McCormick & Company 10-K 2008
Documents found in this filing:
Annual Report to Stockholders
A TASTE FOR THE FUTURE
Chinese Five-Spice balances equal parts anise, Szechuan peppercorn, cinnamon, cloves and fennel seed into a blend that is pungent, fragrant, hot and slightly sweet all at once. This years annual report is scented with Chinese Five-Spice.
These financial results include the impact of activities related to our restructuring plan.
In 2007, these activities reduced operating income by $34.0 million, net income by $24.2 million and diluted earnings per share by $0.18. In 2006, these activities reduced operating income by $84.1 million, net income by $30.3 million and diluted earnings per share by $0.22.
On a comparable basis, excluding the impact of restructuring activities, diluted earnings per share rose 11.6% in 2007.
All around the world, people seeking bold, exotic and exciting flavors are turning to McCormick. Inside this report we provide a taste for the future a look ahead at the trends and opportunities that are driving our growth.
Letter to Shareholders 2
Bob and Alan team up in their letter to shareholders to discuss our progress in 2007, strategies for growth and business outlook.
Discussion with Management Committee 5
Join our executives as they sit down to address some of the most commonly asked questions from investors.
A Journey with Bob Lawless 14
We recall Bobs many contributions during his 30-year career and time as CEO of McCormick.
Managements Discussion and Analysis 15
This section begins with a company description and includes information about business segments, 2007 financial results and much more.
Directors and Officers 34
A profile of our Board of Directors and list of executive officers are presented along with our governance statement.
Financial Information 36
The 2007 financial statements, accompanying notes and reports of both management and the auditors are in this section.
Investor Information 61
Investors can find company contact and related information.
Based on the strength and momentum of our business and the commitment of its leadership, your company is well-positioned for long-term sales and profit growth on a global basis. We exceeded key 2007 financial goals and made excellent progress during the year with initiatives to increase sales, reduce costs and expand our markets. In addition, we took the next step in an orderly transition of the executive team.
We are excited about our prospects as we look across our business and to 2008 and beyond. Through this letter and the discussion that follows, we want to share that excitement and give you a taste for the future.
Growth in global markets
We are achieving good sales growth in each region and segment of our business.
Consumer sales rose 6% in North America, driven by pricing, new products, effective marketing programs and, in the first half of the year, the incremental impact of our acquisition of Simply Asia Foods. At the same time, our industrial business in North America achieved higher sales to food manufacturers, though the gains were offset in part by sales to restaurants, which were affected by industry weakness in 2007.
Our business in Europe is turning a corner as a result of stronger marketing support and greater focus on our primary markets. With favorable foreign exchange rates, price increases and higher volume in both France and the U.K. we increased consumer sales 11%. Strong sales of condiments and seasonings for snack products, along with favorable foreign exchange rates, fueled a 20% increase in the industrial business in Europe. And expansion in China was a primary factor behind an increase of 20% in sales across both segments in the Asia Pacific region.
Exceeded key 2007 financial goals
Financial results in 2007 exceeded a number of our key objectives. We increased sales 7%, surpassing our goal of 4 to 6%. And cost savings related to a three-year restructuring program were $35 million in 2007, $5 million ahead of target and pushing cumulative savings from the program to $45 million. Increased costs for raw materials offset a portion of these cost savings. We have also taken certain pricing actions to provide an additional offset to higher costs.
Earnings per share were $1.73. On a comparable basis, excluding the impact of restructuring activities in 2007 and 2006, this was a 12% improvement, above our initial goal to increase earnings per share by 8 to 10%.
The Company again generated a significant amount of cash, funding $157 million of share repurchases and a 9% increase in dividends paid our 21st consecutive year of dividend increases. With the Boards approval, we have increased dividends per share at a 14% compound annual growth rate for the past five years.
Positioned for the future
The same growth strategy that has driven our success for a decade continues to set our future direction: improve margins, invest in the business, and increase sales and profits.
Margin improvement is a key element of our success. A restructuring program that includes consolidating our global manufacturing and eliminating administrative redundancies is on track to deliver at least $50 million in annual savings by the end of 2008. In addition, we are reducing complexity by selectively eliminating certain products and customers. These actions have increased average sales per customer for our U.S. industrial business by 51% in 2007 when compared to 2005. We see additional opportunities to improve efficiency and optimize our supply chain across our global operations.
Cost savings such as these were key to offsetting higher raw material costs in 2007. We are also using a portion of our margin improvement to invest in the growth of our business, funding marketing support, product innovation and other areas that offer the greatest potential to increase sales.
The same growth strategy that has driven our success for a decade continues to set our future direction.
Robert J. Lawless and Alan D. Wilson
To drive consumer demand, we are revitalizing our venerable brands in worldwide markets. The most significant of these efforts is under way in the United States the largest and most profitable market for our consumer business where a gravity-fed merchandising system is being installed in 12,000 to 14,000 supermarkets. The innovative product display is increasing purchases by consumers and reducing restocking time for the retailers. In Europe, we are driving sales of our Schwartz® brand in the U.K. and Ducros® brand in France with improved merchandising systems and increased advertising.
Product innovation is also driving sales as we build upon platforms such as health and wellness, convenience and ethnic flavors, and meet consumer desire for reduced fat and sodium with flavorful products in both our consumer and industrial businesses. And as time-pressed consumers turn more and more to grilling, slow cookers and seafood preparation, we are responding with additional flavor solutions. In North America, 2007 sales of seafood complements grew by 6%, grilling products by 7% and slow cooker seasonings by 17%. Across all businesses, new products launched in the last three years added 10% to 2007 sales.
Since 2002, the Company has achieved an average annual increase in net sales of 7%. One-fourth of this increase has been driven by acquisitions.
Emerging markets offer an opportunity for rapid sales growth, as evidenced by the 23% growth of our business in China in 2007. We are focused on additional markets with similar growth characteristics, such as India, as we strive to double our sales in the Asia Pacific region over the next five years.
Acquisitions are also an integral part of our growth strategy. We are particularly interested in acquiring leading brands in regions where we have low penetration, and niche products in more developed markets. Above all else, however, flavor is the defining factor in all of our targeting efforts. Altogether, acquisitions have added one-fourth of our sales increase in the past five years, and we are working to sustain this level of contribution. As evidence of our continued progress, in November 2007, we were pleased to sign an agreement to purchase the Lawrys business with annual sales of approximately $150 million.
A look ahead
Over the years, our business has faced challenges from higher costs, difficult economic conditions, aggressive competitors and demanding customers. We have weathered cost pressures and weak economies, and have the margin improvement potential to do so in the future. We are staying ahead of our competitors and creating value for our
customers by continuing to develop new capabilities in areas such as quality, service, systems, marketing and innovation.
Our leading market position, effective growth strategy, strong balance sheet and focus on flavor have positioned us well. Once we complete our restructuring program in 2008, we expect our sales initiatives to drive sales growth of 4 to 6% annually. These higher sales and improved margins should generate an increase of 9 to 11% in earnings per share.
As always, McCormicks engaged employees are at the center of our success. Throughout our operations, we interact in a participative manner based on our Multiple Management Board approach. In 2007 we celebrated the 75th anniversary of this problem-solving and professional development system, which is deeply ingrained in our corporate culture.
Strong, far-sighted leadership is also essential to continued success. Our Board is comprised of experienced business leaders and we are pleased to welcome Joseph McGrath, President & CEO of Unisys Corporation as a new director. Over the past year we completed the transition of our executive team. Following his promotion to President & COO at the end of 2006, Alan became a member of the Board in November and was appointed President & CEO as of January 1, 2008. Bob retired at the beginning of the new year but continues to serve as Chairman of the Board.
In addition, Gordon Stetz, who has provided key financial leadership to our U.S. and international operations for two decades, was promoted to CFO following the announcement of Fran Continos upcoming retirement from the Company and the Board. During his ten years at McCormick, Fran was instrumental in establishing common systems and processes throughout our operations with our B2K program, strengthening internal controls and building a terrific financial team. Frans involvement has led to success with our acquisition strategy and, since 2004, he has led our strategic planning effort at the Company. We thank him for his many contributions.
The executive team that will take this Company forward has been an integral part of setting our direction, formulating programs and achieving great execution in recent years. We approach the years ahead with excitement and tremendous optimism.
Our business is well-positioned with leading brands and a focus on flavor. An effective and sustainable strategy sets our direction. Motivated and energetic employees move us forward. We are confident in our ability to build shareholder value.
It promises to be a future as bold and exciting as the flavors upon which McCormick & Company has built its success since 1889.
Robert J. Lawless, Chairman of the Board
Alan D. Wilson, President and CEO
Left to Right:
Francis A. Contino, Executive Vice President Strategic Planning
Lawrence E. Kurzius, President Europe, Middle East & Africa
Charles T. Langmead, President U.S. Industrial Group
Robert J. Lawless, Chairman of the Board
Gordon M. Stetz, Executive Vice President Chief Financial Officer
Mark T. Timbie, President North American Consumer Foods
Alan D. Wilson, President & Chief Executive Officer
Join McCormicks Management Committee and Bob Lawless as they address some of the questions shareholders ask most often. These are arranged by topic...
With an expanded array of organic products, the introduction of exotic sea salts and growing interest in TV cooking shows, we grew U.S. sales of our gourmet products 12% in 2007.
Brand spending behind print ads has one of the highest returns as measured by incremental sales. Shown here is an ad for some of our popular seasoning mixes.
You have achieved good sales growth in the past. Looking ahead, what do you believe will be the primary drivers of future sales growth?
MARK > In the United States we are revitalizing our entire spice and seasoning line to bring renewed interest and excitement to the category.
This initiative tackles some of the foremost consumer issues with an easy-to-open flip-top cap and an easier-to-shop merchandising system. With this system we can prominently feature new items such as our tabletop spices, seasoned pepper blends or roasting rubs. For our grocery customers, the system is reducing out-of-stock situations and reducing restock time by up to 40%. We have installed 8,500 stores and aim to convert another 3,500 to 5,500.
