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McCormick &, Incorporated (NYSE:MKC)

Q4 2012 Earnings Call

January 24, 2013 8:00 am ET

Executives

Joyce L. Brooks - Vice President of Investor Relations and Member of Investment Committee

Alan D. Wilson - Chairman, Chief Executive Officer and President

Gordon M. Stetz - Chief Financial Officer, Executive Vice President, Director and Chairman of Investment Committee

Analysts

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

Thilo Wrede - Jefferies & Company, Inc., Research Division

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division

Robert Dickerson - Consumer Edge Research, LLC

Robert Moskow - Crédit Suisse AG, Research Division

Andrew Lazar - Barclays Capital, Research Division

Eric R. Katzman - Deutsche Bank AG, Research Division

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Erin Swanson Lash - Morningstar Inc., Research Division

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

Joyce L. Brooks

Good morning. This is Joyce Brooks, McCormick's Vice President of Investor Relations. Thank you for joining today's call to review the company's fourth quarter financial results and 2013 outlook. We have posted a set of slides to accompany today's call at our website, ir.mccormick.com. [Operator Instructions] A question-and-answer session will follow our remarks. [Operator Instructions] As a reminder, the conference is being recorded.

With me on today's call are Alan Wilson, Chairman, President and CEO; and Gordon Stetz, Executive Vice President and CFO. Alan is going to begin with comments on our fourth quarter results, followed by remarks about fiscal year 2012 and an outlook for 2013. Gordon will provide a more detailed review of our fourth quarter financial performance and financial guidance for 2013. After that, we look forward to discussing your questions and some closing remarks from Alan.

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 as a result of new information, future events or other factors. As seen on Slide 2, our forward-looking statement also provides information on risk factors that could affect our financial results.

It is now my pleasure to turn the discussion over to Alan.

Alan D. Wilson

Thanks, Joyce. Good morning, everyone, and thanks for joining us.

Our fourth quarter results enabled us to meet our 2012 objectives to grow sales 9% to 11% in local currency and deliver earnings of $3.03 to $3.08 per share. For fiscal year 2012, we grew sales 9% to reach $4 billion for the first time. This is double our sales of a decade ago. For the past 5 years, we've delivered a 6% compounded annual growth rate in sales at the top end of our long-term objectives.

Including the impact of our 2011 acquisitions, we increased sales in emerging markets, 47%, to reach 14% of 2012 sales. This is up from 10% of sales in 2011 and has moved us forward towards our goal of 20% of sales by 2015.

We continued to invest in product innovation. We expanded our facilities and capabilities in the U.K., Mexico, U.S., South Africa and early in January, celebrated the grand opening of our new state-of-the-art R&D facility in China. Our investment in product development led to the launch of more than 250 new branded products in 2012.

On the industrial side of the business, a move toward healthier products directed a significant portion of our development work with more than 30% of new product briefs globally having some wellness aspect.

We invested nearly $200 million in brand marketing support, twice what we spent in 2005. Globally, digital marketing was 12% of our total spending, up from 5% in 2010.

Slide 5 features some of our successes in this area beginning with a double-digit increase in our U.S. online traffic. We have similar progress underway in Europe as we align our digital presence to a common global framework.

Employees in our operations around the world achieved $56 million of CCI cost savings. This was a key step in our ability to manage through a period of high material cost inflation. And we generated significant cash in 2012.

Cash flow from operations reached a record $455 million. We returned $297 million to shareholders through dividends and share repurchases, a 25% increase from $238 million in 2011. In November, McCormick's board approved a 27th consecutive dividend increase, ensuring our place among approximately 60 companies in the S&P dividend aristocrats. We achieved these results as we continue to navigate a challenging environment and adapt to the pressures faced by today's consumers.

Clearly, employees throughout McCormick are driving our strategy to grow sales and profit by investing in the business and fueling that investment with our CCI program. I want to thank them for all their efforts and recognize their achievements.

In the fourth quarter, we had a mixed performance with strong results in some areas of the business and other parts that did not meet expectations. We're extremely pleased with our results in Europe, the Middle East and Africa, EMEA, with strong top line growth of 10% in local currency, including a 6% increase in volume and product mix. As 2012 progressed, our Consumer business team in EMEA gained traction with new product introductions and brand marketing support.

In addition, our merchandising effectiveness was recently recognized by a leading U.K. retailer that awarded McCormick top supplier of the year. We delivered 10% growth for this customer with our new merchandise and fixtures.

In our EMEA emerging markets, we continued to exceed expectations with the Kamis brand in the fourth quarter and grew sales to increase exports in the Middle East and Africa.

Our Industrial business in the EMEA had another outstanding sales performance backed by increases in branded food service items and higher demand from quick service restaurants across the region, as well as some distribution gains with these customers.

A third area that drove fourth quarter sales growth was our Asia Pacific Consumer business. We grew sales in China at a double-digit rate in local currency with increases across all categories.

While the Asia Pacific region had a strong sales result for the Consumer business, demand from industrial customers, primarily quick service restaurants, was weak. This was largely an outcome of less new product and promotional activity versus the year-ago period. We expect this decline to extend into the first quarter of 2013, which has a tough year-ago comparison. If you recall, we grew base business industrial sales in the Asia Pacific region 22% in local currency in the first quarter of 2012.

In the Americas, our sales and profit were below our expectations in the fourth quarter of 2012. For our Consumer business in the Americas, sales were comparable to the year-ago period, a 2% increase in price offset a 2% decline in volume and product mix that resulted largely from customer purchase patterns and some temporary supply chain disruptions.

