Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Dollars 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, 2016
and
2015
. 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,
|
|
2016
|
|
2015
|
|
% Increase (Decrease)
|
Net sales
|
$
|
1,815.8
|
|
|
$
|
1,952.0
|
|
|
(7
|
)%
|
Gross profit
|
$
|
722.7
|
|
|
$
|
728.7
|
|
|
(1
|
)%
|
% of net sales
|
39.8
|
%
|
|
37.3
|
%
|
|
|
|
Operating income
|
$
|
293.8
|
|
|
$
|
267.1
|
|
|
10
|
%
|
% of net sales
|
16.2
|
%
|
|
13.7
|
%
|
|
|
Net income:
|
|
|
|
|
|
Net income
|
$
|
170.0
|
|
|
$
|
136.4
|
|
|
25
|
%
|
Net income per common share – assuming dilution
|
$
|
1.46
|
|
|
$
|
1.14
|
|
|
28
|
%
|
Adjusted gross profit
(A)
|
$
|
719.0
|
|
|
$
|
741.8
|
|
|
(3
|
)%
|
% of net sales
|
39.6
|
%
|
|
38.0
|
%
|
|
|
Adjusted operating income
(A)
|
$
|
364.0
|
|
|
$
|
356.1
|
|
|
2
|
%
|
% of net sales
|
20.0
|
%
|
|
18.2
|
%
|
|
|
Adjusted income:
(A)
|
|
|
|
|
|
Income
|
$
|
217.2
|
|
|
$
|
190.9
|
|
|
14
|
%
|
Earnings per share – assuming dilution
|
$
|
1.86
|
|
|
$
|
1.60
|
|
|
16
|
%
|
|
|
(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 7 percent in the
first
quarter of
2017
, driven by lower net price realization and the noncomparable impact from the U.S. canned milk business, which was divested during the third quarter of 2016. Operating income increased 10 percent, primarily due to lower selling, distribution, and administrative (“SD&A”) expenses in 2017, partially offset by a slight decrease in gross profit. Operating income excluding non-GAAP adjustments (“adjusted operating income”) increased 2 percent. Our non-GAAP adjustments include amortization expense related to intangible assets, merger and integration and restructuring costs, and unallocated gains and losses on commodity and foreign currency exchange derivatives. Net income per diluted share increased 28 percent in the
first
quarter of
2017
, while income per diluted share excluding non-GAAP adjustments (“adjusted earnings per share”) increased 16 percent. Both 2017 per share measures reflect the benefit of a lower effective tax rate and a decrease in weighted-average common shares outstanding as a result of our share repurchase activities during the fourth quarter of 2016.
Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2016
|
|
2015
|
|
Increase
(Decrease)
|
|
%
|
Net sales
|
$
|
1,815.8
|
|
|
$
|
1,952.0
|
|
|
$
|
(136.2
|
)
|
|
(7
|
)%
|
Milk divestiture
|
—
|
|
|
(39.5
|
)
|
|
39.5
|
|
|
2
|
|
Foreign currency exchange
|
4.6
|
|
|
—
|
|
|
4.6
|
|
|
—
|
|
Net sales excluding divestiture and foreign currency exchange
(A)
|
$
|
1,820.4
|
|
|
$
|
1,912.5
|
|
|
$
|
(92.1
|
)
|
|
(5
|
)%
|
Amounts may not add due to rounding.
|
|
(A)
|
Net sales excluding divestiture and foreign currency exchange is a non-GAAP measure used to evaluate performance internally. This measure provides useful information to investors because it enables comparison of results on a year-over-year basis.
|
In the first quarter of 2017, net sales decreased $136.2, of which $39.5 was due to the impact of prior year sales from the divested U.S. canned milk business. Excluding the noncomparable divested business and foreign currency exchange, net sales decreased $92.1, or 5 percent. This was driven by a 4 percentage point impact of lower net price realization, mainly within the U.S. Retail Coffee segment. Unfavorable volume/mix, driven by the U.S. Retail Pet Foods segment, also contributed to lower net sales.
