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, 2018
and
2017
. All comparisons presented are to the corresponding period of the prior year, unless otherwise noted.
On May 14, 2018, we acquired Ainsworth Pet Nutrition, LLC (“Ainsworth”) in an all-cash transaction, which was funded by debt and valued at $1.9 billion. Ainsworth is a leading producer, distributor, and marketer of premium pet food and pet snacks, predominantly within the U.S. The majority of Ainsworth’s sales are generated by the
Rachael Ray
Nutrish
brand, which is driving significant growth in the premium pet food category. We anticipate the acquired business to contribute net sales of approximately $800.0 in 2019. Annual cost synergies of approximately $55.0 are expected to be fully realized within three years after the closing, with approximately $25.0 anticipated in 2019. The transaction was accounted for under the acquisition method of accounting and, accordingly, the results of Ainsworth's operations, including
$162.8
in revenue and a
$4.1
operating loss, are included in our consolidated financial statements from the date of acquisition. The operating loss reflects the recognition of a fair value purchase accounting adjustment attributable to the acquired inventory.
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
Rachael Ray
is a trademark of Ray Marks Co. LLC.
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 Dr Pepper Inc., used with permission.
Results of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2018
|
|
2017
|
|
% Increase (Decrease)
|
Net sales
|
$
|
1,902.5
|
|
|
$
|
1,748.9
|
|
|
9
|
%
|
Gross profit
|
$
|
678.2
|
|
|
$
|
662.1
|
|
|
2
|
|
% of net sales
|
35.6
|
%
|
|
37.9
|
%
|
|
|
Operating income
|
$
|
226.9
|
|
|
$
|
235.2
|
|
|
(4
|
)
|
% of net sales
|
11.9
|
%
|
|
13.4
|
%
|
|
|
Net income:
|
|
|
|
|
|
Net income
|
$
|
133.0
|
|
|
$
|
126.8
|
|
|
5
|
|
Net income per common share –
assuming dilution
|
$
|
1.17
|
|
|
$
|
1.12
|
|
|
4
|
|
Adjusted gross profit
(A)
|
$
|
700.2
|
|
|
$
|
650.2
|
|
|
8
|
|
% of net sales
|
36.8
|
%
|
|
37.2
|
%
|
|
|
Adjusted operating income
(A)
|
$
|
317.1
|
|
|
$
|
301.9
|
|
|
5
|
|
% of net sales
|
16.7
|
%
|
|
17.3
|
%
|
|
|
Adjusted income:
(A)
|
|
|
|
|
|
Income
|
$
|
202.4
|
|
|
$
|
171.6
|
|
|
18
|
|
Earnings per share – assuming dilution
|
$
|
1.78
|
|
|
$
|
1.51
|
|
|
18
|
|
|
|
(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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2018
|
|
2017
|
|
Increase
(Decrease)
|
|
%
|
Net sales
|
$
|
1,902.5
|
|
|
$
|
1,748.9
|
|
|
$
|
153.6
|
|
|
9
|
%
|
Ainsworth acquisition
|
(162.8
|
)
|
|
—
|
|
|
(162.8
|
)
|
|
(9
|
)%
|
Foreign currency exchange
|
(0.8
|
)
|
|
—
|
|
|
(0.8
|
)
|
|
—
|
%
|
Net sales excluding acquisition and foreign currency exchange
(A)
|
$
|
1,738.9
|
|
|
$
|
1,748.9
|
|
|
(10.0
|
)
|
|
(1
|
)%
|
Amounts may not add due to rounding.
|
|
(A)
|
Net sales excluding acquisition and foreign currency exchange is a non-GAAP measure used to evaluate performance internally. This measure provides useful information because it enables comparison of results on a year-over-year basis.
|
Net sales in the
first
quarter of
2019
increased $153.6, or
9 percent
, reflecting a $162.8 contribution from the Ainsworth acquisition. Excluding Ainsworth and the impact of foreign currency exchange, net sales declined $10.0, or 1 percent, reflecting lower net price realization. This was mostly attributable to the pet food, coffee, and oils categories, partially offset by higher net pricing in the peanut butter category.
Operating Income
The following table presents the components of operating income as a percentage of net sales.
