Earnings Call Transcript - MKC Q1 2022

Kasey Jenkins, Senior Vice President of Corporate Strategy and Investor Relations

Good morning. This is Kasey Jenkins, Senior Vice President of Corporate Strategy and Investor Relations. Thank you for joining today's first 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'll 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 statements on Slide 2 for more information. I will now turn the discussion over to Lawrence.

Lawrence Kurzius, Chairman, President and CEO

Good morning, everyone. Thanks for joining us. Before I go to business, it is with great sadness that I mention the passing of Buzz McCormick, who is one of the most beloved and admired leaders in McCormick's history. Buzz's career at McCormick spanned 50 years, rising through the ranks across many functions, becoming President and CEO in 1987 and serving as Chairman of the Board for a total of 11 years until his retirement for the third time in 1999. As CEO, Buzz focused McCormick on flavor by divesting noncore businesses and driving category leadership in spices and seasonings, setting the course for McCormick to be the global leader in flavor. Notably, McCormick's market cap grew by 4x under his leadership. Buzz will not only be remembered for his enduring legacy of performance but just as importantly, for his deep commitment to the well-being of all McCormick employees. He truly made McCormick a great place to work, leaving his biggest accomplishment as a CEO to be helping all McCormick employees have a better life. Today, as we reflect on his life and its contributions, we know that his legacy will live on. He has inspired many generations of McCormick leaders with his passion for people, focus on flavor, and commitment to delivering shareholder value. Next, I'd like to comment on the situation in Ukraine. First and foremost, we extend our deepest sympathies to the people of Ukraine and hope for an immediate end to the conflict and the suffering of innocent people. As we previously announced, we suspended our operations in Russia in mid-March. Our operations in Ukraine have been paused to focus on the safety of our employees and their families. Our thoughts are with the people impacted by these tragic events, particularly our employees, who we continue to support through aid in humanitarian efforts we're donating to the Polish Center for International Aid and the World Centre for Pigeon. I would also like to express my sincere appreciation to our EMEA employees, especially those in Poland, for their many personal efforts in aiding their Ukrainian neighbors in need. Their actions epitomize our power of people principle. Now moving to Slide 4 and our business results. We delivered solid financial results in the first quarter, in line with our expectations, driven by the successful execution of our strategies and the engagement of employees. We are confident our strong year-to-date momentum will continue to drive strong performance throughout 2022. In the first quarter, we grew sales 3% or 4% in constant currency on top of our 20% constant currency growth in the first quarter of last year, demonstrating again the strength of our product offering and broad global portfolio, which drives differentiated growth and consistency in our performance. Consumer segment sales, while lapping high year ago demand, continued to reflect the sustained shift to higher at-home consumption compared to pre-pandemic levels. Our Flavor Solutions segment growth was driven by outstanding growth with our packaged food and beverage customers as well as robust demand from restaurants and other foodservice customers, due in part to recovery from curtailed away-from-home dining in the year ago period. Through the breadth and reach of our balanced flavor portfolio, we are meeting the global demand for flavor and delivering flavor experiences for every meal occasion through our products and our customers' products; we are end-to-end flavor. Adjusted operating income was down 14% or 12% in constant currency, and adjusted earnings per share was down 13%. As anticipated, the profit driven by our sales growth was more than offset by the well-known and anticipated effects of higher inflation and broad-based supply chain challenges. We have a demonstrated history of successfully navigating through a volatile environment, and we expect to do the same through this high current inflationary period using pricing and other levers to offset cost pressures, which is reflected in our 2022 profit outlook. Now for more on our first quarter segment performance. Starting with the Consumer segment on Slide 5. Growth in the Americas was more than offset by lower sales in the EMEA and APZ regions. Total Consumer segment sales declined 2% against 35% consumer growth in the first quarter of 2021. Given the difficult year-over-year comparison, volume declines were reflected in each region. On a 2-year basis, however, compared to the first quarter of 2020, each region grew sales by double digits. This growth highlights the strength of our categories and importantly, our products as consumers continue to cook more at home, and demand for flavor continues to grow. The pricing actions we have taken were also reflected in each region's results, and the elasticity impact we experienced has been lower than historical levels. As we look ahead, as our additional pricing actions are phased in, the elasticity we experienced may change, and this could be a cumulative effect, but we still expect the impact to be lower than historical levels. Turning to 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 2%, which follows a 15% consumption increase in the first quarter of 2021. This is the eighth consecutive quarter of double-digit consumption growth versus the 2-year ago period. Demand has remained high, and we continue to realize the benefit of the manufacturing capacity we added, as well as our increased resilience. Our first quarter shipments were in line with consumption; however, some products remain stretched by sustained high demand. Shelf conditions continue to improve, as does our share performance, with another sequential improvement in the first quarter as we expected. Versus last year, we are beginning to grow our spices and seasoning share, and in recipe mixes, we had another quarter of considerable share gain of over 4 share points. We continue to see further improvement as we begin the second quarter, and we are confident in our continued momentum. In EMEA during the first quarter, we lapped high prior year demand, partially due to restrictions resulting from COVID resurgences last year while continuing our momentum with strong consumption growth in key categories compared to the first quarter of 2020. Our market share performance was stronger this quarter. We maintained our total EMEA region herb, spices, and seasoning share on top of strong gains in the first quarters of the last 2 years. Of note, Frank's RedHot has grown consumption 60% and gained significant share versus the 2-year ago period. And in the Asia Pacific region, first quarter growth was tempered by scaled down Chinese New Year celebrations due to several cities in China imposing restrictions as a result of new COVID outbreaks. These restrictions impacted our branded foodservice demand that is included in the consumer segment in China. Turning to Slide 6. Our Flavor Solutions segment grew 12% or 14% in constant currency, driven by base business growth, new products and one month of incremental sales for our acquisition of FONA in December 2020. All 3 regions contributed to our growth, each with higher volume and product mix as well as the pricing actions to partially offset costs. Our first quarter Flavor Solutions results reflect similar market conditions across the region. As a reminder, our customer base in the Americas is skewed more to packaged food and beverage customers and in EMEA and APZ to quick service restaurant or QSR customers. Our differentiated customer engagement and technical capabilities continue to drive outstanding growth, both in base business and with new products, with our packaged food and beverage customers or at-home customer base. Our performance with these customers led our first quarter Flavor Solutions results with double-digit growth in flavors for Performance Nutrition and health end market applications as well as savory snacks. And our momentum with flavors for alcoholic beverages also continued. Our QSR momentum has been strong with core menu items and limited time offers driving first quarter growth, and other restaurant business continues to rebound. Our first quarter results also reflect the lapping of curtailed away-from-home dining last year. The restaurants are benefiting from the shift to takeaway and delivery that was amplified by the pandemic. There's been a blurring between channels, with most of the restaurant food being consumed off-premise. For instance, one in four dinners consumed at home was supplemented with a restaurant or other foodservice items. For our other institutional foodservice customers and our branded foodservice product category, we