Earnings Call Transcript - MKC Q2 2023

Kasey Jenkins, Chief Strategy Officer

Good morning. This is Kasey Jenkins, Chief Strategy Officer. Thank you for joining today's second quarter earnings call. To accompany this call, we've posted a set of slides at ir.mccormick.com. With me this morning are Lawrence Kurzius, Chairman and CEO; Brendan Foley, President, and COO; and Mike Smith, Executive Vice President, and CFO. I would also like to welcome our new Vice President, Investor Relations, who joined McCormick earlier this month. During this call, we will refer to certain non-GAAP financial measures. The nature of these 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. 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 statements on slide two for more information. I will now turn the discussion over to Lawrence.

Lawrence Kurzius, Chairman and CEO

Good morning, everyone. Thanks for joining us. To start, last night, we announced that Brendan Foley will become McCormick’s next Chief Executive Officer on September 1, and he is joining the Board of Directors immediately. I could not be more pleased with Brendan as my successor. I will continue to serve McCormick and all of its stakeholders as Executive Chairman of the Board once Brendan becomes CEO. This is a transition that we have been planning internally as part of an orderly multi-year succession plan, and it's exciting to finally share the news with all of you. As many of you know, Brendan is exceptionally well qualified and prepared to lead McCormick. He deeply understands the importance of delivering continued strong growth while doing the right things for people, communities, and the planet. With our advantaged competitive positioning, supported by the growing demand for flavor and with our tremendous depth of talent, I have utmost confidence that McCormick, under Brendan's leadership, will continue to drive differentiated growth and long-term shareholder value. Congratulations, Brendan. Now on to our earnings update. First, I'll provide an overview of our second quarter results. Brendan will provide the business segment update, Mike will provide details on our financial results and 2023 outlook, and after your questions, I will have some final comments. Starting with our second quarter results. We're pleased with our strong second quarter performance, which reflects sustained demand across our business and effective execution of our strategy. We delivered double-digit constant currency sales growth. Our pricing actions are in place and, importantly, our volume performance improved. We continue to see top line momentum in our business, positioning McCormick for sustained growth. Additionally, we drove meaningful year-over-year margin expansion in both segments, underscoring our focus on profit realization. Our global operating effectiveness or GOE program, which includes the optimization of our supply chain cost structure, is yielding results. We grew adjusted earnings per share by 25% driven by significant adjusted operating income growth, despite interest rate and tax headwinds. Year-to-date, cash flow from operations more than doubled driven by higher earnings, working capital improvements, and notably, we are reducing inventory levels as planned. Both segments in all regions contributed with strong growth. Our results benefited from our recovery in China. And while the timing and pace of recovery in our China business was less robust than anticipated, it was still strong, and we are confident in the contribution China will provide to our results as the year progresses. Overall, we are pleased with our execution and results during the first half of 2023. Our year-to-date results, combined with the strong demand we continue to expect across our portfolio and our diligent approach to optimizing our cost structure, bolster our confidence in our growth trajectory as we enter the second half of the year. As such, we are raising our adjusted operating income and earnings per share outlook for the full year. Turning to slide five. In the second quarter, we drove 8% sales growth or 10% in constant currency. Our constant currency sales growth reflected strong business performance, with an 11% contribution from pricing and a 1% decline in volume and product mix. Netted in this volume decline are a net 1% volume increase from China recovery, partially offset by our Kitchen Basics divestiture and the exit of our consumer business in Russia, and a 1% decline attributable to pruning low-margin business. From a segment lens, both the Consumer and Flavor Solutions segments delivered strong sales growth in each region. In the Consumer segment, we continue to have strong price realization and we drove a sequential improvement in volume performance. Flavor Solutions, our exceptional performance continued with our ninth consecutive quarter of constant currency double-digit sales growth. Our sales performance demonstrates the strength of our broad global portfolio and positions us well for continued top line growth for the balance of the year. I'd like to share a few highlights about our gross margin performance, which Mike will cover in more detail in a few moments. We drove significant gross margin improvement, reflecting the continued recovery of the cost inflation that our pricing lagged last year. Cost savings from our CCI and GOE programs and the impact of strategic decisions we've made to optimize our portfolio, with a focus on driving margin improvement as we continue to prune low-margin business. Our gross margin expansion in the quarter was partially offset by higher SG&A as we build back incentive compensation as planned. Our adjusted operating income increased by 35% versus the second quarter of last year or, in constant currency, 36%. This growth drove an adjusted earnings per share increase of 25%, which also reflected a higher interest and effective tax rate. We remain confident that we have the right plans in place and are taking the right actions. We are halfway through the year. Our year-to-date results speak for themselves. We expect to continue driving profitable growth for the balance of the year. Demand is strong. We're driving improvements in our margin profile and optimizing our cost structure effectively. I want to thank McCormick employees worldwide for their collective power in driving our success. I'm proud of the tremendous job that the McCormick team has done navigating the dynamic environment over the last few years. I'd like to recognize their energy and excitement for the business, which is coming through in our results. Now, I'd like to ask Brendan to share the second quarter business updates for our segments.

