McCormick & Company, Incorporated's (MKC) CEO Lawrence Kurzius on Q2 2022 Results - Earnings Call Transcript

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McCormick & Company, Incorporated (NYSE:MKC) Q2 2022 Earnings Conference Call June 29, 2022 8:00 AM ET

Company Participants

Kasey Jenkins - Chief Strategy Officer & Senior Vice President of Investor Relations

Lawrence Kurzius - Chairman, President and CEO

Mike Smith - Executive Vice President and CFO

Brendan Foley - President & Chief Operating Officer

Conference Call Participants

Andrew Lazar - Barclays

Ken Goldman - JPMorgan

Steve Powers - Deutsche Bank

Robert Moskow - Credit Suisse

Alexia Howard - Bernstein

Adam Samuelson - Goldman Sachs

Peter Galbo - Bank of America

Kasey Jenkins

Good morning. This is Kasey Jenkins, Chief Strategy Officer and Senior Vice President of Investor Relations. Thank you for joining today's Second Quarter Earnings Call. To accompany this call, we posted a set of slides at

With me this morning are Lawrence Kurzius, Chairman and CEO; Brendan Foley, President and Chief Operating Officer; and Mike Smith, Executive Vice President and CFO.

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.

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

Good morning, everyone. Thanks for joining us. I'd like to start by welcoming Brendan to this morning's call. In addition to his continuing role as President of our Global Consumer business, Brendan now has responsibility for our business worldwide in his newly appointed role as President and COO. At the end of our prepared remarks, I may ask him to weigh in on some of your questions.

McCormick's long-term performance, including through the pandemic and other volatility, has been industry-leading and met or exceeded our financial objectives. Broadly, our results in the second quarter were in line with our sales and profit expectations despite certain global challenges, including a greater-than-expected level of high cost inflation and supply chain challenges, significant disruption in China from COVID-related lockdowns and the conflict in Ukraine. As our second quarter progressed, the dynamics of these conditions intensified and negatively impacted our sales and profit results.

Before discussing our second quarter results in more detail, I'd like to comment on each of these, starting on Page 5. Consistent with the rest of the industry, high cost inflation and supply chain are continuing challenges. To partially offset cost pressures, we've taken multiple pricing actions and, as planned, we are raising prices again. Inflation continued to escalate, and we've adjusted our upcoming pricing actions accordingly. 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 reducing discretionary spend where possible. We expect our pricing actions and other levers to begin to outpace cost pressures late in the third quarter, with higher cost and higher offsetting pricing actions than we expected on our last call, which further weights our 2022 profit to the second half of the year. We plan to fully offset cost pressures over time.

In China, during the second quarter, there was significant unanticipated disruption in consumption due to severe COVID-related lockdowns in Shanghai and other cities throughout China. China is our second biggest sales country, with operations in Shanghai, Guangzhou and Wuhan. Our Shanghai operation produces approximately 40% of our total China sales, which are distributed throughout the country and supports both of our segments. And as a reminder, our branded food service demand is included in our Consumer segment in China.

The lockdowns lasted roughly 75 days, with our Shanghai plant forced to close for two weeks at the onset, with employees living in the facility. Once we were able to reopen, we were impacted by lockdown-related labor shortages due to workers being quarantined. During April and May, we incurred significant incremental manufacturing and transportation costs to supply our customers.

In addition, as restaurants largely closed and consumers unable to shop for extended periods in our strongest geographies, we experienced significant demand softness as well. Market conditions in China have also allowed very little opportunity to increase prices. While we are currently experiencing the short-term pressure, we continue to believe in the long-term growth trajectory of our business in China, but we will not be able to recover the sales and profit impact we experienced in this fiscal year.

Finally, regarding the conflict in Ukraine, in mid-March, we suspended operations in Russia, and our operations in Ukraine were paused. These countries account for less than 1% of our overall business. We have recently decided to exit our Consumer business in Russia.

Now for more detail on our second quarter results, starting with sales on Slide 7. Sales declined 1% from the second quarter of last year, including an unfavorable impact from currency. Our constant currency sales were comparable to last year, with growth from pricing actions offset by a decline in volume and product mix.

The volume decline was impacted unfavorably by several discrete items, including a 1% impact from the China consumption disruption and the conflict in Ukraine I just mentioned, a 1% impact from the exit of low-margin business in India and a 2% impact from lapping the U.S. trade inventory replenishment during last year's second quarter.

Excluding these items, our sales performance would have been 4% growth, reflecting the strength of our broad global portfolio and effective execution of our strategies and pricing actions. While growth in both segments was impacted by the discrete items, they were more impactful to our Consumer segment. Notably, our growth in Flavor Solutions was outstanding.

Comparisons to 2021 and 2020 remain difficult due to the dramatic shift in consumer consumption between at-home and away-from-home experienced in the second quarter of the last two years. Using 2019 as a pre-pandemic baseline, second quarter sales have grown at a constant currency compounded annual growth rate, or CAGR, of 6%.

Moving to profit. Adjusted operating income was down 33% or 32% in constant currency and adjusted earnings per share was down 30%. The adjusted operating income comparison includes 7% unfavorable impact from the disruption to China's consumption and the conflict in Ukraine.

Although we anticipated the profit driven by sales growth in the second quarter would be more than offset by higher inflation and broad-based supply chain challenges, the impact was greater than expected due to continuing cost escalation. While this pressured second quarter profit, we expect to mitigate this impact later this year.

Now moving to second quarter business updates for each of our segments. Starting with our Consumer segment on Slide 9, our second quarter sales reflect the impact of our pricing actions in all three regions. In the Americas, our first wave of pricing was phased in during our fourth quarter of last year, the second wave during the second quarter in April, and the third wave will go into effect at the end of the third quarter.