expect some recovery coming into 2022, and we saw that demand strengthen in our first quarter and drive growth in the Americas and EMEA regions. Now I'd like to share some comments on our momentum and the growth initiatives we have underway. Turning to Slide 7. Global demand for flavor remains the foundation of our sales growth, and we have intentionally focused on great fast-growing categories that will continue to differentiate our performance. We are capitalizing on the long-term consumer trends that accelerated during the pandemic, healthy and flavorful cooking, increased digital engagement, trusted brands, and purpose-minded practices. These long-term trends and the rising global demand for great taste are as relevant today as ever with the younger generations fueling them at a greater rate. Our alignment with these trends, in combination with the breadth and reach of our global portfolio and the successful execution of our strategies sustainably positions us for future growth. In this current dynamic global environment, we remain focused on long-term sustainable growth. We continue to experience cost pressures from higher inflation and broad-based supply chain challenges. To partially offset the rise in costs, we raised prices where appropriate late last year and are currently facing additional pricing actions. And as costs have continued to accelerate, we will raise prices again this year where appropriate. We appreciate our customers working with us to navigate this environment. Additionally, our plans to mitigate cost pressures include our CCI-led cost savings, revenue management initiatives, and taking prudent steps to reduce discretionary spending where possible. Throughout our history, we have successfully grown and compounded our growth regardless of the environment and plan to do so again in 2022 as we continue to accelerate our momentum and drive growth from a position of strength. In our Consumer segment, across our major measured markets, we have gained millions of households over the last 2 years and had double-digit buyer rate growth. Our brands have gained new consumers, and we have driven increased usage at the same time. This performance, combined with billions of additional at-home eating occasions from consumers cooking more at home, has created a new baseline for growth. We are continuing to drive our consumer segment momentum by accelerating flavor usage, including delivering on the demand for heat, building confidence in the kitchen and inspiring flavor exploration. We're also strengthening our consumer relationships at every point of purchase and creating a delicious, healthy, and sustainable future. We are fueling growth through our brand marketing investments, category management initiatives, and new products. Our brand marketing is resonating with consumers, particularly as we connect with them online. And as we expand the capabilities of our marketing excellence organization globally, we're gaining efficiencies, executing with greater speed and shifting our investments to work in dollars to drive greater effectiveness. Our U.S. spice aisle reinvention is further driving our category leadership with growth for McCormick and our customers. This initiative is continuing this year with additional stores being implemented, and we're also starting to build momentum with similar initiatives in Canada, the UK, and France. Our consumer new product innovation differentiates our brands and strengthens our relevance with our consumers. Our new products are focused on what’s important to consumers, such as freshness, modern packaging, convenience, and flavor exploration, as well as affordability and value. 75% of global consumers find it more economical to cook at home. And in the current inflationary environment, it resonates even more now. Our products are already part of the consumer solution to manage inflation across their whole grocery basket. For instance, inflation is hitting the meat case hard and a little bit of our flavor can make less impressive meat more palatable and make the consumer's whole meal both more affordable and flavorful. We have products at all price points that attract many types of consumers and households as well as different income levels. We continue to focus on ensuring we're launching new products that appeal to all types of consumers, such as additional entry-level price points for affordability as well as value offerings, including larger sizes to meet the needs of price-conscious consumers. And with our new products and recipes tailored to popular new appliances such as air fryers and Instant Pot, we are providing consumers flavor inspiration and greater convenience when using our products. In our Flavor Solutions segment, we plan to continue migrating our portfolio to more value-added products and technically insulated products, particularly in our Flavor product category. We're targeting opportunities to grow with our customers in attractive, high-growth end markets such as alcoholic beverages, savory snacks, and Performance Nutrition. We have been outpacing the market growth in these categories. They all contributed towards a strong growth in our first quarter results and further migrated our portfolio. Following a record year of new product growth last year, we are excited about our robust 2022 pipeline of culinary-inspired innovation. We are leveraging our broad technology platform to develop clean label, organic, and better-for-you solutions to some of our customers' issues without compromising on taste. We're using Sage, our AI-enabled product development tool, to develop consumer-preferred flavors at an increased speed that have a track record for lasting longer in the market for our customers. And we are building a pipeline of opportunities to accelerate our global seasoning growth by expanding our mid-tier customer base being added to our core supplier list and strengthening our leadership in heat. We plan to continue to drive flavor solutions growth through differentiated customer engagement. We have a strong passion for creating a flawless customer experience. Across both segments, our installed sales and growth plans bolster our confidence in continuing our growth trajectory. We also recognize we are operating in a challenging global environment. Before Mike reiterates our guidance in a few moments, I'd like to comment on some current conditions. We will continue to monitor the situation in Russia and Ukraine very closely and adapt accordingly. Cost inflation has remained persistent with recent escalation in some areas such as transportation costs. And as such, we have raised our cost inflation guidance. It is now a mid to high teen increase. And in regard to COVID, as I mentioned earlier, there are new COVID restrictions being imposed in several cities in China. We are continually assessing the dynamics of these conditions as they evolve. We recognize there will be some near-term impact, which we expect to mitigate later in the year, in part with additional pricing actions. We are well positioned to deliver another strong year of growth and performance in 2022 and through the effective execution of our strategy and with robust operating momentum. In addition to delivering top-tier financial results, we are also committed to doing what's right for people, communities, and the planet. We recently released our 2021 purpose-led performance progress report, which highlights our key initiatives and the progress we are making, including our recent announcements on the update of our science-based targets, reduced greenhouse gas emissions by 2030, aligning with the United Nations 1.5 degree Celsius target, as well as our commitment to net zero by 2050. As we move forward in 2022, we are excited to continue to share our progress and success on all our purpose-led performance goals. Now for some summary comments on Slide 11, before turning it over to Mike. The combination of our strong business model, the investments we have made, the capabilities we have built, and the power of our people position us well to continue our robust growth momentum. We are in attractive categories and are capitalizing on long-term consumer trends that are in our favor. We are actively responding to changing market conditions, consumer behaviors, and customer needs while remaining forward-looking in an ever-changing environment. We have a strong foundation and are well equipped to navigate in today’s environment responding with agility to volatility and disruption while remaining focused on the long-term objectives, strategies, and values that have made us successful. Through the execution of our strategy that is designed to drive long-term value, we have grown and compounded that growth successfully over the years, regardless of the environment. Our fundamentals that drove that performance and our momentum and outlook are stronger than ever. McCormick employees continue to do a great job navigating a dynamic environment; their agility and teamwork drive our momentum and success, and I want to thank them for their dedicated efforts and engagement. Now I'll turn it over to Mike.

