UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended October 31, 2014
or
For the transition period from to
Commission file number 1-5111
THE J. M. SMUCKER COMPANY
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Registrant’s telephone number, including area code: (330) 682-3000
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The Company had 101,817,058 common shares outstanding on November 21, 2014.
The Exhibit Index is located at Page No. 40.
TABLE OF CONTENTS
Condensed Statements of Consolidated Income
Condensed Statements of Consolidated Comprehensive Income
Condensed Consolidated Balance Sheets
Condensed Statements of Consolidated Cash Flows
Notes to Unaudited Condensed Consolidated Financial Statements
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PART I. FINANCIAL INFORMATION
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
(Dollars in millions, except per share data)
Net sales
Cost of products sold
Gross Profit
Selling, distribution, and administrative expenses
Amortization
Other special project costs (A)
Other operating expense (income) – net
Operating Income
Interest expense – net
Other income (expense) – net
Income Before Income Taxes
Income taxes
Net Income
Earnings per common share:
Net Income - Assuming Dilution
Dividends Declared per Common Share
See notes to unaudited condensed consolidated financial statements.
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CONDENSED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(Dollars in millions)
Net income
Other comprehensive loss:
Foreign currency translation adjustments
Cash flow hedging derivative activity, net of tax
Pension and other postretirement benefit plans activity, net of tax
Available-for-sale securities activity, net of tax
Total Other Comprehensive Loss
Comprehensive Income
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CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
Current Assets
Cash and cash equivalents
Trade receivables, less allowance for doubtful accounts
Inventories:
Finished products
Raw materials
Other current assets
Total Current Assets
Property, Plant, and Equipment
Land and land improvements
Buildings and fixtures
Machinery and equipment
Construction in progress
Accumulated depreciation
Total Property, Plant, and Equipment
Other Noncurrent Assets
Goodwill
Other intangible assets – net
Other noncurrent assets
Total Other Noncurrent Assets
Total Assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts payable
Accrued trade marketing and merchandising
Current portion of long-term debt
Short-term borrowings
Other current liabilities
Total Current Liabilities
Noncurrent Liabilities
Long-term debt
Deferred income taxes
Other noncurrent liabilities
Total Noncurrent Liabilities
Total Liabilities
Shareholders’ Equity
Common shares
Additional capital
Retained income
Amount due from ESOP Trust
Accumulated other comprehensive loss
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
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CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
Share-based compensation expense
Loss on sale of assets – net
Defined benefit pension contributions
Changes in assets and liabilities, net of effect from businesses acquired:
Trade receivables
Inventories
Accrued liabilities
Income and other taxes
Other – net
Net Cash Provided by Operating Activities
Investing Activities
Businesses acquired, net of cash acquired
Additions to property, plant, and equipment
Proceeds from disposal of property, plant, and equipment
Net Cash Used for Investing Activities
Financing Activities
Short-term borrowings – net
Repayments of long-term debt
Quarterly dividends paid
Purchase of treasury shares
Proceeds from stock option exercises
Net Cash Provided by (Used for) Financing Activities
Effect of exchange rate changes on cash
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and Cash Equivalents at End of Period
( ) Denotes use of cash
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, unless otherwise noted, except per share data)
Note 1: Basis of Presentation
The unaudited condensed consolidated financial statements of The J. M. Smucker Company (“Company,” “we,” “us,” or “our”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments of a normal recurring nature considered necessary for a fair presentation have been included.
Operating results for the six-month period ended October 31, 2014, are not necessarily indicative of the results that may be expected for the year ending April 30, 2015. For further information, reference is made to the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended April 30, 2014.
Note 2: Recently Issued Accounting Standards
In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 will be effective for us on May 1, 2017, and will require either retrospective application to each prior reporting period presented or retrospective application with the cumulative effect of initially applying the standard recognized at the date of adoption. We are currently evaluating the impact the application of ASU 2014-09 will have on our financial statements and disclosures.
Note 3: Acquisitions
On September 2, 2014, we acquired Sahale Snacks, Inc. (“Sahale”), a privately-held manufacturer and marketer of premium, branded nut and fruit snacks for $80.3. The purchase price was allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. The purchase price allocation includes total intangible assets of $30.4. To the extent the purchase price exceeded the estimated fair value of the net identifiable tangible and intangible assets acquired, the excess was allocated to goodwill. Preliminary valuations resulted in Sahale goodwill of $46.9, of which $42.2 was assigned to the U. S. Retail Consumer Foods segment and $4.7 was assigned to the International, Foodservice, and Natural Foods segment.
The results of operations for the acquired business are included in the condensed consolidated financial statements from the date of the transaction and did not have a material impact on the quarter ended October 31, 2014, nor expected to materially affect results of operations for the year ending April 30, 2015.
During 2014, we completed two acquisitions for aggregate net cash consideration of $101.8, net of working capital adjustments. Enray Inc. (“Enray”), a leading manufacturer and marketer of premium organic, gluten-free ancient grain products, was acquired in August 2013. Silocaf of New Orleans, Inc. (“Silocaf”), a strategic investment related to our green coffee supply chain, was acquired in September 2013.
The purchase price for each business acquired was allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. The purchase price allocations include total intangible assets of $37.6 for both Enray and Silocaf. To the extent the purchase price exceeded the estimated fair value of the net identifiable tangible and intangible assets acquired, the excess was allocated to goodwill. Valuations resulted in Enray goodwill of $29.3, which was assigned to the International, Foodservice, and Natural Foods segment, and Silocaf goodwill of $22.8, which was assigned to the U.S. Retail Coffee segment.
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Note 4: Restructuring
During 2010, we announced plans to restructure our coffee and fruit spreads operations as part of our ongoing efforts to enhance the long-term strength and profitability of our leading brands. Since then, we expanded our restructuring plan to include the Canadian pickle and condiments operations and the capacity expansion of our peanut butter business. Pickle and condiments production was transitioned to third-party manufacturers during 2012. The consolidation of coffee production in New Orleans, Louisiana, related to these restructuring initiatives is complete, and the transitioned retail and foodservice fruit spreads volume is being produced at our new facility in Orrville, Ohio. All of the impacted facilities have been closed, resulting in the reduction of 850 full-time positions as anticipated.
We expect to incur total restructuring costs of approximately $265.0 for the entire restructuring plan, of which $253.9 has been incurred through October 31, 2014. The majority of the remaining costs are anticipated to be recognized this fiscal year and relate to the conversion of the Memphis, Tennessee, fruit spreads facility into a peanut butter plant.
The following table summarizes the restructuring activity, including the liabilities recorded and the total amount expected to be incurred.