I'll discuss customer purchase patterns first. If you recall, we had reported a year ago that sales in the fourth quarter of 2011 had declined approximately $10 million or 2% due to customer purchases in advance of a price increase in the U.S. This created a favorable year-on-year comparison for us in the fourth quarter of 2012 based on customer purchase patterns.

However, based on our analysis of fourth quarter 2012, we determined that a number of U.S. retailers lowered their inventory of spices and seasonings from year-ago levels. We believe that this reflects buying patterns resulting from past pricing actions, as well as some caution on the part of retail customers following weaknesses in year-ago sales consumption.

For those of you who follow us closely know that we've experienced quarter-to-quarter fluctuations in customer buying patterns periodically for the past several years largely in response to our pricing actions. Across the past several years, we've taken pricing actions on 6 different occasions in the U.S. These actions have helped -- have had a cumulative increase of 25% and together have helped address a 45% increase in material costs.

Importantly, we've been able to execute the necessary pricing while maintaining our volumes. This is illustrated on Slide 9, which shows for our American Consumer business the significant impact of pricing in each of the last 4 years along with our volume and product mix results.

Looking ahead to 2013, with material cost inflation estimated at approximately 3% and no major pricing actions currently planned, we expect retail buying patterns for our products to normalize and for consumers to face less pressure from higher pricing.

Realizing that consumers in the Americas were still adjusting to high prices in this past holiday season, we stepped up fourth quarter activity behind coupons and focused our trade promotion funds on optimizing retail price points for key products.

This redeployment of marketing funds to couponing and price promotion put some added pressure on top line growth. It also lowered our fourth quarter brand marketing recorded in SG&A, which across all businesses was down $2 million from the year-ago period instead of up by $2 million that we had forecast in our previous earnings call. These changes in our marketing efforts paid off with improved consumer offtake during the Thanksgiving and Christmas holiday periods.

Heading into 2013, we will remain close to the consumer using a combination of equity building programs and promotions to position our business for success in the marketplace.

Also affecting Consumer business sales in the Americas were some temporary supply chain disruptions that occurred in the fourth quarter and related largely to Hurricane Sandy. While this devastating storm had a limited impact on our sales to customers in the Northeast, it did impact a number of suppliers in this area, which created product shortages during our critical holiday selling period. We also lost several shifts of production time in our manufacturing distribution facilities in Maryland.

The other supply chain disruption during the quarter, one that affected our operating income result, related to our Industrial business in the Americas. During the quarter, we recorded a $4 million charge as a result of material from one of our suppliers that was out of specification. We expect to recover a portion of this charge in 2013.

Across all of our businesses, operating income also had an unfavorable impact from our business mix. With the relative performance in the Americas versus our smaller regions, our business mix was less favorable at the operating income line. As most of you know, our Americas business is more profitable due to greater scale and less complexity. This mix of business was a primary reason for the decline in gross profit margin and also impacted operating income.

While this business mix had an unfavorable impact on operating income, keep in mind that there was some offset in the tax rate as most of our international businesses operated lower tax rate than in the U.S. We have further tax benefit from the repatriation of cash implemented in the third quarter. In total, the tax rate variance contributed to a 13% increase in EPS along with increased operating income and a significant increase in our income from unconsolidated operations. This was led by our joint venture in Mexico, which achieved double-digit sales growth.

Looking back on the fourth quarter, we were pleased with our progress and results in some areas and managed through some challenges in other parts of our business.

Looking ahead, across our global portfolio, we are well positioned as a global leader in flavor and see excellent long-term growth opportunities for our business.

Consumer interest in flavor continues to drive demand for our products. On Slide 10, you can see the latest 52-week category growth for spices and seasonings in our top 5 markets. These growth rates range from 3% in France to 8% in the U.K. and Poland and in China, the category is growing at a strong double-digit pace.

Our 2012 U.S. study revealed that while today's consumer is under pressure and striving to save both time and money, the one thing they refuse to give up is flavor. If you take a look at the metrics on Slide 11, the one that I find the most compelling is that more than half of consumers point to flavor and seasonings as a great way to add variety to everyday dishes.

Turning to Slide 12, Euromonitor projects that globally, herbs and spices will be one of the strongest of all flavor-related grocery categories through 2016. We believe these latest flavor trends, together with our effective growth initiatives and sustainable business strategy, will drive strong underlying financial performance in 2013 even in a still challenging global economic environment.

As Gordon will describe in more detail, our profit projections include some offset to this growth as a result of year-on-year increases in our tax rate and retirement benefit expense.

Before I turn it over to him, I want to share some of our projections and plans for 2013. Excluding the impact of any acquisitions, we expect to grow sales 3% to 5%, which is in line with our long-term objective for sales growth before acquisitions. We have a great lineup of new products for our Consumer business in 2013. Innovation continues to be one of the best ways to distinguish our brands from private label and other competition. Consumers in the U.S. are already seeing more than 25 new products on the store shelf this month, including new varieties of Grill Mates, Perfect Pinch, Recipe Inspirations and recipe mixes. We are introducing Zatarain's rice mixes in a convenient retort pouch and a line of frozen Thai Kitchen single serve entrées.

In Canada, we're launching a range of recipe mixes to easily prepare authentic Chinese and Philippine dishes. We're expanding our range of Vahiné dessert items including new extracts, decorations, toppings and baking mixes in France. In Poland, we're introducing 8 recipe mixes and 4 Bag 'n Season items under the Kamis brand.