Brendan Foley, President and COO

Thank you, Lawrence. Starting with our Consumer segment, on slide eight. Our underlying performance was strong, reflecting our price realization and continuing positive momentum in our consumption trends. We continue to see sequential improvement. Now for some highlights by region, starting with the Americas. Our total U.S. branded portfolio consumption, as indicated by our IRI consumption data and combined with unmeasured channels, grew 7%. The difference between our sales and consumption was attributable to the retail sell-through of discontinued items and listing fees for an increase in new distribution and products, for example, our new Cholula and Stubb's items and Tabitha Brown line expansions. As anticipated, our alignment between consumption and shipments is normalizing. In spices and seasonings, both consumption dollars and units accelerated sequentially from the last several quarters, with unit strength in core products such as straight fill spices and vanilla, as well as our seasoning blends, which provide consumers both convenience and flavor exploration. Lunch-to-date results of our Lawry's everyday spice range continue to be positive. We are seeing incremental sales and profits in the category, and like the first quarter, over half of the purchases are from new buyers to McCormick and overall incremental to the category. We also continue to see consumers trade up from private label. Our excitement and distribution for this product line continues to build. The renovation of our U.S. core Everyday Spice portfolio is rolling out according to plan and is a seamless transition for our retail partners as it fits into existing shelf spots. At the end of the second quarter, we had about 30% of our SKUs on shelf; we will continue to roll out the product over the course of the year, and our significant brand marketing campaign will be ramping up at the end of the third quarter. Our larger-sized Super Deal herbs and spices continue to benefit the category, with 11% consumption growth in the second quarter, as consumers continue to put more at home. Super Deal's purchase cycle is similar to that of smaller sizes, even though they are three times the volume. And household penetration remains greater than pre-COVID. We kicked off the grilling season at the end of the second quarter, and early results are good. Frank’s RedHot and Cholula Hot Sauces, French's mustard, Lawry's Marinades, and McCormick mayonnaise, all delivered double-digit growth in the second quarter. With Stubbs barbecue sauce, as well as Grill Mates seasoning blends and recipe mixes, following close with high-single-digit growth. We are expecting our new grilling products and strong promotions to increase share performance. We're really excited about our Stubbs Real Smoke Rubs, which capture real authentic hardwood smoke flavor and Stubbs Jalapeno and Honey Barbecue Sauce, which combines two trending flavor profiles and the nuance of heat and flavor that our Frank's Smoke and Sweet Barbecue Wing sauce offers. We are fired up for the grilling season and expect the launch of our fire up brand marketing campaign in the third quarter to boost consumer demand as well. Our expansion into the fast-growing Mexican aisle with Cholula Taco recipe mixes and salsas based on authentic Mexican formulas is off to a great start following our Cinco de Mayo execution. During the third quarter, we are increasing our Cholula brand marketing investments to support our expanded portfolio. Our third quarter brand marketing will also include increasing our investments for our McCormick Gourmet product line with our further for flavor campaign, highlighting our commitment to sustainability from farm to table. With our supply issues for this product line resolved, we are excited to support this premium product offering for the first time in two years. In the Americas, we continue to drive double-digit consumption growth in e-commerce, led by spices and seasonings. We're realizing high returns on our investments, gaining new customers, and growing with new products, such as our new Frank Dill Pickle hot sauce on our direct-to-consumer platform, which sold out in less than a week. We will start to expand distribution in stores late this year. In EMEA, our second quarter was our strongest quarterly sales performance in two years. Our effective pricing accelerated to contribute to double-digit growth, and our volume performance improved sequentially. We grew volume in the U.K. and Eastern Europe. Consumption data continues to indicate consumers are holding up well in our categories and our share performance is solid. We are growing herbs, spices, and seasonings share in Eastern Europe and in Italy, and our growth plans in France are also yielding results with improved share performance. We're excited about celebrating the 60th anniversary of our Schwartz brand this year. We're scaling up our grilling activation in France and partnering with key retailers to celebrate the brand's anniversary and to spark another reason to celebrate around the grill. In the U.K., we have also kicked off the grilling season and are building out our support in the discount channel featuring our Schwartz Grill Mates products. Across the region, we're making meaningful progress in the fast-growing discount channel, expanding distribution, and gaining share. Finally, we are gaining share of the U.K. hot sauce category. We continue to drive strong Frank's RedHot performance and are accelerating our Cholula growth, with new distribution and e-commerce multi-packs contributing significantly to our hot sauce growth. Overall, our investments in brand marketing, merchandising, and new products are proving to be effective and driving growth in EMEA. In the Asia Pacific region, growth for the quarter reflected lapping the COVID-related disruptions in China. While our business is recovering and our second quarter growth was robust, it was lower than our expectations as the pace of reopening is proving to be more gradual and consumer spending was pressured by broad-based economic pressures in the region. We remain optimistic for a more normal operating environment emerging as the year progresses and we enter into 2024, driving sustainable growth as we execute our strategies. Outside of China, new products and brand marketing initiatives drove double-digit growth in other markets, with strength in branded spices and seasonings and Frank's RedHot. Wrapping up our consumer update, we’re fueling our growth with the power of our brands and increased innovation and brand marketing. The supply issues we experienced last year are resolved, and we're using our strength in category management to increase distribution and drive McCormick and category growth. Our year-to-date results bolster our confidence that we will continue to drive sales growth as we have in the past, before, during, and after the pandemic. We believe the execution of our growth plans will be a win for consumers, customers, our categories, and McCormick, differentiating us even more and strengthening our leadership in core categories. Now turning to flavor solutions on slide 10. We are continuing our outstanding sales growth momentum in this segment. As Lawrence already mentioned, the second quarter was our ninth consecutive quarter with double-digit constant currency sales growth. We have previously shared our commitment to restoring profitability in this segment, and the second quarter marks an inflection point toward our objective to continue building our margin. Our growth was led by pricing actions in all three regions, we are priced to cover current year inflation and are continuing to recover the cost inflation that our pricing lagged last two years. The recovery in the second quarter was even greater than the first. Now for regional highlights. Our Americas second quarter strong sales growth was led by our flavors product category. Within flavors, seasonings growth was strong, including volume growth related to new products, which is outpacing last year's new product contribution, as well as our strength in our customers' iconic products. We are winning in seasonings with our heat platform, flavors for performance nutrition beverages, and health-end market applications also contributing to our strong performance as we continue driving double-digit sales growth. We are winning with new products for existing and new customers. In branded food service, we continue to gain share in hot sauce, mustard, spices, and seasonings, with strength this quarter in Grill Mates and Lawry's. Our grilling portfolio is thriving in branded food service just like in our consumer segment. Moving to EMEA, we continue to drive broad-based growth across the portfolio, led by higher sales to our quick-service restaurant customers in the second quarter. Overall, our price realization accelerated again from last quarter. Notably, we grew sales constant currency by 15% in the quarter despite an impact from pruning low-margin business as Lawrence mentioned earlier, and softness in some of our QSR impacted food and beverage customers' volumes within their own business. In APZ, we also experienced recovery in China and are encouraged about the return to normal as growth was also driven by strong performance from our quick-service restaurant customers' promotions. Outside of China, we delivered double-digit growth with effective price realization, as well as solid volume growth driven by demand from QSRs. The strength of our flavor solutions portfolio and capabilities, including our differentiated customer engagement and culinary-inspired innovation are driving our outstanding flavor solutions momentum. The power of McCormick and FONA together continues to create exciting growth opportunities in the technically insulated and value-added part of our portfolio, especially with our recent wins in Healthy Nutrition. In branded food service, we expect new products, increased menu penetration, and culinary partnerships to drive continued growth. Our robust plans for flavor solutions bolster our confidence in continuing our growth trajectory and driving our flavor solutions leadership. Now, I'd like to turn it over to Mike to provide details on our financial performance.