Total expected restructuring charge
Balance at May 1, 2013
Charge to expense
Cash payments
Noncash utilization
Balance at April 30, 2014
Balance at October 31, 2014
Remaining expected restructuring charge
In the three and six months ended October 31, 2014, total restructuring charges of $2.7 and $5.5, respectively, were reported in the Condensed Statements of Consolidated Income. Of the total restructuring charges, the majority were reported in other special project costs. In the three and six months ended October 31, 2013, total restructuring charges of $6.8 and $12.0, respectively, were reported in the Condensed Statements of Consolidated Income. Of the total restructuring charges, $2.1 and $3.5 were reported in cost of products sold in the three and six months ended October 31, 2013, respectively, while the remaining charges were reported in other special project costs.
Employee separation costs include severance, retention bonuses, and pension costs. Severance costs and retention bonuses are recognized over the estimated future service period of the affected employees. The obligation related to employee separation costs is included in current liabilities in the Condensed Consolidated Balance Sheets.
Other costs include professional fees, costs related to closing the facilities, and miscellaneous expenditures associated with the restructuring initiative and are expensed as incurred.
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Note 5: Common Shares
The following table sets forth common share information.
Common shares authorized
Common shares outstanding
Treasury shares
During the second quarter of 2015, the Board of Directors increased our shares authorized for repurchase by 5.0 million common shares, resulting in approximately 10.0 million common shares available for repurchase. During 2014, we repurchased 4.9 million common shares for $495.0.
Note 6: Reportable Segments
We operate in one industry: the manufacturing and marketing of food products. We have three reportable segments: U.S. Retail Coffee, U.S. Retail Consumer Foods, and International, Foodservice, and Natural Foods. The U.S. Retail Coffee segment primarily represents the domestic sales of Folgers®, Dunkin’ Donuts®, Millstone®, Café Bustelo®, and Café Pilon® branded coffee; the U.S. Retail Consumer Foods segment primarily includes domestic sales of Jif ®, Smucker’s®, Pillsbury®, Crisco®, Martha White®, Hungry Jack®, and Eagle Brand® branded products; and the International, Foodservice, and Natural Foods segment is comprised of products distributed domestically and in foreign countries through retail channels, foodservice distributors and operators (e.g., restaurants, lodging, schools and universities, health care operators), and natural foods stores and distributors.
Segment profit represents net sales, less direct and allocable operating expenses, and is consistent with the way in which we manage our segments. However, we do not represent that the segments, if operated independently, would report operating profit equal to the segment profit set forth below, as segment profit excludes certain operating expenses such as corporate administrative expenses and, effective May 1, 2014, unallocated gains and losses on commodity and foreign currency exchange derivative activities. Commodity and foreign currency exchange derivative gains and losses are reported in unallocated derivative gains and losses outside of segment operating results until the related inventory is sold. At that time, we reclassify the hedge gains and losses from unallocated derivative gains and losses to segment profit, allowing our segments to realize the economic effect of the hedge without experiencing any mark-to-market volatility. We would expect that any gain or loss in the estimated fair value of the derivatives would generally be offset by a change in the estimated fair value of the underlying exposures. Prior year results have been modified to exclude the unrealized gains and losses on commodity and foreign currency exchange derivatives to conform to the new definition.
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Net sales:
U.S. Retail Coffee
U.S. Retail Consumer Foods
International, Foodservice, and Natural Foods
Total net sales
Segment profit:
Total segment profit
Unallocated derivative gains (losses) (A)
Cost of products sold – special project costs
Other special project costs
Corporate administrative expenses
Income before income taxes
Note 7: Debt and Financing Arrangements
Long-term debt consists of the following:
4.78% Senior Notes due June 1, 2014
6.12% Senior Notes due November 1, 2015
6.63% Senior Notes due November 1, 2018
3.50% Senior Notes due October 15, 2021
5.55% Senior Notes due April 1, 2022
4.50% Senior Notes due June 1, 2025
Total long-term debt
Total long-term debt, less current portion
The 3.50 percent Senior Notes were issued in a public offering and the remaining Senior Notes were privately placed. The Senior Notes are unsecured and interest is paid semiannually. Scheduled payments are required on the 5.55 percent Senior Notes, of which $75.0 is due on April 1, 2016, and on the 4.50 percent Senior Notes, the first of which is $100.0 due on June 1, 2020. We repaid the 4.78 percent Senior Notes on June 1, 2014. We may prepay at any time all or part of the Senior Notes at 100 percent of the principal amount thereof, together with accrued and unpaid interest, and any applicable make-whole amount.
We have available a $1.5 billion revolving credit facility with a group of 11 banks that matures in September 2018. Interest is payable either on a quarterly basis or at the end of the borrowing term. At October 31, 2014, we did not have a balance outstanding under the revolving credit facility.
During the second quarter of 2015, we entered into a commercial paper program under which we can issue short-term, unsecured commercial paper not to exceed $1.0 billion at any time. The commercial paper program is backed by our revolving credit facility and reduces what we can borrow under the revolving credit facility by the amount of commercial paper outstanding. Commercial paper will be used as a continuing source of short-term financing for general corporate purposes. As of October 31, 2014, we had $545.9 of short-term borrowings outstanding, all of which were issued under our commercial paper program at a weighted-average interest rate of 0.31 percent.
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In the second quarter of 2014, we entered into an interest rate swap, with a notional amount of $750.0, on the 3.50 percent Senior Notes due October 15, 2021, converting the Senior Notes from a fixed- to a variable-rate basis. The interest rate swap was designated as a fair value hedge of the underlying debt obligation. At October 31, 2014, a net gain from changes in the fair value of the interest rate swap of $27.4 was recognized in interest expense with a corresponding offset due to changes in the fair value of the hedged underlying debt, resulting in no net impact to interest expense. For additional information, see Note 11: Derivative Financial Instruments.
Interest paid totaled $12.2 and $22.8 for the three months ended October 31, 2014 and 2013, respectively, and $36.9 and $45.2 for the six months ended October 31, 2014 and 2013, respectively. This differs from interest expense due to the timing of payments, amortization of fair value adjustments, effect of interest rate swap, amortization of debt issue costs, and interest capitalized.
Our debt instruments contain certain financial covenant restrictions including consolidated net worth, a leverage ratio, and an interest coverage ratio. We are in compliance with all covenants.
Note 8: Earnings per Share
The following table sets forth the computation of net income per common share and net income per common share – assuming dilution under the two-class method.
Net income allocated to participating securities
Net income allocated to common stockholders
Weighted-average common shares outstanding
Dilutive effect of stock options
Weighted-average common shares outstanding – assuming dilution
Net income per common share
Net income per common share – assuming dilution
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Note 9: Pensions and Other Postretirement Benefits
The components of our net periodic benefit cost for defined benefit pension and other postretirement benefit plans are shown below.
