SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For Quarterly Period Ended May 31, 2005

 

Commission File Number 001-14920

 

McCORMICK & COMPANY, INCORPORATED

(Exact name of registrant as specified in its charter)

 

MARYLAND		52-0408290
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
18 Loveton Circle, P. O. Box 6000, Sparks, MD		21152-6000
(Address of principal executive offices)		(Zip Code)

 

Registrant’s telephone number, including area code (410) 771-7301

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.  Yes ý No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

		Shares Outstanding
		May 31, 2005
Common Stock		14,810,349
Common Stock Non-Voting		119,078,805

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION
	ITEM 1                                FINANCIAL STATEMENTS
	ITEM 2                                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3                                QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4                                CONTROLS AND PROCEDURES
PART II – OTHER INFORMATION
	ITEM 2.                             PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
	ITEM 4.                             SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 6.                             EXHIBITS
	SIGNATURES
	EXHIBIT INDEX

 

 

 

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PART I – FINANCIAL INFORMATION

 

ITEM 1                  FINANCIAL STATEMENTS

 

McCORMICK & COMPANY, INCORPORATED

CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)

(in thousands except per share amounts)

 

		Three Months Ended						Six Months Ended
		May 31,						May 31,
		2005			2004			2005			2004
Net sales		$	628,571		$	596,164		$	1,232,195		$	1,168,526
Cost of goods sold		387,225			364,238			762,680			714,913
Gross profit		241,346			231,926			469,515			453,613
Selling, general and administrative expense		170,864			168,652			339,775			328,885
Special (credits)/charges		(670		)	(6,448		)	630			(6,379		)
Operating income		71,152			69,722			129,110			131,107
Interest expense		11,942			9,695			23,026			19,267
Other (income)/expense, net		97			(536		)	43			(684		)
Income from consolidated operations before income taxes		59,113			60,563			106,041			112,524
Income taxes		18,916			18,713			33,933			34,769
Net income from consolidated operations		40,197			41,850			72,108			77,755
Income from unconsolidated operations		3,802			1,825			9,258			5,085
Minority interest		(1,205		)	(822		)	(2,537		)	(1,881		)
Net income		$	42,794		$	42,853		$	78,829		$	80,959
Earnings per common share - basic		$	0.32		$	0.31		$	0.58		$	0.59
Average shares outstanding - basic		134,742			137,679			135,193			137,519
Earnings per common share - diluted		$	0.31		$	0.30		$	0.56		$	0.57
Average shares outstanding - diluted		138,739			142,494			139,586			142,133
Cash dividends paid per common share		$	0.16		$	0.14		$	0.32		$	0.28

 

See notes to condensed consolidated financial statements.

 

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McCORMICK & COMPANY, INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEET

(in thousands)

 

		May 31, 2005			May 31, 2004			November 30, 2004
		(unaudited)			(unaudited)
ASSETS
Current Assets
Cash and cash equivalents		$	20,096		$	16,125		$	70,335
Receivables, net		328,117			309,700			407,645
Inventories
Raw materials and supplies		148,643			172,067			153,481
Finished products and work-in process		196,638			201,907			196,699
		345,281			373,974			350,180
Prepaid expenses and other current assets		45,560			37,416			35,917
Total current assets		739,054			737,215			864,077
Property, plant and equipment		977,089			941,964			989,005
Less: accumulated depreciation		(505,594		)	(485,408		)	(502,398		)
Total property, plant and equipment, net		471,495			456,556			486,607
Goodwill, net		674,757			612,951			712,907
Intangible assets, net		114,962			114,554			115,187
Prepaid allowances		50,078			79,711			56,807
Investments and other assets		136,317			129,287			134,064
Total assets		$	2,186,663		$	2,130,274		$	2,369,649
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Short-term borrowings		$	194,796		$	125,658		$	140,153
Current portion of long-term debt		226,659			17,152			33,027
Trade accounts payable		167,816			166,188			195,068
Other accrued liabilities		293,329			295,475			404,446
Total current liabilities		882,600			604,473			772,694
Long-term debt		271,202			495,884			464,957
Other long-term liabilities		197,745			204,900			211,290
Total liabilities		1,351,547			1,305,257			1,448,941
Minority interest		29,128			23,780			30,962
Shareholders’ Equity
Common stock		149,272			118,067			130,037
Common stock non-voting		222,855			194,125			206,056
Retained earnings		375,721			448,463			434,070
Accumulated other comprehensive income		58,140			40,582			119,583
Total shareholders’ equity		805,988			801,237			889,746
Total liabilities and shareholders’ equity		$	2,186,663		$	2,130,274		$	2,369,649

 

See notes to condensed consolidated financial statements.