Mike Smith, Executive Vice President and CFO

Thanks, Brendan, and good morning, everyone. Starting on slide 12, our top line constant currency sales grew 10% compared to the second quarter of last year, reflecting an 11% growth from pricing, partially offset with a 1% volume and mix decline. As Lawrence already mentioned, there were impacts to volume related to the China recovery, the Kitchen Basics divestiture, the exit of our consumer business in Russia, and strategic decisions we made related to optimizing the profitability of our portfolio. At the total company level, all these impacts netted out. In our Consumer segment, constant currency sales increased 7%, reflecting a 9% increase from pricing actions, partially offset by a 2% volume decline. Including in this volume decline are a net 1% increase from the recovery in China, partially offset by the Kitchen Basics divestiture and our business exit in Russia, and a 1% decline from exiting DSD or Direct Store Delivery business for our Hispanic bag products in the Americas. On slide 13, consumer sales in the Americas increased 4% in constant currency, with an 8% increase from pricing actions partially offset by a 1% volume decline due to the Kitchen Basics divestiture, a 2% volume decline from the Hispanic product DSD exit, and a 1% underlying volume and mix decline. Our strong underlying sales growth was driven by the products in our grilling portfolio, which Brendan mentioned earlier. In EMEA, constant currency consumer sales increased 9% with a 12% increase from pricing actions, partially offset by a 2% volume decline from exiting Russia and a 1% underlying volume and mix decline. Excluding Russia, sales growth was broad-based across all categories and markets. Constant currency consumer sales in the Asia Pacific region increased by 28%, driven by a 20% volume increase from China recovery and a 6% increase from pricing actions across the entire region, as well as a 2% increase in all other volume and product mix. Turning to our flavor solutions segment on slide 16, we grew second quarter constant currency sales by 13%, reflecting a 14% increase from pricing actions, partially offset by a 1% volume decline. Included in this volume decline are a net 1% increase from the recovery in China offset by a 1% decline from discontinuing a private label food service product line in EMEA. In the Americas, flavor solutions, constant currency sales rose 11%. Pricing actions contributed to higher sales across the customer base. Volume and product mix declined in the quarter as strong volume growth in seasonings was more than fully offset by the impact of pruning of low-margin business. In EMEA, constant currency sales increased by 15%, with pricing actions partially offset by lower volume and product mix, including a 2% impact from discontinuing the private label product line I mentioned earlier. EMEA's flavor solutions outstanding growth was driven by pricing and was broad-based across its portfolio, led by higher sales to QSR customers. Volume and mix outside the product discontinuation declined due to softness in some of our customers' volume within their own businesses, mainly packaged food and beverage customers as well as QSRs. In the Asia Pacific region, flavor solution sales grew by 22% in constant currency with a 13% volume benefit in China due to lapping the prior year’s COVID-related disruption, an 8% increase from pricing actions, and a 1% increase in all other volume and mix driven by Australia. As seen on slide 20, gross profit margin expanded by 310 basis points in the second quarter versus the year-ago period, reflecting our unwavering focus on increasing profit realization. Favorable drivers in the quarter were our CCI and GOE programs, the continued recovery of the cost inflation our pricing lagged over the last two years as we planned, and favorable product mix in both segments. We offset current year inflation in the second quarter with our pricing. Notably, in flavor solutions, while we continue to incur some level of higher cost to meet high demand in certain parts of our business, we continue to make progress on reducing the level of these costs. As we expected, the second quarter's dual running costs we experienced in the U.K. were comparable to last year. We are very pleased with our gross margin expansion for the quarter and expect to continue to drive margin improvement in the balance of the year. Now moving to slide 21, selling, general, and administrative expenses, or SG&A, increased relative to the second quarter of last year as higher employee incentive compensation expenses and distribution costs were partially offset by CCI lead and GOE savings. Brand marketing increased compared to the second quarter of last year and we are expecting an even more significant year-over-year increase in the third quarter. As a percentage of net sales, SG&A increased by 20 basis points. Strong sales growth and gross margin expansion, partially offset by higher SG&A costs, resulted in a constant currency increase in adjusted operating income of 36% compared to the second quarter of 2022. In constant currency, the consumer segment's adjusted operating income increased by 24% and the flavor solutions segment grew by 66%. Turning to interest expense and income taxes on slide 22. Our interest expense increased significantly over the second quarter of 2022, driven by the higher interest rate environment. Our second quarter adjusted effective tax rate was 22.3%, compared to 18.6% in the year-ago period. Both periods were favorably impacted by discrete tax items, with a more significant impact last year. At the bottom line, as shown on slide 23, second quarter 2023 adjusted earnings per share was $0.60, as compared to $0.48 for the year-ago period. The increase was driven by higher adjusted operating income, partially offset by higher interest expense and a higher effective tax rate. On slide 24, we've summarized highlights for cash flow and the quarter-end balance sheet. Our cash flow from operations year-to-date was strong: $394 million in 2023 compared to $154 million for the first half of 2022. The increase was primarily driven by higher net income and working capital improvements, including lower inventory, as well as lower incentive compensation payments. We returned $209 million of cash to our shareholders through dividends and used $119 million for capital expenditures through the second quarter. We expect 2023 to be a year of strong cash flow driven by our profit and working capital initiatives. Our