With the first wave, we saw a very low level of elasticity. With the second wave, we are seeing more price elasticity, although still below historical levels. While consumer spending has remained strong, consumers are now under significant pressure for broad-based inflation, notably fuel prices and other macro factors. As we look ahead and our additional pricing actions are phased in, the elasticity we experienced may change, but we still expect the impact to be lower than historical levels.

Overall, our pricing actions in EMEA and APZ are on track and our elasticity impacts are similar to the Americas. In EMEA and APZ, pricing timing varies by market within each region. In some markets, particularly in EMEA, there are regulatory guidelines on when we take pricing, which generally creates a lag in the timing of pricing compared to the Americas. In this unprecedented environment, however, we are taking additional action in markets across the EMEA.

Now for some further 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 1%. And over the last three years, since 2019, consumption has grown at a three-year CAGR of 7%, which highlights how the sustained shift in consumer consumption continues to drive increased demand for our products and outpace pre-pandemic levels.

In the Americas, a sales decline in the second quarter included the impact of lapping a 4% over-shipment of consumption to replenish retailer inventories in the second quarter of last year. Our second quarter shipments this year were in line with our consumption change. Demand has remained high, and we are realizing the benefit of the manufacturing capacity we added as well as our increased resilience. However, some products remain stressed by sustained high demand.

Shelf conditions continue to improve, as seen in our recipe mix share performance of another quarter of share gain. Our spices and seasoning share was pressured during the quarter by the shortage of certain packaging materials as well as certain organic spices. Some of these have been resolved and some will remain ongoing.

We continue to use our category and revenue management capability to strengthen our spices and seasoning portfolio and optimize the category performance for both McCormick and our retailers. The strength of our brands and our category leadership has recently won us new distribution which we will begin to realize later this year.

In EMEA, we continue to have strong share performance in most categories and markets. During the second quarter, we lapped strong year-ago consumption, partially due to last year's COVID-related restrictions throughout EMEA, where restrictions extended longer than other regions. Our Vahine brand of homemade dessert products in France, a product line unique to our EMEA region, was most impacted as recently we've seen baking returned to a more pre-pandemic baseline level. In other categories in the region, we believe there has been a step-up in consumption.

And in the Asia-Pacific region, in addition to the consumption disruption in China, second quarter growth was impacted by the exit of low-margin business in India. At the end of last year, we decided to exit our rice business, the Kohinoor brand, to enable the region to focus on our higher-margin core category.

Turning to Flavor Solutions on Slide 10. Our sales performance for the quarter was outstanding, with both pricing and volume growth contributing. We drove double-digit growth in both the at-home and away-from-home parts of our portfolio.

Looking at our Flavor Solutions growth over the past three years, since the COVID-19 restrictions caused dramatic second quarter comparisons in '20 and '21, our sales CAGR is 8%, largely driven by volumes.

Our pricing actions increased sales in all three regions. Broadly, pricing actions in the branded foodservice part of our portfolio followed the same cadence as those in each region in Consumer business.

In the rest of our Flavor Solutions business, pricing is based on contractual windows, with automatic price adjusters in many contracts and the timing is going to vary based on those windows. In this dynamic environment though, with costs escalating so quickly, we are having discussions outside of those windows and passing costs through faster than usual.

Higher volumes also contributed to growth in the Americas and EMEA region. Demand has remained strong for certain parts of our business in these regions. Our supply chain is being pressured to meet this demand and we are still taking on some extraordinary costs to service our customers. We appreciate our customers working with us through this pressure.

In the Americas, where our customer base is skewed more to packaged food and beverage customers, our at-home customers, strong growth was driven by flavors for savory snacks as well as performance nutrition and health applications with these customers.

In EMEA, our customer base is more skewed to quick service restaurants or QSRs, and our strong QSR momentum contributed to growth in all markets, partially driven by expanded distribution. Branded foodservice growth was strong in both the Americas and EMEA regions, driven by restaurant and institutional food service customers.

Demand continues to strengthen in this channel, particularly as travel accelerates and restaurants benefit from consumers shifting to take-away and delivery. Overall, our Flavor Solutions sales demand and growth momentum continues to be strong. Now let me expand on our growth platform and positioning in the current environment.

Turning to Slide 11. 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, but the younger generations fueling them at a greater rate. McCormick is uniquely positioned to capitalize on this demand for great taste, with the breadth and reach of our global flavor portfolio we are delivering flavor experiences for every meal occasion through our products and our customers' products.

We are end-to-end flavor. We continue to make investments to sustainably meet the growing demand and to fuel further growth. In our global supply chain, we increased our capacity with our recently opened U.K. Peterborough Flavor Solutions manufacturing facility and have begun our expansion of FONA's footprint to support future flavor growth. We are also increasing our capacity in the fast-growing hot-sauce category and investing in seasoning capacity to support increased demand and strengthen resiliency.

As we've said, with the sustained level of high consumer demand, we're benefiting from the manufacturing capacity we've added. While we still experienced disruptions in the supply chain, they are much more specific mainly from a transportation and packaging supply standpoint. We experienced the peak disruption in the third quarter of last year. And with every month, the supply chain continues to get better, we feel good about the progress we're making.

We are strategically investing behind our brands to drive growth, including in brand marketing, as we did throughout the pandemic with our three-year brand marketing CAGR approximating our consumer segment sales CAGR for the same period. We're pivoting our messaging to emphasize to consumers how our products help them stretch their grocery dollar. For instance, we're launching a digital messaging highlighting the value of our product by making a great flavorful meal economically.

