McCormick & Company, Inc. FY2017 Form 10-K Summary
Business context and reporting period
McCormick manufactures, markets and distributes spices, seasonings, condiments and flavor solutions globally through consumer and industrial segments. The filing covers the fiscal year ended November 30, 2017; fourth-quarter data is included, but this is an annual Form 10-K rather than a standalone quarterly filing.
On August 17, 2017, McCormick acquired Reckitt Benckiser’s Food Division, or RB Foods, for approximately $4.21 billion net of acquired cash. The acquisition added the French’s, Frank’s RedHot and Cattlemen’s brands and was funded with approximately 6.35 million non-voting shares and new debt.
Financial performance and key metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Net sales | $4,834.1 million | $4,411.5 million | +9.6% |
| Gross profit | $2,010.2 million | $1,831.7 million | +9.7% |
| Gross margin | 41.6% | 41.5% | +10 bps |
| Operating income | $702.4 million | $641.0 million | +9.6% |
| Operating margin | 14.5% | 14.5% | Flat |
| Net income | $477.4 million | $472.3 million | +1.1% |
| Diluted EPS | $3.72 | $3.69 | +0.8% |
| Operating cash flow | $815.3 million | $658.1 million | +23.9% |
- Adjusted operating income, excluding special charges and RB Foods transaction and integration expenses, was $786.3 million, up 19.7%, with an adjusted margin of 16.3% versus 14.9%.
- Adjusted diluted EPS was $4.26, up 12.7% from $3.78.
- Consumer sales were $2,970.1 million, up 7.9%; segment operating margin increased to 19.0% from 17.8%.
- Industrial sales were $1,864.0 million, up 12.4%; segment operating margin increased to 11.9% from 10.0%.
- Reported sales growth reflected 1.7% volume and mix growth, 2.1% pricing, 6.5% acquisitions and a 0.7% unfavorable foreign-exchange impact.
- Capital expenditures were $182.4 million, compared with $153.8 million in 2016. Dividends paid were $237.6 million, and share repurchases were $137.8 million.
- Cash and cash equivalents were $186.8 million at year-end, versus $118.4 million in 2016.
Debt, liquidity and balance-sheet changes
- Total debt was approximately $5.03 billion, comprising $257.6 million of short-term borrowings and $4.77 billion of long-term debt including current maturities.
- Long-term debt increased from $1.05 billion to $4.44 billion, primarily to fund the RB Foods acquisition. Interest expense increased to $95.7 million from $56.0 million.
- Net debt was $4.92 billion and the reported leverage ratio was 5.1, compared with 1.7 in 2016. The covenant leverage ratio, including pro forma acquisition EBITDA, was 4.5.
- McCormick had a $1.0 billion revolving credit facility expiring in August 2022, with $780.6 million of capacity after commercial paper usage at year-end. Management expected to comply with applicable covenants and considered available liquidity sufficient for ongoing operations.
- Contractual cash obligations totaled $6.91 billion, including $4.81 billion of long-term debt, $1.19 billion of interest payments and $469.4 million of raw-material purchase obligations.
Material changes versus the prior comparable period
- RB Foods contributed $190.1 million of sales from the acquisition date through year-end but had an approximately $42 million adverse impact on 2017 income before taxes, including transaction, integration and financing costs.
- McCormick recorded $77.1 million of RB Foods transaction and integration expenses, including $20.9 million in cost of goods sold, $15.4 million of bridge financing costs and $40.8 million in other operating expenses. The company expected total such costs of approximately $100 million through 2018.
- Special charges increased to $22.2 million from $16.0 million, primarily for the Global Enablement initiative and manufacturing, severance and exit actions.
- Operating cash flow improved by $157.2 million, while investing cash use increased to $4.51 billion because of $4.33 billion of acquisition spending.
- Goodwill increased to $4.49 billion from $1.77 billion, and intangible assets increased to $3.07 billion from $424.9 million, largely due to RB Foods purchase accounting. The RB Foods valuation remained preliminary at year-end.
- The company curtailed share repurchases after the acquisition to reduce leverage. Approximately $189 million remained under the $600 million authorization at November 30, 2017.
- McCormick froze certain U.S. and U.K. pension benefits and reduced certain postretirement benefits, generating significant non-cash gains recorded in other comprehensive income.
Guidance, outlook, risks and unusual items
- For 2018, management projected sales growth of 12% to 14%, including an estimated 1% favorable currency impact, or 11% to 13% on a constant-currency basis.
- Management projected adjusted operating income growth of 23% to 25%, adjusted diluted EPS of $4.80 to $4.90 excluding specified tax, special-charge and integration effects, and reported diluted EPS of $6.89 to $7.14.
- Management expected approximately $100 million of CCI-led cost savings in 2018, gross-margin expansion of approximately 150 to 200 basis points, capital expenditures of approximately $200 million and continued elevated brand-marketing investment.
- The December 2017 U.S. Tax Act had no impact on FY2017 results but was expected to produce a $400 million reduction in U.S. deferred tax liabilities and a $70 million to $90 million deemed-repatriation tax in fiscal 2018. Management expected a non-recurring after-tax EPS benefit of approximately $2.33 to $2.48.
- Key risks include RB Foods integration and performance, substantially higher debt service and credit-rating risk, customer concentration, retailer bargaining power, commodity cost and availability volatility, foreign exchange, product safety and recalls, regulatory changes, cybersecurity, pension obligations, goodwill and brand impairment, tax uncertainty and climate-related agricultural disruption.
- Wal-Mart and PepsiCo each represented 11% of consolidated sales in 2017. The top three industrial customers represented approximately 50% to 54% of industrial sales.
- Management reported no material pending legal proceedings, no off-balance-sheet arrangements and an unqualified audit opinion. Internal-control assessments excluded RB Foods, which was scheduled to be included beginning in the 2018 assessment.
Investor verification checklist
- Verify the final purchase-price allocation for RB Foods, including goodwill, brand valuations, deferred taxes and any resulting 2018 adjustments.
- Reconcile reported versus adjusted operating income and EPS, particularly the $77.1 million of RB Foods transaction and integration costs and the $22.2 million of special charges.
- Monitor debt repayment, covenant leverage and progress toward management’s long-term leverage target of 1.5 to 1.8.
- Assess whether RB Foods delivers the projected sales growth, synergies and margin benefits after integration costs decline.
- Evaluate the cash and earnings effects of the U.S. Tax Act, including the deemed-repatriation tax, deferred-tax remeasurement and future global-tax provisions.
- Review exposure to major customers, commodity inflation, currency movements and potential impairment of the recently acquired RB Foods brands and goodwill.