priority is to continue to have a balanced use of cash, funding investments to drive growth, returning a significant portion to our shareholders through dividends, and paying down debt. We remain committed to a strong investment-grade rating and we have a history of strong cash generation and profit realization. Now turning to our updated 2023 financial outlook on slide 25. Our 2023 outlook reflects our continued positive top line growth momentum and with the optimization of our cost structure, increased profit realization. We expect to drive margin expansion with strong sales and adjusted operating income growth that reflects the health of our underlying business performance, as well as the net favorable impact from several discrete drivers. We expect our adjusted operating profit growth will be partially offset below operating profit by higher interest expense and a higher projected effective tax rate. We also expect there will be a minimal impact from currency rates, although there will be a timing aspect as we realize an unfavorable impact in the first half of the year, and projected favorable impact in the second half. For fiscal 2023, we are reaffirming our sales outlook and as Lawrence mentioned, we are raising adjusted operating income and adjusted earnings per share, driven by our strong year-to-date performance, combined with the robust demand we continue to expect and our diligent approach to optimizing our cost structure. At the top line, we continue to expect 5% to 7% growth, driven primarily by the wrap of last year's pricing actions combined with new pricing actions we have taken in 2023. We expect several factors to impact our volume and product mix over the course of the year, including price elasticities consistent with 2022 at lower levels than we have historically experienced, but in line with the current environment, a 1% estimated benefit from lapping last year's impact of COVID-related disruptions in China, although we expect the impact will vary from quarter to quarter given 2022's level of demand volatility. The divestiture of our Kitchen Basics business in August of last year and the exit of our consumer business in Russia during last year's second quarter. And finally, the continual pruning of lower margin business from our portfolio. We estimate the Americas Consumer segment DSD exit and the EMEA Flavor Solution's private label discontinuation to impact approximately 1% for the year, which began to impact us in the second quarter. As always, we plan to drive growth through the strength of our brands, as well as our category management, brand marketing, new products, and customer engagement plans. Our 2023 gross margin is projected to range between 50 basis points to 100 basis points higher than 2022, compared to our prior guidance of 25 basis points to 75 basis points. This gross margin expansion reflects a favorable impact from pricing, cost savings from our CCI-led and GOE programs and portfolio optimization, partially offset by the anticipated impact of a low to mid-teens increase in cost inflation. We expect cost pressures to be more than offset by pricing during the year as we recover the cost inflation our pricing lagged for the last two years. Moving to adjusted operating income. First, let me walk through some discrete items and their expected impact on our 2023 adjusted operating profit growth. First, the cost savings from our GOE program are expected to have an 800 basis point impact. The savings from this program are expected to scale up as the year progresses. Next, the benefit of lapping the impact of COVID-related disruptions in China is expected to have a 300 basis point favorable impact. The Kitchen Basics divestiture is expected to have an unfavorable 100 basis point impact. And finally, an 800 basis point unfavorable impact is expected as we build back incentive compensation. The net impact of these discrete items is a favorable 200 basis points. This favorable impact, combined with expected 8% to 10% underlying business growth, which is driven by our improved operating momentum, results in our adjusted operating income projection of 10% to 12%, compared to our previous guidance of 9% to 11%. In addition to the adjusted gross margin impacts I just mentioned, this projection also includes a low-single-digit increase in brand marketing investments and our CCI-led cost savings target of approximately $85 million. We continue to anticipate a meaningful step up in interest expense driven by the higher interest rate environment, which will impact our floating debt. We estimate that our interest expense will range from $200 million to $210 million in 2023, spread evenly throughout the year. As a reminder, in 2022, we realized an $18 million favorable impact from optimizing our debt portfolio, which we will lap in the third quarter of 2023. The net impact of these interest-related items is expected to be approximately an 800 basis point headwind to our 2023 adjusted earnings per share growth. Our 2023 adjusted effective income tax rate is projected to be approximately 22% based upon our estimated mix of earnings by geography, as well as factoring in a level of discrete impacts versus our 2022 adjusted effective tax rate. We expect this outlook to be a 100 basis point headwind to our 2023 earnings growth. To summarize, our 2023 adjusted earnings per share expectations reflect strong underlying business growth of 10% to 12% and a 2% net favorable impact from the discrete items I just mentioned impacting profit. The GOE program, the China recovery, the Kitchen Basics divestiture, and the employee benefit cost rebuild, partially offset by the combined interest and tax headwind of 9%. This resulted in an expected increase of 3% to 5% in our projected guidance range for adjusted earnings per share in 2023 of $2.60 to $2.65. Before turning it back to Brendan, I would like to recap the key takeaways I've seen on slide 27. Our second quarter sales growth reflects sustained demand across our business and the effective execution of our strategies. Our pricing actions are in place, and our volume performance improved. We drove meaningful year-over-year margin expansion in both segments underscoring our focus on profit realization. Our cost savings programs are yielding results in line with our expectations. Our year-to-date results combined with continued robust demand expectations and our actions to optimize our cost structure bolster our confidence in delivering the strong operating performance projected in our enhanced 2023 outlook.

