Summary of MCCORMICK & CO INC

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand McCormick & Company Incorporated, our operations and our present business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes thereto contained in Item 8 of this report.
McCormick is a global leader in flavor. The company manufactures, markets and distributes spices, seasoning mixes, condiments and other flavorful products to the entire food industry-retail outlets, food manufacturers and foodservice businesses. We manage our business in two operating segments, consumer and industrial as described in Item 1 of this report.
Our strategy for growth is to increase sales and profit by investing in the business and fueling that investment with our Comprehensive Continuous Improvement - CCI - cost savings. CCI is our ongoing initiative to improve productivity and reduce costs throughout the organization. Our long-term annual growth objectives are to increase sales 4% to 6%, increase operating income 7% to 9% and increase earnings per share 9% to 11%. Over time, we expect similar contributions to sales growth largely from three sources: 1) our base business-driven by brand marketing support, expanded distribution and category growth; 2) product innovation; and 3) acquisitions. In addition to fueling sales growth, our CCI program is contributing to higher operating income and earnings per share.
Our business generates strong cash flow and we have a balanced use of cash, funding dividends, which we have increased in each of the past 27 years, capital expenditures, acquisitions and share repurchases. Each year, we expect a combination of acquisitions and share repurchases to add about 2% to earnings per share growth.
In 2012, our financial results were at or above these long-term goals. Sales grew 9%, exceeding the long-term objective of 4% to 6%, due to increased pricing taken in response to significant increases in raw and packaging material costs, as well as incremental sales from three acquisitions completed in 2011. The increase in operating income of 7%, was within our long-term goal, but below our expectations of 9% to 11% growth in 2012. Earnings per share rose 9% to $3.04 from $2.79 in 2011. This growth was achieved with the increase in operating income and a favorable income tax rate, offset in part by lower income from unconsolidated operations which were under pressure from unfavorable foreign currency exchange rates, primarily the Mexican peso.
We generated strong cash flow in 2012. Net cash provided by operating activities reached a $455 million, a 34% increase from $340 million in 2011. In addition to higher net income, inventory was unchanged in 2012 in contrast to a significant increase in 2011 that was driven by higher costs, strategic inventory purchases and acquisitions.
Along with our solid financial performance, there were a number of important accomplishments in 2012, which included:
ź We launched more than 250 branded products for our consumer business and across both businesses, new products launched in the past three years added 8% to 2012 sales.

ź Due in part to acquisitions completed in 2011, sales in emerging markets rose 47% to reach 14% of net sales, an increase from 10% in the prior year.

ź CCI cost savings reached $56 million.

RESULTS OF OPERATIONS-2012 COMPARED TO 2011

                  2012        2011
Net sales      $ 4,014.2   $ 3,697.6
Percent growth       8.6 %      10.8 %

Sales for the fiscal year rose 8.6% from 2011 with strong growth in both of our consumer and industrial businesses. Pricing actions, taken in response to increased raw material and packaging costs, added 4.4% to sales. The incremental impact of acquisitions completed in 2011 accounted for a 4.3% increase to sales, and increased volume and product mix in the base business added 1.4% to sales. The impact of foreign exchange rates was unfavorable in 2012, reducing sales 1.5%.

                       2012        2011
Gross profit        $ 1,617.8   $ 1,522.5
Gross profit margin      40.3 %      41.2 %

In 2012, gross profit increased 6.3%, however our gross profit margin declined 90 basis points. In fiscal year 2012, we were able to offset the dollar impact of a high single digit increase in raw material and packaging costs with our pricing actions and CCI cost savings. In 2012, CCI cost savings totaled $56 million of which $39 million lowered cost of goods sold. While pricing and CCI cost savings offset the dollar impact of increased material costs, the net impact of these factors caused downward pressure on gross profit as a percentage of net sales. Margins were further pressured by our mix of sales in 2012, as sales in international markets grew at a faster rate than in the U.S., where our gross profit margin is higher due to larger scale and less complexity. In 2013 we expect material cost inflation to moderate to an increase of approximately 3%. Due to the low interest rate environment, retirement benefit expense is expected to increase by $22 million in 2013. About 40% of this increase is expected to impact cost of goods sold.