Mike Smith, Executive Vice President and CFO

Thanks, Lawrence, and good morning, everyone. Starting on Slide 13. Our top line growth continues to be strong. During the first quarter, we grew constant currency sales 4%, driven by pricing actions across both segments and incremental sales from our FONA acquisition. Consumer segment sales declined 2% in constant currency due to lapping high demand in all 3 regions last year, with a partial offset from pricing. On a 2-year basis, compared to the first quarter of 2020, constant currency sales grew 30% with double-digit growth in all 3 regions, reflecting the sustained shift to at-home consumption higher than pre-pandemic levels. On Slide 14, consumer sales in the Americas increased 2% in constant currency, driven by pricing actions, partially offset by lower volume of the product mix due to lapping last year's elevated demand. Branded products led the growth with strength in McCormick, Zatarain's, Stubb's, Otay, Simply Asia, Frank's RedHot, and French's, partially offset by a decline in private label. In EMEA, constant currency consumer sales declined 9% from a year ago, driven by lower volume and product mix, most significantly in Vahiné homemade dessert products due to lapping last year's high demand across the region. This decline was partially offset by pricing actions. Constant currency consumer sales in the Asia Pacific region declined 6%, driven by the exit of lower-margin business in India. China's consumer and branded foodservice demand, partially related to the Chinese New Year impact Lawrence mentioned earlier, also contributed to the decline. These declines were partially offset by pricing actions. Turning to our Flavor Solutions segment on Slide 17. We grew first quarter constant currency sales 14%, including a 2% contribution from incremental FONA sales in December. As a reminder, we acquired FONA on December 30, 2020. The remaining increase was driven by higher volume and product mix as well as pricing actions. Compared to the first quarter of 2020, constant currency sales grew 18%, with double-digit growth in all 3 regions. In the Americas, flavor solutions constant currency sales grew 12%, with FONA contributing 2% and the remaining growth due to both pricing and the combination of volume and product mix. Higher sales to packaged food and beverage companies, with particular strength in snack seasonings, led the growth with the recovery of demand from branded foodservice customers also contributing. In the EMEA, we drove 24% constant currency sales growth with a 17% increase in volume and product mix and 7% related to pricing actions. EMEA's growth was led by the robust recovery of demand from QSRs and branded foodservice customers. In the Asia Pacific region, Flavor Solutions sales rose 5% in constant currency, driven by pricing actions and growth from higher volume and product mix. This growth was driven by our QSR customers, both in their core menu items as well as their limited-time offers and promotional activities. As seen on Slide 21, adjusted operating income, which excludes transaction and integration costs related to the Cholula and FONA acquisitions as well as special charges, declined 14% or in constant currency, 12% in the first quarter versus the year-ago period. Adjusted operating income declined 12% in the Consumer segment with minimal impact from currency. And in the Flavor Solutions segment, it declined 17% or 11% in constant currency. Both segments were unfavorably impacted by higher inflation and distribution costs, both of which accelerated in the second half of last year, as well as incremental investment spending on our ERP program, which we expected to be higher earlier in 2022 versus 2021. CCI-led cost savings favorably impacted both segments. In the Consumer segment, lower sales, partially offset by a reduction in COVID-19-related costs also contributed to the decline. In the Flavor Solutions segment, higher sales were more than offset by the unfavorable drivers I just mentioned as well as costs related to supply chain investments, which will continue in the second quarter. As seen on Slide 22, adjusted gross profit margin declined 260 basis points in the first quarter versus the year-ago period. This was driven by the net impact of cost pressures we are experiencing and the pricing actions we have taken. We estimate the dilutive impact of pricing to offset this dollar inflation increase was approximately 200 basis points in the first quarter. Additionally, a sales shift between segments also contributed to the margin decline. Our selling, general and administrative expense as a percent of net sales increased 20 basis points from the first quarter of last year due to higher distribution costs and a higher level of investment in our ERP program. This, combined with the adjusted gross margin compression, resulted in an adjusted margin decline of 280 basis points, in line with our expectations. Turning to income taxes on Slide 23. Our first quarter adjusted effective tax rate was 19.7% compared to 22.7% in the year-ago period, driven by a higher level of discrete tax items this year. Adjusted income from unconsolidated operations declined 30% versus the first quarter of 2021 due to the elimination of higher earnings associated with minority interest, as well as higher inflation costs impacting our McCormick de Mexico joint venture. At the bottom line, as shown on Slide 25, first-quarter 2022 adjusted earnings per share was $0.63 as compared to $0.72 for the year-ago period. The decrease was driven by our lower adjusted operating income. On Slide 26, we've summarized highlights for cash flow and the year-end balance sheet. Our cash flow from operations was an inflow of $18 million in the first quarter of 2022, compared to an outflow of $32 million in the first quarter of 2021. This increase was primarily driven by working capital improvements and lower payments for transaction and integration costs related to our Cholula and FONA acquisitions. We returned $99 million of cash to our shareholders through dividends and used $44 million for