CHUCK > For our U.S. industrial business, strong customer relationships continue to be the critical factor in achieving our growth targets.
On average, our share of business with strategic customers is about 25%. To grow this, we are guided by the customers view of what is important as we build upon our strong foundation of trust, innovative processes and efficient supply chain initiatives.
This partnership model led to the successful design and implementation of our new Create IT® process. Together with the customers marketing and innovation teams, we start with idea generation and move quickly and efficiently through product development, consumer validation and commercialization. In this way our customers are reducing their development cost and getting successful products to market ahead of their competition. The benefit to McCormick is a greater share of our customers business and our participation in products that succeed in the marketplace over a longer time horizon.
ALAN > With the goal of improving both sales growth and profitability, we are completing a transformation of our U.S. industrial business that began in 2006. Chuck and his team have reduced the number of customers we serve by 31% and reduced the number of products sold by 20%. In very short order, we have better aligned our resources, particularly in product innovation, behind our strategic customers.
Product innovation is also a key initiative to drive sales of our consumer business. We have had considerable success building upon a number of product platforms.
In recent years 10% of our global sales came from products that we have introduced in the last three years.
As part of our Create IT process, we bring together culinary chefs, sensory experts and flavor technologists to discuss trends and develop winning new product ideas.
MARK > Our GrillMates® line in the U.S. is a good example. It began in the early 1990s with a single seasoning blend that originated in Canada. Today 31 GrillMates items include marinades, rubs, reduced sodium varieties and more. Year after year we have grown sales of these products at a rapid pace, and annual sales are now $35 million.
Following the acquisition of the Ducros brand in Europe, we introduced three Ducros grinders in the U.S. under the McCormick label. Six years later, these products have reached $22 million in sales with 14 varieties.
We have also been expanding our products designed for consumers of Hispanic descent. These products now account for 8% of U.S. consumer sales, and they grew 11% in 2007.
BOB > The Hispanic items we offer include mayonnaise and marmalade imported from McCormick de Mexico. This 60-year-old joint venture has made McCormick the leading brand in Mexico, and Hispanic consumers in many U.S. markets actively seek these products. This highly successful joint venture now accounts for most of our income from unconsolidated operations, which in 2007 comprised nearly 10% of our earnings per share.
We cant overlook two other avenues of sales growth our marketing programs and acquisitions.
ALAN > We have increased our level of brand support in recent years and are getting better each year at measuring the effectiveness of our spending. We are seeing the best returns from our public relations activity, print advertising and television advertising.
As for acquisitions, theyve accounted for one-fourth of our 7% average annual sales growth in the past five years and will continue to be a key part of our sales growth. Our recently announced agreement to acquire the Lawrys business is evidence of our continued progress with acquisitions. In our developed markets, we are seeking niche brands that have a distinct flavor profile. In markets where we currently have low penetration, including emerging markets, we are targeting leading brands.
Besides acquisitions, how will you grow sales outside North America?
LAWRENCE > Europe is our second-largest market, contributing 25% of Company sales. Many of the same consumer business initiatives we talked about for North America are driving our growth in this market.
New merchandising systems introduced in the U.K. and France are designed to simplify the shopping experience, reduce labor and optimize our shelf space. Product innovation includes an award-winning spice package, easy-to-use
We are gaining distribution of our products in Chinas street markets which are a frequent stop for consumers.
In Europe we are growing sales with increased brand support, improved merchandising systems and the introduction of innovative new products.
Toppers® and a relaunch of our successful grinders. Brand support includes TV advertising featuring our chef character in France, and both TV and radio advertising in the U.K. We have just launched a print advertising campaign in the U.K. that will be rolled out more broadly across Europe in 2008.
GORDON > Having just returned from several years in Europe, I can tell you first-hand that we have turned a corner with this business. We have reduced complexity, focused on our most profitable businesses, built our brands and developed our people capabilities.
The most striking example of our progress is in our industrial business, where we have gone from approximately 500 customers in 2003 to 50 customers by the end of 2007. In this market as well, we are focused on the largest customers with the greatest potential for growth.
LAWRENCE > These customers are the leaders in their industry, and many of them have multinational businesses. In addition to a strong top-to-top relationship, we are supporting them from our locations around the world with product innovation and production.
ALAN > This is certainly true in China and was really the origin of our business there about 15 years ago. We built a facility to support the expansion of industrial customers in this region and from this same facility, launched a line of consumer products that is profitable and growing rapidly.
China, together with Australia and other countries in the region, comprised 6% of 2007 sales. Our goal is to more than double our sales in the Asia Pacific region by 2012. We expect to continue our rapid pace of both consumer and industrial sales growth in China and to expand into other markets with good growth characteristics, such as India.
Across all markets, what eating trends are you watching most closely?
ALAN > McCormick is on the leading edge of flavor. Every year we bring together top chefs to discuss the hottest trends and develop our McCormick Flavor ForecastTM, which is eagerly awaited by professional chefs and food editors.
I would say consumers interest in health and wellness is the number-one trend. We recently launched the McCormick Science Institute to advance the health benefits of natural spices and herbs. As consumers work to reduce their intake of fat, salt or sugar, McCormick is ideally suited as an expert in natural spices and herbs.
Members of our global financial team met in 2007. The discussion included using the power of our systems to lower costs in the supply chain.
Over the past few years, much of your time has been spent on restructuring the Company. With this program nearly complete, are there more opportunities to improve the supply chain?
FRAN > Toward the end of 2005, we announced an ambitious three-year restructuring program that included actions to consolidate facilities and eliminate administrative redundancies. Our goal was to realize annual cost savings of $50 million by the end of 2008.
Thanks to the hard work of our employees and diligent planning and management of this program, we have made terrific progress. By the end of 2007 we had already achieved annual savings of $45 million, and we expect up to $10 million more in 2008.
While we have made great strides in improving our supply chain and profit margins with this program and other initiatives, we still see lots of opportunities ahead opportunities in areas like procurement, manufacturing, distribution, sales and marketing, and administration.
CHUCK > In the U.S. industrial business, our resources are focused on our most important customers. By reducing the overall number of customers and products, we have been able to close facilities and lower our cost to serve. In 2007, the margin improvement from these actions was largely offset by significant commodity cost increases on certain product categories and customers. As commodity costs moderate, as pricing actions are fully implemented and as we experience continued success in delivering value added products, we will make further progress toward higher sustainable margins for the industrial business.
In addition to lowering our costs, we are also reducing the level of inventory on hand. Again, this was partially offset in 2007 by higher prices for many raw materials, but our supply chain initiatives are leading to reduced time supply and lower safety stock levels.
ALAN > In addition to our U.S. industrial business, there are opportunities to lower inventory and total working capital in all of our operations around the world.
Following the implementation of SAP, our first priority was to improve processes and identify and achieve expense reductions. As Fran indicated, our restructuring program was an important step in this direction.
McCormick expects to reach up to $55 million in annual savings in 2008, ahead of its $50 million goal.
Our spice buyers work with growers around the world to procure consistent high-quality ingredients.
McCormick is an industry leader in designing techniques to test the quality and consistency of our ingredients.
As we continue up the learning curve with our systems, I have challenged employees across all locations and functions to increase their proficiency and apply these tools in new ways. I am convinced that this will lead to additional insights about our business and opportunities to lower costs.
GORDON > In 2008 we are changing our incentive program to align everyone in the organization with working capital management. We are adding a capital cost for the amount of assets, net of liabilities, that are managed by our operating units.
Our business generates a significant amount of cash. We can take this to the next level with better supply chain management, which means lower costs and better management of our working capital.
What is McCormick doing in the area of sustainability?
ALAN > Our business was built on a cultural foundation of concern for one another. For 75 years, our Multiple Management philosophy has encouraged the involvement of employees in community service activities as well as at all levels of the Company. We are open in our communications, value diversity among our employees and provide many opportunities for learning and development.
Global sourcing is a core competency for our business. We firmly believe that providing assistance to the communities that supply our raw materials and manufacture our products will enable them to improve their productivity and their living conditions. For more than 20 years we have provided training for agriculture and processing of spices and herbs and have improved food safety, quality and yield. This is critical to our continued growth and success.
LAWRENCE > Having led our consumer business in the U.S. and now both our consumer and industrial businesses in Europe, I am keenly aware of our reputation as a reliable supplier of high-quality products. This is a real advantage as we compete against smaller suppliers that do not have a close connection to the source of their raw materials or the same degree of quality assurance that we can provide.
ALAN > In 2007 we set goals to monitor our impact on the environment. We have introduced metrics that will measure our progress in several key areas: solid waste reduction, energy use reduction, lower greenhouse gas emissions and the development of fair trade for selected commodities.
At McCormick, we dont view sustainability as a side issue, but as something that is an integral part of our business and essential to our success.
We are expanding acquired businesses with new product introductions such asThai Kitchen®meal kits, Zatarains® reduced sodium rice mixes and Silvo® Toppers.
In 2007 you shared some financial projections beyond 2008. Please help me understand how you will achieve 9 to 11% growth in earnings per share?
BOB > Id like to explain how we developed the longer-term financial projections for the business and why we decided to communicate them to investors. Fiscal year 2007 marked the mid-way point in our three-year restructuring program. During this period, sales and profits were somewhat curtailed by our rationalization of smaller and less profitable customers and products.
As part of our strategic planning process we asked our leadership team to take a look ahead at their portfolio of products, growth prospects and supply chain initiatives. With good visibility, each operating group developed projections for sales growth, margin improvement and increased operating income that were then consolidated for the total Company.
We recognized that many of our shareholders would benefit from learning and understanding our longer-term outlook.
GORDON > Investors have asked if we think some of our projections are overly ambitious. We dont think so.
We expect to grow sales 4 to 6% annually. As Alan indicated earlier, we have achieved average annual sales growth of 7% for the past five years, with one-fourth of this increase coming from acquisitions.