                                                    2012       2011
Selling, general & administrative expense (SG&A) $ 1,039.5   $ 982.2
Percent of net sales                                  25.9 %    26.6 %

Selling, general and administrative expenses increased 5.8% in 2012 from 2011, but decreased as a percentage of net sales for those same time periods. The decrease in SG&A as a percent of net sales was primarily driven by a leveraging effect of our higher sales on these costs. We had a benefit from CCI cost savings that lowered SG&A $17 million in 2012 and a favorable comparison to 2011 when SG&A included $10.9 million of transaction costs related to completed acquisitions, while 2012 had only $1.7 million of such costs.
During 2012, we increased brand marketing support by $11.0 million to $198.3 million. A large portion of this increase was in digital marketing, which is one of our highest return investments in brand marketing support.
In 2013, due to the low interest rate environment, retirement benefit expense is expected to increase by $22 million. About 60% of this increase is expected to impact SG&A.

                   2012    2011
Interest expense  $ 54.6  $ 51.2
Other income, net    2.4     2.3

Interest expense for 2012 was higher than the prior year. The impact of higher average debt balances in 2012 compared to 2011 was partially offset by the impact of lower interest rates for 2012 compared to 2011. The higher average debt balances in 2012 were due to the acquisitions completed late in 2011.

                                                          2012      2011
Income from consolidated operations before income taxes $ 526.1   $ 491.4
Income taxes                                              139.8     142.6
Effective tax rate                                         26.6 %    29.0 %

In 2012, we repatriated $70.0 million of cash from foreign subsidiaries. This transaction generated U.S. foreign tax credits due to the mix of foreign earnings that related to this cash. These U.S. foreign tax credits reduced 2012 tax expense by $9.7 million and were the major driving factor in a reduction in the tax rate for 2012 as compared to the prior year.
Discrete tax benefits in 2012 were $2.0 million compared to $0.8 million in 2011. The increase in 2012 is mainly due to the reversal of a portion of a valuation allowance originally established against a subsidiary's net operating losses. This subsidiary has established a pattern of profitability which resulted in us concluding that a portion of the valuation allowance should be reversed.

In 2010, the Internal Revenue Service (IRS) commenced an examination of our U.S. federal income tax return for the 2007 and 2008 tax years. During the course of the examination, we held discussions with the IRS on certain issues and in October 2012 we received proposed adjustments for these tax years. In November 2012 we deposited $18.8 million with the IRS to stop any potential interest on these proposed adjustments. We believe we have established appropriate deferred taxes or tax accruals under US GAAP for these issues in prior periods. While it is often difficult to predict the final outcome or the timing of resolution of uncertain tax positions, we believe that our unrecognized tax benefits reflect the most likely outcome. We will continue to update these unrecognized tax benefits, and the related interest, in light of changing facts and circumstances in the future.
In addition, see note 10 of the financial statements for a reconciliation of the U.S. federal statutory tax rate with the effective tax rate.

2012 2011 Income from unconsolidated operations $ 21.5 $ 25.4

Income from unconsolidated operations decreased $3.9 million in 2012 compared to 2011. Most of this decrease is attributable to our largest joint venture, McCormick de Mexico, which was negatively impacted by an unfavorable foreign exchange rate between the Mexican peso an the U.S. dollar for most of 2012. While this business grew sales 6%, profits were also pressured by higher soybean oil cost (a main ingredient for mayonnaise which is the leading product for this joint venture). This situation began in the fourth quarter of 2011 and the year-on-year impact in the fourth quarter of 2012 had eased.
In 2012, our McCormick de Mexico joint venture represented 59% of the sales and 82% of the net income of our unconsolidated joint ventures. We own a 26% share in our Eastern Condiments joint venture and on average own 50% of our other unconsolidated joint ventures.
We reported diluted earnings per share of $3.04 in 2012, compared to $2.79 in 2011. The following table outlines the major components of the change in diluted earnings per share from 2011 to 2012:

2011 Earnings per share-diluted                   $ 2.79
Increased operating income                          0.20
Decrease in tax rate                                0.10
Decrease in income from unconsolidated operations  (0.03 )
Higher interest expense                            (0.02 )
2012 Earnings per share-diluted                   $ 3.04


Consumer Business

                           2012        2011
Net sales               $ 2,415.3   $ 2,199.9
Percent growth                9.8 %      10.0 %
Operating income            456.1       428.4
Operating income margin      18.9 %      19.5 %

