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MKC > SEC Filings for MKC > Form 10-Q on 27-Sep-2013All Recent SEC Filings

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Form 10-Q for MCCORMICK & CO INC


27-Sep-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW
Our Business
We are a global leader in flavor, with the manufacturing, marketing and distribution of spices, seasoning mixes, condiments and other flavorful products to the entire food industry. Customers range from retail outlets and food manufacturers to food service businesses. Our major sales, distribution and production facilities are located in North America and Europe. Additional facilities are based in China, Australia, Mexico, India, Singapore, Central America, Thailand and South Africa. Annually, approximately 40% of our sales have been outside of the United States.
We operate in two business segments, consumer and industrial. Consistent with market conditions in each segment, our consumer business has a higher overall profit margin than our industrial business. In 2012, the consumer business contributed 60% of sales and 79% of operating income and the industrial business contributed 40% of sales and 21% of operating income. Across both segments, we have the customer base and product breadth to participate in all types of eating occasions, whether it is cooking at home, dining out, purchasing a quick service meal or enjoying a snack. We offer consumers a range of products from value-priced to premium.
Our Strategy and Outlook
Our strategy is straightforward - we invest in the business to drive sales and profits and fund these investments with cost savings from our Comprehensive Continuous Improvement (CCI) program. This simple strategy has been the driver of our success and is our plan for growth in the future.
Increasing Sales and Profits - Our long-term goals are to grow sales 4% to 6%, increase operating income 7% to 9% and increase earnings per share 9% to 11%. Long-term, we expect to achieve our sales growth with one-third from category growth, share gains and new distribution, one-third from product innovation and one-third from acquisitions. In 2013, we are making progress with each of these growth initiatives. We plan to increase brand marketing approximately $13 million to support more digital marketing activity and other programs designed to build consumer awareness and drive volume. We are launching a number of new products for 2013 that include new varieties of seasonings blends, grilling products, dessert items and authentic ethnic meals, as well as snack seasonings and other flavor products for industrial customers. In mid-2013 we announced our acquisition of Wuhan Asia Pacific Condiments Co. Ltd. (WAPC) in China (see the Acquisitions note to our financial statements).
Based on financial results through the third quarter and our latest business outlook, we expect to grow sales at the lower end of our initial range of 4% to 6%. Earnings per share are expected to be at the lower end of our initial range of $3.13 to $3.19. This outlook is an increase from $3.04 earnings per share in 2012, and reflects the impact of higher sales and the CCI cost savings, offset in part by a year-on-year increase in the tax rate and an increase of $22 million in retirement benefit expenses. Our range of $3.13 to $3.19 is a non-GAAP measure and does not include an estimated expected settlement charges of approximately $20 million related to our U.S. pension plan in the fourth quarter of 2013. (See Non-GAAP discussion at the end of this section and the U.S. Pension Plan discussion later in MD&A.) In addition to increased sales and profit, our business generates strong cash flow (we generated $455 million in cash flow from operations in 2012 and $227 million through the nine months ended August 31, 2013). Long-term, we expect higher cash flow and more efficient asset utilization as we anticipate growth in net income and further reductions in our working capital. We are increasing shareholder return with consistent dividend payments. We have paid dividends every year since 1925 and increased the dividend in each of the past 27 years. Investing in the Business - We are investing in our consumer business with new products, new packaging and greater marketing support. In 2012, we increased brand marketing by $11 million, or 6%, over the prior year to support additional digital marketing, which is one of our highest return investments in brand marketing support. Between 2005 and 2012 we doubled our brand marketing support and plan to increase our spending by approximately $13 million in 2013.