 

4

 

McCORMICK & COMPANY, INCORPORATED

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

(in thousands)

 

		Six Months Ended
		May 31,
		2005			2004
Cash flows from operating activities
Net income		$	78,829		$	80,959
Adjustments to reconcile net income to net cash flow from operating activities:
Depreciation and amortization		35,493			34,702
Income from unconsolidated operations		(9,258		)	(5,085		)
Changes in operating assets and liabilities		(47,504		)	(31,943		)
Dividends from unconsolidated affiliates		9,020			900
Net cash flow from operating activities		66,580			79,533
Cash flows from investing activities
Capital expenditures		(30,316		)	(27,654		)
Proceeds from sale of property, plant and equipment		488			1,271
Net cash flow from investing activities		(29,828		)	(26,383		)
Cash flows from financing activities
Short-term borrowings, net		54,686			(28,686		)
Long-term debt borrowings		5			49,788
Long-term debt repayments		(352		)	(260		)
Proceeds from exercised stock options		28,983			31,273
Common stock acquired by purchase		(120,732		)	(80,740		)
Dividends paid		(43,337		)	(38,561		)
Net cash flow from financing activities		(80,747		)	(67,186		)
Effect of exchange rate changes on cash and cash equivalents		(6,244		)	5,020
Decrease in cash and cash equivalents		(50,239		)	(9,016		)
Cash and cash equivalents at beginning of period		70,335			25,141
Cash and cash equivalents at end of period		$	20,096		$	16,125

 

See notes to condensed consolidated financial statements.

 

5

 

McCORMICK & COMPANY, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.                             ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of McCormick & Company, Incorporated (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and notes required by United States generally accepted accounting principles for complete financial statements.  In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments, which are of a normal and recurring nature, necessary to present fairly the financial position and the results of operations for the interim periods.

 

The results of consolidated operations for the three and six month periods ended May 31, 2005 are not necessarily indicative of the results to be expected for the full year.  Historically, the Company’s consolidated sales and net income are lower in the first half of the fiscal year and increase in the second half.  The increase in sales and earnings in the second half of the year is mainly due to the U.S. consumer business, where customers purchase for the fourth quarter holiday season.

 

For further information, refer to the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended November 30, 2004.

 

Accounting and Disclosure Changes

 

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment,” a revision of SFAS No. 123,”Accounting for Stock-Based Compensation” and superseding APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123R requires the Company to expense grants made under the stock option and employee stock purchase plan programs. The cost will be recognized over the vesting period of the plans. Pro-forma compensation expense related to stock options subject to accelerated vesting upon retirement is currently recognized over the entire period of actual employment (up to the date of actual retirement). Upon adoption of SFAS No. 123R, compensation expense related to accelerated vesting will be recognized up to the date on which the employee becomes eligible to retire, regardless of the date on which the employee actually retires. If there are no changes made to the Company’s stock option plan, the Company now believes this change will have a material effect upon adoption of this statement. The Company is continuing to evaluate the alternatives allowed under the standard, which the Company is required to adopt beginning in the first quarter of 2006.

 

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations.” The Interpretation clarifies the accounting for a conditional asset retirement obligation as identified in SFAS No. 143, “Accounting for Asset Retirement

 

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Obligations.” Interpretation No. 47 is effective for fiscal years ending after December 15, 2005. The Company believes there will be no material effect upon adoption of this statement.

 

Stock Based Employee Compensation

 

The Company uses the intrinsic value method as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for stock options issued to employees and directors.  Accordingly, no compensation expense is recognized for these stock options since all options granted have an exercise price equal to the market value of the underlying stock on the grant date. The following table illustrates the effect on net income and earnings per common share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock Based Compensation.” Pro-forma compensation expense related to stock options subject to accelerated vesting upon retirement is recognized over the period of employment up to the date of actual retirement.

 

In the first quarter of 2005, the Company changed the valuation model used for estimating the fair value of options granted from a Black-Scholes option pricing model to a Binomial lattice pricing model. This change was made in order to provide a better estimate of fair value. The Binomial model can incorporate a range of possible outcomes over an option’s term and can be adjusted for changes in certain assumptions over time. The Black-Scholes model assumptions are more constant over time, which is not always consistent with an employee’s exercise behavior. In accordance with APB 20, “Accounting Changes,” this change was made for options granted to employees and directors beginning in the first quarter of 2005. A total of 2.4 million stock options were granted in the first quarter of 2005 at a weighted average fair value of $7.47 per share. The Black-Scholes model would have produced a value that was approximately 15% higher. The three and six month after-tax decrease in pro forma stock based employee compensation expense as a result of this change was approximately $0.2 million and $0.3 million, respectively, and is reflected in the table below. The 2005 decrease in pro forma stock based employee compensation expense is anticipated to be approximately $0.6 million ($0.4 million after-tax). The employee stock purchase plan continues to be valued using the Black-Scholes model as employee exercise patterns are not relevant to this plan.

