels. But I think, if you think about it being our largest business and the ability for it to fully leverage the capabilities that we built, co-locating the business with some of those capabilities is really key. As it relates to talent we are working hard to retain and attract several of our key folks there and so far, we’ve had some very nice wins. So, we are keenly aware of the risks and we are doing everything that we possibly can to ensure that we mitigate them. I don’t know if…
I just add to, Ken this is Dave Lemmon. We have strong offers with the number of acceptances to move them to date, so that’s one positive. The second positive is that we have strong retention programs in place to ensure there is business continuity through the move. And I would just say that we're really excited about the opportunity of bringing the pet business under one roof and being able to harness the excitement of the entire organization against pet moving forward.
Our next question comes from Alexia Howard with Bernstein. Your line is now open.
Can we start with the pet food business and the recall? Are you concerned about any knock-on implications in terms of traction with the retailers in the shelf place allocation given all the channel mix shift? And I guess, a broader question in there is, given that you’ve got Amazon entering the cash agreement with the Wag brand entry into food, drug and mass, second on the toes of some of the larger pet companies, are you worried about pricing pressure in the category as a whole?
Hi, Alexia. This is Barry. Let me take the questions there. As far as the recall is concerned, a couple of comments on that. First, just to clarify, we have made the decision to exit the Gravy Train web business because of profitability challenges and we’ve made that decision last summer. So that product line did not meet our profitability hurdles. So, we had communicated that to our customers and that had actually discontinued production and then the recall occurred. We fully expect to recover all of those costs associated with that recall from our supplier who provided us with the ingredient associated with that and we expect to recover these costs by the middle of this fiscal year.
As far as knock on, Gravy Train dry business continues to perform incredibly well. If we look at consumption just over the last 13 weeks period, it’s actually up 2% despite the fact that that value segment is down I think by 9 points. So, we think that brand has tremendous equity and we have not seen the knock-on effect across the portfolio.
But as far as price -- let me just talk to Wag and I know there’s been a lot of attention on Amazon’s launch there. We compete with private label in every channel where we do business, so if another private label clearly Amazon has strength with the consumer base but our Natural Balance brand, our Nature’s Recipe brand are incredibly strong, performed very well for the e-commerce channel. We will continue to invest in those brands holistically and we think we will continue to be able to compete effectively against Amazon’s brand or other private label brands that either currently exist or may appear.
As far as pricing pressures and Mark alluded earlier, we are seeing cost headwinds on input costs especially against our -- across our entire portfolio and we will monitor the market and if and when it’s appropriate we will move price accordingly. So, some thoughts there on you questions. Thanks for those.
Thank you. Our next question comes from Pablo Zuanic with SIG. Your line is now open.
I guess one question first for Mark Smucker. Mark, I would say -- you say you appointed new people in most of your divisions. You gave a possibly spin on that. I could turn that and say that you have some senior departures like Steve Oakland, Barry Dunaway, is that a concern? Why are people leaving at this junction some very strong assets for the company? That’s the first question.
And the second one I guess for Mark Belgya, I know that we’ve gone back and forth on the guidance, in a very specific term -- terms if I take your $7.96 EPS for fiscal year ‘18, that’s 28% tax rate. If I use your 24% tax rate, that’s a $0.44 benefit for next year plus $0.25 of Ainsworth, that’s going to get me to $8.65, right? And your guidance is $8.40 to $8.65 so maybe it’s a comment more than a question but you and I are on the thesis but again may be despite 2% organic growth, despite talk about better margins in coffee in the first half at the end of the day your guidance is implying that ex-Ainsworth and ex the tax rate EPS is going to be flat to down next year for the quarter. So, if you can comment on that.
And the last one I’m sorry, not only 2 but, the third one just very briefly for the pet, for the new pet division, can you comment in terms of the $800 million sales for the Ainsworth. What does that reflecting in terms of underlying sales growth for the business just kind of its slowing, what’s the room for growth there in SJM? Can you do more in specialty with that brand or ecommerce? If you can give some color in the sense with shelf. And also, where there is room to expand in the private label business that you have there fewer balance with Walmart but can also be expanded. So, in terms of how Ainsworth can grow from the 800 bases. Thanks.