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2018
|
|
2017
|
Gross profit
|
35.6
|
%
|
|
37.9
|
%
|
Selling, distribution, and administrative expenses:
|
|
|
|
Marketing
|
7.4
|
%
|
|
6.6
|
%
|
Selling
|
3.5
|
|
|
3.8
|
|
Distribution
|
3.5
|
|
|
3.3
|
|
General and administrative
|
5.8
|
|
|
6.2
|
|
Total selling, distribution, and administrative expenses
|
20.1
|
%
|
|
19.9
|
%
|
|
|
|
|
Amortization
|
3.2
|
|
|
2.9
|
|
Other special project costs
|
0.4
|
|
|
1.5
|
|
Operating income
|
11.9
|
%
|
|
13.4
|
%
|
Amounts may not add due to rounding.
Gross profit increased $16.1, or
2 percent
, in the
first
quarter of
2019
, primarily driven by the addition of Ainsworth. This was partially offset by an unfavorable net impact of lower prices and higher costs, attributable to an unfavorable change in the impact of derivative gains and losses. Reflected in gross profit was a $10.9 fair value purchase accounting adjustment attributable to acquired Ainsworth inventory, which resulted in higher cost of products sold when the related inventory was sold during the quarter. Operating income decreased $8.3, or
4 percent
, due to a $34.5 increase in selling, distribution, and administrative expenses and a $9.0 increase in amortization expense, both of which were primarily due to the Ainsworth acquisition. A $20.1 reduction in special project costs partially offset these factors.
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. Refer to “Non-GAAP Financial Measures” in this discussion and analysis for further information. On a non-GAAP basis, adjusted gross profit increased $50.0, or 8 percent, in the
first
quarter of
2019
, with the primary difference from GAAP results being the exclusion of a $34.6 unfavorable change in the impact of unallocated derivative gains and losses. Adjusted operating income increased $15.2, or
5 percent
, further reflecting the exclusion of special project costs and amortization expense.
Interest Expense
Net interest expense increased $11.6, or 28 percent, in the
first
quarter of
2019
, primarily due to the impact of the incremental interest related to the debt issued to finance the Ainsworth acquisition. For additional information, see “Capital Resources” in this discussion and analysis.
Income Taxes
Income taxes decreased $22.1, or 36 percent, in the
first
quarter of 2019, due to a decrease in income before income taxes and a lower effective tax rate in 2019 of 23.2 percent, compared to 32.9 percent in 2018.
The lower 2019 effective tax rate primarily resulted from the lower U.S. federal statutory tax rate of 21.0 percent following U.S. tax reform, compared to 35.0 percent previously. During the
first
quarter of 2019, the effective tax rate varied from the statutory tax rate primarily due to the impact of state income taxes. We anticipate a full-year effective tax rate for 2019 of approximately 24.5 percent, which includes an estimate of the impact of the Ainsworth acquisition on our overall consolidated effective tax rate.
During the third quarter of 2018, we recorded a net provisional benefit of
$765.8
related to U.S. tax reform, which included the revaluation of net deferred tax liabilities at the reduced federal income tax rate, offset in part by the estimated impact of a one-time repatriation tax on earnings of certain foreign subsidiaries that were previously tax deferred (“transition tax”). The provisional amount recorded was based on assumptions and estimates that may change as a result of future guidance and interpretation from the Internal Revenue Service, the U.S. Securities and Exchange Commission, the Financial Accounting Standards Board, and various taxing jurisdictions. All of these potential legislative and interpretive actions could result in adjustment to our provisional estimates when the accounting for the income tax effects of U.S. tax reform is completed, which we expect to be no later than the third quarter of 2019. During the
first
quarter of 2019, there were no adjustments to the recorded provisional amount.
Integration Activities
We expect to incur approximately
$50.0
in one-time costs related to the Ainsworth acquisition, of which the majority are expected to be cash charges. Approximately two-thirds of these one-time costs are expected to be recognized in 2019. We incurred integration charges of $2.0 related to the Ainsworth acquisition in the
first
quarter of 2019.