 

		Three Months Ended						Six Months Ended
		May 31,						May 31,
		2005			2004			2005			2004
		(in thousands)
Net income as reported		$	42,794		$	42,853		$	78,829		$	80,959
Add: stock based employee compensation expense recorded, net of tax		49			428			124			447
Deduct: pro forma stock based employee compensation expense, net of tax		(3,253		)	(3,666		)	(7,238		)	(6,555		)
Pro forma net income		$	39,590		$	39,615		$	71,715		$	74,851
Earnings per common share:
Basic - as reported		$	0.32		$	0.31		$	0.58		$	0.59
Basic - pro forma		$	0.29		$	0.29		$	0.53		$	0.54
Diluted - as reported		$	0.31		$	0.30		$	0.56		$	0.57
Diluted - pro forma		$	0.29		$	0.28		$	0.51		$	0.53

 

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Reclassifications

 

Certain amounts in the prior year have been reclassified to conform to the current year presentation.  The effect of these reclassifications is not material to the condensed consolidated financial statements.

 

2.                             SPECIAL (CREDITS)/CHARGES

 

During the fourth quarter of 2001, the Company adopted a plan to further streamline its operations. This plan included the consolidation of several distribution and manufacturing locations, the reduction of administrative and manufacturing positions, and the reorganization of several joint ventures. As of May 31, 2005, the targeted 392 position reductions had taken place.

 

The total cost of the plan was $32.8 million ($22.3 million after tax). Total cash expenditures were $22.9 million, funded through internally generated funds.  The Company does not expect to incur any other costs related to the plan.

 

The Company recorded a credit in special charges under the 2001 restructuring plan of $0.7 million ($0.5 million after tax) for the three months ended May 31, 2005 and recorded $0.6 million ($0.4 million after tax) of special charges for the six months ended May 31, 2005. The credit was an adjustment of previously accrued severance costs which were over accrued. The costs recorded in 2005 are the final portion of severance and related benefits associated with position eliminations. During the three and six months ended May 31, 2004, the Company recorded special charges under the 2001 restructuring plan of $2.2 million ($1.5 million after tax) and $2.3 million ($1.6 million after tax).  The costs recorded in 2004 are costs to relocate machinery and equipment and the write-off of certain assets related to the consolidation of industrial manufacturing facilities in the U.K.  These expenses were classified in the special (credits)/charges line in the condensed consolidated statement of income.

 

The major components of the special charges and the remaining accrual balance related to the 2001 restructuring plan as of May 31, 2005 follow (in thousands):

 

		Severance and personnel costs			Asset write-downs			Other exit costs			Total
November 30, 2004		$	4,055		$	—		$	378		$	4,433
Special charges		630			—			—			630
Amounts utilized		(4,456		)	—			(366		)	(4,822		)
May 31, 2005		$	229		$	—		$	12		$	241

 

The major components of the special charges and the remaining accrual balance related to the 2001 restructuring plan as of May 31, 2004 follow (in thousands):

 

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		Severance and personnel costs			Asset write-downs			Other exit costs			Total
November 30, 2003		$	4,715		$	—		$	102		$	4,817
Special charges		20			785			1,468			2,273
Amounts utilized		(1,790		)	(785		)	(1,570		)	(4,145		)
May 31, 2004		$	2,945		$	—		$	—		$	2,945

 

Also included in special charges/(credits) for the three and six months ended May 31, 2004 is a net gain of $8.7 million ($5.5 million after tax) related to funds received from a class action lawsuit that was settled in the Company’s favor.  This matter dated back to 1999 when a number of class action lawsuits were filed against manufacturers and sellers of various flavor enhancers for their violation of antitrust laws.  The Company, as a purchaser of such products, participated as a member of the plaintiff class.  In the second quarter of 2004, the Company received $11.1 million as a settlement of this claim and as a result of the settlement, was required to settle claims against the Company for a portion of this gross amount.  The net gain recorded was $8.7 million. This amount was recorded as a special credit and was not allocated to the business segments.

