Earnings Call Transcript - MKC Q3 2021

Operator, Operator

Good morning. This is Kasey Jenkins, Vice President of McCormick Investor Relations. Thank you for joining today’s Third Quarter Earnings Call. To accompany this call, we posted a set of slides at ir.mccormick.com. We will begin with remarks from Lawrence Kurzius, Chairman, President and CEO; and Mike Smith, Executive Vice President and CFO, and we will close with a question-and-answer session. During this call, we will refer to certain non-GAAP financial measures. The nature of those non-GAAP financial measures and the related reconciliations to the GAAP results are included in this morning's press release and slides. In our comments, certain percentages are rounded. Please refer to our presentation for complete information. In addition, as a reminder, today’s presentation contains projections and other forward-looking statements. Actual results could differ materially from those projected. The company undertakes no obligation to update or revise publicly any forward-looking statements whether because of new information, future events, or other factors. Please refer to our forward-looking statement on slide two for more information. I will now turn the discussion over to Lawrence.

Lawrence Kurzius, CEO

Thank you, Kasey. Good morning, everyone. Thanks for joining us. Our third quarter performance demonstrates again that the combination of our balanced portfolio with the effective execution of our strategies to capitalize on accelerating consumer trends and strong engagement with our employees have positioned us well to drive differentiated growth. Remarkably, we delivered an eight percent sales increase versus last year and seventeen percent versus twenty nineteen. Our third quarter results reflect a robust and sustained growth momentum as we delivered organic sales growth on top of our exceptional third quarter performance last year. Our third quarter results also include strong contributions from Cholula and FONA. Sales growth in our Flavor Solutions segment was broad-based with the at-home products in our portfolio, flavors and seasoning, growing at approximately the same rate as our away-from-home product, which was primarily driven by a robust recovery from last year's lower demand from our restaurants and other food service customers attributable to COVID-nineteen restrictions and consumers' reluctance to dine out. Our consumer segment results reflect the lapping of the year ago elevated demand in the lockdown days of the pandemic from consumers eating and cooking more at home, as well as a sustained shift to consumer at-home consumption higher than pre-pandemic levels. Taken together, these results continue to demonstrate strength and diversity of our offering, the breadth and reach of our portfolio of compelling offerings for every retail and customer strategy across all channels creates a balanced and diversified portfolio that enables us to drive consistency in our performance even at a volatile environment. Turning to slide five, total third quarter sales grew eight percent from the year ago period or five percent in constant currency. Substantial constant currency sales growth in our Flavor Solutions segment more than offset a slight constant currency sales decline in our consumer segment, driven by the factors I just mentioned. Adjusted operating income was comparable to the third quarter of last year, including a three percent favorable impact from currency. The benefit of higher sales was more than offset by higher cost inflation and industry-wide logistics challenges as well as by a shift in sales between segments. On the bottom line, our third quarter adjusted earnings per share was zero point eight zero dollars compared to zero point seven six dollars in the year ago period, driven by higher sales and a lower tax rate, partially offset by cost pressures. As we’ve stated previously, we expect growth to vary by quarter in twenty twenty one. Importantly, we have delivered outstanding year-to-date performance. Sales and adjusted operating income are up thirteen percent and nine percent year-over-year, respectively. Both of which include a three percent favorable impact from currency as we’ve grown adjusted earnings per share of eight percent. Year to date versus twenty nineteen, we've driven sales, adjusted operating income, and adjusted earnings per share growth of nearly twenty percent across all three metrics. I'd like to say a few words about the current cost environments' impact on our third quarter results, as well as our outlook, which Mike will cover in more detail. We stated in our July earnings call, we are operating in a dynamic cost environment and like the rest of the industry experiencing cost pressure. We're seeing broad-based inflation across our raw and packaging materials, as well as transportation costs. To partially offset rising costs, we have raised prices where appropriate, but as usual, there is a timeline lag associated with pricing, particularly with how quickly costs are escalating. Therefore, the phase-in of most of our actions is taking place during the fourth quarter, and those pricing actions are on track, and we appreciate our customers working with us to navigate this environment. In the last few months, inflation has continued to escalate, mainly with packaging and transportation costs. We’re experiencing the highest inflationary period of the last decade or even two. We, along with our peers and customers, are also facing additional pressure on our supply chain due to strained transportation capacity and labor shortages in distribution. These pressures not only impact costs, but also negatively impact sales as the addition of further supply chain complexity makes it harder to get orders shipped and received by customers. This pressure is exemplified by continued elevated demand. Overall, we have a demonstrated history of managing through inflationary periods with a combination of pricing and cost savings and we expect to manage through this period as we have in the past. Now let's turn to our third quarter segment business performance which includes comparisons to twenty nineteen pre-pandemic levels as we believe these will be more meaningful than the comparisons to twenty twenty, given the dramatic shift in consumer consumption between at-home and away-from-home experienced in the year ago period. Starting on slide seven. Consumer segment sales grew one percent, including a two percent favorable impact from currency and incremental sales from our Cholula acquisition compared to the highly elevated demand levels of the year ago period. Our consumer segment organic sales momentum on a two-year basis was up double digits, highlighting how the sustained shift in consumer consumption continues to drive increased demand for our product and outpace pre-pandemic levels. Our Americas constant currency sales declined one percent in the first quarter with incremental sales from our Cholula acquisition contributing three percent growth. Our total McCormick U.S. branded portfolio consumption, as indicated in our IRI consumption data combined with unmeasured channels, declined ten percent, following a thirty-one percent consumption increase in the third quarter of twenty twenty, which results in a nineteen percent increase on a two-year basis. Demand has remained high as we are realizing the benefit of our U.S. manufacturing capacity expansion, although some products remain stretched by sustained high demand. Shelf conditions are improving and we're seeing sequential improvement in our share performance.

