The J. M. Smucker Company — Form 10-Q Summary
Business context and reporting period
This filing covers the three months ended July 31, 2018, the company’s first quarter of fiscal 2019. Smucker operates in food and beverage manufacturing and marketing, with four reportable segments: U.S. Retail Coffee, U.S. Retail Consumer Foods, U.S. Retail Pet Foods, and International and Away From Home. Unless stated otherwise, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $1,902.5 | $1,748.9 | Up 9% |
| Gross profit / margin | $678.2 / 35.6% | $662.1 / 37.9% | Profit up 2%; margin down 2.3 points |
| Operating income / margin | $226.9 / 11.9% | $235.2 / 13.4% | Down 4% |
| Net income | $133.0 | $126.8 | Up 5% |
| Diluted EPS | $1.17 | $1.12 | Up 4% |
| Net interest expense | $53.6 | $42.0 | Up $11.6 |
| Operating cash flow | $243.0 | $304.3 | Down $61.3 |
| Free cash flow, company-defined non-GAAP | $141.7 | $234.7 | Down $93.0 |
Adjusted gross profit was $700.2, or 36.8% of sales, versus $650.2, or 37.2%. Adjusted operating income was $317.1, or 16.7% of sales, versus $301.9, or 17.3%; adjusted net income was $202.4 and adjusted diluted EPS was $1.78, compared with $171.6 and $1.51. These are non-GAAP measures; the company excludes amortization, integration and restructuring costs, and unallocated commodity and foreign-currency derivative gains and losses, among other specified items.
At July 31, cash and cash equivalents were $192.0, total debt was $6,714.9 (including $530.0 of short-term borrowings), and shareholders’ equity was $7,930.8. Total debt was $4,832.0 at April 30, 2018. The company had a $1.8 billion revolving credit facility, with no balance outstanding on it, and reported compliance with debt covenants. It stated that available cash, operating cash flow, borrowing capacity, and capital-market access were expected to meet requirements for the next 12 months, absent significant acquisitions or investments.
Material changes and segment trends
- Sales increased $153.6, primarily from $162.8 of Ainsworth Pet Nutrition revenue following its May 14 acquisition. Excluding Ainsworth and foreign exchange, sales declined $10.0, or 1%, with lower net price realization the main factor.
- U.S. Retail Pet Foods sales rose 29% to $671.2, reflecting Ainsworth; excluding it, sales fell 2%. Segment profit increased 3% to $100.4, but included a $10.9 acquired-inventory fair-value adjustment that raised cost of goods sold.
- U.S. Retail Coffee sales rose 2% to $489.5 and segment profit rose 20% to $147.8, mainly due to lower input costs. U.S. Retail Consumer Foods sales fell 1% to $483.3 and segment profit fell 12% to $97.3, reflecting higher input and freight costs and unfavorable volume/mix. International and Away From Home sales fell 1% to $258.5, while segment profit rose 8% to $43.4.
- GAAP operating income declined despite higher sales, as selling, distribution and administrative costs and amortization increased, largely because of Ainsworth. Lower special-project costs partly offset these increases. GAAP gross margin also fell, partly reflecting unfavorable derivative impacts and lower prices and higher costs.
- Operating cash flow declined mainly because working-capital movements were less favorable than in the prior-year quarter. Investing cash use was $2,031.5, including $1.9 billion for Ainsworth and $101.3 of capital expenditures; financing cash provided was $1,790.5, largely from acquisition-related borrowing.
Outlook, commentary, risks, and unusual items
- Management expected Ainsworth to contribute approximately $800 of net sales in fiscal 2019 and forecast annual cost synergies of approximately $55, fully realized within three years, including approximately $25 anticipated in fiscal 2019. Integration costs are expected to total approximately $50, mostly cash costs.
- Management anticipated a fiscal 2019 effective tax rate of approximately 24.5%. The quarter’s effective rate was 23.2%, versus 32.9% a year earlier. A $765.8 provisional tax-reform benefit had been recorded in the prior fiscal year; no adjustment was recorded this quarter, and the estimate remained subject to revision.
- The company agreed to sell its U.S. baking business, which generated approximately $370 of 2018 sales, for approximately $375 in proceeds, subject to working-capital adjustment. It estimated a pretax gain of approximately $25 and expected closing in the second quarter of fiscal 2019, subject to customary conditions. The disposal group was classified as held for sale at July 31.
- The organization-optimization program is expected to cost approximately $75 and reduce headcount by about 375 positions; approximately 75% of the planned reductions had occurred by July 31. Office closures and other restructuring actions were expected to continue through 2019.
- A California Proposition 65 lawsuit alleges coffee acrylamide warning violations. The company disputes the claims, has recorded no loss contingency because loss was not considered probable or estimable, and could not predict the outcome. A proposed state regulation clarifying that coffee warnings are not required could lead to dismissal if finalized; adverse remedies could nevertheless result in penalties, costs, or sales effects.
- Other cited risks include Ainsworth integration and synergy execution, achieving cash deleveraging objectives, commodity and freight costs, pricing and competitive pressures, foreign-exchange and interest-rate movements, and completion of the baking-business sale. The company noted that adoption of the new lease standard was expected to materially increase recognized lease assets and liabilities, but the effect had not yet been quantified.
Important facts for investors to verify
- Whether Ainsworth delivers the projected sales and synergies, and how its integration, acquired-intangible amortization, and financing affect margins and cash flow.
- Progress on debt reduction and liquidity after the acquisition, including the effects of variable-rate borrowing and working-capital seasonality.
- Completion, final proceeds, and gain from the U.S. baking divestiture, and the resulting change in segment comparability.
- Underlying sales, pricing, input and freight costs, and segment profitability—particularly trends excluding acquisitions and derivative mark-to-market effects.
- Developments in the Proposition 65 litigation, tax-reform estimates, acquisition purchase-price allocation, and the quantified balance-sheet effect of lease-standard adoption.