McCormick & Company, Incorporated
Q2 2011 Earnings Call Transcript

Published: 30 Jun 2011

[Operator:]

Greetings, and welcome to the McCormick's Second Quarter 2011 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joyce Brooks, Vice President, Investor Relations for McCormick. Thank you. Ms. Brooks, you may begin.

[Joyce Brooks:]

Good morning to everyone on today's call and to those joining us by webcast. The purpose of our call is to provide an update on our business, review McCormick's second quarter financial results and share our latest 2011 outlook. We've posted a set of slides to accompany today's call at our web site, ir.mccormick.com. Joining us for the call are Alan Wilson, Chairman, President and CEO; and Gordon Stetz, Executive Vice President, CFO and Treasurer. Alan is going to start with the business review and discussion of the recent business agreements and transactions. Gordon will follow with the review of our second quarter financial results and an update to our 2011 outlook. After that, we look forward to discussing your questions. As a reminder, our presentation today contains projections and other forward-looking statements. Actual results could differ materially from those projected. The company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or other factors. In addition, certain information we will present today are non-GAAP measures. This includes annual financial results from 2010 and prior years that exclude items affecting comparability. We present this non-GAAP information for comparative purposes alongside the most directly comparable GAAP measures. Reconciliations of GAAP to non-GAAP measures can be found in the presentation slides for our call. It's now my pleasure to turn this discussion over to Alan.

[Alan Wilson:]

Thanks, Joyce. Good morning, everyone, and thanks for joining us. Some of you that dialed in on our last quarterly call in March remarked that it was an unusually short call. I don't know that anybody was actually complaining, but in our efforts to exceed your expectation, you'll find this morning's call a little bit longer, since we've got a lot of really good news to report. The good news starts with our latest financial performance and a double-digit increase in sales and profit for the second quarter. This was accomplished in an economic environment that remains challenging for McCormick, as well as our customers and our consumers. Both our Consumer and Industrial segments achieved a strong sales performance. Through new products, increased distribution and our brand marketing, we were able to offset areas of weakness in certain parts of the business. On the cost front, we were effectively managing through a volatile and inflationary material cost environment with our pricing actions and through our Comprehensive Continuous Improvement program, CCI, which is now expected to generate at least $45 million in cost savings in 2011. Following the end of our quarter, we announced 2 agreements

[Gordon Stetz:]

Thanks, Alan, and good morning, everyone. Today's announcement of our second quarter sales and profit performance demonstrates the strength of our brands and the effectiveness of our CCI program. We are particularly pleased to be delivering year-to-date high performance across most of our operating units. Let's start with a closer look at top line results. There has been a lot of interest in our pricing activities, so let me begin with a few general remarks and then move into a discussion of our 2 segments. In response to higher raw and packaging material costs, we began to implement pricing actions early in fiscal year 2011. In the second quarter, pricing added 3% to our sales growth -- all right, let me correct that, in the first quarter, pricing added 3% to our sales growth. In the second quarter, our pricing actions were more fully in place for our Consumer business, and we continue to pass-through higher costs with increases to industrial customers. As a result, pricing added nearly 5% to second quarter sales. Keep in mind that as we head into the third quarter of 2011, we will begin to lap some significant pricing on pepper that was taken in August 2010. As indicated on Slide 14, in the Americas region, Consumer business sales were up 9%. Our pricing actions accounted for 7% of this increase, and we grew volume and product mix by 2% in the quarter. This increase was led by authentic regional cuisine in the U.S. and dry seasoning mixes and Billy Bee Honey in Canada. Unit sales of Zatarain's branded products rose 16% as a result of distribution gains for frozen products and incremental marketing behind the brand. We grew net sales of Hispanic items in the U.S. at a double-digit pace through our direct store delivery system in Western markets and the campaign Alan described. For many of our other products, we believe the emphasis by certain retailers on private label limited our sales growth during this period. We are responding to this environment by analyzing and adjusting our promotional activities, launching differentiated new products and ensuring we have good distribution of our products, both brand and private label, in all channels. Consumer sales in EMEA increased 10% and in local currency rose 2%. In this region, pricing of 4% was offset in part by a 2% decline in volume and product mix. This was an improvement from a 6% decline in volume and product mix during the first quarter. What we saw in this most recent period were mixed results. Sales of our Ducros and Vahiné brands in France benefited from new product introductions and product distribution. Increases in developing markets related primarily to distribution gains. In the U.K. and the Netherlands, we experienced volume and product mix declines. In these countries, consumers remained under pressure and a competitive retail environment has led to aggressive actions with private label items in many categories. As stated in the first quarter, we are addressing this situation by