We add flavor for only pennies per serving and recipes like our 30-minute Taco Casserole are family and budget-friendly answers to what's for dinner. We continue to invest in new products. In our Consumer segment, we are responding to new consumer behaviors, like increased at-home lunches. For instance, our new patent pending French's Creamy Mustard is off to a great start.

We're sensitive to the needs of price-conscious consumers, not just in these challenging economic times, but every day. Our portfolio includes branded items to accommodate consumers' needs and provide solutions for everyone at every price point as well as private label products. Our new product launches include additional entry-level price point product for affordability and larger sizes of key high usage items for better value.

While we are still seeing strong consumer spending, we know that inflation is a significant concern for consumers, more so than COVID. We're leveraging our proprietary research, which served us well during the pandemic, to monitor for any signals of changing behavior.

Our research continues to indicate consumers are going to cook as much at home or more than they did during the pandemic for many reasons. One of them is that they find it more economical. To the extent there is a recession, it further reinforces cooking at home, and we know from our past sales performance that our categories and brands perform well during a recessionary period.

Now for some summary comments on Slide 13 before turning it over to Mike. We remain focused on the long-term goals, strategies and values that have made us so successful. We have grown and compounded that growth over the years regardless of the environment, the long-term fundamentals that drove our industry-leading historical performance remains strong.

The strength of our business value of our products and capabilities and the execution of our proven strategies by our experienced leaders while adapting to changes accordingly gives us confidence, in our growth momentum and in our ability to navigate a challenging global environment. Despite the pressures we experienced in the second quarter, we are well positioned and confident in delivering strong performance in 2022 and beyond, while driving sustainable long-term value for our shareholders.

McCormick employees continue to do a great job navigating a dynamic environment. Their agility and their teamwork drive our momentum and success, and I want to thank them for their dedicated efforts and engagement.

And now, I'll turn it over to Mike.

Mike Smith

Thanks, Lawrence, and good morning, everyone. Starting on Slide 15. Our top line constant currency sales were comparable to the second quarter of last year, reflecting 7% growth from pricing actions, offset by a 7% decline in volume and product mix. Excluding the 4% impact of the discrete item Lawrence mentioned earlier, our sales performance would have reflected 4% growth.

Consumer segment sales declined 7% in constant currency. The impact from lapping the U.S. trade inventory replenishment, the consumption disruption in China, the exit of low-margin business in India and the conflict in the Ukraine contributed 6% to that decline. The remaining 1% decline was due to lower volume, partially offset by pricing actions. On a three-year basis, our second quarter constant currency sales CAGR was 4%.

On Slide 16, consumer sales in the Americas declined 4% in constant currency, driven by lower volume and mix, partially offset by pricing actions. This decline is attributable to lapping trade inventory replenishments in the second quarter of last year. Over the past three years, constant currency sales in the Americas grew at a CAGR of 7%.

In EMEA, constant currency consumer sales declined 11%, primarily due to lapping high year-ago demand driven by COVID-related lockdowns, the most significant impact of which was lower sales of Vahine homemade dessert products. A 1% unfavorable impact from lower sales in Russia and Ukraine also contributed to the decline. Pricing actions in all markets partially offset the lower volume. Over the past three years, EMEA's constant currency sales grew at a 3% CAGR.

Constant currency consumer sales in the Asia-Pacific region declined 18%, including a 20% unfavorable impact from the consumption disruption in China as well as the exit of low-margin business in India. Pricing actions in all markets across the region partially offset this unfavorable impact. On a three-year basis, APZ's second quarter constant currency sales CAGR was a 7% decline, driven by the China and India impact I just mentioned. Excluding this impact, sales grew at a 5% CAGR over the past three years.

Turning to our Flavor Solutions segment in Slide 19. We grew second quarter constant currency sales 11% due to pricing actions as well as higher volume and mix. This growth was partially offset by a 1% decline in sales related to the combined impact of the China disruption and the conflict in Ukraine. Second quarter constant currency sales for the last three years grew at an 8% CAGR.

In the Americas, Flavor Solutions' constant currency sales grew 12%, driven by both pricing and the combination of volume and mix. Higher sales to packaged food and beverage companies with particular strength in snack seasonings led the growth, with higher demand from branded foodservice customers also contributing to growth. Over the past three years, constant currency sales in the Americas grew at a CAGR of 8%.

In EMEA, we drove 19% constant currency sales growth with a 14% increase in volume and mix and 5% related to pricing actions. EMEA's Flavor Solutions growth, excluding a 1% decline related to the conflict in Ukraine, was broad-based across its portfolio, led by strong growth with QSR and branded foodservice customers. Over the past three years, EMEA's constant currency sales grew at a 10% CAGR.

In the Asia-Pacific region, Flavor Solutions sales declined 6% in constant currency. The decline was driven by a 7% impact from lower volume in China due to the COVID-related restrictions, partially offset by pricing actions in all markets across the region. APZ grew constant currency sales at a 3% CAGR over the past three years.

As seen on Slide 23, adjusted gross profit margin declined 550 basis points in the second quarter versus the year ago period. Realizing this is a sizable compression, I will spend a moment on the significant drivers.

Let me start with the drivers we anticipated. First, nearly half of this decline, approximately 250 basis points, is due to the dilutive impact of pricing to offset our dollar cost increases. We focus on gross profit dollars. This impact was more significant than in the first quarter because of the higher level of pricing in the second quarter. Product mix was unfavorable as compared to the second quarter of last year.