MARK > The largest part of the 4 to 6% sales increase will come from a 2 to 3% increase in our base business. Our revitalization of packaging, products and merchandising is lifting sales of the entire category for our core consumer businesses. In addition, we are working to build our market share with more effective advertising. The introduction of new products will add another 1 to 2% to sales.
GORDON > Over time, we believe we can increase gross profit margins by half a percentage point per year. About half of this increase will come from our supply chain initiatives. The other half will result from the faster growth of our consumer business, which has a higher margin than the industrial business.
As part of our growth strategy, we intend to invest a portion of this margin improvement back in the business to build for the future. Higher margins will also contribute to a 9 to 11% annual increase in earnings per share.
Beyond 2008, once our restructuring program is complete, we expect to grow annual sales 4-6%.
With a leading share, it is our responsibility to bring innovation, news and excitement to consumers.
Our Multiple Management Board in Mexico is one of 13 around the world. This is a team-based system that allows a diverse cross-section of employees to develop and work on projects to improve nearly any aspect of the business.
What distinguishes McCormick from other companies?
LAWRENCE > We operate from a position of strength in our primary markets. We have the number-one market share in the U.S., Canada, U.K., France and China, as well as several smaller markets.
As the clear category leader, we supply our retail customers with the entire range of spice and seasoning products, from premium gourmet items to value-priced store brands. Among packaged food companies, this is an enviable position.
CHUCK > Our business is all about flavor. Datamonitor recently reported that 41% of U.S.and European consumers have tried food with new and exotic flavors in the last 12 months.
We dont sell a single type of product. Rather, flavor is something that spans all types of food and all types of eating occasions. Our two business segments consumer and industrial connect us to a wide array of products where we can add great taste. Whether it is a meal at home, a night out or a snack on-the-go, we have an opportunity to provide the flavor.
We like to say, No matter where or what you eat, each day you are likely to enjoy something flavored by McCormick.
ALAN > As described earlier, we have a unique expertise in the sourcing of spices and herbs from locations around the world.
Consumer interest in natural spices and herbs fits perfectly with our capabilities in this regard. For our industrial business, quality and reliability are paramount. Our customers know that McCormick understands the importance of a brand and will apply rigorous standards to the products we supply.
A side benefit of our global sourcing effort is that we have an established link with several of the emerging markets that we have targeted for expansion.
MARK > McCormick also has a unique position in the area of acquisitions. As a mid-size food company, we are targeting a number of brands and businesses of a size that might not interest larger food companies. In fact, some of the smaller businesses these larger companies might shed as they refine their portfolio of products would be meaningful additions to our Company.
FRAN > We have maintained a strong balance sheet that has afforded us an excellent credit rating and leverage for acquisitions such as Lawrys. While some investors have asked why we have not increased our debt and been more aggressive with share repurchases, we prefer to maintain our financial flexibility.
Between our consumer and industrial businesses, no matter where or what you eat, each day you are likely to enjoy something flavored by McCormick.
We will continue to use our strong cash flow wisely by balancing dividends, capital expenditures, acquisitions and stock repurchases.
What else should a prospective investor know about McCormick?
GORDON > McCormick has been aggressive in pursuing margin improvement. We have been willing to challenge all areas of our business, including systems, facilities and organization. We see opportunities ahead to optimize our business.
While our financial objectives may seem aggressive, we are convinced they are achievable. Sales growth of 4 to 6% and earnings per share growth of 9 to11% are in line with our long-term track record. The momentum and initiatives underway give us the confidence to set and share these long-term projections.
BOB > This confidence is based on the abilities and enthusiasm of McCormick employees around the world, as well as the experience and motivation of the leadership team.
Throughout the Company, we have a deep culture of hard work and ethics that has endured significant changes to the business. Our Multiple Management philosophy lays the foundation by encouraging the participation and inclusion of all employees.
Im pleased that we have seamlessly transitioned to a new executive team. This team has the drive and knowledge to lead McCormick through its next generation of growth.
Alan > Our strategy for growth is to improve margins, invest in the business and grow sales and profits. Its a simple strategy, but one that is known and understood by our employees around the world. It has been behind our success in nearly tripling earnings per share and more than doubling the market capitalization of this Company in the past 10 years.
This strategy is both effective and sustainable, and it will guide us through McCormicks next period of growth.
A Journey with Bob Lawless
Bob Lawless retirement as Chief Executive Officer concluded a 30-year career as an active McCormick employee in which he brought a boundless energy to each goal he pursued. Over the past 11 years as President and CEO, he led the transformation of the Company solidifying its position as an industry leader and a global company on the move.
Bobs global travels gave him the opportunity to interact with thousands of McCormick employees worldwide. It was through such regular contact with the vast employee population that he communicated his passion to grow McCormick. The regular employee interaction also confirmed to him that measures to contemporize the business be made in harmony with the Shared Values and culture of this unique company. The results have been impressive.
He drove initiatives that brought the Companys commitment to innovation to new levels. Technologically, the Company made tremendous strides under Bobs leadership. His approach to acquisitions brought resounding success as companies purchased under Bobs tenure were assimilated seamlessly and brought the desired return. His support of building brands and serving customers on a global basis met with repeated success. As a result, recognition from industry groups and major customers was a regular occurrence during Bobs tenure.
And stockholders enjoyed the benefits of the Lawless years as well. Since 1996, the stock price has tripled and the quarterly dividend is now $0.22 up from $0.07 per share.
Bobs impact over the years went beyond the walls of McCormick. His spirit of community service inspired many McCormick employees to follow his lead and volunteer helping those less fortunate. McCormick has a tradition of charitable giving, and Bob was a committed steward of that legacy during his years as Company leader.
During Bob Lawless time with McCormick, he has lived the Companys Shared Values and leaves a lasting impact on the business. Bob, weve enjoyed The Journey. Thanks and best wishes from the entire McCormick family.
Since 1996, the stock price has tripled and the quarterly dividend is now $0.22 up from $0.07 per share.
MANAGEMENTS DISCUSSION AND ANALYSIS
The purpose of the Managements Discussion and Analysis (MD&A) is to provide an understanding of McCormicks business, financial results and financial condition.
The MD&A is organized as follows:
Page 15 Business Overview describes our global operations, strategy, growth initiatives and segments.
Page 18 Results of Operation compares the financial results for 2007 to 2006 and also compares financial results for 2006 to 2005.
Page 22 Liquidity and Financial Condition supplies information regarding our cash flow and financing.
Page 25 Acquisitions profiles a 2007 agreement to acquire the Lawrys business and our 2006 acquisition of Simply Asia Foods.
Page 26 Restructuring Activities reviews our three-year plan to improve margins.
Page 28 A graph showing Stock Price Performance, is followed by our assessment of Market Risk Sensitivity, our Contractual Obligations and Commercial Commitments, the impact of Recently Issued Accounting Pronouncements, our use of Critical Accounting Estimates and Assumptions, and our comments regarding Forward-Looking Information.
The information in the charts and tables in the MD&A are for the years ended November 30. All dollars are in millions, except per share data. Unless otherwise indicated, the results include the impact of our restructuring activities for all years presented.
McCormick is a global leader in the manufacture, marketing and distribution of spices, herbs, seasonings and other flavors to the entire food industry. Customers range from retail outlets and food service providers to food manufacturers. Founded in 1889 and built on a culture of Multiple Management, we have approximately 7,500 employees.
Our major sales, distribution and production facilities are located in North America and Europe. Additional facilities are based in Mexico, Central America, Australia, China, Singapore, Thailand and South Africa. In 2007, 41% of sales were outside the United States.
We operate in two business segments, consumer and industrial. Consistent with market conditions in each segment, our consumer business has a higher overall profit margin than our industrial business.
Across both segments, we have the customer base and product breadth to participate in all types of eating occasions, whether it is cooking at home, dining out, purchasing a quick service meal or enjoying a snack.
A Sustainable Strategy
Our strategy to improve margins, invest in our business and increase sales and profits has been behind our success over the past 10 years and is our plan for growth in the future.
During the past five years, this strategy has led to average annual sales growth of 7% with acquisitions driving approximately one quarter of the increase. Gross profit margin has risen from 39.1% in 2002 to 40.9% in 2007 and driven increases in operating income and net income.
We are increasing margins with cost-savings programs, new capabilities and improved processes. Our acquisition of high-margin brands and introduction of higher-margin, more value-added new products are also lifting margins. As we reduce the number of lower-margin products and customers, we are eliminating complexity and further boosting margins.
A portion of the cost savings associated with our actions is being used to fund product development and brand support. During the past five years, we have increased research and development expense 57%. In 2007, we spent $55 million in advertising to consumers, compared to $27 million in 2002. These are effective investments that are driving sales and profit growth at McCormick.
Key Growth Initiatives
Key initiatives underway to grow sales and profits include:
· A restructuring program to improve our global supply chain was announced in 2005 and will extend through 2008. This plan is reducing our complexity and creating an organization more focused on growth opportunities. We expect to reach up to $55 million in annual cost savings, ahead of our initial goal of $50 million.
· We are building consumer interest by revitalizing our consumer brands. Currently under way is the revitalization of McCormick brand spices and seasonings in the United States. Along with new packaging, we are installing new shelving systems in 12,000 to 14,000 stores to make shopping easier for the consumer and restocking easier for grocers. A similar effort is under way that is designed to drive growth of our Schwartz brand in the U.K. and the Ducros brand in France.
· As a leader in our industry, we watch the latest trends to direct our product development activity. Consumer demand for wellness, freshness, convenience, ethnic flavors and more, guide our new products. Innovation at McCormick extends to grinders and other new packaging, and to distribution, such as our penetration of the more frequently shopped street markets in China.
· Through acquisitions we are adding leading brands to extend our reach into new geographic regions where we currently have little or no distribution. We have a particular interest in emerging markets that offer high growth potential. In our developed markets, we are seeking brands that have a niche position and meet a growing consumer trend.
Our Financial Objectives
With good visibility into our business prospects and operating environment, we use growth objectives as internal goals and to provide a financial outlook for our shareholders. Upon completion in 2008 of our three-year restructuring program, we expect to grow sales annually by 4 to 6% and achieve an annual increase of 9 to 11% in earnings per share.
