McCormick & Company, Incorporated

Good morning. This is Casey Jenkins, Chief Strategy Officer and Senior Vice President, Investor Relations. Thank you for joining today's third quarter earnings call. To accompany this call, we've posted a set of slides at ir.performix.com. With me this morning are Lawrence Curzius, Chairman and CEO, Brendan Foley, President and COO, and Mike Smith, Executive Vice President and CFO. During this call, we will refer to certain non-GAAP financial measures, The nature of those non-GAAP financial measures and the related reconciliation to the GAAP results are included in this morning's press release and slides. In our comments, certain percentages are rounded. Please refer to our presentation for complete information. Today's presentation 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 because of new information, future events, or other factors. Please refer to our forward-looking statement on slide two for more information. I will now turn the discussion over to Lauren.

Good morning, everyone. Thanks for joining us. Third quarter sales increased 3% from the year-ago period as anticipated. In constant currency, sales grew 6%, reflecting 10% growth from pricing actions, partially offset by a 1% decline from the kitchen basics divestiture the 1% decline attributable to the exits of low margin business in India and the consumer business in Russia, and a 2% decline in all other volume and product mix. Our underlying third quarter growth reflects the strength of our broad global portfolio, as well as the effective execution of our strategies and pricing actions against the backdrop of a volatile operating environment. Using 2019 as a pre-pandemic baseline, Third quarter sales grew at a constant currency, three-year compounded annual growth rate, or CAGR, of 7%, reflecting the sustained momentum in our business across both our consumer and flavor solution segments. Moving to profit, adjusted operating income was down 12%, or 11% in constant currency, and adjusted earnings per share was down 14%. During the third quarter, supply chain challenges continued, and recovery of certain constrained materials is taking longer than expected. We continue to incur elevated costs and meet high demand in our flavor solutions segment, while in our consumer segment, where demand moderated from elevated consumption trends more quickly than expected, we are experiencing lower than optimal operating leverage. Across the supply chain, we remain focused on managing inventory levels and eliminating inefficiencies, though the normalization of our supply chain costs is taking longer than expected. pressuring gross margin and profit realization in the current period. Over the coming months, we will be aggressively eliminating supply chain inefficiencies. Importantly, as we had expected in the third quarter, our price increases are catching up with the pace of cost inflation in both segments. We began to recover the cost inflation that had been outpacing our pricing actions and other levers most significantly in the consumer segment. We expect this will continue into the next year as we plan to fully offset inflation over time. Before discussing our third quarter segment performance in more detail, I'd like to comment on our supply chain plans, starting on slide five. We have a focused plan in flight that leverages the discipline of our established Comprehensive Continuous Improvement, or CCI, program to ensure that we are able to flexibly support customer demand, both where it has been sustained at higher levels and where it has moderated. While eliminating inefficiencies and normalizing both our cost structure and inventory levels, our actions are well underway. Our top supply chain priority remains keeping our customers in supply and supporting their growth. There are areas of our business that have sustained high levels of demand for an extended period, and our supply chain has been pressured to meet this demand. We have several initiatives in progress that will increase our capacity, strengthen our supply chain resiliency, and importantly, enable us to service our customers so they can grow their business. For example, we're investing in additional Flavor Solutions seasoning capacity, which will be online in early 2023. We're expanding Fona's footprint to support our flavor growth. We recently opened our new UK Peterborough Flavor Solutions manufacturing facility to support our strong growth momentum with quick service restaurants. And just earlier this week, the first pallet was shipped from our new Maryland Logistics Center. And from a cost perspective, as we responded to demand volatility over the past several years, we have incurred additional costs above inflation to service our customers and have seen inefficiencies develop in our supply chain. These are costs we have absorbed. We have not passed them to customers in our pricing actions. We are targeting to eliminate at least $100 million of these costs with a significant benefit in 2023. We're moving aggressively to take these costs and inefficiencies out, as well as normalize