In our Consumer segment, as we mentioned earlier, we are lapping strong U.S. spices and seasonings growth related to the inventory replenishment. In our Flavor Solutions segment, sales growth in our away-from-home products was higher than our at-home products and we are lapping strong sales of beverage flavors last year. A sales shift between our Consumer and Flavor Solutions segments also contributed to the unfavorable product mix.

In our Flavor Solutions segment, as we mentioned in our last earnings call, gross margin was unfavorably impacted by start-up and dual running costs as we transitioned production to our new U.K. Peterborough manufacturing facility. Of note, CCI-led cost savings partially offset the impacts I just walked through and we are on track to deliver our expected savings of $85 million for the full year.

In addition to the net impact of the anticipated items I just detailed, gross margin was also unfavorably impacted by the following items: As Lawrence discussed, cost inflation and supply chain pressures escalated during the second quarter impacting our results more than expected, primarily related to transportation costs and faster-turning materials.

While we have adjusted our upcoming pricing actions to reflect that escalation and we plan to fully offset cost pressures over time, our second quarter gross margin compression reflects the usual lag associated with pricing. We expect pricing to begin outpacing the cost pressures later this year and continue into next year. Our cost recovery will vary by region and segment. Currently, our pricing lag is more significant in our Flavor Solutions segment.

Lawrence previously mentioned we have incremental costs to meet strong demand for certain parts of our Flavor Solutions business, thus impacting our gross margin. And finally, as already mentioned, significant cost due to the COVID-related restrictions in China had an unfavorable impact to profit.

Moving to Slide 24. Selling, general and administrative expenses were lower than the second quarter of last year and as a percentage of net sales declined 20 basis points. The decline was driven by lower employee benefit and brand marketing expenses as well as discretionary spending reductions, partially offset by higher distribution costs. The decline in brand marketing investments was driven by China and Russia reductions. Importantly, across our other markets, we invested in brand marketing at a comparable level to last year.

The net impact of the factors I just mentioned resulted in a decline in adjusted operating income, which excludes special charges, of 33% compared to the second quarter of 2021. In the Consumer segment, adjusted operating income declined 29%. And in the Flavor Solutions segment, it declined 40%. A 1% unfavorable impact from currency is included in each of these declines.

Turning to income taxes on Slide 25. Our second quarter adjusted effective tax rate was 18.6% compared to 22.2% in the year ago period, driven by a higher level of discrete tax items this year.

At the bottom line, please turn on Slide 26, second quarter 2022 adjusted earnings per share was $0.48 as compared to $0.69 for the year ago period. The decrease was driven by our lower adjusted operating income.

On Slide 27, we summarize highlights for cash flow and the quarter-end balance sheet. Our cash flow from operations was $154 million through the second quarter of 2022 compared to $229 million through the second quarter of 2021. This decrease was primarily driven by lower net income. Cash flow from operations will be weighted to the second half of the year, similar to our profit growth.

We returned $198 million of cash to our shareholders through dividends and used $102 million for capital expenditures through the second quarter. We expect 2022 to be a year of strong cash flow driven by profit and working capital initiatives. And 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 28. As a reminder, last quarter, the conditions in Russia, Ukraine and China were just unfolding and cost inflation and supply chain challenges remain dynamic and fast moving. Today, we have a better view of the macro environment and our guidance for the full year considers the greater impact from these items. In addition, and as noted previously, we have always expected our profit growth to be weighted to the second half of the year. We now expect it to be even more so.

We are projecting strong top line growth with profit impacted by the global challenges I just mentioned. We also expect there will be an estimated two-percentage point unfavorable impact of currency rates on sales, adjusted operating income and adjusted earnings per share, an increase from our previous estimate of one-percentage point unfavorable.

On the top line, we now expect to grow constant currency sales 5% to 7%. We expect sales to be driven primarily by pricing, which will accelerate significantly in the second half versus the first half. While we anticipate volume and product mix to be impacted by increasing elasticity, we expect elasticity to remain at a lower rate than historical levels.

Our volume and product mix will also continue to be impacted by the pruning of lower-margin business from our portfolio as well as the impact of demand disruptions in China and Ukraine. We plan to drive continued growth through the strength of our brands as well as our category management, brand marketing, new product and customer engagement growth plans.

We are now projecting our 2022 adjusted gross profit margin to be 200 basis points to 150 basis points lower than 2021. Given the rapidly escalating cost environment, cost pressures have outpaced our pricing and future actions have been adjusted to reflect the higher cost level. This adjusted gross margin compression reflects the impact of a high teens increase in cost inflation, an unfavorable impact of sales mix between segments and favorable impacts from pricing and CCI-led cost savings.

As a reminder, we price to offset dollar cost increases. We focus on gross profit dollars. This has a dilutive impact on our adjusted gross margin and is the primary driver of our projected compression.

We now expect to grow our adjusted operating income 2% to 4% in constant currency. In addition to the gross margin impacts I just mentioned, this projection also includes our CCI-led cost savings target of approximately $85 million and brand marketing investments comparable to 2021 which reflects reductions in China and Russia.

Considering the year-to-date impact from discrete items as well as our estimated mix of earnings by geography, we now project our 2022 adjusted effective income tax rate to be approximately 22%. This outlook is expected to be a year-over-year headwind to our 2022 adjusted earnings per share of approximately 2%.

We are lowering our 2022 adjusted earnings per share expectations to a range of $3.03 to $3.08. This compares to $3.05 of adjusted earnings per share in 2021 and represents a decline of 1% to an increase of 1% or in constant currency, growth of 1% to 3%. This reflects our lower adjusted operating profit outlook and an expected $15 million benefit from the impact of optimizing our debt portfolio.