As an industry leader, McCormick brings innovative ideas to consumers and to industrial customers. Innovation continues to be one of the best ways to distinguish our brands from private label and other competition. In the U.S., these include new varieties of GrillMates, Perfect Pinch, Recipe Inspirations and recipe mixes. We are also introducing Zatarain's rice mixes in a convenient microwavable pouch and a line of frozen Thai Kitchen single-serve entrees. In Canada, we are launching a range of recipe mixes to easily prepare authentic Chinese and Philippine dishes and a line of Bag'n Season products. In France, new products include Vahiné dessert items, a recipe mix range and a line of premium gourmet spices and herbs. Product innovation in Poland includes recipe mixes and Bag'n Season items under the Kamis brand. In Australia, we launched liquid marinades in


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a convenient packaging format and are expanding our Aeroplane gelatin brand with ready-to-serve varieties and a line of "Sweet Treats" dessert mixes. Our first new products for Kohinoor in India include a convenient mix of Rice 'n Spice and a "2 Minute Meal kit." On the industrial side of our business, we have a solid pipeline of new flavors and seasonings aligned with our customers' new product launch plans.

Inspiring healthy choices is one of our company pillars and we have a number of reduced-sodium and gluten-free products that help consumers create great-tasting meals. Through the McCormick Science Institute, founded by McCormick in 2007, we are funding the advancement of scientific knowledge of the potential health benefits of culinary spices and herbs. This institute is also committed to educating consumers, nutritionists and dietitians about these potential health benefits. In 2012, we added creative and sensory facilities in Mexico and South Africa, and completed new flavor labs in the U.S. and U.K. Early in 2013, we opened a new Asian center for technical innovation in China, similar to our centers for North America and EMEA, where we are developing on-trend, consumer preferred products.

Through acquisitions we are adding leading brands to extend our reach into new geographic regions where we currently have little or no distribution. We have a particular interest in emerging markets that offer high growth potential, such as India and China. On May 31, 2013, we completed our acquisition of the assets of WAPC in China. In our developed markets, we are seeking consumer brands that have a defensible market position and meet a growing consumer trend. Cost Savings from CCI - CCI is our ongoing initiative to improve productivity and reduce costs throughout the company. With CCI, each business unit develops cost reduction opportunities and sets specific goals. Our projects fall into the areas of cost optimization, cost avoidance and productivity that includes streamlining processes. However, the only amounts we report are actual cost reductions where costs have decreased from the prior year. CCI cost savings totaled $56 million in 2012, of which $39 million lowered cost of goods sold. In 2013, CCI-related cost savings are expected to reach at least $55 million, with a large portion impacting our cost of goods sold.
Material cost inflation is expected to moderate to about 3% in 2013, compared to a high single-digit increase in 2012. As such, the year-on-year increase in material costs is expected to ease in 2013 as we progress through the year. We anticipate the 2013 impact of the material cost inflation will be offset largely by the cost savings from our CCI program. Non-GAAP Financial Measure
The table below includes a financial measure of projected diluted earnings per share excluding the expected estimated impact of a $20 million U.S. pension settlement charge in the fourth quarter. This is a non-GAAP financial measure which is prepared as a complement to our financial results prepared in accordance with United States generally accepted accounting principles. We believe this non-GAAP information is important for purposes of comparison to prior periods and development of future projections and earnings growth prospects. This information is also used by management to measure the profitability of our ongoing operations and analyze our business performance and trends. Management believes the non-GAAP measure provides a more consistent basis for assessing the Company's performance than the closest GAAP equivalent. This non-GAAP measure may be considered in addition to results prepared in accordance with GAAP, but it should not be considered a substitute for, or superior to, GAAP results. We intend to continue to provide this non-GAAP financial measure as part of our future earnings discussions and, therefore, the inclusion of this non-GAAP financial measure will provide consistency in our financial reporting. A reconciliation of this non-GAAP measure to GAAP financial results is provided below.
2013 Projected Earnings per Share range - diluted (A) $3.03 to $3.09 Expected estimated U.S. pension settlement charge $0.10 Adjusted 2013 Projected Earnings per Share range - diluted (A) $3.13 to $3.19

(A) The company has guided to the lower end of the earnings per share range and adjusted earnings per share range for fiscal 2013.