inventory levels that have built up. Some of our actions include investing to increase both manufacturing capacity and reliability in bottleneck areas to enable better customer service and repatriation of production from excessive use of co-packers. We're returning to more normal shift schedules and reducing our spend on extensive surge capacity. we are already seeing the benefit of lower overtime and temporary labor reductions. In this more normalized environment, as well as through customer collaboration, we are already beginning to reduce expedited freight costs and lessen truckload shipping costs, as well as other transportation inefficiencies. We are resolving raw material and packaging supply issues. For example, we are beyond the shortages of glass bottles and certain organic spices, which impacted supply of our U.S. gourmet line. A supplier facility closure announced in September drove the discontinuation of a component of our dry recipe mix packaging, and through our quick qualification of alternative supply, we mitigated a major disruption during the fourth quarter. A long-running shortage of French's mustard bottles will be resolved in the first half of 2023 as new molds come online at a second supplier. And from an inventory perspective, we are also executing on plans to return to historical safety stock levels which were raised to protect against supply disruption. We expect the impact of our actions will normalize our supply chain costs, increase our efficiency and ability to meet demand, lower our inventory levels, and importantly, increase our profit realization beginning in the first half of 2023. We have managed through various supply chain challenges over the last several years with the peak disruption experienced in the third quarter of last year. Since then, there has been steady improvement, building progress and bolstering our confidence in our plan to enhance our operational performance and optimize our cost structure. While we will always prioritize meeting our customers' needs, I'm encouraged by our disciplined approach to resolving the increased costs within our supply chain. We've continued to define and quantify specific actions within our plan since we shared we would be driving the elimination of the supply chain inefficiencies. and our pre-announcement last month. We look forward to sharing more details and progress with you in January when we provide our 2023 outlook. Now, moving to third quarter business updates for each of our segments. Starting with our consumer segment on slide six and the status of our pricing actions, our third quarter sales reflect the impact of our pricing actions in all three regions with an acceleration of effective pricing in the quarter versus the first half of the year. in line with what we expected. While broad pressure on consumers' cost of living from inflation, which heightened during our third quarter, has resulted in higher price elasticity than we originally anticipated, our elasticities remain lower than historical levels. In our most recent pricing actions, which in the U.S. took effect as we began our fourth quarter, we focused on areas that are less elastic and did not take pricing on some products where we had seen the highest elasticity. Now for some further highlights by region, starting with the Americas. Our total U.S. branded portfolio consumption, as indicated by our IRI consumption data and combined with unmeasured channels, grew 4% in line with our shipment. And over the last three years, since 2019, consumption has grown at a three-year CAGR of 8%, which highlights how the sustained shift in consumer consumption continues to drive increased demand for our products and outpace pre-pandemic levels. In early August, we divested our kitchen basics business. We consistently grew this brand over the years, but as it was the only U.S. brand we had in the stock and broth aisle, our resources were better focused on core categories where we have leading brands. Demand has remained high with strong growth in the majority of our categories. Spices and seasonings has been one of our strongest categories in the past three years. And as a result, we are lapping all-time highs in consumption. This has created challenging comparisons in some product lines, such as baking-related items, which have returned to a pre-pandemic level unlike most of our categories. Grilling-related items were impacted versus last year by high meat prices, although grilling is still strong versus pre-pandemic. Sales conditions continue to improve, as seen in our recipe mix share performance, with the fourth consecutive quarter of share gains. Our spices and seasoning share was pressured by service-related distribution losses, the shortage of certain packaging items, as well as certain organic spices, which has largely been resolved, and some trading down by consumers who remain under pressure from broad-based inflation. We are using our category and revenue management capabilities to strengthen our spices and seasoning presence on shelf. The strength of our brands and our category leadership has recently won us