McCormick [MKC] Conference call transcript for 2022 q1
2022-03-29 12:45:23
Fiscal: 2022 q1
Kasey Jenkins: Good morning. This is Kasey Jenkins, Senior Vice President of Corporate Strategy and Investor Relations. Thank you for joining today's first quarter earnings call. To accompany this call, we posted a set of slides at ir.mccormick.com. We will begin with remarks from Lawrence Kurzius, Chairman, President and CEO; and Mike Smith, Executive Vice President and CFO, and we'll close with a question-and-answer session. During this call, we will refer to certain non-GAAP financial measures. The nature of those non-GAAP financial measures and the related reconciliations to the GAAP results are included in this morning's press release and slides. In our comments, certain percentages are rounded. Please refer to our presentation for complete information. In addition, as a reminder, today's presentation contains projections and other forward-looking statements. Actual results could differ materially from those projected. The company undertakes no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events or other factors. Please refer to our forward-looking statements on Slide 2 for more information. I will now turn the discussion over to Lawrence.
Lawrence Kurzius: Good morning, everyone. Thanks for joining us. Before I go to business, it is with great sadness that I mention the passing of Buzz McCormick, who is 1 of the most beloved and admired leaders in McCormick's history. Buzz's career at McCormic span 50 years rising through the ranks across many functions becoming President and CEO in 1987 and serving as Chairman of the Board for a total of 11 years until his retirement for the third time in 1999. As CEO, Buzz focused McCormick on flavor by divesting noncore businesses and driving category leadership in spices and seasonings, setting the course for McCormick to be the global leader in flavor. Notably, McCormick's market cap grew by 4x under his leadership. Buzz will not only be remembered for his enduring legacy of performance but just as importantly, for his deep commitment to the well-being of all McCormick employees. He truly made McCormick a great place to work, leaving his biggest accomplishment as a CEO is helping all McCormick employees have a better life. Today, as we reflect on his life and its contributions, we know that his legacy will live on. He has inspired many generations of McCormick leaders with his passion for people, focus on flavor and commitment to delivering shareholder value. Next, I'd like to comment on the situation in Ukraine. First and foremost, we extend our deepest sympathies to the people of Ukraine and hope for an immediate end to the conflict and the suffering of innocent people. As we previously announced, we suspended our operations in Russia in mid-March. Our operations in Ukraine have been paused to focus on the safety of our employees and their families. Our thoughts are with the people impacted by these tragic events, particularly our employees who we continue to support through aid in humanitarian efforts we're donating to the Polish Center for International Aid and the World Centre for Pigeon. I would also like to express my sincere appreciation to our EMEA employees, especially those in Poland for their many personal efforts in aiding their Ukrainian neighbors in need. Their actions epitomize our power of people principle. Now moving to Slide 4 and our business results. We delivered solid financial results in the first quarter, in line with our expectations, driven by the successful execution of our strategies and the engagement of employees. We are confident our strong year-to-date momentum will continue to drive strong performance throughout 2022. In the first quarter, we grew sales 3% or 4% in constant currency on top of our 20% constant currency growth in the first quarter of last year, demonstrating again the strength of our product offering and broad global portfolio, which drives differentiated growth and consistency in our performance. Consumer segment sales, while lapping high year ago demand continued to reflect the sustained shift to higher at-home consumption compared to pre-pandemic levels. Our Flavor Solutions segment growth was driven by outstanding growth with our packaged food and beverage customers as well as robust demand from restaurants and other foodservice customers due in part to recovery from curtailed away-from-home dining in the year ago period. Through the breadth and reach of our balanced flavor portfolio, we are meeting the global demand for flavor and delivering flavor experiences for every meal occasion through our products and our customers' products we are end-to-end flavor. Adjusted operating income was down 14% or 12% in constant currency, and adjusted earnings per share was down 13%. As anticipated, the profit driven by our sales growth was more than offset by the well-known and anticipated effects of higher inflation and broad-based supply chain challenges. We have a demonstrated history of successfully navigating through a volatile environment, and we expect to do the same through this high current inflationary period using pricing and other levers to offset cost pressures, which is reflected in our 2022 profit outlook. Now for more on our first quarter segment performance. Starting with the Consumer segment on Slide 5. Growth in the Americas was more than offset by lower sales in the EMEA and APZ regions. Total Consumer segment sales declined 2% against 35% consumer growth in the first quarter of 2021. Given the difficult year-over-year comparison, volume declines were reflected in each region. On a 2-year basis, however, compared to the first quarter of 2020, each region grew sales by double digits. This growth highlights the strength of our categories and importantly, our products as consumers continue to cook more at home, demand for flavor continues to grow. The pricing actions we have taken were also reflected in each region's results, and the elasticity impact we experienced has been lower than historical levels. As we look ahead and our additional pricing actions are phased in, the elasticity we experienced may change, and this could be a cumulative effect, but we still expect the impact to be lower than historical levels. Turning to highlights by region, starting with the Americas. Our total U.S. branded portfolio consumption as indicated by our IRI consumption data and combined with unmeasured channels, grew 2% which follows a 15% consumption increase in the first quarter of 2021. This is the eighth consecutive quarter of double-digit consumption growth versus the 2 year ago period. Demand has remained high, and we continue to realize the benefit of the