Brendan Foley, President and COO

Thank you, Mike. Before we turn it over to Q&A, I would like to provide some additional comments. First, I would like to say, I am truly honored and excited about the opportunity to lead this great company with its rich and very promising future. Global demand for flavor remains the foundation of our sales growth, and we have intentionally focused on great, fast-growing categories. Our alignment with long-term consumer trends, healthy and flavorful cooking, increased digital engagement, trusted brands, and purpose-minded practices continues to create a tailwind for growth. McCormick is uniquely positioned to capitalize on this demand for great flavor. With the breadth and reach of our strong global flavor portfolio, we are delivering flavor experiences for every meal occasion. We are the global leader in flavor from end-to-end for our consumers and our customers. As we look ahead to the back half of the year, we will continue to focus on capitalizing on strong demand, optimizing our cost structure, and positioning McCormick to deliver sustainable growth and long-term shareholder value. We have compelling growth plans in place, including building momentum with our new products and heat platform and are delivering on our commitment to increasing our profit realization. We are confident that with successful execution of our plans and concrete actions, we will realize the profitable growth reflected in our updated 2023 financial outlook. The strength of our business model, the value of our products and capabilities, and execution of our proven strategies further bolsters our confidence in our growth trajectory in both segments, particularly as the environment begins to normalize. Remaining relentless with our focus on growth, performance, and people combined with the compounding impact of our continued growth investments and alignment with consumer trends underscores McCormick's position to deliver long-term differentiated growth. Our fundamentals remain strong, and we expect to continue to not only deliver strong sales growth, but also drive total shareholder return at an industry-leading pace. Importantly, I'd like to personally thank Lawrence for his mentorship and continued service to McCormick. On behalf of shareholders and employees, I want to recognize his outstanding leadership as CEO of this great company. Lawrence has been a transformational leader for McCormick, bringing our global flavor platform to life through his entrepreneurial spirit, innovative thinking, and growth-oriented vision for the company. During his time as CEO, we have grown sales by over 50% and market capitalization more than doubled, creating significant shareholder value. We have prioritized investing to drive future growth, increased our profit realization, improved cash flow from operations, and have returned more than $2.5 million to shareholders. Lawrence is widely credited with embedding purpose-led performance into McCormick's culture by championing the company's industry-leading sustainability efforts, driving a period of tremendous growth, performance, and expansion, including acquisitions of iconic brands like Frank's RedHot, French's, Cholula, as well as FONA, and successfully leading McCormick through the unprecedented global pandemic. This is an enviable track record, congratulations, and we look forward to your continued support as Executive Chairman. Now for your questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from Andrew Lazar with Barclays. Please go ahead with your question.

Andrew Lazar, Analyst

Great. Thanks very much. First, I just wanted to congratulate both of you, Lawrence and Brendan, on last evening's announcement. I know McCormick puts a tremendous amount of effort into succession planning, and I'm sure this transition will go every bit as smoothly as previous ones.

Brendan Foley, President and COO

Well, thank you, Andrew. That's very kind of you to say that.

Lawrence Kurzius, Chairman and CEO

And Andrew, thank you very much for that as well. I'm glad you mentioned that McCormick does this very well. McCormick prides itself on leadership development and succession planning, and the Board and I have been very thoughtful and deliberate in a multiyear process to get us to this point. Over the last few years, I've had a chance to partner with Brendan on many of our key initiatives, and his disciplined approach to delivering growth reflects the leading qualities you've come to expect from an ideal CEO for this company going forward. With the appointment to President last year, we were signaling this. And we have given all of you on this call and off this call, an opportunity to get to know Brendan and see his qualities firsthand.

Andrew Lazar, Analyst

Good stuff. Good stuff. I've got just two questions. The first one would be McCormick essentially flowed through the second quarter EPS upside to the full year, but also did not flow through any of the more significant upside in Q1 to the year. So I'm trying to get a sense whether this is simply some conservatism, or is there something in the back half of the year that changes the requirement for either the need for more marketing or it's really just McCormick being sort of opportunistic about the increased marketing in Q3?

Lawrence Kurzius, Chairman and CEO

Well, I'll say that, first of all, we are confident in our outlook for the back half of the year. There's a lot that's exciting within the business, and we're pleased with our execution so far this year. The biggest part of the year is still in front of us. The third and fourth quarters are two largest quarters of the year. And so while we are optimistic, we also want to be prudent about what is still in front of us. There are some puts and takes in the business overall. Our recovery in China has been a bit slower than we expected, and we have factored that into our guidance. Whereas, for the most part, everything else is moving in the right direction, and we're quite positive. So we're not trying to signal anything. We did reflect the fact that we have had strong performance year-to-date and the increase in our guidance reflects that strong performance, but we also didn't want to get ahead of ourselves.

Andrew Lazar, Analyst

And then second, as we think about the back half of the year and McCormick starting to lap some of the pricing, would your expectations still be that volume would turn positive? And if so, what would be the key drivers that give you the sort of the visibility to that?

Lawrence Kurzius, Chairman and CEO

I'm going to say a few words about that, and I'm going to let Brendan pick it up. But as we have been saying all along, we expect our volume performance to improve as we go through the year and to be stronger in the second half versus the first half. And that outlook has not changed. Given that we have slightly softer volumes in China in our outlook, we have a little bit less contribution from that part of the business. But in the second half, overall, as a company, we're expecting volumes to be very close to flat. Call it, plus or minus 1%, and maybe we're talking about numbers that are really not meaningful and well within the range of forecast there.

Brendan Foley, President and COO

From a regional perspective, in the Americas, our performance is in line with expectations. It's important to consider both volume and price together to understand the overall profile. We're seeing consistent sequential improvement across our portfolio on a month-to-month and quarter-to-quarter basis. Additionally, the second quarter results reflect the exit from the DSD business, and removing that aspect highlights our broader outlook for the second half, which shows improvement compared to the first half. In China, we anticipate a strong recovery, although it may be slightly less gradual than initially expected. Nonetheless, we are still confident in the recovery. In the EMEA region, we are satisfied with the volume performance, and when excluding the effects of exiting Russia, we have observed a positive underlying volume and mix. Regarding the DSD exit, we have been working to enhance this business over time. The DSD component delivered to stores, alongside our warehouse and distribution delivery, was not profitable. Therefore, we decided to exit this segment, which significantly impacted our second quarter results by about two points. As we move away from this business, there will likely be ongoing effects for the remainder of the year, but this has been accounted for in our planning.