Okay Pablo, it’s Mark Smucker, I’ll start and we’ll just go around the table here. Thank you for the question on leadership because we were expecting that and gives us the opportunity to speak a little bit more. So first of all, you mentioned Steve and Barry, both of whom are very seasoned leaders, managers with the company. Similarly, I would tell you that Dave on Pet, Joe on Coffee and Tina on Food are quite frankly some of our best leaders in the company they are very seasoned, they all have 20 plus years with the company, they have work in various functions and businesses. In some cases, actually, I think in every case, they’ve all been mentored by Mr. Oakland and that all to some degree, Barry.
And so, there is a tremendous amount of depth of knowledge, understanding of the consumer and clear leadership capabilities both in managing people and businesses and all of them have delivered results and growth in their various roles with the company. Dave in Pet is probably the newest and although he has been on these calls in the past in his current or former role, you all, will get an opportunity to get to know him a little bit better, he obviously comes from Canada and has spent a tremendous amount of time managing an extremely complex business in a very concentrated customer environment. And I think that positions him well to manage Pet, which one could argue is probably our most complex business as well. And also, is a very concentrated customer environment. So those are some of the reasons why, I just feel tremendously confident in this team. And I have very, very high hopes for them. So, thank you for the question.
Pablo, this is Mark Belgya, I’ll go after your second question. So, what you said, is right to a degree. So simply adding the benefit of tax in Ainsworth gets you sort of the, call it, the middle part of our guidance range. I think these just underscores, we talk about, if you look at our cost savings programs and look at our increase in marketing, those basically awash. We’re saving $80 million plus in initiatives and we increased our marketing on legacy Smucker by about the same amount. So, and then if you add to the cost inflation in Longmont cost, that’s the draw down.
What I would say is that, as we talk about pricing, we still think that there’s always pricing opportunity to address them these costs. So, I’d say it’s more negative weighted, because we’re getting the full 12 months of impact of cost, and we still have pricing opportunity to go forward. Candidly, we’ll see volume impact to that, but we expect to cover off of that. So, you’re right in the simplest math, but I think you really need to break it down to the next level, double-click on the components. And again, if you go back to Mark’s earlier comment, we did feel that because of the opportunities with tax savings and cost savings that we need to spend appropriately behind the brands and end up to get to the math that you suggested.
Pablo just to touch on some of your questions with respect to Ainsworth, it’s stable environment by the way. I would say the brand is doing extremely well. We have seen it growing at 27% both on the 13 and 52-week basis. And as we look to the future on that business, we see huge upside on snacks and cat through innovation targeted behind those businesses and those segments. And then really sort of the juggernaut of the business is on dog foot and there is continued growth through wide space on distribution and through innovation planned against the brand. So, we feel very confident that the brand will continue to grow at the pace it’s currently growing.
Is there room to grow the private label business?
What’s that?
Within Ainsworth, is there room to grow the private label business or are you going to exit that because it’s a big part of the total sales number anyway, right? The private label business.
We are still committed to the private label business that we are packing and from a growth perspective, we expected to grow our category levels.
Pablo, this is Mark Belgya. Just maybe one more point on Ainsworth, kind of honed it on the near term. But one of the things to your point is while we're comfortable with the private label business as Dave suggested as the category grows. Our expectation is Nutrish as the brand that will grow. And so, over time that proportion will be very positive across this P&L as we see improvement across the segment profit, gross profit et cetera. So, maintaining the private label and growing as the Nutrish is really the driver strategically.
Pablo, this is Mark Smucker, again. Just one final point on Ainsworth. One of the reasons that we’re so excited about it is that the growth potential, the growth that that team has achieved and we believe there is room to grow, I mean there’s plenty of opportunity on that brand and we think there’s definitely upside. I will also say that the team, that team which is primarily located in Pittsburgh is a fantastic team, also they’re incredible passionate and their leader, Jeff Waters, who is a seasoned pet expert or he has got a tremendous amount of years of experience in pet has agreed to stay on and continue to drive that growth. So, we are very pleased that we still have a great team there as well and very confident in that group of people.
Thank you. So very helpful. Mark, can I ask a quick follow-up? The dilution from the baking business that you estimate is $0.25 to $0.30, does that sound right to you?