Service cost
Interest cost
Expected return on plan assets
Recognized net actuarial loss
Prior service cost (credit)
Net periodic benefit cost
Note 10: Contingencies
We, like other food manufacturers, are from time to time subject to various administrative, regulatory, and other legal proceedings arising in the ordinary course of business. We are currently a defendant in a variety of such legal proceedings. We cannot predict with certainty the ultimate results of these proceedings or reasonably determine a range of potential loss. Our policy is to accrue costs for contingent liabilities when such liabilities are probable and amounts can be reasonably estimated. Based on the information known to date, we do not believe the final outcome of these proceedings will have a material adverse effect on our financial position, results of operations, or cash flows.
Note 11: Derivative Financial Instruments
We are exposed to market risks, such as changes in commodity prices, foreign currency exchange rates, and interest rates. To manage the volatility related to these exposures, we enter into various derivative transactions. We have policies in place that define acceptable instrument types we may enter into and establish controls to limit our market risk exposure.
Commodity Price Management: We enter into commodity futures and options contracts to manage the price volatility and reduce the variability of future cash flows related to anticipated inventory purchases of key raw materials, notably green coffee, edible oils, and flour. We also enter into commodity futures and options contracts to manage price risk for energy input costs, including natural gas and diesel fuel. The derivative instruments generally have maturities of less than one year.
Effective May 1, 2014, we elected to no longer qualify commodity derivatives for hedge accounting treatment and as a result the derivative gains and losses are immediately recognized in earnings. Prior to 2015, certain of our derivative instruments met the hedge criteria and were accounted for as cash flow hedges. The mark-to-market gains and losses on qualifying hedges were deferred and included as a component of accumulated other comprehensive loss to the extent effective, and reclassified to cost of products sold in the period during which the hedged transaction affected earnings. The deferred net gains included in accumulated other
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comprehensive loss, net of tax, were $18.3 at April 30, 2014, and $6.5 at October 31, 2014. Although we no longer perform the assessments required to achieve hedge accounting for derivative positions, we believe all of our commodity derivatives are economic hedges of our risk exposure.
The commodities hedged have a high inverse correlation to price changes of the derivative commodity instrument. Thus, we would expect that any gain or loss in the estimated fair value of the derivatives would generally be offset by an increase or decrease in the estimated fair value of the underlying exposure.
Foreign Currency Exchange Rate Hedging: We utilize foreign currency forwards and options contracts to manage the effect of foreign currency exchange fluctuations on future cash payments primarily related to purchases of certain raw materials and finished goods in Canada. The contracts generally have maturities of less than one year.
Effective May 1, 2014, we elected to no longer qualify instruments used to manage foreign currency exchange exposures for hedge accounting treatment. Prior to 2015, instruments used to manage foreign currency exchange exposures did not qualify for hedge accounting treatment and the change in value of these instruments was immediately recognized in cost of products sold.
Interest Rate Hedging: We utilize derivative instruments to manage changes in the fair value and cash flows of our debt. Interest rate swaps mitigate the risk associated with the underlying hedged item. At the inception of the contract, the instrument is evaluated and documented for hedge accounting treatment. If the contract is designated as a cash flow hedge, the mark-to-market gains and losses on the swap are deferred and included as a component of accumulated other comprehensive loss to the extent effective, and reclassified to interest expense in the period during which the hedged transaction affects earnings. If the contract is designated as a fair value hedge, the interest rate swap would be recognized at fair value on the balance sheet and changes in the fair value would be recognized in interest expense. Generally, changes in the fair value of the derivative are equal to changes in the fair value of the underlying debt and have no impact on earnings.
During 2014, we entered into an interest rate swap on the 3.50 percent Senior Notes due October 15, 2021, which was designated as a fair value hedge and used to hedge against the changes in the fair value of the debt. We receive cash flows from the counterparty at a fixed rate and pay the counterparty variable rates based on LIBOR. The difference between the fixed rate and variable rates resulted in a favorable impact to interest expense for the three and six months ended October 31, 2014. The interest rate swap was recognized at fair value in the Condensed Consolidated Balance Sheets at October 31, 2014 and April 30, 2014, and changes in the fair value were recognized in interest expense. The net gain of $27.4 recognized on the derivative instrument at the end of the second quarter had no net impact to earnings, as the change in the fair value of the derivative was equal to the change in fair value of the underlying debt.
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The following table sets forth the gross fair value amounts of derivative instruments recognized in the Condensed Consolidated Balance Sheets.
Derivatives designated as hedging instruments:
Interest rate contract
Commodity contracts
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments:
Foreign currency exchange contracts
Total derivatives not designated as hedging instruments
Total derivative instruments
We have elected to not offset fair value amounts recognized for our exchange-traded commodity derivative instruments and our cash margin accounts executed with the same counterparty that are generally subject to enforceable netting agreements. We are required to maintain cash margin accounts in connection with funding the settlement of our open positions. At October 31, 2014 and April 30, 2014, we maintained cash margin account balances of $9.4 and $8.1, respectively, included in other current assets in the Condensed Consolidated Balance Sheets. The change in the cash margin account balances is included in other – net, investing in the Condensed Statements of Consolidated Cash Flows. In the event of default and immediate net settlement of all of our open positions with individual counterparties, all of our derivative liabilities would be fully offset by either our derivative asset positions or margin accounts based on the net asset or liability position with our individual counterparties.
The following table presents information on pre-tax commodity contract gains and losses recognized on derivatives designated as cash flow hedges prior to May 1, 2014, and pre-tax losses related to the termination of a prior interest rate swap.
Losses recognized in other comprehensive loss (effective portion)
Gains (losses) reclassified from accumulated other comprehensive loss to cost of products sold (effective portion)
Losses reclassified from accumulated other comprehensive loss to interest expense (effective portion)
Change in accumulated other comprehensive loss
Included as a component of accumulated other comprehensive loss were deferred pre-tax net gains of $10.3 and $29.1 at October 31, 2014 and April 30, 2014, respectively, related to commodity contracts. The related tax expense recognized in accumulated other comprehensive loss was $3.8 and $10.8 at October 31, 2014 and April 30, 2014, respectively. The entire amount included in accumulated other comprehensive loss is expected to be recognized in earnings this fiscal year as the related commodities are sold.
Included as a component of accumulated other comprehensive loss were deferred pre-tax losses of $4.5 and $4.8 at October 31, 2014 and April 30, 2014, respectively, related to the termination of a prior interest rate swap in October 2011 on the 3.50 percent Senior Notes due October 15, 2021. The related tax benefit recognized in accumulated other comprehensive loss was $1.5 and $1.7 at October 31, 2014 and April 30, 2014, respectively. Approximately $0.6 of the pre-tax loss will be recognized over the next 12 months.
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The following table presents the net gains and losses recognized in cost of products sold on derivatives not designated as qualified hedging instruments.
