Business context and reporting period
The J. M. Smucker Company’s Form 10-Q covers the three months ended July 31, 2017, the first quarter of fiscal 2018. The company manufactures and markets food and beverage products across U.S. Retail Coffee, U.S. Retail Consumer Foods, U.S. Retail Pet Foods, and International and Away From Home.
Key financial results
Amounts are in millions of dollars, except per-share data. Comparisons are with the three months ended July 31, 2016.
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $1,748.9 | $1,815.8 | Down 4% |
| Gross profit / margin | $662.1 / 37.9% | $722.7 / 39.8% | Down 8%; margin down 1.9 percentage points |
| Operating income / margin | $233.8 / 13.4% | $293.8 / 16.2% | Down 20%; margin down 2.8 points |
| Net income | $126.8 | $170.0 | Down 25% |
| Diluted EPS | $1.12 | $1.46 | Down 23% |
| Operating cash flow | $304.3 | $238.9 | Up $65.4 |
| Capital expenditures | $69.6 | $50.2 | Up $19.4 |
| Free cash flow (non-GAAP) | $234.7 | $188.7 | Up $46.0 |
Adjusted operating income was $300.5, down 17%, and adjusted diluted EPS was $1.51, down 19%. These non-GAAP measures exclude amortization, integration and restructuring costs, and unallocated derivative gains and losses; they are not substitutes for GAAP results.
Segment performance
- U.S. Retail Coffee: sales $480.8, down 6%; segment profit $123.8, down 29%. Volume/mix fell 8%, partly offset by 2% higher net pricing.
- U.S. Retail Consumer Foods: sales $492.4, down 8%; segment profit $110.9, roughly flat. Volume/mix declined 11%, partly offset by higher pricing and lower marketing expense.
- U.S. Retail Pet Foods: sales $521.7, roughly flat; segment profit $98.3, down 20%. Lower pricing, higher costs, and increased marketing weighed on profit.
- International and Away From Home: sales $254.0, up 3%; segment profit $38.3, down 3%.
Financial position and liquidity
- Cash and equivalents were $183.2 at July 31, compared with $166.8 at April 30. Current assets were $1,692.1 and current liabilities $1,750.9.
- Total debt was $5,228.0, down from $5,398.5 at April 30; this included $499.3 current long-term debt, $283.9 short-term borrowings, and $4,444.8 long-term debt. Shareholders’ equity was $6,931.9.
- Operating cash flow rose chiefly because working capital decreased versus a year-earlier increase, particularly in receivables and inventory; lower net income partly offset the improvement. Inventory increased $75.6 from April 30.
- Financing cash outflow was $260.1, including $170.1 of net short-term borrowing repayments and $84.9 of dividends paid. The quarterly dividend declared was $0.78 per share, versus $0.75 a year earlier.
- The company had a $1.5 billion revolving credit facility maturing in September 2018 and a commercial paper program capped at $1.0 billion. It reported no revolver balance and compliance with all debt covenants.
Material changes, outlook, and risks
- Management attributed the 4% sales decline mainly to unfavorable volume/mix, particularly in coffee and oils, partly offset by higher net pricing and pet-food gains. Lower gross profit, driven by volume/mix and unfavorable cost/pricing effects in coffee and pet foods, was the main cause of lower operating income.
- Management expected a full-year fiscal 2018 effective tax rate of 32.5%–33.0%. It said the impact of higher coffee costs was expected to moderate over the remainder of the year. The filing provides no full-year sales or earnings guidance.
- Big Heart integration costs totaled $256.4 to date, within an estimated $290.0 total through 2018. The company reported $177.8 of approximately $200.0 in targeted annual synergies achieved to date and expected to reach the target by the end of 2018.
- The organization optimization program was expected to cost approximately $45.0 and deliver about $50.0 in annual savings, mainly during 2018; about 80% of planned reductions of approximately 275 positions had been completed by July 31. A separate cost-management program targets approximately $200.0 of annual cost reductions by the end of 2020.
- The proposed Wesson oil brand acquisition was valued at approximately $285.0, expected to be funded primarily with debt, and projected to add about $230.0 in annual sales. Closing remained subject to customary conditions, including regulatory approval; expected annual synergies were about $20.0 within two years after closing.
- Construction began on a Longmont, Colorado, Uncrustables facility. Phase 1 investment could reach $200.0; the full two-phase potential investment was $340.0, with production expected to begin in 2019.
- Key risks include commodity and energy price volatility, competition and pricing, execution of cost savings and integration, Wesson closing conditions, foreign-exchange and interest-rate changes, and the ability to generate cash for deleveraging. The company said ordinary-course legal proceedings were not expected to have a material adverse effect, while noting it could not predict their outcomes.
- Derivative accounting affected comparability: unallocated derivative gains were $12.6 versus $7.7 a year earlier. Management’s adjusted measures remove these gains and other specified items. Management also reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales and margins stabilize, especially in coffee and consumer foods, and whether higher input costs moderate as management expected.
- Progress toward the stated Big Heart synergies and the cost-management and restructuring savings, alongside remaining implementation costs.
- Wesson regulatory approval, financing, closing timing, and realization of projected sales and synergies.
- Cash generation and working-capital seasonality, debt reduction, and the refinancing or repayment of the $500.0 of senior notes due March 2018.
- The basis and limitations of adjusted earnings and free cash flow, including the effects of derivative mark-to-market changes and other excluded costs.