McCormick & Company, Inc. — Q2 2020 Form 10-Q Summary
Business context and reporting period
McCormick manufactures and markets spices, seasonings, condiments and other flavor products globally through its Consumer and Flavor Solutions segments. The filing covers the three and six months ended May 31, 2020, during the COVID-19 pandemic. Approximately 40% of fiscal 2019 sales were outside the United States.
Financial performance and key metrics
| Metric | Three months ended May 31, 2020 | Year-over-year change | Six months ended May 31, 2020 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $1,401.1 million | +7.6% | $2,613.1 million | +3.1% |
| Gross profit | $579.5 million | +14.0% | $1,049.4 million | +7.6% |
| Gross margin | 41.4% | +230 bps | 40.2% | +170 bps |
| Operating income | $257.4 million | +23.7% | $451.6 million | +11.5% |
| Net income | $195.9 million | +31.1% | $340.6 million | +14.5% |
| Diluted EPS | $1.46 | +30.4% | $2.54 | +14.4% |
Reported operating margin was approximately 18.4% in the quarter and 17.3% year to date; net margin was approximately 14.0% and 13.0%, respectively. Consumer segment sales increased 26.0% in the quarter and 10.2% year to date, while Flavor Solutions sales decreased 18.5% and 7.2%, respectively. Consumer segment operating margin increased to 24.1% for the quarter and 21.1% year to date; Flavor Solutions margin declined to 6.5% and 11.0%, respectively.
Cash flow from operations was $355.5 million in the first six months, compared with $314.2 million in the prior-year period. Capital expenditures were $87.1 million, and management expected approximately $215 million of fiscal 2020 capital expenditures. Cash and equivalents were $185.0 million at May 31, 2020, compared with $155.4 million at November 30, 2019.
Total reported debt, including short-term borrowings and the current portion of long-term debt, was approximately $4.287 billion. Long-term debt carrying value, including the current portion, was $4.203 billion. Net debt under the company’s covenant definition was $4.177 billion, and the trailing-twelve-month adjusted EBITDA leverage ratio was 3.3x, down from 3.9x a year earlier. The company issued $500 million of 2.50% notes due 2030, receiving net proceeds of $495 million, primarily to repay short-term borrowings.
Material changes versus the prior comparable period
- COVID-19 drove a substantial shift toward at-home consumption, benefiting Consumer products while reducing Flavor Solutions demand from restaurants, quick-service restaurants and foodservice customers.
- Quarterly Consumer sales rose $198.5 million, while Flavor Solutions sales fell $99.3 million. The consolidated sales increase was driven by volume and product mix of 7.4% and pricing actions of 2.2%, partially offset by a 2.0% foreign-exchange impact.
- Gross margin benefited from the more favorable Consumer/Flavor Solutions mix and CCI savings, but higher conversion, material, distribution and COVID-related costs partially offset the improvement.
- Interest expense declined $8.0 million in the quarter and $15.7 million year to date, reflecting lower average borrowings, lower rates and the benefit of cross-currency interest-rate swaps.
- Special charges declined to $2.9 million in the quarter and $3.9 million year to date, compared with $7.1 million and $9.2 million, respectively, in 2019. The charges primarily related to EMEA streamlining and the Global Enablement initiative.
- Income taxes included discrete benefits of $16.5 million in the quarter and $26.9 million year to date, including valuation allowance releases, share-based compensation benefits, intra-entity asset-transfer benefits and reversals of unrecognized tax benefits.
Guidance, outlook, commentary and risks
Management withdrew its fiscal 2020 financial outlook and did not provide a replacement outlook because the timing and extent of the COVID-19 recovery remained highly uncertain. Management expected at-home consumption to remain favorable for Consumer products, but at a lower level than in the second quarter; packaged-food demand in Flavor Solutions to return toward pre-COVID levels; and away-from-home demand to recover only partially and remain below the prior-year level.
Management continued to expect COVID-19-related disruption in China to reduce fiscal 2020 consolidated sales growth by 1% to 2%, mid-single-digit inflationary pressure, approximately $105 million of CCI savings, a mid-single-digit increase in brand marketing investment, unfavorable foreign-exchange effects and a high- to mid-single-digit percentage decline in income from unconsolidated operations.
Key risks include renewed or prolonged pandemic restrictions, facility closures, supply-chain and raw-material disruptions, customer failures or reduced purchases, restaurant and foodservice weakness, foreign-exchange volatility, commodity inflation, higher debt-service requirements, covenant limitations, pension and goodwill or intangible-asset valuation changes, cybersecurity, tax uncertainty and execution of the ERP and broader business-transformation initiatives. The global ERP replacement program was paused for the balance of fiscal 2020.
The company adopted ASC 842 lease accounting on December 1, 2019, recognizing $136.5 million of operating lease right-of-use assets and $140.0 million of operating lease liabilities. Management stated that the adoption did not materially affect net income or cash flows. Disclosure controls were evaluated as effective, and no material pending legal proceedings were reported.
Important facts for investors to verify
- Whether the elevated Consumer demand and gross-margin benefit persist after pandemic-related at-home consumption normalizes.
- The pace and extent of recovery in Flavor Solutions, particularly restaurant, quick-service and foodservice customers.
- Actual fiscal 2020 sales, earnings, cash flow and margin outcomes, since formal guidance was withdrawn.
- Debt maturities, refinancing needs, interest-rate exposure and compliance with leverage and other credit-facility covenants.
- The effect of COVID-19 on supply chains, facilities, customers, credit losses and potential goodwill or intangible-asset impairments.
- The timing and remaining cost of the Global Enablement initiative, ERP implementation and other special-charge programs.
- The sustainability of tax benefits recorded in 2020 and the impact of future foreign-exchange movements on earnings, cash flow and accumulated other comprehensive loss.