McCormick & Company, Inc. — 2019 Q3 Form 10-Q Summary
Business context and reporting period
McCormick manufactures, markets and distributes spices, seasoning mixes, condiments and other flavor products worldwide through its Consumer and Flavor Solutions segments. The filing covers the three and nine months ended August 31, 2019. Results are seasonal, with sales, earnings and operating cash flow typically higher in the second half of the fiscal year.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $1,329.2 million | $1,318.2 million | $3,862.6 million | $3,834.9 million |
| Operating income | $253.5 million | $229.9 million | $658.5 million | $599.6 million |
| Net income | $191.9 million | $173.5 million | $489.3 million | $719.4 million |
| Diluted EPS | $1.43 | $1.30 | $3.65 | $5.41 |
| Gross margin | 40.6% | 39.6% | 39.2% | 38.8% |
| Operating cash flow | Not separately provided | Not separately provided | $494.6 million | $389.0 million |
Q3 sales increased 0.8% as reported and 2.2% in constant currency. Nine-month sales increased 0.7% as reported and 3.0% in constant currency. Q3 adjusted operating income was $261.2 million, or 19.7% of sales, versus $238.8 million, or 18.1%, in the prior-year period. Nine-month adjusted operating income was $675.4 million, or 17.5% of sales, versus $635.6 million, or 16.6%.
At August 31, 2019, cash and cash equivalents were $162.9 million. Short-term borrowings were $683.6 million, current long-term debt was $119.3 million and long-term debt was $3,843.1 million, for total reported debt of approximately $4.65 billion. Net debt under the company’s covenant measure was $4.56 billion, and the trailing twelve-month leverage ratio was 3.7x, down from 4.3x at August 31, 2018 and 4.0x at November 30, 2018.
Nine-month investing cash outflow was $104.5 million, including $107.1 million of capital expenditures. Financing cash outflow was $319.2 million, including $214.6 million of long-term debt repayments and $226.4 million of dividends paid. The company states that existing cash, internally generated funds and available borrowing capacity are expected to meet requirements over the next twelve months.
Material changes versus the prior comparable period
- Sales growth was modest on a reported basis because unfavorable currency reduced Q3 sales by 1.4% and nine-month sales by 2.3%.
- The Consumer segment performed strongly: Q3 sales rose 2.8% and segment operating income rose 16.1%, with margin expanding to 22.2% from 19.7%.
- Flavor Solutions Q3 sales declined 2.0% and segment operating income declined 2.4%; nine-month sales increased 0.7% and operating income increased 0.8%.
- Gross margin expanded by 100 basis points in Q3 and 40 basis points for the nine-month period, primarily reflecting CCI-led cost savings and favorable product mix.
- SG&A declined 1.8% in Q3 and 1.5% for the nine months, while SG&A as a percentage of sales improved.
- Interest expense declined $3.4 million in Q3 and $4.0 million for the nine months, reflecting lower average borrowings and favorable cross-currency interest-rate swaps.
- Special charges increased to $7.7 million in Q3 and $16.9 million for the nine months, compared with $3.3 million and $13.9 million, respectively. RB Foods transaction and integration expenses were eliminated in 2019 but totaled $5.6 million in Q3 2018 and $22.1 million for the first nine months of 2018.
- Net income and EPS comparisons were distorted by the $308.2 million U.S. Tax Act benefit recognized in the first nine months of 2018. The 2019 nine-month period included $44.4 million of discrete tax benefits.
- Operating cash flow increased $105.6 million year over year, while long-term debt repayments reduced total debt and improved the leverage ratio.
Guidance, outlook and management commentary
- Fiscal 2019 reported sales growth is projected at 1% to 2%, or 3% to 4% in constant currency, with no incremental acquisition-related sales expected.
- Fiscal 2019 gross margin is expected to improve by 50 to 75 basis points versus 2018.
- Reported operating income is expected to increase 8% to 9%; adjusted operating income is expected to increase 6% to 7%, or 8% to 9% in constant currency.
- Adjusted diluted EPS is projected at $5.30 to $5.35, with reported diluted EPS projected at $5.20 to $5.25. The company expects adjusted EPS growth of 7% to 8%, or 9% to 10% in constant currency.
- 2019 special charges are expected to total approximately $20 million. The Global Enablement initiative is expected to cost approximately $55 million to $65 million over its multi-year course and generate annual savings of approximately $30 million to $40 million once implemented.
- CCI-led cost savings are targeted at approximately $110 million for 2019. Capital expenditures are expected to be approximately $185 million.
- The company expects an underlying 2019 tax rate of approximately 24% and a consolidated effective tax rate of approximately 20%, including discrete items.
Risks, contingencies and unusual items
- Key risks include foreign currency volatility, raw-material and packaging costs, tariffs and trade restrictions, customer and private-label competition, supply-chain disruptions, product quality or safety issues and increased debt service following the RB Foods acquisition.
- Brexit was identified as an updated risk, including possible tariffs, border delays, higher import costs, weaker sterling and economic disruption.
- The multi-year Global Enablement and ERP replacement programs require substantial spending and could create operational, financial-reporting, cybersecurity or implementation risks. ERP-related spending is estimated at $90 million to $120 million of capital expenditures and $60 million to $80 million of program expenses through 2021.
- The company uses foreign-exchange, cross-currency and interest-rate derivatives as hedges, not for trading. At August 31, 2019, interest-rate derivative notional value was $350 million and cross-currency contract notional value was approximately $480 million.
- The company reported no material pending legal proceedings, no material changes to most previously disclosed risk factors, and effective disclosure controls as of August 31, 2019.
Important facts for investors to verify
- Whether reported sales and adjusted EPS remain within the company’s fiscal 2019 guidance after currency effects and seasonal fourth-quarter demand.
- Progress toward the $110 million CCI savings target and the expected $30 million to $40 million annual Global Enablement savings.
- Execution, timing and total cost of the ERP replacement and broader business transformation program.
- Debt repayment, commercial paper usage, covenant headroom and the sustainability of the 3.7x leverage ratio.
- Whether Flavor Solutions sales weakness, raw-material inflation, pricing actions and customer timing affect future margins.
- The recurrence or reversal of discrete tax benefits, since 2018 comparisons were materially affected by the U.S. Tax Act benefit.