In addition, we are well positioned with our broad and advantaged flavor portfolio and effective growth strategies to continue our operating momentum and drive another year of strong performance.

Lawrence Kurzius

Thank you, Mike. Now that Mike has shared our financial results and outlook in more detail, I'd like to recap the key takeaways, as seen on Slide 29. Our long-term performance has been industry-leading and met or exceeded our objectives, including through volatile environments. The long-term fundamentals that drove this historical performance remained strong.

Several discrete items unfavorably impact our sales comparison to the second quarter of last year. Excluding these impacts, our sales performance reflects the strength of our broad global portfolio, the effective execution of our strategies and our pricing actions. Our sales growth momentum is strong.

Persistent high cost inflation and supply chain challenges intensified as the second quarter progressed and unfavorably impacted our profit. Importantly, we expect to mitigate this impact in the second half of the year.

We're confident that with our broad and advantaged flavor portfolio, effective growth strategies and our ability to navigate challenging environments, we will drive another year of strong performance in 2022 and build value for our shareholders.

Now, let's turn to your questions.

Question-and-Answer Session


Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Andrew Lazar with Barclays. Please proceed with your question.

Andrew Lazar

I guess, first off, as you talked about, organic sales came in below where The Street was looking for it, though you raised the outlook for organic for the full year. And I appreciate some of the items in 2Q you highlighted were discrete. But maybe you could talk a little bit about, what gives you the confidence in raising the organic guidance for the full year? Are you expecting headwinds in 2Q to become tailwinds in the second half or better momentum in the underlying business? The scanner data has not necessarily showed any meaningful inflection yet that I can see at least on a year-over-year basis, I appreciate the multiyear CAGR of organic sales. So, I'm trying to get a better sense for the underlying confidence in raising the full year organic to start with.

Lawrence Kurzius

Sure, Andrew. Well, first of all, our plan, as we shared on previous calls and conferences, has always been back half-loaded and stronger in the second half than in the first half. And one of the factors driving that is the cadence of our pricing actions. There is twice as much effective pricing in the second half of the year as in the first half of the year.

As you can see, right now, for the quarter, our pricing contribution to sales was about 7% and it's significantly higher going into the second half of the year. And that is a big driver of total sales build third quarter, fourth quarter. And that's -- I mean that's the driver of sales. It's also the driver on the operating profit, EPS and so on as we go through.

The second thing is that we did not expect the disruption that we had in China in the second quarter. The extent of the lockdown was a surprise to us and I think to everybody. And China is a big contributor to us and we expect a normalization of business in China as we go through the second half. Particularly, we really expect it to be normal by the time we get to fourth quarter.

And just our experience with the initial COVID lockdown a couple of years ago tells us that once we get normalization, there's a significant surge in restocking by both the consumer and by our trade channels. And so, we would expect a strong contribution from China in the second half of the year.

And then finally, our U.S. and EMEA have less difficult comparisons going in through the second half than they did in the first half of the year, not lapping inventory replenishment that we talked about last year and also not lapping some of the COVID lockdowns that were still in effect, particularly in the second quarter.

And finally, we expect continued strong underlying demand from our consumers and our customers that we're continuing to see. Mike, do you have anything you want to add to that? Do you want to add something?

Mike Smith

Yes. I think I'd add that we see a lot of strength in our Flavor Solutions business. We saw that in the second quarter and we know that will continue in the second half. So we certainly think that's going to support, I think, really our outlook for the second half overall.

But also we're seeing a lot of new business come through in the back half of the year in both segments. And so we see a lot of strength coming through on that, too. So, the growth again does look even stronger as we move towards the back half.

Andrew Lazar

Great. And then just a quick follow-up. I don't think you mentioned it, I know you did last quarter when you were talking about in the core consumer business, private label, had not yet really had much of a move one way or the other. I don't think you mentioned it this time around. I'm just curious what you're seeing there. Anything of note that we should be aware of?

Lawrence Kurzius

I don't think that there's anything of special note there. We are seeing some trade held by consumers, not just in our category but in other categories that we track. It's no surprise that consumers at the lower end of the income scale particularly are feeling a bit of pressure from inflation, not ours, but inflation across everything. I mean, gas prices are $5 or $6 a gallon, depending on where you live, and that puts pressure on consumers' pocketbook.

But I would say that it's still at a pretty low level, particularly when we look at our brands and the elasticity that we're experiencing, it's still significantly below historical levels and it's not a particular concern. I'd say also, I'll add to that, our sales with private label products are certainly an important part of our business, but not particularly surging.


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

Ken Goldman

I just wanted to make sure I heard your commentary about pricing correctly and then I'm doing some basic math, right? You did about, I think, 6% pricing in the first half. You're saying that will double in the second half. And you also, I think, are implying that you need around 10% organic sales growth in the second half to hit your guide. Sorry to do the math on the call, I apologize for putting you on the spot, but are you effectively saying that it's reasonable for us to model maybe 12% pricing overall in the second half with volume maybe down around 2%? Is that correct [indiscernible] here?

Lawrence Kurzius

Yes, Ken, let me start with that. I'm going to let Mike point in on that. But I think you're in the right neighborhood with those numbers. We took -- first, when I think about the cadence of our increases and the timing of their effectiveness, you're in the right neighborhood when you think about going from 6% to 12% in the second half. I would have that -- again, our next pricing action in the Americas, our largest region, is in August. And so if you're thinking about phasing that, you should have that in mind as well.

Mike Smith

I'd also just add, you're going to see it across both Consumer and Flavor Solutions pretty much at the same level.

