J M SMUCKER Co quarterly report, Q3 FY2011

Business context and reporting period

The J. M. Smucker Company filed this unaudited Form 10-Q for the quarter and nine months ended January 31, 2011 (fiscal 2011). It manufactures and markets food products across four reportable segments: U.S. Retail Coffee, U.S. Retail Consumer, U.S. Retail Oils and Baking, and Special Markets. Financial amounts below are in millions unless stated otherwise.

Financial performance and position

For the nine months, operating cash flow was $394.4, capital expenditures were $111.1, and company-defined free cash flow was $283.2. Cash and cash equivalents were $549.6 at January 31, 2011. Total debt was $1,300.0, all long-term; shareholders’ equity was $5,363.3. The company had no borrowings under its $600.0 revolving credit facility and reported compliance with debt covenants.

Material changes versus the prior comparable period

• Quarterly sales rose 9%; nine-month sales rose 3%. Management attributed growth principally to pricing and favorable mix, with quarterly volume up 3% but nine-month volume down 2%.
• Reported operating income increased 1% in both periods, while reported net income fell 3% in the quarter and rose 3% for nine months. Diluted EPS was $1.11 versus $1.14 for the quarter and $3.23 versus $3.14 year to date.
• Excluding restructuring and merger/integration costs, management reported operating income growth of 12% for the quarter and 9% year to date, and adjusted diluted EPS of $1.27 and $3.69, respectively. These are non-GAAP measures.
• Margins were pressured by higher raw-material costs and restructuring charges. Reported gross margin fell from 38.0% to 36.1% in the quarter and from 38.4% to 37.9% year to date. Restructuring costs included in cost of products sold were $16.9 for the quarter and $38.4 year to date.
• Segment results were mixed. Quarterly coffee sales and profit rose 18% and 19%; consumer-market profit rose 9%; oils and baking profit fell 12%; and Special Markets profit fell 8%, including Europe’s Best impairment charges. Year-to-date oils and baking sales and profit declined 5% and 11%.
• Operating cash flow declined from $511.6 to $394.4 year to date, primarily due to higher income-tax payments and increased receivables and inventory. Cash increased from $283.6 at April 30, 2010, partly reflecting debt issuance and financing activity.
• Debt increased from $910.0 to $1,300.0, including issuance of $400.0 of 4.50% senior notes due 2025. The company repurchased approximately 3.7 million shares for about $240.0 and paid $143.1 in dividends during the nine months.

Outlook, management commentary, risks and unusual items

• The company expects approximately $175.0 of capital expenditures for fiscal 2011, as restructuring-related investment accelerates. Management said the restructuring was proceeding as planned and expected operating cash flow in the second half to exceed the first half.
• The restructuring program is expected to cost approximately $235.0 in total; $79.0 had been incurred through January 31, 2011. It includes an estimated $220.0 of capital investment, six facility closures, and an approximately 850-position reduction, with remaining costs expected over the next four fiscal years.
• Management cited higher green coffee costs ahead and announced a 10% price increase in early February for most coffee items, principally Folgers and Dunkin’ Donuts packaged coffee. The filing does not provide formal full-year earnings or sales guidance.
• Europe’s Best impairment charges totaled $17.2 in the quarter and year to date, reducing the trademark and customer-relationship assets. The filing also flags continuing competitive and promotional pressure in oils and baking; sustained weakness could lead to impairment of goodwill or other indefinite-lived assets. The company’s third-quarter assessment supported current carrying values.
• Key risks include commodity-cost volatility and hedging outcomes, ability to implement pricing, competitive activity, restructuring execution and savings, customer concentration, impairment of goodwill and intangibles, labor disruptions, and foreign-exchange and interest-rate movements. The company said ordinary-course legal proceedings were not expected to have a material adverse effect, though outcomes and potential losses could not be predicted with certainty.
• Management stated that cash on hand, operating cash flow, and available credit were expected to cover the next 12 months’ requirements, including capital expenditures, dividends, interest, and share repurchases, absent material acquisitions or other significant investments.

Important facts for investors to verify

• Whether coffee price increases offset further green coffee cost inflation without materially weakening volumes.
• Progress, timing, total costs, and expected savings from the $235.0 restructuring and related facility closures.
• Trends in oils and baking competition and whether the segment’s goodwill and intangible-asset valuations remain supportable.
• Drivers of lower operating cash flow, including tax-payment timing and working-capital needs, and the planned $175.0 fiscal-year capital expenditure level.
• Capital allocation and leverage following the $400.0 debt issuance, share repurchases, and dividend payments; confirm capacity under the revolving credit facility and covenant compliance.