 

3.                             EARNINGS PER SHARE

 

The following table sets forth the reconciliation of average shares outstanding (in thousands):

 

		Three months ended				Six months ended
		May 31,				May 31,
		2005		2004		2005		2004
Average shares outstanding - basic		134,742		137,679		135,193		137,519
Effect of dilutive securities:
Stock options and employee stock purchase plan		3,997		4,815		4,393		4,614
Average shares outstanding - diluted		138,739		142,494		139,586		142,133

 

During the quarter ended May 31, 2005, the Company issued 834,530 shares of common stock under its stock option and employee stock purchase plans and repurchased 2,156,600 shares of common stock in connection with its stock repurchase program.  During the six months ended May 31, 2005, the Company issued 1,681,002 shares of common stock under its stock option and employee stock purchase plans and repurchased 3,357,576 shares of common stock in connection with its stock repurchase program. During the quarter ended May 31, 2004, the Company issued 1,567,924 shares of common stock under its stock option and employee stock purchase plans and repurchased 1,999,791 shares of common stock in connection with its stock repurchase program.  During the six months ended May 31, 2004, the Company issued 2,341,701 shares of common stock under its stock option and employee stock purchase plans and repurchased 2,416,271 shares of common stock in connection with its stock repurchase program. Under its stock option plans, the Company may issue shares on a net basis at the request of the option holder.  This occurs when the option price is settled by tendering outstanding shares held for at least six months by the option holder.

 

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4.                             COMPREHENSIVE INCOME

 

The following table sets forth the components of comprehensive income (in thousands):

 

		Three months ended						Six months ended
		May 31,						May 31,
		2005			2004			2005			2004
Net income		$	42,794		$	42,853		$	78,829		$	80,959
Other comprehensive income (loss), (net of tax):
Minimum pension liability adjustment		1,245			729			1,015			(770		)
Net unrealized gain on investments		—			109			—			598
Foreign currency translation adjustments		(63,142		)	(28,365		)	(62,877		)	17,595
Derivative financial instruments		(2,313		)	4,015			419			3,148
Comprehensive (loss)/income		$	(21,416	)	$	19,341		$	17,386		$	101,530

 

5.                             PENSION AND POSTRETIREMENT BENEFITS

 

The following table presents the components of the Company’s pension expense for the three months ended May 31, 2005 and 2004 (in thousands):

 

		United States						International
		2005			2004			2005			2004
Defined benefit plans
Service cost		$	2,977		$	2,910		$	1,410		$	1,289
Interest costs		5,165			4,945			1,905			1,594
Expected return on plan assets		(5,083		)	(4,649		)	(1,752		)	(1,661		)
Amortization of prior service costs		4			4			19			18
Amortization of transition assets		—			—			(22		)	(21		)
Recognized net actuarial loss		2,858			2,872			315			143
Total pension expense		$	5,921		$	6,082		$	1,875		$	1,362

 

The following table presents the components of the Company’s pension expense for the six months ended May 31, 2005 and 2004 (in thousands):

 

		United States						International
		2005			2004			2005			2004
Defined benefit plans
Service cost		$	5,954		$	5,819		$	2,835		$	2,575
Interest costs		10,330			9,890			3,830			3,186
Expected return on plan assets		(10,166		)	(9,299		)	(3,523		)	(3,321		)
Amortization of prior service costs		8			8			37			35
Amortization of transition assets		—			—			(44		)	(41		)
Recognized net actuarial loss		5,716			5,745			633			284
Total pension expense		$	11,842		$	12,163		$	3,768		$	2,718

 

On December 31, 2004, the Company paid $22 million for its annual contribution to its major U.S. pension plan. Contributions to international plans are generally funded throughout the year.  Total contributions to the Company’s pension plans in 2005 are expected to be approximately $38.3 million.

 

The following table presents the components of the Company’s other postretirement benefits expense for the three and six months ended May

 

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31, 2005 and 2004 (in thousands):

 

		Three months ended						Six months ended
		May 31,						May 31,
		2005			2004			2005			2004
Other postretirement benefits
Service cost		$	881		$	646		$	1,586		$	1,334
Interest costs		1,169			1,314			2,508			2,712
Amortization of prior service costs		(284		)	(284		)	(567		)	(568		)
Amortization of (gains)/losses		(77		)	265			119			644
Total other postretirement expense		$	1,689		$	1,941		$	3,646		$	4,122

 

6.                    FINANCIAL INSTRUMENTS

 

On March 31, 2005, the Company entered into forward starting interest rate swaps to manage the interest rate risk associated with the anticipated issuance of $100 million fixed rate medium-term notes expected to be issued in late 2005 under the Company’s existing shelf registration statement. The Company’s intention is to cash settle these swaps upon issuance of the medium-term notes thereby effectively locking in the fixed interest rate in effect at the time the swaps were initiated. The Company has designated these outstanding interest rate swap contracts, which expire on December 15, 2005, as hedges of the variability in cash flows in the future quarterly interest payments on the debt due to changes in the benchmark interest rate that will occur in the period prior to issuance. The proceeds upon issuance of the medium-term notes will be used to pay down maturing long-term debt. The gain or loss on these swaps is deferred in other comprehensive income and will be amortized over the ten-year life of the medium-term notes as a component of interest expense. Hedge ineffectiveness associated with these hedges was not material in the quarter.