Our team in Australia is introducing a new packaging format with liquid marinade in a bag. And our first new products for Kohinoor in India include a convenient mix of Rice n Spice and a 2-minute meal kit.

In our Industrial business, we have a solid pipeline of new flavors and seasonings more than sufficient to meet our sales growth objectives and align with our customers' new product launch plans. Our brand marketing plans include further increases in digital marketing, support for new product launches and a sharp focus on retail price points.

In the U.S., we're stepping up activity behind the first quarter events, including a multi-brand approach to Super Bowl with nearly twice as many in-store displays, as well as an additional winter cooking recipe mix event and an early start to our activity for Easter. In Europe, we plan to increase television advertising behind our core line based on strong returns in 2012.

Throughout the company, work by our higher performance team is well underway with a goal to achieve at least $45 million in CCI cost savings, providing an important offset to increase costs. And we continue to focus on the management of working capital to improve our cash generation.

As a final note, we are on track to complete the acquisition of Wuhan Asia-Pacific Condiments in mid-2013, and we'll make any adjustments to our financial guidance at that time.

To summarize, I firmly believe that McCormick's business strategy and growth initiatives, powered by employees around the world have us positioned to deliver strong underlying performance in 2013 and momentum for future success.

Let me turn it over to Gordon now for more insight into our fourth quarter financial results and more details on our 2013 guidance. Gordon?

Gordon M. Stetz

Thanks, Alan, and good morning, everyone. Our results for the fourth quarter included 4% sales growth in local currency, a 4% increase in operating income and earnings per share up 13%. We recognize that our results for the quarter differ from many of your projections, and I would like to help you understand the key variances.

Let's begin with a closer look at sales and operating income for each of our 2 segments starting with the Consumer business. As seen on Slide 17, we grew Consumer business sales 4% in local currency, a result driven by pricing and the impact of our 2011 acquisitions.

Volume and product mix was comparable to 2011 in the fourth quarter, but varied by region. In the Americas region, volume and product mix declined 2% as shown on Slide 18. We had some benefit from pricing taken in the fourth quarter of 2011, as well as higher prices on pepper that went into effect in August 2012.

Heading into the fourth quarter of 2012, we had a favorable comparison to the year-ago period when we reported an estimated $10 million shift in sales to the third quarter of 2011 from the fourth quarter of 2011.

However, as Alan described, volume and product mix in this region in the fourth quarter of 2012 was affected by further fluctuations in the timing of purchases by our retail customers and by supply chain disruptions. We estimate that the fluctuations in retail purchase patterns lowered year-on-year sales in the fourth quarter by approximately 2%. And we estimate that the supply chain disruptions largely related to Hurricane Sandy lowered sales approximately 1%. Importantly, we believe that the supply chain disruptions were temporary, and we expect no impact to results heading into 2013.

As for the shift in customer purchase patterns for this part of our business, a less inflationary cost environment should lead to more normal retail purchase patterns.

In Europe, the Middle East and Africa, EMEA, we grew consumer sales 9% in local currency. The level of success behind new products, brand marketing and retail distribution was evident in the 6% increase in volume and product mix. The implementation of master branding in Europe is proceeding well. Sales of Kamis products in local currency are ahead of plan, and we are growing sales in additional emerging markets, the Middle East and Africa through export.

Consumer business sales in the Asia Pacific region rose 32%. Excluding the impact of acquisitions and currency, the increase was 7% led by double-digit growth rate in China.

Across all 3 regions, fourth quarter Consumer business operating income was $177 million, a $13 million increase from the year-ago period. The Consumer business had higher sales, the benefit of CCI cost savings and a favorable comparison to the fourth quarter of 2011 when we recorded $7 million of transaction costs related to acquisitions. The positive impact of these factors was offset in part by the unfavorable mix of business across regions.

While this mix of stronger international sales had an unfavorable impact on operating margin, keep in mind that it contributed to the favorable tax rate during the fourth quarter.

Turning to our Industrial business, let's start with a review of sales. For this segment, we grew fourth quarter sales 4% in local currency driven by pricing taken in response to increased material costs. As with the Consumer business, the growth in volume and product mix varied by region.

On Slide 23, industrial sales in the Americas rose 6% as a result of pricing actions. During the fourth quarter, we grew sales of seasonings and flavors to food manufacturers and also increased sales of branded items to food service distributors. Offsetting this growth was a continuation of weak demand for our products sold to quick service restaurants in this region.

In EMEA, our Industrial business achieved another consecutive quarter of strong sales growth in the fourth quarter. We grew sales 12% in local currency with a 7% increase in volume and product mix. Quick service restaurants continue to expand in parts of EMEA, and we have gained share from the competition.

In addition, we have introduced new branded food service items.

In contrast to the consumer results in the Asia Pacific region, this was another weak quarter for the Industrial business with sales in local currency down 11%. We had a tough comparison to the fourth quarter of 2011 when we grew sales in local currency by 22%.

Following a strong first quarter in 2012, as Alan noted, we have been impacted by a lower level of promotional activity behind some of the quick service restaurant items we flavor in this region.

Operating income for the Industrial business was $23 million, down from $28 million in the fourth quarter of 2011. As previously discussed, the $4 million supplier charge was a significant part of this decrease with the remainder largely attributable to the mix of sales this period between regions. As with the Consumer business, this mix had an unfavorable impact on operating income, but helped lower the tax rate.

For the total company, we grew fourth quarter operating income 4% to $200 million. The benefit of higher sales, our CCI program and $7 million of acquisition-related costs in the year-ago period were offset in part by the unfavorable mix of sales in both segments and the $4 million charge. The unfavorable mix was also the primary reason for the 100-basis point decline in gross profit margin in the quarter.