Ken Goldman

Great. That's helpful. Thanks. And then a quick follow-up. It sounds like you mentioned pricing will kind of phase in a little bit over the second half. In this context and given some of the other factors you talked about, how do we think about the cadence of the gross margin improvement in the back half? Should we expect a substantial improvement in 3Q? Is it more 4Q-weighted? Maybe any color you could provide there would be helpful as we think about modeling.

Mike Smith

Ken, this is Mike. That's a great question. We see -- actually, the cost peak year-on-year we see is third quarter and a little bit of moderation in the fourth quarter. We see the pricing obviously growing second to third to fourth. So I think what you'll see is some -- still some gross margin challenges in the third quarter. But in the fourth quarter, the combination impact of that pricing and full benefit there and the cost.

And also think about the fourth quarter is our strongest quarter overall from a volume perspective there. And as Lawrence said before, things like China, which we make really the margin on, as that recovers from third into fourth, too, that should be a positive for 4Q.


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

Steve Powers

Yes. So you gave a good deal of bottoms-up color on the incremental headwinds facing the business. So I think I'm clear on that. But I just want to play it back from the top down. Because your overall sales outlook hasn't really changed despite the more adverse currency. You're now expecting a marginally lower tax rate, a marginally lower share count, slightly less brand marketing. And while the expected cost inflation is higher at the high-teens level, it's not outside the balance of the prior outlook. So I guess just -- I just want to isolate and see if you could better define what is exactly driving the reduced operating profit and EPS outlook. It feels like it's the updated outlook on China, Russia, Ukraine and supply conditions above and beyond the normal cost inflation. But I just want to -- I want to confirm that. And if there's a way to quantify or rank order those factors, that would be great.

Lawrence Kurzius

Steve, this is Lawrence. And I think that you -- some of the little things that I think we're going to want to come back and talk about some of those marginal changes that you talked about. But on the big picture item, you've got it exactly right. And in fact, this was part of what we were trying to message at your recent conference. The big change here are the things that were external factors that surprised us and that is what's flowing through.

I'll let Mike walk through the actual fringe on that. But --

Mike Smith

Yes. If you think about our guidance, we're coming down $0.14. If you think about from a China, Russia, Ukraine perspective, that's $0.11 right there. And then FX, as you said, we're going up 1%, that's $0.03. So there's your $0.14.

Now we're recognizing that the cost inflation which you mentioned, we had mid to high double digit, we actually moved that to high double digit. So 1% to 2% more cost during the year driven by transportation, packaging, things like that. So that did hurt us in the second quarter. However -- and we're dropping a bit of that through the rest of the year, we have pricing to help mitigate that.

And then below the line, some of the things you talked about, tax is a little bit of a help. Some of the interest expense things are going to help offset that.

But the big drivers of the external factors -- the one thing I wanted to just correct you on brand or just to give you insight, brand marketing is now flat. However, that is really driven by the reduction in China, Russia, Ukraine and FX. So we're still spending up in our big markets to drive growth.

Steve Powers

Okay. That's helpful. Yes, that's perfect. That's perfect. Just a quick follow-up. On the -- to follow up on, I think, Ken's question, just the cadence of gross margin recovery. Is there anything that you would call out in the second quarter as truly transitory? So is there anything that -- any headwind that you experienced in the second quarter that is kind of unique and discrete to the second quarter that doesn't carry over, at least directionally? Trying to get a sense if there's anything behind you.

Mike Smith

The one thing I'd say, and you're new to our business, but the China business to us is very material. It's our second biggest market. We have three large manufacturing facilities. And the shutdown really put a lot of pressure on our cost there, a lot of extra cost for transportation, loss absorption, things like that. So as that business recovers, obviously, that goes away.

I think the other thing, too, is if you think about some of these costs that came up rapidly like transportation and packaging. I mean, fuel cost, if you go back to March, gasoline prices in the quarter versus March were up 25%. That stuff rolls through the P&L very quickly. And pricing will catch up on that, but a one-month lag in pricing could be $30 million to $40 million of impact, which is like $0.10 a share. So we're mitigating that as quickly as we can, but sometimes we see that as kind of stabilizing now.

And going forward, like I told you, the third and fourth quarter, where we see our cost outlook. But I think that is -- to your point about what is transitory, what is not, I think that gets the most of it.

Lawrence Kurzius

And Steve, I would really underscore that timing aspect. A one-month difference on the effective date of our price increase, we would be having a different conversation. It would be $0.11, $0.12 of EPS on the quarter. And -- and of course, those price increases are in effect I would just say they [have been] one month earlier. That's what the difference would have been. That's one reason why we're pretty confident that the -- that we're going to catch up with the cost.

Steve Powers

Understood. I just want to play back just real quick Mike's point on China. I get it that China was uniquely detrimental to 2Q, but I don't think you're saying that, that's 100% transitory. That doesn't -- as of June 1, that's not behind you, right? That -- it gets better, but it's not --

Mike Smith

So that's why I said that's going to really help us in the fourth quarter more. It's still -- different levels of openings that are happening now, that will happen throughout the quarter, yes.


Our next question comes from the line of Robert Moskow with Credit Suisse.

Robert Moskow

Lawrence, in your opening remarks, you said that your research shows that there's -- that consumers will continue to cook as much at home as they did during the pandemic, if not more. And just anecdotally, I find that this year, that's not the case. People are regaining mobility, returning to the workforce, what have you. And you can see it in your numbers, too. So do you have any like kind of real-time insight into how consumers are behaving this year in light of the fact that your category in the U.S., it's much weaker than other packaged foods categories have been tracking.

Lawrence Kurzius

Brendan, I'm going to let you take that one.

