Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Dollars and shares in millions, unless otherwise noted, except per share data
This discussion and analysis deals with comparisons of material changes in the unaudited condensed consolidated financial statements for the
three
-month periods ended
July 31, 2017
and
2016
. All comparisons presented are to the corresponding period of the prior year, unless otherwise noted.
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 Packing Corp. and its affiliates; and
Douwe Egberts
®
and
Pickwick
®
are registered trademarks of Jacobs Douwe Egberts.
Dunkin’ Donuts
brand is licensed to us for packaged coffee products, including K-Cup
®
pods, sold in retail channels such as grocery stores, mass merchandisers, club stores, and drug stores. Information in this document does not pertain to
Dunkin’ Donuts
coffee 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
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2017
|
|
2016
|
|
% Increase (Decrease)
|
Net sales
|
$
|
1,748.9
|
|
|
$
|
1,815.8
|
|
|
(4
|
)%
|
Gross profit
|
$
|
662.1
|
|
|
$
|
722.7
|
|
|
(8
|
)
|
% of net sales
|
37.9
|
%
|
|
39.8
|
%
|
|
|
Operating income
|
$
|
233.8
|
|
|
$
|
293.8
|
|
|
(20
|
)
|
% of net sales
|
13.4
|
%
|
|
16.2
|
%
|
|
|
Net income:
|
|
|
|
|
|
Net income
|
$
|
126.8
|
|
|
$
|
170.0
|
|
|
(25
|
)
|
Net income per common share – assuming dilution
|
$
|
1.12
|
|
|
$
|
1.46
|
|
|
(23
|
)
|
Adjusted gross profit
(A)
|
$
|
650.2
|
|
|
$
|
719.0
|
|
|
(10
|
)
|
% of net sales
|
37.2
|
%
|
|
39.6
|
%
|
|
|
Adjusted operating income
(A)
|
$
|
300.5
|
|
|
$
|
364.0
|
|
|
(17
|
)
|
% of net sales
|
17.2
|
%
|
|
20.0
|
%
|
|
|
Adjusted income:
(A)
|
|
|
|
|
|
Income
|
$
|
171.6
|
|
|
$
|
217.2
|
|
|
(21
|
)
|
Earnings per share – assuming dilution
|
$
|
1.51
|
|
|
$
|
1.86
|
|
|
(19
|
)
|
|
|
(A)
|
We use non-GAAP financial measures to evaluate our performance. Refer to “Non-GAAP Financial Measures” in this discussion and analysis for a reconciliation to the comparable GAAP financial measure.
|
Net sales decreased
4 percent
in the
first
quarter of
2018
, reflecting declines within the U.S. Retail Consumer Foods and U.S. Retail Coffee segments. The overall net sales decline was driven by unfavorable volume/mix, which was partially offset by higher net price realization in the current year. Operating income decreased
20 percent
, primarily due to reduced gross profit, mainly driven by the U.S. Retail Coffee and U.S. Retail Pet Foods segments. Operating income excluding non-GAAP adjustments (“adjusted operating income”) decreased
17 percent
in the
first
quarter of 2018. Our non-GAAP adjustments include amortization expense and impairment charges related to intangible assets, integration and restructuring costs, and unallocated gains and losses on commodity and foreign currency exchange derivatives. Net income per diluted share decreased
23 percent
in the
first
quarter of
2018
, while income per diluted share excluding non-GAAP adjustments (“adjusted earnings per share”) decreased
19 percent
. Both 2018 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 fourth quarter of 2017.
Net Sales
Net sales in the first quarter of 2018 decreased $66.9, or 4 percent, reflecting a 5 percentage point impact from unfavorable volume/mix. This was driven by declines in several categories, notably coffee and oils, which were partially offset by gains in
pet food. Net price realization contributed 1 percentage point to net sales, as higher net pricing for coffee and the
Smucker's
brand was partially offset by lower net pricing within the U.S. Retail Pet Foods segment.
Operating Income
The following table presents the components of operating income as a percentage of net sales.