new distribution, which we're beginning to realize now. In EMEA, we continue to have solid share performance in herbs, spices, and seasonings in the UK, Eastern Europe, and Italy, somewhat offset by softer performance in France. We're continuing to gain share on Frank's Red Hot in the UK, and we're beginning to build momentum with Cholula as we expand that brand into this market. For the quarter and year-to-date versus last year, as well as since 2019, we are driving the UK hot sauce category growth. Our botany brand of homemade dessert products in France, a product line unique to our EMEA region, has slowed as we have seen baking return to a more pre-pandemic baseline level in EMEA 2, again, unlike our other categories. Turning to the Asia Pacific region, last year the region experienced supply chain challenges such as ocean freight capacity constraints, and lapping that impact contributed to growth in the third quarter. Additionally, Following an extended lockdown in the second quarter, COVID restrictions in Shanghai and some other cities throughout China eased as we began the third quarter, resulting in trade and pantry replenishments contributing to growth. Recently, several cities in central China, which is the primary market of our Wuhan operations, have experienced new COVID-related lockdowns, and we're continually monitoring the situation. Overall, our China performance is on track with our expectations. Across all regions in our consumer segment, we are achieving the price realization we expected, and we are executing on our proven growth strategies, pivoting action plans as needed based on our consumer insights and the environment. We continue to invest behind our brands. We increased brand marketing investments in the third quarter and have additional investments planned for the fourth quarter. In addition to our highly effective and inspiring holiday messaging, we have pivoted our digital messaging to emphasize value and show consumers how our products help them stretch their grocery dollars without sacrificing flavor. We are focusing our innovation efforts to meet the needs of consumers concerned about their budgets. In the Americas, we have launched a new Lowry's branded opening price point range of everyday 10 spices. And our large size format, Super Deal, is one of the best performing product lines as consumers are looking for greater value. This format size is approximately a 40% better value per ounce than the smaller sizes. We've also launched large size resealable pouches of top selling items in markets across all regions. In terms of category management, we're collaborating with our customers to ensure the right assortment and price points on shelf to optimize category performance and increase profitability for our customers. And as always, we have a strong merchandising program planned for the holiday season. We are confident in our brand marketing investments, innovation, and category management initiatives, which will continue to drive strong growth. Turning to flavor solutions on slide 8, our sales performance for the quarter was strong, with growth led by our pricing actions in all three regions, with an increase in our effective pricing versus the first half of the year as we expected. Now for some regional highlights. In the Americas, strong growth was driven by snack seasonings, savory flavors, and branded food service products. Demand continues to strengthen with branded food service restaurants and institutional food service customers as mobility and strong summer travel continue to fuel consumption, and importantly, we also are expanding distribution. In EMEA, growth remains strong across our entire customer base. Our third quarter growth was led by strong quick service restaurant, or QSR, momentum in all markets, partially driven by expanded distribution and our customers' promotional activities. And we're seeing an acceleration of demand in branded food service as customers shift to more economical formats. Our full spectrum of solutions across price points is driving growth. We're winning in both regions with our new product momentum. In Americas, growth from new products contributed approximately 25% more growth in flavors in the third quarter than the year-ago period, driven by beverage, savory snacks, and performance nutrition flavors. We're continuing to win share in these categories. And in EMEA, our third quarter new product launches accelerated versus earlier in the year. And for the full year, we expect new product introductions to outpace 2021. We are fueling future growth. we're driving further menu penetration with our QSR customers, winning new, limited-time offers, as well as realizing growth from strong performance of their core menu items we flavor. In many cases, we are the heat in their spicy offerings. Overall, Flavor Solutions has remained strong, and for certain parts of our business in the Americas and EMEA regions, our supply chain continues to be pressured to meet this high demand. And as I said earlier, we are still taking on some extraordinary costs to service our customers. We appreciate