[Operator:]

[Operator Instructions] Our first question is coming from the line of Ken Goldman of JPMorgan Chase.

[Kenneth Goldman:]

To supported brands you talk about or your brands, McCormick adjusting your promotional activities. Is that just promoting more? Is it a broader adjustment than that? I know you touched on this a little bit in your comments, but if you could provide some color there, that would be useful, I think.

[Alan Wilson:]

Yes, sure. What we're doing, as Gordon pointed out, is a little bit of a shift from second quarter last year to third quarter where we're up spending more against some of our -- the newer products that are hitting. So we're going to have an incremental spend. The second thing that we're doing is our promotional spending is going to be fairly similar. But we're going to emphasize the value of our business to consumers as they're under pressure. So it's more of a message as opposed to just increasing the promotional spend.

[Kenneth Goldman:]

And can you talk a little bit about the pricing environment for private label right now? Another private label manufacturer, not in the spices, but recently cited some unusual pushback from its customers. I'm curious if that's something you're experiencing too or whether it's different in your categories.

[Alan Wilson:]

It's been a little different in our categories mainly because we took our pricing earlier and have really strong justification. I would say similar to what you've heard from other companies, both in brands and private label, you have to really be pretty descriptive on what's happening with cost in order to get pricing approved these days. But we had very good justifications we went in. Now I will say in terms of private label pricing on the shelf, we still have not seen in every segment private label passing through the increased cost at this point.

[Operator:]

Our next question is from the line of Andrew Lazar of Barclays Capital.

[Andrew Lazar:]

Gordon, I was hoping maybe you could just give us a little bit more color around the year-over-year change in gross margin in terms of -- we know part of that was just the dynamic around the higher pricing, which impacts the margin percentage. But any color around the underlying change year-over-year in the margin, whether it be to the mix of your businesses, which I know can impact margin quite a bit and things to that nature would be helpful.

[Gordon Stetz:]

Yes, as we described in the script, Andrew, we were able to cover the dollar increases through pricing or CCI. And so the math is such that when you're just covering the cost increases, the margin points will start to decline. You can see both businesses, Consumer and Industrial, grew at similar rates. Industrial is slightly higher than Consumer. So it was not a huge mix impact. It really was a function of the math as it relates to the increases that we were trying to cover through pricing and CCI.

[Andrew Lazar:]

Great. And then I guess, as I think about your business in the -- from a margin perspective, I know that you had obviously a big increase in the first quarter as cost hadn't kind of fully flowed through, you're seeing that impact now. And if I missed this, I'm sorry, but you talked about originally the 7% to 8% input cost inflation this year with some increases still coming in the back half. Has that 7% to 8% been updated to be greater at this point for the full year, or is it still 7% to 8% just with more of that inflation coming in the back half?

[Alan Wilson:]

Yes. As you saw in our comments, we're upping our CCI because our teams have been very, very good at delivering that, but that's really going to offset greater increases than anticipated. We haven't put out a specific number, but I can say that, that 7% to 8% is going to be higher. And to give a broad range, I'd say it's approaching more high-single digits. And we're offsetting that through the CCI activities that we described earlier.

[Andrew Lazar:]

Great. And last thing would just be on the Industrial side, I know a couple of years ago, you adjusted sort of the way that you're able to sort of pass-through pricing to make it smoother, if you will, or to manage through more volatile environments a bit better there. It seems like that's sort of playing out the way that you would hope through this more volatile environment, but any perspective there would be helpful as well.