Brendan Foley

Yes, sure. Rob, we're -- I guess, just to react to some of the thoughts you just shared there. We're seeing through a lot of our research, also what we're seeing in secondary research out there, is that there's still a heavy level of sustained cooking at home in the data overall, whether we're researching it or we're getting it from some of our suppliers there. We definitely see a sustained level of eating at home. And overall, I would say that the consumer hasn't really changed that much.

Now it's performing in our categories, we're seeing it play out in a number of our categories, our recipe mix, hot sauces, we still have a lot of strong sort of consumption growth there. And so we certainly still see it play out.

Certainly, there are categories like meat where you see -- you do see some decline going on there. That might affect an item or two here, but we definitely still have a very balanced portfolio where we're seeing still a lot of at-home consumption going on.

Mike Smith

And frankly, historically, you go back, Rob, a long way with us, if a recession does occur, that will drive more people cooking at home. So that bodes well, I think, for our broad portfolio.

Brendan Foley

Our research, I would say is recent in the last 30 days, is telling us that there is still a sustained level.

Lawrence Kurzius

And I mean if you look at our Flavor Solutions business, I mean, clearly, foodservice is strong. Restaurants have reopened. People are not forced to cook at home. But there still seems to be a strong preference in that direction. And actually, as we went through the first half, we saw in the macro data that there was a return to dining away from home and a reduction in cooking at home. But in recent weeks, that has started to turn back the other way, probably driven by economic pressures on consumers. Cooking at home is more economical.

I think for a variety of reasons, we're still pretty optimistic on the whole retention of cooking at home behaviors. There are some pockets that are different. Baking was really largely driven by kids being at home from school. We've seen baking-related items return to the kind of really pre-pandemic levels. That certainly is a part of our European story where our Vahine brand is a big factor.

But overall, the general cooking-at-home trend persists and all of those few meal occasions that are food -- home occasions because of people working remotely continue to support that strong consumption.

Robert Moskow

Okay. And then maybe a follow-up for Brendan. As you're talking to the trade about the holiday seasons and the price increases and consumer behavior, what's the reception been like? Is the price increase well understood for seasons, the reasons why? And are they eager to merchandise aggressively during the holiday season?

Brendan Foley

Yes, I think the way our conversations are unfolding with customers and looking at the holiday season is one where you're still looking at, I think, improvement in supply across the season. And that is I think one of the things that underpins really a lot of optimism and strength as we go into the back half, especially as we go into this holiday season. We are certainly communicating a strength in our ability to supply and drive the holiday promotions and displays and everything else. So I would say the conversations with customers have been rather positive and strong and the outlook remains pretty healthy. Underpinned by supply, I would say, is one of the important factors there.

With -- related to pricing, I mean, I think we work a lot with our customers in making sure that we're both driving category growth. And so that is a big part of our conversations as well. And -- and again, I think those conversations, and we appreciate the partnership and working with our customers on that. But the outlook, I think, remains very healthy.

Lawrence Kurzius

And again, I'll just underscore that, well, we don't want to get too specific on discussions about pricing because there is customer or competitive considerations there and there is always some natural tension in those discussions. Our customers know that we've taken a long-term perspective on our relationship with them, that we are transparent in the reasons for pricing and they themselves are continuing to experience inflation. That's very broad based on some of the same factors that we are. And so those conversations have continued to be quite constructive.


Our next question comes from the line of Alexia Howard with Bernstein.

Alexia Howard

Can I ask about just the global supply chain dynamics. You obviously are sourcing ingredients from many different places around the world, probably more so than other large packaged food companies. I'd just be curious to hear sort of what you're seeing in terms of global supply chain, domestic supply chain. Where are the real pain points for you now? And is there any light at the end of the tunnel?

Lawrence Kurzius

Sure, Alexia. This is actually a -- I'd say our worst disruption on supply chain really was third quarter of last year and has continued to get better incrementally every month. We're not out of the woods by a long shot in terms of normalization. But the really broad scale disruptions that we were experiencing a year ago are behind us and the disruptions are pretty much more discrete factors.

I'd say our global sourcing of raw materials from points all around the world for our various markets around the world has been one of our strengths through the whole pandemic experience and the post-pandemic time and continues to be a strength. Our challenges have been more on either predominantly local packaging issues and specific packaged materials from very specific suppliers. Some of them are -- continue to be a sore point.

And then there's -- in areas where we have -- there's still some areas where even though we've added a lot of capacity, the demand is still extraordinary and we're pressed to meet the needs of our customers. And those -- and again, those would be in a few very specific areas.

Alexia Howard

And then just as a quick follow-up. There was a comment in the press release about unfavorable mix in Flavor Solutions. How important was that? Because obviously, the profit decline was very marked this quarter. And what drove that? And then I'll pass it on.

Mike Smith

Yes. I mean -- it's Mike. I mean unfavorable mix was one of the factors. If you think on a quarter-to-quarter perspective look back here, really strong performance in some of the higher-margin categories kind of -- and this year, the strongest performance was in the away-from-home versus to at-home.

So a little bit -- between those two categories we mixed down a little bit, nothing to be concerned about. As we've talked about, Flavor Solutions can be lumpy based on the products we sell and things like that. But that's part of the reason.


Our next question comes from the line of Adam Samuelson with Goldman Sachs.

