Business context and reporting period
The J. M. Smucker Company’s fiscal 2019 third-quarter Form 10-Q covers the three and nine months ended January 31, 2019, compared with the corresponding prior-year periods. The filing is for the period ending in January 2019, not calendar-year 2018 Q3. The company reports four segments: U.S. Retail Coffee, U.S. Retail Consumer Foods, U.S. Retail Pet Foods, and International and Away From Home.
Results include Ainsworth Pet Nutrition from its May 14, 2018 acquisition and exclude the U.S. baking business sold on August 31, 2018. Unless noted, amounts below are in millions of dollars.
Financial performance and liquidity
| Metric | Three months ended Jan. 31, 2019 | Three months ended Jan. 31, 2018 | Nine months ended Jan. 31, 2019 | Nine months ended Jan. 31, 2018 |
|---|---|---|---|---|
| Net sales | $2,011.9 | $1,903.3 | $5,935.9 | $5,575.8 |
| Gross profit | $773.8 | $728.5 | $2,223.3 | $2,145.6 |
| Gross margin | 38.5% | 38.3% | 37.5% | 38.5% |
| Operating income | $217.6 | $164.0 | $775.0 | $731.3 |
| Net income | $121.4 | $831.3 | $442.9 | $1,152.7 |
| Diluted EPS | $1.07 | $7.32 | $3.89 | $10.15 |
| Adjusted diluted EPS (non-GAAP) | $2.26 | $2.50 | $6.20 | $6.03 |
Quarterly operating margin was 10.8%, versus 8.6%; nine-month operating margin was 13.1% in both periods. Adjusted operating income was $406.2 for the quarter, down 1%, and $1,139.0 for nine months, up 5%; adjusted operating margins were 20.2% and 19.2%, respectively, versus 21.1% and 19.5% a year earlier. These adjusted measures are non-GAAP.
Quarterly sales rose 6%, but excluding acquisition, divestiture, and foreign-exchange effects increased 1%. Nine-month reported sales rose 6%, while the comparable measure was essentially flat. Nine-month operating cash flow was $867.0, compared with $903.6; capital spending was $267.2, leaving reported free cash flow of $599.8, versus $693.3 (non-GAAP). Cash and equivalents were $206.5 at January 31, 2019.
Total debt was $6,089.1, up from $4,832.0 at April 30, 2018; shareholders’ equity was $8,021.6. Debt includes $504.0 of commercial paper and $5,585.1 carrying value of long-term debt, including the current portion. The company had no revolver borrowings, had a $1.8 billion revolving credit facility, and reported compliance with debt covenants. Net interest expense increased 20% for the quarter and 25% for nine months, primarily due to acquisition financing. Dividends declared were $0.85 per share for the quarter and $2.55 for nine months.
Material changes and unusual items
- Ainsworth acquisition: The $1.9 billion all-cash acquisition contributed $199.2 of quarterly sales and $546.2 of nine-month sales. Management expected acquired-business sales to exceed $750 in fiscal 2019, with approximately $55 of annual cost synergies expected to be fully realized within three years, including about $20 in 2019.
- U.S. baking divestiture: The sale generated $371.4 of proceeds and a $27.6 pretax gain. It reduced year-over-year comparable sales, particularly in Consumer Foods.
- Impairment: The company recorded a noncash $107.2 impairment of certain indefinite-lived pet-food trademarks in the current quarter. The prior-year quarter included $176.9 of pet-food goodwill and trademark impairments. Management said pet-food goodwill and remaining indefinite-lived trademarks remain susceptible to further impairment because fair values are close to carrying values; further charges could be material.
- Tax comparison: Prior-year net income included a $765.8 net tax benefit from U.S. tax reform, making the large GAAP net-income and EPS declines poor indicators of underlying operating trends. The company’s nine-month 2019 effective tax rate was 26.1%; management anticipated approximately 26.0% for fiscal 2019.
- Segment trends: Pet Foods sales and profit increased largely due to Ainsworth; excluding it, nine-month sales and segment profit declined. Consumer Foods sales fell primarily due to the baking divestiture, while profit also faced higher input costs and lower pricing. Coffee sales increased modestly; International and Away From Home sales declined.
Outlook, risks, and contingencies
Management cited plans for a March 2019 list-price decrease on select U.S. Jif products in response to anticipated lower peanut costs, and a February 2019 price increase on select U.S. pet foods due to sustained input-cost increases. Production at the Longmont, Colorado, Uncrustables facility was expected to begin in the second half of calendar 2019. The filing does not provide a clear full-year earnings or EPS outlook.
Management expected approximately $50 of Ainsworth integration costs, mostly cash, with about two-thirds expected by the end of 2019. The organization-optimization program was expected to cost approximately $75 in total and reduce headcount by about 450 positions; most remaining costs were expected through 2019.
Key risks include acquisition integration and delivery of synergies, input-cost and commodity volatility, pricing and competitive pressures, cash generation and debt reduction, and potential impairment of goodwill and intangible assets. A California Proposition 65 lawsuit alleges coffee warning-label violations related to acrylamide. No loss was accrued because loss was not considered probable or estimable; a regulatory proposal clarifying that coffee warnings are not required was pending. The company noted potential penalties, labeling costs, and sales effects if the case proceeds. It also reported that most tuna price-fixing-related lawsuits had been settled, with the remainder expected to be resolved in the near future.
Most important facts for investors to verify
- Assess sales and profit trends excluding the Ainsworth acquisition and U.S. baking divestiture, and distinguish GAAP from the company’s non-GAAP adjusted measures.
- Review the final Ainsworth purchase-price allocation, integration progress, and whether the stated sales and synergy expectations are achieved.
- Monitor pet-food brand forecasts and valuation headroom for potential additional goodwill or trademark impairments.
- Track debt, interest expense, operating cash flow, free cash flow, and progress toward management’s cash-deleveraging objectives.
- Follow the Proposition 65 proceedings and any outcome that could require warnings, penalties, or affect coffee sales.