management’S diScuSSion and analYSiS The J. M. Smucker Company realization as a result of coffee price declines taken during 2013 and 2012. Despite a peanut butter price decline taken in the third quarter of 2013, net price realization was higher, driven by price increases taken on peanut butter during 2012, and mostly offset higher costs. Excluding special project costs, gross profit increased $150.7, or 8 percent, and improved to 34.6 percent of net sales in 2013, compared to 34.2 percent in 2012. Selling, distribution, and administrative expenses (“SD&A”) increased 9 percent in 2013, compared to 2012, but increased only slightly as a percentage of net sales. Marketing expense increased 10 percent, driven mainly by an increase in brand building investments, primarily in support of our coffee brands. Selling expense increased 8 percent, driven by the incremental impact of the Sara Lee foodservice business in 2013. General and administrative expenses increased 13 percent, primarily due to increased incentive compensation and employee benefit costs. Higher amortization expense was recognized in 2013, compared to 2012, due to the intangible assets associated with the Sara Lee foodservice business acquisition. Operating income increased $132.1, or 17 percent, in 2013, compared to 2012, and increased as a percentage of net sales from 14.1 percent to 15.4 percent over the same period. Special project costs decreased $54.7 in 2013, compared to 2012, reflecting substantial progress made on the related projects, with the majority of costs having been incurred in prior years. Excluding the impact of special project costs in both periods, operating income increased $77.4, or 9 percent, and was 16.5 percent of net sales in 2013, compared to 16.2 percent in 2012. Both operating income measures include a loss on divestiture of $11.3 in 2012. 2012 Compared to 2011 Gross profit increased $46.7, or 3 percent, in 2012, compared to 2011, due to the contribution from acquisitions and a decrease in special project costs included in cost of products sold. Excluding these special project costs in both periods, gross profit increased $35.8. Raw material costs were higher in 2012, compared to 2011, most significantly for green coffee, edible oils, peanuts, flour, milk, and sweetener. Higher prices in place during the year more than offset these higher costs, most significantly on peanut butter, but did not offset the overall impact of volume declines. Gross profit as a percentage of net sales contracted from 38.4 percent in 2011 to 34.2 percent in 2012, excluding special project costs. SD&A increased 3 percent in 2012, compared to 2011, yet decreased as a percentage of net sales from 17.9 percent to 16.2 percent, reflecting the impact of price increases on net sales. Total marketing expense decreased 3 percent in 2012, compared to 2011, although the portion allocated to advertising increased during the same period. A portion of the marketing expense decline was redeployed to trade and consumer promotions during 2012, which were reflected as a reduction of sales. Selling expenses and general and administrative expenses increased 15 percent and 6 percent, respectively, primarily due to the Sara Lee foodservice business and Rowland Coffee acquisitions. Distribution expenses decreased 1 percent. Noncash impairment charges of $4.6 and $17.6 were recognized in 2012 and 2011, respectively. The 2012 impairment charge related to a regional canned milk trademark, while the majority of the 2011 charge resulted from the write-down to estimated fair value of the intangible assets of the Europe’s Best business. In 2012, we recognized an $11.3 loss on the sale of Europe’s Best. Operating income decreased $6.0, or 1 percent, in 2012, compared to 2011. Special project costs increased $2.5 in 2012, compared to 2011, as a decrease in restructuring costs due to the closure of several facilities was offset by an increase in integration costs related to the Sara Lee foodservice business and Rowland Coffee acquisitions. Excluding the impact of special project costs in both periods, operating income decreased from 18.6 percent of net sales in 2011 to 16.2 percent in 2012. Interest Expense – Net Net interest expense increased $13.6 during 2013, compared to 2012, primarily due to an incremental five and one-half months of interest expense during 2013, related to the October 2011 public issuance of $750.0 in Senior Notes. Net interest expense increased $12.7 during 2012, compared to 2011, due to higher average debt outstanding as a result of the October 2011 public debt issuance. The increased borrowing costs were somewhat offset by the benefit of interest rate swap activities and higher capitalized interest associated with capital expenditures. During the second quarter of 2012, two interest rate swaps were terminated, resulting in a net settlement gain of $17.7 to be recognized over the remaining life of the underlying debt instruments, including $1.7 in 2012. Income Taxes Income taxes increased 13 percent in 2013, compared to 2012, primarily as a result of a 17 percent increase in income before income taxes. The effective tax rate decreased to 33.4 percent in 2013 from 34.4 percent in 2012, primarily due to lower state income taxes in 2013. Income taxes increased 2 percent in 2012, compared to 2011, despite a 2 percent decrease in income before income taxes during the same period. The effective tax rate increased to 34.4 percent in 2012 from 33.1 percent in 2011, primarily due to decreased tax benefits related to the domestic manufacturing deduction and slightly higher state income taxes in 2012. 2013 Annual Report 27