Good morning and welcome to The J. M. Smucker Company's Second Quarter 2016 Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open the conference for questions-and-answers after the presentation. Please limit yourself to two initial questions during the Q&A session and re-queue if you have an additional question. I will now turn the conference over to Aaron Broholm, Director, Investor Relations. Please go ahead, sir.

Good morning, everyone. Thank you for joining us on our second quarter earnings conference call. With me today and presenting our prepared remarks are Richard Smucker, Chief Executive Officer; and Mark Belgya, Chief Financial Officer. Also joining us for the Q&A portion of the call is Vince Byrd, Vice Chairman; Steve Oakland, President, Coffee and Foodservice; Mark Smucker, President, Consumer Foods; Dave West, President, Pet Foods; and Barry Dunaway, President, International. During this conference call, we will make forward-looking statements that reflect the company's current expectations about future plans and performance. These statements rely on a number of assumptions and estimates and actual results may differ materially due to risks and uncertainties. I encourage you to read the full disclosure statement in this morning's press release concerning forward-looking statements. Additionally, please note the company uses non-GAAP results for the purpose of evaluating performance internally as detailed in the press release which is located on our corporate Web site at jmsmucker.com. A replay of this call will also be available on our Web site. If you have any questions after today's call, please contact me. I will now turn the call over to Richard.

Thank you, Aaron. Good morning, everyone and thank you for joining us. It was great to see many of you last month at our investor day when we celebrated our 50th anniversary of being listed on the New York Stock Exchange. We appreciate the opportunity to discuss a number of key initiatives across our business and reinforce why we remain very excited about the continued growth of the company and we also look forward to updating you on these activities in the months ahead. Today our comments will focus on the strong second quarter financial results that we announced early this morning and it reflects the momentum we are seeing across our businesses and the excellent work by our teams. Let me begin with a few highlights for the quarter. First, net sales increased 40% to a record level of nearly $2.1 billion, driven by the addition of Big Heart pet brands. Excluding acquisitions and foreign exchange, sales grew 2.5%. This growth was led by U.S. retail coffee which was up 10% for the quarter. Second, non-GAAP operating income grew $91 million or 36% for the second quarter, reflecting the addition of pet food along with the strong profit performance -- growth performance for international and food service as well as the coffee segment. Third, with increased interest expense and a higher share count, non-GAAP earnings per share increased 6% to $1.62. Excluding the amortization, adjusted earnings per share were $1.91, an increase of 13% from the comparable measure in the prior year. Lastly, we generated free cash flow of $211 million for the quarter. Overall, we are very pleased with the results for the second quarter and the first half of the fiscal year and we look forward to this momentum continuing through the remainder of the year and…

Thank you, Richard and good morning everyone. I will start by providing additional color on our second quarter results and then conclude by updating our outlook for the full year. Net sales increased by $596 million in the quarter, this largely reflects the addition of Pet Food. For the remaining businesses, volume and mix combined to add 5% points of growth led by Dunkin' Donuts K-Cup and Folgers roast and ground coffee. Lower net pricing primarily for coffee and peanut butter detracted 3% points from net sales. Foreign exchange was also unfavorable in the quarter reducing net sales by about 1% point. GAAP earnings per share were $1.47 this quarter, 5% below the prior year. Included in these GAAP earnings were $34 million of special project costs related to merger and integration activities compared to $3 million of such cost in the prior year. Also included were $6 million of unallocated derivative gains compared to $8 million last year. Excluding these items, non-GAAP EPS was $1.62 or an increase of 6%, and further excluding the amortization expense of $53 million, adjusted EPS was $1.91, up 13% for the quarter. Our non-GAAP gross profit grew 48% reflecting the addition of Pet Food and favorable volume mix for the coffee segment. This resulted in a 200 basis point increase in gross margin to 37.7%. Commodity costs were favorable in the second quarter, most notably through green coffee but were offset by lower net pricing. SG&A increased at a greater rate than sales due to a planned increase in both selling expense due to the royalties associated with the Dunkin' Donuts business as well as marketing which was attributable to the U.S. retail coffee and pet food. Conversely, administrative expenses grew slower than net sales reflecting the recognition of Big Heart synergies during…

[Operator Instructions] Our first question comes from Eric Katzman with Deutsche Bank.