Operating Income
The following table presents the components of operating income as a percentage of net sales.
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2016
|
|
2015
|
Gross profit
|
39.8
|
%
|
|
37.3
|
%
|
Selling, distribution, and administrative expenses:
|
|
|
|
Marketing
|
6.0
|
%
|
|
5.9
|
%
|
Selling
|
3.6
|
|
|
4.3
|
|
Distribution
|
3.3
|
|
|
3.2
|
|
General and administrative
|
6.7
|
|
|
6.5
|
|
Total selling, distribution, and administrative expenses
|
19.6
|
%
|
|
19.9
|
%
|
|
|
|
|
Amortization
|
2.8
|
|
|
2.7
|
|
Other special project costs
|
1.2
|
|
|
1.2
|
|
Other operating income – net
|
(0.1
|
)
|
|
(0.1
|
)
|
Operating income
|
16.2
|
%
|
|
13.7
|
%
|
Amounts may not add due to rounding.
Gross profit decreased $6.0, or 1 percent, in the first quarter of 2017, reflecting lower net pricing and the loss of U.S. canned milk profits. These factors were mostly offset by a reduction in commodity costs, primarily attributed to green coffee, and incremental synergy realization related to the 2015 acquisition of Big Heart Pet Brands ("Big Heart"). SD&A expenses decreased $31.6, or 8 percent, in the first quarter of 2017, primarily driven by synergy realization and reduced selling expense. Operating income increased $26.7, or 10 percent, in the first quarter of 2017, primarily reflecting the lower SD&A expenses.
Gross profit excluding non-GAAP adjustments (“adjusted gross profit”) decreased $22.8, or 3 percent, in the first quarter of 2017, with the primary difference from GAAP results being the exclusion of a $17.7 favorable change in unallocated derivative gains and losses. Adjusted operating income increased $7.9, or 2 percent.
Income Taxes
Income taxes decreased 3 percent in the
first
quarter of
2017
, as a 14 percent increase in income before income taxes was more than offset by the impact of a more normalized effective tax rate in
2017
of 32.9 percent. The
2016
effective tax rate of 38.8 percent was impacted by higher deferred state income tax expense, which was a result of state tax law changes. We anticipate a full-year effective tax rate for 2017 of approximately 33.5 percent.
Integration and Restructuring Activities
Total one-time costs related to the Big Heart acquisition are anticipated to be approximately $275.0 and are expected to 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 costs of $201.4 related to the integration of Big Heart, including $20.2 in the first quarter of
2017
.
In addition to the integration activities discussed above, an organization optimization program was approved by the Board of Directors during the fourth quarter of 2016 as part of our ongoing efforts to reduce costs, integrate, and optimize the combined organization. Total restructuring costs related to the program are expected to be approximately $40.0, primarily consisting of employee-related, site preparation, equipment relocation, and production start-up costs. In addition, we expect to invest approximately $15.0 to $17.0 in capital expenditures. We have incurred total restructuring costs of $7.3, the majority of which was incurred in the first quarter of
2017
. The remaining costs are anticipated to be recognized through 2018, with the majority of the costs expected to be recognized in 2017. Upon completion, the restructuring plan will result in a reduction of approximately 125 full-time positions.
As part of this program, we will discontinue the production of coffee at our Harahan, Louisiana, facility and consolidate all roast and ground coffee production into one of our facilities in New Orleans, Louisiana, which we expect to complete by December 2017. Additionally, we will exit two leased facilities in Livermore, California, and consolidate all ancient grains and pasta production into our facility in Chico, California, which we expect to complete by January 2017.
We anticipate synergies related to the Big Heart acquisition and our organization optimization program to result in net realized savings of approximately $200.0 annually by the end of 2018. In 2017, we expect to realize $100.0 of incremental savings as compared to 2016, of which $32.0 were realized in the first quarter of
2017
. To date, we have realized $69.0 of our goal of $200.0 in annual synergies. In addition, we expect approximately $50.0 of incremental annual cost savings to be recognized over the next few years, much of which we plan to invest in our businesses.