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2017
|
|
2016
|
Gross profit
|
37.9
|
%
|
|
39.8
|
%
|
Selling, distribution, and administrative expenses:
|
|
|
|
Marketing
|
6.6
|
%
|
|
6.0
|
%
|
Selling
|
3.8
|
|
|
3.6
|
|
Distribution
|
3.3
|
|
|
3.3
|
|
General and administrative
|
6.3
|
|
|
6.7
|
|
Total selling, distribution, and administrative expenses
|
20.0
|
%
|
|
19.6
|
%
|
|
|
|
|
Amortization
|
2.9
|
|
|
2.8
|
|
Other special project costs
|
1.5
|
|
|
1.2
|
|
Other operating expense (income) – net
|
—
|
|
|
(0.1
|
)
|
Operating income
|
13.4
|
%
|
|
16.2
|
%
|
Amounts may not add due to rounding.
Gross profit decreased $60.6, or
8 percent
, in the
first
quarter of
2018
, primarily driven by unfavorable volume/mix. A net unfavorable impact of increased costs and pricing, mainly within the U.S. Retail Coffee and U.S. Retail Pet Foods segments, also contributed to the gross profit decline. Selling, distribution, and administrative (“SD&A”) expenses decreased $5.8, as benefits from our cost savings initiatives more than offset a 6 percent increase in marketing expense. Operating income decreased $60.0, or
20 percent
, in the
first
quarter of
2018
. Gross profit excluding non-GAAP adjustments (“adjusted gross profit”) decreased $68.8, or
10 percent
, while adjusted operating income decreased $63.5, or
17 percent
.
Income Taxes
Income taxes decreased 25 percent in the
first
quarter of 2018, entirely due to the decrease in income before income taxes. The effective tax rate of 32.9 percent for the
first
quarter of 2018 was consistent with the prior year. We anticipate a full-year effective tax rate for 2018 in the range of 32.5 to 33.0 percent.
Integration Activities
Total one-time costs related to the acquisition of Big Heart Pet Brands (“Big Heart”) at the end of 2015 are anticipated to be approximately $290.0 and will be incurred through 2018. These costs primarily consist of employee-related costs, outside service and consulting costs, and other costs related to the acquisition. We have incurred total cumulative costs of $256.4 related to the integration of Big Heart, including $11.1 in the
first
quarter of
2018
.
We anticipate net realized synergies related to the Big Heart acquisition of approximately $200.0 annually by the end of 2018. To date, we have realized $177.8 of that goal, reflecting $18.8 of synergies in the
first
quarter of
2018
that were incremental to those achieved in the first quarter of 2017.
Restructuring Activities
An organization optimization program was approved by the Board of Directors during the fourth quarter of 2016. Under this program, we identified opportunities to reduce costs and optimize the organization, which we expect to achieve by the end of 2018. Related projects include an organizational redesign and the optimization of our manufacturing footprint. During the third quarter of 2017, we exited two leased facilities in Livermore, California, and consolidated all ancient grains and pasta production into our facility in Chico, California. Additionally, we will consolidate all coffee production at our Harahan, Louisiana, facility into one of our facilities in New Orleans, Louisiana, by December 31, 2017. Upon completion of these initiatives, the organization optimization program will result in total headcount reductions of approximately
275
full-time positions, of which approximately
80 percent
were reduced as of
July 31, 2017
.
Upon completion of this program in 2018, total restructuring costs related to the program are expected to be approximately
$45.0
, of which the majority represents employee-related costs, while the remainder primarily consists of site preparation, equipment relocation, and production start-up costs at the impacted facilities. We have incurred total cumulative restructuring costs of $36.6, including $16.7 in the
first
quarter of
2018
.
We expect to achieve approximately $50.0 of annual cost reductions related to our organization optimization program, mainly during 2018, and plan to invest these savings in our businesses.
Cost Management Program
In addition to our organization optimization program, we announced a separate cost management program during the fourth quarter of 2017, which is comprised of several cost reduction initiatives, including zero-based budgeting, SKU rationalization, and revenue growth management. We expect to realize approximately $200.0 of cost reductions annually by the end of 2020 as a result of these initiatives.
Segment Results
We have
three
reportable segments: U.S. Retail Coffee, U.S. Retail Consumer Foods, and U.S. Retail Pet Foods. Within our segment results, International and Away From Home, previously referred to as International and Foodservice, represents a combination of the strategic business areas not included in the U.S. retail market segments. The U.S. Retail Coffee segment primarily includes the domestic sales of
Folgers,
Dunkin’ Donuts,
and
Café
Bustelo
branded coffee; the U.S. Retail Consumer Foods segment primarily includes domestic sales of
Jif
,
Smucker’s
,
Crisco
, and
Pillsbury
branded products; and the U.S. Retail Pet Foods segment primarily includes domestic sales of
Meow Mix
,
Milk-Bone
,
Natural Balance
,
Kibbles ’n Bits
,
9Lives
,
Pup-Peroni
, and
Nature’s Recipe
branded products. International and Away From Home is comprised of products distributed domestically and in foreign countries through retail channels and foodservice distributors and operators (e.g., restaurants, lodging, schools and universities, health care operators).