capital expenditures this quarter. We expect 2022 to be a year of strong cash flow, driven by 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. Now turning to our 2022 financial outlook on Slide 27. First, I would like to provide some additional perspective on some of the current conditions Lawrence mentioned earlier. As we have said, we are currently not operating in Russia and Ukraine. And while the impact is not fully known, our business in these markets is small, with the combined sales across both segments totaling less than 1% of total company sales last year. Additionally, we have no manufacturing in either country. Any operating profit impact would include those related to the impact on sales as well as potential expenses stemming from the current situation. Regarding cost inflation, we are revising our outlook and are now projecting inflationary pressure in the mid- to high teens, as compared to mid-teens increases in our previous guidance. We expect cost inflation to remain persistent, especially as it relates to transportation, and we are continuing actions to mitigate these costs, including pricing. Again, as Lawrence mentioned, we recognize these dynamics will have some impacts on our results, certainly in the second quarter. While we continue to monitor impacts on the broader economy and will adapt as necessary, we are reiterating our 2022 sales and profit outlook that we previously shared in our January earnings call. We are projecting strong top line growth and operating performance with earnings growth partially offset by a higher projected effective tax rate. We also expect there will be an estimated 1 percentage point unfavorable impact of currency rates on sales, adjusted operating income, and adjusted earnings per share. On the top line, we expect to grow constant currency sales 4% to 6%. We expect pricing to be a significant driver of our growth with volume and product mix to be impacted by elasticities, although at a lower level than we have experienced historically. We plan to drive growth through the strength of our brands as well as our category management, brand marketing, new product, and customer engagement growth plans. Our volume and product mix will also continue to be impacted by the cooling of lower-margin business from our portfolio. Our 2022 adjusted gross margin is projected to range between comparable to 2021 to 50 basis points lower than 2021. This adjusted gross margin compression reflects the anticipated impact of a mid- to high-teens increase in cost inflation, an unfavorable impact of sales mix between segments, a favorable impact from pricing, and CCI-led cost savings. As a reminder, we price to offset dollar cost increases; we do not margin up. This has a dilutive impact on our adjusted gross margin and is the primary driver of our projected compression. We expect to grow our adjusted operating income 8% to 10% in constant currency, which reflects our robust operating momentum, a reduction in COVID-19-related costs, and our continuing investment in ERP business transformation. This projection includes inflationary pressure in the mid- to high teens, a low single-digit increase in brand marketing investments, and our CCI-led cost savings target of approximately $85 million. As we shared on our last earnings call, we expect our profit growth to be weighted to the second half of the year. During the second quarter, we are phasing in pricing actions, and with costs continuing to escalate, we'll raise prices again as appropriate. While we plan to cover the cost pressures due to the recent acceleration of inflation, there will be a lag. And as a result, our profit will now be weighted to the second half of the year, even more than originally expected. And as a reminder, we expect our ERP investment to be higher earlier in the year versus 2021. Our 2022 adjusted effective income tax rate is projected to be 22% to 23%, based upon our estimated mix of earnings by geography, as well as factoring in a level of discrete impacts. This outlook, versus our 2021 adjusted effective tax rate, is expected to be a headwind to our 2022 adjusted earnings per share growth of approximately 3%. Our 2022 adjusted earnings per share expectations reflect strong operating growth of 8% to 10% in constant currency, partially offset by the tax headwind I just mentioned. This resulted in an increase of 4% to 6% or 5% to 7% in constant currency. Our guidance range for adjusted earnings per share in 2022 is $3.17 to $3.22 compared to $3.05 of adjusted earnings per share in 2021. In summary, we are well positioned with our broad and advantaged flavor portfolio and effective growth strategies to continue to accelerate our operating momentum and drive another year of strong growth and performance.

Lawrence Kurzius, Chairman, President and CEO

Thank you, Mike. Now that Mike has shared our financial results and outlook in more detail, I would like to recap the key takeaways as seen on Slide 28. We delivered solid first quarter results in line with our expectations, with strong sales growth on top of our 20% constant currency growth last year. We are confident that the hard work and dedication of our employees will continue to drive momentum. We recognize we're operating in a challenging global environment. Through the execution of our strategies, we've successfully grown long-term value over the years regardless of the environment. Our long-term fundamentals that drove our performance are stronger than ever. The strength of our business model, the value of our products and capabilities, our alignment with long-term consumer trends that are in our favor, and the attractive categories we are in provide a strong foundation for long-term sustainable growth. We're confident that our broad and advantaged flavor portfolio, our robust operating momentum, and effective growth strategies will drive another year of strong growth in 2022 and build value for our shareholders. Now let's turn to your questions.

Operator, Operator

And our first question today will be coming from the line of Andrew Lazar with Barclays.