Mike Smith, CFO

Thanks, and good morning, everyone. For the reasons Lawrence mentioned, my comments will also include comparisons to twenty nineteen. Starting on slide thirteen. Our top line growth continues to be strong. We grew constant currency sales five percent during the third quarter compared to last year with incremental sales from our Cholula and FONA acquisitions contributing four percent across both segments. Our volume and mix drove our organic sales increase with Flavor Solutions growth offsetting a decline in the consumer segment. Versus the third quarter of twenty nineteen, we grew sales fifteen percent in constant currency with both segments growing double digits. During the third quarter, our consumer segment continued to lap last year's exceptionally high demand. Versus twenty twenty, our third quarter consumer segment sales declined one percent in constant currency, which includes a three percent increase from the Cholula acquisition. Compared to the third quarter of twenty nineteen, consumer segment sales grew fourteen percent in constant currency. On slide fourteen, consumer segment sales in the Americas declined one percent in constant currency, lapping the elevated lockdown demand in the year-ago period, as well as the logistics challenges Lawrence mentioned earlier. Incremental sales from the Cholula acquisition contributed three percent growth. Compared to the third quarter of twenty nineteen sales increased seventeen percent in constant currency, led by significant growth in the McCormick, Lawry’s, Grill Mates, OLD BAY, Frank's RedHot, Cholula, Zatarain's, Gourmet Garden, Simply Asia, Stubb’s and all branded products. That's a lot of brands. Partially offset by a decline in private label. In EMEA, constant currency consumer sales declined eleven percent from a year ago, also due to lapping the high demand across the region last year. Notably, this decline includes strong growth in our Eastern European market. On top of their significant volume growth last year, which was more than offset by declines in the region's other markets. On a two-year basis, sales increased ten percent in constant currency, driven by strong growth in our Kamis, Schwartz, and Frank’s RedHot branded products.

Lawrence Kurzius, CEO

McCormick continues to win in Hot Sauce. Across our brands, McCormick grows to be the number one Hot Sauce manufacturer globally earlier this year. In the third quarter, Frank's RedHot, the number one brand in the U.S. was joined at the top of the category by Cholula, which we have driven to the number two ranking. We are not only creating buzz through our digital marketing but also with our e-commerce direct-to-consumer new product launches. In the Americas, we drove new passionate users to our brands and digital properties with the launch of sunshine all-purpose seasoning, a new product developed in partnership with a social media influencer. Inspired by personality and health and wellness-focused recipes with salt-free and gluten-free Caribbean-inspired blend sold out in just thirty-nine minutes, generating record sales from e-commerce-driven innovation and over seven hundred million earned impressions. Turning to category management, our initiatives are designed to strengthen our category leadership by driving growth for both McCormick and retailers. These initiatives include simply changing shelf placement, for instance, increasing Cholula’s velocity over thirty percent by changing the tile placement at a large retailer to reinvesting in the spice and seasoning shopping experience. In the U.S. we're anticipating a cumulative implementation of our spice sell program, since it began in twenty twenty of ten thousand stores by year-end versus twenty nineteen to remove year-over-year noise; sales in the beginning of August show retailers that have adopted despite all changes are growing the category faster than those who have not. McCormick’s branded spice and seasoning portfolio is growing solid mid-single digits faster in implemented stores versus stores which have not adopted the changes. We're excited about our growth trajectory and expect long-lasting growth from the sustained shift to consumers cooking more at home fueled by our brand marketing, new products, and category management initiatives. Turning to slide nine, our Flavor Solutions segment grew twenty-one percent or seventeen percent in constant currency reflecting both strong base business growth and contributions from our FONA and Cholula acquisition. Our third quarter results include the robust recovery from last year's lower demand from our restaurant and other food service customers, many of which are lapping the curtailment away from home dining, as well as strong continued momentum on our packaged food and beverage customers. Notably, growth was driven equally from both the at-home and away-from-home products in our portfolio. In Eastern Europe, the rollout of our first choice bottle, which is perceived as premium and what was predominantly a sachet-only market, is elevating the spices and seasoning category and driving increased share in our Eastern European market.