Our business generates strong cash flow. Actions to grow net income and improve working capital are designed to lead to higher levels of cash. We have paid dividends each year since 1925 and have increased the annual dividend in each of the last 21 years. In the future, we expect to increase dividends at a rate similar to the increase in earnings per share.
Additional cash is being used to fund strategic acquisitions and capital projects. A share repurchase program is lowering shares outstanding and improving value for McCormick shareholders.
During the past five years, 86% of cash from operations directly benefited shareholders in the form of dividends and share repurchases.
BUSINESS SEGMENTS AT A GLANCE
From locations around the world, our consumer brands reach nearly 100 countries.
RESULTS OF OPERATIONS 2007 COMPARED TO 2006
The increase in sales for 2007 was due to pricing actions taken to offset higher material cost, favorable product mix and higher volumes (including the 0.9% impact of Simply Asia Foods, acquired in June of 2006). Favorable foreign exchange rates added 2.9% for the year. The 2007 sales also reflect the impact of actions to eliminate low margin business, which lowered sales approximately 1%.
Gross profit margin in 2007 decreased 0.1 percentage point. Included in cost of goods sold were restructuring charges for production facilities that are being closed. These charges in 2007 were less than in 2006 and increased gross profit margin by 0.4 percentage point. Cost savings related to restructuring activity lowered cost of goods sold, adding nearly 1.0 percentage point to gross profit margin. Gross profit margin was unfavorably impacted by higher material costs in 2007 that were only partially offset by price increases. Production costs in certain facilities were also affected by incremental costs early in 2007 to maintain customer service during our facility consolidation.
Selling, general and administrative expenses were higher in 2007 than 2006 on a dollar basis but declined as a percentage of net sales. As a percentage of net sales, administrative expense decreased while distribution, selling, promotion, advertising and research and development in total were relatively unchanged. The decrease in administrative expense during 2007 was driven by the benefit of expense reductions from our restructuring program.
The following is a summary of restructuring activities:
Pre-tax restructuring charges for both 2007 and 2006 related to actions under our restructuring program to consolidate our global manufacturing, rationalize our distribution facilities, improve our go-to-market strategy and eliminate administrative redundancies. The gain on the sale of unconsolidated operations in 2006 is primarily for the redemption of our ownership investment in Signature Brands LLC (Signature). More details of the restructuring charges are discussed later in MD&A and in note 3 of the financial statements.
The increase in interest expense was due to higher average short-term borrowings and higher short-term interest rates in 2007 when compared to 2006. However, these effects were partially offset by the refinancing of higher interest rate long-term debt in 2006, which has reduced the average interest rate on our total debt in 2007 when compared to 2006.
The increase in other income was due to higher interest income.
The increase in the effective tax rate was due to a reduction in discrete tax benefits in 2007. The 2006 discrete items of $5.2 million included the favorable resolution of an international tax audit, a reduction of accruals recorded for state tax audits and additional tax benefit related to the closure of our operation in Finland. Income taxes in 2007
included $1.9 million for discrete tax benefits, primarily the result of new tax legislation enacted in The Netherlands, the UK and the U.S. We expect the tax rate in 2008 to be slightly higher than the 30.5% effective rate in 2007.
Income from unconsolidated operations and minority interest, combined, increased 21% in 2007 compared to 2006. This increase was driven primarily by the move from an unprofitable unconsolidated joint venture in Asia to a licensing agreement in the fourth quarter of 2006, as well as the performance of our joint venture in Mexico due to strong mayonnaise sales.
The following table outlines the major components of the change in diluted earnings per share from 2006 to 2007:
Favorable foreign exchange rates added 3.1% to consumer sales in 2007 compared to 2006. The remaining increase of 4.3% was driven by higher pricing, favorable product mix, the acquisition of Simply Asia Foods (acquired in June 2006) which added 1.5% to net sales and volume from brand revitalization, effective marketing programs and new products.
In the Americas, consumer business sales increased 5.6%. Together favorable foreign exchange rates and incremental sales from Simply Asia Foods added 2.6% to net sales. Pricing on certain items such as pepper and favorable product mix further increased sales. Higher volumes of Hispanic items, the expanded organic line, grinders and seafood items were offset by lower volumes on other items including pepper, warehouse club products and the discontinuance of certain underperforming products.
In Europe, consumer sales rose 11.4%, of which 9.1% was due to favorable foreign exchange rates. The remaining increase of 2.3% was due primarily to pricing actions and volume increases in the U.K. and France. During 2007, these increases were offset in part by the impact of a competitive situation in The Netherlands and our action to close our business in Finland which both occurred in 2006.
Sales in the Asia/Pacific region increased 12.1%, with 8.4% due to favorable foreign exchange rates. Sales in China grew at a double-digit rate due to expanded distribution and marketing support behind our core spice and seasoning products, along with increases in a number of condiments and sauces. Sales growth in China was offset in part by lower sales of our branded spices and herbs in Australia due to the move by a large retailer earlier in 2007 to introduce a private label line of spices and herbs.
The increase in operating income excluding restructuring activities was driven by strong sales performance and cost reduction efforts. When comparing operating income margin excluding restructuring activities, higher sales, pricing actions and cost savings from our restructuring program more than offset increases in raw materials and fuel.
The 7.3% sales increase was driven by higher pricing to reflect the increased costs of pepper as well as certain commodities including cheese, soybean oil and flour.
Favorable foreign exchange rates added 2.8% to sales, while actions to eliminate lower margin products decreased sales approximately 2%.
Sales in the Americas rose 1.9% with favorable foreign exchange rates adding 0.5%. In this region, customer and product rationalization reduced sales approximately 2%. The remaining increase was primarily due to price increases. During 2007 new products and other volume gains with sales to food manufacturers were offset by weakness in the restaurant industry.
In Europe, sales increased 20.1%, which included a favorable foreign exchange rate impact of 9.2%. In this region, customer and product rationalization reduced sales approximately 2%. The remaining increase of approximately 13% was mostly volume-related due to increases in snack seasonings and products sold to quick service restaurants.
In the Asia/Pacific region, sales increased 25.8% with 8.0% from foreign exchange rates. Rapid expansion of industrial business, especially in China with quick service restaurant customers, contributed to sales in this region.
Operating income excluding restructuring activities decreased in both dollar terms and in terms of margin. Higher material costs during the year more than offset the benefit of our 7.3% sales increase and the cost savings from our restructuring activities. At the end of 2007 and into early 2008, we took further pricing actions in response to higher costs.
RESULTS OF OPERATIONS 2006 COMPARED TO 2005
Key initiatives that drove sales in 2006 included higher volume driven by acquisitions, new products and effective marketing programs, as well as pricing actions taken early in the year. Sales from Simply Asia Foods, acquired in the third quarter of 2006, contributed 0.7% to the sales increase. Foreign exchange rates had an unfavorable effect on sales in the first half of 2006 and a favorable effect on reported sales in the second half of the year. On a full year basis, the sales effect of foreign exchange rates was slightly favorable.
The increase in margin was attributable to initiatives to reduce costs, pricing actions taken early in 2006 in response to the higher costs of certain materials, employee benefits and energy, as well as a more favorable product mix. Included in cost of goods sold were restructuring charges for production facilities that were being closed. These charges reduced gross profit margin in 2006 by 0.5%. Also, gross profit margin in 2005 was negatively impacted by higher costs of vanilla.
The increase in SG&A was primarily due to increased incentive compensation on higher earnings, as well as stock-based compensation and higher advertising costs. Stock-based compensation of $22.0 million, which accounted for a 0.8 percentage point increase as a percentage of net sales, was recorded in 2006 as a result of the adoption of Statement of Financial Accounting Standards (SFAS) 123(R) effective December 1, 2005 (see note 9 of the financial statements). Advertising expense increased by $12.7 million, adding another 0.5 percentage point increase to SG&A as a percentage of net sales, as we spent at a higher level to support our consumer brands.
The following is a summary of restructuring activities:
Pre-tax restructuring charges for both 2006 and 2005 related to actions under our restructuring plans to consolidate our global manufacturing, rationalize our distribution
facilities, improve our go-to-market strategy and eliminate administrative redundancies. The gain on the sale of unconsolidated operations in 2006 was primarily for the redemption of our ownership investment in Signature and, to a lesser extent, the exit of our consumer joint venture in Japan. More details of the restructuring charges are discussed later in MD&A and in note 3 of the financial statements.
Interest expense in 2006 increased $5.5 million. Higher interest rates on our variable rate debt during 2006 accounted for most of this increase. Average borrowings during the year increased slightly.
Other income increased to $7.1 million in 2006 compared to $0.4 million in 2005 due mostly to higher interest income.
The effective tax rate was 29.0% in 2006 down from 32.7% in 2005. This decrease was due to both the mix of earnings among the different tax jurisdictions in which we do business and several discrete tax benefits. The discrete items were the favorable resolution of an international tax audit for $3.5 million, a $1.0 million reduction of accruals recorded for state tax audits and a $0.6 million additional tax benefit related to the closure of our operation in Finland.
We participated in two separate joint ventures with the same joint venture partner, Hero A.G. We owned 50% of Signature and 51% of Dessert Products International, S.A.S. (DPI). Signature is a cake decorating business in the U.S. and DPI markets the Vahine® brand of dessert aids in France and other European countries.
In the second quarter of 2006 we received the remaining 49% share of DPI in redemption of our 50% ownership investment in Signature. Since this transaction happened early in the year, it resulted in a decrease in our income from unconsolidated operations but also decreased the negative impact of our minority interest reported in the income statement. Excluding these effects, the increase in unconsolidated income was mainly from our joint venture in Mexico where stronger mayonnaise sales and moderate soybean oil prices contributed to the improved performance of this joint venture.
The following table outlines the major components of the changes in diluted earnings per share from 2005 to 2006:
We began recording stock-based compensation expense in 2006. Total stock-based compensation expense recorded in the consumer business operating results was $13.9 million.