Gains (losses) on commodity contracts
Gains on foreign currency exchange contracts
Total gains (losses) recognized in cost of products sold
Commodity and foreign currency exchange derivative gains and losses are reported in unallocated derivative gains and losses outside of segment operating results until the related inventory is sold. At that time, we reclassify the hedge gains and losses from unallocated derivative gains and losses to segment profit, allowing our segments to realize the economic effect of the hedge without experiencing any mark-to-market volatility. The following table presents the activity in unallocated derivative gains and losses.
Net gains (losses) on mark-to-market valuation of unallocated derivative positions
Net losses (gains) on derivative positions reclassified to segment operating profit
Net mark-to-market valuation of certain derivative positions recognized in unallocated derivative gains (losses)
As of October 31, 2014, net realized losses of $2.1 were included in unallocated derivative gains and losses.
The following table presents the gross contract notional value of outstanding derivative contracts.
Note 12: Other Financial Instruments and Fair Value Measurements
Financial instruments, other than derivatives, that potentially subject us to significant concentrations of credit risk consist principally of cash investments and trade receivables. The carrying value of these financial instruments approximates fair value. Our other financial instruments, with the exception of long-term debt, are recognized at estimated fair value in the Condensed Consolidated Balance Sheets.
The following table provides information on the carrying amounts and fair values of our financial instruments.
Other investments
Derivative financial instruments – net
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions.
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The following tables summarize the fair values and the levels within the fair value hierarchy in which the fair value measurements fall for our financial instruments.
Other investments: (A)
Equity mutual funds
Municipal obligations
Money market funds
Derivative financial instruments: (B)
Commodity contracts – net
Foreign currency exchange contracts – net
Interest rate contract – net
Long-term debt (C)
Total financial instruments measured at fair value
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Note 13: Income Taxes
During the three-month and six-month period ended October 31, 2014, the effective income tax rate varied from the U.S. statutory income tax rate primarily due to the domestic manufacturing deduction, partially offset by state income taxes.
Within the next 12 months, it is reasonably possible that we could decrease our unrecognized tax benefits by an additional $0.4, primarily as a result of expiring statute of limitations periods.
Note 14: Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss, including the reclassification adjustments for items that are reclassified from accumulated other comprehensive loss to net income, are shown below.
Balance at May 1, 2014
Reclassification adjustments
Current period (charge) credit
Income tax benefit (expense)
Income tax expense
Balance at October 31, 2013
Note 15: Guarantor and Non-Guarantor Financial Information
Our 3.50 percent Senior Notes due October 15, 2021, are fully and unconditionally guaranteed, on a joint and several basis, by J.M. Smucker LLC and The Folgers Coffee Company (the “subsidiary guarantors”), which are 100 percent wholly-owned subsidiaries of the Company. A subsidiary guarantor will be released from its obligations under the indenture governing the notes (a) if we exercise our legal or covenant defeasance option or if our obligations under the indenture are discharged in accordance with the terms of the indenture or (b) upon delivery of an officer’s certificate to the trustee that the subsidiary guarantor does not guarantee our obligations under any of our other primary senior indebtedness and that any other guarantees of such primary senior indebtedness of the subsidiary guarantor have been released other than through discharges as a result of payment by such guarantor on such guarantees.
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Condensed consolidating financial statements for the Company, the subsidiary guarantors, and the other subsidiaries of the Company that are not guaranteeing the indebtedness under the 3.50 percent Senior Notes (the “non-guarantor subsidiaries”) are provided below. The principal elimination entries relate to investments in subsidiaries and intercompany balances and transactions, including transactions with our 100 percent wholly-owned subsidiary guarantors and non-guarantor subsidiaries. We have accounted for investments in subsidiaries using the equity method.
CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
Selling, distribution, and administrative expenses and other special project costs
Other operating (income) expense – net
Interest (expense) income – net
Other income – net
Equity in net earnings of subsidiaries
Other comprehensive (loss) income, net of tax
Other expense – net
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CONDENSED CONSOLIDATING BALANCE SHEETS
Property, Plant, and Equipment – Net
Investments in Subsidiaries
Intercompany Receivable
Intercompany payable
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CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Net Cash (Used for) Provided by Operating Activities
Equity investments in subsidiaries
(Disbursements of) repayments from intercompany loans
Net Cash (Used for) Provided by Investing Activities
Revolving credit facility – net
Investments in subsidiaries
Net increase (decrease) in cash and cash equivalents
Repayments from (disbursements of) intercompany loans
Revolving credit facility - net
Effect of exchange rate changes
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This discussion and analysis deals with comparisons of material changes in the unaudited condensed consolidated financial statements for the three-month and six-month periods ended October 31, 2014 and 2013. Results for the quarter and six months ended October 31, 2014 and 2013, include Sahale Snacks, Inc. (“Sahale”) since the completion of the acquisition on September 2, 2014, Enray Inc. (“Enray”) since the completion of the acquisition on August 20, 2013, and the impact of our licensing and distribution agreement with Cumberland Packing Corp. (“Cumberland”), which commenced on July 1, 2013.
We are the owner of all trademarks, except for the following, which are used under license: Pillsbury, the Barrelhead logo, and the Doughboy character are trademarks of The Pillsbury Company, LLC; Carnation® is a trademark of Société des Produits Nestlé S.A.; Dunkin’ Donuts is a registered trademark of DD IP Holder, LLC; Sweet’N Low®,NatraTaste®, Sugar In The Raw®, and the other “In The Raw” trademarks are registered trademarks of Cumberland and its affiliates; and Douwe Egberts® and Pickwick® are registered trademarks of D.E Master Blenders 1753 N.V.Borden® and Elsie are also trademarks used under license.
Dunkin’ Donutsbrand is licensed to us for packaged coffee products sold in retail channels such as grocery stores, mass merchandisers, club stores, and drug stores. Information in this document does not pertain to Dunkin’ Donutscoffee or other products for sale in Dunkin’ Donuts restaurants. K-Cup® is a trademark of Keurig Green Mountain, Inc., used with permission.
Results of Operations
Gross profit
% of net sales
Operating income
Net income:
Gross profit excluding certain items affecting comparability (A)
Operating income excluding certain items affecting comparability(A)
Income excluding certain items affecting comparability: (A)
Income
Income per common share – assuming dilution
Net sales in the second quarter of 2015 decreased 5 percent, compared to the second quarter of 2014, primarily due to the impact of volume declines in the U.S. Retail Coffee segment. Operating income increased 2 percent in the second quarter of 2015, compared to the second quarter of 2014, and decreased 4 percent excluding the impact of restructuring and merger and integration costs and unallocated gains and losses on commodity and foreign currency exchange derivatives (“certain items affecting comparability”). Operating income in the second quarter of 2015, as compared to the second quarter of 2014, was impacted by a $9.1 favorable change in the impact of unallocated derivative gains and losses, which is not reflected in operating income excluding certain items affecting comparability. Net income per diluted share increased 6 percent in the second quarter of 2015, as compared to the second quarter of 2014, while income per diluted share excluding certain items affecting comparability was flat over the same period. Both per share measures reflect the benefit of a decrease in weighted-average common shares outstanding as a result of our share repurchase activities during the second half of 2014 and a reduction in interest expense.