Mike Smith, CFO

We expect growth in both segments next year. At the foundation of our sales growth is the rising consumer demand for flavor fueled by younger generations. We've intentionally focused on great categories that are growing and generating a long-term tailwind.

Lawrence Kurzius, CEO

I think our outlook continues to be positive for strong sales growth. And if you look at consensus sales for next year that are out there, they're pretty anemic and I guess we're trying to definitely suggest that there's a reason to reconsider that.

Operator, Operator

Thank you. At this time we’ll be conducting a question-and-answer session. Our first question comes from the line of Andrew Lazar with Barclays. Please proceed with your questions.

Andrew Lazar, Analyst

Good morning, everybody.

Lawrence Kurzius, CEO

Hi, Andrew.

Mike Smith, CFO

Good morning, Andrew.

Andrew Lazar, Analyst

Hi there. Maybe to start out at our recent conference and then, again, this morning, you’ve alluded to cost and supply chain disruptions likely continuing into fiscal twenty twenty-two, others have made very similar sort of comments. Of course, you’ll have more pricing kicking in among other actions to mitigate some of the challenges. I think you also had mentioned that ERP costs could be offset by COVID expenses coming down. So, I guess, things remain very fluid, of course, and you're not obviously giving specific twenty-two guidance as of yet. But I'm trying to get a sense of whether on algorithm year, particularly on the profit side would be too much to ask in fiscal twenty twenty-two at this stage. All things considered, particularly given what I assume will be continued margin pressure, at least through the first half next year?

Lawrence Kurzius, CEO

Right. Well, first of all, Andrew, thanks for the opportunity to talk about it. It’s kind of a pretty high-level question, right? In your question, you are close to a couple of my points that I would actually make to answer it. Beginning with -- just to be clear, I'm not going to give guidance for next year. There are a lot of moving parts; things are fluid. We are right in the middle of putting together our budgets for next year right now. As we said in the call, our long -- we're very confident about our algorithm over the long term. I'm just not ready to talk about it in twenty twenty-two, specifically just yet. But in our prepared remarks, I did say we expect growth in both segments. And so, I'll start there and then I'll bring it back to profit.

Andrew Lazar, Analyst

Right. I appreciate that color. That's helpful. And then one very quick follow-up and it may be tough to parse out. In the quarter though, are you able to sort of break out what impact some of the supply constraints may have had on overall sort of company organic growth? I think organic growth was up about one percent. I don’t know if some of the supply constraints were significant enough that it would meaningfully change what organic growth looked like in the quarter. Thank you so much.

Lawrence Kurzius, CEO

It actually did have an impact on the fourth quarter. I think -- sorry, I said forth, I misspoke there, it’s third quarter. And we haven't quantified that and I'm not prepared to, but it was material. We normally would not have a backlog at all to have -- the idea of having a backlog of orders is unprecedented; we have backlog that's measurable in days. And so it did have a – it definitely had an impact. It would have been our hope to actually continue to rebuild trade inventories as we went through the quarter which have not yet been fully recovered, and we were not able to do so. We really wanted and planned to ship more of these logistics challenges are very real -- we've got a very strategic discussion just now and a very tactical one. But just simply getting product out there has been a challenge in the face of the -- but it's still very high demand at the same time that we're having these logistical challenges. I’d say that the trade channels are still a bit starved for inventory.

Mike Smith, CFO

We’ve noticed -- we didn't narrow our range on sales to the high end of the range. So we have very strong confidence in the fourth quarter.

Ken Goldman, Analyst

Hi. Thank you. Just on pricing, are there any geographies or categories or brands where maybe getting the pricing you hoped for has been a little more challenging than in others? And I guess I'm curious where you are in your, I guess, journey, so to speak of taking incremental pricing to offset some of the newer or more severe headwinds you're facing? I'm trying to figure out, if you're still having conversations with customers, do you feel most of the heavy lifting is done there for maybe some of the second rounds that'd be helpful. Thank you.