Adam Samuelson

So I was hoping to just maybe try to understand the second half, kind of framing it maybe from a different light. Because it would seem like the full year guidance implies second half operating margins up about 250 basis points year-over-year. I get that there's an incremental pricing actions that benefit and the price cost balance reflect -- will probably flip positively presumably in the fourth quarter. But also that's a dilutive impact to percent margins. Just trying to get a sense of what -- how do we -- notwithstanding some of the discrete things in the May quarter, specifically to the China impact in particular, but we've got volumes that -- demand elasticity that would suggest volumes aren't going to get better. Between businesses, Flavor Solutions is probably growing faster than Consumer. So that's a mix headwind at the corporate level. And I'm just trying to understand kind of how do we get to that magnitude of percent margin improvement in the back half.

Lawrence Kurzius

Adam, I'm going to start and I'm going to let Mike pick it up. Again, I want to let us underscore that there is a big change in the relationship between pricing and cost as we go through the -- as we go through the year. In the second half, we -- price increases begin to overtake the cost increases and rather than trailing or beginning the year, we're recovering the cost increases. That's going to be a big factor between the continued strong demand and having twice as much effect of pricing in the second half as the first half is going to be a really big factor.

Mike, do you want to talk --

Mike Smith

There's other factors to add. I mean we really we talk about pricing as a way to offset cost, and we have other levers when we talk about revenue management, our CCI-led cost savings. So we continue to lean hard on driving additional cost savings in this inflationary environment. We see continued strong demand driving that. High-margin products helping us there. So there's a lot of reasons to believe.

To your point, though, I mean, between third and fourth quarter, I mean, the fourth quarter is where a lot of this comes to fruition from getting to a positive margin change year-on-year.

Lawrence Kurzius

Yes. I'll add. So we don't expect COVID lockdowns to repeat in China. That's a wildcard. We've been surprised there before, that could happen again. We don't think -- we're not expecting that. But that was a big unfavorable in the first half, particularly in the second quarter that we expect to correct and normalize as we go through the second half.

Adam Samuelson

Okay. So maybe just to help clarify that. As we think about the year-to-date second quarter or year-to-date kind of performance. What's been the realized CCI savings year-to-date relative to the 85% that you talked about for the full year? First -- I don't think I heard a specific number in terms of what the realized cost inflation has been year-to-date just relative to that high teens number that you've targeted or you've expected for the full year. And I guess just any way to help dimensionalize some of the -- you gave the brand marketing piece, but other SG&A, just where that magnitude of kind of tightening [bulk savings] there and how much that can contribute in the second half?

Mike Smith

This is weighted to the second half, and that's all I'm going to say.


Our next question comes from the line of Peter Galbo with Bank of America.

Peter Galbo

Lawrence, I just wanted to circle back actually to Andrew's question around private label and going back to the slides, you do have a section here talking about more entry price points. And I'm just curious, is that a response to what you see as impending, more share shifting to private label. And so you feel like you need more entry price points? Or is it something else? You talked about inflating cost baskets and maybe in other categories like proteins. And I noticed here you're talking about entry price points on things like Grill Mates and Lawry's, which tend to be more tied to protein. So just curious to kind of get the thoughts around that.

Lawrence Kurzius

Yes, that really doesn’t have anything to do with private label. What it has to do is there's a concern that consumers may be under pressure as we were seeing some early times the consumers may be feeling some economic pressure. It's no secret that things like gas prices are up. Our customers are -- retailer customers are talking about consumers feeling some pressure. And we have some concern that between the inflationary environment and the high risk of inflation -- sorry, that's the wrong word there, the high risk of recession as we go into the second half and even into 2023, that we want to be able to make sure that consumers, especially in the lower half of the income scale, are still being served and have access to our categories.

Our goal is to have products that appeal to consumers at every price point across the whole category. And between our new product launches, our brand marketing and our brand marketing activity, we are taking a tone that tries to address that pressure to consumer. We've got -- I know we're kind of hitting time and General Mills is probably talking right now, but Brendan's got a lot of color that he can add on this question and I'd like to give him a chance to.

Brendan Foley

Well, I think, Lawrence Kurzius, I think you hit it largely right. We're trying to make sure that our portfolio and our assortment is really geared towards what consumers are starting to face. And it could very well be price points that are lower in terms of smaller sizes.

I would say though, also, there's another dynamic on the other end which is happening, which is we actually see even more consumers switching to larger sizes, looking for more value. And so it's playing out really on both ends. And so those are things that we're reacting to and making sure that we drive even more distribution and items in our assortment that serve those needs and those price points that consumers are looking for.

Peter Galbo

Got it. That's helpful. And maybe just a quick one. Lawrence, you did mention I think that packaging tightness was impacting a certain couple of categories in U.S. season -- spices and seasonings. Just any more color there? What specifically brands or categories we should be looking at just if that starts to improve, would we see a new…

Lawrence Kurzius

I don't want to get too specific, but I also don't really want to call out our suppliers with whom we're trying to have a constructive [multiple speakers] competitors either for that matter. But we had some trouble with glass for our organic spices in our gourmet range that I think we have resolved now. And we've had some ongoing challenges on some other -- more of the rigid container kind of packaging and mostly in the U.S., frankly.


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

Lawrence Kurzius

Thank you. McCormick's alignment with consumer trends and the rising demand for flavor, in combination with the breadth and reach of our global portfolio and our strategic investments, provide a strong foundation for sustainable growth. We're disciplined and are focused on the right opportunities and investing in our business. We're continuing to drive further growth as we successfully execute on our long-term strategy, 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

Thank you, Lawrence, and thank you to everybody joining today's call. I apologize for those that we didn't get to. If you have any further questions, please reach out to me today. And this concludes this morning's call. Thank you very much.

And for those of you in the U.S., have a wonderful holiday weekend, grill a lot. And for those of you in Canada, happy Canada Day. And everybody else, have a great weekend.

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