Yes, maximized yet, that’s probably right, and I guess just while the question has been addressed, I think one of the things we have to take into consideration is, is that we are already thinking about in the event that that business is the divested of how we would try to shore up at least some of the dilution in the current year. We obviously will have proceeds that we might be able to do things with, we're looking at that cost savings opportunities to help offset some of the absolute dilution. So, the growth is in the ballpark.
Thank you. Our next question comes from Scott Mushkin with Wolfe Research. Your line is now open.
So, I wanted to talk about the long-term model here a little bit and I know we talked about pricing in the short run, but I was just down in Bentonville, spending some time with the folks at target. They talk openly about the investments they’re making in their business, and the cost to doing business that you are seeing going up, and they also talk openly about their CPG partners having much higher margins just generally. So, I guess, I’m just kind of looking at my model, over like a 10-year period and saying. Can we sustain EBIT margins with your partners under so much pressure? And I guess, I just wanted to get your comments on that?
This is Mark Belgya. I’ll start and then I’ll see who wants to jump in. So, it’s a very fair question, I think it’s a near-term question, it’s clearly a longer term strategic question. And a couple of thoughts, I think that we have talked to you folks for years about the importance of number one brand and that continues and we have a great portfolio of that though, that we do believe will allow us to price.
I think as we move forward, we need to make sure that we’re making the proper investments to generate the returns and keep those products and categories that are desirable to the retailer. We don’t want to be a marginalized category, so I think that’s a focus. But candidly, I think we have to continue as an industry to look at opportunity to manage costs in other places than just COGS. And we want to hold on to that operating profit that we have become accustomed to it in the industry.
And so, I think, while its started by some of our peers maybe I the short-term ways to drive shareholder value. I think longer term that is a strategic approach. And so, we’re going to very thoughtful as we add costs going forward and we’re going to continue to work with our suppliers to make sure that we’re in a good place from a cost perspective on incoming raw material and services. So, it’s fair, I think it is a reasonable challenge as an industry we are facing. But again, I think we fall back on the two things. One is we have incredibly good relationships with our retail partners and we also have great brands to offer up to them.
Scott, this is Mark Smucker. I would just add that we have seen this type of pressure in the past. We’ve been in the business a long time, and there are moments in our history and the industry's history where our retail partners push harder than others, and this happens to be one of those times. as Mark said, we have incredibly strong relationships with our customers which have helped us clearly but then I would just go back to the very first question Andrew asked is that, we have an obligation to strengthen the bond between our brands and our consumers. And in the classic sense of a push versus a pull strategy, to the extent that we are successful in strengthening the bond, the emotional bonds between consumers and our brands and consumers are demanding our brands, whether they be large or small brands, that also allows us to continue to grow our business. So, it’s not just about getting selling in our brands with our customers, it is about engaging with our consumers actively and investing in those efforts.
So, two follow-ups. Number one to what you just said. Again, it suggests maybe a little downward pressure on margins with long-term to in the new environment with ecommerce and other things going on to really engage with that customers. That’s follow-up number one. And then my follow-up number two actually is just about cannibalization in the Dunkin’ Donuts brand with 1850. Have you guys planned for that? What's the early seeing? And then yield? Thank you very much for taking my questions.
Hey, Scott. This is Mark Belgya. So, I think your first question is basically around kind of a little bit honing on e-commerce and just margin pressures, that that will push and then just some of the near term. So, we had conversations several times over the last couple of years as we looked at e-commerce and the growth and the expectation of it. And for those who have been around the industry a while, it’s a little bit take us back in time to -- as the business got traditional versus retail and club and mass came stronger and had similar issues in terms of margin pressures because it was just not an established channel and so forth. We recognize right now that growth in that area is going to put some margin pressure but we are working actively across the company in ways to identify how best to improve that margin as more of the business shifts to Internet and e-commerce. So, we think that’s an addressable situation moving forward because we understand we have to do that.
And then just broader, I think we’ve pretty much covered, there might be some margin pressures as we work through this, this time period that Mark suggested from a retailer standpoint. But again, continue to repeat ourselves, but just the relationship and the brands often we think that will get us through that as well.
Okay, Scott, sorry. This is Joe. I will take your 1850 question, yes. We are excited about 1850. It is a very different positioning than the Dunkin’ brands. It will slide into that entry-level premium segment. And the work we've done prior to launch shows that it is highly incremental. The positioning, the way we talk to the consumer, the product is very different and I think when you start to see some of our consumer communication, you will see the differences there. So, we are not concerned on cannibalization there with the Dunkin’ Donuts brand.