Andrew Lazar, Analyst

McCormick reiterated its full year outlook, right, despite a worsening in inflation outlook and still dynamic operating environment. And as you noted, now requires an even more significant margin inflection in the back half of the year to stay within sort of your full year gross margin guidance. So I was hoping you could speak a little bit to what gives you the visibility that is playing out. And I know you detailed some items on the last call, such as pricing and lapping COVID costs, smoother cadence of ERP spend, and CCI savings and such. So perhaps you can remind us of these and share if there are any additions or changes to the above?

Lawrence Kurzius, Chairman, President and CEO

Thanks, Andrew. I'll start on this and then let Mike follow up and talk about those specific items. But first of all, I want to emphasize that first quarter is really right up in the middle with our expectations. And it all starts with strong demand and strong top line performance. We expect to see continued strong demand as we go through the year. And as we go through the second quarter, in particular, more pricing action goes into effect, which on top of that strong demand and with the relatively low elasticity that we're seeing will translate into both strong top line and strong bottom line growth in the second half of the year. This is in line with the guidance that we talked about on our last call at the end of last year when we gave guidance for the year initially. Mike, you want to talk about those specific guidance?

Mike Smith, Executive Vice President and CFO

Yes, I think the thing that's really changed since the first quarter for the year-end call when we talked about the inflation moving from mid-teens to mid to high teens. Really, there's been a bit of an acceleration in things like fuel cost that will impact our second quarter. But we see, on average across the year, that cost inflation around the same mid- to high single teens, but it's been moved forward into the second quarter. Pricing, though, is continuing to build, as Lawrence said. For the full year, before we said on the last call, mid- to high pricing impact, we're at the high end of that now. And actually, in the second half, we'll be in a low double-digit pricing impact range, which gives us more confidence about the second half profit realization. As you mentioned, there were some other factors. ERP spending is up in the first versus last year. Investments in supply chain, we just announced some of the transition of production over to the Peterborough facility in the UK. There are start-up costs that have hit us in the first quarter. There will be more of that in the second quarter, really hitting the Flavor Solutions segment. So we do see some of those negative impacts in Q2, but really feel confident about the second half with some of the actions that we've identified.

Andrew Lazar, Analyst

And then just quickly, you've talked about the capacity coming online. And I think you mentioned you shipped essentially or closer to consumption this quarter, so sort of making progress there, and we've seen that in the market share improvements. But it doesn’t sound like you’ve yet had the ability to sort of really rebuild retail or inventories. And I assume there's still some opportunity for that as you go forward through this year? And perhaps you could just update us on that.

Lawrence Kurzius, Chairman, President and CEO

I think that this is a work in progress. Supply chain continues to get better. It's not perfect, as some of our customers will remind us. But the disruptions that we are seeing are much more discrete and specific rather than the third quarter of last year, where it seemed like everything was a problem. So supply chain has gotten better, and our ability to meet that demand has really gotten better. And although I made that remark about certain customers a minute ago, the fact is our customers tell us that, generally, we are performing better than our competitive set, and this is allowing us to win new business. So we really feel pretty good about how that has improved. And I think you'll continue to see us build share performance consecutively as we have been for the last several quarters with our ability to supply, and that additional capacity coming on has really made the difference.

Operator, Operator

The next question is coming from the line of Alexia Howard with Bernstein.

Alexia Howard, Analyst

Can I ask, first of all, about the private label dynamics because we're looking at the level of price inflation really across the grocery store? And under normal circumstances, you would expect to trade down to private label. But I know that you mentioned that your private label sales are actually down year-on-year. I'm just wondering what's driving that. Is it supply chain related? Is it retail-driven? Or is it simply that consumers are feeling reasonably flush and able to afford the branded products? And then I have a follow-up.

Lawrence Kurzius, Chairman, President and CEO

Sure. I think two things. First of all, we have not yet seen significant movement in private label as a trend in either direction. Some of the recent market data shows some increase, but it's really slight in our categories. There's a dynamic you have to watch out for private label: the costs are going up for everybody. And it's driven by raw material, packaging, and transportation. The same penny cost increase that's impacting brands is also impacting private label. And so when you put that same amount of cost increase through to private label, the percentage of increase is bigger, and it creates an uptick of private label growing faster on a dollar basis. It's again, it's that cost pass-through. So I want to make that clear. The second point that I want to make, though, is that we believe there's a role for both our brand and private label, especially in the urban spice category, and we provide both to our customers and the best competitive environment for us as a company. It's when both our brand and private label are obtaining share, putting pressure on everybody else.

Alexia Howard, Analyst

Great. As a follow-up, the situation between Russia and Ukraine is very challenging right now. Can you share what percentage of your sales comes from that area? I believe it’s relatively low, but what do you see as the global risks if the situation continues? I’m talking about how previous commodity cycles have led to issues, such as the unaffordability of basic foods like bread in Egypt. Regarding your supply chain, based on past experiences with these grain cycles, are there specific ingredients that you think might face more challenges? I'm trying to understand the risks involved.

Mike Smith, Executive Vice President and CFO

Alexia, it's Mike. I'll start the answer. We have said in our 8-K that sales for Russia and Ukraine are less than 1% of our total sales. So that's grossed in. It will have an impact in the second quarter, obviously, because that's when the crisis has unfolded. As far as your question about broader impacts, primarily inflation, I think you've seen in the last couple of weeks and part of the reasons we've taken our inflation expectations up and discussed pricing is because of some of those impacts. From a commodity perspective, I mean, our market basket is a lot different than a lot of other food companies. I mean, there are products that could be impacted; we source mustard from that part of the world, but we have secondary sourcing capabilities there, which we've moved to. So I think our global supply chain, one of the strengths we have is it's deep and has a long history and there's alternative markets for a lot of our materials. And no one raw material makes up more than 5% of our total cost of goods sold. So I think that diversity really helps us.

Lawrence Kurzius, Chairman, President and CEO

And I would say we're less exposed to the grain complex. Most of our peer companies would be. I think our concern, and part of what we're considering in our inflationary outlook, is cost of energy, which now looks like it's going to remain higher than perhaps it might have otherwise. That flows through the packaging to the plastic resins and things like that.