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 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
,
Nature’s Recipe
, and
Gravy Train
branded products. International and Foodservice 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).
Effective May 1, 2016, amortization expense related to intangible assets, including any related impairment charges, is reported outside of segment operating results. Prior year segment results have been modified to conform to the new presentation. For additional information on the change, see Note 6: Reportable Segments.
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2016
|
|
2015
|
|
% Increase
(Decrease)
|
Net sales:
|
|
|
|
|
|
U.S. Retail Coffee
|
$
|
513.3
|
|
|
$
|
565.0
|
|
|
(9
|
)%
|
U.S. Retail Consumer Foods
|
537.0
|
|
|
582.2
|
|
|
(8
|
)
|
U.S. Retail Pet Foods
|
519.5
|
|
|
549.9
|
|
|
(6
|
)
|
International and Foodservice
|
246.0
|
|
|
254.9
|
|
|
(3
|
)
|
Segment profit:
|
|
|
|
|
|
|
U.S. Retail Coffee
|
$
|
173.8
|
|
|
$
|
173.8
|
|
|
—
|
%
|
U.S. Retail Consumer Foods
|
111.4
|
|
|
119.4
|
|
|
(7
|
)
|
U.S. Retail Pet Foods
|
122.2
|
|
|
116.8
|
|
|
5
|
|
International and Foodservice
|
39.5
|
|
|
36.1
|
|
|
9
|
|
Segment profit margin:
|
|
|
|
|
|
|
U.S. Retail Coffee
|
33.9
|
%
|
|
30.8
|
%
|
|
|
|
U.S. Retail Consumer Foods
|
20.7
|
|
|
20.5
|
|
|
|
|
U.S. Retail Pet Foods
|
23.5
|
|
|
21.2
|
|
|
|
|
International and Foodservice
|
16.1
|
|
|
14.2
|
|
|
|
|
U.S. Retail Coffee
The U.S. Retail Coffee segment net sales decreased $51.7, reflecting lower net price realization, which was primarily attributed to the impact of two 6 percent list price declines since the beginning of 2016. Favorable volume/mix for the
Folgers
and
Café Bustelo
brands was offset by declines for
Dunkin’ Donuts
K-Cup
®
pods, which were anticipated following the successful introduction of the product line at the beginning of 2016. Segment profit was comparable to the prior year, primarily due to lower commodity costs and favorable volume/mix being offset by lower net price realization and the reduced contribution from
Dunkin’ Donuts
K-Cup
®
pods.
U.S. Retail Consumer Foods
The U.S. Retail Consumer Foods segment net sales decreased $45.2, primarily reflecting noncomparable sales of $34.2 in the prior year related to the divested U.S. canned milk business. Excluding the impact of the divestiture, net sales decreased 2 percent. The decline reflected lower net price realization, primarily attributable to the
Crisco
,
Pillsbury
, and
Jif
brands. Volume/mix was comparable to the prior year as contributions from the
R.W. Knudsen Family
®
and
Sahale Snacks
®
brands were offset by a decrease for the S
mucker's
brand. Segment profit decreased $8.0, primarily reflecting the loss of U.S. canned milk profits.
U.S. Retail Pet Foods
The U.S. Retail Pet Foods segment net sales decreased $30.4, primarily due to unfavorable volume/mix, which impacted net sales by 5 percentage points. This was driven by
Kibbles 'n Bits
dry dog food and the
Natural Balance
brand, which benefited from initial shipments in the prior year related to distribution gains. Segment profit increased $5.4 as synergy realization, lower commodity costs, and a decrease in marketing expense more than offset the impact of unfavorable volume/mix.