Andrew Lazar, Analyst

Thanks so much and congratulations again.

Lawrence Kurzius, Chairman and CEO

Thanks, Andrew.

Operator, Operator

Thank you. Our next question comes from the line of Ken Goldman with JPMorgan. Please proceed with your question.

Ken Goldman, Analyst

Hi, thanks and please accept my sincere congratulations as well, Lawrence, Brendan, and Kasey too. Everyone's moving up in the world; it’s great to see. I think I'm contractually obligated after yesterday to ask how you're feeling about, I guess, your customers' inventory levels in general? And if you're sensing maybe any risk of a retail safety stock deload or anything similar as your supply chain continues to normalize and get back to where it was?

Lawrence Kurzius, Chairman and CEO

Brendan, why don't you take that one.

Brendan Foley, President and COO

Ken, thanks for the question. We're not experiencing anything unusual or significant trade inventory destocking. Honestly, there's really not much drama in the quarter for us on this. The difference between our sales and consumption was more attributable to just the retail sell-through of the discontinued items, and the point I just made regarding DSD is an example of that. Additionally, we have higher listing fees this quarter just due to the fact that we're launching more new products. As we anticipated, our alignment between consumption and shipments is normalizing. There's not really anything unusual going on in this quarter.

Lawrence Kurzius, Chairman and CEO

And I'll underscore that our service levels have been pretty solid for quite a while now. So retailers have had plenty of time to adjust their stock levels and so on. This seems like something that over the past year and a half has already occurred for us.

Ken Goldman, Analyst

Thank you. I wanted to follow up on the commentary regarding Europe and the Consumer side, particularly the softness noted in the Flavor Solutions segment. How is that progressing as we move into the current quarter? Is the situation still worsening? I'm trying to understand how some of your larger customers in food, beverage, or QSR are performing as the year goes on.

Brendan Foley, President and COO

Hey, Ken, on the Flavor Solutions side of our business in EMEA, definitely, it's been softer than we would have expected, I think, mostly because we're just seeing a slowing of consumer demand from our customers. And that would be both food and beverage, but I would say it's most coming through the quick-service restaurant customer channel. We think it's really more a reflection of what we see happening and what's being reported in terms of overall inflationary impact in EMEA, specifically Europe. But definitely, as we kind of noted in the remarks leading into the call here, that is something that is probably more affecting our overall volume rate in the EMEA region.

Mike Smith, Executive Vice President and CFO

I think too, just to add a little color on the volume there. About one-third of that decrease in volume is due to the exit of that private label, the two service lines. So again, another portfolio optimization.

Lawrence Kurzius, Chairman and CEO

Yes. And that was actually contemplated in our plans for the beginning of the year. Maybe for customer relations reasons, we couldn't be specific about that, but that is not a surprise to us.

Ken Goldman, Analyst

Great. Thanks so much.

Operator, Operator

Thank you. Our next question comes from the line of Peter Galbo with Bank of America. Please proceed with your question.

Peter Galbo, Analyst

Hey, guys. Good morning and congratulations again to Brendan and to Lawrence.

Lawrence Kurzius, Chairman and CEO

Thank you.

Brendan Foley, President and COO

Thanks, Peter.

Peter Galbo, Analyst

Guys, thank you for the commentary, I guess, on the exit of DSD. I think it's helpful, particularly in the context of some questions we've been getting this morning around the Consumer business. So I appreciate that. I guess, maybe what I wanted to pick up on in Americas Consumer, specifically some of your comments around grilling. You do obviously have pretty easy compares from last year just given where kind of protein prices were. So curious just kind of what you saw coming out of Memorial Day, what you're expecting over the course of the summer. Obviously, you have some specific things that you're working on, but anything you can help with us there?

Brendan Foley, President and COO

Thanks for the question, Peter. We’re off to a great start for this summer’s grilling season, which we noticed was a positive beginning in the second quarter. This success is largely due to our strong innovation plan for grilling, as we are launching new grilling products. Additionally, we have a much better supply of mustard and Frank's RedHot compared to last year. Looking at Lawry’s marinades, we are now in a position where we have full and reliable supply for our customers, and we’re returning to normal promotional activities. All these factors combined—innovation, supply stability, and returning to a regular seasonal approach—contribute to a strong start to the year. From a market share perspective, we believe we performed quite well kicking off in the second quarter. So, all these elements together set us up for a successful summer season.

Peter Galbo, Analyst

Great. No, that's helpful. And maybe just a question for Mike around kind of the gross margin guidance. Just where you’ve covered in the first half of the year, the guidance range implies about the back half, maybe there's some conservatism in there. But I did notice you kind of didn't change the inflation guide, maybe just help us kind of think about that over the balance of the year?

Mike Smith, Executive Vice President and CFO

Yes. I mean, for the year, Peter, as you know, we did raise our guidance on gross margin from 25 basis points to 75 basis points to now 50 basis points to 100 basis points. So we reflected some of the increased pricing realization we talked about in the call. We're really, really doing well in our GOE program and realizing those savings, which will ramp up in the second half. The thing about the second quarter, that 300 basis point improvement, second quarter last year was our worst performance of the year. You'll see improvements in the back half and basis points versus last year, but they won't be as big as the 300 we had in the second quarter.

Peter Galbo, Analyst

Got it. Mike, maybe, sorry go ahead.

Lawrence Kurzius, Chairman and CEO

Go ahead. Finish your line of...

Peter Galbo, Analyst

Sure. Yes, Mike, while the year-over-year change may not be as significant, margins generally tend to improve in the second half of the year. I'm curious about your thoughts on that.