Moving below operating income. Our tax rate for the quarter was 24.7% compared to a rate of 28.7% in the fourth quarter of 2011. As mentioned, the favorable rate in 2012 included the geographic mix of business across tax jurisdictions, as well as an additional benefit from the repatriation of cash from foreign subsidiaries that occurred in the third quarter of 2012 as was discussed in our September earnings call.

Income from unconsolidated operations has begun to lap some difficult results that began in the fourth quarter of 2012 -- 2011 related to pressure from higher material costs compounded by unfavorable currency exchange rates primarily for our joint venture in Mexico. In the fourth quarter of 2012, income from our unconsolidated operations rose $3 million to add $0.02 to EPS growth.

Sales of these businesses grew 7% this period. We reported earnings per share of $1.11, a 13% increase from $0.98 in the fourth quarter of 2011 with contributions from the favorable tax rate, higher operating income and the increase in unconsolidated income.

Let's turn next to our cash flow and year-end balance sheet. Cash flow from operations was $455 million, up from $340 million in 2011. The improvement was led by the change in inventory, which was just about flat in 2012 compared to a significant use of cash in 2011 when we increased our strategic inventory of certain spices and herbs and had an impact from steep material cost inflation.

In 2012, we used $132 million of cash to repurchase 2.3 million shares. At year end, we had $137 million still available on our $400 million authorization. Our balance sheet remains strong. We paid down $85 million of debt in the fourth quarter and returned to our target debt level.

As a final topic, I want to discuss our 2013 guidance and then get to your questions.

Turning to Slide 32, we are projecting a solid sales performance with 3% to 5% growth in local currency, driven primarily from higher volume and product mix. At this time, we are projecting a minimal sales impact from currency and about 1% from pricing. This range of sales growth currently excludes the impact of our agreement to acquire Wuhan Asia-Pacific Condiments. If we close this deal as expected in mid-2013, it will add about 1% to the sales range, putting our 2013 target right in line with our long-term sales growth target of 4% to 6%.

Alan indicated earlier that the Industrial business in the Asia Pacific region has a difficult year-ago comparison in the first quarter of 2013. In fact, we'll have a difficult sales comparison in each of our 3 regions for the Industrial business. In the first quarter of 2012, we grew volume and product mix 8% in the Americas, 8% in EMEA and 19% in the Asia Pacific region.

Moving to gross profit margin, we anticipate about a 50-basis point increase due in part to our goal to achieve at least $45 million in cost savings from our CCI program.

As Alan noted, material cost inflation is projected to be up approximately 3% for the total year, a significant moderation from the past 2 years. Because this easing of material cost is expected to occur gradually as we progress through the year, the gross profit margin improvement should be marginal in the first quarter and then increase with each successive quarter.

At this time last year, we did not think that the interest rate environment could go much lower. We were wrong. At that time, we reported to you a year-on-year increase of $9 million in 2012 retirement benefit expense. Due primarily to a further reduction in the discount rate, a key factor in determining these expenses, we are facing a steeper year-on-year increase of $22 million in 2013.

While this expense increase should affect each quarter fairly evenly, it is expected to have a greater impact to EPS growth in the first half when EPS tends to be lower than in the second half of our fiscal year.

Looking ahead to 2014, while I won't predict where interest rates will go from here, I believe the most likely scenario is a stabilization of retirement benefit expense at this level. We continue to evaluate ways to lower retirement expenses and manage plan liabilities. Early in 2012, we closed our U.S. pension plans to new participants and in early 2013, announced the closure of our defined benefit plan in Canada. In order to improve the funding level of the U.S. plan, we contributed $35 million to the plan at the end of fiscal year 2012 and another $28 million early in fiscal year 2013. Largely as a result of this expense increase, we have set up our operating income growth range at 6% to 8%, slightly below our longer-term goal of 7% to 9%.

Our guidance for 2013 includes a 29.5% tax rate, a 10% increase in income from unconsolidated operations, and a 1% reduction in shares outstanding.

At the EPS line, we project $3.15 to $3.23 for 2013, which is an increase of 4% to 6% from $3.04 in 2012. This is below our long-term objective of 9% to 11% largely as a result of the year-on-year increases in tax rate and retirement benefit expense, which are expected to lower our EPS growth rate by 8 percentage points as shown on Slide 33.

We expect higher sales growth in our CCI program to drive a double-digit increase in EPS excluding these 2 factors. Largely due to the difficult year-ago sales comparison for our Industrial business and the greater impact of material cost inflation in the first part of 2013, we expect EPS in the first quarter to be comparable to the year-ago period close to $0.55, which we reported in the first quarter of 2012.

To wrap up our guidance, capital expenditures in 2013 are expected to be in a range of $120 million to $130 million, up from $110 million in 2012. This range includes our plans to expand for growth in China and Poland, as well as funding for new product development technology.

In 2013, we expect our increased profit and further improvement on working capital to deliver another year of strong cash flow.

Let's turn now to your questions. After which, Alan will provide some closing remarks. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Alexia Howard of Sanford Bernstein.

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

Can I ask about the consumer takeaway data in the U.S.? It looks as though the volumes have fallen off a bit in the recent months. And it's kind of hard for us to tell how much of this is supply chain related or the timing of the Nielsen cutoff dates or maybe Hurricane Sandy and so on. Maybe you could just go through how much these supply chain issues affected the Americas, maybe both consumer and industrial volumes this last quarter. And then, as we look out to 2013, how confident are you in the volume outlook in the North American Consumer business given that consumer takeaway data that we're seeing?