We grew consumer business sales 9.8% in 2012 when compared to 2011, which included a 7.2% increase from acquisitions completed in 2011. The remaining increase was driven by higher pricing which added 3.7% and volume and product mix which added 0.3%. Unfavorable foreign exchange rates reduced sales by 1.4%. In the Americas, consumer business sales rose 4.0%, primarily as a result of pricing actions which added 4.5%. These pricing actions, taken in response to an increase in material costs, went into effect late in fiscal year 2011. Our 2011 acquisition of Kitchen Basics® added 0.8% to sales, volume and product mix reduced sales by 1.1% and foreign exchange rates reduced sales by 0.2%. While higher prices had an unfavorable impact on volume and product mix, we offset this in part with our initiatives to drive growth through new product introductions and brand marketing. In 2012, our new product launches included a line of gourmet recipe mixes, authentic Hispanic recipe mixes, Zatarain's frozen Dinners for Two, new varieties of Grill Mates, and in Canada, Club House brand grinders. A portion of our incremental brand marketing support was in support of our new products. We also increased our digital marketing activity, which offers a more personal way to interact with consumers. Recipe views at www.mccormick.com rose 30% in 2012 and our Facebook fan base grew to 1.5 million. In 2011, we reported that an estimated $10 million in sales shifted from the first quarter of 2011 into the fourth quarter of 2010, as a result of customer purchases in advance of a late 2010 price increase.

In Europe, the Middle East and Africa (EMEA), consumer business sales increased 15.3%, with our 2011 acquisition of Kamis adding 16.9% to sales. Unfavorable foreign currency decreased sales 5.7%. In local currency and excluding the impact of acquisitions, we grew sales 4.1% with 2.9% from volume and product mix and 1.2% from pricing actions. During 2012, we successfully completed the integration of Kamis and sales from this Poland-based business benefited from particular strength in its subsidiary in Russia. For the base business in EMEA, strong execution behind product innovation, brand marketing and new distribution enabled us to achieve growth in a difficult economic environment. We have moved to a masterbrand approach to gain synergies and efficiencies in product development and brand marketing support across our country-specific brands. New products introduced in 2012 included Bag 'n Season®, Grill Mates®, Recipe Inspirations® and a number of Vahiné brand dessert items.
In the Asia/Pacific region, sales rose 65.3%. The impact of our 2011 Kohinoor joint venture added 53.8% to sales and favorable foreign exchange rates added 0.4%. We grew sales in local currency, excluding the impact of Kohinoor, 11.1% with 7.7% from volume and product mix and 3.4% from pricing. This increase was driven by China where we achieved rapid sales growth of 23.1% based largely on increased consumer demand. In our other market, Australia, we grew sales 2.9% despite a difficult competitive environment, due in part to new product activity.
Consumer business operating income rose to $456.1 million from $428.4 million in 2011, a 6.4% increase. The growth in operating income was the result of higher sales and CCI savings. Also, operating income in 2011 included the impact of $10.9 million of transaction costs related to the completion of acquisitions that year. In 2012, we invested $13.2 million in additional brand marketing support. Operating income margin was 18.9% in 2012 compared to 19.5% in 2011. This reduction is due in part to the mix of business across regions, as sales in international markets grew at a faster rate than in the U.S., where our profit margin is higher due to larger scale and less complexity.

Industrial Business

                           2012        2011
Net sales               $ 1,598.9   $ 1,497.7
Percent growth                6.8 %      11.9 %
Operating income            122.2       111.9
Operating income margin       7.6 %       7.5 %

Sales for the industrial business grew 6.8% from 2011. Pricing actions taken to offset the impact of higher material costs added 5.3%, while volume and product mix added 3.1% and unfavorable foreign exchange rates decreased sales 1.6%. Both food manufacturers and foodservice customers continue to have an interest in products that feature all natural ingredients, reduced sodium and other healthy attributes. These types of projects accounted for more than 30% of our product development activity during 2012.
In the Americas, we grew industrial business sales 8.2%, with 6.4% from pricing actions and a 2.8% increase from favorable volume and product mix, partially offset by a decrease of 1.0% from unfavorable foreign exchange rates. We grew sales of seasonings and flavors to a number of food manufacturers and also increased sales of branded items to foodservice distributors. However, for the quick service restaurant industry, we saw lower demand for our products and less customer-driven innovation during this period.
In EMEA, industrial business sales rose 5.5%, with a strong 7.7% increase in volume and product mix, as well as a 3.6% increase from pricing actions. These were partially offset by unfavorable foreign exchange rates that reduced sales by 5.8%. Demand from quick service restaurants remains robust, and we are meeting this demand with products that we supply from our facilities in the U.K., Turkey and South Africa.
Industrial business sales in the Asia/Pacific region rose 1.1%. Higher pricing added 2.4% and favorable foreign exchange rates added 1.2%, while volume and product mix declined 2.5%. By comparison, volume and product mix for our industrial business in the Asia/Pacific region rose 10.7% in 2011 and included a significant impact from new product introductions and regional expansion by quick service restaurants. While we did not have a similar incremental benefit from new product and customer promotion activity in 2012, we believe this part of our business continues to offer long-term growth.
Industrial business operating income increased to $122.2 million from $111.9 million in 2011, a 9.2% increase. The growth in operating income was driven largely by higher sales and cost savings from CCI. Our industrial business operating income margin ended 2012 at 7.6% compared to 7.5% in 2011.