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Net sales in the first six months of 2015 decreased 4 percent, compared to the first six months of 2014, reflecting volume declines and lower net price realization. Operating income also decreased 4 percent and decreased 1 percent excluding certain items affecting comparability. Operating income in the first six months of 2015, as compared to the first six months of 2014, was impacted by a $16.9 unfavorable change in the impact of unallocated derivative gains and losses, which is not reflected in operating income excluding certain items affecting comparability. Net income per diluted share increased 2 percent in the first six months of 2015, as compared to the first six months of 2014, while income per diluted share excluding certain items affecting comparability increased 4 percent over the same period. Both per share measures reflect the benefit of a decrease in weighted-average common shares outstanding as a result of our share repurchase activities during 2014 and a reduction in interest expense.
Net Sales
Adjust for certain noncomparable items:
Acquisitions
Distribution agreement
Foreign currency exchange
Net sales adjusted for certain noncomparable items (A)
Amounts may not add due to rounding.
The net sales decrease in the second quarter of 2015, compared to the second quarter of 2014, was mostly due to the impact of volume declines in the U.S. Retail Coffee segment driven by the Folgers brand. Volume declines were also realized due to the continued impact of the private label hot beverage business exits in the International, Foodservice, and Natural Foods segment and in the Pillsbury and Robin Hood® baking brands. Volume gains were realized in Jif peanut butter, Crisco oils, Smucker’s Uncrustables® frozen sandwiches, and R.W. Knudsen Family® beverages.
Net price realization was essentially flat as higher coffee list prices were offset by promotional coffee spending and lower net pricing for oils, peanut butter, and fruit spreads. Sales mix was unfavorable in the second quarter of 2015, compared to the second quarter of 2014, driven by the volume declines in the U.S. Retail Coffee segment, and represented 2 percentage points of the net sales decrease. The acquired Sahale business and the incremental impact of Enray contributed a combined $10.2 to net sales in the second quarter of 2015.
The net sales decrease in the first six months of 2015, compared to the first six months of 2014, was primarily due to the impact of volume declines in the U.S. Retail Coffee segment driven by the Folgers brand. Volume declines were also realized due to the continued impact of the private label hot beverage business exits and in the Pillsbury baking brand and Santa Cruz Organic® beverages, while gains were realized inCrisco oils and Jif peanut butter.
Lower net price realization, driven by the Crisco and Jif brands, and unfavorable sales mix each represented 1 percentage point of the net sales decrease. Sahale and the incremental impact of Enray and Cumberland contributed a combined $33.8 to net sales in the first six months of 2015.
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The following table presents the components of operating income as a percentage of net sales.
Selling, distribution, and administrative expenses:
Marketing
Selling
Distribution
General and administrative
Total selling, distribution, and administrative expenses
Gross profit decreased $16.1, or 3 percent, in the second quarter of 2015, compared to the second quarter of 2014, driven by lower volume and unfavorable mix. Excluding certain items affecting comparability, which primarily consisted of the impact of unallocated derivative gains and losses, gross profit decreased $27.2, or 5 percent. Effective in 2015, we elected to no longer qualify commodity and foreign currency exchange derivatives for hedge accounting treatment, resulting in immediate recognition of gains and losses on these derivatives in earnings. These amounts are recorded in cost of products sold as unallocated derivative gains and losses and are excluded from segment profit and non-GAAP profit measures until the related inventory is sold. For additional information, see Non-GAAP Measures.
Overall, the net impact of commodity costs and net price realization was slightly favorable to gross profit. Peanut and oil costs were lower and not fully offset by lower net prices in the second quarter of 2015, compared to 2014. This was mostly offset by the impact of higher green coffee costs which were not fully recovered by higher net price realization due to promotional spending.
Selling, distribution, and administrative (“SD&A”) expenses decreased $17.9, or 7 percent, in the second quarter of 2015, compared to the second quarter of 2014, driven by a 19 percent decrease in marketing, which was primarily related to reductions in the U.S. Retail Coffee segment. The decrease in marketing was slightly offset by a 3 percent increase in general and administrative expenses, which was driven by an increase in supply chain support costs as corporate administrative expenses decreased 5 percent.
Operating income increased $4.0, or 2 percent, in the second quarter of 2015, compared to the second quarter of 2014, reflecting a favorable change in certain items affecting comparability. Excluding certain items affecting comparability in both periods, operating income decreased $11.2, or 4 percent.
Gross profit decreased $30.3, or 3 percent, in the first six months of 2015, compared to the first six months of 2014, driven by lower volume. Excluding certain items affecting comparability, which primarily consisted of a $16.9 unfavorable change in the impact of unallocated derivative gains and losses, gross profit decreased $16.5, or 2 percent, during the same period.
Overall, the net impact of commodity costs and net price realization was favorable to gross profit. Peanut costs were lower and not fully offset by lower net prices in the first six months of 2015, compared to 2014. This more than offset the impact of higher green coffee costs which were not recovered by higher net price realization due to promotional spending.
SD&A expenses decreased $14.7, or 3 percent, in the first six months of 2015, compared to the first six months of 2014, due to an 11 percent decrease in marketing, which was driven by reductions in the U.S. Retail Coffee segment.
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Operating income decreased $17.7, or 4 percent, in the first six months of 2015, compared to the first six months of 2014, reflecting the unallocated derivative impact which is not included in operating income excluding certain items affecting comparability, which decreased $5.2, or 1 percent, over the same period.
Interest Expense – Net
Net interest expense decreased $4.3 and $10.7 in the second quarter and first six months of 2015, respectively, compared to 2014, reflecting the impact of long-term debt repayments made over the last 12 months and an interest rate swap entered into during the second quarter of 2014, converting a portion of our long-term debt from a fixed- to a variable-rate basis.
Segment Results
Effective May 1, 2014, commodity and foreign currency exchange derivative gains and losses are reported in unallocated derivative gains and losses outside of segment operating results until the related inventory is sold. At that time we reclassify the hedge gain or loss from unallocated derivative gains and losses to segment profit, allowing our segments to realize the economic effect of the hedge without experiencing any mark-to-market volatility. Prior year results have been modified to exclude the unrealized gains and losses on commodity and foreign currency exchange derivatives.