Restructuring Activities
An organization optimization program was approved by the Board of Directors (the “Board”) during the fourth quarter of 2016. Under this program, we identified opportunities to reduce costs and optimize the organization. Related projects include an organizational redesign and the optimization of our manufacturing footprint. In addition, the program was recently expanded to include the restructuring of our geographic footprint, which includes the centralization of our pet food and pet snacks business, as well as certain international non-manufacturing functions, to our corporate headquarters in Orrville, Ohio, furthering collaboration and enhanced agility, while improving cost efficiency. As a result, we plan to close the San Francisco and Burbank, California, offices by the end of 2019, and our international offices in China and Mexico during the first half of 2019. The majority of the related restructuring costs are expected to be incurred through the end of 2019. Upon completion of these initiatives, we anticipate that the organization optimization program will result in total headcount reductions of approximately
375
full-time positions, of which approximately
75 percent
were reduced as of July 31, 2018.
Total restructuring costs are expected to be approximately
$75.0
, 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 $48.3, of which $5.7 was incurred during the
first
quarter of 2019. For further information, refer to Note 5: Integration and Restructuring Costs.
Divestiture
On July 9, 2018, we announced a definitive agreement to sell our U.S. baking business to Brynwood Partners VII L.P. and Brynwood Partners VIII L.P., subsidiaries of Brynwood Partners, and expect to close the transaction during the second quarter of 2019, subject to customary closing conditions. The transaction includes products that are sold in U.S. retail channels under the
Pillsbury
,
Martha White
,
Hungry Jack
,
White Lily
,
and
Jim Dandy
brands, along with all relevant trademarks and licensing agreements, and our manufacturing facility in Toledo, Ohio. This business generated net sales of approximately $370.0 in 2018, primarily in the U.S. Retail Consumer Foods segment. The transaction does not include our baking business in Canada.
We will receive approximately $375.0 in proceeds from the divestiture, which is subject to a final working capital adjustment, and anticipate recognizing a gain upon completion of the transaction. The pre-tax gain is estimated to be approximately
$25.0
based on the expected proceeds, including the assumed working capital and the carrying value of the assets, less estimated costs to sell, at the closing date.
Segment Results
We have
four
reportable segments: U.S. Retail Coffee, U.S. Retail Consumer Foods, U.S. Retail Pet Foods, and International and Away From Home. 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
Rachael Ray Nutrish,
Meow Mix
,
Milk-Bone
,
Natural Balance
,
Kibbles ’n Bits
,
9Lives
,
Pup-Peroni
, and
Nature’s Recipe
branded products. The International and Away From Home segment is composed 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).
Effective May 1, 2018, the convenience store channel, which was previously included in the U.S. retail segments, is now included in the International and Away From Home segment. Segment performance for the three months ended July 31, 2017, has been reclassified for this realignment.
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2018
|
|
2017
|
|
% Increase
(Decrease)
|
Net sales:
|
|
|
|
|
|
U.S. Retail Coffee
|
$
|
489.5
|
|
|
$
|
479.4
|
|
|
2
|
%
|
U.S. Retail Consumer Foods
|
483.3
|
|
|
487.9
|
|
|
(1
|
)
|
U.S. Retail Pet Foods
|
671.2
|
|
|
520.7
|
|
|
29
|
|
International and Away From Home
|
258.5
|
|
|
260.9
|
|
|
(1
|
)
|
Segment profit:
|
|
|
|
|
|
|
U.S. Retail Coffee
|
$
|
147.8
|
|
|
$
|
123.2
|
|
|
20
|
%
|
U.S. Retail Consumer Foods
|
97.3
|
|
|
110.1
|
|
|
(12
|
)
|
U.S. Retail Pet Foods
|
100.4
|
|
|
97.8
|
|
|
3
|
|
International and Away From Home
|
43.4
|
|
|
40.2
|
|
|
8
|
|
Segment profit margin:
|
|
|
|
|
|
U.S. Retail Coffee
|
30.2
|
%
|
|
25.7
|
%
|
|
|
U.S. Retail Consumer Foods
|
20.1
|
|
|
22.6
|
|
|
|
U.S. Retail Pet Foods
|
15.0
|
|
|
18.8
|
|
|
|
International and Away From Home
|
16.8
|
|
|
15.4
|
|
|
|
U.S. Retail Coffee
The U.S. Retail Coffee segment net sales increased $10.1 in the
first
quarter of
2019
. Favorable volume/mix contributed 2 percentage points, driven by the
Dunkin’ Donuts
,
1850
TM
, and
Café Bustelo
brands, partially offset by declines in
Folgers
roast and ground coffee. The favorable volume/mix was slightly offset by lower net price realization, driven by the
Folgers
brand. Segment profit increased $24.6, primarily due to lower input costs, which more than offset an increase in marketing expense.