I guess the first question that I have has to do with the consolidated sales forecast. I guess, Mark Belgya, at the analyst day you lowered the forecast by $100 million but you are now including the divestiture of the canned business which I guess is about a run rate of $100 million for this year. So effectively you've increased your forecast after lowering it. So I'm kind of wondering what that's due to and then I'll have a follow-up.

Yes, Eric. Thank you for the question. You are right. The milk sales on an annual basis were about $200 million. Obviously, it's more front-end loaded the first eight months with the holidays. So we expect to lose about $50 million in the back half. So by the fact that we kept the $7.9 billion full year target would indicate that we have basically added back that amount in the base business. That’s probably primarily in the area of coffee as I think I had in my scripted comments.

Okay. All right. That's helpful. And then I guess this would be -- is Steve there or Dave -- in terms of pet, one of your competitors Blue Buffalo talked about trade inventory de-loading but you seem, I guess, pretty comfortable with the business at the moment. Do you feel that inventory levels for you are okay and that your consumer off-take is on track? Maybe just discuss that a bit.

Well, if you think about what we have in the channel, Eric, we are entering places where we haven't been before. So we are putting incremental inventory into the system so we are getting to the right inventory levels out of the gate. So there is no reduction for us in one of those big retailers. So I can't really comment on what other people are feeling. As we are entering there, we are putting the right amount of inventory in. But we feel good we are tracking to the metrics that we wanted to track to. Importantly, as we have entered PetSmart in the last quarter, we are tracking with them in terms of the right metrics as we go on. But also, this for us is trying to be good stewards in the channel and increasing channel penetration in shopping and bringing more consumers across the business. So we are working with the other retailers and the independents to make sure that we are supporting them equally wells so we don’t -- we want this whole launch to be incremental as we roll out across the channel. So far so good. Early days. Again, we are feeling pretty good about where we are in this channel.

Our next question comes from Ken Goldman with J.P. Morgan.

Question, I wanted to make sure I heard this right. On the pet foods segment, I think you guided today to sequential EBIT dollar improvements as the quarters progress. Is that what I heard correctly? You talked about something progressing in Pet Food, I want to make sure that...

Yes. We did -- with margins, Ken. I think we have said that [but] [ph] it was margins. Again, obviously we have talked about the way the synergies will flow through. So we said, I think, the outset of the year that as the year progresses we would move in. We knew the marketing investment was heavy in Q2 as I stated but in three and four it should be sequential improvement.

Okay. Is the implication there that, because when I think sequential improvement I think every quarter is a little better than the prior one. Historically, and I know this isn't apples-to-apples, but that segment has had a much higher EBIT margin in the third quarter than the fourth quarter. So when you are saying sequential, are you talking halves? Are you talking quarters? Help me understand what breaks that pattern a little bit.

Okay. So let's just take a step back. In Q1, segment profits, we defined, it was 16.4%. This quarter it's 15.6%. We will see a step up from Q2 to Q3 and then from that point we will see a step up from Q3 to Q4 in margin. Again, synergies are flowing through. As I said that of the back half there is more synergies in Q4 than Q3, so that will benefit a little bit. And Dave, I don’t know if there is any other reasons you want to comment on.

