McCormick & Company, Inc. — Q2 2018 Form 10-Q Summary
Business context and reporting period
McCormick is a global manufacturer and distributor of spices, seasoning mixes, condiments and other flavor products. It operates through Consumer and Flavor Solutions segments. This filing covers the three and six months ended May 31, 2018. Results include RB Foods, acquired August 17, 2017, including the French’s, Frank’s RedHot and Cattlemen’s brands.
Key financial metrics
| Metric | Three months ended May 31, 2018 | Three months ended May 31, 2017 | Six months ended May 31, 2018 | Six months ended May 31, 2017 |
|---|---|---|---|---|
| Net sales | $1,327.3 million | $1,114.3 million | $2,564.4 million | $2,158.0 million |
| Gross profit | $575.2 million | $444.6 million | $1,095.2 million | $857.6 million |
| Gross margin | 43.3% | 39.9% | 42.7% | 39.7% |
| Operating income | $191.7 million | $132.6 million | $375.4 million | $266.8 million |
| Net income | $123.3 million | $100.0 million | $545.9 million | $193.5 million |
| Diluted EPS | $0.93 | $0.79 | $4.11 | $1.53 |
| Operating cash flow | Not separately provided | Not separately provided | $234.9 million | $177.2 million |
- Second-quarter sales increased 19.1%; six-month sales increased 18.8%. Constant-currency growth was 15.6% and 15.1%, respectively.
- Acquisitions contributed 12.9% of second-quarter sales growth and 12.7% of six-month sales growth, primarily from RB Foods. Favorable foreign exchange contributed 3.5% and 3.7%, respectively.
- Adjusted operating income, excluding special charges and RB Foods transaction and integration costs, was $207.9 million in the quarter and $402.5 million year to date, compared with $137.3 million and $275.1 million, respectively.
- Consumer segment sales increased 19.7% in the quarter and 19.1% year to date; segment operating margins were 16.7% and 17.1%, versus 13.9% and 14.6%.
- Flavor Solutions sales increased 18.3% in the quarter and 18.4% year to date; segment operating margins were 14.2% and 13.6%, versus 10.0% in both prior-year periods.
- Interest expense rose to $44.2 million in the quarter and $86.0 million year to date, primarily because of debt incurred to finance RB Foods.
- Cash and cash equivalents were $202.6 million at May 31, 2018. Total debt, including short-term borrowings and current maturities, was approximately $5.16 billion. The reported leverage ratio was 4.5, compared with 2.0 at May 31, 2017 and 5.1 at November 30, 2017.
- Capital expenditures were $59.9 million year to date; fiscal 2018 capital expenditures were expected to be approximately $200 million. Dividends paid were $136.5 million, and share repurchases were $32.1 million.
Material changes versus the prior comparable period
- RB Foods materially increased sales, goodwill and intangible assets. At May 31, 2018, goodwill was $4.58 billion and intangible assets were $2.89 billion, compared with $1.89 billion and $489.0 million, respectively, at May 31, 2017.
- Debt increased substantially following the RB Foods acquisition. Long-term debt was $4.46 billion at May 31, 2018, compared with $804.3 million at May 31, 2017.
- Gross margin expanded by 340 basis points in the quarter and 300 basis points year to date, supported by RB Foods mix, Comprehensive Continuous Improvement savings and a shift toward higher-value products.
- Special charges were $8.4 million in the quarter and $10.6 million year to date, compared with $4.7 million and $8.3 million, respectively. RB Foods transaction and integration expenses were $7.8 million in the quarter and $16.5 million year to date.
- Year-to-date net income included a provisional $297.9 million net tax benefit from the U.S. Tax Act. Excluding that benefit and other specified items, adjusted net income was $269.1 million versus $199.4 million in the prior-year period.
- Operating cash flow increased by $57.7 million year to date, although the filing notes that the U.S. Tax Act benefit was non-cash and that cash flow is typically weighted toward the second half of the fiscal year.
Guidance, outlook, risks and unusual items
- Management projected 2018 sales growth of 13% to 15%, including approximately 2% favorable currency impact, or 11% to 13% on a constant-currency basis.
- Adjusted operating income was expected to increase 23% to 25%, with adjusted gross margin approximately 175 to 225 basis points above 2017. Management targeted at least $105 million of 2018 cost savings.
- Reported diluted EPS guidance was $6.85 to $6.95. Adjusted diluted EPS guidance, excluding the estimated $2.24 per-share U.S. Tax Act benefit, special charges and integration expenses, was $4.85 to $4.95.
- Management expected approximately $23 million of RB Foods transaction and integration expenses in 2018 and total 2018 special charges of approximately $18.5 million.
- The three-year Global Enablement initiative was expected to cost approximately $55 million to $65 million and generate annual savings of approximately $30 million to $40 million after implementation.
- The U.S. Tax Act benefit was provisional under SEC Staff Accounting Bulletin No. 118 and could change during the measurement period. The estimated $78.6 million transition tax included $72.3 million of cash tax payable over eight years.
- Key risks include high post-acquisition leverage and debt service, RB Foods integration, commodity and freight inflation, foreign exchange volatility, customer and credit concentration, supply-chain disruption, food safety and regulatory requirements, cyber risks, pension obligations, tax-law uncertainty and the GDPR.
- Management stated that existing cash, operating cash flow and available borrowing capacity should be adequate for the next twelve months. The $1.0 billion revolving credit facility expires in August 2022, but covenant compliance and leverage could restrict future borrowing capacity.
- The company reported no material pending legal proceedings, no defaults on senior securities, and effective disclosure controls as of May 31, 2018.
Important facts for investors to verify
- Whether RB Foods delivers the projected revenue, margin and integration benefits while remaining within the expected cost envelope.
- Progress toward reducing leverage from the reported 4.5 ratio toward management’s long-term target of 1.5 to 1.8.
- The final accounting allocation for RB Foods, which was not complete as of May 31, 2018 and was expected to be finalized in the third quarter of 2018.
- Any revisions to the provisional $297.9 million U.S. Tax Act benefit and the resulting effective tax rate.
- Execution of the Global Enablement initiative, including the estimated $55 million to $65 million cost and $30 million to $40 million annual savings.
- Second-half operating cash generation, seasonal working-capital requirements, capital expenditures and debt repayments.
- Exposure to raw-material costs, freight capacity, foreign exchange movements and customer or retailer financial weakness.