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RESULTS OF OPERATIONS - COMPANY

                                        Three months ended August 31,           Nine months ended August 31,
(in millions)                               2013                2012              2013                 2012
Net sales                            $       1,016.4       $      977.7     $      2,953.4       $      2,868.4
Percent increase                                 4.0 %              6.2 %              3.0 %               10.9 %
Gross profit                         $         407.6       $      391.7     $      1,163.6       $      1,135.4
Gross profit margin                             40.1 %             40.1 %             39.4 %               39.6 %

The sales increase of 4.0% for the third quarter of 2013 included a 0.2% unfavorable impact from foreign currency exchange rates and a 2.7% increase from our WAPC acquisition on May 31, 2013. Excluding the acquisition and foreign currency impact, we grew sales 1.5%. This increase was split between the result of pricing actions, which added 0.9% to net sales, and higher volume and product mix, which rose 0.6%, driven by our consumer business. For the consumer business, sales increased 7.8%, which included a 0.4% favorable impact from foreign exchange rates and a 4.7% increase from acquisitions. Volume and product mix added 1.8% to consumer sales, while pricing actions increased sales by 0.9%. For the consumer business in the U.S., we again offered a holiday display program to our customers to encourage adequate supply and early displays for fall cooking and the holidays. Sales under this year's program significantly exceeded last year's program. Also in this market, a price increase was implemented in the fourth quarter in response to 2013 increases in certain raw and packaging materials. We estimate that retailer purchases in a stronger response to the holiday display program and in advance of the pricing action shifted an estimated $30 million in sales from the fourth quarter into the third quarter when compared to the prior year periods. This increased consumer business sales and total company sales approximately 5% and 3%, respectively in the third quarter. For the industrial business, net sales decreased 1.3%, which included a 1.0% unfavorable impact from foreign exchange rates. Volume and product mix declined 1.0% due largely to lower demand from quick service restaurants, which was mostly offset by pricing actions which added 0.7% to industrial net sales.

Gross profit for the third quarter of 2013 increased by 4.1% over the comparable period from last year, while our gross profit margin was equal to the third quarter of 2012. This was a continual improvement from the 50 and 20 basis point declines that we experienced in the first and second quarters, respectively, of 2013 compared to the same periods of 2012. This improvement was primarily due to a favorable mix of business and our CCI cost savings. While we were able to offset most of the material cost increases with price increases and CCI initiatives on a dollar basis, it has had a negative impact on gross margin percentage for the nine months ended August 31, 2013 as compared to the same period for the prior year. We expect overall average material cost inflation of about 3% in fiscal 2013, down from a high single digit rate of increase in 2012. As material costs inflation is anticipated to ease, we expect further improvement in the fourth quarter of 2013.

                                        Three months ended August 31,         Nine months ended August 31,
(in millions)                              2013               2012               2013               2012
Selling, general & administrative
expense (SG&A)                       $       259.2       $       247.5     $       787.2       $       757.4
Percent of net sales                          25.5 %              25.4 %            26.7 %              26.4 %

SG&A as a percentage of net sales increased 0.1% for the third quarter of 2013 as compared to the third quarter of 2012 due to increased brand marketing support, which was $3.8 million higher in the third quarter of 2013 as compared to the same period from the prior year. In addition, third quarter 2013 SG&A included an increase in retirement benefit expense, partially offset by cost savings from our CCI program. For the nine months ended August 31, 2013, the SG&A percentage was impacted by an increase in retirement benefit expense and $4.1 million of transaction costs for our WAPC acquisition. Total brand marketing support for the nine months ended August 31, 2013 is $2.8 million higher when compared to the same period of the prior year, however, as a percentage of net sales it was 0.1% lower in 2013 as compared to 2012. For the fourth quarter, we are estimating an increase of $10 million of brand marketing support from our 2012 levels with the largest increases planned in the EMEA and Asia-Pacific regions to support product introductions.

                                         Three months ended August 31,     Nine months ended August 31,
(in millions)                                 2013              2012           2013              2012
Interest expense                        $          14.0     $     13.2   $          41.4     $     40.7
Other income, net                                   0.3            0.9               1.7            1.8


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The impact of higher interest rates for 2013 compared to 2012, that was partially offset by the impact of lower average debt balances for the same periods, led to higher interest expense for the third quarter and nine months ended August 31, 2013 compared to the same periods from the prior year.

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