U.S. Retail Consumer Foods
The U.S. Retail Consumer Foods segment net sales decreased $4.6 in the
first
quarter of
2019
, driven by unfavorable volume/mix. Excluding the U.S. baking business, which is pending divestiture, net sales were comparable to the prior year as volume/mix gains for
Smucker’s Uncrustables
®
were partially offset by declines for the
Jif
brand. Segment profit decreased $12.8, due to higher input and freight costs and the unfavorable volume/mix.
U.S. Retail Pet Foods
The U.S. Retail Pet Foods segment net sales increased $150.5 in the
first
quarter of
2019
, reflecting the $162.8 contribution from Ainsworth. Excluding Ainsworth, net sales declined $12.3, or 2 percent. Lower net price realization reduced net sales by 1 percentage point. Unfavorable volume/mix also reduced net sales by 1 percentage point, reflecting declines for the
Natural Balance
brand and the discontinuation of certain
Gravy Train
®
products, partially offset by gains for the
Nature’s Recipe
,
Milk Bone
, and
Meow Mix
brands. Segment profit increased $2.6, reflecting the addition of Ainsworth. However, profit contributions from the Ainsworth acquisition reflected the unfavorable impact of the $10.9 fair value purchase accounting adjustment. Excluding Ainsworth, segment profit declined as the net impact of lower prices and higher input and freight costs was only partially offset by reduced marketing expense.
International and Away From Home
The International and Away From Home segment net sales decreased $2.4 in the
first
quarter of
2019
, due to lower net price realization. Segment profit increased $3.2, reflecting a net benefit of lower prices and costs, as well as lower marketing expense.
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, 2018
, total cash and cash equivalents of
$192.0
was comparable to the balance at
April 30, 2018
.
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,
|
|
2018
|
|
2017
|
Net cash provided by (used for) operating activities
|
$
|
243.0
|
|
|
$
|
304.3
|
|
Net cash provided by (used for) investing activities
|
(2,031.5
|
)
|
|
(38.1
|
)
|
Net cash provided by (used for) financing activities
|
1,790.5
|
|
|
(260.1
|
)
|
|
|
|
|
Net cash provided by (used for) operating activities
|
$
|
243.0
|
|
|
$
|
304.3
|
|
Additions to property, plant, and equipment
|
(101.3
|
)
|
|
(69.6
|
)
|
Free cash flow
(A)
|
$
|
141.7
|
|
|
$
|
234.7
|
|
|
|
(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
$61.3
decrease in cash provided by operating activities in the
first
quarter of
2019
was mainly due to a less significant decrease in overall working capital during 2019, as compared to the prior year. The change in working capital was driven by the timing of trade receivables and accounts payable.
Cash used for investing activities in the
first
quarter of
2019
consisted of $1.9 billion related to the Ainsworth acquisition,
$101.3
in capital expenditures, and a $23.7 increase in our derivative cash margin account balances. 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 provided by financing activities in the
first
quarter of
2019
consisted primarily of
$1.5
billion in long-term debt proceeds and a
$386.0
increase in short-term borrowings, partially offset by dividend payments of
$88.4
. For additional information on
our new borrowings, see “Capital Resources” in this discussion and analysis. 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
.