RESULTS OF OPERATIONS-2011 COMPARED TO 2010
                  2011        2010
Net sales      $ 3,697.6   $ 3,336.8
Percent growth      10.8 %       4.5 %

Sales for the fiscal year rose 10.8% from 2010 with double-digit growth in both of our consumer and industrial businesses. Our pricing actions, which were taken to offset the impact of steep increases in material costs, added 4.6% to sales, and favorable foreign exchange rates increased sales another 2.1%. New product introductions, expanded distribution and brand marketing support led to favorable volume and product mix, which combined, added 2.5% to sales. Acquisitions added 1.6% to sales.

                       2011        2010
Gross profit        $ 1,522.5   $ 1,417.7
Gross profit margin      41.2 %      42.5 %

In 2011, gross profit increased 7.4%, however our gross profit margin declined 130 basis points. In fiscal year 2011, we experienced a double digit increase in raw material and packaging costs. While we were able to offset the dollar impact of these costs with our pricing actions and CCI cost savings, the net impact of these factors caused downward pressure on gross profit as a percentage of net sales. In addition, we had a negative effect on gross margin from product and segment mix in the year. Product mix was unfavorable in our industrial business with an increased demand for ingredients and weak demand for branded foodservice products during this period. Unfavorable segment mix was due to the higher sales growth rate of our industrial business, which has lower gross margin than our consumer business. CCI cost savings totaled $65 million in 2011, of which $45 million lowered cost of goods sold.

                                                   2011      2010
Selling, general & administrative expense (SG&A) $ 982.2   $ 907.9
Percent of net sales                                26.6 %    27.2 %

Selling, general and administrative expenses in total dollars increased in 2011 compared to 2010, but decreased as a percentage of net sales for those same time periods. The increase in total dollars was largely driven by higher incremental brand marketing support, SG&A of acquired businesses and $10.9 million of transaction costs related to completed acquisitions. The decrease in SG&A as a percent of net sales is primarily driven by lower selling costs as a percentage of net sales.
During 2011, we increased brand marketing support by $20.1 million or 12%. A portion of this increase was in digital marketing, which is one of our highest return investments in brand marketing support. We nearly doubled our digital marketing in the past year, including a program behind Grill Mates in the U.S. that contributed to a 7% unit increase in 2011. We also increased support behind our Hispanic products in the U.S., which included television and a sampling program. This helped drive a 9% increase in sales of Hispanic products which exceeded $100 million for the first time in 2011.

                   2011    2010
Interest expense  $ 51.2  $ 49.3
Other income, net    2.3     2.2

Interest expense for 2011 was higher than the prior year. This was caused by higher average debt balances, due to our acquisitions in 2011 and a slightly higher weighted-average interest rate.

                                                          2011      2010
Income from consolidated operations before income taxes $ 491.4   $ 462.7
Income taxes                                              142.6     118.0
Effective tax rate                                         29.0 %    25.5 %

The increase in the tax rate in 2011 was due to a lower level of net discrete tax benefits, decreased U.S. foreign tax credits in the current year as compared to the prior year, partially offset by a favorable mix of earnings among our different tax jurisdictions.

Discrete tax benefits in 2011 were $0.8 million compared to $20.1 million in 2010. The $20.1 million in 2010 was mainly due to a $13.9 million reversal of a tax accrual for a closed tax year. This tax accrual was recorded in a prior period based on uncertainties about the tax aspects of transactions related to the reorganization of our European operations and divestment of certain of our joint ventures.
In 2010, U.S. foreign tax credits included the impact of a $108.5 million repatriation of cash from foreign subsidiaries. Due to the mix of foreign earnings related to this cash, the repatriation generated additional tax credits.
In addition, see note 10 of the financial statements for a reconciliation of the U.S. federal statutory tax rate with the effective tax rate.