Alan D. Wilson

Yes, a couple of things, Alexia. The Nielsen data cutoff, I think, on the 22nd or 23rd, so -- I think it was 22nd. So we missed 2 pretty important days of sales for our products. And as we look at the more longer-term based on IRI, which is what we measure, we saw a pretty good recovery, and we're encouraged by what we saw in consumer takeaway in the Thanksgiving and Christmas holiday periods for our products. So that's part of the reason why we are displaying more confidence in our outlook in the U.S. business. We think there may be some impact, but not a lot of impact of actual consumer takeaway in -- from Hurricane Sandy. There's certainly an area of the country that is extremely important for us, where we have very high shares, was impacted but we think the bigger impact was on our supply chain in the quarter.

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And then maybe as a follow-up. There were a number of mentions of a negative mix effect this quarter, and I'm thinking more globally now. I'm trying to get a sense for the company-wide margin outlook as you continue to push for growth in emerging markets. So I mean, have you got to a point where you're profitable in places like the Middle East and Africa or China on the Consumer business, for example? And if you're not at a level of profitability there yet, how are you managing that transition as you really balance growth in emerging markets versus profitability?

Gordon M. Stetz

Alexia, this is Gordon. We are profitable in those markets. The particular issue within the fourth quarter that we were pointing to relates to the relative mix of the business of the U.S. versus those foreign markets. And given the skewing of our results and the importance of the holiday period within the fourth quarter to the extent the U.S. market doesn't perform to the expectations that we have had, that can have a negative relative mix on both the gross and operating margin lines. So that's the near-term impact that we saw within the quarter. On a longer-term basis, we fully expect the Americas businesses to continue to grow. We've talked about the Americas margin structure being a strong line as it is, so our desire is for that business to continue to grow over time. And the emerging markets, as we gain scale and share and expand our presence there, we would expect those to start to approximate overall corporate margins as well. And the margin story really does differ by which emerging market we talk about. We've been in certain areas for quite some time, China in particular. That would be a better relative margin to, say, India where we're still establishing an infrastructure and then versus Poland, where we have an established business there that's being integrated into the European team, where they have margins comparable to the overall company structure.

Operator

Our next question comes from the line of Thilo Wrede of Jefferies.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Gordon, you indicated that the Wuhan acquisition could add about 1 point of incremental sales growth that's not included in your guidance right now. Is there any reason to assume that the income benefit would be in similar range?

Gordon M. Stetz

It more than likely would be flat to slightly dilutive, and that's primarily a function of the transaction cost that we would expense at the time we close the transaction, which we've indicated previously are about $4 million.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Okay, fair enough. And then the China Industrial business, what impact do you expect from the troubles that YUM! is having in China or just had in China?

Alan D. Wilson

Well, certainly, when our customers in China are not growing their sales, it does impact us in a couple of ways and, without giving specifics on a particular customer, I think our larger customers there, our quick service customers, have reported challenges in their current sales as a result of this chicken issue. Most of it, the quick service business there, is chicken, although we do a lot of other kinds of things like dessert toppings and drink mixes. But if their traffic's down, then our sales are under some level of pressure.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Do you see a corresponding uptick in your Consumer business then if China's consumers don't want to go to quick service?

Alan D. Wilson

Our Consumer business grew very strong in China through the year, and we've continued with that momentum.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Okay. And then last question I have is for the Industrial business overall, is the target still to get to about 10% EBIT margin and kind of what's the time frame you're looking at right now?

Gordon M. Stetz

Well, what obviously impacts that and many of you heard us talk about this is the material cost environment, to the extent it's inflationary, which is what we've seen through -- from 2011 to 2012. Our pricing mechanisms are pass-throughs as we've talked about, and those pass-throughs do not allow for a margin expansion. In fact, it's passing dollar for dollar through on the raw material cost and actually has margin -- gross margin points compression on it. So what we point to in those periods is year-on-year operating income growth. We've seen consistent year-on-year operating income growth out of that Industrial business, and we've seen margins stuck pretty much in that 7.5% to 8% range. So underneath this period of cost inflation, there actually is margin improvement. But in terms of the timing of when we continue to believe we can get to that, say, 8% to 10% range is going to be very much a function of the cost outlook.

Operator

Our next question comes from the line of Akshay Jagdale of KeyBanc Capital Markets.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

My first question is on gross margins. You've talked a lot about mix. So based on your comments, my interpretation is that because of the softness in the Americas business, your gross margins came in below even your plans. So if I'm wrong on that, please correct me. But my broader question on gross margins is your long-term goal has been to increase gross margins, I believe, roughly by 50 basis points every year. We've had now 2 or 3 years of -- 2 years, at least, of significant margin compression, and now commodity costs seem to be easing. So at some point, shouldn't we start to see gross margins increase higher than the 50% rate that you typically expect? And if you can give us an answer to when that might happen, that's my first question.

