SJM

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended January 31, 2009, for The J. M. Smucker Company. The reporting period is significantly impacted by the acquisition of The Folgers Coffee Company from Procter & Gamble, which closed on November 6, 2008. Consequently, the results for the three and nine months ended January 31, 2009, include the operations of the Folgers business, whereas the prior year periods do not.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 78% for the quarter and 39% year-to-date compared to the prior year. This growth is primarily driven by the Folgers acquisition, which contributed approximately $491.7 million in the quarter and $558.1 million year-to-date.
• Organic Performance: Excluding acquisitions and foreign exchange, net sales increased 6% for the quarter and 11% year-to-date, driven by a 13% net pricing gain that offset a 7% volume and mix decline.
• Profitability: Operating income increased 97% for the quarter and 32% year-to-date. Gross profit margins improved to 33.9% (quarter) and 31.7% (YTD) from 29.4% and 31.0% respectively, aided by the Folgers addition and better pricing alignment with costs.
• Expenses: Selling, distribution, and administrative (SD&A) expenses rose 74% for the quarter due to Folgers integration. Merger and integration costs were $32.8 million for the quarter and $42.4 million year-to-date.
• Debt Structure: Total debt increased significantly to $1.54 billion from $790 million at the prior year-end. This includes $350 million in variable rate debt assumed from Folgers and $400 million in new Senior Notes issued in October 2008.

Outlook, Risks, and Management Commentary

• Merger Integration: Management expects to incur one-time merger and integration costs of approximately $100 million to $125 million over the two fiscal years following the merger. The purchase price allocation is preliminary and expected to be completed in the first half of fiscal 2010.
• Capital Expenditures: Capital expenditures for fiscal 2009 are expected to total approximately $115 million to $120 million, including amounts associated with Folgers.
• Market Risks:
  • Commodity Prices: The company faces volatility in raw material costs (coffee, wheat, soybean oil, milk, peanuts). Hedging strategies are in place but may not fully offset market movements.
  • Consumer Behavior: Economic downturns may drive consumers toward lower-priced private label products, potentially reducing volume and margins.
  • Food Safety: A competitor's peanut butter recall in January 2009 caused a 22% volume decline in the retail peanut butter category, a pressure expected to continue through the fourth quarter.
  • Facility Concentration: Approximately 80% of Folgers' production capacity is located in New Orleans, creating a risk of significant disruption from natural disasters.
• Liquidity: The company maintains an $180 million revolving credit facility. Management believes cash on hand, operating cash flow, and available credit are sufficient to meet requirements for the next twelve months.

Investor Verification Checklist

• Merger Synergies: Verify the timeline and actual realization of the projected $100-$125 million in one-time integration costs and the expected synergies from the Folgers acquisition.
• Volume Trends: Monitor the impact of the competitor's peanut butter recall on Jif sales volume and the broader category recovery in the fourth quarter.
• Debt Servicing: Review the interest rate exposure on the new $350 million variable rate debt and the $400 million fixed rate notes, particularly in the context of rising interest rates.
• Inventory Valuation: Confirm the final year-end LIFO inventory valuation for coffee, as interim results are based on estimates and could materially change at fiscal year-end.
• Capital Allocation: Track the company's ability to maintain dividend payments ($0.32 per share declared for the quarter) while funding capital expenditures and debt obligations.