Higher volume, pricing actions and a favorable product mix added 5.3%, while foreign exchange rates had no effect on sales. This included sales from Simply Asia Foods, acquired in June 2006, which added 1.3% to sales.
In the Americas, consumer business sales increased 8.1%, with 1.9% of the sales increase attributable to the Simply Asia Foods acquisition and 0.6% from favorable foreign exchange. The majority of the increase was driven by higher volume from new product introductions and more effective marketing, as well as pricing actions in the U.S. taken early in 2006. In 2006, we grew sales of Hispanic products, GrillMates, lower sodium items and slow cooker seasonings, with new varieties and marketing support. Print advertisements helped drive sales of gourmet products and gravy items. A new program, across our entire line of products, encouraged consumers to replace out-of-date spices and herbs. During the fourth quarter of 2005 , demand for our McCormick and Zatarains consumer products in the Gulf region of the U.S. was lower due to the effects of Hurricane Katrina. This had a positive impact when 2006 is compared to 2005.
In Europe, sales declined 0.8%, with unfavorable foreign exchange rates reducing sales 1.5%. Lower distribution in The Netherlands and our decision to close our operations in Finland early in 2006 reduced sales. In the U.K., sales of Schwartz branded herbs and spices were strong, but were offset in part by weaker performance in dry seasoning mixes and some non-core wet products. In France, higher sales in 2006 were led by core spice and seasoning products.
Sales in the Asia/Pacific region increased 1.1%, including a decline of 0.5% due to unfavorable foreign exchange rates. The sales contribution from China was particularly strong in 2006, partially offset by a decline in Australia.
The decrease in operating income and operating income margin, excluding restructuring charges was driven by stock-based compensation expense, increased incentive compensation expense and increased advertising expense in 2006, partially offset by strong sales performance and cost reduction efforts.
We began recording stock-based compensation expense in 2006. Total stock-based compensation expense recorded in the industrial business operating results was $8.1 million.
Higher volumes related to new product introductions was the primary driver of the sales increase while favorable foreign exchange rates added 0.4%. As part of the global industrial strategy, certain low margin business was eliminated which reduced sales by approximately 1% in 2006.
Sales in the Americas rose 4.9% with favorable foreign exchange rates adding 0.7%. This increase reflects higher sales to strategic customers. Sales to food manufacturers led this increase with particular strength in snack seasonings and new flavors for beverages and other consumer products. We increased sales to both quick service and casual dining restaurants. Sales of our seasoning and coating systems for chicken were especially strong. We also benefited from higher volume and a price increase implemented earlier in 2006 for products sold to food service distributors. In this region, customer and product rationalization reduced sales approximately 1.0%.
In Europe, sales increased 4.1%, which was negatively impacted by an unfavorable foreign exchange rate impact of 1.3%. Some of the same types of products as in the Americas drove the increase in Europe, including snack seasonings and products to flavor chicken sold through the food service channel. In this region, customer and product rationalization reduced sales approximately 1.0%.
In the Asia/Pacific region, sales declined 2.4%, including a favorable foreign exchange rate effect which increased sales 1.3%. The main reason for this decline was the loss of certain low margin products in Australia, which began in the first quarter of 2006. In China, we continued to grow sales to both food service customers and food manufacturers.
The higher operating income and operating income margin, excluding restructuring activities, was driven by higher sales and gross profit margin, partially offset by stock-based compensation and higher incentive compensation accruals due to the higher profit level. Cost savings from our restructuring plan and a focus on strategic customers lifted margins in 2006. Also, the industrial business was negatively impacted in 2005 by several factors including extreme volatility in the vanilla market.
LIQUIDITY AND FINANCIAL CONDITION
We generate strong cash flow from operations which enables us to fund operating projects and investments that are designed to meet our growth objectives, make substantial share repurchases, increase our dividend and fund capital projects and restructuring costs.
In the cash flow statement, the changes in operating assets and liabilities are presented excluding the effects of changes in foreign currency exchange rates, as these do not reflect actual cash flows. Accordingly, the amounts in the cash flow statement do not agree with changes in the operating assets and liabilities that are presented in the balance sheet.
Operating Cash Flow When 2007 is compared to 2006, most of the decrease in operating cash flow was due to $30 million in increased payments made in 2007 for incentive compensation based upon 2006 operating results and $41 million in higher income tax payments made in 2007 when compared to 2006. Also impacting 2007 cash flow is a higher level of receivables in 2007 due to higher sales and the timing of sales within the year. When 2006 cash provided by operations is compared to 2005, the decrease was primarily the result of spending on restructuring of $55.9 million and lower dividends from unconsolidated operations, offset by higher operating income, exclusive of restructuring. In total, changes in operating assets and liabilities were comparable between 2006 and 2005. However, increases in inventories attributable to a build-up in anticipation of production transfer from facilities that will be closed, as well as increased purchases of certain raw materials, were offset by an increase in other accrued liabilities in 2006 as compared to 2005. The increase in other accrued liabilities was due to increased incentive compensation and restructuring charges.
Investing Cash Flow The reduction in investing cash flows in 2007 compared to 2006 is due to a decrease in cash used for acquisitions of businesses. Cash outflow for the acquisitions of businesses was primarily the purchase of Thai Kitchen in Europe in 2007, the Simply Asia Foods asset purchase in 2006 and a small business purchase in France in 2005 (see note 2 of the financial statements). Also, included in 2006 was $9.2 million in net proceeds from the redemption of a joint venture (see note 3 of the financial statements). Net capital expenditures (capital expenditures less proceeds from the sale of fixed assets) were $76.9 million in 2007, $78.7 million in 2006 and $64.5 million in 2005. The increase in net capital expenditures for 2007 and 2006 compared to 2005 is mainly due to increased spending under our restructuring program. We expect 2008 net capital expenditures to be slightly in excess of depreciation and amortization.
Financing Cash Flow We increased our total borrowings $65.5 million in 2007 compared to an increase of $77.2 million in 2006 and a decrease of $67.6 million in 2005. The main cause of the increase in 2007 was to fund our share repurchase program. The increase in 2006 was to fund the Simply Asia Foods asset purchase for $97.6 million. In 2006, we issued $100 million of 5.80% senior notes due 2011. Net interest payments are payable semi-annually in arrears in January and July of each year. Also, in 2006, we issued $200 million of 5.20% senior notes due 2015. Net interest payments are payable semi-annually in arrears in June and December of each year. The net proceeds from the $200 million offering were used to pay down $195 million of long-term debt which matured in 2006. In 2005, we paid off $30 million of medium-term notes at maturity.
The following table outlines the activity in our share repurchase programs:
Net share repurchases are net of proceeds from exercised stock options. Net capital expenditures are net of proceeds from the sale of fixed assets.
In the fourth quarter of 2005, we completed our $300 million share repurchase authorization and began to buy against our $400 million authorization approved by the Board of Directors in June 2005. As of November 30, 2007, $49 million remained under the $400 million share repurchase program. The pace of share repurchases in 2008 will be moderated in anticipation of the Lawrys acquisition (see note 2 of the financial statements). The common stock issued in 2007, 2006 and 2005 relates to our stock compensation plans.
Our dividend history over the last three years is as follows:
In November 2007, the Board of Directors approved a 10.0% increase in the quarterly dividend from $0.20 to $0.22 per share. During the last five years, dividends per share have risen at a compound annual rate of 14.9%.
Cash payments to pension plans, including unfunded plans, were $41.6 million in 2007, $41.2 million in 2006 and $32.8 million in 2005. During 2007, our primary U.S. defined benefit pension plan moved from underfunded to overfunded status driven by good return on plan assets, a change in the liability due to the impact of a higher discount rate and a cash contribution of $22.0 million. Because of the current overfunded status of this pension plan as of November 30, 2007, it is likely that the 2008 pension plan contributions will be significantly less than in 2007. Future increases or decreases in pension liabilities and required cash contributions are highly dependent on changes in interest rates and the actual return on plan assets. We base our investment of plan assets, in part, on the duration of each plans liabilities. Across all plans, approximately 62% of assets are invested in equities, 32% in fixed income investments and 6% in other investments.
The decrease in our debt-to-total-capital ratio in 2007 (total capital includes debt, minority interest and shareholders equity) was the result of a significant increase in shareholders equity of $151.8 million, partially offset by an increase in our total debt. A large increase in equity was due to the effect of foreign currency translation adjustments and the increase in debt was due to funding our share repurchase program. During the year, the level of our short-term debt varies and it is usually lower at the end of the year. The average short-term borrowings outstanding for the year ended November 30, 2007 and 2006 were $369.4 million and $271.9 million, respectively.
The reported values of our assets and liabilities held in our non-U.S. subsidiaries and affiliates have been significantly affected by fluctuations in foreign exchange rates between periods. During the year ended November 30, 2007, the exchange rates for the Euro, British pound sterling and Canadian dollar were substantially higher versus the U.S. dollar than in 2006. Exchange rate fluctuations resulted in an increase in accounts receivable of $23 million, inventory of $15 million, goodwill of $61 million and other comprehensive income of $123 million since November 30, 2006.
In August 2007, we entered into $150 million of forward treasury lock agreements to manage the interest rate risk associated with the forecasted issuance of $250 million of fixed rate medium-term notes issued subsequent to our 2007 fiscal year-end. We cash settled these treasury lock agreements for a loss of $10.5 million simultaneous with the issuance of the medium-term notes and effectively fixed the interest rate on the $250 million notes at a weighted average fixed rate of 6.25%. We had designated these outstanding forward treasury lock agreements, which were terminated on December 4, 2007, as cash flow hedges. The loss on these agreements will be deferred in other comprehensive income and will be amortized over the 10-year life of the medium-term notes as a component of interest expense. Hedge ineffectiveness of these agreements was not material in 2007. A portion of the proceeds of this $250 million debt issuance will be used to repay $150 million of notes maturing in 2008.