 

In January 2005, the Company entered into a $400 million five-year credit facility, which expires in January 2010. This facility replaces the credit facilities totaling $350 million existing on November 30, 2004, of which $125 million would have expired in June 2005 and $225 million would have expired in June 2006.

 

In addition, in January 2005, the Company filed a $500 million shelf registration statement with the Securities and Exchange Commission, which became effective February 23, 2005. Under the shelf registration statement, the Company may offer and sell any combination of debt securities in one or more offerings of up to a total dollar amount of $500 million.

 

On April 1, 2004, the Company issued a total of $50 million in medium-term notes under its existing $375 million shelf registration statement filed with the Securities and Exchange Commission in January 2001. The $50 million of medium-term notes mature on April 15, 2009 and pay interest semi-annually at a rate of 3.35%. The proceeds from the new issuance were used to pay off commercial paper debt.

 

In addition, on April 1, 2004, the Company entered into an interest rate swap contract with a total notional amount of $50 million to receive interest at 3.356% and pay a variable rate of interest based on six-month LIBOR minus .21%. The Company designated

 

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this swap, which expires on April 15, 2009, as a fair value hedge of the changes in fair value of the $50 million of medium-term notes maturing on April 15, 2009. No hedge ineffectiveness will be recognized as the interest rate swap’s provisions match the applicable provisions of the debt.

 

7.                    COMMITMENTS AND CONTINGENCIES

 

In the first quarter of 2005, Premier Foods, PLC (Premier Foods), a supplier, notified the Company of a market withdrawal of Worcester Sauce supplied by Premier Foods. The product contained Sudan One, a red dye not permitted for food use. In response to Premier Foods’ notification, the Company withdrew all Worcester Sauce products supplied by Premier Foods and any other products containing Worcester Sauce as an ingredient. In the first quarter of 2005, the Company recorded a charge of $0.7 million ($0.5 million after-tax) in cost of goods sold related to this withdrawal. Although the Company expects to be fully indemnified by Premier Foods for these costs, it is premature to record a receivable for such costs as of May 31, 2005. The Company has not had additional claims from customers in the second quarter of 2005. The Company expects to be fully indemnified for costs incurred and will file a claim for damages in due course.

 

8.                    BUSINESS SEGMENTS

 

The Company operates in two business segments: consumer and industrial. The consumer and industrial segments manufacture, market and distribute spices, herbs, seasonings, condiments and other flavors throughout the world. The consumer segment sells to retail outlets, including grocery, drug, dollar and mass merchandise stores under a variety of brands, including McCormick and Zatarain’s in the U.S., Ducros, Vahine and Silvo in continental Europe, Club House in Canada, and Schwartz in the U.K. The industrial segment sells to other food processors and the restaurant industry both directly and through distributors and warehouse clubs.

 

The Company measures segment performance based on operating income. Although the segments are managed separately due to their distinct distribution channels and marketing strategies, manufacturing and warehousing are often integrated to maximize cost efficiencies.  Because of manufacturing integration for certain products within the segments, products are not sold from one segment to another but rather inventory is transferred at cost.  Corporate and eliminations includes general corporate expenses and other charges not directly attributable to the segments.

 

		Consumer			Industrial			Corporate & Eliminations			Total
		(in thousands)
Three months ended May 31, 2005
Net sales		$	323,796		$	304,775		$	—		$	628,571
Special (credits)/charges		—			—			(670		)	(670		)
Operating income		54,124			27,698			(10,670		)	71,152
Income from unconsolidated operations		2,957			845			—			3,802
Six months ended May 31, 2005
Net sales		$	645,851		$	586,344		$	—		$	1,232,195
Special (credits)/charges		—			—			630			630
Operating income		108,315			43,863			(23,068		)	129,110
Income from unconsolidated operations		7,607			1,651			—			9,258

 

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		Consumer			Industrial			Corporate & Eliminations			Total
		(in thousands)
Three months ended May 31, 2004
Net sales		$	297,338		$	298,826		$	—		$	596,164
Special (credits)/charges		23			2,179			(8,650		)	(6,448		)
Operating income		45,616			28,913			(4,807		)	69,722
Income from unconsolidated operations		1,310			515			—			1,825
Six months ended May 31, 2004
Net sales		$	596,392		$	572,134		$	—		$	1,168,526
Special (credits)/charges		55			2,190			(8,624		)	(6,379		)
Operating income		94,614			54,271			(17,778		)	131,107
Income from unconsolidated operations		3,975			1,110			—			5,085

 

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

 

OVERVIEW

 

Sales for the second quarter of 2005 rose to $628.6 million, an increase of 5.4% above the second quarter of 2004.  New products, effective marketing programs and incremental sales from the Silvo business acquired in 2004 drove an increase of 3.6%, with 1.8% attributable to Silvo. Favorable foreign exchange rates added 1.8%. Sales for the six months ended May 31, 2005 were $1,232.2 million, an increase of 5.4% above the same period of the previous year.  Higher volume, higher prices and favorable product mix contributed 3.4% of the increase, with 1.9% attributable to Silvo. Favorable foreign exchange rates added 2.0%.