Segment profit margin:
The U.S. Retail Coffee segment net sales decreased 10 percent in the second quarter of 2015, compared to the second quarter of 2014. The net sales decrease reflects lower volume somewhat offset by favorable sales mix and higher net price realization which resulted from the 9 percent list price increase taken in the first quarter of 2015, driven by higher green coffee costs, offset by promotional spending. Segment volume decreased 18 percent in the second quarter of 2015, compared to the second quarter of 2014, driven by a 20 percent decrease in the Folgers brand. The Folgers brand volume decline was attributed to consumer response to higher promoted price points on shelf for its roast and ground coffee offerings, competitive activity, and reduced promotional effectiveness. Promotional spending decreased sequentially from the first quarter of 2015 resulting in significantly higher promoted price points on shelf. The Café Bustelo brand and Dunkin’ Donuts packaged coffee volumes also decreased in the quarter, 12 percent and 3 percent, respectively. Volume of K-Cup® packs increased 15 percent, while net sales increased 12 percent in the second quarter of 2015, compared to the second quarter of 2014.
The U.S. Retail Coffee segment profit decreased $29.4 in the second quarter of 2015, compared to the second quarter of 2014, driven by lower volume. The net impact of higher green coffee costs and prices was modestly unfavorable to segment profit in the second quarter of 2015, compared to 2014, and was offset by favorable mix. A reduction in marketing expenses contributed favorably to segment profit in the second quarter of 2015, compared to 2014.
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The U.S. Retail Coffee segment net sales decreased 7 percent in the first six months of 2015, compared to the first six months of 2014, driven by a 9 percent volume decline, primarily due to a 10 percent decrease in the Folgers brand. Volume for the Café Bustelo brand increased 5 percent over the same period, while Dunkin’ Donuts packaged coffee volume was flat. The impact of the volume decline was partially offset by favorable sales mix. Net price realization was essentially flat in the first six months of 2015, compared to the first six months of 2014, as the benefit of the recent list price increase was offset by the impact of an increase in promotional spending mostly in the first quarter. Volume and net sales of K-Cup® packs increased 11 percent and 6 percent, respectively, in the first six months of 2015, compared to the first six months of 2014.
The U.S. Retail Coffee segment profit decreased $34.4 in the first six months of 2015, compared to the first six months of 2014, primarily driven by the segment volume decline and K-Cup® pack profitability. ExcludingK-Cup® packs, the net impact of higher green coffee costs and prices was essentially neutral to segment profit in the first six months of 2015, compared to the first six months of 2014. We anticipate an unfavorable relationship between net price realization and green coffee costs during the last six months of 2015, compared to the prior period.
The U.S. Retail Consumer Foods segment volume was flat in the second quarter of 2015, compared to the second quarter of 2014. Segment net sales decreased 1 percent over the same period, reflecting lower net price realization primarily for the Crisco and Jifbrands. The Sahale business contributed $6.0 to segment net sales in the second quarter of 2015.
Jif brand volume increased 2 percent and net sales were flat in the second quarter of 2015, compared to the second quarter of 2014. Smucker’s Uncrustables frozen sandwiches were up 22 percent and 21 percent in volume and net sales, respectively. Crisco brand volume increased 2 percent, while net sales decreased 8 percent, impacted by a 9 percent list price decline taken in the fourth quarter of 2014. Volume for the Pillsbury brand decreased 3 percent, and was the primary contributor to the overall flat segment volume, and net sales decreased 6 percent.
The U.S. Retail Consumer Foods segment profit increased $17.3 in the second quarter of 2015, compared to the second quarter of 2014. Overall lower commodity costs, primarily for peanuts and oils, were partially offset by lower net price realization and drove the segment profit increase. Segment profit in the prior year was impacted by temporary incremental costs at our fruit spreads manufacturing facility and capacity expansion at our Smucker’s Uncrustables facility.
The U.S. Retail Consumer Foods segment volume was flat in the first six months of 2015, compared to the first six months of 2014, and segment net sales decreased 2 percent over the same period, reflecting lower net price realization, primarily for the Crisco andJif brands.
Jif brand volume increased 3 percent in the first six months of 2015, compared to the first six months of 2014, while net sales increased 2 percent. Smucker’s Uncrustables frozen sandwiches were up 17 percent and 16 percent in volume and net sales, respectively. Crisco brand volume increased 6 percent, while net sales decreased 5 percent, impacted by the list price decline. Volume for the overall Pillsbury brand decreased 6 percent, and was the primary contributor to the overall flat segment volume, and net sales decreased 8 percent.
The U.S. Retail Consumer Foods segment profit increased $35.0 in the first six months of 2015, compared to the first six months of 2014, driven by the net benefit of lower peanut costs. While costs were lower for most other commodities, they did not significantly benefit segment profit as they were mostly offset by lower net price realization. Segment profit in the prior year was impacted by temporary incremental costs at our fruit spreads manufacturing facility and capacity expansion at our Smucker’s Uncrustables facility. Effective November 2014 we took a 7 percent price decline on the majority of our peanut butter items sold in the U.S in response to the decrease in our peanut costs.
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Net sales in the International, Foodservice, and Natural Foods segment decreased 2 percent in the second quarter of 2015, compared to the second quarter of 2014. Excluding the impacts of Sahale, Enray, and foreign currency exchange, segment net sales decreased 1 percent and volume decreased 3 percent. The volume decline reflects the impact of the planned exit of our private label foodservice hot beverage business and decreases in the Robin Hood and Five Roses® brands in Canada that offset gains in R.W. Knudsen Family beverages and other brands. Overall net price realization was flat and sales mix was favorable.
The International, Foodservice, and Natural Foods segment profit decreased $2.2 in the second quarter of 2015, compared to the second quarter of 2014. Higher costs were realized in Canada and were attributed to sourcing certain products from the U.S., reflecting the impact of a weaker Canadian dollar compared to a year ago, and an increase in green coffee costs.
Net sales in the International, Foodservice, and Natural Foods segment decreased 2 percent in the first six months of 2015, compared to the first six months of 2014. Excluding the impacts of Sahale, Enray, Cumberland, and foreign currency exchange, segment net sales and volume both decreased 4 percent. The volume decline, which was partially offset by favorable sales mix, reflects the impact of the planned exit of our private label foodservice hot beverage business and decreases in Santa Cruz Organic beverages and the Robin Hood and Five Roses brands in Canada, while gains were achieved in the R.W. Knudsen Family brand.
The International, Foodservice, and Natural Foods segment profit decreased $9.9 in the first six months of 2015, compared to the first six months of 2014, primarily due to the realization of higher costs in Canada, which were attributed to sourcing certain products from the U.S., reflecting the impact of a weaker Canadian dollar compared to a year ago, and an increase in green coffee costs. Additionally, trade spending related to foodservice coffee was higher in the first six months of 2015, compared to the first six months of 2014, while mix was favorable.