manufacturing capacity we added as well as our increased resilience. Our first quarter shipments were in line with consumption, however, some products remain stretched by sustained high demand. Shelf conditions continue to improve as does our share performance with another sequential improvement in the first quarter as we expected. Versus last year, we are beginning to grow our spices and seasoning share and in recipe mixes, we had another quarter of considerable share gain over 4 share points. We continue to see further improvement as we begin the second quarter, and we are confident in our continued momentum. In EMEA during the first quarter, we lapped high prior year demand, partially due to restrictions resulting from COVID resurgences last year while continuing our momentum with strong consumption growth in key categories compared to the first quarter of 2020. Our market share performance was stronger this quarter. We maintained our total EMEA region herb, spices and seasoning share on top of strong gains in the first quarters of the last 2 years. Of note, Frank's RedHot has grown consumption 60% and gained significant share versus the 2 year ago period. And in the Asia Pacific region, first quarter growth was tempered by scaled down Chinese New Year celebration due to several cities in China imposing restrictions as a result of new COVID outbreaks.These restrictions impacted our branded food service demand that is included in the consumer segment in China. Turning to Slide 6. Our Flavor Solutions segment grew 12% or 14% in constant currency driven by base business growth, new products and 1 month of incremental sales for our acquisition of FONA in December 2020. All 3 regions contributed to our growth each with higher volume and product mix as well as the pricing actions to partially offset costs. Our first quarter Flavor Solutions results reflect similar market conditions across the region. As a reminder, our customer base in the Americas is skewed more to packaged food and beverage customers and in EMEA and APZ to quick service restaurant or QSR customers. Our differentiated customer engagement and technical capabilities continue to drive outstanding growth, both in base business and with new products, with our packaged food and beverage customers or at home customer base. Our performance with these customers led our first quarter Flavor Solutions results with double-digit growth in flavors for Performance Nutrition and health end market applications as well as savory snacks. And our momentum with flavors for alcoholic beverages also continued. Our QSR momentum has been strong with core menu items and limited time offers driving first quarter growth and other restaurant business continues to rebound. Our first quarter results also reflect the lapping of curtailed away-from-home dining last year. The restaurants are benefiting from the shift to takeaway and delivery that was amplified by the pandemic. There's been a blurring between channels and most of the restaurant food being consumed off-premise. For instance, 1 in 4 dinners consumed at home was supplemented with a restaurant or other foodservice items. For our other institutional food service customers and our branded foodservice product category, we expected some recovery coming into 2022, and we saw that demand strengthen in our first quarter and drove growth in the Americas and EMEA regions. Now I'd like to share some comments on our momentum and the growth initiatives we have underway. Turning to Slide 7. Global demand for flavor remains the foundation of our sales growth and we have intentionally focused on great fast-growing categories that will continue to differentiate our performance. We are capitalizing on the long-term consumer trends that accelerated during the pandemic, healthy and flavorful cooking, increased digital engagement, trusted brands and purpose-minded practices. These long-term trends and the rising global demand for great taste are as relevant today as ever with the younger generations fueling them at a greater rate. Our alignment with these trends, in combination with the breadth and reach of our global portfolio and the successful execution of our strategies sustainably positions us for future growth. In this current dynamic global environment, we remain focused on long-term sustainable growth. We continue to experience cost pressures from higher inflation and broad-based supply chain challenges. To partially offset rise in cost we raised prices where appropriate late last year and are currently facing an additional pricing actions. And as costs have continued to accelerate, we will raise prices again this year where appropriate. We appreciate our customers working with us to navigate this environment. Additionally, our plans to mitigate cost pressures include our CCI-led cost savings, revenue management initiatives and taking prudent steps to reduce discretionary spend where possible. Throughout our history, we have successfully grown and compounded our growth regardless of the environment and plan to do so again in 2022 as we continue to accelerate our momentum and drive growth from a position of strength. In our Consumer segment, across our major measured markets, we have gained millions of households over the last 2 years and had double-digit buyer rate growth. Our brands have gained new consumers, and we have driven increased usage at the same time. This performance, combined with billions of additional at-home eating occasions from consumers cooking more at home has created a new baseline for growth. We are continuing to drive our consumer segment momentum by accelerating flavor usage, including delivering on the demand for heat, building confidence in the kitchen and inspiring flavor exploration. We're also strengthening our consumer relationships at every point of purchase and creating a delicious, healthy and sustainable future. We are fueling growth through our brand marketing investments, category management initiatives and new products. Our brand marketing is resonating with consumers, particularly as we connect with them online. And as we expand the capabilities of our marketing excellence organization globally, we're gaining efficiencies, executing with greater speed and shifting our investments to work in dollars to drive greater effectiveness. Our U.S. spice aisle reinvention is further driving our category leadership with growth for McCormick and our customers. This initiative is continuing this year with additional stores being implemented and we're also starting to build momentum with similar initiatives in Canada, the U.K. and France. Our consumer new product innovation differentiates our brands and strengthens our relevance with our consumers. Our new products are focused on what’s important to consumers, such as freshness, modern packaging, convenience and flavor exploration as well as affordability and value. 