McCormick & Company, Incorporated — Q3 2015 Form 10-Q
Reporting period: Fiscal quarter and nine months ended August 31, 2015. McCormick is a global manufacturer and distributor of spices, seasonings, condiments and flavor products serving consumer and industrial customers. Results are seasonally stronger in the second half of the fiscal year, particularly the fourth quarter.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net sales | $1,059.9 million | $1,042.8 million | $3,094.4 million | $3,069.6 million |
| Gross profit | $421.9 million | $420.1 million | $1,215.6 million | $1,224.1 million |
| Gross margin | 39.8% | 40.3% | 39.3% | 39.9% |
| Operating income | $138.7 million | $157.3 million | $336.2 million | $403.6 million |
| Net income | $97.6 million | $122.9 million | $252.4 million | $289.9 million |
| Diluted EPS | $0.76 | $0.94 | $1.95 | $2.21 |
Reported sales increased 1.6% in the quarter and 0.8% year to date, despite unfavorable currency impacts of 5.7% and 5.1%, respectively. Constant-currency sales increased 7.3% in the quarter and 5.9% year to date. Volume and product mix, pricing and acquisitions contributed to constant-currency growth.
Operating income excluding special charges was $153.8 million in the quarter and $398.7 million year to date, compared with $159.6 million and $405.9 million in the comparable periods. Consumer operating margin excluding special charges declined to 18.2% from 19.6% in the quarter and to 15.5% from 16.3% year to date. Industrial operating margin improved to 9.1% from 8.9% in the quarter and to 9.0% from 8.5% year to date.
Net cash provided by operating activities was $316.6 million for the first nine months, up from $275.8 million. Investing cash flow used $280.6 million, including $210.9 million for acquisitions and $70.0 million of capital expenditures. Financing activities provided $13.3 million, including $214.1 million of net short-term borrowings, offset by $153.7 million of dividends and $72.3 million of share repurchases. Cash and cash equivalents were $108.4 million at August 31, 2015.
Total debt was $1,492.0 million at August 31, 2015, comprising $481.2 million of short-term borrowings, $203.6 million of current long-term debt and $807.2 million of long-term debt. Total debt to adjusted EBITDA was 2.02, compared with 1.81 at August 31, 2014 and 1.73 at November 30, 2014. The company entered into a new $750 million revolving credit facility expiring in June 2020 and stated that available liquidity should be adequate for the next twelve months.
Material changes versus the prior comparable period
- Currency materially reduced reported sales and operating results; constant-currency growth was substantially stronger than reported growth.
- Gross margin declined 50 basis points in the quarter and 60 basis points year to date, primarily because of weaker Kohinoor performance and higher material costs, partly offset by cost savings and pricing.
- Operating income and diluted EPS declined, substantially reflecting higher special charges, higher interest expense and unfavorable operating effects in the consumer segment.
- Industrial sales and profitability improved, while consumer profitability declined. The consumer segment was affected by Kohinoor weakness, higher employee benefit costs and higher material costs.
- Debt increased to fund acquisitions, and leverage rose to 2.02 times adjusted EBITDA.
- Accumulated other comprehensive loss increased to $353.6 million, principally reflecting foreign-currency translation losses and pension-related amounts.
Acquisitions, unusual items and outlook
McCormick acquired Brand Aromatics for $62.5 million, Drogheria & Alimentari for $49.0 million net of cash acquired, and One World Foods, maker of Stubb’s, for $99.4 million. Preliminary purchase accounting produced substantial goodwill and intangible assets. D&A also carries potential contingent consideration of up to €35 million payable in 2018; its recorded fair value was $28.6 million at August 31, 2015.
Special charges totaled $15.1 million in the quarter and $62.5 million year to date, compared with $2.3 million in each 2014 period. The charges included a $9.6 million non-cash impairment of the Kohinoor brand, $3.4 million of inventory write-downs and restructuring and severance costs. The company expects an additional approximately $2 million to $4 million of Kohinoor-related costs over the following three to nine months.
Management projected fiscal 2015 sales growth at the upper end of its 4% to 6% constant-currency target, with an approximately 5% unfavorable currency impact on reported sales. Adjusted diluted EPS guidance was $3.47 to $3.54, with performance expected at the lower end after an estimated $0.36 per-share impact from special charges. Constant-currency adjusted EPS growth was expected at the lower end of the 7% to 9% range. The company expected at least $75 million of 2015 CCI cost savings, approximately $20 million of additional savings from streamlining and reorganizations, and $130 million to $140 million of capital expenditures.
Key risks include foreign-currency volatility, raw-material cost and availability, the ability to achieve cost savings and integrate acquisitions, customer and competitive pressures, product quality and safety, supply-chain disruption, pension obligations, tax-rate volatility, cybersecurity incidents and availability of credit markets. No material pending legal proceedings were reported, and management concluded that disclosure controls were effective.
Investor verification points
- Reconcile GAAP results with management’s adjusted operating income and adjusted EPS, including the treatment and tax effects of special charges.
- Monitor whether Kohinoor restructuring improves profitability and whether the remaining $2 million to $4 million of estimated costs are incurred.
- Assess acquisition integration, purchase-price allocation changes, goodwill and intangible-asset impairment risk, and the eventual D&A earn-out obligation.
- Track currency effects separately from underlying volume, pricing and mix performance.
- Evaluate the increase in borrowings, 2.02 leverage ratio and planned issuance of at least $100 million of fixed-rate notes.
- Verify achievement of projected CCI and restructuring savings, fiscal 2015 EPS guidance and capital-expenditure plans.
- Review the company’s $1.0 billion aggregate share-repurchase authorizations, including $43 million remaining under the earlier authorization and the full $600 million newer authorization.