Financial Condition – Liquidity and Capital Resources
Liquidity
On an annual basis, our principal source of funds is cash generated from operations, supplemented by borrowings against our commercial paper program and revolving credit facility. Total cash and cash equivalents at October 31, 2014, were $105.3, compared to $153.5 at April 30, 2014.
We typically expect a significant use of cash to fund working capital requirements during the first half of each fiscal year, primarily due to the buildup of inventories to support the Fall Bake and Holiday period, the additional increase of coffee inventory in advance of the Atlantic hurricane season, and seasonal fruit procurement. We expect cash provided by operations in the second half of the fiscal year to significantly exceed the amount in the first half of the year, upon completion of the Fall Bake and Holiday period.
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The following table presents selected cash flow information.
Net cash provided by operating activities
Net cash used for investing activities
Net cash provided by (used for) financing activities
Free cash flow (A)
Cash provided by operating activities decreased $84.1 in the first six months of 2015, compared to the first six months of 2014, primarily due to a greater amount of cash required to fund working capital in 2015. The increase was partially driven by higher green coffee costs in 2015, as compared to the prior year.
Cash used for investing activities in the first six months of 2015 consisted primarily of $113.7 in capital expenditures and $80.3 related to the acquisition of Sahale. Cash used for investing activities in the first six months of 2014 consisted primarily of $102.0 related to the acquisitions of Enray and Silocaf of New Orleans, Inc., as well as $83.4 in capital expenditures. For additional information on this year’s acquisition of Sahale, see Note 3: Acquisitions.
Cash provided by financing activities in the first six months of 2015 consisted primarily of $297.5 of net borrowings under our commercial paper program and revolving credit facility, mostly offset by the $100.0 repayment of the 4.78 percent Senior Notes and quarterly dividend payments of $123.9. Cash used for financing activities in the first six months of 2014 consisted primarily of the purchase of treasury shares for $165.5 and quarterly dividend payments of $116.4, partially offset by net borrowings under our revolving credit facility of $207.0.
Capital Resources
The following table presents our capital structure.
Long-term debt, less current portion
Total debt
Shareholders’ equity
Total capital
We have available a $1.5 billion revolving credit facility with a group of 11 banks that matures in September 2018. Additionally, during the second quarter of 2015, we entered into a commercial paper program under which we can issue short-term, unsecured commercial paper not to exceed $1.0 billion at any time. The commercial paper program is backed by our revolving credit facility and reduces what we can borrow under the revolving credit facility by the amount of commercial paper outstanding. As of October 31, 2014, we had $545.9 of short-term borrowings outstanding, all of which were under our commercial paper program, at a weighted-average interest rate of 0.31 percent. As of November 25, 2014, we had $408.0 of commercial paper borrowings, at a weighted-average interest rate of 0.32 percent, and no outstanding balance under the revolving credit facility. We are in compliance with all of our debt covenants. For additional information on our revolving credit facility, commercial paper program, and debt covenants, see Note 7: Debt and Financing Arrangements.
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As of October 31, 2014, we had approximately 10.0 million common shares available for repurchase under Board of Directors’ authorizations, including 5.0 million common shares which were authorized in October 2014. There is no guarantee as to the exact number of shares that may be repurchased or when such purchases may occur.
Absent any material acquisitions or other significant investments, we believe cash on hand, combined with cash provided by operations and borrowings available under our commercial paper program and revolving credit facility, will be sufficient to meet cash requirements for the next 12 months, including capital expenditures, the payment of quarterly dividends, interest and principal payments on debt outstanding, and share repurchases. As of October 31, 2014, total cash and cash equivalents of $92.5 was held by our international subsidiaries. We do not intend to repatriate these funds to meet any of these cash requirements. Should we repatriate these funds, we will be required to pay taxes based on the applicable U.S. tax rates net of any foreign tax credit consideration.
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Non-GAAP Measures
We use non-GAAP financial measures including: net sales adjusted for the noncomparable impact of the Sahale acquisition, the incremental impact of the Enray acquisition and the Cumberland distribution agreement, and foreign currency exchange; gross profit, operating income, income, and income per diluted share, excluding certain items affecting comparability; and free cash flow, as key measures for purposes of evaluating performance internally. In addition, income per diluted share excluding certain items affecting comparability is used as a component of the Board of Director’s measurement of performance for incentive compensation purposes. We believe that these measures provide useful information to investors because they are the measures we use to evaluate performance on a comparable year-over-year basis. Effective May 1, 2014, we have defined certain items affecting comparability to include restructuring and merger and integration costs (“special project costs”) and unallocated gains and losses on commodity and foreign currency exchange derivatives (“unallocated derivative gains and losses”) and modified prior year results to conform to the new definition. The special project costs in the table below relate to specific restructuring and merger and integration projects that are each nonrecurring in nature and can significantly affect the year-over-year assessment of operating results. Unallocated derivative gains and losses reflect the changes in fair value of our commodity and foreign currency exchange contracts and also affect comparability on a year-over-year basis. These non-GAAP financial measures are not intended to replace the presentation of financial results in accordance with U.S. generally accepted accounting principles (“GAAP”). Rather, the presentation of these non-GAAP financial measures supplements other metrics we use to internally evaluate our businesses and facilitate the comparison of past and present operations and liquidity. These non-GAAP financial measures may not be comparable to similar measures used by other companies and may exclude certain nondiscretionary expenses and cash payments. The following table reconciles certain non-GAAP financial measures to the comparable GAAP financial measure and prior years’ measures have been revised to reflect the change discussed above. See page 27 for a reconciliation of free cash flow to the comparable GAAP financial measure.
Reconciliation to gross profit:
Unallocated derivative (gains) losses
Gross profit excluding certain items affecting comparability
Reconciliation to operating income:
Operating income excluding certain items affecting comparability
Reconciliation to net income:
Income before income taxes excluding certain items affecting comparability
Income taxes, as adjusted
Income excluding certain items affecting comparability
Weighted-average shares – assuming dilution
Income per common share excluding certain items affecting comparability – assuming dilution
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Off-Balance Sheet Arrangements and Contractual Obligations
We do not have material off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as variable interest entities. Transactions with related parties are in the ordinary course of business and not material to our results of operations, financial condition, or cash flows.
The following table summarizes our contractual obligations by fiscal year at October 31, 2014.