I think it's hard to get to an apples-to-apples comparison because you have got all the amortization in there and all the synergies in there. So let me just make a comment stepping back, either from a gross margin standpoint or some sort of a controllable profit measure. I talked to, when we were at the analyst day in New York, about 100 plus basis point improvement in gross margin as we were looking at the first quarter. We had gross margin expansion again in the second quarter. So despite the mainstream food business being down, remember this isn't a pass through category. So even with 5% decline in that kind of mid-single digit, let's call it 5% declines in the mainstream food business, we still expanded gross margin dollars and gross margin profit, obviously, in that business. So we would expect maybe in the second half to be a little bit more competitive with respect to some of those tactics in market. Bonus bags and some other sharper price points, potentially kind of matching what's already out there in the market. But we still see good margin expansion as commodities have fallen this year. So when you look at it apples to apples and take out the $29 million of amortization, the business is up double digits in earnings on a year-over-year basis. So really healthy profit driven by good management of the deflation in the market place. It's not a pass-through category so we have been able to keep some of that margin and then reinvest that into marketing. We were very heavy in marketing in the second quarter. And so as we look at the business, it's healthy, it's delivering exactly what we thought it would deliver for the year. And because of the timing of launches and the timing of channel expansion in pet specialty, it's probably a little lumpier than you would have seen it in the past. But from here on out, as we put synergy in the business you should see margin acceleration.

Our next question comes from Alexia Howard with Bernstein.

You mentioned that the U.S. retail business has a few brands in there that have come under some pressure. A lot of the retailers are talking about a movement to the perimeter of the store, how fresh and chilled products are really where the growth is. And that segment for you doesn’t have quite as much exposure to that edge of store type of product. How do you handle that? Is the option to change the portfolio, what can you do to address that shifting dynamic. Thank you.

This is Richard. I will start. First of all, we think we are in a pretty good position with basically the three platforms of our business. Obviously, coffee which is center of the store but it is still a hot area to be in and a growing business. And then if you look at the rest of our foods, peanut butter is a very low cost, high protein business and it's all vegetable. So we are very good -- and then pet food of course is one of the fastest growing segments. So we think our overall portfolio is really, positions us well to be in the consumer goods industry. But we should also remember that although there are a lot of -- the perimeter of the store is growing, the retailers still make probably -- definitely more than half their product profit from the center of the store. So that is still a great place to play if you have the right product line up which we believe we do.

I will just add, Alexia, this is Mark Smucker. Couple of things. So just, Rich, again, we are in on-trend categories for the most part as you think of the center of the store. But given the trends and the growth in snacking and consuming different day parts rather than 3 square meals which many consumers are with Sahale and Jif bars, we are well positioned well with -- you have heard our results on uncrustables has been fantastic. So those are all, whether it be snacking or sort of on the go type of items, those would be helping our mix. And then of course our natural business is doing very very well also. So we just feel like we are in the right places at the right time.

Our next question comes from Chris Growe with Stifel.

I just had two questions, if I could. The first was, you talked about a little bit of softness on the Folgers K-Cups, and I'm just curious, we've seen some pretty aggressive price competition there, in particular on the low-end and particularly from private label. Is it more that Folgers is interacting with that aggressive price competitor there? Or is it something amongst the brands that's made it more competitive in the K-Cup arena there?

Good morning, Chris. Hi, Steve Oakland. I think what you are seeing in the K-Cup category is the natural evolution of this whole category. There has been tremendous growth and the manufacturer and the retailer have all thrown SKUs at, right. If you walk in any store you will see all of this proliferation of SKUs. I mean you will see tens of flavor to same flavor items. And so I think within all of that noise, it's difficult to market. And I know you will see other results out there would suggest that. Dunkin' Donuts has been able to shine through that and the Dunkin' results here in the last quarter or so, or quarter or two, have been great. I think you will start to see manufacturers like us work with the retailer. I think we will use classic category management like we have done in other categories to try to segment that category to good, better, best to get the right price positions across each one of the brands. There is no question that there is a lot of brands trying to get noticed right now and our Folgers K-Cups maybe took a backseat to some of the other promotional effort that we were doing and the retailers were doing. But we think those big national brands long-term will have the lion's share of that business and we feel like we are positioned to do it. So we have got more ahead of us.

Do you want to be more price competitive in the short run then to try and sustain share within that brand?

Yes. We have opportunities on our mainstream to do that. Right. Especially with coffee costs where they are, we have the opportunity to do that. Quite frankly, we have got a pretty strong wave going with the Dunkin' business. So as we look at the whole segment, we probably didn’t have to do that today.