We, like other food manufacturers, are from time to time subject to legal proceedings arising in the ordinary course of business that could have a material adverse effect on our financial position, results of operations, or cash flows. In particular, we are currently a defendant in Council for Education and Research on Toxics v. Brad Barry LLC, et al., which alleges that we, in addition to nearly eighty other defendants who manufacture, package, distribute, or sell coffee, failed to provide warnings for our coffee products of exposure to the chemical acrylamide as required under California Health and Safety Code Section 25249.5, the California Safe Drinking Water and Toxic Enforcement Act of 1986, commonly referred to as “Proposition 65.” As part of a joint defense group organized to defend against the lawsuit, we dispute these claims. Acrylamide is not added to coffee, but is inherently present in all coffee in small amounts (measured in parts per billion) as a byproduct of the coffee bean roasting process. The outcome and the financial impact of the case, if any, cannot be predicted at this time. Accordingly, no loss contingency has been recorded for this matter as of July 31, 2018, as the likelihood of loss is not considered probable or estimable. However, if we are required to pay significant statutory penalties or to add warning labels to any of our products or place warnings in certain locations where our products are sold as a result of Proposition 65, our business and financial results could be adversely impacted, and sales of those products could suffer not only in those locations but elsewhere. For additional information, see Note 15: Contingencies.
Capital Resources
The following table presents our capital structure.
|
|
|
|
|
|
|
|
|
|
July 31, 2018
|
|
April 30, 2018
|
Short-term borrowings
|
$
|
530.0
|
|
|
$
|
144.0
|
|
Long-term debt
|
6,184.9
|
|
|
4,688.0
|
|
Total debt
|
$
|
6,714.9
|
|
|
$
|
4,832.0
|
|
Shareholders’ equity
|
7,930.8
|
|
|
7,891.1
|
|
Total capital
|
$
|
14,645.7
|
|
|
$
|
12,723.1
|
|
In April 2018, we entered into a senior unsecured delayed-draw Term Loan Credit Agreement (“Term Loan”) with a syndicate of banks and an available commitment amount of $1.5 billion. The full amount of the Term Loan was drawn on May 14, 2018, to partially finance the Ainsworth acquisition. Borrowings under the Term Loan bear interest on the prevailing U.S. Prime Rate or London Interbank Offered Rate, based on our election, and is payable either on a quarterly basis or at the end of the borrowing term. The Term Loan does not require scheduled amortization payments. Voluntary prepayments are permitted without premium or penalty. The interest rate on the Term Loan at July 31, 2018, was 3.21 percent. The Term Loan matures on May 14, 2021.
We have available a
$1.8 billion
unsecured revolving credit facility with a group of
11
banks that matures in September 2022. Additionally, we participate in a commercial paper program under which we can issue short-term, unsecured commercial paper not to exceed
$1.8 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
July 31, 2018
, we had
$530.0
of short-term borrowings outstanding, all of which were issued under our commercial paper program, at a weighted-average interest rate of
2.25 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 9: Debt and Financing Arrangements.
During the
first
quarter of
2019
, we did not repurchase any common shares under a repurchase plan authorized by the Board. At
July 31, 2018
, approximately
3.6 million
common shares remain available for repurchase pursuant to the Board's authorizations. There is no guarantee as to the exact number of shares that may be repurchased or when such purchases may occur.
In June 2017, we began construction of a
Smucker's Uncrustables
frozen sandwich manufacturing facility in Longmont, Colorado. 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 includes up to an initial $210.0 investment to construct and equip the new facility, with
an opportunity to invest an additional $130.0 for phase 2 expansion, dependent on product demand. Production is expected to begin at the new facility during 2020.
Absent any additional 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 our cash requirements for the next 12 months, including capital expenditures, the payment of quarterly dividends, interest payments on debt outstanding, and share repurchases.
As of
July 31, 2018
, total cash and cash equivalents of $183.4 was held by our international subsidiaries. During the fourth quarter of 2018, we recorded a provisional one-time transition tax of $26.1 on the undistributed earnings of certain foreign subsidiaries that were previously deferred from U.S. income taxes, as required by U.S. tax reform. As of
July 31, 2018
, the undistributed earnings of our foreign subsidiaries continue to be permanently reinvested, and we do not intend to repatriate any of the amounts to meet our cash requirements. For further information, refer to Note 13: Income Taxes.
Non-GAAP Financial Measures
We use non-GAAP financial measures, including: net sales excluding acquisition and foreign currency exchange, adjusted gross profit, operating income, income, earnings per share, 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 operating income, 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. See page 22 for a reconciliation of net sales adjusted for certain noncomparable items to the comparable GAAP financial measure.
