Business context and reporting period
The J. M. Smucker Company’s Form 10-Q covers the third quarter and first nine months of fiscal 2017, ended January 31, 2017. The company manufactures and markets coffee, consumer foods, and pet foods. Comparisons below are with the corresponding 2016 periods; prior-year results include the U.S. canned milk business until its December 2015 divestiture.
Financial performance
Dollars in millions, except per-share data. GAAP results:
| Metric | Three months 2017 | Three months 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $1,878.8 | $1,973.9 | $5,608.5 | $6,003.6 |
| Gross profit / margin | $722.9 / 38.5% | $763.8 / 38.7% | $2,188.5 / 39.0% | $2,279.8 / 38.0% |
| Operating income / margin | $237.7 / 12.7% | $318.3 / 16.1% | $834.8 / 14.9% | $899.2 / 15.0% |
| Net income | $134.6 | $185.3 | $481.9 | $497.7 |
| Diluted EPS | $1.16 | $1.55 | $4.14 | $4.16 |
For the quarter, sales fell 5%, operating income 25%, and net income 27%. Excluding the canned milk divestiture and foreign exchange, sales declined 3%; for the nine months, the comparable decline was 4%. Management cited unfavorable volume/mix and lower net price realization. Adjusted operating income, a non-GAAP measure, was $382.8 million for the quarter, down 6%, and $1,143.0 million for nine months, down 1%. Adjusted diluted EPS was $2.00, down 2%, for the quarter and $5.92, up 6%, for nine months. These adjusted measures exclude specified items including amortization, impairment, integration and restructuring costs, and unallocated derivative gains or losses.
Quarterly segment sales and profit were: U.S. Retail Coffee $537.6 million and $172.2 million; U.S. Retail Consumer Foods $517.3 million and $119.2 million; U.S. Retail Pet Foods $550.9 million and $126.3 million; International and Foodservice $273.0 million and $45.5 million. Coffee and Consumer Foods segment profit declined 12% and 8%, respectively; Pet Foods profit rose 2%, and International and Foodservice profit declined 7%. Segment profit is a company-defined measure, not consolidated operating income.
Cash flow, balance sheet, and debt
For the first nine months, operating cash flow was $794.8 million, versus $1,124.8 million; capital expenditures were $136.6 million, yielding reported free cash flow of $658.2 million versus $964.0 million. The operating cash flow decline primarily reflected higher working capital, including increased inventory, timing of accrued liabilities, and a prior-year $49.6 million tax refund. Investing activities used $148.1 million; financing activities used $612.4 million, principally dividends of $252.1 million, long-term debt repayments of $200.0 million, and a $142.0 million reduction in short-term borrowings. Cash increased to $139.6 million from $109.8 million at April 30, 2016.
At January 31, 2017, total debt was $5,087.0 million: $4,945.0 million long-term and $142.0 million short-term. Total debt had declined $343.0 million since April 30, 2016. Shareholders’ equity was $7,241.9 million. The company had a $1.5 billion revolving credit facility maturing in September 2018, with no amount drawn, and $142.0 million of commercial paper outstanding. It reported compliance with all debt covenants and believed available cash, operating cash flow, and borrowing capacity would cover requirements for the next 12 months. Of cash and cash equivalents, $131.1 million was held by international subsidiaries; management did not intend to repatriate it for U.S. cash needs.
Material changes and unusual items
- A $75.7 million noncash impairment charge was recorded in the quarter on certain indefinite-lived trademarks in U.S. Retail Pet Foods. No goodwill impairment was recorded. The Pet Foods reporting unit’s estimated fair value was close to carrying value; specified sensitivity cases placed fair value at or slightly below carrying value, and the trademarks remain susceptible to further impairment.
- The prior-year comparison included a $25.3 million pretax gain on the canned milk divestiture and profits from that business before its sale. The divestiture also reduced comparable reported sales by $46.3 million in the quarter and $153.5 million in the nine-month period.
- Quarterly selling, distribution, and administrative expense fell $43.9 million, mainly due to Big Heart synergies and lower marketing and integration costs. For nine months, it fell $102.2 million.
- Pet Foods segment profit included $5.0 million of costs related to a product recall during the quarter.
Outlook, management commentary, and risks
- Management anticipated a fiscal 2017 effective tax rate of approximately 32.5%; actual rates were 31.9% for the quarter and 32.7% for the first nine months.
- Big Heart integration costs were expected to total approximately $290 million through 2018; $237.6 million had been incurred cumulatively. The company expected approximately $200 million in annual Big Heart synergies by the end of 2018 and reported $123.8 million realized to date.
- The organization optimization program was expected to incur approximately $40 million of restructuring costs and $15–$17 million in capital expenditures, with about 125 full-time positions eliminated upon completion. Management expected approximately $50 million of incremental annual savings by the end of 2019 from this program, plus approximately $100 million of annual savings by 2020 from additional cost initiatives. Across these programs, it forecast approximately $350 million of annual cost reductions, of which $300 million would benefit earnings and $50 million would be reinvested.
- In January 2017, the company implemented a 6% list-price increase on most U.S. packaged coffee products, excluding K-Cup pods, in response to sustained green coffee cost increases.
- A proposed Uncrustables facility in Longmont, Colorado, could involve up to $340 million of investment in two phases. Construction depended on tax and business incentive approvals and completion of the real estate purchase; production was expected to begin in 2019.
- Principal disclosed risks include commodity and input-cost volatility, pricing and volume trends, competition, realization of acquisition synergies, cash generation and deleveraging, further impairment of goodwill or intangible assets, foreign-exchange and interest-rate changes, and supply-chain or food-safety issues. The company said ordinary-course legal proceedings were not expected to have a material adverse effect, but it could not predict their outcomes or estimate a loss range.
Important facts for investors to verify
- Whether coffee and pet-food volume trends and pricing improve, and whether the announced coffee price increase offsets higher input costs.
- Whether the Pet Foods reporting unit and acquired trademarks avoid additional impairment, given the reported sensitivity to assumptions and recent trademark charge.
- Progress toward the $200 million Big Heart synergy target and the broader $350 million annual cost-reduction plan, including execution costs and timing.
- Cash conversion and working-capital trends, particularly inventory, alongside debt reduction and the company’s planned share repurchases.
- Conditions, final investment, and execution schedule for the proposed Longmont facility; the filing does not establish that the project approvals or property purchase were completed.