J. M. Smucker Company — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three months ended July 31, 2019, the first quarter of fiscal 2020. Smucker manufactures and markets food and beverage products across U.S. Retail Pet Foods, U.S. Retail Coffee, U.S. Retail Consumer Foods, and International and Away From Home. Comparisons are with the three months ended July 31, 2018.
Key financial metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $1,778.9 million | $1,902.5 million | Down 6% |
| Gross profit / margin | $699.6 million / 39.3% | $678.2 million / 35.6% | Profit up 3%; margin up 3.7 percentage points |
| Operating income / margin | $257.6 million / 14.5% | $226.9 million / 11.9% | Up 14% |
| Net income | $154.6 million | $133.0 million | Up 16% |
| Diluted EPS | $1.36 | $1.17 | Up 16% |
| Operating cash flow | $221.5 million | $243.0 million | Down $21.5 million |
| Free cash flow (non-GAAP) | $148.5 million | $141.7 million | Up $6.8 million |
Adjusted results were weaker: adjusted gross profit was $670.6 million, down 4%; adjusted operating income was $290.7 million, down 8%; adjusted net income was $179.7 million, down 11%; and adjusted diluted EPS was $1.58 versus $1.78. The GAAP improvement partly reflects a $51.0 million favorable year-over-year change in unallocated derivative gains and losses; these are excluded from the company’s non-GAAP measures.
Cash and cash equivalents were $48.8 million at July 31, compared with $101.3 million at April 30. Total debt was $5,780.2 million, down from $5,910.8 million; shareholders’ equity was $8,007.7 million. Short-term borrowings were $295.9 million, and the current portion of long-term debt was $799.0 million. The company had no revolver balance and reported compliance with debt covenants. It stated that available cash, operating cash flow, borrowing facilities, and capital-market access should cover expected needs for the next 12 months.
Material changes and management commentary
- Reported sales fell $123.6 million. Excluding acquisition, divestiture, and foreign-exchange effects, sales declined 4%, reflecting unfavorable volume/mix and lower net pricing.
- The prior-year comparison included the U.S. baking business, sold in August 2018, while the current quarter included incremental Ainsworth pet-food sales. Ainsworth-related sales were $25.4 million; the company had realized $37.5 million in cumulative synergies and expected approximately $55.0 million in annual synergies, largely by the end of 2020 and fully by the end of 2021.
- Segment sales and profit: Pet Foods sales were essentially flat and profit rose 20%; Coffee sales fell 5% and profit fell 13%; Consumer Foods sales fell 17% and profit fell 17%; International and Away From Home sales fell 7% and profit fell 26%. Divestiture effects affected Consumer Foods comparisons.
- Operating cash flow was lower mainly because working capital required more cash, including higher inventory and payments for accounts payable. Capital expenditures were $73.0 million; quarterly dividends paid were $96.5 million.
- The effective tax rate was 25.2%, versus 23.2% a year earlier. Management expected a full-year fiscal 2020 effective tax rate of 24.5%–25.0%.
Outlook, risks, contingencies, and unusual items
- Remaining Ainsworth integration costs were expected to bring total costs to approximately $50.0 million; $35.4 million had been incurred through July 31, 2019. Remaining costs were expected by the end of 2020.
- Goodwill and indefinite-lived trademarks in U.S. Retail Pet Foods, including acquired Ainsworth assets, were described as susceptible to impairment if projections or macroeconomic conditions deteriorate.
- A California Proposition 65 lawsuit alleges that coffee products require acrylamide warnings. The state-approved regulation exempting coffee warnings was scheduled to take effect October 1, 2019, which the company said should result in dismissal; a challenge to the regulator’s authority remained. No loss was accrued because a loss was not considered probable or estimable, but penalties, warnings, costs, or sales effects could be material.
- The company cited risks including input-cost and commodity volatility, pricing and promotional execution, competition, acquisition synergies, cash generation and deleveraging, impairment, foreign-exchange and interest-rate movements, and customer or supplier concentration.
- Lease accounting was adopted May 1, 2019. At quarter-end, operating lease right-of-use assets were $149.2 million and operating lease liabilities were $156.1 million. Two distribution-center leases not yet commenced were expected to add about $40.0 million of assets and liabilities.
Important facts for investors to verify
- Whether reported sales and adjusted profitability trends improve, particularly in Coffee and International and Away From Home.
- Whether Ainsworth synergies meet management’s targets and whether the remaining integration costs stay within the approximately $50.0 million estimate.
- Debt refinancing and repayment plans for near-term maturities, including $300.0 million of senior notes due December 2019 and $500.0 million due March 2020.
- Cash conversion and inventory levels, given lower operating cash flow and increased working-capital needs.
- Developments in the Proposition 65 coffee litigation and potential impairment exposure for pet-food goodwill and trademarks.