Mike Smith, Executive Vice President and CFO

I mean, based on the mix of our business, generally, the back half does have higher margins, especially in the fourth quarter. Our implied guidance has a high of almost a 90 basis points improvement to lows of 0%. So you get a little bit of a squeeze factor there. But if we continue to have success, and again, we see that ramp up in the second half. China is going to have a really strong recovery in Q4, that's a positive for us. We have scale over there and have good margins.

Lawrence Kurzius, Chairman and CEO

I mean, we're quite optimistic with continued gross margin improvement and operating profit margin improvement as we go through the year and going forward.

Mike Smith, Executive Vice President and CFO

I guess, Lawrence said, everything is moving in the right direction.

Peter Galbo, Analyst

Got it.

Lawrence Kurzius, Chairman and CEO

Peter, I know you have some interest in the DSD exit, so I want to take a moment to explain that. This part of the business involves a large number of units, but they are of very low value. We're dealing with bagged spices and dried peppers mainly distributed through unscanned channels. We've operated a DSD business in this area for a long time, but we've decided to exit it as part of our strategy to optimize our portfolio and enhance profit performance. We still sell those brands through warehouse distribution to major customers, where the different distribution channel allows for better margins and justifies staying in that part of the business. However, the DSD segment has not been profitable. While it involves many units, they do not bring significant value.

Peter Galbo, Analyst

Got it, very helpful. Thank you, guys.

Operator, Operator

Thank you. Our next question comes from the line of Alexia Howard with Bernstein. Please proceed with your question.

Alexia Howard, Analyst

Good morning, everyone, and congratulations to all. Thank you for your contributions. My first question is about regaining lost distribution in U.S. retail channels. It appears that a number of smaller retailers dropped off due to supply chain disruptions. As you work on rebuilding that distribution, where do you stand in the process? Can you estimate how much of a boost this could provide over the next year to 18 months?

Brendan Foley, President and COO

Well, Alexia, thank you for the question on TDPs and overall distribution. First of all, I'd like to say, we continue to make really good progress year-to-date. And as we look at our performance and our trends and all the different metrics we might look at, we're happy to see that come through as a positive, especially in the second quarter. We do expect to see continued progress as we go into the back half. We have some significant improvements that we know will start to come online just because as customers reset their shelves, and those things start to happen. A lot of the wins that we get through category management and all of that really important effort we put forth in terms of helping the retailer guide the category. We know that there's going to be some helpful improvements coming through on that as we move through ‘23 and also into ‘24. I'm reluctant to quantify all that as we think about that into the back half of 2023 and all the way into 2024. But this is an effort, as we've said before, that we're going to continue to work on over the course of not only this year but also next year. As we look at overall distribution, we know that we're not going to get all of that back in terms of rough points because almost half of that was discontinuations originally. So we feel really good about our progress right now in overall distribution points, and it should continue to improve as we go through 2023 and into 2024.

Lawrence Kurzius, Chairman and CEO

And Alexia, as I said on our last quarterly call, we have a tremendous amount of innovation. On top of that, the restoration of our U.S. Everyday spice line is starting to hit the market in Q2 and build through the second half of the year. All of those hands on the shelf give us opportunities to get a more advantageous set and a greater amount of distribution on the shelf. We have a number of major customer wins that we talked about in the first quarter that are going on shelf in Q3, which should further build on TDP. So we're pretty confident continuing to see improvement in those areas we have through the year.

Mike Smith, Executive Vice President and CFO

And then with our brand marketing, we’re going to be increasing our mid-single-digit investment in the second half. A lot of that is going to support those plans.

Alexia Howard, Analyst

Great. And as a follow-up, can you just give us an overview of the one-time costs that are going to be eliminated by 2024? I seem to remember you have two plants running in the U.K. as you transition there. There are co-manufacturing costs here in the U.S. Just an idea of how much more there is to come out that's one-time from recent events?

Mike Smith, Executive Vice President and CFO

We have ongoing operational costs in our EMEA region due to our new large facility there. I mentioned in the last call that we expect these costs to be around $20 million for this year, similar to last year. We will continue to incur some costs next year during the first and second quarters of the transition, as these are substantial manufacturing facilities. If I had to estimate, I'd say about half of those costs will be eliminated, but the timing may vary.

Lawrence Kurzius, Chairman and CEO

And of course, our GOE program continues next year.

Mike Smith, Executive Vice President and CFO

Yes, yes. We'll see a nice wrap into 2024 from that.

Alexia Howard, Analyst

Great. Thank you very much. I’ll pass it on.

Operator, Operator

Thank you. Ladies and gentlemen, our final question comes from the line of Steve Powers with Deutsche Bank. Please proceed with your question.

Steve Powers, Analyst

Great, good morning. And congratulations to everyone as well from me. Two questions both related to Flavor Solutions. The first one, in part as a follow-up to the topic that Ken Goldman had raised, just around inventory dynamics. We've heard various discussions of potential customer destocking from a Flavor Solutions perspective, as well from different pockets of the industry. I was just curious to see if that's at all impacting you or if you expect it to impact the business over the second half of the year?

Brendan Foley, President and COO

Steve, thank you for your question. Regarding our Flavor Solutions business, our current volume mix profile reflects our focus on categories like performance nutrition, seasonings, and health and nutrition. We continue to see strong growth in these areas, which we have deliberately prioritized. I can't comment on specific customer activities, but we believe our volume profile represents the overall composition of our business. At this time, we are not seeing widespread discussions about restocking with our customers.

Lawrence Kurzius, Chairman and CEO

I’ll also agree that with a lot of customer wins, we believe we’re gaining share in this space, and that’s a positive contributor for us as well.

Mike Smith, Executive Vice President and CFO

A lot of our growth in flavor solutions comes from innovations too. And those are the things that really drive volume and margin in Flavor Solutions.