[Alan Wilson:]

Yes, sure. On -- this is Alan. We are -- our protocols are working for the market basket of commodities like soybean oil and flour and those sorts of things. Where we have a little more negotiation and aren't necessarily part of the protocols is kind of all other stuff like packaging and minor ingredients, which we are also seeing increase. So those, we're chasing a little bit more -- there's more of a delay in those as opposed to the raw commodities where we collaborate. But I would say we're pleased that we have the ability to work with our customers on passing those through.

[Operator:]

Our next question is from Alexia Howard of Sanford C. Bernstein.

[Alexia Howard:]

Can I ask a little bit about the new inventory management process that you referenced? I think that might have been linked to your efforts to secure supply in certain areas. Could you tell us a little bit more about where the biggest areas by product, by region, where you've had to take those extra steps to secure supply?

[Alan Wilson:]

Well, certainly, as we saw some of the unrest in the Middle East, we buy a lot of herbs out of places like Egypt. We increased our inventory to make -- to assure supply. And so there is some of that. The other thing that as we see commodities rising from time-to-time, we're taking longer positions of spices to try to offset as much as we can. What we see are higher prices. And that's just a pattern of what we do. So we're pretty balanced. I think what you're seeing in the inventory levels is a combination of higher costs, some strategic positions to help offset future costs and then some inventory for -- to make sure we have supply assurance in the case of some unrest.

[Alexia Howard:]

Okay. And then just a quick follow-up. Last quarter, I think we saw very sluggish sales growth in the Asia/Pacific region for the Industrial business. But this quarter, it seems to have rebounded nicely. I think you mentioned innovative new flavors and beverages. Are we likely to see that kind of lumpiness going forward amongst those quick-service restaurants, or do you think you're now on much more of a steady trajectory here?

[Alan Wilson:]

I would expect to see a more steady trajectory, although that is one of the things that we're subject to what our customers are driving. And what we saw in the first quarter is customers were driving more core menu items and focus there. But as they've headed into an innovation cycle, which we expect to continue, we see the benefit of that. A lot of our growth is built on those product innovations in -- especially in China.

[Alexia Howard:]

Great. I'll pass it on.

[Alan Wilson:]

Okay, thanks a lot.

[Gordon Stetz:]

Thank you.

[Operator:]

Our next question is from Eric Serotta of Wells Fargo investments.

[Eric Serotta:]

I'm wondering whether you could provide a little bit of additional color on the areas of the business where you're seeing increased retailer emphasis on private label. I realize it's in Americas consumer you highlighted, but is that in core herbs and spices? And maybe you could provide a little bit color around that.

[Alan Wilson:]

Yes, it is around core herbs and spices, and it's predominantly in the U.S., the U.K. and a little bit in Canada. But most of our products aren't duplicated in private label. It's about -- and it's pretty focused on the top 10 or 15 items in core herbs and spices. But what we have seen so far this year, our retailers holding the line on pricing, largely in private label, even though the cost have gone up. Now we expect over time, as we've seen in the past, those 2 eventually flow their way through. But I would say the most aggressive market for private label, and has been for a long time is the U.K. The U.S. continues to be a good market for private label, but we've held our own in share with our brands. But it is just a few items that are duplicated in the stores.

[Eric Serotta:]

Okay. And could you talk a bit about the incremental cost pressures that you're seeing in the second half? Where -- what types of inputs are you seeing that in because there's a good deal of your inputs where there is frankly not a lot of transparency or visibility, things like pepper or garlic. We don't have quite the read that you guys do, obviously. Where are the -- where are you seeing the input cost inflation or the incremental input cost inflation as we enter the second half?

[Alan Wilson:]

It's predominantly around the agricultural commodities. And the biggest impact for us is pepper, both black, white and red. And so we're continuing to manage that. We're seeing some relief in garlic later in the year as the new crop comes on. But pepper is more than offsetting that. We're still seeing, and I think we will for awhile, we're still seeing some of the more published commodities, which you do have transparency on in flour, in soybean oil, stay pretty high. So those are all kind of flowing their way through. I would say packaging is still -- we're seeing inflation in packaging as well.