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2017
|
|
2016
|
|
% Increase
(Decrease)
|
Net sales:
|
|
|
|
|
|
U.S. Retail Coffee
|
$
|
480.8
|
|
|
$
|
513.3
|
|
|
(6
|
)%
|
U.S. Retail Consumer Foods
|
492.4
|
|
|
537.0
|
|
|
(8
|
)
|
U.S. Retail Pet Foods
|
521.7
|
|
|
519.5
|
|
|
—
|
|
International and Away From Home
|
254.0
|
|
|
246.0
|
|
|
3
|
|
Segment profit:
|
|
|
|
|
|
|
U.S. Retail Coffee
|
$
|
123.8
|
|
|
$
|
173.8
|
|
|
(29
|
)%
|
U.S. Retail Consumer Foods
|
110.9
|
|
|
111.4
|
|
|
—
|
|
U.S. Retail Pet Foods
|
98.3
|
|
|
122.2
|
|
|
(20
|
)
|
International and Away From Home
|
38.3
|
|
|
39.5
|
|
|
(3
|
)
|
Segment profit margin:
|
|
|
|
|
|
U.S. Retail Coffee
|
25.7
|
%
|
|
33.9
|
%
|
|
|
U.S. Retail Consumer Foods
|
22.5
|
|
|
20.7
|
|
|
|
U.S. Retail Pet Foods
|
18.8
|
|
|
23.5
|
|
|
|
International and Away From Home
|
15.1
|
|
|
16.1
|
|
|
|
U.S. Retail Coffee
The U.S. Retail Coffee segment net sales decreased $32.5 in the
first
quarter of
2018
. Volume/mix reduced net sales by 8 percent, driven by declines for the
Folgers
brand, partially offset by gains for the
Dunkin’
Donuts
and
Café Bustelo
brands. Net price realization improved, adding 2 percent to net sales. Segment profit decreased $50.0, primarily due to the impact of volume/mix and the net unfavorable impact of
higher commodity costs and higher pricing
. We anticipate that the impact of higher costs will moderate throughout the remainder of the year.
U.S. Retail Consumer Foods
The U.S. Retail Consumer Foods segment net sales decreased $44.6 in the
first
quarter of
2018
. Volume/mix reduced net sales by 11 percent, primarily driven by the
Crisco
,
Pillsbury
, and
Smucker's
brands. Net price realization was higher and added 3 percent to net sales, primarily attributed to the
Smucker's
and
Crisco
brands. Segment profit was comparable to the prior year as the impact of unfavorable volume/mix was offset by higher pricing and reduced marketing expense.
U.S. Retail Pet Foods
The U.S. Retail Pet Foods segment net sales increased $2.2 in the
first
quarter of
2018
. Improved volume/mix, primarily related to the
Nature’s Recipe
and
Natural Balance
brands, increased net sales by 2 percent. We expanded distribution of the
Nature's Recipe
brand into grocery and mass merchandise outlets during the third quarter of 2017. The impact of volume/mix was mostly offset by lower net price realization. Segment profit decreased $23.9, primarily due to the net unfavorable impact of lower pricing and higher costs, as well as increased marketing expense.
International and Away From Home
International and Away From Home net sales increased $8.0 in the
first
quarter of
2018
, reflecting favorable volume/mix, driven by the
Jif
and
Smucker's
brands. Net price realization improved, but was offset by the unfavorable impact of foreign currency exchange. Segment profit decreased $1.2 as the contribution from the net sales increase was more than offset by the foreign currency exchange impact and higher commodity costs.
Financial Condition – Liquidity and Capital Resources
Liquidity
Our principal source of funds is cash generated from operations, supplemented by borrowings against our commercial paper program and revolving credit facility. At
July 31, 2017
, total cash and cash equivalents was
$183.2
, compared to
$166.8
at
April 30, 2017
.
Within the U.S. Retail Coffee and U.S. Retail Consumer Foods segments, we generally 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. In these businesses, 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. However, the impact of seasonality on our overall working capital requirements is partially reduced by the U.S. Retail Pet Foods segment, which does not experience significant seasonality.
The following table presents selected cash flow information.
