McCormick & Company, Inc. — Q2 2017 Form 10-Q Summary
Business context and reporting period
McCormick is a global producer and distributor of spices, seasonings, condiments and flavor solutions serving consumer and industrial customers. The filing covers the three and six months ended May 31, 2017, compared with the corresponding 2016 periods. The company operates through Consumer and Industrial segments and notes that sales, earnings and operating cash flow are typically stronger in the second half of the fiscal year.
Key financial metrics
| Metric | Three months ended May 31, 2017 | Three months ended May 31, 2016 | Six months ended May 31, 2017 | Six months ended May 31, 2016 |
|---|---|---|---|---|
| Net sales | $1,114.3 million | $1,063.3 million | $2,158.0 million | $2,093.5 million |
| Operating income | $132.6 million | $125.0 million | $266.8 million | $254.1 million |
| Net income | $100.0 million | $93.8 million | $193.5 million | $187.2 million |
| Diluted EPS | $0.79 | $0.73 | $1.53 | $1.46 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $177.2 million | $212.7 million |
- Second-quarter sales increased 4.8%; constant-currency growth was 7.2%. Six-month sales increased 3.1%; constant-currency growth was 5.5%.
- Gross margin was 39.9% for the quarter and 39.7% year to date, down from 40.7% and 40.0%, respectively, primarily because of material cost inflation and unfavorable foreign currency effects.
- Reported operating margin was approximately 11.9% for the quarter and 12.4% year to date. Operating income excluding special charges was $137.3 million for the quarter and $275.1 million year to date.
- Net margin was approximately 9.0% for the quarter and 9.0% year to date.
- Consumer sales increased 2.3% in the quarter and 1.5% year to date; Industrial sales increased 8.6% and 5.5%, respectively. Segment operating margins excluding special charges were 13.9% and 14.6% for Consumer, and 10.0% for Industrial in both periods.
- At May 31, 2017, cash and cash equivalents were $130.0 million. Total debt, including short-term borrowings and current and long-term debt, was approximately $1.71 billion; the trailing-twelve-month total debt-to-EBITDA ratio was 2.12, above the company’s stated target range of 1.5 to 1.8.
- Year-to-date investing cash flow was negative $189.8 million, including $124.0 million for the Giotti acquisition and $66.2 million of capital expenditures. Capital expenditures for 2017 were expected to be $170 million to $190 million.
- Year-to-date financing cash flow was positive $24.6 million, including $135.8 million of share repurchases and $117.4 million of dividends paid. Approximately $191 million remained under the $600 million repurchase authorization at May 31, 2017.
Material changes versus the prior comparable period
- Sales growth benefited from pricing, acquisitions, and higher volume and product mix, partially offset by unfavorable currency translation. Acquisitions contributed 2.7% to total sales growth in both the quarter and first half.
- Giotti, acquired in December 2016 for $124.0 million, added $18.5 million of second-quarter sales and $29.6 million of first-half sales. Gourmet Garden added $15.9 million and $32.5 million, respectively.
- Gross margin declined despite pricing actions because material cost inflation exceeded the margin benefit from pricing.
- SG&A as a percentage of sales improved to 27.6% in the quarter from 28.6%, and to 27.0% year to date from 27.6%, helped by lower pension and acquisition-related costs and a $1.6 million gain from settling D&A contingent consideration.
- Operating cash flow declined $35.5 million year to date, mainly because of the timing of income tax and incentive compensation payments.
- Debt increased substantially from November 30, 2016, primarily to fund the Giotti acquisition, share repurchases and dividends. Short-term borrowings were $656.2 million at May 31, 2017 versus $390.3 million at November 30, 2016.
- The company early adopted ASU 2016-09, resulting in $7.0 million of second-quarter and $8.6 million of year-to-date discrete tax benefits from excess tax benefits related to share-based compensation.
- Pension plan freezes produced a non-cash, pre-tax actuarial gain of approximately $77.7 million, principally a $76.7 million curtailment gain recorded in other comprehensive income.
Guidance, outlook, risks and unusual items
- For 2017, management projected sales growth of 4% to 6%, including an estimated 1% unfavorable currency impact; constant-currency sales growth was projected at 5% to 7%.
- Reported diluted EPS was projected at $3.94 to $4.02. Adjusted diluted EPS, excluding an estimated $0.11 impact from special charges, was projected at $4.05 to $4.13. Constant-currency adjusted EPS growth was expected to be 9% to 11%.
- Management expected at least $100 million of 2017 cost savings, mid-single-digit material cost inflation largely offset by pricing, and mid- to high-single-digit growth in brand marketing investment.
- Special charges were $4.7 million in the quarter and $8.3 million year to date. The company expected an additional $11.5 million of special charges during the remainder of 2017.
- After the reporting period, management approved the three-year McCormick Global Enablement initiative. Expected special charges were $55 million to $65 million over three years, with anticipated annual savings of $30 million to $40 million after implementation. Approximately $7 million of related charges were expected in the second half of 2017.
- Material risks include commodity cost and availability volatility, foreign exchange and Brexit-related uncertainty, higher interest rates, customer concentration and credit risk, competitive pressure from private label, acquisition integration, supply-chain disruption, product quality or safety issues, cyber risk, tax and pension exposure, and the company’s ability to realize planned savings.
- The company entered into a 364-day, $250 million revolving credit facility expiring in March 2018 and had hedges covering foreign-exchange and anticipated fixed-rate debt issuance. Management stated that available cash, operating cash flow and financing sources were adequate for expected requirements over the next twelve months.
- No material pending legal proceedings or material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether pricing actions can offset continued material inflation without causing further volume or mix deterioration, particularly in EMEA.
- The sustainability of reported growth after acquisition contributions and the profitability of Giotti and Gourmet Garden after integration costs.
- Progress toward reducing leverage from the 2.12 total debt-to-EBITDA ratio and the planned issuance of at least $150 million of fixed-rate notes by December 2017.
- Actual timing and total cost of the McCormick Global Enablement initiative versus the $55 million to $65 million estimate, and whether projected annual savings of $30 million to $40 million are achieved.
- The effect of currency movements, Brexit-related developments and joint-venture performance on reported sales and earnings.
- The extent to which discrete tax benefits, pension-related gains and other unusual items affected comparability of 2017 earnings.