[Eric Serotta:]

And lastly, when do you expect to start to see some of the benefits from the new inventory management processes that you have in place to offset some of the headwinds that you talked about on the inventory side?

[Gordon Stetz:]

Well, this is Gordon, Eric. Our team is working very hard with the new module and the new processes. We've put a new organization in place just recently in this year. So we're going to see where we stand at the end of this year and evaluate the progress that's been made and give you more clarity. I can say that as a company, we're working very hard on improving our management of inventories. And I know our teams are very dedicated to doing that. The volatility of the cost environment has made projections on this pretty difficult. So we've decided to just give you a heads-up as we did in the conference call script on new timing of our goal for cash conversion cycle. We'd like the teams to work through this a bit and then at year end, we can update you.

[Eric Serotta:]

Okay. I'll pass it on.

[Joyce Brooks:]

Thanks, Eric.

[Gordon Stetz:]

Thanks, Eric.

[Operator:]

Our next question is from the line of Thilo Wrede of Jefferies & Company.

[Thilo Wrede:]

My first question was regarding your updated guidance. There were a lot of moving parts. You're taking it up, the top line, by a percent because of the acquisitions, another percent because of FX. But then there are integration costs and different share count. So when I put all these parts together, my impression is that the underlying business, the like-for-like business is maybe slightly weaker than you previously thought?

[Gordon Stetz:]

No, I wouldn't -- that's not the takeaway. I would be careful in doing that. Really, the headline messages is, we are reaffirming. There's a number of these puts and takes between a share buyback and other items. But in the end, it's the range that we're providing here so. We're reaffirming the range and the only assurance that we're really indicating at least earnings per share at the acquisition-related costs.

[Thilo Wrede:]

Okay, that's helpful. And then the -- at the current inflation levels that you're looking at your input costs, if you look out into fiscal '12, would you expect the rate of increase of the year-over-year inflation to be better or worse than what you're seeing right now?

[Gordon Stetz:]

Well, it's early to call 2012, but we would not -- we would expect to see higher prices and some continued inflation, but not at the level that we've seen this year.

[Thilo Wrede:]

So with the inventory management that you are working on this run rate of inventory being about 17% of sales, that should definitely come down late this year, early next year?

[Gordon Stetz:]

Well, again, we're working hard on managing our inventories and the volatility environment is such that we're reluctant to give you a specific projection on that. We would expect to start to see underlying improvement in particular in our finished goods area as we progress through the end of this year and into next year. But in total, inventory, given the cost environment, we want to assess that at year end and come back to you with a specific projection.

[Operator:]

Our next question is from the line of Chris Growe of Stifel, Nicolaus.

[Christopher Growe:]

I just had a couple of questions for you here. The first one, in relation to your cost increases for the second half, similar to an earlier question, are those primarily coming through in Industrial and primarily, therefore, in sort of pass-through costs? Or is it sort of across the board, or is it even more of your Consumer business related too? And then talk about the second half inflation here.

[Gordon Stetz:]

It's fairly balanced. We're seeing across both of our businesses. I mean, Alan referred to some of the headline commodities that impact the Industrial business mostly, and you can see follow those and see those. But as we indicated as well, we're seeing it in packaging and pepper, so it's -- we're feeling the pressures across both businesses.

[Christopher Growe:]

Okay. And are you -- so the given incremental inflation, is there more pricing to come or -- and I guess I'm really looking more at the Consumer business or the idea just to use the CCI savings to offset that and not actually bring it to the consumer?

[Gordon Stetz:]

Yes. Pricing is the last lever that we want to pull, and we're evaluating whether there will be additional pricing actions. Right now, we haven't made any decisions on that. But the first thing that we attempt to do is to offset it with productivity. And so that's our objective. We're not at a point yet to declare whether we're going to take additional pricing in the year.

[Christopher Growe:]

Okay. And just 2 quick ones. First one, just to be clear on that, $6 million increase in the third quarter, that's not incremental, that's sort of part of the full year plan, just happen to be a little bit more weighted to the third quarters. Is that the way to say it?