our customers working with us, and we see light ahead. Now, some summary comments before turning it over to Mike. Turning to slide 9, global demand for flavor remains the foundation of our sales growth, and we have intentionally focused on great, fast-growing categories that will continue to differentiate our performance. We continue to capitalize on the long-term consumer trends that accelerated during the pandemic, healthy and flavorful cooking, increased digital engagement, trusted brands, and purpose-minded practices. These long-term trends and the rising global demand for great taste are more relevant today than ever, with the younger generations fueling them at a greater rate. McCormick is uniquely positioned to capitalize on this demand for great taste With the breadth and reach of our strong global flavor portfolio, we are delivering flavor experiences for every meal occasion, for our products and our customers' products, and our driving growth. We are end-to-end flavor. We remain focused on the long-term goals, strategies, and values that have made us so successful. We have grown and compounded that growth over the years, including through the pandemic and other periods of volatility. Our solid track record of achieving our long-term objectives highlights the resiliency of our business through a variety of market conditions, as well as our focus on sales growth and profit realization. The long-term fundamentals that drove our industry-leading historical performance remain strong. The strength of our business model, the value of our products and capabilities, and the execution of our proven strategies by our experienced leaders, while adapting to changes accordingly, give us confidence in our growth momentum and in our ability to navigate the global dynamic environment. The compounding benefits of our relentless focus on growth, performance, and people continues to position McCormick to drive sales growth and balance with our focus on lowering costs to expand margins to realize long-term sustainable earnings growth. The teamwork of our McCormick employees drive our momentum and success, and I want to thank them for their dedicated efforts and engagement. And now I will turn it over to Mike. Thanks, Lawrence, and good morning, everyone. Starting on slide 12, our top line constant currency sales grew 6% compared to the third quarter of last year, including a 1% unfavorable impact from the kitchen basics divestiture, as well as a 1% impact from the exits of low margin business in India and the consumer business in Russia. In our consumer segment, we drove constant currency sales growth of 4%, with 10% related to pricing actions, partially offset by a 1% impact from the kitchen basics to vestiture, as well as lower volume, with the exits of low-margin business in India and the consumer business in Russia contributing a combined 1% impact to the lower volume. On a three-year basis, our third-quarter constant currency sales CAGR was 6%. On slide 13, consumer sales in the Americas increased 3% in constant currency, driven by pricing actions partially offset by a decline in volume, as well as a 1% impact from the kitchen basics to vestiture. As Lawrence mentioned, the volume decline was impacted not only by elasticities, but also by constrained supply of certain input materials, primarily packaging items. Over the past three years, constant currency sales in the Americas grew at a CAGR of 6%. In EMEA, constant currency consumer sales declined 1%, which included a 3% unfavorable impact from lower sales in Russia. Growth in other markets was driven by pricing actions, partially offset by lower volume, with the most significant volume impact attributable to lower sales of Vahine homemade dessert products. Over the past three years, EMEA's constant currency sales grew at a 3% CAGR. Constant currency consumer sales in the Asia-Pacific region grew 10%, including a 7% unfavorable impact from the exit of low margin business in India. As Lawrence mentioned, growth was driven by higher volume, mainly attributable to trade and pantry replenishments in China, following the extended Shanghai lockdown last quarter, as well as the region lapping supply chain challenges in the year-ago period. Pricing actions in all markets across the region also contributed to growth. On a three-year basis, APZ's third-quarter cost of currency sales grew at a 4% CAGR. Turning to our flavor solution segment and slide 16, We grew third quarter constant currency sales 10%, primarily due to pricing actions, with higher volume and product mix also contributing to growth. Third quarter constant currency sales for the last three years grew at an 8% CAGR. In the Americas, flavor solutions constant currency sales grew 10% driven by pricing. Higher sales to packaged food and beverage companies with particular strength in snack seasonings led to growth. Higher demand from branded food service customers also contributed to growth. Over the past three years, constant currency sales in the Americas grew at a taker of 8%. In EMEA, we drove 11% constant currency sales growth, with 7% related