Business Context and Reporting Period
McCormick & Company, Incorporated is a global producer and marketer of spices, seasonings, condiments and flavor products. It operates through Consumer and Flavor Solutions segments. This unaudited Form 10-Q covers the three and nine months ended August 31, 2018, within the fiscal year ending November 30, 2018.
Financial Performance and Position
| Metric | Three Months Ended August 31, 2018 | Year-over-Year Change | Nine Months Ended August 31, 2018 | Year-over-Year Change |
|---|---|---|---|---|
| Net sales | $1,345.3 million | +13.5% | $3,909.7 million | +16.9% |
| Gross profit | $594.9 million | +22.8% | $1,690.1 million | +25.9% |
| Gross margin | 44.2% | +330 bps | 43.2% | +310 bps |
| Operating income | $233.0 million | +38.7% | $608.4 million | +39.7% |
| Net income | $173.5 million | +60.3% | $719.4 million | +138.5% |
| Diluted EPS | $1.30 | +52.9% | $5.41 | +128.3% |
- Adjusted operating income was $241.9 million for the quarter and $644.4 million for the nine-month period, compared with $203.8 million and $478.9 million, respectively, in the comparable periods.
- Adjusted operating margin was 18.0% for the quarter and 16.5% for the nine months, compared with 17.2% and 14.3% in the prior-year periods.
- Consumer segment sales increased 13.5% in the quarter and 17.2% year to date. Flavor Solutions sales increased 13.5% and 16.6%, respectively.
- Quarterly sales growth reflected a 9.6% contribution from acquisitions, 3.5% from volume and product mix, 0.5% from pricing and a 0.1% unfavorable foreign-exchange impact. The nine-month acquisition contribution was 11.6%.
- Net cash provided by operating activities was $389.0 million, compared with $303.0 million in the prior-year period. Capital expenditures were $112.6 million.
- Cash and cash equivalents were $73.0 million at August 31, 2018, versus $186.8 million at November 30, 2017.
- Total debt was approximately $4,985.1 million, including short-term borrowings, current long-term debt and long-term debt. The reported leverage ratio was 4.3, down from 5.1 at November 30, 2017 and 6.0 at August 31, 2017.
- Dividends paid during the first nine months were $204.9 million. The company repurchased $40.0 million of shares, and $149.3 million remained under its $600 million authorization.
Material Changes Versus the Prior Comparable Period
- The August 2017 acquisition of RB Foods, including French’s, Frank’s RedHot and Cattlemen’s, was the principal driver of sales growth and contributed $386.0 million of incremental sales in the first nine months of 2018.
- Gross-margin expansion reflected the RB Foods business, CCI-led cost savings, favorable product mix and the absence of the $5.9 million RB Foods inventory fair-value adjustment recorded in 2017.
- SG&A increased to $353.0 million for the quarter and $1,045.7 million year to date, driven by RB Foods, higher brand marketing and higher distribution and freight costs.
- Interest expense increased to $44.7 million for the quarter and $130.7 million year to date, primarily because of debt incurred to finance RB Foods.
- Nine-month net income included a $308.2 million provisional net tax benefit from the U.S. Tax Act, including a $381.4 million deferred-tax revaluation benefit partly offset by an estimated $73.2 million transition-tax impact. This benefit materially distorts reported year-over-year net income and EPS comparisons.
- Transaction and integration expenses related to RB Foods were $5.6 million for the quarter and $22.1 million year to date, versus $45.8 million in the comparable 2017 periods.
Guidance, Outlook, Commentary and Risks
- Management projected 2018 sales growth of 12% to 14%, including an estimated 1% favorable currency impact, or 11% to 13% on a constant-currency basis. RB Foods was expected to contribute approximately 8% of sales growth.
- Adjusted gross margin was expected to increase approximately 175 to 225 basis points from 2017, supported by favorable mix and CCI savings. Management expected at least $105 million of CCI savings in 2018.
- Adjusted operating income was projected to increase 22% to 23%. Diluted EPS guidance was $7.03 to $7.08; adjusted diluted EPS guidance was $4.95 to $5.00, excluding the U.S. Tax Act benefit, special charges and RB Foods integration expenses.
- Management expected 2018 capital expenditures of approximately $200 million and total 2018 special charges of approximately $18.5 million. The Global Enablement initiative is expected to cost $55 million to $65 million over three years and generate annual savings of $30 million to $40 million once implemented.
- Liquidity is supported by operating cash flow, cash balances, short-term borrowing capacity and a $1.0 billion revolving credit facility expiring in August 2022. Management stated that available sources should be adequate for the next twelve months.
- Key risks include elevated debt service following RB Foods, interest-rate and foreign-exchange exposure, commodity and freight-cost volatility, supply-chain disruptions, customer and retailer concentration, acquisition integration, regulatory and food-safety requirements, cybersecurity, GDPR compliance, litigation and uncertainty in the provisional U.S. Tax Act accounting.
- The company reported no material pending legal proceedings, no material changes to most previously disclosed risk factors, and effective disclosure controls and procedures.
Important Facts for Investors to Verify
- Reconcile reported EPS and net income with adjusted results, particularly the $308.2 million provisional U.S. Tax Act benefit.
- Monitor RB Foods integration costs, expected remaining 2018 costs and whether the acquired brands sustain projected growth and margins.
- Assess debt reduction, interest expense, covenant compliance and progress toward management’s long-term leverage target of 1.5 to 1.8.
- Evaluate whether CCI and Global Enablement savings offset higher brand marketing, freight, commodity and other operating costs.
- Verify the final accounting for the U.S. Tax Act, including the transition tax and deferred-tax remeasurement, during the remaining measurement period.
- Compare future operating cash flow and capital allocation with the company’s seasonal cash-flow pattern and stated commitments to dividends, capital expenditures and debt repayment.