In March 2006, we entered into interest rate swap contracts for a total notional amount of $100 million to receive interest at 5.20% and pay a variable rate of interest based on three-month LIBOR minus .05%. We designated these swaps, which expire on December 15, 2015, as fair value hedges of the changes in fair value of $100 million of the $200 million 5.20% medium-term notes due 2015 that we issued in December 2005. As of November 30, 2007, the fair value of these swap contracts was an unrealized gain of $4.9 million, which was offset by a corresponding increase in value of the hedged debt. Any unrealized gain or loss on these swaps will be offset by a corresponding increase or decrease in value of the hedged debt. No hedge ineffectiveness was recognized as these interest rate swaps qualify for the shortcut treatment.
We have available credit facilities with domestic and foreign banks for various purposes. In July 2007, we entered into a $500 million five-year revolving credit agreement with various domestic banks for general business purposes. Our current pricing under the new credit agreement, on a fully drawn basis, is LIBOR plus 0.25%. The agreement, which replaces a previously existing $400 million revolving credit agreement, expires in July 2012, and supports our commercial paper borrowing arrangement. The amount of unused credit facilities at November 30, 2007 was $605.8 million. We believe that internally generated funds and the existing sources of liquidity under our credit facilities are sufficient to meet current liquidity needs and fund ongoing operations.
In November 2007, we entered into a definitive agreement to purchase the assets of Lawrys for $605 million in cash. Upon the closing of this transaction (expected in the second half of fiscal year 2008), we will finance this purchase through cash from operations, bank lines and commercial paper borrowings. Additional bank facilities are being negotiated and we anticipate no difficulties in obtaining financing. Post-closing, an appropriate longer-term capital structure will be put in place.
Acquisitions of new brands are part of our strategy to improve margins and increase sales and profits.
On November 13, 2007, we signed a definitive agreement with Unilever to purchase the assets of the Lawrys business for $605 million in cash. The transaction is expected to close in 2008. Lawrys manufactures and sells a variety of marinades and seasoning blends under the well-known Lawrys® and Adolphs® brands. The acquisition includes the rights to the brands as well as related inventory and a small number of dedicated production lines. It does not include any manufacturing facilities or employees. The closing of the Lawrys acquisition is subject to the expiration or termination of the Hart-Scott-Rodino (HSR) waiting period and other customary closing conditions. We have agreed to pay Unilever a $30 million termination fee, subject to certain limited conditions, in the event that HSR clearance is not obtained.
On June 27, 2006, we purchased the assets of the Simply Asia Foods business for $97.6 million in cash. The $97.6 million purchase price was initially funded with commercial paper. In July 2006, we issued $100 million of 5.80% senior notes due 2011 to pay down this commercial paper debt. This business operates in North America and has been included in our consumer segment since the date of acquisition. Simply Asia Foods develops, imports and markets a line of authentic, easy-to-prepare Asian products under the Thai Kitchen® and Simply Asia® brands. Its primary products include noodle and soup bowls, meal kits, coconut milk, and various sauces and pastes. In 2007, we completed the final valuation of assets for Simply Asia Foods which resulted in $4.8 million being allocated to tangible net assets, $28.2 million allocated to other intangibles assets and $64.6 million allocated to goodwill. This valuation was not significantly different than the preliminary valuation. The value for brands and other intangible assets consists of $12.1 million which is amortizable and $16.1 million which is non-amortizable.
On July 30, 2007, we purchased Thai Kitchen SA for $12.8 million in cash, a business which operates the Thai Kitchen brand in Europe. This acquisition complements our U.S. purchase of Simply Asia Foods in 2006. The annual sales are approximately $7 million.
On August 1, 2006, we invested $5.0 million in an industrial joint venture in South Africa.
As part of our plan to improve margins, we announced in September 2005 significant actions to improve the effectiveness of our supply chain and reduce costs. At that time, we also stated that a comprehensive review of our global industrial business was under way to identify improvements. These actions were included in the comprehensive restructuring plan which the Board of Directors approved in November 2005. As part of this plan, over a three-year period, we are consolidating our global manufacturing, rationalizing our distribution facilities, improving our go-to-market strategy, eliminating administrative redundancies and rationalizing our joint venture partnerships. In addition, for the industrial business, we are reallocating resources to key customers and taking pricing actions on lower volume products to meet new margin targets. Through 2008, these actions are intended to reduce the number of industrial business customers and products in the U.S. by approximately 25%. Sales related to these customers and products represented approximately 2 to 5% of industrial business sales in the U.S. As these sales had minimal profit, this reduction is expected to lead to higher margins. These reductions also led to the consolidation of certain manufacturing facilities.
The restructuring plan is reducing complexity and increasing the organizational focus on growth opportunities in both the consumer and industrial businesses. We are projecting up to $55 million ($37 million after-tax) of annual cost savings by the end of 2008. In 2006, we realized $10 million ($7 million after-tax) of savings and another $35 million ($24 million after-tax) in 2007. This has improved margins and increased earnings per share, offset higher costs, as well as allowed us to invest a portion of these savings in sales growth drivers such as brand advertising. These savings are reflected in both cost of goods sold and selling, general and administrative expenses in the income statement.
Total pre-tax charges under this restructuring plan are estimated to be $115 to $125 million with approximately 65% related to the consumer segment and 35% related to the industrial segment. Of these charges, we expect that $85 to $90 million will consist of severance and other personnel costs and $50 to $55 million of other exit costs. Asset write-offs are expected to be $10 to $15 million, exclusive of the $34 million gain on our redemption of Signature in 2006.
Restructuring charges to date include $10.7 million recorded in 2005, $50.1 million recorded during 2006 (including the gain on Signature) and $34.8 million recorded in 2007. For the total plan, the cash related portion of the charges will be $95 to $105 million, with total cash spent to date of $83.3 million, after offsetting the $9.2 million in net cash received from the redemption of Signature. This program is expected to be completed by the end of fiscal year 2008.
We are funding this spending through internally generated funds. A significant portion of the cash expenditures are for employee severance. The actions being taken pursuant to the restructuring plan are expected to eliminate 1,200 positions over the three-year period. Of the expected global workforce reduction, 1,015 positions have been eliminated as of November 30, 2007.
Joint Venture Transactions Previously, we participated in two separate joint ventures with the same joint venture partner, Hero A.G. We owned 50% of Signature and 51% of DPI. In 2006, we received the remaining 49% share of DPI in redemption of our 50% ownership investment in Signature. In addition, we received $9.2 million in cash with this transaction.
In recording this transaction, we valued both the investment received and the investment given at their fair value. On the disposition of our Signature investment, the fair value of our investment was $56.0 million as compared to our book value of this unconsolidated subsidiary of $21.7 million. After consideration of transaction costs of $0.6 million
We expect to reach up to $55 million in annual savings in 2008, ahead of our $50 million goal.
and taxes of $7.2 million, we recorded a net after-tax gain of $26.5 million which is shown on the line entitled (Loss) gain on sale of unconsolidated operations in our income statement. On the acquisition of the 49% minority interest of DPI, the fair value of these shares was assessed at $46.9 million. Since this business was consolidated, the book value of this 49% share was shown as $29.9 million of minority interest on our balance sheet. After consideration of transaction costs of $0.7 million, we allocated $17.7 million to goodwill. The impact of increasing our share in DPI and disposing of Signature on future net income is not material.
In 2006, in connection with exiting an unconsolidated joint venture in Japan, we recorded a net gain of $0.3 million, after- tax. Finalization of these unconsolidated joint venture transactions resulted in a loss of $0.8 million, after tax, in 2007.
These actions are part of our plan to simplify our joint venture structure under the restructuring program and focus on those areas we believe have strong growth potential.
Other Restructuring Costs In 2007, we recorded restructuring charges of $34.0 million, of which $30.7 million is reflected in restructuring charges and $3.3 million is reflected in cost of goods sold in our income statement. We recorded $14.9 million of severance costs, primarily associated with the reduction of administrative personnel in the U.S. and Europe. In addition, we recorded $16.7 million of other exit costs resulting from the closure of manufacturing facilities in Salinas, California and Hunt Valley, Maryland and the consolidation of production facilities in Europe. The remaining $2.4 million of asset write-downs is comprised of inventory write-offs as a result of the closure of the manufacturing facilities in Salinas, California and Hunt Valley, Maryland and accelerated depreciation of assets, mostly offset by the asset gain from the sale of our manufacturing facility in Paisley, Scotland.
In 2006, we recorded restructuring charges, exclusive of the gain on Signature, of $84.1 million, of which $72.4 million is reflected in restructuring charges and $11.7 million is reflected in cost of goods sold in our income statement. We recorded $54.9 million of severance costs and special early retirement benefits associated with our voluntary separation program in several functions in the U.S.; closures of manufacturing facilities in Salinas, California; Hunt Valley, Maryland; Sydney, Australia; Paisley, Scotland; and Kerava, Finland; and reorganization of administrative functions in Europe. In addition, we recorded $15.7 million of other exit costs associated with the consolidation of production facilities and the reorganization of the sales and distribution networks in the U.S. and Europe and contract termination costs associated with customers and distributors in connection with the closure of the business in Finland. The $13.5 million of restructuring charges for asset write-downs is primarily accelerated depreciation related to the closure of manufacturing facilities in Salinas, California and Hunt Valley, Maryland, the closure of the plants in Paisley, Scotland and Kerava, Finland and inventory write-offs as a result of the plant closings. These expenses were partially offset by net gains on the disposition of assets.
In 2005, we recorded $10.7 million of charges as a result of actions taken under the restructuring plan. These charges included certain severance costs associated with the closing of our consumer manufacturing plant in Salinas, California, closing costs for a small plant in Belgium and costs associated with the reorganization of the sales and distribution networks in the U.S. and Europe.
In our income statement, restructuring charges under this program are displayed in three line items. The gain related to our disposition of Signature and a joint venture in Japan as described under joint venture transactions is on the line entitled (Loss) gain on sale of unconsolidated operations. Other restructuring costs are included in restructuring charges and cost of goods sold.