Long-term debt obligations
Interest payments
Operating lease obligations
Purchase obligations
Other liabilities
Total
Long-term debt obligations and interest payments in the above table exclude the impact of any interest rate swaps or offering discounts. Purchase obligations include agreements that are enforceable and legally bind us to purchase goods or services. Included in this category are certain obligations related to normal, ongoing purchase obligations in which we have guaranteed payment to ensure availability of raw materials and packaging supplies. We expect to receive consideration for these purchase obligations in the form of materials. These purchase obligations do not represent the entire anticipated purchases in the future, but represent only those items for which we are contractually obligated. Other liabilities in the above table mainly consist of projected commitments associated with our defined benefit pension plans and other postretirement benefits. The table excludes the liability for unrecognized tax benefits and tax-related net interest and penalties of approximately $33.5 under Financial Accounting Standards Board Accounting Standards Codification 740, Income Taxes, since we are unable to reasonably estimate the timing of cash settlements with the respective taxing authorities.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to market risk related to changes in interest rates, foreign currency exchange rates, and commodity prices.
Interest Rate Risk: The fair value of our cash and cash equivalents at October 31, 2014, approximates carrying value. Exposure to interest rate risk on our long-term debt is mitigated due to fixed-rate maturities.
We utilize derivative instruments to manage changes in the fair value of our debt. Interest rate swaps mitigate the risk associated with the underlying hedged item. At the inception of the contract, the instrument is evaluated and documented for hedge accounting treatment. If the contract is designated as a cash flow hedge, the mark-to-market gains or losses on the swap are deferred and included as a component of accumulated other comprehensive loss to the extent effective, and reclassified to interest expense in the period during which the hedged transaction affects earnings. If the contract is designated as a fair value hedge, the swap would be recognized at fair value on the balance sheet, and changes in the fair value would be recognized in interest expense. Generally, changes in the fair value of the derivative are equal to changes in the fair value of the underlying debt and have no net impact on earnings. We entered into an interest rate swap during 2014, designated as a fair value hedge, on a portion of fixed-rate Senior Notes in an effort to achieve a mix of variable- versus fixed-rate debt under favorable market conditions.
Based on our overall interest rate exposure as of and during the three months ended October 31, 2014, including derivatives and other instruments sensitive to interest rates, a hypothetical 10 percent movement in interest rates would not materially affect our results of operations. In measuring interest rate risk by the amount of net change in the fair value of our financial liabilities, a hypothetical 1 percent decrease in interest rates at October 31, 2014, would increase the fair value of our long-term debt by $81.7.
Foreign Currency Exchange Risk: We have operations outside the U.S. with foreign currency denominated assets and liabilities, primarily denominated in Canadian currency. Because we have foreign currency denominated assets and liabilities, financial exposure may result, primarily from the timing of transactions and the movement of exchange rates. The foreign currency balance sheet exposures as of October 31, 2014, are not expected to result in a significant impact on future earnings or cash flows.
We utilize foreign currency exchange forwards and options contracts to manage the price volatility of foreign currency exchange fluctuations on future cash payments in Canada, primarily related to purchases of certain raw materials and finished goods. The contracts generally have maturities of less than one year. Effective May 1, 2014, we elected to no longer qualify instruments used to manage foreign currency exchange exposures for hedge accounting treatment. Therefore, the gains and losses on all foreign currency forwards and options contracts will be immediately recognized in cost of products sold. Based on our hedged foreign currency positions as of October 31, 2014, a hypothetical 10 percent change in exchange rates would not result in a material loss of fair value.
Revenues from customers outside the U.S., subject to foreign currency exchange, represented 8 percent of net sales during the six-month period ended October 31, 2014. Thus, certain revenues and expenses have been, and are expected to be, subject to the effect of foreign currency fluctuations, and these fluctuations may have an impact on operating results.
Commodity Price Risk: We use certain raw materials and other commodities that are subject to price volatility caused by supply and demand conditions, political and economic variables, weather, investor speculation, and other unpredictable factors. To manage the volatility related to anticipated commodity purchases, we use futures and options with maturities of generally less than one year. Effective May 1, 2014, we elected to no longer qualify commodity derivatives for hedge accounting treatment. As a result, the gains and losses on all commodity derivatives will be immediately recognized in cost of products sold.
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The following sensitivity analysis presents our potential loss of fair value resulting from a hypothetical 10 percent change in market prices related to commodities.
High
Low
Average
The estimated fair value was determined using quoted market prices and was based on our net derivative position by commodity for the previous four quarters. The calculations are not intended to represent actual losses in fair value that we expect to incur. In practice, as markets move, we actively manage our risk and adjust hedging strategies as appropriate. The commodities hedged have a high inverse correlation to price changes of the derivative commodity instrument; thus, we would expect that any gain or loss in the estimated fair value of its derivatives would generally be offset by an increase or decrease in the estimated fair value of the underlying exposures.
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Certain Forward-Looking Statements
Certain statements included in this Quarterly Report contain forward-looking statements within the meaning of federal securities laws. The forward-looking statements may include statements concerning our current expectations, estimates, assumptions, and beliefs concerning future events, conditions, plans, and strategies that are not historical fact. Any statement that is not historical in nature is a forward-looking statement and may be identified by the use of words and phrases such as “expects,” “anticipates,” “believes,” “will,” “plans,” and similar phrases.
Federal securities laws provide a safe harbor for forward-looking statements to encourage companies to provide prospective information. We are providing this cautionary statement in connection with the safe harbor provisions. Readers are cautioned not to place undue reliance on any forward-looking statements, as such statements are by nature subject to risks, uncertainties, and other factors, many of which are outside of our control and could cause actual results to differ materially from such statements and from our historical results and experience. These risks and uncertainties include, but are not limited to, the following:
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Readers are cautioned not to unduly rely on such forward-looking statements, which speak only as of the date made, when evaluating the information presented in this Quarterly Report. We do not undertake any obligation to update or revise these forward-looking statements to reflect new events or circumstances.
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Evaluation of Disclosure Controls and Procedures. Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of October 31, 2014 (the “Evaluation Date”). Based on that evaluation, our principal executive officer and principal financial officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed in reports that we file or submit under the Exchange Act is (1) recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to management, including the chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Controls. There were no changes in our internal control over financial reporting that occurred during the quarter ended October 31, 2014, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Our business, operations, and financial condition are subject to various risks and uncertainties. The risk factors described in “Part I, Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended April 30, 2014, should be carefully considered, together with the other information contained or incorporated by reference in this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission, in connection with evaluating the Company, our business, and the forward-looking statements contained in this Quarterly Report. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may affect us. The occurrence of any of these known or unknown risks could have a material adverse impact on our business, financial condition, and results of operations.
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(a) Not applicable.
(b) Not applicable.
(c) Issuer Purchases of Equity Securities
Period
August 1, 2014 - August 31, 2014
September 1, 2014 - September 30, 2014
October 1, 2014 - October 31, 2014
Information set forth in the table above represents the activity in our second fiscal quarter.
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See the Index of Exhibits that appears on Page No. 40 of this report.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
/s/ Richard K. Smucker
/s/ Mark R. Belgya
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INDEX OF EXHIBITS
Exhibit
No.
Description
40