McCormick & Company, Inc. — Q2 2015 Form 10-Q Summary
Business context and reporting period
McCormick is a global producer and distributor of spices, seasonings, condiments and flavor products serving consumer retail, food manufacturers and foodservice customers. The company operates consumer and industrial segments. This unaudited Form 10-Q covers the three and six months ended May 31, 2015, compared with the corresponding 2014 periods. Results are seasonally weighted toward the second half of the fiscal year.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $1,024.1 million | $1,033.4 million | $2,034.5 million | $2,026.8 million |
| Gross profit | $404.0 million | $412.5 million | $793.7 million | $804.0 million |
| Gross margin | 39.4% | 39.9% | 39.0% | 39.7% |
| Operating income | $103.8 million | $121.7 million | $197.5 million | $246.3 million |
| Net income | $84.3 million | $84.5 million | $154.8 million | $167.0 million |
| Diluted EPS | $0.65 | $0.64 | $1.20 | $1.27 |
| Cash dividends per share | $0.40 | $0.37 | $0.80 | $0.74 |
Reported Q2 sales decreased 0.9% and first-half sales increased 0.4%. Excluding foreign exchange, sales increased 4.6% in Q2 and 5.1% year to date. Foreign currency reduced reported sales by 5.5% and 4.7%, respectively. Volume and product mix contributed 2.7% in Q2 and 3.7% year to date; pricing contributed 1.4% and 1.2%.
Q2 operating income excluding special charges was $122.8 million, compared with $121.7 million of reported operating income in Q2 2014. Adjusted diluted EPS was $0.75 in Q2 and $1.45 for the first six months, versus reported diluted EPS of $0.65 and $1.20, respectively.
- Consumer segment: Q2 sales were $599.8 million, down 2.5% reported but up 3.2% on a constant-currency basis. Operating income excluding special charges was $80.8 million, down 5.8% reported; margin declined to 13.5% from 14.0%.
- Industrial segment: Q2 sales were $424.3 million, up 1.4% reported and 6.6% on a constant-currency basis. Operating income excluding special charges rose 17.1% to $42.0 million; margin improved to 9.9% from 8.6%.
- Cash flow: Six-month operating cash flow was $185.9 million, compared with $182.1 million in 2014. Investing cash flow was negative $154.1 million, including $111.5 million for acquisitions and $42.7 million of capital expenditures. Financing cash flow was negative $10.3 million.
- Liquidity and debt: Cash and equivalents were $89.5 million at May 31, 2015. Short-term borrowings were $416.7 million, current maturities of long-term debt were $205.9 million, and long-term debt was $807.9 million. Total debt was $1,430.5 million on a trailing-twelve-month basis, and total debt to adjusted EBITDA was 1.92, versus 1.73 at November 30, 2014.
Material changes versus the prior comparable period
- Gross margin declined 50 basis points in Q2 and 70 basis points year to date, primarily because of higher material costs, partly offset by cost savings and pricing.
- Operating income declined $17.9 million in Q2 and $48.8 million year to date, principally reflecting special charges of $19.0 million and $47.4 million, respectively.
- Net income was approximately flat in Q2 but declined 7.3% year to date. Lower operating income was substantially offset by discrete tax benefits, higher income from unconsolidated operations, and fewer shares outstanding.
- Q2 and year-to-date effective tax rates were 15.9% and 20.1%, compared with 28.5% and 29.8%. The 2015 periods included discrete tax benefits of $13.4 million and $17.2 million, respectively.
- Foreign currency translation materially reduced comprehensive income. Six-month currency translation adjustments were a $150.6 million loss, compared with a $4.1 million gain in 2014, contributing to accumulated other comprehensive loss of $324.7 million at May 31, 2015.
- Debt increased primarily to fund acquisitions. The company acquired Brand Aromatics for $62.5 million and Drogheria & Alimentari for $49.0 million net of cash acquired; D&A also carries potential earn-out consideration with a preliminary fair value of $26.0 million.
Guidance, outlook, commentary and unusual items
- Long-term objectives remain sales growth of 4% to 6%, operating income growth of 7% to 9%, and EPS growth of 9% to 11% annually.
- For 2015, management projects sales growth of 4% to 6% on a constant-currency basis and adjusted diluted EPS of $3.47 to $3.54, representing reported growth of 3% to 5% and constant-currency growth of 7% to 9% versus 2014 adjusted EPS of $3.37.
- Management expects approximately $0.29 per share of 2015 special-charge impact and an annual effective tax rate of approximately 27%, absent additional discrete items.
- 2015 CCI cost savings are expected to reach at least $65 million, with approximately $20 million of additional savings from North American streamlining and EMEA reorganization. Material cost inflation is expected in the mid-single digits and is expected to be largely offset by savings and pricing.
- Special charges include North American effectiveness actions, a voluntary retirement plan, and EMEA restructuring. The North American initiative is expected to cost approximately $27 million and generate approximately $25 million of annual savings beginning in 2016. EMEA actions are expected to generate approximately $16 million of annual savings by the end of 2017.
- Capital expenditures are projected at $130 million to $140 million for 2015; pension contributions are estimated at approximately $16 million.
- After the quarter, McCormick entered a new $750 million revolving credit facility expiring in June 2020 and announced an approximately $100 million acquisition of Stubb’s, expected to close in Q3 2015. Management does not expect Stubb’s to be EPS accretive in 2015 because of transaction, integration and financing costs.
- Key risks include foreign currency volatility, raw-material price and availability, private-label competition, customer concentration and credit risk, acquisition integration, supply-chain disruption, cybersecurity, pension obligations, tax-rate volatility, regulation, litigation and climate-related effects on raw materials. No material pending legal proceedings were reported.
Important facts for investors to verify
- Reconcile reported results with adjusted and constant-currency measures, particularly the $47.4 million of year-to-date special charges and the $17.2 million of discrete tax benefits.
- Monitor leverage, refinancing and liquidity following acquisitions: total debt to adjusted EBITDA was 1.92, and current debt obligations increased materially from the prior year.
- Assess whether CCI savings, pricing and productivity actions offset mid-single-digit material-cost inflation and restore gross margins.
- Evaluate consumer-segment margin pressure versus industrial-segment improvement and the continuing effect of foreign exchange.
- Track completion and integration of Brand Aromatics, D&A and the announced Stubb’s acquisition, including the D&A earn-out liability and final purchase-price valuations.
- Consider the sustainability of EPS guidance given seasonal cash generation, elevated restructuring costs, tax benefits that may not recur, share repurchases and additional financing needs.