Gordon M. Stetz

Akshay, this is Gordon. Your first assumption is correct. The gross margin impact was very much a function of the geographic mix of the business, as we've said in the call, and that's primarily the Americas region softness we pointed to. As we have indicated in the call, we expect -- because of a more benign environment, improvement in our gross margin this year, and that follows 2 years of material cost inflation, which we've had that compression on now. In those periods of material cost inflation, we want to make sure that we're still able to deliver operating income dollar growth, and certainly our teams primarily in the industrial group but also in the consumer group have been focused on delivering those operating income growth targets. It's difficult to give you an exact time frame as to where we will be on the gross profit margin in the long term. I can tell you in a benign environment, we would expect this nice steady improvement that we had seen over time, and that would be a function of the Consumer business growth outpacing the Industrial business growth. Our Industrial business margin structure is getting better through their CCI and portfolio mix, and that's still the strategy that we have adhered to.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

Okay, great. And just one follow-up on the pension expense issue. So it's a little bit hard to judge that from an analyst perspective. So I mean, it's been a bit frustrating because your underlying performance has been very solid. So to glean into that, I'm trying to understand, I mean, when you set your management compensation plans, are you excluding those type of issues as onetime? I mean, I'm just trying to understand, I mean, if the interest rate environment reverses, how would you deal with some positive tailwinds from this type of item?

Alan D. Wilson

Just -- our philosophy is that we're all in it. So when we have a negative like we did in 2012, we take the hit on that. When we have a negative like we expect in 2013, we've got to figure out how to overcome it from a compensation standpoint. And when it's positive, we expect that there will be some level of benefit to our growth rate. Obviously, every year is unique as we set our compensation plans, so we will adjust targets and goals based on that. But our basic philosophy is we're all in and we're measuring ourselves against top-tier performance.

Operator

Our next question comes from the line of Chris Growe of Stifel, Nicolaus.

Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division

I just had 2 questions for you. The first one I want to be clear on was in your discussion with -- to Alexia's question about product -- or about mix. I want to make sure I also understood the product mix within businesses. I'm not sure if you were addressing that or if you're addressing the business mix between Industrial and Consumer. Can you speak to the product mix within each division, and how that was a factor? In particular, it sounds like it was a negative in Industrial in the quarter.

Gordon M. Stetz

Yes, on the Consumer side, it was mostly the volume issue as it relates to the entire portfolio mix in the Americas softness. But within the Industrial business, I would agree that we did have some negative mix, in particular in the U.S. Industrial business within the quarter.

Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division

And that would be related to weaker QSR performance? Is that the main factor there?

Gordon M. Stetz

Yes, that's certainly a part of it, yes.

Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then I want to ask just a bigger picture question about, I guess, the cash flow but more importantly like how you expect to use the cash in 2013? You got some share repurchase authorization available. And I guess, along those lines, can you also talk about maybe acquisition pipeline and how that -- it looks for the company from here?

Alan D. Wilson

Yes, I'd say, as always our priorities on the use of cash are dividend is extremely important. Acquisitions, because we believe investing in growth is important. We have some CapEx as we're expanding our facilities in China and Poland specifically, and investing in a new flavor technology in the U.S., which we're very keen on, and we think we'll have a positive impact long term on margins in that business. But we have room as we do acquisitions for cash repurchases with, at least, the Wuhan acquisition that we have on the table right now, we'll continue to buy back shares. We are always in the market. We see some level of activity. I would say it's not as robust as we've seen in some years, but we still have -- we have some good targets and continue conversations at expanding our footprint.

Gordon M. Stetz

Chris, I would just add that's given where we are with our targeted debt level and the amount of cash we generate, depending on the acquisition size, we've historically been able to do both share repurchase and acquisitions, and that's our intention as we go into this year.

Operator

Our next question comes from the line of Rob Dickerson of Consumer Edge Research.

Robert Dickerson - Consumer Edge Research, LLC

I guess, first question is just I've heard you say, I guess, on the Q3 call and also this morning that overall you would expect that consumers would increasingly become a little bit more comfortable spending on flavors because it's such an attractive category, and flavor matters at current prices. But then, at the same time, it seems like your couponing and retail takeaway in the IRI data, which precludes the full holiday, does seem to improve a little bit on the margin and volume, part of that could be from the increased couponing. So I'm just curious, I guess, what studies, one, have you done not on flavor being a great category, but on consumers willing to pay current prices for that flavor; and then two, if the couponing seems to be working, would there be a point such that you would consider lowering your pricing to actually get volume growth?

Alan D. Wilson

Thanks. We do a tremendous amount of work on price elasticity. And we have, as we've gone in this aggressive pricing environment, as I said on the call, we've had about a 45% increase in commodity cost over the last 4 years and have taken about 25% pricing and we've taken a number of different actions along the way, and we are always evaluating the impact of that on volume. The consumer is looking at 2 things. One is we're a fairly low-frequency purchase, and there has traditionally been less price sensitivity on some of our items than there is in a number of other categories. All that said, though, on the shelf, when you've got a range of price points ranging everything from $1 up to about $8 in gourmet, we want to get the promoted price right when the consumer is there to buy. Our business is largely a base business, which means that a small percentage is sold on promotion. But as we get into some of these key periods, we want to make sure that we're incenting customers to buy our brand and not let them have a reason to walk away. Coupons are always a part of our mix, as are price promotions at certain times of the year, that really hasn't changed. We did view that we needed to make sure that we were driving positive volume consumption in the fourth quarter, and so we shifted some of our spending and we'll keep evaluating what the right mix to get to consumers are. We've taken some price reductions on shelf on a couple of key items that we talked about like vanilla and grinders, and we're measuring the impact of that. We think it's -- the results have been generally positive in terms of that, and we'll continue to evaluate certain items to get to the right price points. And this -- and by the way, what we have seen as our pricing has gone up, we have seen those price gaps close now as competition, largely private label, has also taken price increases to either catch up or improve their margins. So we're seeing that situation moderate a bit. All that, we -- it's fairly complex because of the number of items and we've got different elasticities with different items. So we may be trying to be sharper on things like dry seasoning mixes and evaluating what we do on certain spice items, but we do a tremendous amount of work in really understanding that dynamic.