 

Diluted earnings per share for the second quarter of 2005 were $0.31 compared to $0.30 in the second quarter of 2004. Higher operating income added $0.01 to earnings per share and was the net result of an increase in sales, lower gross profit margin, and the effect of income related to the settlement of a class action lawsuit that was recorded in the second quarter of 2004. Higher cost vanilla beans continued to have a negative impact on gross profit margin in the second quarter, resulting in a decrease in earnings per share of $0.02 to $0.03. The Company purchased a strategic supply of vanilla beans in 2003 to ensure an ongoing supply of quality product for customers and manage the cost of this raw material. However, a larger than expected high quality crop caused vanilla bean costs to drop rapidly and as projected, the Company is experiencing significant margin pressure, particularly in the industrial business. Gross profit margin was also affected by additional operational accounting adjustments recorded in cost of goods sold for both the consumer and industrial segments related to the condiment operation in the U.K. They were recorded as a result of an extensive review of operational accounting in the Company’s condiment plants and resulted in a $0.02 earnings per share negative impact this period. Earnings per share this period were also impacted by higher income from the Company’s joint venture in Mexico and lower shares outstanding.  These positive factors were offset by higher interest rates and a higher tax rate.

 

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Diluted earnings per share from continuing operations for the six months ended May 31, 2005 were $0.56 compared to $0.57 for the same period of 2004, a decrease of 1.8%.  Despite a 5.4% sales increase, earnings declined due to lower gross profit margin, additional operational accounting adjustments related to the condiment operation in the U.K., as well as higher interest rates and tax rate.

 

For the six months ended May 31, 2005, net cash flow from operating activities was $66.6 million as compared to $79.5 million for the same period last year. In 2005, the Company used operating cash flow and additional borrowings to fund $120.7 million of share repurchases and $43.3 million of dividend payments. In 2004, the Company used operating cash flow and additional borrowings to fund $80.7 million of share repurchases and $38.6 million of dividend payments.

 

RESULTS OF OPERATIONS - SEGMENTS

 

CONSUMER BUSINESS

 

		Three months ended						Six months ended
		May 31,						May 31,
		2005			2004			2005			2004
		(in thousands)
Net sales		$	323,796		$	297,338		$	645,851		$	596,392
Operating income		54,124			45,616			108,315			94,614

 

For the second quarter of 2005, sales from McCormick’s consumer business rose 8.9% when compared to 2004.  Higher volume added 5.1% to sales of which 3.6% was due to the acquisition of Silvo. Favorable price and product mix added 2.0% and favorable foreign exchange rates added 1.8%.  In the Americas, sales increased 5.3%, with a 2.8% increase from favorable price and product mix, 1.8% from higher volume, and 0.7% from favorable foreign exchange rates.  Price and product mix benefited from the price increase announced in the first quarter of 2005 for the U.S. business. The early introduction of new Grillmates products, Hispanic products, grinder blends and dry seasoning mixes benefited volumes. The Company is gaining good trade acceptance for these items and the timing of the initial product shipments was ahead of plan. The inventory reduction efforts by the Company’s retail trade customers that impacted the first quarter of 2005 had no material impact in the second quarter. Consumer sales in Europe increased 18.3% for the quarter. The 2004 acquisition of Silvo added 11.8% and foreign exchange rates added 4.5%. While difficult market conditions and a poor economy continued, primarily in France, the Company grew volumes by 3.3%, excluding Silvo. This was offset in part by a 1.3% decline in price and product mix due largely to higher promotional spending. Increased promotional spending is targeted at certain ingredient items that compete with products in the discount retail chains. Discount retail chains in France continue to gain market share in the retail sector. Sales of a limited selection of the Company’s spices and herbs continue to be under pressure from lower price products offered in discount retail chains.  The Company has increased promotional spending behind these items to support retail trade customers and

 

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maintain market share.  While this higher spending is recorded as a reduction of sales and therefore reduces net sales, the Company has been successful in slowing the shift in sales to this alternative channel in recent quarters. In the Asia/Pacific region, sales decreased 0.9%, despite favorable foreign exchange rates adding 3.2%.

 

For the six months ended May 31, 2005, sales from McCormick’s consumer business increased 8.3% compared to the same period of 2004. The 2004 acquisition of Silvo added 3.8% to sales, favorable foreign exchange rates added 2.3%, and higher volume, price and product mix added 2.2%.

