MCCORMICK & CO INC annual report, FY2018

McCormick & Company, Inc. — Fiscal 2018 Form 10-K Summary

Business context and reporting period

McCormick is a global producer and distributor of spices, seasonings, condiments and flavor solutions serving retail, food manufacturers and foodservice customers. The filing covers the fiscal year ended November 30, 2018; fourth-quarter results are included in the annual filing. Operations are managed through Consumer and Flavor Solutions segments, with approximately 40% of sales generated outside the United States.

The 2018 results include the full-year impact of the August 2017 acquisition of RB Foods, whose brands include French’s, Frank’s RedHot and Cattlemen’s. The acquisition cost approximately $4.21 billion, net of acquired cash.

Key financial metrics

Metric	2018	2017	Change
Net sales	$5,408.9 million	$4,834.1 million	11.9% increase
Gross profit	$2,371.6 million	$2,010.2 million	18.0% increase
Gross margin	43.8%	41.6%	220 basis-point increase
Operating income	$903.3 million	$702.4 million	28.6% increase
Operating margin	16.7%	14.5%	220 basis-point increase
Net income	$933.4 million	$477.4 million	95.5% increase
Diluted EPS	$7.00	$3.72	88.2% increase
Operating cash flow	$821.2 million	$815.3 million	0.7% increase
Capital expenditures	$169.1 million	$182.4 million	Decrease

Reported earnings benefited from a $301.5 million non-recurring net tax benefit related to the U.S. Tax Act. Excluding the tax benefit, special charges and RB Foods transaction and integration expenses, adjusted net income was $662.0 million and adjusted diluted EPS was $4.97, up 21.1% and 16.7%, respectively.

Consumer: Sales were $3,318.0 million, up 11.7%; segment operating income was $644.9 million, with a 19.4% margin versus 19.0% in 2017.
Flavor Solutions: Sales were $2,090.9 million, up 12.2%; segment operating income was $297.2 million, with a 14.2% margin versus 11.9% in 2017.
Sales growth reflected 2.2% from volume and product mix, 0.5% from pricing, 8.0% from acquisitions and 1.2% from foreign exchange.
CCI productivity savings were $117.9 million in 2018; brand marketing investment increased 18% and brand marketing costs totaled $324.8 million.
Cash conversion cycle improved to 55.5 days from 76.6 days.

Debt, liquidity and shareholder returns

Total debt was approximately $4.7 billion at November 30, 2018, including $560.0 million of short-term borrowings and $4,136.4 million of long-term debt, including current maturities.
Interest expense increased to $174.6 million from $95.7 million, primarily because of debt incurred to finance RB Foods.
Cash and cash equivalents were $96.6 million; the company had $490.1 million of unused capacity under its $1.0 billion revolving credit facility, plus $149.9 million of unused uncommitted lines.
Net debt was $4,674.8 million and the reported leverage ratio was 4.0x, down from 5.1x in 2017. Management’s long-term leverage target is 1.5x to 1.8x.
Dividends paid were $273.4 million, or $2.08 per share. The quarterly dividend was increased 9.6% in November 2018 to $0.57 per share.
Share repurchases totaled $62.3 million. Repurchases and acquisition activity were curtailed to support deleveraging; $127 million remained under the $600 million authorization at year-end.
Contractual cash obligations totaled $6.512 billion, including debt, interest, leases and raw-material purchase commitments.

Material changes versus the prior comparable period

RB Foods contributed an incremental 8.0% to 2018 sales growth and was fully reflected in the year, compared with only a partial contribution in 2017.
Gross and operating margins expanded materially as RB Foods mix, CCI savings and product mix more than offset higher material, freight, marketing and interest costs.
RB Foods transaction and integration expenses declined to $22.5 million from $77.1 million. Special charges declined to $16.3 million from $22.2 million.
Interest expense and leverage remained substantially above pre-acquisition levels, although debt repayment reduced net debt by year-end.
Net income and EPS growth substantially exceeded operating performance because of the U.S. Tax Act benefit. The reported 2018 effective tax rate was a 21.2% benefit versus a 25.4% expense in 2017.
Goodwill and intangible assets remained significant at $7.486 billion, including $4.528 billion of goodwill and $2.647 billion of brand names and trademarks.

Guidance, outlook and unusual items

For 2019, management expects sales growth of 1% to 3%, or 3% to 5% in constant currency, including an estimated 2% unfavorable currency impact.
Reported operating income is expected to increase 10% to 12%; adjusted operating income is expected to increase 7% to 9%, or 9% to 11% in constant currency.
Reported diluted EPS is projected at $5.09 to $5.19. Adjusted diluted EPS, excluding estimated special charges, is projected at $5.17 to $5.27, representing 4% to 6% growth on a reported currency basis.
Management expects 2019 gross margin to increase by 25 to 75 basis points and targets approximately $110 million of CCI-led cost savings. Capital expenditures are expected to approximate $210 million.
The 2019 outlook assumes no incremental sales contribution from acquisitions, lower special charges of approximately $15 million and no RB Foods transaction and integration expenses.
The Global Enablement initiative is expected to generate total special charges of approximately $55 million to $65 million over its multi-year implementation and annual savings of approximately $30 million to $40 million once fully implemented.
Fiscal 2019 adoption of revenue-recognition and pension-cost presentation standards will reclassify historical income statement items but is not expected to affect net income or EPS. The filing estimates historical annual sales will be reduced by approximately $100 million to $110 million under the revenue standard.

Principal risks and contingencies

High leverage and variable-rate debt increase exposure to interest rates, refinancing conditions, credit ratings, LIBOR-related changes and restrictive covenants.
RB Foods integration, expected synergies, brand performance and goodwill or intangible-asset impairment remain important execution risks.
Raw-material price and availability volatility, weather, climate change, freight costs and supply-chain interruptions may pressure margins.
Customer concentration is significant: Wal-Mart represented approximately 11% of consolidated sales and PepsiCo approximately 10% in 2018; the top three Flavor Solutions customers represented 48% to 54% of that segment’s sales.
Competition from branded and private-label products, customer consolidation, pricing pressure and changing retail channels could affect volume and profitability.
Foreign exchange, Brexit-related trade disruption, tariffs, geopolitical conditions and international regulatory requirements may affect results.
Food safety, labeling, product recalls, litigation, cybersecurity incidents and data-protection compliance could damage operations or brand reputation.
No material pending legal proceedings or material off-balance-sheet arrangements were reported. The filing states that internal controls were effective and the auditor issued unqualified opinions.

Investor verification checklist

Reconcile reported 2018 EPS of $7.00 with adjusted EPS of $4.97 and isolate the $2.26 per-share U.S. Tax Act benefit.
Assess deleveraging progress, debt maturities, interest-rate exposure and compliance with leverage covenants.
Verify whether RB Foods sales, margins, integration costs and anticipated synergies are tracking management’s expectations.
Evaluate the sustainability of margin expansion after adjusting for acquisition mix, CCI savings, pricing and one-time items.
Review the effects of the fiscal 2019 revenue-recognition and pension-cost classification changes on reported sales and margins.
Monitor foreign exchange, commodity costs, customer concentration, private-label competition and Brexit-related developments.
Assess goodwill and brand-asset impairment sensitivity, particularly the $2.320 billion of RB Foods brand assets and the significant goodwill balance.