MCCORMICK & CO INC annual report, FY2013

McCormick & Company, Inc. — FY2013 Form 10-K Summary

Business context and reporting period

McCormick is a global manufacturer, marketer and distributor of spices, seasonings, condiments and flavor products serving retail, food manufacturing and foodservice customers. Operations are divided between Consumer and Industrial segments, with approximately 40% of fiscal 2013 sales generated outside the United States.

The filing reports the fiscal year ended November 30, 2013. Results are seasonal, with sales, income and operating cash flow generally strongest in the fourth quarter. The fourth quarter included significant EMEA reorganization charges and a pension settlement loss.

Financial performance and key metrics

Metric	2013	2012	Change
Net sales	$4,123.4 million	$4,014.2 million	+2.7%
Gross profit	$1,665.8 million	$1,617.8 million	+3.0%
Gross margin	40.4%	40.3%	+10 basis points
Operating income	$550.5 million	$578.3 million	-4.8%
Operating margin	13.4%	14.4%	-100 basis points
Net income	$389.0 million	$407.8 million	-4.6%
Diluted EPS	$2.91	$3.04	-4.3%
Operating cash flow	$465.2 million	$455.0 million	+$10.2 million

Excluding $25.0 million of EMEA special charges and a $15.3 million voluntary pension settlement loss, adjusted operating income was $590.8 million, adjusted net income was $418.2 million and adjusted diluted EPS was $3.13. Adjusted operating income increased 2.2% and adjusted diluted EPS increased 3.0%.

Consumer sales increased 5.1% to $2,538.0 million; segment operating income increased 3.6% to $472.3 million. Consumer operating margin declined to 18.6% from 18.9%.
Industrial sales declined 0.8% to $1,585.4 million; segment operating income declined 3.0% to $118.5 million. Industrial operating margin declined to 7.5% from 7.6%.
Pricing actions added 1.5% to consolidated sales, the WAPC acquisition added 1.5%, base volume and mix added 0.1%, and foreign exchange reduced sales by 0.4%.
Cost inflation in raw materials and packaging was approximately 3%. CCI productivity savings totaled $63 million, including $48 million in cost of goods sold.
SG&A increased to $1,075.0 million, partly because retirement benefit expense increased $20.0 million and brand marketing support rose to $207.8 million.
Capital expenditures were $99.9 million, compared with $110.3 million in 2012. Depreciation and amortization was $106.0 million.

Liquidity, debt and capital allocation

Cash and cash equivalents were $63.0 million at November 30, 2013, compared with $79.0 million at the prior year-end.
Total debt was $1,233.1 million, consisting of $211.6 million of short-term borrowings and approximately $1,021.5 million of long-term debt before the current portion presentation.
Total debt to adjusted EBITDA was 1.71, compared with 1.66 in 2012. Management’s target range is 1.5 to 1.7, excluding temporary acquisition effects.
The company issued $250 million of 3.50% notes due 2023 and used the proceeds, together with cash, to repay $250 million of 5.25% notes maturing in 2013. The effective fixed rate on the 2023 notes was 3.30% after hedging.
McCormick had a $600 million committed revolving credit facility expiring in 2016, with $399.7 million of capacity available after supporting commercial paper. Additional uncommitted facilities were also available.
Cash used in investing activities was $239.7 million, including $142.3 million for acquisitions and $99.9 million of capital expenditures.
Cash used in financing activities was $245.9 million. The company paid $179.9 million of dividends and repurchased $177.4 million of common stock.
The quarterly dividend was increased 8.8% in November 2013, from $0.34 to $0.37 per share.
At November 30, 2013, approximately $360 million remained under the $400 million share repurchase authorization approved in April 2013.

Material changes versus the prior comparable period

Growth slowed materially from 8.6% sales growth in 2012 to 2.7% in 2013.
Consumer growth was supported by pricing, innovation, marketing and the WAPC acquisition, while the U.S. business experienced slower momentum in the second half and increased competition from private-label and smaller brands.
Industrial sales were pressured by weaker quick-service restaurant demand in the United States and China, as well as lower volume and product mix.
Reported operating income and EPS declined because of the EMEA reorganization charges and pension settlement loss, higher retirement benefit expense and weaker industrial results.
Operating cash flow improved modestly, but inventory increased by $59.9 million, partly due to strategic purchases and higher material costs. The cash conversion cycle increased to 84.8 days from 82.1 days.
Total assets increased to $4,449.7 million from $4,165.4 million, largely reflecting the WAPC acquisition and higher goodwill. Goodwill increased to $1,798.5 million.
Shareholders’ equity increased to $1,947.7 million from $1,700.2 million, helped by comprehensive income and partially offset by dividends and share repurchases.

Guidance, outlook, risks and unusual items

Management’s long-term objectives are annual sales growth of 4% to 6%, operating income growth of 7% to 9% and EPS growth of 9% to 11%.
For 2014, management expected sales growth of 3% to 5%, gross-margin improvement of 50 to 100 basis points, capital expenditures of $120 million to $130 million, and approximately $16 million of pension contributions.
The EMEA reorganization is expected to generate approximately $27 million of total charges, including approximately $2 million in 2014, with approximately $18 million of implementation cash costs and annual cost savings of approximately $10 million by 2015. Completion was expected by 2015.
The WAPC acquisition cost $144.8 million, contributed $59.4 million of 2013 sales and had a neutral 2013 net-income impact because integration and financing costs offset operating profit. Its purchase-price allocation was preliminary at year-end.
Key risks include commodity price and availability volatility, weather and climate impacts on agricultural inputs, foreign exchange exposure, customer consolidation and pricing pressure, private-label competition, food safety and product recalls, supply-chain disruptions, acquisitions and integration, pension obligations, tax disputes, cybersecurity, regulatory changes and litigation.
The company had no material pending legal proceedings, no material off-balance-sheet arrangements and no material environmental capital expenditures planned for 2014.
The IRS examination of 2007 and 2008 U.S. federal tax returns remained unresolved. The company had $58.0 million of unrecognized tax benefits at year-end and had deposited $18.8 million with the IRS in 2012 concerning proposed adjustments.
Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective.

Most important facts for investors to verify

Reconcile GAAP 2013 EPS of $2.91 with adjusted EPS of $3.13 and assess whether the special charges and pension settlement should be treated as nonrecurring.
Evaluate whether the projected EMEA cost savings and the 2014 reorganization timetable are achieved.
Monitor consumer-market momentum in the United States, private-label share gains and the contribution from WAPC.
Assess industrial demand, particularly quick-service restaurant exposure in the United States and China.
Track raw-material inflation, pricing realization, CCI savings and the expected gross-margin improvement.
Review leverage, 2015 and later debt maturities, commercial paper reliance and available revolving-credit capacity.
Assess pension funding requirements, actuarial assumptions and the sensitivity of 2014 expense to discount rates and asset returns.
Review the resolution of IRS tax matters and the potential cash and effective-tax-rate impact of uncertain tax positions.