Thank you. Our next question comes from Farha Aslam with Stephens. Your line is now open.
A question on pet food. You now have three kind of premium dog food brands, you have Nature’s Recipe, Nutrish and Natural Balance. Could you share with us kind of the positioning of each and what growth you expect next year from each of those?
This is Barry. Let me start there and Dave feel free to jump in. As far as Natural Balance is concerned, that is our super premium line of pet food. And we have made the commitment to this point to sell that exclusively through the pet specialty channel. We think that’s where the nutritionist is shopping and that’s where we will continue to be consumer led as we think about that brand.
As relative to Nature’s Recipe and Nutrish, first this is based on the successful launch of Nature’s. We I think continue to believe there is a place for that in the mass channel, the grocery and mass channel, again based on the launch success it was up 20% in this latest quarter. We have double-digit growth plan for this next year.
Where we are seeing that brand perform particularly well is in the grain-free segment of the premium. And so, our innovation and marketing efforts over the next year will be focused in that grain-free area as we think about differentiating it. So, we were the first mover in bringing that brand over from pet specialty and it has that halo of important natural ingredients as a pet specialty brand. The Nutrish brand also competes in that premium segment but it’s a different consumer and just the accessible nature of the brand and the culinary focus with the Rachael Ray equity. So as the team brings those portfolios together I know a lot of work's going to make sure that we continue to differentiate those brands, but we believe they can continue to be highly complementary in each of those channels, respectively.
Dave, do you have anything add to that?
Yes. I just say, Nature’s Recipe, there is a lot of growth through the innovation in the LAD segment, delimited ingredient diet -- Natural Balance, excuse me. And the delimited ingredient diet segment. Nature’s Recipe were really pushing out on innovation in grain free in pet food and pet snacks and then on the Nutrish’s side they have over 10 concepts that they are bringing to market this year in dog, cat and snacks, and that will really provide field for growth. So, we feel very confident about that.
Double-digit growth for Nutrish as well?
Yes.
And then just a broader question on pricing. Are you highlighted that are you successfully taking pricing? Are competitors following and what private label pressure are you seeing. So how much of that pricing are you able to retain? Because in coffee, you had to spend back this quarter with higher trade spend.
We haven’t taken a lot of price, as I might turn to Tina, but we haven’t taken a lot of price up in the last yearish because commodities have been lower. We would expect competitors to follow. But I think that’s a question probably for the future and I think Tina might have a couple of comments.
Good morning, Farha. It’s Tina. From a food perspective, we took price on peanut butter about a year ago, we’ll be lapping that in June and we took our customer Uncrustables price up in May of last year as well. And again, it did take competition some time to follow, but they did follow and if you take a look at even the most recent IRI data, you can see that the business is strong, and we are up versus prior year. So, the execution of pricing has been successful within those brands.
I think the other thing, Farha, this is Mark Belgya to keep in mind we didn’t go through listing of [indiscernible] the areas the cost are going to up. But these are costs that are going up in several categories. So, whether you’re a brand manufacturer or private label manufacturer, you’re going to be incurring costs. We are in a world of inflation. And inflation means rising prices overtime. Now the time that may alter a little bit, but we expect that’s a little bit both to why we feel that’s why. Just to clarify, my earlier comment, what I said is, we reflected all the inflation in our plan and so we’re going to look for opportunities for pricing that will help mitigate those and actually be net positive. But we’ve assumed basically all the inflation across the 12-month window.
And this is Barry. One thing I would add is we did just take pricing on selected snacks, again where we lead in the category and where we thought it was appropriate again based on certain threshold. So that pricing has been taken to our retailers and will be effective at the end of July.
That’s helpful. And so net that 2% to 3% on core growth, how much of that is pricing for next year?
None or very little. Just other than what Barry mentioned in pet snacks.
Our next question comes from Akshay Jagdale with Jefferies. Your line is now open.
I wanted to ask about pet. So just to clarify the Nutrish brand obviously is growing well into the 20s. Can you remind us what the mix is because I believe private label's around 17%, 18% but I am wondering how much of the growth is going to be driven by Nutrish and how much Nutrish is as a portion of the 800 million? That’s the first question.