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2017
|
|
2016
|
Net cash provided by (used for) operating activities
|
$
|
304.3
|
|
|
$
|
238.9
|
|
Net cash provided by (used for) investing activities
|
(38.1
|
)
|
|
(62.5
|
)
|
Net cash provided by (used for) financing activities
|
(260.1
|
)
|
|
(173.2
|
)
|
|
|
|
|
Net cash provided by (used for) operating activities
|
$
|
304.3
|
|
|
$
|
238.9
|
|
Additions to property, plant, and equipment
|
(69.6
|
)
|
|
(50.2
|
)
|
Free cash flow
(A)
|
$
|
234.7
|
|
|
$
|
188.7
|
|
|
|
(A)
|
Free cash flow is a non-GAAP measure used by management to evaluate the amount of cash available for debt repayment, dividend distribution, acquisition opportunities, share repurchases, and other corporate purposes.
|
The $65.4 increase in cash provided by operating activities in the
first
quarter of 2018 was mainly due to a decrease in working capital during 2018, as compared to an increase in the prior year, partially offset by lower net income in 2018. The reduction in working capital was driven by trade receivables and inventory. Trade receivables were lower at the end of the current quarter, as compared to the prior year, which was partially a result of a reduction in days sales outstanding.
Cash used for investing activities in the
first
quarter of 2018 consisted primarily of $69.6 in capital expenditures, partially offset by a $31.4 reduction in our derivative cash margin account balances. Cash used for investing activities in the
first quarter of 2017 consisted primarily of $50.2 in capital expenditures and a $12.4 increase in our derivative cash margin account balances.
Cash used for financing activities in the
first
quarter of
2018
consisted primarily of a $170.1 reduction in short-term borrowings during the year and dividend payments of $84.9. Cash used for financing activities in the first quarter of 2017 consisted primarily of a $100.0 prepayment on the Term Loan and dividend payments of $77.8.
Capital Resources
The following table presents our capital structure.
|
|
|
|
|
|
|
|
|
|
July 31, 2017
|
|
April 30, 2017
|
Current portion of long-term debt
|
$
|
499.3
|
|
|
$
|
499.0
|
|
Short-term borrowings
|
283.9
|
|
|
454.0
|
|
Long-term debt, less current portion
|
4,444.8
|
|
|
4,445.5
|
|
Total debt
|
$
|
5,228.0
|
|
|
$
|
5,398.5
|
|
Shareholders’ equity
|
6,931.9
|
|
|
6,850.2
|
|
Total capital
|
$
|
12,159.9
|
|
|
$
|
12,248.7
|
|
We have available a $1.5 billion revolving credit facility with a group of 11 banks that matures in September 2018. Additionally, under our commercial paper program, 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. Along with the revolving credit facility, commercial paper is used as a continuing source of short-term financing for general corporate purposes. As of
July 31, 2017
, we had
$283.9
of short-term borrowings outstanding, all of which were issued under our commercial paper program, at a weighted-average interest rate of
1.42 percent
.
We are in compliance with all of our debt covenants. For additional information on our long-term debt, sources of liquidity, and debt covenants, see Note 7: Debt and Financing Arrangements.
As of
July 31, 2017
, we had approximately 3.6 million common shares available for repurchase under the Board of Directors' authorizations. There is no guarantee as to the exact number of shares that may be repurchased or when such purchases may occur.
During 2017, we announced our plans to build a
Smucker's Uncrustables
®
frozen sandwich manufacturing facility in Longmont, Colorado. Construction of the facility began in June 2017, and production is expected to begin in calendar year 2019. The new facility will help meet growing demand for
Smucker's Uncrustables
frozen sandwiches and will complement our existing facility in Scottsville, Kentucky. The Longmont facility will be constructed in two phases, with a total potential investment of $340.0. Phase 1 will include up to an initial $200.0 investment to construct and equip the new facility, with an opportunity to invest an additional $140.0 for phase 2 expansion, dependent on product demand.
On May 30, 2017, we announced a definitive agreement to acquire the
Wesson
®
oil brand from Conagra Brands, Inc. (“Conagra”). The all-cash transaction, which is expected to be funded primarily with debt, is valued at approximately $285.0, subject to a post-closing working capital adjustment. We anticipate the addition of the
Wesson
brand will add annual net sales of approximately $230.0. Following the close of the transaction, Conagra will continue to manufacture products sold under the
Wesson
brand and provide certain other transition services for up to one year. After the transition period, we expect to consolidate
Wesson
production into our existing oils manufacturing facility in Cincinnati, Ohio. Within two years after the closing, we expect to realize synergies of approximately $20.0 annually. The closing of the transaction is subject to the fulfillment of customary closing conditions, including receipt of regulatory approvals.