to price actions and 4% volume and mix. EMEA's flavor solutions growth, excluding a 1% decline related to lower sales in Russia, was broad-based across its portfolio. led by strong growth with QSR, branded food service, and packaged food and beverage company customers. Over the past three years, EMEA's constant currency sales growth was 9% CAGR. In the Asia Pacific region, flavor solution sales grew 11% in constant currency, with pricing actions and higher volume contributing to the increase. Growth was driven by higher sales to QSR customers, in part due to the timing of the promotional activities. APV grew constant currency sales at a 6% CAGR over the past three years. As seen on slide 20, adjusted gross profit margin declined 320 basis points in the third quarter versus the year-ago period. Let me spend a moment on the significant drivers. First, almost 80% of this decline, approximately 250 basis points, is due to the diluted impact of pricing to offset our dollar cost increases. Next, I'll cover the impact of supply chain challenges on gross margin. In our flavor solution segment, we have continued to incur elevated costs to meet high demand for certain parts of that business. And there has also been an unfavorable impact from the startup and dual running costs as we transition production to our new UK Peterborough manufacturing facility. In our consumer segment, where demand is moderated more quickly than we expected, we are experiencing lower operating leverage. Overall, while the normalization of our supply chain costs is taking longer than expected, pressuring gross margin, we are taking actions to normalize our costs, as Lawrence mentioned, which we are confident will be reflected in our 2023 gross margin. Partially offsetting these impacts I just mentioned were our CCI-led cost savings, where we are on track to deliver our expected savings of $85 million for the full year. And finally, of note, in line with our expectations, the impact of our pricing actions in the third quarter began outpacing cost inflation in both segments, more significantly in the consumer segment. We expect pricing to continue outpacing inflation into next year as we plan to fully offset inflation over time. Overall, our cost recovery and gross margin improvement will vary by region and segment, with a slower flavor solutions recovery. Importantly though, we have now passed the inflection point with significant gross margin improvement since last quarter, driven by our consumer segment performance, and we expect further improvement in the fourth quarter. Now, moving to slide 21, selling general and administrative expenses, or SG&A, were comparable to the third quarter of last year, with higher distribution costs and brand marketing investments all set by lower employee benefit expenses. Every percent of net sales, SG&A declined 60 basis points. The net impact of the factors I just mentioned resulted in a constant currency decline in adjusted operating income, which excludes special charges and transaction integration costs, of 11% compared to the third quarter of 2021. In the consumer segment, adjusted operating income declined 1% in constant currency, and in the flavor solution segment, it declined 34%. Turning to income taxes on slide 22, a third quarter adjusted effective tax rate was 21.2%, compared to 14.1% in the year-ago period. Both periods were favorably impacted by discrete tax items with a more significant impact last year. At the bottom line, as shown on slide 23, third quarter 2022 adjusted earnings per share was 69 cents as compared to 80 cents for the year-ago period. The decrease was driven by our lower adjusted operating income. A favorable impact from optimizing our debt portfolio in the third quarter was fully offset by the impact of higher adjusted effective tax rate in the third quarter of this year. On slide 24, We've summarized highlights for cash flow in a quarter end balance sheet. Our cash flow from operations was $250 million through the third quarter of 2022, which is lower than the same period last year. This decrease was primarily driven by lower net income and higher inventory levels. We returned $298 million of cash to our shareholders through dividends and used $167 million for capital expenditures through the third quarter. Our priority is to continue to have a balanced use of cash, funding investments to drive growth, returning a significant portion to our shareholders through dividends, and paying down debt. While our fourth quarter has historically generated our highest cash flow from operations, based on our current profit outlook and working capital position, we do not expect it to deliver to our targeted net debt to adjusted EBITDA ratio of approximately three times by the end of fiscal 22. We remain committed to a strong investment grade rating, And we have a history of strong cash generation and profit realization. With our improving gross margin, as well as our plan to normalize our supply chain costs and inventory levels, we will be better positioned to continue paying down debt. Now turning to our 2022 financial outlook