Okay. I had a quick follow-up for Mark Belgya. When you disclosed the marketing spending in the quarter, that percentage of sales pushing on towards 6%, is that a good estimate for the year? I'm just trying to get a sense of how much marketing needs to increase here overall for the business.

Well, the marketing increase in coffee was pretty substantial. It would still be up pretty dramatically for the rest of the year but not to that degree. But overall, that’s probably okay. The 6% is okay to use.

A good estimate? Okay, got it.

Yes.

Our next question comes from David Driscoll with Citigroup.

First question is just on Pet Food. You gave a lot of different pieces of guidance. Maybe I could just simplify this and say, with all the changes in allocations from how Pet Food used to be as a standalone and how some monies have moved into corporate, etcetera. Is $380 million, give or take, the right ballpark for segment profits in Pet for the year?

You are in the ball park.

Okay. Second question, also related to Pet Food. Can you guys just talk, Dave, maybe you could talk a little bit more about the promotional activity but I was hoping you might just delineate between the traditional Pet Food brands and what feels like lower grain costs that are affecting the price structure there. And then very separately, talk about the promotional activity happening at the pet specialty stores and in the premium pet foods. Here it feels like the promotional step-ups are for a different reason, just like competitive activity, but really wanted to understand where you saw these promotional levels going.

Yes. So let me just kind of give you the category dynamics a little bit. So what you are seeing in mainstream grocery and mass, particularly, given grain costs and that the source of protein there is more -- remember, that's more corn and soy based. When you get into the pet specialty around the protein source is different. And so it's not as grain based when you get into the pet specialty realm. So you're right. It is the pricing. The pricing and the ingredient cost work differently. So let me stay for a minute in grocery and mass and particularly in dog food, not as much as in cat food but particularly in dog food you are seeing deflation. You are seeing folks pass through some of those savings that are occurring either in the form of bonus bags or reduced price points. And so you are seeing a decline in dollars in the mainstream, particularly dog food. For us, it's Kibbles 'n Bits and Gravy Train. But it's not an absolute pass-through category. We talked at the analyst day and I mentioned today that total company pet food margins for the first half and our gross margins are up over 100 basis points and actually the mainstream food business is even pacing ahead of what the total average for the business unit is. So we are seeing, even with mid-single digit declines in our mass food business on a sales basis, we're hitting both our gross profit dollars and our gross margin percentage targets. So they're actually up. So it's not a total pass-through. People are managing, and we're managing the balance of share and net sales and profit pretty well. And as you look out on the curve, this is kind of the environment we're going…

Our next question comes from John Baumgartner with Wells Fargo.

Dave, I'd like to go back to Big Heart and particularly the pressure in dry dog in measured channels. I understand the comments about disinflationary pricing, but the scanner data for the quarter also showed a 9% drop in the volume for you and it also shows in the measured channels that dog business hasn't grown volumes since, I guess, at least 2011. Is there anything else more underlying going on here, impacting measured channels in the volume side?

Well, I think you've got to make sure that you've got everything measured. Remember, there's dollar and that's probably not all measured in there and you may not have all the club. So you may not have all the measurements. But the reality of it is, you're down 9%, 10%, 11%. That's about right for Kibbles 'n Bits, dollars and/or volume. There is an emerging mass premium segment that's growing. We aren't participating there at this point so there's a little bit of that there. And overall I think what you're also seeing is you're seeing some channel switching as people are moving from mass up into the pet specialty channel. So those are some of the trends. I think we talked about it at the analyst day but what you're reading is right. And as I said I think it's, right now for us, yes, there is deflation and there is some volume leakage but from a brand standpoint we're managing it for a combination of net sales and profit and share. We're about on target as the portfolio role goes. I think that the mass cat food business is a bit different. It's tended to be a little bit healthier and more robust and with Meow Mix and 9Lives we're very happy with our position there.