Operator, Operator

Our next question comes from the line of an analyst with JPMorgan.

Unidentified Analyst, Analyst

Given the incremental cost pressures you're experiencing, is the year-on-year decline we noted in the first quarter gross margin something we should expect to continue in the second quarter? Or should we consider the first quarter to be the lowest point in this trend?

Mike Smith, Executive Vice President and CFO

I'd say between the first half and the second half, you're going to have that big change due to the pricing dynamic I mentioned before and some of the one-timers in the first 6. The things we've laid out as far as cost increasing versus our original expectations in the second quarter. I think it's probably a pretty good estimate that in that range of gross margin, what we did in the first quarter is probably close. We do have the additional Peterborough supply chain investment costs I talked about for dual running costs and things like that. So I don't think you're far out of the ballpark there.

Unidentified Analyst, Analyst

Great. That's helpful. I wanted to ask about pricing in the consumer EMEA region. Pricing has been relatively stable this quarter. Could you explain what we can expect in terms of pricing for this region as the year moves forward? What challenges, if any, do you foresee in adjusting pricing here?

Lawrence Kurzius, Chairman, President and CEO

We plan to adjust pricing as necessary, recognizing that inflation impacts and pricing levels will vary across different regions and countries. Each area may experience changes in timing for when these pricing adjustments will take effect.

Mike Smith, Executive Vice President and CFO

Even within the segments.

Lawrence Kurzius, Chairman, President and CEO

Even within our segments, I can say that broadly, our current pricing actions are very much on track. We have pricing going into effect in the second quarter in several markets. I know your question is about EMEA, but I want to be more specific about our U.S. consumer business because increases are going into effect this week for the next round. In our Flavor Solutions segment, the branded foodservice part of the portfolio aligns with consumer pricing. The rest of the flavor solutions business has pricing based on contractual windows, and the timing will vary significantly based on the windows for reassessing pricing. In EMEA and APZ, the pricing actions are on track and will be phased in through the first half of the year. Pricing is always an ongoing discussion, and we will not get too specific right now due to customer and competitive reasons.

Mike Smith, Executive Vice President and CFO

Yes, I think you'll see the same trends across the regions that pricing will build during the year.

Operator, Operator

Next question is coming from the line of Robert Moskow with Credit Suisse.

Robert Moskow, Analyst

Thanks for the question. I guess it's in two parts. I wanted to confirm what I heard about the level of pricing you think, Mike, that will show up in your P&L by the end of the year. I thought I heard you say low teens, but I could have gotten that wrong. Is it scaling up that much? And then the second part is, I think, Lawrence, you said that you're operating from a higher baseline because you brought in a lot of consumers to the franchise and the category has expanded perhaps structurally. But the category is declining in the U.S. modestly. It's declining a lot in Europe from what I can tell. Is there a risk here that as consumers regain more mobility and they're gaining it very quickly right now that the consumer category might not be at the right baseline, that there might be a lower baseline out there than what you would expect?

Lawrence Kurzius, Chairman, President and CEO

Rob, I think we'll start with the pricing.

Mike Smith, Executive Vice President and CFO

Let me address that. To clarify, we have indicated that our pricing guidance for the full year is expected to be in the mid to high single digits. Due to recent cost increases, we are leaning towards the high end of that range. It's a bit confusing, but we are talking about mid to high single digits, and we’re moving towards the high end due to some recent cost inflation that mainly affects the second quarter. Regarding the first half and second half of the year, particularly in the second half, we anticipate seeing low double-digit price increases that will accumulate in the third and fourth quarters. So, it increases over the course of the year, specifically in the second half, not for the full year.

Robert Moskow, Analyst

Yes. Yes. Okay. That's a big price increase in the back half of the year.

Mike Smith, Executive Vice President and CFO

Well, I think you're lapping and you're lapping last year in the Americas, particularly pricing in the fourth quarter last year. So you do get that cumulative impact of several price increases, three of them actually.

Robert Moskow, Analyst

Okay. And then the risk to the baseline?

Lawrence Kurzius, Chairman, President and CEO

Well, of course, there was elevated demand because consumers were forced to stay at home to cook. And we never expected all of it to remain. But we do believe that consumers have moved to a higher level of consumption and at a higher level of cooking at home structurally. All of our research points in that direction. Just the logic of people still cooking at home. And it starts from working from home in part. Lunch is going to be a meal occasion. That is consumed more at home. The breakfast because of work from home, people are actually cooking breakfast instead of using more ready-to-eat solutions. And there's kind of both the qualitative and the quantitative work at that point to say consumption at home is going to continue to remain elevated. I mean 88% of consumers say they're going to cook as much at home or as much or more at home than they did during the pandemic. To the extent there's economic pressure on us from a recession, that also reinforces the whole cook at home. And we know, in particular, our categories and our brands performed well during recessionary periods during both of the last two recessions. Our brand growth was right in line with our long-term guidance. We are seeing a difference in our consumer business in the U.S. versus Europe. But the biggest factor there is actually that in our European business, we have a significant component that is baking, particularly with our Botanical brand in France. And so we've seen baking return to more of a baseline level. But we do believe that there's been a step up in our other categories.

Mike Smith, Executive Vice President and CFO

Yes. I mean you just look at total McCormick consumer in the last two years, we were lapping a really tough quarter last year in Q1. We're up 30% in two years constant currency consumer sales. That's pretty amazing. That's that step-up that Lawrence was talking about.

Robert Moskow, Analyst

And maybe one last follow-up, if I could. If pricing is up low double-digit, let's say, it's like 12% in the back half of the year. It's probably not unheard of to expect a volume decline of like negative 5%, negative 6%. Is that close to how you're thinking about elasticity? Number one. And if volume is down that much, does that have any implications for your fixed cost leverage? Or what does it do to the rest of your P&L, if anything?