And then more importantly, what are your expectations and sort of how much visibility do you have on the innovation pipeline as part of the M&A process? And then competition, right, there is obviously some other competing brands that are entering channels, you’ve entered a new channel as well, Nutrish has entered a new channel. So, there are some concerns I think about competition and also about channel fill. So, if you could address those in the context of your top-line growth guidance for that segment -- for that business, that would be really helpful?
Akshay, this is Barry, and I think Dave and I can tag team this. As far as the growth, the numbers that Dave quoted earlier, the 27%, that is all the Rachael Ray Nutrish brand. So, by far the majority of the business is the branded side of the business and that double-digit growth will all be driven through that brand. A lot of that growth is resulting from expanded distribution of the pet specialty channel, seeing significant growth in the e-commerce channel as well and continued growth in food, drug and mass. So just to the earlier point, private label will continue to grow more in line with the category, but that significant growth will really come from the Rachael Ray Nutrish brand.
As far as innovation is concerned, we did have a view into that pipeline, somewhat limited through the diligence process but obviously now that it’s part of our company, much greater visibility and a high degree of confidence in the success that will come from that innovation pipeline.
Yes, basically I don’t have much to add, this is Dave Lemmon by the way. Innovation is clear in the pipeline across both businesses obviously. We feel as though there is room for growth across all portfolios of our business and we have the most robust pipeline since we’ve owned the business. So, we feel very confident moving forward that there won’t be anything taken off of the list, there will be only things added to the list.
And then may be just from a competitive standpoint Akshay, even with the incremental competition, the Nutrish brand's continued to grow its share in the last four consecutive periods. They have record share now at about 8.5% of dry dog. And then significant growth across premium cat, dry cat, wet cat, snacks and so forth. So that brand has tremendous strength, and yes, there is more competition but velocities continue to be strong and market share continues to grow.
So just to summarize may be roughly two-thirds of the business seems to be Nutrish and if all of the growth is coming from there and you’re talking like low 20% growth, if I am understanding what you said correctly, most of that growth is just from distribution, right? And the innovation would be on top of that, correct? I mean I am guessing you hadn’t planned for innovation gains in your 800 million number. So am I understanding that correctly and then I just had a follow-up on margins for that business.
And we're going to have keep moving on, Akshay, I am sorry we have others on the call.
Yes, most of the growth this year, for this fiscal year was based on the incremental distribution gains that the business had secured across all channels. So that’s where the majority of that growth is coming from for instance, there is significant gains in premium cat distribution that is in place that will be effective and going to shelf in August. So, the majority and as we said also incremental distribution of pet specialty. The innovation will be so in future years, Akshay, that is built into more of the deal model. But this year is primarily based on you just continued velocity as well as incremental distribution.
Our next question comes from Jason English with Goldman Sachs. Your line is now open.
I know we’re running a little bit late bit. I’ll try to keep this rapid and on point. I’m walking your guidance back from EPS with the sales and I’m getting to a gross margin number of a little bit shy of 35% at the midpoint. Is that roughly, correct?
Yes. That’s pretty significantly Jason. I think we’d more aligned where F ‘18 came in.
Okay.
Maybe, I don’t know, maybe if the way, you’re handling the cost savings, I don’t know, but yes, our gross margin will be much more in line if it’s a 38%-ish that we’ve achieved in ’18.
Cool. Then that’s a less alarming number and I’ll follow up with you guys afterwards to kind of figure out where my walk is a little bit off. And we were expecting next year you have to absorb maybe 100, 100 plus basis points of negative margin mix from Ainsworth at gross margin. Clearly, we don’t have P&L visibility. Is that roughly the magnitude of mix headwind that you’re facing next year?
That’s probably ballpark-ish close, yes.
Yes.
I have feeling that its weighted synergies and cost savings are playing out on the base business that might be what’s skewing you a little bit.
Probably, probably. And then I’ll follow up with you, guys, after that. And one last question on pet. How much EBIT, do you expect Ainsworth to add to pet next year and what is your assumption of underlying profit growth ex-Ainsworth and pet?
So, I guess, just in the spirit of what we disclosed, so if you go with the commentary off of our interest in that, most of the interest increase is due to Ainsworth and then you’re going to get call it 90 million to 100 million ish of EBIT on the business.