[Gordon Stetz:]

Yes. That's the way to think about it. Our second quarter advertising spend was roughly in line with last year. Our third quarter advertising spend is going to be up a little bit compared to last year.

[Christopher Growe:]

Okay. And then my final question, just to understand -- I guess, really a question for Gordon. You had a couple of acquisitions here, couple of good sized ones with that. Your balance sheet though looks it will still be in pretty good shape. So is it -- you just curtailing share purchase. Is that sort of done for this year? I guess when I start looking at my cash flow projections and where the balance sheet stands, I would argue you could do that -- you could get back to repurchasing shares in 2012. But I want to understand kind of where you want the debt EBITDA or your debt levels to stand here going forward?

[Gordon Stetz:]

While we manage to a debt-to-EBITDA range of say, 1.5% to 1.7%. And we expect to be higher than that by year end. So for the moment, we are curtailing our share repurchase. Again, we'll reevaluate this at year end as we look into cash flow and projections next year and determine whether or not it's appropriate for us to go back into the share repurchase market.

[Operator:]

Our next question is from the line of Ann Gurkin of Davenport & Company.

[Ann Gurkin:]

Just wondering if you would comment on current consumer behavior trends in the U.S. Are consumers eating more at home, changing their purchase patterns, any kind of update there?

[Alan Wilson:]

Yes, we're not seeing -- we are seeing consumers continue to eat at home and we're seeing some softness in the food service sector, which is impacting our Industrial business a little bit. We're seeing a little bit of a different pattern than we saw in 2008 and 2009, where we saw a significant growth in dry seasoning mixes during then. And what we're seeing now is more flat dry seasoning mixes. So there may be a little bit of that change. Certainly, everything we're hearing from customers that consumers are buying closer to when they need the products, they're spending less on their trips because they're trying to manage through that and buying a lot closer to paydays.

[Ann Gurkin:]

Okay, and then congratulations on all your acquisition. Are there any opportunities for cross-selling or bringing products to different markets? Are you that far along yet in the stat analysis?

[Alan Wilson:]

Absolutely. We go into -- into these with the idea that we've got great products in all of our markets and that we want to bring those products to new consumers wherever they are. And that's really what we've done with all of our acquisitions. We'll do things like we did with Ducros, with Grinders, and bring those around the world. We're doing the same thing with Slow Cookers. So we see great opportunities with these new countries and new channels of distribution to bring innovative new products to them.

[Ann Gurkin:]

That's great.

[Operator:]

Our next question is from the line of Rob Moskow of Credit Suisse.

[Robert Moskow:]

Actually, just 2 questions. One, is there anyway to quantify all of these distribution gains that you have in the Americas? And what I'm trying to get at is maybe this is like a gift that keeps on giving for a few more quarters, you mentioned Hispanic items in the West, I think Billy Bee Honey in Canada, is there anyway to quantify these things? And then lastly, just in the language of the press release, in the Americas you said you're adjusting your promo activities. In the EMEA, you're redirecting brand marketing support. It sounds like you're kind of course correcting in the middle of the year, but the first half was a good first half. Your volume is up, your pricing is up. So what's causing you to have to make these changes in the middle of the year? And are they disruptive, or is the trade asking for them? What -- maybe you can just help me understand exactly what's changing and how significant it is?

[Alan Wilson:]

To answer the first question, it's kind of hard to specifically quantify the impact of the new distribution. But as they come on, there is certainly a gift that keeps on giving because we'll keep lapping the impact of the new distribution and our objective is to keep growing the business as we get new distribution. So we think that will -- but we've taken that into account with our sales guidance. In terms of the course correction, I would say it's more we're adapting our programs to the environment and specifically in the U.K. where we're not getting the volume growth that we would like to see. Well, I agree, we've had a good first half to the year. But I would say it's more tweaking and changing our mix than necessarily a big course correction in the middle of the year.

[Robert Moskow:]

In the U.S., what's changing?

[Alan Wilson:]

In the U.S., we're continuing our programs. But we're going to keep emphasizing the value of our products on meals.