Great. And then just a follow-up. In terms of natural and organic, Crisco has been in the market now for about six months with the organic coconut oil and it seems as though the established natural organic leader is already seeing some pressure. Maybe in contrast to the view that M&A is the best route to pursue to make a bigger dent into natural and organic, can you talk a little bit about maybe extrapolating from this coconut oil experience, the relevance of your brands in natural and organic? Do you have to really go outside? Can you expand these brands into natural and organic that you have in-house already?

John, it's Mark Smucker. The answer is, in short sometimes, so I think in the case of Crisco, we have been very successful and have been able to take advantage of the trend that the natural and organic consumer is buying more of those types of products across multiple categories in the conventional channel versus the natural or organic channels. So we are seeing consumer shift more to that channel. As it relates to coconut oil specifically, it just is a very on-trend product and we were fortunately able to find the right supply chain to provide an organic product and it has done very well. And that is just, that's an on-trend product. It's not only used for cooking. It's just done very well. So, yes, I think in the right categories we can.

Okay. Thanks, Mark.

This is Richard. I might just add to that. Obviously, we have made some acquisitions in the health food category and some brands in that, healthy snacks with Sahale and our ancient grain business which were acquisitions. But the problem with buying someone in those fields, the multiples you have to pay are extreme, normally, and the ROI is not too good. So as Mark mentioned, wherever we can expand our own brands that we currently have or some of the natural brands that we've had in our portfolio for some time, we've been able to do that I think on a judicious and wise way. So it's a little bit of both but it's always better if we can extend one of our existing brands.

Just [indiscernible] increased organic in nut butters and applesauces and so we are pushing that, traditionally a juice brand, out into other categories.

And we have basically about a half a dozen great health perceived brands out there that we can also extend.

Our next question comes from Rob Moskow with Credit Suisse.

Just a question for Mark. It's always great when Smucker beats consensus. But I do remember at your analyst day, Mark, that you said that you thought that the earnings were closing the gap. And then we had a discussion as to what the gap was versus and now you're up quite a bit from a year ago. So did something happen in the last couple of weeks of the quarter to deliver all of that upside versus what you were thinking at the analyst day?

Thanks for the question, Rob. A couple of points on that. I think the commentary back in October was, it was really intended to recognize that we were pulling forward around $0.03 of synergy that we had not planned for originally. So that was really the genesis of that commentary. But candidly we did have a pretty strong finish to the quarter. Obviously, on the business side that speaks for itself. And then on the spending side it came in a little bit favorable versus our expectations for the quarter as well on the G&A side which you can see in the results as well. So never going to apologize for a great quarter. And again the point was last quarter or last month rather, was just to call attention to that we were pulling forward with synergy.

Okay. And also can you remind us? After March 1 when the integration is I guess more complete, what's the nature of the savings and synergies that are going to start flowing through? And can you give us a kind of peek at fiscal '17, maybe the first half of that period? Like, what's going to drive the synergies that much higher? Is there going to be another step-up in '17 and what's sending those numbers higher?

Yes. Clearly with $25 million coming through which we feel very good about, certainly with March 1st there will be integration savings that will obviously kick in at that time. I think we said at our meeting, we're expecting $100 million in synergies in fiscal '17, and of course that's driving, incremental I should say, so that would put it $125 million in total. So well on our way to the $200 million by the end of next fiscal. And that of course is leading to the double-digit EPS growth that we have committed to.

Yes, but what's driving the extra $100 million in '17? What specifically is happening to make...?

There's a number of things. If you go back, just to direct those on the call back to what we presented, we gave four buckets of synergies and quite candidly, it's across that. We will be moving much of the shared services, the back office, the information services, the finance operations from Pittsburgh. That will move. But it really does cross. So it's procurement and the other areas that we spoke to. And the same thing will happen in the 2018 as the remainder of those four areas will be completed.

Our next question comes from Jonathan Feeney with Athlos Research.

I'm sorry if I missed this, but did you tell us, of the sales growth in Coffee, was that all or how much of that was the May 1st launch of Dunkin' Donuts cups?