Our next question comes from John Baumgartner with Wells Fargo. Your line is now open.
I wanted to come back to Rachael Ray for a moment. Looking at the dog food category. Obviously seeing quiet, a bit on accelerating from premium, executed innovation. And when we look at Rachael Ray, it’s also gone down that path with just 6, the DISH, the zero grain, but it feels like the traction on that front has been pretty limited. So, I guess, when you’re going through a diligence for the deal, I mean how are you thinking about the ability to segment up in dog food, outside the opportunities compared to cat?
We just think there is tremendous brand equity there. And as the team, the Ainsworth team has thought about further segmentation in premium. We continue to believe there are opportunities for additional segmentation there. The velocities will probably be somewhat slighter, but or slower I am sorry, but we -- again back to Dave’s point, where we build tremendous growth in where we see exceptional growth is in the premium cat and also in snack. So, dog is going to continue to grow but we moderated that growth based on just how fast the brand is growing, incremental competition within dry dog, but where we have really focused and where we believe the growth for that brand is going to come from is in premium cat and snacks.
Okay. And then just a follow-up just briefly. When you include the Ainsworth assets into the base pet business, how are you thinking about the long-term revenue growth target there, I mean upside to that number going forward?
This is Mark. We will probably update our growth rates for all our businesses as part of our Investor Day. I mean all things being equal, based on the conversations we have with the Ainsworth expectations are in the near term, it will drive a higher number than what we said about the big business. But just in terms of the absolute guidance, I think we’re going to hold off on that for a few months. Let’s get a few months under our belt.
Thank you. Our next question comes from Rob Dickerson with Deutsche Bank. Your line is now open.
Great, thank you. Very short quick question just on free cash flow. I know you said this year it’s about 850, ended ‘18 around 900 given tax benefits there’s obviously some net income growth flowing through, and I know CapEx is up a bit. But I am just wondering kind of what else is the offset such that free cash flow will be down year-over-year? That’s all. Thanks.
Yes, so to answer that, you’re right. There is some incremental tax benefit that’s a plus to that number. The backup number would be CapEx about 40 million, if you take a middle range and then the other big component would be the increase in what we will call one-time cost that is split between merger integration and then some of the costs from what we call our organizational op program which is cost associated with some of the office closings and so forth that we talked about. And then there's a little bit of a different conservative assumption around working capital use, but most of it is CapEx and one-time costs.
So, you would really view it as a just more of a -- there’s the CapEx piece but that’s somewhat one-time and then the other roll-off is a little one-time as well such that 20 hopefully should be growing again.
Yes, I think that’s a great point. We’ve spoken to that a couple of time. Once we get over the Longmont investment last couple of years, we should see a little bit more return our 3%, 3.5% sales number.
Thank you. Our next question comes from Pamela Kaufman with Morgan Stanley. Your line is now open.
I just wanted to get a sense for your outlook on the competitive landscape in coffee for next year? Do you expect any changes in the environment given the Nestle-Starbucks JV and your continued evidence of private label competition in the category?
This is Joe, I will take that. Yes, I mean obviously there is a lot of activity in the coffee space. I mean the Nestle-Starbucks deal, two well respected organizations, private label growth. We are always what I would say competitively vigilant and we will continue to monitor that. But we are very focused on what we have to do to execute our strategy and drive growth, and really whether it’s private label or competitive, brand competitive, we know we’ve got to do three things, invest in innovation, continue to engage with our consumers, and ensure we’re executing the right price and trade strategy. And if we can do those things we feel like we will be in a good place.
And also, just wanted to follow-up on Jif. What drove the weakness in the quarter? Just given that the retail takeaway data seems like it was still positive more recently?
Yes. Hi, Pamela. It’s Tina. Thanks for the question. It’s very interesting. We came up from a really strong third quarter. I mean, if you look back on Jif and really, we were posting high comps versus the prior year. If you look at the full year for Jif, it’s really strong. We ended up flat is slightly up from a net sales perspective. And as you mentioned, our comps look really good, so we’re really confident and look forward to a good first quarter.
I think some of it was just timing.
Yes. I would add, the launch in Canada has helped our Jif business tremendously. The fourth quarter, we picked up a significant piece of distribution, which really pushed the brand. And we have over achieved their share targets in year one. So really strong support from Canada as well.