Operator

Our next question comes from the line of Robert Moskow of Crédit Suisse Group.

Robert Moskow - Crédit Suisse AG, Research Division

I think you're not the only food company or CPG company that's kind of entered the year thinking that they could increase brand marketing and then have to adjust that expectation down, but I wanted to get to a final number for you for the year. Were you still up about $10 million in terms of increasing your brand marketing for the year, and -- I'll leave it at that.

Gordon M. Stetz

Yes, Rob. We were up $11 million and a significant portion of that was also up in the advertising. So we were up year-over-year. We also -- as mentioned, we had a significant portion in digital that we're spending behind. So yes, we were up.

Robert Moskow - Crédit Suisse AG, Research Division

And was that kind of in line with sales growth, or was it kind of below sales growth? And how would we compare that to your guidance for 2013, which is to be in line with sales growth?

Gordon M. Stetz

It was just ever so slightly below sales growth if we do the math.

Operator

The next question comes from the line of Andrew Lazar of Barclays Capital.

Andrew Lazar - Barclays Capital, Research Division

With respect to some of your comments about industrial sales in the Americas, I think, you were -- and actually the organic side of that were actually pretty good, and I think you said it was driven by increased sales of branded products to food service as opposed to the QSR. So that's fairly consistent, I think, with some of your comments in the third quarter where you said you were a bit more optimistic that as pricing was starting to wane, volumes for the -- just the branded sort of packaged food companies, many of which you supply, were starting to improve a bit. So I was hoping to get a bit of an update from you on just kind of how you see the landscape around the branded packaged food guys and if that trend has continued in a way that keeps you somewhat maybe cautiously optimistic from an industry standpoint.

Alan D. Wilson

Yes, we're encouraged by what we're seeing in that part of the business. Obviously, different companies have different philosophies and challenges. I'd say the one thing that we didn't see as we went into last year is the amount of actual new product launches that we would typically expect to see. A lot of our customers are going through restructurings and have focused on some level of reorganization. We do see a pretty strong pipeline of new product activity among the consumer food customers that we have, that does encourage us as we go into the second half of the year.

Andrew Lazar - Barclays Capital, Research Division

Got it. Okay, that's helpful. And then, I know that from time to time, not just in your business, but in others, there can be these quarter-to-quarter shifts in kind of inventory management in key customers, particularly, in the ends of key retailers' fiscal years, and we've seen that from time to time. Is -- I guess, I'm trying to get a sense of how your capabilities or systems allows you to have some visibility to what your inventories are at the customer level. Has your ability or capabilities there changed at all in the last couple of years to where you have a better sense of how that tracks, because it still seems like a lot of companies in this space get blindsided every so often by some of these shifts? And admittedly, maybe that's just the reality of the customer shifting things kind of quickly in a given period that you can't read. But I'm trying to get a sense of what your level of visibility is to that.

Alan D. Wilson

Yes, we have a level of visibility to about half our U.S. volume because of things like vendor managed inventory or data that we can purchase to evaluate consumption versus their factory sales. So we have that level of visibility. It doesn't -- even in the case of our BMI customers, though, it doesn't change the fact that they decide on a short term that they're going to aggressively manage inventory that, that won't happen. I would say we did miss this a bit in terms of laying out what we thought was going to happen relative to prior periods because of the amount of pricing that we've taken. I'd say there's probably a little bit of an underlying caution by a number of our customers because of some softness in December and January of last year. Now we're seeing the volumes pick up, so we're encouraged by that. But I think, in terms of their inventory management, there was a level of caution around what they thought they needed to bring in, in that period.

Andrew Lazar - Barclays Capital, Research Division

Got it. And I think Gordon said that you felt like separate from the supply chain issues from Sandy, that these issues as well, around the inventory side seem like they're pretty well behind you, or is some of that bleed into the first quarter? I wasn't clear on that piece.

Gordon M. Stetz

No. We think it's -- just based on what we've seen so far since we closed the year, we're cautiously optimistic and encouraged by what we're seeing in the U.S. business.

Operator

[Operator Instructions] Our next question comes from the line of Eric Katzman of Deutsche Bank.

Eric R. Katzman - Deutsche Bank AG, Research Division

I still have a couple of questions. I guess, first, Gordon, a number of companies have changed their pension accounting and have offset having to take a pension expense hit. Obviously, yours is pretty significant. Did you look into that, and why didn't you use this mark-to-market methodology or maybe Hershey's IFRS approach to offset some of this $22 million in expense?

Gordon M. Stetz

Our philosophy, Eric, has been to disclose the amount, the underlying economics whether -- based on whatever accounting you're using doesn't really change. So from our standpoint, we felt certainly it's important for our investment community to know what the amount is and for you to evaluate the impact to us. We've given you the cash impact associated with some of the funding as well, but we do look at those things. However, we finally landed that the best way to disclose this was purely to give you the amount that was the impact. And as Alan said, we're challenged as a management team to overcome this and move on.

Eric R. Katzman - Deutsche Bank AG, Research Division

Okay. And then, I guess, on Slide 15, maybe you answered this question, but you -- Alan, you talked about retail price points. And maybe you could expand on that a little bit. I don't recall for a long time you talking about retail price points. I assume you mean sharpening those to drive consumption higher because you weren't talking about higher pricing in the business. So...

Alan D. Wilson

No, there's a couple of initiatives. One is making sure we got the right prices on items that are price sensitive. So things like dry seasoning mixes and pepper and vanilla and that sort of thing, and so we've got some initiatives on that. We're not talking about higher prices. We're talking generally about how we apply our promotion funds to make sure we're hitting the items that are really volume -- that are really price sensitive.

