McCormick & Company, Inc. — Q3 2017 Form 10-Q Summary
Business context and reporting period
McCormick is a global manufacturer, marketer and distributor of spices, seasonings, condiments and flavor solutions through consumer and industrial segments. This unaudited Form 10-Q covers the three and nine months ended August 31, 2017, within a fiscal year that typically generates stronger sales, earnings and operating cash flow in the second half.
On August 17, 2017, McCormick completed its approximately $4.21 billion acquisition of RB Foods, including the French’s, Frank’s RedHot and Cattlemen’s brands. RB Foods contributed $22.5 million of sales in the quarter and was included in consolidated results from the acquisition date.
Financial performance and position
| Metric | Three months ended August 31 | Nine months ended August 31 |
|---|---|---|
| Net sales | $1,185.2 million, up 8.6% | $3,343.2 million, up 5.0% |
| Gross profit | $484.4 million | $1,342.0 million |
| Gross margin | 40.9%, down 70 basis points | 40.1%, down 50 basis points |
| Operating income | $168.7 million | $435.5 million |
| Net income | $108.2 million, versus $127.7 million | $301.7 million, versus $314.9 million |
| Diluted EPS | $0.85, versus $1.00 | $2.37, versus $2.46 |
| Operating cash flow | Not separately provided | $303.0 million, versus $322.4 million |
Quarterly sales growth reflected 4.0% from acquisitions, 2.4% from volume and product mix, 2.0% from pricing and 0.2% from foreign currency. Nine-month sales growth included 3.2% from acquisitions, 2.2% from pricing and 1.1% from volume and mix, partly offset by a 1.5% foreign-currency headwind.
Adjusted operating income, excluding special charges and RB Foods transaction and integration costs, was $203.8 million in the quarter and $478.9 million year to date. Adjusted diluted EPS was $1.12 and $2.69, respectively, versus $1.03 and $2.51 in the comparable periods.
At August 31, 2017, cash and equivalents were $166.1 million. Total debt was approximately $5.38 billion, comprising $349.2 million of short-term borrowings and $5,027.8 million of long-term debt, including the current portion. The reported leverage ratio was 6.0, while the covenant calculation including pro forma acquisition EBITDA was 4.9; management expected compliance with the applicable covenant.
Liquidity included a new $1.0 billion revolving credit facility, of which $686.0 million was available after supporting commercial paper. Management stated that existing cash, operating cash flow and borrowing capacity should be adequate for the next twelve months.
Material changes versus the prior comparable period
- RB Foods materially increased goodwill and intangible assets. Goodwill rose to $4,503.3 million from $1,813.3 million a year earlier, and intangible assets, net, rose to $3,091.5 million from $433.6 million.
- Debt increased substantially to finance RB Foods. McCormick issued $2.5 billion of senior unsecured notes, obtained $1.5 billion of term loans and issued approximately 6.35 million non-voting shares for net proceeds of approximately $554.0 million.
- Interest expense increased to $21.5 million from $14.1 million in the quarter and to $50.9 million from $41.7 million year to date. RB Foods-related bridge financing costs added $15.4 million of other debt costs.
- Net income and diluted EPS declined despite higher sales, primarily because of acquisition-related costs, higher interest expense, lower gross margins and a higher effective tax rate.
- Gross margin declined because of material-cost inflation, unfavorable currency effects and $5.9 million of RB Foods acquired-inventory fair-value amortization.
- Consumer segment sales increased 5.3% in the quarter and 2.8% year to date; industrial segment sales increased 13.8% and 8.4%, respectively. Adjusted segment operating margins were 20.0% and 16.5% for consumer, and 13.1% and 11.1% for industrial.
- Operating cash flow decreased $19.4 million year to date, driven principally by the bridge financing commitment fee, timing of tax payments and higher incentive compensation payments.
Guidance, outlook, commentary and unusual items
- For 2017, management projected sales growth of 9% to 10%, including an estimated 1% foreign-currency headwind, or 10% to 11% on a constant-currency basis.
- Reported diluted EPS guidance was $3.69 to $3.73. Adjusted diluted EPS guidance was $4.20 to $4.24, excluding estimated impacts of $0.12 per share from special charges and $0.39 per share from RB Foods transaction and integration costs. Constant-currency adjusted EPS growth was projected at 12% to 13%.
- Management expected at least $105 million of 2017 cost savings, mid-single-digit material-cost inflation largely offset by pricing, and high-single-digit growth in brand-marketing spending.
- RB Foods transaction and integration costs were expected to total approximately $100 million through fiscal 2018. McCormick had incurred $45.8 million through August 31, expected an additional $31.4 million in the fourth quarter of 2017 and $22.8 million in fiscal 2018.
- The McCormick Global Enablement initiative was expected to cost approximately $55 million to $65 million over three years and generate annual savings of approximately $30 million to $40 million once implemented. An additional $9.1 million of special charges was expected in the fourth quarter of 2017.
- Capital expenditures were projected at $170 million to $190 million for 2017. The company expected approximately $19 million of pension contributions for 2017.
- Unusual items included $76.7 million of pension curtailment gains and $27.1 million of postretirement benefit credits recognized in other comprehensive income, as well as $17.3 million of year-to-date discrete tax benefits.
- Key risks include RB Foods integration and performance, elevated debt service and leverage, possible credit-rating effects, goodwill and brand-asset impairment, commodity inflation, foreign-currency volatility, Brexit-related uncertainty, customer concentration and supply-chain disruption.
Most important facts for investors to verify
- Whether RB Foods delivers the expected growth, synergies and integration savings, and whether the remaining acquisition-related costs approximate management’s estimates.
- Progress in reducing the 6.0 reported leverage ratio toward management’s long-term target of 1.5 to 1.8, including debt repayment and the curtailed share-repurchase program.
- Whether pricing and cost savings offset material inflation without causing further volume or mix deterioration, particularly in EMEA.
- The sustainability of reported and adjusted margins after the remaining RB Foods inventory fair-value amortization is expensed.
- Potential impairment exposure from the $4.5 billion goodwill balance and $2.8 billion of brand names and trademarks, much of which was recorded in connection with RB Foods.
- Actual fourth-quarter seasonality, operating cash flow, capital expenditures, pension contributions and liquidity relative to management’s guidance.
- The filing states that controls and procedures were effective; however, management excluded RB Foods from its year-end internal-control evaluation under applicable SEC guidance while transition services remain in place.