Our next question comes from Robert Moskow with Credit Suisse. Your line is now open.
One of your prepared remarks, Mark, I think you said the first quarter is off to a strong start. I look to the Nielsen data for May, and it indicated down 2% for Smucker overall. It looks like a deceleration. I was wondering if your data is showing something different. And then the second part is gross margin, I think what you’re implying is gross margin expansion for your core business. What’s driving that, it sounded like you’ve got more competitive pressure in coffee, and so what gives you comfort that gross margin can go higher in core business in ’19?
So, Rob, this is Mark Smucker. So, I know you, guys, are looking at Nielsen data, and we get IRI for our category as well. And then just reconciling that to shipments and consumption, we are seeing, it’s early in the quarter, we’re not quite halfway through the first quarter, but we’ve seen some pretty positive trends, of note coffee. So, we’re seeing some of that turnaround. And just looking at some of the obviously the new products, as well we were off to a good start there. But even in base coffee, we’re seeing a little bit of a pick-up as well. So, I think that’s why, hopefully, you’ll see some of that translate into the consumption numbers in the next 4 weeks or so. I wonder if you guys have anything to add. Good?
Hi Rob, this is Mark Belgya. I guess to answer your gross margin or good profit question is that, yes, I mean, it comes from the base. I mean we are getting gross margin expansion out of just the innovation. I mean, although, it’s a loss, segment profits of the marketing spend has obviously gross profit dollar been generated. And then I think in my expected comments, we talked about. We had still incremental cost savings or cost benefits coming through with lower green and also with the first half of the KGM savings that we started in October a year ago. So that is probably a little bit of mix in there as well. And then just cost saving programs certainly some of those are affecting the comp line.
And our final question comes from Brian Holland with Consumer Edge Research. Your line is now open.
Just quickly on coffee. Thinking about the competitive landscape here. I guess, first on the innovation side, if there’s any way you can give us a sense of what would define success for the roll out of 1850? I mean if I do the math of one share of -- a quick math, one share of bagged, one share of pods, would sort of equal out or net out to about 50 million. So, I am just trying to understand what would define success in year one on the innovation front for 1850? And then secondly, you’ve got on the bag side, or just across all coffee, you have Nestle partnering with Starbucks on that licensing deal for CPG, Keurig talked about at their investor day sort of stepping up their efforts on the bag business. So just wondering how you think about your efforts to drive 1850 and bolster your portfolio against the more competitive or what would figure to be a more competitive backdrop over the next 12 months? Thanks.
This is Mark Belgya. I am going to start and I am going to throw it to Joe. So just in turn, we’re not going to give specific dollar expectation on 1850 right now but I will say it’s larger of the two components and obviously I would say that most of the 2% or equal to the 2% top-line growth, just do the math right, 150 million total. And there's two innovations on that, that are a good portion of that. So that's where that number is coming from. The one interesting comment is that in today’s world in CPG, $50 million to $35 million launch is incredibly successful first year in sales, it’s a top 10 item. And we think that this has the potentially certainly of being there.
Yes, I would say first and foremost, measure of success would be just distribution and acceptance and I think we are well on our way our goal of full distribution, we should be there by August. So, from a standpoint of success in retail acceptance and out in the marketplace we feel like we’re well on our way there. From a bag’s perspective, again like you said very competitive state. Obviously, we have a very strong partnership with Dunkin’ Donuts. We continue to see opportunity there. The launch of 1850 as I said earlier a very different positioning, a very different consumer. Dunkin’ leveraging on that shop equity, we feel like there is opportunity with both of those great brands in the premium bag space and we will continue to support both of those as we go through the year.
Now, I’ll turn the call back over to management to conclude.
Okay. Thank you, all. I know it’s a long call and really appreciate you guys hanging in there. Obviously very important call, given the quarter and what we are doing. But I really do hope that you all came away with the same level of confidence that we have in the actions we are taking to realign our portfolio, focusing on the growth segments and again just encouraged by our efforts paying off wherever we focus. So still work to do, we acknowledge that. But again, I think as always, we want to thank our employees, they are awesome, and they are really what allows us to succeed and they will continue to help us drive success going forward. So, thank you for your support and have a good weekend.
Ladies and gentlemen, this concludes our conference call for today. Thank you for participating and have a nice day. All parties may now disconnect.