 

Second quarter operating income for the consumer business increased 18.7% compared to the same period of 2004. The operating income increase was driven mainly by increased sales as well as the results of cost savings initiatives that more than offset the impact of lower vanilla margins and the operational accounting adjustment. Operating income margin (operating income as a percentage of sales) increased to 16.7% in the second quarter of 2005 from 15.3% in the comparable period last year.

 

For the six months ended May 31, 2005, operating income for the consumer business increased 14.5% compared to the same period of 2004.  Operating income margin for the six months ended May 31, 2005 increased to 16.8% compared to 15.9% in the comparable period last year.  These increases were the result of similar factors as for the quarter discussed above.

 

INDUSTRIAL BUSINESS

 

		Three months ended						Six months ended
		May 31,						May 31,
		2005			2004			2005			2004
		(in thousands)
Net sales		$	304,775		$	298,826		$	586,344		$	572,134
Operating income		27,698			28,913			43,863			54,271

 

For the second quarter of 2005, sales for the Company’s industrial business increased 2.0% when compared to 2004. Higher volumes added 3.9% and foreign exchange rates added 1.6%, partially offset by a 3.5% decline from unfavorable price and product mix including lower vanilla pricing. In the Americas, industrial sales increased 2.0%, with a 2.1% increase in volume and a 0.9% increase in foreign exchange rates, offset in part by a 1.0% decline in price and product mix.  The higher volume came primarily from new snack seasoning sales as well as increased sales to food service distributors. As in the first quarter, these gains were partially offset by lower vanilla prices. Industrial sales in Europe increased 1.0% for the quarter, with a 4.0% increase from foreign exchange rates, and a net 3.0% decline from volume, price and product mix.  Sales in the second quarter of 2005 continued to be impacted by an initiative begun in 2004 to eliminate lower margin SKU’s. In the Asia/Pacific region, industrial sales rose 4.4%, a net increase of 2.5% from volume, price and product mix and a 1.9% benefit from favorable foreign exchange.

 

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For the six months ended May 31, 2005, total industrial sales increased 2.5% with 1.7% from favorable foreign exchange rates and 2.3% from higher volumes, partially offset by a 1.5% decline in pricing and product mix.

 

In the second quarter of 2005, industrial business operating income decreased 4.2% or $1.2 million when compared to second quarter of 2004. The impact of lower vanilla prices and a portion of the operational accounting adjustment were offset in part by cost reductions and a positive product mix. Operating income margin decreased to 9.1% in the second quarter of 2005 from 9.7% in the comparable period last year as a result of the factors discussed above.

 

For the six months ended May 31, 2005, operating income for the industrial business decreased 19.2% compared to the same period of 2004.  The decrease is primarily the result of the factors discussed above. Operating income margin for the six months ended May 31, 2005 decreased to 7.5% compared to 9.5% in the comparable period last year as a result of the factors discussed above.

 

RESULTS OF OPERATIONS - COMPANY

 

Gross profit margin (gross profit as a percentage of sales) decreased 0.5% to 38.4% in the second quarter of 2005 from 38.9% in the comparable period of the prior year. Gross profit margin in the second quarter of 2005 was negatively impacted by lower vanilla pricing and additional operational accounting adjustments related to the condiment operation in the U.K. This negative impact was offset in part by the favorable impact of cost reductions achieved as part of the $70 million cost reduction program begun in 2004. The Company is on track to meet its $25 million cost reduction goal for 2005. The cost reduction target of $25 million includes reduction in both cost of sales and selling, general and administrative expenses. Gross profit margin for the six months ended May 31, 2005 decreased to 38.1% compared to 38.8% for the same period of 2004.  This decrease is also a result of the items discussed above.

 

Selling, general and administrative expenses in the second quarter of 2005 increased 1.3%, but decreased 1.1% as a percentage of sales to 27.2%. As a percentage of sales, lower administrative more than offset higher distribution costs and increased promotional spending. Also, the second quarter of 2004 included $4.3 million of costs related to the reorganization of administrative and other functions in international locations, contributing to the higher selling, general and administrative expenses for that quarter. For the six months ended May 31, 2005, selling, general and administrative expenses as a percentage of sales decreased to 27.6% from 28.1% for the same period of 2004 as a result of the items mentioned above.

 

Pension expense for 2005 is expected to increase approximately 6% over the 2004 expense of $30.0 million.  In connection with the valuation performed at the end of 2004, no changes were made to the assumptions used to determine benefit obligations.

 

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Interest expense in the second quarter of 2005 increased by $2.2 million compared to the second quarter of 2004 due to higher average short-term interest rates and increased debt.

