McCormick & Company, Inc. — Q1 2018 Form 10-Q Summary
Business context and reporting period
McCormick is a global manufacturer, marketer and distributor of spices, seasonings, condiments and other flavor products. It operates through Consumer and Flavor Solutions segments. This report covers the three months ended February 28, 2018, compared with the three months ended February 28, 2017.
Results include the RB Foods business, acquired on August 17, 2017, including the French’s, Frank’s RedHot and Cattlemen’s brands. RB Foods contributed $127.6 million of sales in the quarter.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $1,237.1 million | $1,043.7 million | 18.5% |
| Gross profit | $520.0 million | $413.0 million | 25.9% |
| Gross margin | 42.0% | 39.6% | +240 bps |
| Operating income | $183.7 million | $134.2 million | 36.9% |
| Net income | $422.6 million | $93.5 million | 352.0% |
| Diluted EPS | $3.18 | $0.74 | +$2.44 |
| Cash dividends per share | $0.52 | $0.47 | 10.6% |
Reported net income and EPS were materially affected by a provisional $297.9 million net tax benefit related to the U.S. Tax Cuts and Jobs Act. Excluding special charges, RB Foods transaction and integration costs, and the tax benefit, adjusted net income was $133.2 million versus $96.0 million, and adjusted diluted EPS was $1.00 versus $0.76.
Adjusted operating income was $194.6 million, or 15.7% of sales, compared with $137.8 million, or 13.2%, in the prior-year quarter. Consumer segment sales were $757.4 million and adjusted operating income was $132.2 million, while Flavor Solutions sales were $479.7 million and adjusted operating income was $62.4 million.
Net cash used in operating activities was $20.5 million, compared with $44.3 million of operating cash flow provided in Q1 2017. Investing activities used $35.2 million, including $31.3 million of capital expenditures. Financing activities provided $39.2 million, primarily from increased short-term borrowings. Cash and cash equivalents were $179.6 million at February 28, 2018.
Total debt was approximately $5.13 billion, consisting of $680.7 million of short-term borrowings, $75.6 million of current long-term debt and $4.38 billion of long-term debt. The trailing twelve-month leverage ratio was 4.9, or 4.5 under the applicable credit agreement calculation, versus 2.0 at February 28, 2017. Management reported that it expected to comply with its debt covenants and believed available liquidity was adequate for the next twelve months.
Material changes versus the prior comparable period
- Sales growth was driven primarily by acquisitions, which contributed 12.4 percentage points, favorable foreign exchange of 3.9 points, volume and product mix of 1.5 points, and pricing of 0.7 points. Constant-currency sales growth was 14.6%.
- Gross margin expanded by 240 basis points, supported by RB Foods, a shift toward higher-value products and Comprehensive Continuous Improvement cost savings.
- Interest expense increased to $41.8 million from $14.5 million because of debt incurred to finance RB Foods.
- RB Foods transaction and integration expenses were $8.7 million in the quarter; approximately $23 million was expected for the full year 2018.
- Special charges declined to $2.2 million from $3.6 million, primarily reflecting Global Enablement, Thailand manufacturing-transfer and China facility-relocation activities.
- The company repaid $250.0 million of notes and $68.8 million of term-loan principal, while increasing short-term borrowings by $423.6 million.
- Share repurchases were curtailed because of elevated leverage. The company repurchased approximately $16.8 million of shares during the quarter, with $173 million remaining under its authorization.
Guidance, outlook, commentary and risks
For fiscal 2018, management projected sales growth of 13% to 15%, including an estimated 2% favorable currency effect, and adjusted operating income growth of 23% to 25%. Adjusted diluted EPS was projected at $4.85 to $4.95, excluding an estimated $2.24 per-share non-recurring U.S. Tax Act benefit, $0.11 of special charges and $0.13 of RB Foods integration expenses. Reported diluted EPS guidance was $6.85 to $6.95.
Management expected adjusted gross margin to improve by approximately 150 to 200 basis points, CCI savings to reach approximately $100 million, and capital expenditures to be approximately $200 million. Long-term objectives were constant-currency sales growth of 4% to 6%, adjusted operating income growth of 7% to 9% and adjusted EPS growth of 9% to 11%.
The $297.9 million U.S. Tax Act benefit was provisional and subject to revision during the applicable measurement period. Management expected an underlying 2018 effective tax rate of approximately 23%, excluding the transition tax and deferred-tax revaluation effects.
Key risks include elevated debt service and leverage following RB Foods, integration execution, raw-material and packaging cost volatility, foreign exchange movements, customer concentration and credit risk, supply-chain disruption, private-label competition, product quality or safety issues, achievement of expected cost savings, pension obligations, tax-law interpretation and the availability and cost of credit.
The company expects Global Enablement special charges of approximately $55 million to $65 million over three years and annual savings of approximately $30 million to $40 million once implemented. No material pending legal proceedings or material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Reconcile reported EPS with adjusted EPS and isolate the $297.9 million provisional U.S. Tax Act benefit.
- Track RB Foods integration costs, purchase-price allocation changes, goodwill and intangible-asset valuations.
- Monitor leverage, debt maturities, interest expense, short-term borrowings and compliance with credit-facility covenants.
- Assess whether projected CCI savings, gross-margin expansion and Global Enablement savings are achieved.
- Compare fiscal 2018 sales and EPS performance with management’s guidance, including currency and acquisition contributions.
- Review operating cash flow and working-capital trends, particularly given negative first-quarter operating cash flow and seasonal cash generation.