The business segment components of the restructuring charges recorded in 2007, 2006 and 2005 are as follows:
The restructuring charges recorded in the consumer business include severance costs and special early retirement benefits associated with our voluntary separation program in several functions in the U.S. and Europe; consolidation of certain manufacturing facilities in Europe; and closures of manufacturing facilities in Salinas, California, Sydney, Australia, and Kerava, Finland.
The restructuring charges recorded in the industrial business include severance costs and special early retirement benefits associated with our voluntary separation program in several functions in the U.S. and Europe; closures of manufacturing facilities in Hunt Valley, Maryland, and Paisley, Scotland (offset by the asset gain) including other exit and inventory write-off costs and accelerated depreciation of assets.
During the year ended November 30, 2005, we recorded restructuring charges of $0.5 million in connection with a previous restructuring plan.
PERFORMANCE GRAPH SHAREHOLDER RETURN
Set forth below is a line graph comparing the yearly change in McCormicks cumulative total shareholder return (stock price appreciation plus reinvestment of dividends) on McCormicks Common Stock with (1) the cumulative total return of the Standard & Poors 500 Stock Price Index, assuming reinvestment of dividends, and (2) the cumulative total return of the Standard & Poors Packaged Foods & Meats Index, assuming reinvestment of dividends.
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN*
Among McCormick & Co., Inc., the S&P 500 Stock Price Index and the S&P Packaged Foods & Meats Index
*The graph assumes that $100 was invested on November 30, 2002 in McCormick Common Stock, the Standard & Poors 500 Stock Price Index and the Standard & Poors Packaged Foods & Meats Index, and that all dividends were reinvested through November 30, 2007.
MARKET RISK SENSITIVITY
We utilize derivative financial instruments to enhance our ability to manage risk, including foreign exchange and interest rate exposures, which exist as part of our ongoing business operations. We do not enter into contracts for trading purposes, nor are we a party to any leveraged derivative instrument. The use of derivative financial instruments is monitored through regular communication with senior management and the utilization of written guidelines. The information presented below should be read in conjunction with notes 6 and 7 of the financial statements.
Foreign Exchange Risk We are exposed to fluctuations in foreign currency in the following main areas: cash flows related to raw material purchases; the translation of foreign currency earnings to U.S. dollars; the value of foreign currency investments in subsidiaries and unconsolidated affiliates and cash flows related to repatriation of these investments. Primary exposures include the U.S. dollar versus the Euro, British pound sterling, Australian dollar, Canadian dollar, Mexican peso, Chinese renminbi and Thai baht. We routinely enter into foreign currency exchange contracts to facilitate managing foreign currency risk.
During 2007, the foreign currency translation component in other comprehensive income was principally related to the impact of exchange rate fluctuations on our net investments in France, the U.K., Canada and Australia. We did not hedge our net investments in subsidiaries and unconsolidated affiliates.
The following table summarizes the foreign currency exchange contracts held at November 30, 2007. All contracts are valued in U.S. dollars using year-end 2007 exchange rates and have been designated as hedges of foreign currency transactional exposures, firm commitments or anticipated transactions, all with a maturity period of less than one year.
FOREIGN CURRENCY EXCHANGE CONTRACTS AT NOVEMBER 30, 2007
We have a number of smaller contracts with an aggregate notional value of $7.0 million to purchase or sell various other currencies, such as the Australian dollar and the Japanese yen as of November 30, 2007. The aggregate fair value of these contracts was $(0.1) million at November 30, 2007.
At November 30, 2006, we had foreign currency exchange contracts for the Euro, British pound sterling, Canadian dollar, Australian dollar, Japanese yen and Singapore dollar with a notional value of $47.9 million, all of which matured in 2006. The aggregate fair value of these contracts was $(0.2) million at November 30, 2006.
Contracts with durations which are less than 5 days and used for short-term cash flow funding are not included in the notes or table above.
Interest Rate Risk Our policy is to manage interest rate risk by entering into both fixed and variable rate debt arrangements. We also use interest rate swaps to minimize worldwide financing costs and to achieve a desired mix of fixed and variable rate debt. The table that follows provides principal cash flows and related interest rates, excluding the effect of interest rate swaps and the amortization of any discounts or fees, by fiscal year of maturity at November 30, 2007 and 2006. For foreign currency-denominated debt, the information is presented in U.S. dollar equivalents. Variable interest rates are based on the weighted-average rates of the portfolio at the end of the year presented.
YEAR OF MATURITY AT NOVEMBER 30, 2007
YEAR OF MATURITY AT NOVEMBER 30, 2006
The table above displays the debt by the terms of the original debt instrument without consideration of interest rate swaps and any loan discounts or origination fees. Interest rate swaps have the following effects. The variable interest rate on $75 million of commercial paper is hedged by interest rate swaps through 2011. Net interest payments on the $75 million will be fixed at 6.35% during this period. Interest rate swaps, settled upon the issuance of the medium-term notes maturing in 2008, effectively fixed the interest rate on $150 million of notes at a weighted-average fixed rate of 7.71%. The fixed interest rate on $50 million of 3.35% medium-term notes due in 2009 is effectively converted to a variable rate by interest rate swaps through 2009. Net interest payments are based on LIBOR minus 0.21% during this period. The fixed interest rate on $100 million of the 5.20% medium-term note due in 2015 is effectively converted to a variable rate by interest rate swaps through 2015. Net interest payments are based on LIBOR minus 0.05% during this period.
In December 2007 we issued $250 million of 5.75% medium-term notes due in 2017. Forward treasury lock agreements, of $150 million, settled upon the issuance of these medium-term notes, effectively fixed the interest rate on the full $250 million of notes at a weighted-average fixed rate of 6.25%. A portion of the net proceeds of these medium-term notes will be used to pay down $150 million of current maturity of long-term debt maturing in 2008. As a result, the current portion of medium-term notes maturing in 2008 were classified in the Thereafter totals in the table above to reflect the 2017 maturity date of the new issuance. On a pro forma basis, after giving consideration to the issuance of the $250 million of medium-term notes and the repayment of the $150 million of medium-term notes, the Thereafter totals for 2007 would be $505.0 million of fixed rate debt at an average interest rate of 5.77%.
Commodity Risk We Purchase certain raw materials which are subject to price volatility caused by weather, market conditions, growing and harvesting conditions, governmental actions and other factors beyond our control. Our most significant raw materials are cheese, pepper, soybean oil, wheat, sweeteners, garlic, capsicums and onion. While future movements of raw material costs are uncertain, we respond to this volatility in a number of ways, including strategic raw material purchases, purchases of raw material for future delivery and customer price adjustments. We have not used derivatives to manage the volatility related to this risk.
Credit Risk The customers of our consumer business are predominantly food retailers and food wholesalers. Consolidations in these industries have created larger customers, some of which are highly leveraged. In addition, competition has increased with the growth in alternative channels including mass merchandisers, dollar stores, warehouse clubs and discount chains. This has caused some customers to be less profitable and increased our exposure to credit risk. We continually evaluate and monitor our credit exposure to our customers and believe that the risks have been adequately provided for in our bad debt allowance.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table reflects a summary of our contractual obligations and commercial commitments as of November 30, 2007:
CONTRACTUAL CASH OBLIGATIONS DUE BY YEAR
(a) Includes $150 million of debt due in less than 1 year in the More than 5 years category based on our ability and intent to refinance this amount for this term.
(b) Raw material purchase obligations outstanding as of year-end may not be indicative of outstanding obligations throughout the year due to our response to varying raw material cycles.
(c) Other purchase obligations primarily consist of advertising media commitments.
In 2008, our pension and postretirement funding is expected to be approximately $22 million. Pension and postretirement funding can vary significantly each year due to changes in legislation and our significant assumptions. As a result, we have not presented pension and postretirement funding in the table above.
COMMERCIAL COMMITMENTS EXPIRATION BY YEAR
OFF-BALANCE SHEET ARRANGEMENTS
We had no off-balance sheet arrangements as of November 30, 2007 and 2006.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 160, Noncontrolling Interests in Consolidated Financial Statements This standard outlines the accounting and reporting for ownership interest in a subsidiary held by parties other than the parent. SFAS No. 160 is effective for our our first quarter of 2010. We have not yet determined the impact from adoption of this new accounting pronouncement on our financial statements.
In December 2007, the FASB issued SFAS No. 141R, Business Combinations. This standard establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. This statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS No.141R is effective for us for acquisitions made after November 30, 2009. We have not yet determined the impact from adoption of this new accounting pronouncement on our financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans. This standard requires us to (a) record an asset or a liability on our balance sheet for our pension plans overfunded or underfunded status (b) record any changes in the funded status of our pension and postretirement plans in the year in which the changes occur (reported in comprehensive income) and (c) measure our pension and postretirement assets and liabilities at November 30 versus our current measurement date of September 30. The requirements to record the funded status and provide additional disclosures are effective this year and are further disclosed in note 8 of the financial statements. Changes in funded status will be recorded beginning in 2008. The requirement to change our measurement date will be effective beginning with our year ending November 30, 2009. The impact of measuring the funded status as of November 30 will be dependent upon interest rates, market performance and other factors at the measurement date and therefore cannot be determined.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This standard defines fair value and provides guidance for measuring fair value and the necessary disclosures. This standard does not require any new fair value measurements but rather applies to all other accounting pronouncements that require or permit fair value measurements. In December 2007, the FASB proposed a one-year deferral for non-financial assets and liabilities to comply with SFAS No. 157. If adopted as proposed, SFAS No. 157 will be effective for our first quarter ending February 29, 2008 for all financial assets and liabilities and effective for non-financial assets and liabilities for our first quarter ending February 28, 2009. We do not expect any material impact from initial adoption of this new accounting pronouncement on our financial statements for our first quarter ending February 29, 2008. We have not yet determined the impact on our financial statements from adoption of SFAS No.157 as it pertains to non-financial assets and liabilities for our first quarter ending February 28, 2009.