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Three Months Ended July 31,
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2018
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|
2017
|
Gross profit reconciliation:
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|
|
|
Gross profit
|
$
|
678.2
|
|
|
$
|
662.1
|
|
Unallocated derivative losses (gains)
|
22.0
|
|
|
(12.6
|
)
|
Cost of products sold – special project costs
|
—
|
|
|
0.7
|
|
Adjusted gross profit
|
$
|
700.2
|
|
|
$
|
650.2
|
|
Operating income reconciliation:
|
|
|
|
Operating income
|
$
|
226.9
|
|
|
$
|
235.2
|
|
Amortization
|
60.5
|
|
|
51.5
|
|
Unallocated derivative losses (gains)
|
22.0
|
|
|
(12.6
|
)
|
Cost of products sold – special project costs
|
—
|
|
|
0.7
|
|
Other special project costs
|
7.7
|
|
|
27.1
|
|
Adjusted operating income
|
$
|
317.1
|
|
|
$
|
301.9
|
|
Net income reconciliation:
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|
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|
Net income
|
$
|
133.0
|
|
|
$
|
126.8
|
|
Income tax expense (benefit)
|
40.1
|
|
|
62.2
|
|
Amortization
|
60.5
|
|
|
51.5
|
|
Unallocated derivative losses (gains)
|
22.0
|
|
|
(12.6
|
)
|
Cost of products sold – special project costs
|
—
|
|
|
0.7
|
|
Other special project costs
|
7.7
|
|
|
27.1
|
|
Adjusted income before income taxes
|
$
|
263.3
|
|
|
$
|
255.7
|
|
Income taxes, as adjusted
(A)
|
60.9
|
|
|
84.1
|
|
Adjusted income
|
$
|
202.4
|
|
|
$
|
171.6
|
|
Weighted-average shares – assuming dilution
|
113.7
|
|
|
113.6
|
|
Adjusted earnings per share – assuming dilution
|
$
|
1.78
|
|
|
$
|
1.51
|
|
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|
(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.
The following table summarizes our contractual obligations by fiscal year at July 31, 2018.
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Total
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|
2019
|
|
2020-2021
|
|
2022-2023
|
|
2024 and beyond
|
Long-term debt obligations, including current portion
(A)
|
$
|
6,200.0
|
|
|
$
|
—
|
|
|
$
|
2,300.0
|
|
|
$
|
1,150.0
|
|
|
$
|
2,750.0
|
|
Interest payments
(B)
|
1,928.3
|
|
|
193.1
|
|
|
432.8
|
|
|
239.0
|
|
|
1,063.4
|
|
Operating lease obligations
(C)
|
208.8
|
|
|
33.5
|
|
|
76.5
|
|
|
62.4
|
|
|
36.4
|
|
Purchase obligations
(D)
|
1,408.3
|
|
|
1,173.0
|
|
|
203.8
|
|
|
22.2
|
|
|
9.3
|
|
Other liabilities
(E)
|
315.3
|
|
|
55.4
|
|
|
42.2
|
|
|
26.6
|
|
|
191.1
|
|
Total
|
$
|
10,060.7
|
|
|
$
|
1,455.0
|
|
|
$
|
3,055.3
|
|
|
$
|
1,500.2
|
|
|
$
|
4,050.2
|
|
|
|
(A)
|
Excludes the impact of offering discounts, make-whole payments, and debt issuance costs.
|
|
|
(B)
|
Includes interest payments on our long-term debt, which reflects estimated payments for our variable-rate debt based on the current interest rate outlook.
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(C)
|
Includes the minimum rental commitments under non-cancelable operating leases.
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(D)
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Includes agreements that are enforceable and legally bind us to purchase goods and services, including certain obligations related to normal, ongoing purchase obligations in which we have guaranteed payment to ensure availability of raw materials, packaging supplies, and co-pack arrangements. We expect to receive consideration for these purchase obligations in the form of materials and services. These purchase obligations do not represent the entire anticipated purchases in the future, but represent only those items for which we are contractually obligated.
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(E)
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Mainly consists of projected commitments associated with our defined benefit pension and other postretirement benefit plans. The liability for unrecognized tax benefits and tax-related net interest of $36.6 under FASB Accounting Standards Codification 740, Income Taxes, is excluded, since we are unable to reasonably estimate the timing of cash settlements with the respective taxing authorities.
