Business Context and Reporting Period
McCormick & Company, Incorporated is a global producer and distributor of spices, seasonings, condiments and flavor products through consumer and industrial segments. This unaudited Form 10-Q covers the three and nine months ended August 31, 2016, compared with the corresponding 2015 periods.
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $1,091.0 million | $1,059.9 million | $3,184.5 million | $3,094.4 million |
| Gross profit | $453.9 million | $421.9 million | $1,291.7 million | $1,215.6 million |
| Gross margin | 41.6% | 39.8% | 40.6% | 39.3% |
| Operating income | $167.8 million | $138.7 million | $421.9 million | $336.2 million |
| Net income | $127.7 million | $97.6 million | $314.9 million | $252.4 million |
| Diluted EPS | $1.00 | $0.76 | $2.46 | $1.95 |
| Operating cash flow | Not separately presented | Not separately presented | $322.4 million | $316.6 million |
Reported sales increased 2.9% in both the quarter and year to date. Constant-currency sales growth was 5.6% in the quarter and 6.0% year to date. Reported diluted EPS increased 31.6% in the quarter and 26.2% year to date. Approximate reported operating margins were 15.4% for the quarter and 13.2% year to date; net margins were approximately 11.7% and 9.9%, respectively.
- Consumer sales were $662.0 million in the quarter and $1,937.6 million year to date; adjusted operating margins were 19.2% and 15.9%, respectively.
- Industrial sales were $429.0 million in the quarter and $1,246.9 million year to date; adjusted operating margins were 10.4% and 9.9%, respectively.
- Cash and cash equivalents were $134.2 million at August 31, 2016, versus $112.6 million at November 30, 2015.
- Total debt was $1,617.8 million on a trailing-twelve-month basis for leverage purposes, and total debt to EBITDA was 2.07x versus 2.02x at November 30, 2015.
- Capital expenditures were $87.9 million year to date; dividends paid were $163.6 million; and share repurchases totaled $178.9 million.
Material Changes Versus the Prior Comparable Period
- Gross margin expanded 180 basis points in the quarter and 130 basis points year to date, primarily from CCI cost savings, organizational streamlining, favorable mix and pricing actions.
- Adjusted operating income increased 11.9% in the quarter and 8.3% year to date. Constant-currency adjusted operating income growth was 14.5% and 11.3%, respectively.
- Foreign currency translation reduced sales by 2.7% in the quarter and 3.1% year to date, while reducing adjusted operating income by 2.6% and 3.0%, respectively.
- SG&A increased to 25.8% of sales in the quarter and 27.1% year to date, reflecting higher brand marketing, selling and marketing costs, employee benefits and acquisition-related expenses.
- Special charges declined to $4.3 million in the quarter and $9.8 million year to date, compared with $15.1 million and $62.5 million in the prior-year periods.
- Gourmet Garden, acquired in April 2016 for a net purchase price of $116.2 million, contributed $14.1 million of third-quarter sales and $21.5 million year to date. Management stated that the acquired businesses were not significant contributors to operating income because of financing, acquisition and integration costs.
- Operating cash flow increased only modestly despite higher net income, partly because of less favorable collections of receivables and higher pension contributions.
Guidance, Outlook, Risks and Unusual Items
- For 2016, management projected sales growth of approximately 3%, or approximately 6% on a constant-currency basis. Diluted EPS guidance was $3.68 to $3.72; adjusted diluted EPS guidance was $3.75 to $3.79, excluding an estimated $0.07 per share of special charges.
- Management expected 2016 cost savings of $100 million to $110 million, low-single-digit material-cost inflation, approximately $15 million of additional brand-marketing investment and capital expenditures of $150 million to $160 million.
- Management expected a 25% to 26% annual effective tax rate absent additional discrete items. The nine-month tax rate benefited from $20.7 million of discrete tax benefits, including reversals of tax reserves and a deferred-tax valuation allowance.
- Special charges included EMEA streamlining, the planned exit from leased manufacturing facilities in Singapore and Thailand, North American severance and Kohinoor product-line exits. Additional 2016 charges were expected for EMEA actions, and approximately $2.2 million of additional Singapore/Thailand exit costs were expected over the following two years.
- The company agreed to exit its South African joint venture, with closing expected in October 2016 subject to customary conditions. Any resulting loss was not expected to be material.
- A 15-year headquarters lease signed in July 2016 is expected to commence in the second half of 2018 and requires initial monthly payments of approximately $0.9 million, subject to adjustments.
- Key risks include foreign-exchange volatility, Brexit-related currency and market uncertainty, raw-material costs and availability, customer and credit concentration, competitive and private-label pressure, execution of cost savings, acquisition integration, pension funding, interest rates, cybersecurity, product quality and safety, tax matters, litigation and regulatory changes.
- Management stated that available cash, operating cash flow and existing borrowing facilities should be adequate for the next 12 months. No material changes to reported risk factors or material pending legal proceedings were disclosed.
Investor Verification Priorities
- Verify the sustainability of gross-margin expansion and the $100 million to $110 million 2016 cost-savings target after increased marketing and material costs.
- Reconcile reported EPS with adjusted EPS, including the effect of special charges and the $20.7 million of year-to-date discrete tax benefits.
- Monitor foreign-exchange exposure, particularly the British pound and other currencies affected by Brexit, and compare constant-currency growth with reported results.
- Assess leverage, refinancing needs and seasonal working-capital requirements given total debt of approximately $1.6 billion and a 2.07x debt-to-EBITDA ratio.
- Track integration and returns from Gourmet Garden and other acquisitions, including the D&A contingent consideration liability valued at $30.1 million and payable in fiscal 2018.
- Confirm execution, timing and cash costs of the Singapore/Thailand facility transition, EMEA restructuring, Kohinoor actions and South African joint-venture exit.
- Evaluate the effect of the new headquarters lease, share repurchases, dividends and planned capital expenditures on liquidity and capital allocation.