Lawrence Kurzius, Chairman, President and CEO

I'm not going to go into too much detail about our exact elasticity modeling, but we do consider elasticity in our analysis. The recent price increases are beyond what our models anticipated, and the current environment differs from the conditions under which those models were created. This puts us in somewhat uncharted territory. However, we have assumed a level of elasticity, and so far, the elasticity we are observing is at the lower end of our projections, which is somewhat encouraging. Elasticity tends to be related to how substitutable our products are, and since all prices are increasing, consumers' perceptions of relative preferences are also affected by the rising costs of substitutes. As we've mentioned in our prepared remarks and noted from consumer feedback, our products represent a small portion of overall meal costs and often play a role in addressing their grocery inflation concerns. For instance, while NIM is rising significantly, we are seeing a substantial increase in spice sales as consumers leverage higher quantities of spices to substitute lower-cost options, reflecting a shift in their purchasing behavior.

Mike Smith, Executive Vice President and CFO

Let's read about the fixed cost in our supply chain. I mean we manage ups and downs all the time. So if there happens to be some volume decrease, there's been a lot of large investment in capacity in the last couple of years, and we've gotten out a lot of these co-pack costs from COVID. So we would absorb that.

Lawrence Kurzius, Chairman, President and CEO

Yes. I would say that to meet the high level of demand, the volumes decreased a bit, which ultimately won't be beneficial for us.

Operator, Operator

Next question is coming from the line of Adam Samuelson with Goldman Sachs.

Adam Samuelson, Analyst

I would like to explore the growth in Flavor Solutions further, particularly regarding the performance in various segments. This area has a different comparison structure compared to the consumer segment, where we were previously dealing with easier comparisons in foodservice and quick service last year. Those comparisons are becoming more challenging now. Our packaged food clients, especially in North America, are likely facing similar demand elasticity issues that have been discussed. I'm interested in understanding how we should approach volume growth, whether by region or by different segments of the business, for the remainder of the year.

Lawrence Kurzius, Chairman, President and CEO

Flavor Solutions experienced strong growth across the entire company, particularly in the Americas and EMEA, while Asia Pacific showed slightly lighter growth, but it was still commendable. The food away from home segment lagged behind food at home overall, though results varied by region. Our flavor and seasoning business has been robust in the Americas, significantly contributing to the overall growth. The recovery of quick service restaurants remains strong, and branded food service is now reopening, leading to solid growth in that area. It's difficult to identify any areas of stagnation in our growth.

Mike Smith, Executive Vice President and CFO

Yes, we are not only benefiting from the long-term trends but also securing new business. One acquisition has unlocked opportunities within the flavor business and some rapidly growing categories, which we discussed at CAGNY. Overall, there are many positive trends in Flavor Solutions.

Adam Samuelson, Analyst

I understand your point. I'm considering how the volume comparisons are quite different from the activity levels in our consumer business. I'm particularly focusing on the potential risks of slower economic growth, especially in EMEA, along with the COVID lockdowns in Asia, particularly in China. I'm curious about how you perceive that business as we approach the remainder of the year.

Mike Smith, Executive Vice President and CFO

I believe all companies are facing challenges like this. However, during times when other packaged food companies are working on innovation and looking to reduce costs, we have an opportunity to collaborate with them, given that our products make up a small portion of their total sales to consumers. Therefore, I'm not overly worried about the elasticity they are experiencing. As you noted, we represent a minor part of the meal, whether in branded foodservice or as a snack seasoning.

Lawrence Kurzius, Chairman, President and CEO

And on China specifically, we're monitoring the situation. However, there are always ups and downs in business pressures. What we are observing so far falls within that range.

Operator, Operator

If I could quickly address the point about commodity cost inflation, I understand that your basket looks different from many other food companies. Your diversity is notable, particularly with the seasoning herbs sourced from emerging market growers, many of whom are smallholder farmers. Can you explain how you approach contracting with these growers? Specifically, how do you determine pricing with them throughout the year? I am curious about the impact of significant input cost inflation on the prices you are paying for these commodities and whether this is more of a 2023 concern as we consider their rising costs in relation to your returns.

Mike Smith, Executive Vice President and CFO

I think the impact we’ve discussed, particularly recently, is primarily related to transportation and packaging. There are exposures to resin and oil costs, among other factors. We have a long-standing history of relationships with partners and joint ventures that help secure commodities over time. Our balance sheet shows that we currently have more raw materials than we did last year, which is part of how we safeguard our future supply.

Lawrence Kurzius, Chairman, President and CEO

Right. And I think that we couldn’t get into too much detail here. I would say that our global sourcing and our foods on the ground and our long relationships with producers in these markets, and kind of the strategic partnerships that in some cases are multigenerational, have really advantaged us in this area, and this has actually been an area where I think that we've demonstrated tremendous competitive advantage and is giving us some buffer, and I think that others are probably experiencing even greater cost inflation pressure for some of these same components. It is an area where scale really matters.

Operator, Operator

Our next question is from the line of Steve Powers with Deutsche Bank.

Steve Powers, Analyst

Perhaps, building on your comments in response to Alexia's question on private label and Rob's questions as well, it seems there's an increased focus in your comments this morning on entry price points for affordability, maybe that just limited private label, but generally and value offerings such as the larger pack sizes. I guess I just want to validate that I'm picking up on a fair evolution in tone since the start of the year, number one. And then number two, maybe some comments around how that's altered your outlook for volume versus product mix alongside the increases in pricing. Clearly, you haven't altered the top line outlook and you've mentioned the incremental price anticipated, so we can solve for the difference. But within that, I'm curious how you're thinking about volume versus mix trade-offs. It sounds like you expect the response to skew more towards mix versus a unit volume decline. But I just want to validate that and would love some incremental thoughts.