Jonathan, hi, Steve Oakland. No, it was not at all. We had a great performance on roast and ground. So sequentially if you look at our roast and ground over the last 52, 12 and 4 weeks, we've seen continued momentum there. So it was nicely balanced between roast and ground, for Folgers roast and ground. We did mention that Bustelo although small is on a little bit of a roll, so it's really responding to the marketing effort. And of course, the Dunkin' K-Cup launch. All three contributed nicely.

Thanks. Just one follow-up on that. When you look at the, and forgive me if you talked about this before, but when you look at the list price decrease you took across the board in July, obviously the price mix that you're seeing is less than that list price decrease. I think it was 6%. Are you reevaluating doing a little bit more aggressive revenue management around price promotions that gets you there or are there some big categories of items where that list price increase didn't apply? I'm trying to understand, I guess, what your promo activity looks like on a year-over-year basis across the category of coffee?

Okay. Well, I think there again you have to break it down by segment. There wasn't the same type of price promotion done on the K-Cup segment. So if you take, K-Cups would dilute that. But we did two things in the roast and ground segment. We reduced the canister size 10% to 11% and we took a corresponding price decline with that and then we took a price decline. So what we've been able to do there is, with the lower green coffee costs, and obviously in that market you have visibility into that in the future, we were able to put together a plan for the year where we got the coffee price point on our key promoted items to a point that has both excited the retailer and pulled through the consumer. So red can has done really well, especially compared to what you saw, the gyrations in it that we were forced to do last year. So sequentially nice improvement there. And then we have yet to see that compression on K-Cups, but there is room to do that. I think we got a question earlier on the total mix of K-Cups and Dunkin' versus the legacy Folgers business. We have some room to improve the results on our legacy Folgers business, we just haven't had to do that because of the momentum on Dunkin'.

Our next question comes from Farha Aslam with Stephens Inc.

I wanted to focus on International Foodservice. The margins in that business were quite strong during this quarter versus the year-ago period. Is there anything that we should take into account on that business and kind of the forward read?

Yes. Hey, Farha, this is Mark Belgya. We were hoping that would get called out. Those guys had a terrific quarter, primarily in Foodservice and in Canada. But, candidly, it was a very good quarter so I would not expect that to continue. I look back, I think it was actually the largest segment profit quarter we ever had in that particular businesses. As we look forward to the next six months, some things to consider is obviously FX in Canada is continuing to be a challenge and I'll let Barry comment on that maybe a little broader. And then in Foodservice we know that there's some businesses that just had a very strong, or some categories rather, had a very strong first half. Obviously, we are getting cross-booking back in schools, you can think about maybe the school buying period, we've lapped that a little bit. So both of those businesses probably are going to be a little bit softer in the back half. I wouldn't expect a repeat of the margin we saw this quarter.

Thank you. And then just a follow-up again. On your corporate expense, it was kind of lower than what you've been tracking in the previous quarter. Is the current level sustainable with your pull forward of Big Heart synergies or are the Big Heart synergies squarely in Big Heart Pet Foods?

Yes, I think what you saw the first quarter, I think we were around $90 million, if I know what line you're looking at. I think this quarter was maybe $83 million-$84 million. So $84 million probably is too low a run rate for the next two quarters. You will see synergies slow that. So I would suggest somewhere below $90 million and somewhere about $85 million is probably a little better run rate.

Our next question comes from Akshay Jagdale with Jefferies.

First one is on your largest customer. Obviously, a lot of changes going on there. We're hearing some mix read-throughs as companies are reporting this quarter. Can you give -- it seems like you had a great quarter, so it doesn't look like any of their changes negatively impacted your portfolio of products. But just trying to get some insights on that channel and what you're seeing out there.

Yes. Good morning, Akshay, Steve Oakland. I think as we talked in Richard's comments earlier, we've got a couple of categories that just do really well there and in mainstream grocery. So a lot of retailers are focused on the perimeter but that particular retailer does a great job in the center of the store. They do a great job with brands like Jif. They do a great job with brands like Folgers. And those brands have been developed, or overdeveloped, there for a long time. So when we get things right on those brands, we do well there. They are also very well developed on pet food. And so when you get those pet food and snacks right there, when you get some of these things right, both, we win and they win in those categories.