Lawrence Kurzius, CEO

Well, first of all, I won't say that there's a particular problem; these actions always have some degree of commercial tension in them, and so I don't want to get too specific there. As such, there are ongoing conversations with customers; I think that there are some new conversations that we had. All of our actions on pricing are on track. Particularly for the U.S. the price increases that we talked about earlier in the year have been solved in. There is a time lag though, especially with how quickly costs have gone up. The inflation has accelerated since we launched those pricing. So there's more work to do in that area in twenty twenty-two. Phasing of most of our actions is happening in Q4, and we would expect to see the benefit of that in twenty twenty-two.

Mike Smith, CFO

And I think I'd point you back, Ken, to historical perspective here. We had high inflationary periods in the past in the two thousand and eight, two thousand and nine timeframe, two thousand eleven, two thousand and twelve; we were successfully able to put in pricing, it's actually both U.S. consumer during one of those time periods, and we're able to pass through the pricing. We also pulled a lot of other levers whether it's CPI or discretionary spending to get to Andrew's point about getting back on algorithm from a profit perspective.

Robert Moskow, Analyst

Thanks. I think this question will sound like Ken's question, maybe a different tack though. Is the conversation different with retailers on how to take pricing or how to think about pricing in relation to the latest acceleration, because I think some retailers out there consider the supply chain disruption to be temporary, the labor challenges will go away. And as a result, does that mean you have to shift more towards, I don't know, more variable actions on promotions or packaging changes rather than a straightforward price increase?

Lawrence Kurzius, CEO

Well again, I'm going to say that, I can't give specifics about any one particular customer. Certainly, the pricing actions that we just took, we had a lot of company going out there. And so I think retailers -- what they heard from us was similar to what they heard from others. I'm not so sure we have gotten that kind of feedback that retailers think that these increases are transitory. There's been some discussion about inflation not continuing to escalate, but there hasn't been any discussion about this not being reset of pricing levels. And I think that there's broad recognition of that.

Steve Powers, Analyst

Yes. Hey, thanks. And you might just -- I think you sort of addressed this in response to Chris’s question, but just to play it back. So when we think about your intention to fully offset pressures over time and appreciating that there's a rolling process to this. I think -- I don't know, if Chris -- if you were speaking to Chris about pricing or just all the offsets, but I guess, what I'm trying to get a sense for is just on those rolling offsets when do you think you hit run rate -- your run rate achievement of those offsets? Is that a middle of next year type of timeline? Or is it more realistic to think that it progresses all the way through and it's not until closer to the end of twenty-two where you hit the full offset run rate? Just trying to get a sense order of magnitude of the pacing of your effort?

Mike Smith, CFO

I mean, obviously, I mean a lot depends on the future cost environment too in this. I mean, we put in pricing in the U.S. to just kind of going to partially hit in the fourth quarter like we said last quarter. The full impact is going to be in twenty twenty-two. Now, if costs continue to accelerate, we'll have to address that with other actions. But I think it’s speculative at this point to try to call twenty-two. And the timing is by quarter and by halves.

Rob Dickerson, Analyst

Great. Thank you. I just wanted to touch on private label for a second, given you still operate that side of business a bit as well as brands. Obviously, there's been kind of ongoing discussion kind of where the state of that overall industry kind of sits as we kind of get through the pandemic. So I’m just curious, given some of the comments around, let's say, trade inventory not exactly where you want it to be going and did pricing forthcoming. I'm just kind of curious what you've seen or heard the retailers as of late around demand for kind of your private label products versus brands? And then just kind of how you think about price gaps as you kind of enter this pricing phase. That's the first question. Thanks.

Lawrence Kurzius, CEO

Sure. Well, generally across all categories, private label has lost share in the pandemic as a group have gained, and then recent results that we just announced, our brands were strong, and private labels. When it comes to pricing, that costs are going up for every raw material, packaging, labor and transportation and that applies for private label as well. Pricing actions that we are going forward are including the private label products that we manufacture and I would expect that in many cases, just because the price at a lower price point, that they may see a higher percentage inflation rate because of the same costs flow through, but it's going to be a bigger percentage. I think our outlook continues to be positive for strong sales growth. And if you look at consensus sales for next year that are out there, they're pretty anemic and I guess we're trying to definitely suggest that there's a reason to reconsider that.

Operator, Operator

Thank you for your time this morning.