on slide 25. We are projecting strong top line growth with profit impacted by cost inflation and supply chain challenges. We also expect there will be a three percentage point unfavorable impact of currency rates on sales and a two percentage point unfavorable impact on adjusted operating income and adjusted earnings per share. On the top line, we expect to grow constant currency sales 3% to 5%. We expect sales to be driven primarily by pricing. While we anticipate volume and product mix to be impacted by price elasticities, We expect elasticity to remain at a lower rate than historical levels, given our focused approach led by consumer insights. Our volume and product mix will also be impacted by the divestiture of our kitchen basics business, the demand disruptions experienced in China, and the exit of our consumer business in Russia, as well as continual pruning of lower margin business from our portfolio. We plan to drive continued growth through the strength of our brands, as well as our category management, brand marketing, new product, and customer engagement growth plans. We are projecting our 2022 adjusted gross profit margin to be 350 to 300 basis points lower than 2021, primarily driven by our flavor solutions segment. Given the rapidly escalating cost environment this year, cost inflation outpaced pricing in the first half of the year. We expect pricing to outpace inflation in the second half of the year and continue into next year. This adjusted gross margin compression reflects the impact of a high team's increase in cost inflation, higher supply chain costs, lower operating leverage, an unfavorable impact of sales mixed between segments, and favorable impacts from pricing and CCI-led cost savings. As a reminder, we have price to offset dollar cost increases. This has a dilutive impact on our adjusted gross margin and is the primary driver of our projected compression. We expect our adjusted operating income to decline 11% to 9% in constant currency. In addition to our gross margin impacts I just mentioned, this projection also includes our CCIs at total cost savings target of approximately $85 million and a low single-digit increase in brand marketing investments compared to 2021. We are projecting our 2022 adjusted effective income tax rate to be approximately 22%. This outlook is expected to be a year-over-year headwind to our 2022 adjusted earnings per share of approximately 2%. We are projecting our 2022 adjusted earnings per share to be in the range of $2.63 to $2.68 as compared to $3.05 in 2021. This projection includes a $0.02 unfavorable impact from the divestiture of the kitchen basics business. As we currently progress in our fourth quarter, we are confident in delivering our 2022 outlook, continuing our strong top line growth trajectory, and as our guidance implies, delivering fourth quarter operating margin expansion while executing on a focused plan to drive improvement in our cost structure. We are targeting to eliminate at least $100 million of these costs or approximately a 150 basis point impact to our operating margin. With our proven track record of delivering CCI-led savings to fuel growth investments and expand our operating margin, we are leveraging the discipline of the CCI program to aggressively eliminate costs and inefficiencies. Overall, we are confident our focus on profit realization will drive margin improvement. And while parts of our plan to optimize our cost structure will take longer than others, we expect to begin seeing the benefits of our actions in the first half of 2023. We look forward to sharing more details on progress with you in January when we provide our 2023 outlook. Thank you, Mike. Now that Mike has shared our financial results and outlook in more detail, I'd like to recap key takeaways as seen on slide 26. Our third quarter sales performance reflects the strength of our broad global portfolio and the effective execution of our strategies against the backdrop of a volatile operating environment. Our sales growth momentum is strong. Though challenges in our supply chain have taken longer to normalize, we have now passed an inflection point. We've begun to recover the cost inflation that has been outpacing our pricing actions while executing on a plan to aggressively eliminate supply chain costs. And we expect 2022 fourth quarter operating margin expansion and continued improvement into 2023. Our long-term performance, including through periods of volatility, has been industry-leading and long-term fundamentals that drove this historical performance remain strong. We have a proven track record of execution and are confident we will successfully navigate this dynamic environment for our future sustainable growth and build long-term value for our shareholders. Now, let's turn to your questions.

Thank you. We'll now be conducting the question and answer session. If you'd like to ask a question, please press star 1 from your telephone keypad and the confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is from the line of Ken Goldman with JP Morgan. Pleased to see you with your questions.