 

The effective tax rate for the quarter ended May 31, 2005 was 32.0% versus 30.9% for the quarter ended May 31, 2004. The 2004 rate included the impact of the utilization of certain net operating loss carryforwards. The decrease in available net operating loss carryforwards and mix of earnings among the different taxing jurisdictions in which the Company operates caused the increase in the 2005 effective tax rate.

 

The increase in minority interest in the second quarter of 2005 to $1.2 million from $0.8 million in the second quarter of 2004 was due to strong results from the Vahine dessert line distributed by our 51%-owned joint venture, DPI.

 

Income from unconsolidated operations for the quarter increased by $2.0 million to $3.8 million from the same period in 2004.  This improvement was driven by higher sales and significantly higher income from the Company’s joint venture in Mexico. More effective marketing programs and promotions, lower soy oil cost, and new products all contributed to the continued improved performance in this joint venture.

 

SPECIAL (CREDITS) /CHARGES

 

The Company recorded a credit in special charges under the 2001 restructuring plan of $0.7 million ($0.5 million after tax) for the three months ended May 31, 2005 and recorded $0.6 million ($0.4 million after tax) of special charges for the six months ended May 31, 2005. The credit was an adjustment of previously accrued severance costs which were over accrued. The costs recorded in 2005 are the final portion of severance and related benefits associated with position eliminations. The Company does not expect to incur any other costs related to the plan. During the three and six months ended May 31, 2004, the Company recorded special charges under the 2001 restructuring plan of $2.2 million ($1.5 million after tax) and $2.3 million ($1.6 million after tax), respectively.  The costs recorded in 2004 were costs to relocate machinery and equipment and the write-off of certain assets related to the consolidation of industrial manufacturing facilities in the U.K.  These expenses were classified in the special (credits)/charges line in the condensed consolidated statement of income.

 

Also included in special (credits)/charges for the three and six months ended May 31, 2004 was a net gain of $8.7 million ($5.5 million after tax) related to funds received from a class action lawsuit that was settled in the Company’s favor.  This matter dated back to 1999 when a number of class action lawsuits were filed against manufacturers and sellers of various flavor enhancers for their violation of antitrust laws.  The Company, as a purchaser of such products, participated as a member of the plaintiff class.  In the second quarter of 2004, the Company received $11.1 million as a settlement of this claim and as a result of the settlement, was

 

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required to settle claims against the Company for a portion of this gross amount.  The net gain recorded was $8.7 million. This amount was recorded as a special credit and was not allocated to the business segments.

 

MARKET RISK SENSITIVITY

 

Foreign Exchange Risk

 

The fair value of the Company’s portfolio of forward and option contracts was an unrealized loss of $0.3 million as of May 31, 2005, compared to unrealized losses of $0.8 million as of May 31, 2004 and $3.9 million as of November 30, 2004. The notional value of the Company’s portfolio of forward and option contracts was $27.5 million as of May 31, 2005, lower than the $32.3 million notional value as of May 31, 2004 and the $51.1 million notional value as of November 30, 2004.  The reduction in notional value since November 30, 2004 is primarily due to a decrease in foreign exchange contracts covering Canadian and Australian dollar exposures.

 

Interest Rate Risk

 

The Company manages its interest rate exposure by entering into both fixed and variable rate debt arrangements.  In addition, the Company uses interest rate swaps to minimize worldwide financing costs and to achieve a desired mix of fixed and variable rate debt.  As of May 31, 2005, the Company had a total of $325 million of interest rate swap contracts which are discussed below.

 

In March 2005, the Company entered into forward starting interest rate swaps to manage the interest rate risk associated with the anticipated issuance of $100 million fixed rate medium-term notes expected to be issued in December 2005 under the Company’s existing shelf registration statement. The Company intends to cash settle these swaps upon issuance of the medium-term notes thereby effectively locking in a fixed interest rate in effect at the time the swaps were initiated. As of May 31, 2005 the fair value of these swap contracts was an unrealized loss of $4.7 million.  The Company has designated these outstanding interest rate swap contracts, which expire on December 15, 2005, as hedges of the variability in cash flows in the future quarterly interest payments on the debt due to changes in the benchmark interest rate that will occur in the period prior to issuance. The gain or loss on these swaps is deferred in other comprehensive income and will be amortized over the ten-year life of the medium-term notes as a component of interest expense. Hedge ineffectiveness associated with these hedges was not material in the quarter.

 

In April 2004, the Company entered into a $50 million interest rate swap contract in conjunction with the issuance of $50 million of medium term notes on the same day.  This interest rate swap contract receives interest at 3.356% and pays a variable rate of interest based on six-month LIBOR minus .21%. The Company designated this swap, which expires on April 15, 2009, as a fair value hedge of the changes in fair value of $50 million of medium-term notes maturing on April 15, 2009. As of May 31, 2005, the fair value of this swap contract was an

 

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