Eric R. Katzman - Deutsche Bank AG, Research Division

Okay. And then, last question back to Gordon. You -- right, the pension expense is noncash, although, you are making a contribution. I guess, you have your tax rate going up, and I'm not really sure what that means for actual cash taxes paid. But I guess, my point is if EBIT is up 6% to 8%, and excluding the pension expense, it's up close to 10%, and then you've also got the JV income up 10%. Is your free cash flow in fiscal '13 up double digit, especially if inflation and working capital aren't much of a challenge?

Gordon M. Stetz

We haven't a specific number out there, Eric, but I don't disagree with your math and that certainly could be an outcome as we progress through the year.

Alan D. Wilson

Yes, we do expect a year of strong cash flow, and built into that assumption is that commodity costs are fairly moderate.

Operator

Our next question comes from the line of Ann Gurkin of Davenport & Company.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

I have 2 questions. One, you've commented about the outlook for the Industrial business in the first quarter, but can I get some more detail on your outlook for the overall QSR segment of your business for the year, and as the year progresses the outlook for that QSR segment?

Alan D. Wilson

We think it's going to be fairly challenged. We have some positives in certain markets. And then, as we get into the back half of the year, some easier comparisons. But we do think through the year that, that -- and I'm following our customers' releases as closely as -- probably closer than you are because they really impact us. But I would say that we think that it's going to be fairly challenged.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Great. And then, Alan, in Australia, can you comment on the environment and how you're approaching the consolidating retailer environment and your strategy to address that changing marketplace?

Alan D. Wilson

Yes. Australia has been a tough market for McCormick. As you all know, we're not the brand leader there, and so what we have done is we kind of used it as a laboratory in terms of how a second-place supplier challenges a market leader. And so we've been pretty innovative with new products. We've been very targeted on the kinds of things that we're doing and -- outside our core spice and seasoning line, and we've seen some pretty positive results over the last 2 years as we've done that, but it is a challenging market.

Operator

Our next question comes from the line of Erin Lash of Morningstar.

Erin Swanson Lash - Morningstar Inc., Research Division

I apologize if I missed this, but I was curious, the fourth quarter tends to be a quarter where there's more of a -- branded sales are more emphasized just because of the holiday cooking season and that sort of thing. So I was wondering if you could comment between the mix of branded versus private label sales, if there was an increase in private label sales relative to branded in the fourth quarter?

Alan D. Wilson

I don't have the actual comparative data between branded and private label in the fourth quarter, but typically we do see an increase in branded shares for a couple of reasons. One is consumers are less willing to take chances on their meals. The second is private label is pretty prevalent in really popular items, but a lot of the items that are purchased at the holiday like nutmeg and pumpkin pie spice and apple pie spice and things like that aren't necessarily replicated in private label because they're a onetime purchase. So I'm afraid I don't have the data specific to private label in this period on these items in front of me, but typically what we've seen is our branded shares are at the highest in the fourth quarter of the year. I would expect they still are.

Erin Swanson Lash - Morningstar Inc., Research Division

All right. That's helpful. And then just one other question. When -- with the retailer inventory adjustments that were occurring in the quarter that you discussed, was that concentrated at any one channel, or was that across all channels?

Alan D. Wilson

It was pretty concentrated with a limited number of customers.

Operator

Our final question of the day comes from the line of Leigh Ferst of Wellington Shields & Co.

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

I was wondering if you could comment on your digital marketing spending of 12%. Give us some background on how you spent that in different categories and geographies, and how you're evaluating the impact of that.

Alan D. Wilson

Sure. Our focus is in a couple of areas. The main spending is in our larger consumer markets like the U.S. and EMEA, and we're doing a number of things, everything from digital recipes to promotions that we work with on search to really target where consumers are at -- on their mobile phones. So as they're searching for things like chicken, we're working with retailers on driving specific purchases of specific McCormick items to a retailer, and we're seeing some really great results with that. As we continue to expand, we have some technologies, which allow for individual flavor selection, and we've been talking to a number of retailers around tying that to their programs. But we're very encouraged by what we're seeing in terms of returns, how consumers are responding. The digital consumer is a very engaged consumer, and so it's one that increasingly we're reaching out to.

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

And on your CCI, is there any evolution or change in the focus of the spending this year or in the savings this year?

Alan D. Wilson

I wouldn't say specifically. I think, it's been a pretty balanced approach to everything from SG&A to productivity in our manufacturing plants, as well as looking at savings within our procurement channels. So it's pretty balanced, and I don't expect that, that's going to change. We're not going to be heavier this year in one versus the other, different than we've been in the past.

Operator

At this time, I would like to turn the floor back over to management for any concluding remarks.

Alan D. Wilson

Thanks for your questions and for participating in the call today. We do believe interest in flavor continues to grow, and McCormick is well positioned to meet this through our growth initiative, our increased global presence and our passion for flavor. While today's environment remains challenging, we're staying close to the market, we're going to be agile, and we're going to adapt our business to drive sales and profit. McCormick's leaders and all its employees are committed to building shareholder value. So thank you very much.

Joyce L. Brooks

Thanks, Alan. I'd like to add my thank you to those that participated on today's call. Through January 31, you may access the telephone replay of the call by dialing (877) 660-6853. The conference ID number is 403908. You can also listen to a replay on our website later today. If anyone has additional questions regarding today's information, I would welcome your call at (410) 771-7244. This concludes this morning's conference.

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