Okay. And then on pet food for Dave. So there's a lot of focus, obviously, from the investment community on the dry dog side. But I guess my focus is really on the premiumization side, right? So the snack portfolio is doing well. But can you talk a little bit about pet tech? Maybe it's too early to be talking about that but if you look at a long term trend in premiumization, obviously the snack portfolio is one, the premium portfolio is another way to play it. But how big do you think pet tech could be? And is the way to think of how Big Heart plays in that just from a digital standpoint or how should I think about that opportunity? Thank you.

Well, first, let me thank you for not asking a question about mainstream pet food. I think you're the first person who's ever not asked about it, so I appreciate that. We actually are very pleased. When you think about premiumization and trade up, with respect to food it's sort of following human analog, human trend. So more snacking is occurring. We've got a 40% share of dog snacks in the mass channels. We've got new usage occasions that we're working on including, dental and vitamin treats and things that are clearly from a price realization standpoint but also really new usage occasions, kind of show the role of pet as part of the family and not on the farm anymore or out on the back porch. The pet is squarely in the family. And so as you see that, the same trends that are going to occur, that have started to occur in tech, there will be apps for finding, think about geo-location, finding your dog if your dog is lost. Pet wearables, the same kind of thing as you think about tracking dog, dog health. But you're starting to see those. And then it's very similar because of the emotional attachment to how the baby category might work in terms of just thinking about the need for information and the way that information is coming now is obviously mobile and digital. So we do think a digital ecosystem with first-party data. I think the important thing for us is we want to have the relationship directly with that consumer. And then there will be some decisions that everybody makes about, do you create content, do you curate content or are you really the keeper of the ecosystem where people come for information about their pet food, is an important part of the family. So we're in the process of building a digital ecosystem. I think we talked about it at the analyst day in New York. We're excited about where we are and frankly, right now, being in San Francisco over the last four or five years has led us to be part of some pretty interesting startups and technology. So we're excited about it. We think it's where the future could go and it's really most important for us to have the relationship with the consumer, that one-on-one relationship. And so we think there is a lot of runway here, and stay tuned as we roll out our ecosystem and we'll talk about it more in the future. But thank you for the question.

We will take our next question from Eric Katzman with Deutsche Bank.

Thanks for the follow-up. Two questions. I guess, Mark Belgya, on the -- I assume that -- was the sale of the canned milk business, was that dilutive and if so, you have raised your guidance for the year, so what's the offset to that? And then I have a follow-up question.

Yes, Eric, for the back four months it is very modestly dilutive a couple of cents. Again, a lot of that just has to do with the seasonality of the business. So that $0.02 has been factored in. Obviously one of the reasons that tempered the upside to the $5.80. So we really don't have to worry about that. Probably the bigger question is how we will cover that in fiscal '17. So that will probably come into play a little bit through the synergy management and we'll just look at other opportunities to offset the dilution that flowed through the first eight months' earnings.

Okay. Thank you for that. And then I think this is probably a question for Richard, but your message has been, right, that the business is doing well. Your free cash flow is stronger than you expected. You're already below 4 times levered and that's probably going to improve pretty quickly. One could argue that the buyback of shares is going to be a greater return, given that you're trading at a discount to pretty much everything in the space versus buying back debt or retiring debt. Why not tweak the capital allocation here, given those facts?

Go ahead. I'm going to let Mark start and then I'll finish.

Thanks, Richard. Thanks for the question, Eric. I will answer that. One other data point I did want to get out because I don't think it was quantified but I think it's important for those on the phone, is that -- I think it was in my scripted comments -- when we talked about the puts and takes on the guidance. And I mentioned this, the commentary around the overhead absorption impact of managing our working capital initiative. And just to frame that in for you all on the phone, it's about a nickel. So again not to necessarily explain away all the reasons why we didn't take guidance but that I think is an important point that you go away with. In terms of the question, though, around the capital structure, a couple points. One is that we have consistently said that over the next roughly four to five years we would expect to pay down about $0.5 billion per year to get to where, particularly to pay down a couple of tranches of long-term debt and then the term loan. And we're right on that mark. In fact we're a little ahead of that mark, as you suggested, Eric. So I think we are going to look at opportunities to whether it's share repurchase. We've said that some smaller-scale M&A is clearly on the drawing board as well. We've said this now for the last several months, is the ability to pay down that debt timely and the cash we generate just speeds up the ability for us to take advantage of the strategic opportunities.

