Business Context and Reporting Period
McCormick & Company, Incorporated reported unaudited third-quarter and nine-month results for the periods ended August 31, 2010. The company manufactures and distributes spices, herbs, seasonings, specialty foods and flavors through consumer and industrial segments. Approximately 40% of annual sales are outside the United States, and results are seasonally stronger in the second half of the fiscal year.
Key Financial Metrics
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Net sales | $794.6 million | $791.7 million | $2,357.4 million | $2,267.5 million |
| Gross profit | $334.8 million | $319.0 million | $971.7 million | $905.5 million |
| Gross margin | 42.1% | 40.3% | 41.2% | 39.9% |
| Operating income | $126.0 million | $116.6 million | $324.4 million | $289.0 million |
| Net income | $102.4 million | $75.1 million | $236.5 million | $183.5 million |
| Diluted EPS | $0.76 | $0.57 | $1.76 | $1.39 |
| Operating cash flow | Not separately provided | Not separately provided | $145.2 million | $195.1 million |
Q3 operating income increased 8.1%, while nine-month operating income increased 12.2%. Reported net income increased 36.4% in the quarter and 28.9% year to date, substantially benefiting from discrete tax benefits. Adjusted diluted EPS, excluding restructuring charges and the significant tax-accrual reversal, was $0.66 versus $0.57 in Q3 2009 and $1.66 versus $1.43 for the first nine months.
- Consumer sales increased 0.8% in Q3 and 4.1% year to date. Consumer operating margin excluding restructuring charges was 21.1% in Q3 and 17.9% year to date.
- Industrial sales decreased 0.2% in Q3 but increased 3.7% year to date. Industrial operating margin excluding restructuring charges was 8.9% in Q3 and 8.0% year to date.
- Cash used in investing activities was $46.4 million, including $52.5 million of capital expenditures. Cash used in financing activities was $112.7 million, including $103.7 million of dividends and $38.2 million of share repurchases.
- Cash and cash equivalents were $23.6 million at August 31, 2010, compared with $27.9 million a year earlier and $39.5 million at November 30, 2009.
- Total debt was approximately $977.2 million, comprising $97.4 million of short-term borrowings, $100.3 million of current long-term debt and $779.5 million of long-term debt. Debt-to-total capital was 41.4%, versus 46.4% at August 31, 2009.
Material Changes Versus the Prior Comparable Period
- Gross margin improved 180 basis points in Q3 and 130 basis points year to date, driven by Comprehensive Continuous Improvement savings and favorable product mix, particularly in industrial operations.
- Sales growth was constrained by foreign exchange and pricing. Q3 reported sales growth was 0.4%; growth excluding foreign exchange was 1.5%. Year-to-date reported growth was 4.0%, or 1.7% excluding foreign exchange.
- SG&A increased to 26.2% of sales in Q3 from 25.5% and to 27.4% year to date from 26.8%, reflecting higher benefit costs and increased brand marketing. Year-to-date marketing spending rose $13.6 million, or 13%.
- Operating cash flow declined $49.9 million year to date, primarily because of higher inventories, including inventory accumulated before SAP implementation in Asia and higher raw-material costs.
- Interest expense declined to $12.4 million from $12.8 million in Q3 and to $37.0 million from $40.2 million year to date, reflecting lower average debt and short-term interest rates.
- There were no restructuring charges in 2010; the comparable 2009 periods included $0.9 million in Q3 and $8.2 million year to date.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management projected 2010 comparable EPS growth of 9% to 11%, local-currency sales growth of 2% to 4%, and approximately 100 basis points of full-year gross-margin improvement versus 2009. The filing also states that the underlying 2010 effective tax rate is projected at approximately 32%.
- Management expected 2010 capital expenditures of approximately $85 million to $90 million, pension contributions of approximately $55 million, at least $75 million of share repurchases, and up to $2.5 million of additional restructuring cash spending.
- Income taxes included discrete benefits of $16.1 million in Q3 and $20.8 million year to date. The Q3 amount primarily reflected a $13.9 million reversal of a tax accrual for a closed tax year. Unrecognized tax benefits totaled $15.9 million at August 31, 2010.
- The company signed an agreement to acquire a 26% non-controlling interest in Eastern Condiments Private Limited for approximately $35 million, subject to regulatory approval. Subsequent to quarter-end, it acquired Caamacosta assets for $11 million and formed a start-up consumer joint venture in Turkey.
- A product recall generated $1.7 million of consumer-segment costs and $4.4 million of cost-of-goods-sold expense in the first quarter of 2010.
- Management intends to pay $100 million of debt maturing within 12 months using cash, credit lines and operating cash flow. Management stated that existing liquidity sources should be sufficient for current needs.
- Principal risks include raw-material and packaging-cost volatility, foreign exchange, customer and counterparty credit exposure, dependence on bank commitments and commercial paper markets, pension funding requirements, brand and product-quality risks, recalls, competition from private-label products, acquisitions, economic conditions and the ability to achieve cost savings and margin targets.
- No material pending legal proceedings or material changes to previously disclosed risk factors were reported, other than the product-quality and recall-related risk disclosure.
Important Facts for Investors to Verify
- Whether reported EPS growth is sustainable after removing the $13.9 million tax-accrual reversal and other discrete tax benefits.
- Whether inventory normalization restores operating cash flow and supports planned debt repayment and share repurchases.
- Progress toward the 2010 guidance for sales, comparable EPS, gross-margin expansion, capital expenditures and repurchases.
- The maturity and refinancing or repayment plan for the $100.3 million current portion of long-term debt.
- The approval, valuation and financial contribution of the Eastern Condiments investment, the Caamacosta acquisition and the Turkey joint venture.
- The impact of foreign exchange, raw-material costs, pricing actions, customer demand and any further product-quality or recall matters.