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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, 2018. 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, 2018
, 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 qualifying 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), 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 2018, we entered into an interest rate swap, with a notional value of $500.0, to manage our exposure to interest rate volatility associated with anticipated debt financing in 2020. This interest rate contract is designated as a cash flow hedge, and as a result, an unrealized gain of
$2.6
was deferred in accumulated other comprehensive income (loss) at July 31, 2018.
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 was designated as a cash flow hedge. In December 2017, concurrent with the pricing of the Senior Notes due December 15, 2027, we terminated the treasury lock prior to maturity. The termination resulted in a gain of
$2.7
, which was deferred and included as a component of accumulated other comprehensive income (loss) and will be amortized as a reduction to interest expense – net over the life of the debt.
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, 2018
, the remaining benefit of
$26.5
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, 2018
, would increase the fair value of our long-term debt by $275.4.
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, 2018
, are not expected to result in a significant impact on future earnings or cash flows.
We utilize foreign currency derivatives to manage the effect 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, 2018
, 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 5 percent of net sales during the
three
-month period ended
July 31, 2018
. 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 derivatives 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, 2018
|
|
April 30, 2018
|
High
|
$
|
48.4
|
|
|
$
|
36.0
|
|
Low
|
17.7
|
|
|
17.0
|
|
Average
|
31.1
|
|
|
26.8
|
|
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 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:
|
|
•
|
our ability to successfully integrate the acquired Ainsworth business in a timely and cost-effective manner and retain key suppliers, customers, and employees;
|
|
|
•
|
our ability to achieve synergies and cost savings related to the Ainsworth acquisition in the amounts and within the time frames currently anticipated;
|
|
|
•
|
our ability to successfully complete the divestiture of the U.S. baking business in a timely and cost-effective manner;
|
|
|
•
|
our ability to achieve cost savings related to our organization optimization and cost management programs in the amounts and within the time frames currently anticipated;
|
|
|
•
|
our ability to generate sufficient cash flow to meet our cash deleveraging objectives;
|
|
|
•
|
volatility of commodity, energy, and other input costs;
|
|
|
•
|
risks associated with derivative and purchasing strategies we employ to manage commodity pricing risks;
|
|
|
•
|
the availability of reliable transportation on acceptable terms;
|
|
|
•
|
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;
|
|
|
•
|
the success and cost of marketing and sales programs and strategies intended to promote growth in our businesses, including product innovation;
|
|
|
•
|
general competitive activity in the market, including competitors’ pricing practices and promotional spending levels;
|
|
|
•
|
the impact of food security concerns involving either our products or our competitors’ products;
|
|
|
•
|
the impact of accidents, extreme weather, and natural disasters;
|
|
|
•
|
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;
|
|
|
•
|
the timing and amount of capital expenditures and share repurchases;
|
|
|
•
|
impairments in the carrying value of goodwill, other intangible assets, or other long-lived assets or changes in useful lives of other intangible assets;
|
|
|
•
|
the impact of new or changes to existing governmental laws and regulations and their application, including tariffs;
|
|
|
•
|
the outcome of tax examinations, changes in tax laws, and other tax matters;
|
|
|
•
|
foreign currency and interest rate fluctuations; and
|
|
|
•
|
risks related to other factors described under “Risk Factors” in other reports and statements we have filed with the U.S. Securities and Exchange Commission.
|
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, 2018
(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, 2018
, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except as noted below.
On May 14, 2018, we acquired Ainsworth Pet Nutrition, LLC (“Ainsworth”) (see “Note 4: Acquisition” in Part 1, Item 1 in this Quarterly Report on Form 10-Q). As part of the purchase price allocation process, procedures were performed to validate
the assets acquired and liabilities assumed, including existence testing and a preliminary valuation of the tangible and intangible assets acquired. We are currently integrating Ainsworth into our operations and internal control processes, and, as permitted by Securities and Exchange Commission rules and regulations, we have not yet included Ainsworth in our assessment of the effectiveness of our internal control over financial reporting. Ainsworth constituted $2.2 billion of our consolidated total assets at July 31, 2018, and, for the quarter then ended, Ainsworth net sales and operating loss were $162.8 million and $4.1 million, respectively. We anticipate Ainsworth will be included in management’s evaluation of internal control over financial reporting as of April 30, 2019.