International and Foodservice
International and Foodservice net sales decreased $8.9, reflecting noncomparable sales of $5.3 in the prior year related to the divested U.S. canned milk business and a $4.6 unfavorable impact of foreign currency exchange. Favorable volume/mix, which contributed 2 percentage points of growth to net sales, was offset by a decrease in net price realization. Segment profit increased $3.4, resulting from favorable volume/mix and the net benefit of lower commodity costs and lower prices, which more than offset the impact of the divested business and foreign currency exchange.
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. At
July 31, 2016
, total cash and cash equivalents was $109.6, compared to $109.8 at
April 30, 2016
.
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. In contrast, the U.S. Retail Pet Foods segment does not experience seasonality, and thus our working capital requirements became less seasonal overall subsequent to the Big Heart acquisition.
The following table presents selected cash flow information.
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2016
|
|
2015
|
Net cash provided by operating activities
|
$
|
238.9
|
|
|
$
|
307.0
|
|
Net cash used for investing activities
|
(62.5
|
)
|
|
(38.1
|
)
|
Net cash used for financing activities
|
(173.2
|
)
|
|
(256.2
|
)
|
|
|
|
|
Net cash provided by operating activities
|
$
|
238.9
|
|
|
$
|
307.0
|
|
Additions to property, plant, and equipment
|
(50.2
|
)
|
|
(53.0
|
)
|
Free cash flow
(A)
|
$
|
188.7
|
|
|
$
|
254.0
|
|
|
|
(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 $68.1 decrease in cash provided by operating activities in the
first
quarter of
2017
was mainly due to an increase in working capital during 2017, partially offset by higher net income. The working capital increase resulted from a greater inventory buildup in the first quarter of 2017, compared to the first quarter of 2016, particularly for fruit and coffee. The increased buildup was necessary due to lower inventory levels at the beginning of 2017, compared to 2016, which resulted from last year's working capital reduction initiative achieved mostly in the second half of 2016. Additionally, a tax refund of $49.6 in the first quarter of 2016 drove a portion of the working capital increase.
The $24.4 increase in cash used for investing activities in the
first
quarter of
2017
was due to an increase in our derivative cash margin account balances during 2017, as compared to a reduction during the
first
quarter of
2016
.
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. Cash used for financing activities in the
first
quarter of
2016
consisted primarily of a $250.0 prepayment on the Term Loan and dividend payments of $76.4, partially offset by a $76.6 increase in short-term borrowings during 2016.
Capital Resources
The following table presents our capital structure.
|
|
|
|
|
|
|
|
|
|
July 31, 2016
|
|
April 30, 2016
|
Short-term borrowings
|
$
|
306.0
|
|
|
$
|
284.0
|
|
Long-term debt
|
5,045.7
|
|
|
5,146.0
|
|
Total debt
|
$
|
5,351.7
|
|
|
$
|
5,430.0
|
|
Shareholders’ equity
|
7,095.9
|
|
|
7,008.5
|
|
Total capital
|
$
|
12,447.6
|
|
|
$
|
12,438.5
|
|
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, 2016
, we had $306.0 of short-term borrowings outstanding, all of which were issued under our commercial paper program, at a weighted-average interest rate of 0.65 percent.
During the
first
quarter of
2017
, we reduced total debt by $78.3, driven by the $100.0 prepayment on the Term Loan, partially offset by an increase in short-term borrowings outstanding. We intend to continue our focus on debt repayment in the near term. Reducing our leverage will provide the flexibility to consider other strategic uses of cash, including acquisition opportunities and share repurchases.
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 8: Debt and Financing Arrangements.
As of
July 31, 2016
, we had approximately 6.6 million common shares available for repurchase under 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.
Absent any material acquisitions or other significant investments, we believe that 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
July 31, 2016
, total cash and cash equivalents of $104.9 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.
Non-GAAP Financial Measures
We use non-GAAP financial measures including: net sales excluding divestiture and foreign currency exchange; adjusted gross profit, operating income, income, and 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 Director’s 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 merger and 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 table below relate to specific merger and 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. Beginning May 1, 2016, we redefined our non-GAAP measures to also exclude amortization expense related to intangible assets, including any related impairment charges ("amortization"), and have modified prior year results to conform to the new definition. We believe that excluding amortization in our non-GAAP measures is more reflective of our operating performance and the way in which we manage our business, as amortization is a non-cash expense and can be significantly affected by the timing and size of our acquisitions.