In June 2006, the FASB issued Interpretation 48 (FIN 48), Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for income taxes when it is uncertain how an income or expense item should be treated on an income tax return. FIN 48 describes when and in what amounts an uncertain tax item should be recorded in the financial statements, provides guidance on recording interest and penalties and provides guidance on accounting and reporting for income taxes in interim periods. FIN 48 is effective for our first quarter ending February 29, 2008. Based on our estimates we anticipate that we will record a charge to retained earnings for uncertain tax positions in the range of $7 to $12 million upon adoption of FIN 48.
CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS
In preparing the financial statements in accordance with United States generally accepted accounting principles (GAAP), we are required to make estimates and assumptions that have an impact on the assets, liabilities, revenue and expense amounts reported. These estimates can also affect supplemental information disclosed by us, including information about contingencies, risk and financial condition. We believe, given current facts and circumstances, our estimates and assumptions are reasonable, adhere to GAAP and are consistently applied. Inherent in the nature of an estimate or assumption is the fact that actual results may differ from estimates, and estimates may vary as new facts and circumstances arise. In preparing the financial statements, we make routine estimates and judgments in determining the net realizable value of accounts receivable, inventory, fixed assets and prepaid allowances. We believe our most critical accounting estimates and assumptions are in the following areas:
In several of our major markets, the consumer business sells our products by entering into annual or multi-year contracts with our customers. These contracts include provisions for items such as sales discounts, marketing allowances and performance incentives. The discounts, allowances and incentives are expensed based on certain estimated criteria such as sales volume of indirect customers, customers reaching anticipated volume thresholds and marketing spending. We routinely review these criteria and make adjustments as facts and circumstances change.
Goodwill and Intangible Asset Valuation
We review the carrying value of goodwill and non-amortizable intangible assets and conduct tests of impairment on an annual basis as described below. We will also test for impairment if events or circumstances indicate that it is more likely than not that the fair value of a reporting unit or the non-amortizable intangible asset is below its carrying amount.
We have concluded that our reporting units are the same as our business segments utilizing the guidance under SFAS No.142. We calculate fair value by using a discounted cash flow model of a reporting unit and then compare that to the carrying amount of the reporting unit, including intangible assets and goodwill. An impairment charge would be recognized to the extent the carrying amount exceeds the estimated fair value. As of November 30, 2007, we have $879.5 million of goodwill recorded in our balance sheet. Our testing indicates that the current fair values of our reporting units are significantly in excess of carrying values and accordingly management believes that only significant changes in the cash flow assumptions would result in an impairment of goodwill.
Non-Amortizable Intangible Asset Impairment
Our non-amortizable intangible assets consist of brand names and trademarks. We calculate fair value by using a discounted cash flow model or royalty savings method and then compare that to the carrying amount of the non-amortizable intangible asset. As of November 30, 2007, we have $177.7 million of brand name assets and trademarks recorded in our balance sheet and none of the balances exceed their estimated fair values. We intend to continue to support our brand names. The fair value of non-amortizable intangible assets are sensitive to the assumption of future sales derived from the intangible asset and changes in discount rates used in the cash flow model.
We estimate income taxes and file tax returns in each of the taxing jurisdictions in which we operate and are required to file a tax return. At the end of each year, an estimate for income taxes is recorded in the financial statements. Tax returns are generally filed in the third or fourth quarter of the subsequent year. A reconciliation of the estimate to the final tax return is done at that time which will result in changes to the original estimate. We
are subject to tax audits in each of the jurisdictions, which could result in changes to the taxes previously estimated. The amount of these changes could vary by jurisdiction and are recorded when they are probable and estimable. Income tax expense for 2007 includes $1.5 million of adjustments from prior year estimates to actual filings or tax audits. Management has recorded valuation allowances to reduce our deferred tax assets to the amount that is more likely than not to be realized. In doing so, management has considered future taxable income and on-going tax planning strategies in assessing the need for a valuation allowance.
Pension and Postretirement Benefits
Pension and other postretirement plans costs require the use of assumptions for discount rates, investment returns, projected salary increases, mortality rates and health care cost trend rates. The actuarial assumptions used in our pension and postretirement benefit reporting are reviewed annually and compared with external benchmarks to ensure that they appropriately account for our future pension and postretirement benefit obligations. While we believe that the assumptions used are appropriate, differences between assumed and actual experience may affect our operating results. A 1% change in the actuarial assumption for the discount rate would impact pension and postretirement benefit expense by approximately $13 million. A 1% change in the expected return on plan assets would impact pension expense by approximately $5 million. In addition, see the preceding sections of MD&A and note 8 of the financial statements for a discussion of these assumptions and the effects on the financial statements.
In the first quarter of 2006, we adopted SFAS No. 123(R), Share-Based Payment. This statement required us to expense the fair value of grants of various stock-based compensation programs over the vesting period of the awards. We estimate the fair value of our stock-based compensation using fair value pricing models which require the use of significant assumptions for expected volatility of stock, life of options, dividend yield and risk-free interest rate. The significant assumptions used are disclosed in note 9 of the financial statements.
Certain statements contained in this report, including those related to the expected results of operations of businesses acquired by us, the expected impact of the prices of raw materials on our results of operations and gross margins, the expected margin improvements, expected trends in net sales and earnings performance and other financial measures, annualized savings and other benefits from our streamlining and restructuring activities, the holding period and market risks associated with financial instruments, the impact of foreign exchange fluctuations, the adequacy of internally generated funds and existing sources of liquidity, such as our ability to issue additional debt or equity securities, and our expectations regarding purchasing shares of our common stock under the existing authorizations are forward-looking statements within the meaning of Section 21(E) of the Securities Exchange Act of 1934. Forward-looking statements are based on managements current views and assumptions and involve risks and uncertainties that could significantly affect expected results. Operating results may be materially affected by external factors such as: competitive conditions, customer relationships and financial condition, availability and cost of raw and packaging materials, governmental actions and political events, and economic conditions, including fluctuations in interest and foreign currency exchange rates. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
BOARD OF DIRECTORS
*Denotes committee chairman
McCormicks mission is to enhance shareholder value. McCormick employees conduct business under the leadership of the Chief Executive Officer and the oversight and direction of the Board of Directors. Both management and the Board of Directors believe that the creation of long-term shareholder value requires us to conduct our business honestly and ethically and in accordance with applicable laws. We also believe that shareholder value is well served if the interests of our employees, customers, suppliers, consumers, and the communities in which we live, are appropriately addressed.
McCormicks success is grounded in its value system as evidenced by our core values.
We are open and honest in business dealings inside and outside McCormick. We are dependable and truthful and keep our promises.
Our employees and our Board of Directors are committed to growing our business in accordance with our governance structure, principles and code of ethics.
REPORT OF MANAGEMENT
We are responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report. The consolidated financial statements were prepared in conformity with United States generally accepted accounting principles and include amounts based on managements estimates and judgments. All other financial information in this report has been presented on a basis consistent with the information included in the financial statements.
We are also responsible for establishing and maintaining adequate internal control over financial reporting. We maintain a system of internal control that is designed to provide reasonable assurance as to the fair and reliable preparation and presentation of the consolidated financial statements, as well as to safeguard assets from unauthorized use or disposition.
Our control environment is the foundation for our system of internal control over financial reporting and is embodied in our Business Ethics Policy. It sets the tone of our organization and includes factors such as integrity and ethical values. Our internal control over financial reporting is supported by formal policies and procedures which are reviewed, modified and improved as changes occur in business conditions and operations.
The Audit Committee of the Board of Directors, which is composed solely of independent directors, meets periodically with members of management, the internal auditors and the independent auditors to review and discuss internal control over financial reporting and accounting and financial reporting matters. The independent auditors and internal auditors report to the Audit Committee and accordingly have full and free access to the Audit Committee at any time.
We conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Although there are inherent limitations in the effectiveness of any system of internal control over financial reporting, based on our evaluation, we have concluded with reasonable assurance that our internal control over financial reporting was effective as of November 30, 2007.
Our internal control over financial reporting as of November 30, 2007 has been audited by Ernst &Young LLP.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Internal Control Over Financial Reporting
The Board of Directors and Shareholders of McCormick & Company, Incorporated
We have audited McCormick& Company, Incorporateds internal control over financial reporting as of November 30, 2007, based on the criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). McCormick & Company, Incorporateds management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, McCormick & Company, Incorporated maintained, in all material respects, effective internal control over financial reporting as of November 30, 2007 based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of McCormick & Company, Incorporated and subsidiaries as of November 30, 2007 and 2006 and the related consolidated income statement, statement of changes in shareholders equity and cash flow statement for each of the three years in the period ended November 30, 2007, and our report dated January 22, 2008 expressed an unqualified opinion thereon.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Consolidated Financial Statements
The Board of Directors and Shareholders of McCormick & Company, Incorporated
We have audited the accompanying consolidated balance sheet of McCormick & Company, Incorporated and subsidiaries as of November 30, 2007 and 2006, and the related consolidated income statement, statement of changes in shareholders equity, and cash flow statement for each of the three years in the period ended November 30, 2007. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of McCormick & Company, Incorporated and subsidiaries at November 30, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended November 30, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in note 8 of the notes to consolidated financial statements, the Company changed its method of accounting for defined benefit post retirement plans upon adoption of the recognition and related disclosure provisions of Statement of Financial Accounting Standards No.158, Employers Accounting for Defined Benefit Pension and Other Post Retirement Plans on November 30, 2007.
As discussed in note 9 of the notes to consolidated financial statements, the Company changed the manner in which it accounts for stock-based compensation upon adoption of Statement of Financial Accounting Standards No.123(R), Share-Based Payment on December 1, 2005.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), McCormick & Company, Incorporated and subsidiaries internal control over financial reporting as of November 30, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated January 22, 2008 expressed an unqualified opinion thereon.
CONSOLIDATED INCOME STATEMENT
See Notes to Consolidated Financial Statements, pages 43-59.
CONSOLIDATED BALANCE SHEET