Steve Powers, Analyst

Okay, great. Great. And then my second question, actually, a good segue, is on the margin front. Just because you continue to trend well ahead of at least our expectations year-to-date on Flavor Solution's margin recovery. And I guess if you think about that forward, maybe I was wondering if you could just frame for us how much or whether you expect further progress on that front in the second half. Any updates as to how the progress you’re making here year-to-date influences how you think about that build back to pre-pandemic levels or higher as you look out over the longer term?

Mike Smith, Executive Vice President and CFO

Yes, we are very pleased with our margin progress. As we mentioned on the call, everything is moving in the right direction, including the GOE program and portfolio optimization, which are benefiting both the Consumer and Flavor Solutions segments. As I noted in the last call, pre-pandemic, our Flavor Solutions margins were slightly above 14%. We don’t see that as a ceiling. In the long term, with portfolio migration, we anticipate going higher. In the short term, we are confident we will return to 14%, though it won't happen this year. However, we expect to see sequential improvement, with some quarter-to-quarter variations based on run costs and operational efficiencies. We had a strong second quarter, and while it was an easier comparison to last year's Q2, we remain optimistic about Flavor Solutions’ recovery.

Lawrence Kurzius, Chairman and CEO

And I will just add to that, just if I can step it up to the total company level, it's hard not to be excited about the 280 basis point expansion in operating margin that we had this quarter. We're really moving in the right direction in both of our segments in a big way. And we’ve all seen that we raised OP guidance for the year; it’s a long time on the back of that margin improvement. We’re very pleased with our progress in this area.

Steve Powers, Analyst

Great, thanks for that, and congratulations again.

Operator, Operator

Thank you. Our next question comes from the line of Max Gumport with BNP Paribas. Please proceed with your question.

Max Gumport, Analyst

Hey, thanks for the question. And congrats, everyone. I want to return to the gross margin question with regard to the second half. So it was nice to see the better-than-expected gross margin expansion in the quarter. And when I look at the updated guidance range, it would seem to imply that versus pre-pandemic basis, so whether that means fiscal year '18 or fiscal year '19, that we actually see some reversion in your progress towards gross margin recovery. I'm trying to tie what's implied by that guidance range versus what we're hearing in terms of cost savings ramping up, pricing catching up to inflation, and supply chain improving. All of which I would have thought could lead to gross margins continuing to move closer to pre-pandemic levels as we go through the year. And I do recognize that 3Q and 4Q are big quarters for you, and there's probably some prudence embedded in this outlook, but I just wanted to get some clarity on that point.

Mike Smith, Executive Vice President and CFO

Yes. It's important to remember, Max, that when pricing to cover costs over several years, there will be a significant dilution impact due to the math involved. We noted that this was a significant challenge last year, estimating it to affect margins by 200 to 300 basis points. Although we haven't discussed it much this year, we are still experiencing some of that effect. However, we expect to recover over time through our CCI programs and more typical cost inflation moving forward. Comparing gross margin from four years ago at this point is tricky, as much of it is due to dilution, but we are seeing an upward trend, especially noted in the second quarter. What excites me is that, even while we are catching up on pricing that we have not adequately addressed over the past two years, we still anticipate a positive gross margin impact attributed to the GOE and CCI programs. This gives us confidence as we move ahead.

Max Gumport, Analyst

Got it. Understood. And then turning to the recovery in your TDPs and U.S. spices and seasoning, so it's been nice to see that, and the scanner data that we all track does seem to be approaching flat year-over-year performance. But we're not seeing a pickup in dollar share yet as significantly, and I would think there should be some natural act because as you get the distribution points, maybe then you can start to advertise and bring back the brand building more fully as you've flagged today. Is that the right way to think about it? Should we start to see a more full improvement in dollar share as we move through the year in terms of the trends?

Brendan Foley, President and COO

Yes. Our current trends indicate sequential sales unit and volume improvement across the portfolio, particularly in spices and extracts in the Americas. This reflects the long-term tailwinds of our categories and our growth plans. We are continuing to invest in brand marketing, focused category management, and innovation, enabling us to prioritize volume and sustainable growth, while also benefiting from the compounding effect of these investments. I expect this profile to improve in the second half of the year. Additionally, we anticipate an improvement in dollar share as we see favorable trends in TDP. Our performance is currently driven by increased distribution, brand marketing, category management, and innovation, and we are observing a similar trend in Europe. These are key areas of focus for us. I share the sentiment expressed this morning that everything is moving in the right direction, and we feel the same way about our external performance off the shelf.

Lawrence Kurzius, Chairman and CEO

And I don't want to miss that there are big gains as noted, and we've got share gains in Europe, we've got share gains in Australia and Asia. And we have share gains in our other categories. The spices and seasonings category, certainly in the U.S., is certainly an important area of focus and justifiable. So we're confident that we're going to get there. We're following the same playbook as we've said at CAGNY that we did for recipe mixes and believe that we're going to get to the same with that.

Max Gumport, Analyst

Great. Thanks very much.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Kurzius for any final comments.

Lawrence Kurzius, Chairman and CEO

Thank you. Well, before we end, I'd like to let all of you in the analyst and investor community know I have appreciated the opportunity to tell you about McCormick, our great company, and for the insights and the perspective you've provided me, which helped shape our strategies and clarify our messaging. You have all really helped me be a better CEO. Whether you have a buy, a hold, or sell on us, and whether you've even held our shares, our many interactions have been transparent, constructive, and always mutually respectful. I want to thank you all, and I'm confident McCormick is well positioned for continued success with our alignment to consumer trends, the breadth and reach of our portfolio, as well as our strategic growth investments. We have a strong foundation for sustainable growth and remain committed to driving long-term value for our shareholders.

Kasey Jenkins, Chief Strategy Officer

Thank you, Lawrence, and thank you to everyone for joining today's call. If you have any further questions, please feel free to contact me. And as we enter the summer season and for some of you in the U.S., the 4th of July and Canada, don’t forget to fire up those grills with McCormick products. This concludes this morning's conference call.