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 24 for a reconciliation of free cash flow to the comparable GAAP financial measure.
|
|
|
|
|
|
|
|
|
|
Three Months Ended July 31,
|
|
2016
|
|
2015
|
Gross profit reconciliation:
|
|
|
|
Gross profit
|
$
|
722.7
|
|
|
$
|
728.7
|
|
Unallocated derivative (gains) losses
|
(7.7
|
)
|
|
10.0
|
|
Cost of products sold – special project costs
|
4.0
|
|
|
3.1
|
|
Adjusted gross profit
|
$
|
719.0
|
|
|
$
|
741.8
|
|
Operating income reconciliation:
|
|
|
|
Operating income
|
$
|
293.8
|
|
|
$
|
267.1
|
|
Amortization
|
51.7
|
|
|
53.0
|
|
Unallocated derivative (gains) losses
|
(7.7
|
)
|
|
10.0
|
|
Cost of products sold – special project cost
|
4.0
|
|
|
3.1
|
|
Other special project costs
|
22.2
|
|
|
22.9
|
|
Adjusted operating income
|
$
|
364.0
|
|
|
$
|
356.1
|
|
Net income reconciliation:
|
|
|
|
Net income
|
$
|
170.0
|
|
|
$
|
136.4
|
|
Income taxes
|
83.4
|
|
|
86.4
|
|
Amortization
|
51.7
|
|
|
53.0
|
|
Unallocated derivative (gains) losses
|
(7.7
|
)
|
|
10.0
|
|
Cost of products sold – special project costs
|
4.0
|
|
|
3.1
|
|
Other special project costs
|
22.2
|
|
|
22.9
|
|
Adjusted income before income taxes
|
$
|
323.6
|
|
|
$
|
311.8
|
|
Income taxes, as adjusted
(A)
|
106.4
|
|
|
120.9
|
|
Adjusted income
|
$
|
217.2
|
|
|
$
|
190.9
|
|
Weighted-average shares – assuming dilution
|
116,475,496
|
|
|
119,634,958
|
|
Adjusted earnings per share
|
$
|
1.86
|
|
|
$
|
1.60
|
|
|
|
(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.
|
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, 2016, 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, 2016. As of July 31, 2016, our outstanding commercial commitments were not material to our financial position, liquidity, or results of operations.
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
July 31, 2016
, 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. In 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. In 2015, we terminated this interest rate swap agreement prior to maturity and, 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 will be recognized ratably as a reduction to future interest expense over the remaining life of the related debt. At
July 31, 2016
, the remaining benefit of
$42.0
was recorded as an increase in the long-term debt balance.
Based on our overall interest rate exposure as of and during the
three
months ended
July 31, 2016
, 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
July 31, 2016
, would increase the fair value of our long-term debt by $404.3.
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, 2016
, 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 gains and losses on all foreign currency forwards and options contracts are immediately recognized in cost of products sold. Based on our hedged foreign currency positions as of
July 31, 2016
, a hypothetical 10 percent change in exchange rates would result in a $15.6 loss of 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, 2016
. 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.
|
|
|
|
|
|
|
|
|
|
July 31, 2016
|
|
April 30, 2016
|
High
|
$
|
38.1
|
|
|
$
|
40.0
|
|
Low
|
15.6
|
|
|
16.5
|
|
Average
|
30.5
|
|
|
32.9
|
|
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:
|
|
•
|
our ability to achieve synergies and cost savings related to the Big Heart acquisition in the amounts and within the time frames currently anticipated and to effectively manage the related integration costs;
|
|
|
•
|
our ability to generate sufficient cash flow to meet our 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 the introduction of new products;
|
|
|
•
|
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;
|
|
|
•
|
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 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.