Business context and reporting period
The J. M. Smucker Company’s unaudited Form 10-Q covers the quarter and nine months ended January 31, 2016, within fiscal 2016. Comparisons are with the corresponding prior-year periods. Results include Big Heart Pet Brands from its March 2015 acquisition; this makes reported growth substantially acquisition-driven. The company also sold its U.S. canned milk business on December 31, 2015.
Financial performance
| Metric | Three months | Nine months |
|---|---|---|
| Net sales | $1,973.9 million, +37% | $6,003.6 million, +41% |
| Gross profit / margin | $763.8 million / 38.7%, versus 36.3% | $2,279.8 million / 38.0%, versus 36.2% |
| Operating income / margin | $318.3 million / 16.1%, versus 17.7% | $899.2 million / 15.0%, versus 16.5% |
| Net income | $185.3 million, versus $160.9 million | $497.7 million, versus $435.2 million |
| Diluted EPS | $1.55, versus $1.58 | $4.16, versus $4.28 |
| Operating cash flow | Not presented as a quarterly comparison in the filing summary | $1,122.8 million, versus $511.6 million |
Reported sales growth reflects Big Heart revenue of $580.3 million for the quarter and $1.7 billion for the nine-month period. Excluding acquisitions, divestiture, and foreign exchange, sales declined 1% for the quarter and increased 2% for the nine months. GAAP operating income rose 25% and 28%, respectively, but margins narrowed amid acquisition-related expenses, higher amortization and other costs. On the company’s non-GAAP basis, operating income increased 44% and 39%, while diluted EPS increased 14% and 7%.
For the nine months, free cash flow, defined by the company as operating cash flow less capital expenditures, was $962.0 million versus $349.5 million. Capital expenditures were $160.8 million. Cash and equivalents were $140.5 million at January 31, compared with $125.6 million at April 30, 2015. Total debt was $5,284.3 million, down from $6,170.9 million; this included $5,146.3 million of long-term debt and $138.0 million of commercial paper. The company had an undrawn $1.5 billion revolving credit facility and reported compliance with debt covenants. Current assets were $1,798.4 million and current liabilities $1,006.0 million.
Material changes and segment performance
Big Heart contributed $570.9 million in third-quarter U.S. Retail Pet Foods sales. U.S. Retail Coffee sales rose 1% for the quarter and segment profit rose 17%, supported by Dunkin’ Donuts K-Cup pods and lower costs. U.S. Retail Consumer Foods sales fell 5%, reflecting weaker volume/mix and pricing; segment profit rose 6%, including the $25.3 million canned milk divestiture gain. International and Foodservice sales declined 4%, partly due to unfavorable currency effects.
The company received $193.7 million net proceeds from the canned milk divestiture and recognized a $25.3 million pretax gain. Big Heart acquisition consideration was approximately $5.9 billion. The company had incurred $138.9 million in merger and integration costs since the acquisition and said the expected total, previously approximately $225 million, was trending higher and under review.
Outlook, management commentary, and risks
- Management expected approximately $35 million of Big Heart synergies in fiscal 2016, of which $19.5 million had been realized in the first nine months, and approximately $200 million in annual net savings by the end of 2018.
- The company anticipated a fiscal 2016 effective tax rate of approximately 35%, excluding an estimated $50 million noncash deferred tax benefit expected in the fourth quarter from Big Heart integration. It forecast fiscal 2016 capital expenditures of approximately $240 million, revised up from $220 million.
- Management said cash, operating cash generation, and available borrowing capacity should cover requirements for the next 12 months, including capital expenditures, dividends, and debt service. It intended to use some cash generated over the next three to five years for debt repayment. It did not provide a specific EPS or sales forecast in the presented filing text.
- Risks include integration execution and achieving projected synergies, elevated acquisition costs, leverage and cash generation, commodity and foreign-exchange volatility, competition and pricing, and potential impairment of goodwill or intangible assets. Management expected foreign-exchange effects to remain unfavorable in the fourth quarter and into the next fiscal year.
- A working-capital dispute with Del Monte Foods over Big Heart’s earlier consumer-products sale remained unresolved; the ultimate outcome could not be predicted, and no receivable or liability had been recorded for the dispute. The company stated that ordinary-course legal proceedings were not expected to have a material adverse effect based on information then available.
Important facts for investors to verify
- Whether Big Heart integration delivers the stated savings, and how final one-time costs compare with the estimate that was already trending higher.
- Underlying sales, pricing, and volume trends by brand and segment, particularly in coffee, consumer foods, and pet foods, excluding acquisition effects.
- Progress on debt reduction, interest costs, and covenant headroom, alongside the company’s expected cash generation and capital spending.
- Whether the anticipated tax benefit and approximately 35% fiscal-year tax rate are realized, and whether currency and commodity movements affect results as described.
- The resolution and potential financial effect of the Del Monte working-capital dispute.