Mike Smith, Executive Vice President and CFO

I'll begin by saying there's a lot to consider. The positive aspect of our consumer business is that whether customers are purchasing recipe mixes, bottles of spices, or Frank's RedHot Sauce, our margins remain strong. We have a diverse range of products that contribute to a high-margin business overall. I don't anticipate any significant impact from shifts in purchasing behavior. Historically, during recessionary periods like 2001 and 2009, our products have performed well, showing both volume growth and necessary price increases. While there may be a shift from gourmet items to more budget-friendly recipe mixes, our margins remain intact, and using a single pack of dry seasoning mix instead of a bottle can be beneficial for us. Thus, I believe the concerns you're expressing are unwarranted.

Lawrence Kurzius, Chairman, President and CEO

Yes, we're not trying to signal anything when we discuss this. We offer a complete range of price points, from super premium to mid-tier to entry price points. At a time when everyone is taking pricing actions, we also want to ensure that our products remain accessible to lower-income consumers and value-conscious shoppers. This is how we're striving to provide reassurance in that area. It's not an indication of a change or a shift in our strategy or focus.

Operator, Operator

Next question is from the line of Chris Growe with Stifel.

Chris Growe, Analyst

Just had a couple of quick questions. I think these have become pretty much follow-ups at this point, but just to be clear on a couple of points. Given the higher inflationary outlook, you mentioned you do have more pricing coming online in the second quarter. Is that new pricing? Or is that pricing that was expected to pick up from some of your actions, I think you put in place in the fourth quarter?

Lawrence Kurzius, Chairman, President and CEO

I can tell you that this pricing has been planned. These price increases were presented before our last call, so they are not new. The additional pricing we are planning for later in the year was also planned, and while we are finalizing the magnitude of that pricing, it remains flexible.

Chris Growe, Analyst

I want to clarify the cost inflation that is expected to accelerate in the second quarter. While pricing is indeed increasing, it appears there will be additional costs, including ERP and new facility expenses, that might prevent significant improvement in the gross margin sequentially. However, we anticipate that the second half will show improvement as more of the pricing takes effect. Is this the correct way to understand the relationship between pricing and inflation?

Mike Smith, Executive Vice President and CFO

For the second half, as I said, for the reasons you mentioned, but also the fact that, that cost acceleration for the fuel costs and things like that into the second quarter in addition to some of the things we made out before with some of the supply chain. So yes, you're right.

Lawrence Kurzius, Chairman, President and CEO

I would just say I think you got it.

Chris Growe, Analyst

Okay. Great. One quick question on Flavor Solutions. You talked about some strategic investment spending. Is that related to future demand? Or is that related to Peterborough, for example, are things you're moving around? I'm just curious what that referred to.

Mike Smith, Executive Vice President and CFO

That's primarily associated with the start-up costs in Peterborough and the ongoing redundant expenses there.

Operator, Operator

Our final question is from the line of Peter Galbo with Bank of America.

Peter Galbo, Analyst

Just wanted to circle back, I think, to some comments you made maybe a few years ago around China and make sure some of the numbers we're working with are still okay. But I believe, in the past, you've disclosed that China is sub-10% of the business. And I think about half of that business is away from home just as we're thinking about 2Q impact of potential walk-downs.

Lawrence Kurzius, Chairman, President and CEO

You're correct that it's less than 10%. I think that's accurate enough.

Mike Smith, Executive Vice President and CFO

Taking away from at homes, but

Lawrence Kurzius, Chairman, President and CEO

Yes, that's how I mean.

Mike Smith, Executive Vice President and CFO

Yes. You need to keep in mind that within our consumer business, we have products that are used in foodservice, which we classify as part of the consumer segment. This categorization is somewhat different from other regions because these products can be utilized in both channels.

Peter Galbo, Analyst

Sure. And as a follow-up, Mike, I know we’ve discussed the cost inflation and pricing issues, but I wanted to focus on how we reconcile the gross margin guidance for the year. Considering the challenges from Q1 and the impacts into Q2, along with the fact that the margins won’t improve when we raise prices in the latter half of the year, how do you still expect to achieve a gross margin that’s flat to down 50 basis points from where you are looking internally? Can you provide some clarity on that?

Mike Smith, Executive Vice President and CFO

You need to keep in mind that the first quarter is typically the smallest quarter. The latter half of the year is generally our largest quarter, which contributes to our positive outlook given the increased volumes and pricing we have experienced. We have discussed how these factors help mitigate some of the challenges we're facing. Additionally, we've highlighted initiatives at CAGNY and in our earnings call that will support us. People tend to overlook the decrease in COVID-related costs; we spent $60 million on COVID expenses last year, some of which still impacts our underlying business. This reduction provides us with significant support to counterbalance the segment mix and pricing pressures we've mentioned, which are primary factors. We are also engaging in revenue management strategies to pivot towards higher-margin products in both Flavor Solutions and Consumer segments. There are numerous factors at play affecting the full-year outlook, but after just one quarter, it is premature to make adjustments. Variables such as the situation in Ukraine and Russia, commodity costs, and pricing will influence our results. However, we feel confident in our current position.

Operator, Operator

I'll now turn the floor right to Lawrence Kurzius for closing remarks.

Lawrence Kurzius, Chairman, President and CEO

Great. Thank you. McCormick is differentiated by the breadth and reach of our balanced portfolio, which has positioned us for sustainable growth. We're very proud of our solid first quarter operating performance, our disciplined and our focus on the right opportunities and investing in our business. We're continuing to accelerate our momentum and drive further growth as we successfully execute on our long-term strategies, actively respond to changing consumer behavior, and capitalize on opportunities from our relative strength. We are well positioned for continued success and remain committed to driving long-term value for our shareholders.

Kasey Jenkins, Senior Vice President of Corporate Strategy and Investor Relations

Thank you, Lawrence. Thank you to everybody for joining today's call. If you have any further questions about today's information, please feel free to contact me. This concludes this morning's call. Have a nice day.