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.