Absent any material acquisitions or other significant investments, we believe that cash on hand, combined with cash provided by operations, borrowings available under our commercial paper program and revolving credit facility, and access to capital markets, 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
July 31, 2017
, total cash and cash equivalents of $172.5 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 may be required to pay taxes based on the applicable U.S. tax rates net of any foreign tax credit consideration.
Non-GAAP Financial Measures
We use non-GAAP financial measures, including: adjusted gross profit, operating income, income, and free cash flow, as key measures for purposes of evaluating performance internally. We believe that investors’ understanding of our performance is enhanced by disclosing these performance measures. Furthermore, these non-GAAP financial measures are used by management in preparation of the annual budget and for the monthly analyses of our operating results. The Board of Directors also utilizes the adjusted earnings per share and free cash flow measures as components for measuring performance for incentive compensation purposes.
Non-GAAP measures exclude certain items affecting comparability, that can significantly affect the year-over-year assessment of operating results, which include amortization expense and impairment charges related to intangible assets, integration and restructuring costs (“special project costs”), and unallocated gains and losses on commodity and foreign currency exchange derivatives (“unallocated derivative gains and losses”). The special project costs in the following table relate to specific integration and restructuring projects, and the unallocated derivative gains and losses reflect the changes in fair value of our commodity and foreign currency exchange contracts.
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 measures to the comparable GAAP financial measure.
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2017
|
|
2016
|
Gross profit reconciliation:
|
|
|
|
Gross profit
|
$
|
662.1
|
|
|
$
|
722.7
|
|
Unallocated derivative losses (gains)
|
(12.6
|
)
|
|
(7.7
|
)
|
Cost of products sold – special project costs
|
0.7
|
|
|
4.0
|
|
Adjusted gross profit
|
$
|
650.2
|
|
|
$
|
719.0
|
|
Operating income reconciliation:
|
|
|
|
Operating income
|
$
|
233.8
|
|
|
$
|
293.8
|
|
Amortization
|
51.5
|
|
|
51.7
|
|
Unallocated derivative losses (gains)
|
(12.6
|
)
|
|
(7.7
|
)
|
Cost of products sold – special project costs
|
0.7
|
|
|
4.0
|
|
Other special project costs
|
27.1
|
|
|
22.2
|
|
Adjusted operating income
|
$
|
300.5
|
|
|
$
|
364.0
|
|
Net income reconciliation:
|
|
|
|
Net income
|
$
|
126.8
|
|
|
$
|
170.0
|
|
Income taxes
|
62.2
|
|
|
83.4
|
|
Amortization
|
51.5
|
|
|
51.7
|
|
Unallocated derivative losses (gains)
|
(12.6
|
)
|
|
(7.7
|
)
|
Cost of products sold – special project costs
|
0.7
|
|
|
4.0
|
|
Other special project costs
|
27.1
|
|
|
22.2
|
|
Adjusted income before income taxes
|
$
|
255.7
|
|
|
$
|
323.6
|
|
Income taxes, as adjusted
(A)
|
84.1
|
|
|
106.4
|
|
Adjusted income
|
$
|
171.6
|
|
|
$
|
217.2
|
|
Weighted-average shares – assuming dilution
|
113.6
|
|
|
116.5
|
|
Adjusted earnings per share – assuming dilution
|
$
|
1.51
|
|
|
$
|
1.86
|
|
|
|
(A)
|
Income taxes, as adjusted is based upon our GAAP effective tax rate and reflects the impact of items excluded from GAAP net income to derive adjusted income.
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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.
As of
July 31, 2017
, there were no material changes to our future contractual obligations as previously reported in our Annual Report on Form 10-K for the year ended April 30, 2017.
Critical Accounting Estimates and Policies
A discussion of our critical accounting estimates and policies can be found in the “Management's Discussion and Analysis” section of our Annual Report on Form 10-K for the year ended April 30, 2017. There were no material changes to the information previously disclosed.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
The following discussions about our market risk disclosures involve forward-looking statements. Actual results could differ from those projected in the forward-looking statements. 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
July 31, 2017
, approximates carrying value. We are exposed to interest rate risk with regard to existing debt consisting of fixed- and variable-rate maturities. Our interest rate exposure primarily includes U.S. Treasury rates, London Interbank Offered Rate, and commercial paper rates in the U.S.