[Operator:]

Our next question is from the line of Eric Katzman of Deutsche Bank.

[Eric Katzman:]

I guess, couple of questions. Gordon, can you say what the new run rate on the interest expense should be with roughly, I guess, $400 million or so leaving the building for the 2 acquisitions?

[Gordon Stetz:]

Well, we're in the process of evaluating our new capital structure, as you see, it's potentially going to the debt markets. So I guess I'd prefer for us to have that activity done before I give a specific number. But I mean, you can look at incremental $400 million in the current rate environment and obviously, it will be a mix of what's available in the medium term and commercial paper. So using the incremental $400 million and some rates there, that's probably the best rate. We also have cash available overseas that we will be using to fund it. Approximately $200 million exists overseas already, and we'll be using that to help fund the acquisitions as well.

[Eric Katzman:]

Okay. And the $2 million transaction cost in the quarter, and I guess you're going to have another one in the third quarter, I assume on the segment basis, that's all run through the Consumer business?

[Gordon Stetz:]

Yes. We're -- the vast majority will run through the consumer, yes, because these businesses are largely Consumer businesses.

[Eric Katzman:]

Okay. And then getting back to just last, the $200 million overseas, maybe I'm just missing something, but you only have $48 million of cash on the books?

[Gordon Stetz:]

Yes. Well, we periodically pull that back on a loan basis. So we carry higher commercial paper balances on average throughout the year. But periodically, we pull that back to pay that down. So there is an amount of cash overseas of about $200 million.

[Eric Katzman:]

Okay. All right. And then Alan, I'm kind of wondering if you could just comment a bit because I'm just kind of struck by -- when you go through and I appreciate the detail on the 2 acquisitions, but I'm just kind of struck by the difference. In the Kohinoor, one in India, you paid -- even adjusting for the 15% interest that you don't have, you paid, call it, 1.5-plus times, it's growing at a double-digit rate. But I guess it's just going to be a couple of pennies accretive, which I guess points to it being a pretty low-margin business versus the Polish business, you paid close to 3x sales, it's growing at a decent rate, but it's materially accretive given that. So I mean the sales aren't all that different between the 2 businesses. So is it -- maybe it's just as simple as just a difference in the margin, or is -- or are you planning on spending more back into one versus the other, maybe if you could just kind of help me with that?

[Alan Wilson:]

Yes. The business in India is a business that's going to see investment business spending as we drive and grow that. We're excited about that market, and we're making the investment for the long-term growth. Eastern Europe, which is a more developed market, we are going to invest, we're going to bring new products. But there -- but it's not to the degree of what we will see in India.

[Eric Katzman:]

And I guess, I think the Polish business, that was an auction. But was the India one an auction, or was that just based on your connections?

[Alan Wilson:]

It was based on a long-term relationship that we've had with the family that owned it and an ongoing discussion with them and -- to maintain a long-term partnership. That, as you know, it's a joint venture which we're very, very happy to be able to do. And in Poland, it's an outright acquisition.

[Eric Katzman:]

Okay, and then last question, it just seems -- I don't remember how asked this, but somebody asked about China. And I was thinking more on the consumer side. A couple of years ago, you had to go through like a reset of the product lines. And I think you actually had even to cut back on SKUs. But it seems like over the last few quarters or so that, that business has gained a lot of traction. I mean, my guess is it isn't really big in the scheme of things. But are you just -- like have you kind of hit on a new structure or formula over there or a new distributor that seems to be working?

[Alan Wilson:]

Well, what we've continued to do is bring new products to the market, and that's been a help. And a lot of our growth has been as we expand more of a direct presence into other cities, that's helped. Whereas in the past, what you're talking about is we were in the soybean oil business in China through distributors, and we found that, that wasn't the right business mix for us. So we've refined the mix and feel that we have the right products. We still see opportunities for innovation, but more along expanded distribution and expanded our presence into other markets or other cities.

[Eric Katzman:]

Okay. I'll pass it on.

[Joyce Brooks:]

As we're running past 9