I'll just add to this. It's kind of tangential to your question, but we've traded the last year or so on a number of metrics below maybe some other CPG food companies. And I think maybe we just didn't get our message out well enough because I think we're extremely well positioned in the CPG space. I talked about it earlier but being in coffee, consumer foods and pet food really separates us, I think, from a lot of other CPG companies. And the fact that we're actually, we want to act big but we want the consumers to think of us as small. And I think they do if you look at our brands, whether it's Smucker's or whether it's Jif. They see us, from a consumer basis, as a smaller company, but we act big with our retailers. So I just think we need to get that message out a little bit better because I do think we have an advantaged portfolio that maybe is not recognized.

Our next question comes from Jon Andersen with William Blair.

I guess most of mine have been answered. I did want to circle back around on pet, and I guess this might be one for Dave. Dave, you mentioned that there is an emerging premium segment in the grocery mass channel that's growing. I just wondered if you could share some thoughts on maybe how you see that evolving. Is that a niche? Do you think that gets much bigger from here? And maybe what role Smucker and more specifically Big Heart, intends to kind of play in that over time. Thanks.

I think the consumer perceptions across all food categories, whether it's human consumption or pet consumption, I think the definition and the understanding of better for you ingredients or natural ingredients, or clean label, or those things are, they are kind of, they permeate everything that's out there. So I do think you see an emerging mass premium segment. And I think what defines it, it's kind of defined by the ingredients stack but you also have to define it by the price point. So if you think about it, if you think about a basket trip that's, I don't know, $120 in a mass or grocery store, let's call it that for argument's sake, give or take. How much of it, how much of that, what percentage of it can really be pet food? Is it $29.99 bag? That's 25% of the basket. And so I think there's probably realistically a ceiling on how big that could be in some traditional channels, just based on affordability and what it means as part of the basket. So I think that said, I think there's some, just the economics of it may dictate how big the size can be. But what I would say, though, is consumers care about emerging better for you, better ingredient stacks. We obviously are aware of that. We have a specialty business which is all about nutrition and therefore we are aware of the trends. We'll look at our portfolio. We want to meet consumers wherever they want to shop and whatever they want to buy. So as trends emerge, we're going to answer them. But we want to do it in the realities of their wallet and what they can buy in what channels. So stay tuned as this continues to shift. But we're aware of it and we'll react accordingly when we think we have the right solution.

That's really helpful. One quick one to follow up on just kind of the, there's been a lot of talk about the portfolio in aggregate and I guess its alignment on health and wellness dimensions, etcetera. As you think about continuing to evolve the portfolio in that direction over time, do you see more activity from an M&A perspective in order to acquire into that? Or do you think it's more the ability to do stuff internally by extending some of your existing brands into that space or is it just, frankly, a combination of both? Thanks.

So, Jon, it is a combination of both. And I think we historically have done that. But we have put a little more emphasis on innovation in the last five years than we ever have. And Big Heart Pet is one great example of some of the things that they've added to their portfolio the last couple of years. But we've done that whether it's been coffee or consumer products. And that is probably the most ROI efficient way, if we can just add on to our existing brands. So we're really pushing that. But as you notice, from time to time, we have an acquisition that fits in very nicely. Obviously, the most recent large one being Big Heart. So it's going to be both. It really is going to be both.

That concludes our question-and-answer session for today. I will now turn the conference back to Richard Smucker to conclude.

Well, we thank all of you for being on the phone today and very interesting questions and we wish you and your families a happy and safe holiday period for the next week. Have a great time.

That does conclude today's conference. We thank you for your participation.