We utilize derivative instruments to manage changes in the fair value and cash flows of our debt. Interest rate contracts 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 contract are deferred and included as a component of accumulated other comprehensive income (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 contract is recognized at fair value on the balance sheet, and changes in the fair value are recognized in interest expense. Generally, changes in the fair value of the contract are equal to changes in the fair value of the underlying debt and have no net impact on earnings.
In June 2017, we entered into a treasury lock, with a notional value of
$300.0
, to manage our exposure to interest rate volatility associated with anticipated debt financing in 2018. This interest rate contract is designated as a cash flow hedge, and as a result, an unrealized gain of
$2.5
was deferred in accumulated other comprehensive income (loss) at
July 31, 2017
. A hypothetical 10 percent decrease in treasury rates at
July 31, 2017
would not materially impact the fair value of this interest rate contract.
In 2015, we terminated the 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 fair value of debt. As a result of the early termination, we received $58.1 in cash, which included $4.6 of accrued and prepaid interest and a $53.5 benefit that is deferred as a component of the carrying value of the long-term debt and is being recognized ratably as a reduction to interest expense over the remaining life of the related debt. At
July 31, 2017
, the remaining benefit of
$34.4
was recorded as an increase in the long-term debt balance.
In measuring interest rate risk by the amount of net change in the fair value of our financial liabilities, a hypothetical 100 basis-point decrease in interest rates at
July 31, 2017
, would increase the fair value of our long-term debt by $343.7.
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
July 31, 2017
, 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. We do not qualify instruments used to manage foreign currency exchange exposures for hedge accounting treatment. Therefore, the change in value of these instruments is immediately recognized in cost of products sold. Based on our hedged foreign currency positions as of
July 31, 2017
, a hypothetical 10 percent change in exchange rates would not materially impact the fair value.
Revenues from customers outside the U.S., subject to foreign currency exchange, represented 6 percent of net sales during the
three
-month period ended
July 31, 2017
. 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. We do not qualify commodity derivatives for hedge accounting treatment. As a result, the gains and losses on all commodity derivatives are immediately recognized in cost of products sold.
The following sensitivity analysis presents our potential loss of fair value resulting from a hypothetical 10 percent change in market prices related to commodities.
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July 31, 2017
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April 30, 2017
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High
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$
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41.7
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$
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40.8
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Low
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13.4
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13.2
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Average
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27.3
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26.5
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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.
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 “expect,” “anticipate,” “believe,” “intend,” “will,” “plan,” 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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our ability to achieve synergies and cost savings related to the Big Heart acquisition and other programs in the amounts and within the time frames currently anticipated and to effectively manage the related integration and restructuring costs;
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our ability to satisfy the closing conditions for the
Wesson
transaction, including receipt of required regulatory approvals, without unexpected delays or conditions;
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our ability to generate sufficient cash flow to meet our deleveraging objectives;
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volatility of commodity, energy, and other input costs;
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risks associated with derivative and purchasing strategies we employ to manage commodity pricing risks;
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the availability of reliable transportation on acceptable terms;
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our ability to implement and realize the full benefit of price changes, and the impact of the timing of the price changes to profits and cash flow in a particular period;
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the success and cost of marketing and sales programs and strategies intended to promote growth in our businesses, including the introduction of new products;
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general competitive activity in the market, including competitors’ pricing practices and promotional spending levels;
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the impact of food security concerns involving either our products or our competitors’ products;
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the impact of accidents, extreme weather, and natural disasters;
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the concentration of certain of our businesses with key customers and suppliers, including single-source suppliers of certain key raw materials and finished goods, and our ability to manage and maintain key relationships;
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the timing and amount of capital expenditures and share repurchases;
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impairments in the carrying value of goodwill, other intangible assets, or other long-lived assets or changes in useful lives of other intangible assets;
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the impact of new or changes to existing governmental laws and regulations and their application;
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the outcome of tax examinations, changes in tax laws, and other tax matters;
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foreign currency and interest rate fluctuations; and
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risks related to other factors described under “Risk Factors” in other reports and statements we have filed with the Securities and Exchange Commission.
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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 subsequent to the filing of this Quarterly Report.
Item 4.
Controls and Procedures.
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
July 31, 2017
(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
July 31, 2017
, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.