2011 2010 Income from unconsolidated operations $ 25.4 $ 25.5

Income from unconsolidated operations decreased $0.1 million in 2011 compared to 2010. We increased income with our unconsolidated joint venture in India, Eastern Condiments, which was completed late in fiscal year 2010. This was offset by investment spending behind our new joint venture in Turkey and decreases in some of our smaller joint ventures. Our largest joint venture, McCormick de Mexico, had net income comparable to the prior year. While this business grew sales 12%, profits were pressured by higher soybean oil cost and a weakening Mexico peso in the fourth quarter of 2011.
We own a 26% share in our Eastern Condiments joint venture and on average own 50% of our other unconsolidated joint ventures. In 2011, sales of these joint ventures grew 32% to $709 million (at 100% of these businesses) with many products marketed under the McCormick name. The Eastern Condiments joint venture added 18%, while existing joint ventures increased sales by 14%.
We reported diluted earnings per share of $2.79 in 2011, compared to $2.75 in 2010. The following table outlines the major components of the change in diluted earnings per share from 2010 to 2011:

2010 Earnings per share-diluted          $ 2.75
2010 Reversal of significant tax accrual  (0.10 )
Increased operating income                 0.16
Increase in tax rate                      (0.02 )
Higher interest expense                   (0.01 )
Effect of lower shares outstanding         0.01
2011 Earnings per share-diluted          $ 2.79


Consumer Business

                           2011        2010
Net sales               $ 2,199.9   $ 1,999.0
Percent growth               10.0 %       4.6 %
Operating income            428.4       402.4
Operating income margin      19.5 %      20.1 %

We grew consumer business sales 10.0% in 2011 when compared to 2010. Higher pricing added 5.1% and favorable foreign exchange rates added 1.8%. Volume and product mix rose 3.1%, which included a 2.6% increase from acquisitions in 2011.

In the Americas, consumer business sales rose 8.2%, primarily as a result of pricing actions which added 6.0%. Our acquisition of Kitchen Basics added 1.1% to sales, other increases in volume and product mix added 0.4% and favorable foreign exchange rates added 0.7%. Increased pricing unfavorably impacted volume and product mix during 2011. In addition, an estimated $10 million in sales shifted from the first quarter of 2011 into the fourth quarter of 2010, as a result of customer purchases in advance of a late 2010 price increase. However, the impact of these reductions to volume and product mix were more than offset by a favorable impact of product innovation, brand marketing support and expanded distribution. New products introduced in 2011 included new Recipe Inspirations, grinders, Grill Mates and reduced sodium dry seasoning mixes. We had particular success with new Zatarain's frozen entrees which helped contribute to a 40% increase in sales of Zatarain's frozen products. A portion of our incremental brand marketing support was directed toward a new advertising campaign for dry seasoning mixes, a Hispanic marketing program that included sampling, and a digital marketing program behind Grill Mates which contributed to a 7% unit increase in Grill Mates sales. New distribution was gained for both brand and private label items in a variety of retail channels that included grocery, warehouse clubs, dollar stores and drug chains.
In Europe, the Middle East and Africa (EMEA), consumer business sales increased 13.5%. Our acquisition of Kamis added 6.5% to sales, favorable foreign exchange rates added 4.2% and pricing actions added 2.8%. In our largest market, France, we achieved solid growth with higher pricing, which was slightly offset by lower volume and product mix. We introduced nearly 40 new products in this market, including an organic line of Ducros spices and herbs and a number of Vahiné dessert items, and gained new distribution with a large grocery retailer. A highly competitive retail environment in the U.K. made sales growth in this market a challenge, even with the introduction of new products and distribution gains into smaller store formats with a major customer. We adapted to this environment by redirecting a portion of our brand marketing support to emphasize the value of our products, accelerating the introduction of new products and working to achieve secondary placement of our brand in retail stores. Export sales into developing markets contributed to growth in 2011 and we improved results in smaller markets such as Spain and Portugal, which experienced significant declines in 2010.
Consumer business sales in the Asia/Pacific region rose 22.5%. Favorable foreign exchange rates added 9.4% to sales, the impact of our new Kohinoor joint venture added 9.1% to sales, other increases in volume and product mix added 2.0% and pricing actions added 2.0%. Sales in China grew 10% in local currency during the year as a result of pricing actions, product introductions and new television advertising. Our business in Australia was unfavorably impacted by a challenging competitive environment, leading to a modest decline in 2011 sales when measured . . .