75% of global consumers find it more economical to cook at home. And in the current inflationary environment, it resonates even more now. Our products are already part of the consumer solution to manage inflation across their whole grocery basket. For instance, inflation is hitting the meat case hard and a little bit of our flavor can make less impressive meat, more palatable and make the consumers whole meal both more affordable and fiber. We have products at all price points that attract many types of consumers and households as well as different income levels. We continue to focus on ensuring we're launching new products that appeal to all types of consumers such as additional entry-level price points for affordability as well as value offerings, including larger sizes to meet the needs of price-conscious consumers. And with our new products and recipes tailored, the popular new appliances such as air fryers and Instant Pot, we are providing consumers flavor inspiration and greater convenience when using our products. In our Flavor Solutions segment, we plan to continue migrating our portfolio to more value-added products and technically insulated products, particularly our Flavor product category. We're targeting opportunities to grow with our customers in attractive, high-growth end markets such as alcoholic beverages, savory snacks and Performance Nutrition.We have been outpacing the market growth in these categories. They all contributed towards a strong growth in our first quarter results and further migrate our portfolio. Following a record year of new product growth last year, we are excited about our robust 2022 pipeline of culinary inspired innovation. We are leveraging our broad technology platform to develop clean label, organic and better-for-you solutions to some of our customers' issues without compromising on taste. We're using Sage, our AI-enabled product development tool to develop consumer preferred flavors at an increased speed that have a track record for lasting longer in the market for our customers. And we are building a pipeline of opportunities to accelerate our global seasoning growth by expanding our mid-tier customer base being added to core supplier list and strengthening our leadership in heat. We plan to continue to drive flavor solutions growth through a differentiated customer engagement. We have a strong passion for creating a flawless customer experience. Across both segments, our installed sales and growth plans bolster our confidence in continuing our growth trajectory. We also recognize we are operating in a challenging global environment. Before Mike reiterates our guidance in a few moments, I'd like to comment on some current conditions. We will continue to monitor the situation in Russia and Ukraine very closely and adapt accordingly. Cost inflation has remained persistent with recent escalation in some areas such as transportation costs. And as such, we have raised our cost inflation guidance. It is now a mid- to high-teen increase. And in regard to COVID, as I mentioned earlier, there are new COVID restrictions being imposed in several cities in China. We are continually assessing the dynamics of these conditions as they involve we recognize there will be some near-term impact, which we expect to mitigate later in the year, in part with additional pricing actions. We are well positioned to deliver another strong year of growth and performance in 2022 and through the effective execution of our strategy and with a robust operating momentum. In addition to delivering top-tier financial results, we are also committed to doing what's right for people, communities and the planet. We recently released our 2021 purpose-led performance progress report, which highlights our key initiatives and the progress we are making, including our recent announcements on the update of our science-based targets, reduced greenhouse gas submissions by 2030, aligning with the United Nations 1.5 degree Celsius target as well as our commitment to net zero by 2050. As we move forward in 2022, we are excited to continue to share our progress and success on all our purpose-led performance goals. Now for some summary comments on Slide 11, before turning it over to Mike. The combination of our strong business model, the investments we have made, the capabilities we have built and the power of our people position us well to continue our robust growth momentum. We are in attractive categories and are capitalizing on long-term consumer trends that are in our favor. We are actively responding to changing market conditions, consumer behaviors and customer needs while remaining forward-looking in an ever-changing environment. We have a strong foundation and are well equipped to navigate in today’s environment responding with agility to volatility and disruption while remaining focused on the long-term objectives, strategies and values that have made us so successful. Through the execution of our strategy that are designed to drive long-term value, we have grown and compounded that growth successfully over the years, regardless of the environment. Our fundamentals that drove that performance and our momentum and outlook are stronger than ever. McCormick employees continue to do a great job navigating a dynamic environment, their agility and teamwork drive our momentum and success, and I want to thank them for their dedicated efforts and engagement. Now I'll turn it over to Mike.
Mike Smith: Thanks, Lawrence, and good morning, everyone. Starting on Slide 13. Our top line growth continues to be strong. During the first quarter, we grew constant currency sales 4%, driven by pricing actions across both segments and incremental sales from our FONA acquisition. Consumer segment sales declined 2% in constant currency due to lapping high demand in all 3 regions last year, with a partial offset from pricing. On a 2-year basis, compared to the first quarter of 2020, constant currency sales grew 30% with double-digit growth in all 3 regions, reflecting the sustained shift to at-home consumption higher than pre-pandemic levels. On Slide 14, consumer sales in the Americas increased 2% in constant currency, driven by pricing actions, partially offset by lower volume of the product mix due to lapping last year's elevated demand. Branded products led the growth with strength in McCormick, Zatarain's, Stubb's, Otay, Simply Asia, Frank's RedHot and French's, partially offset by a decline in private label. In EMEA, constant currency consumer sales declined 9% from a year ago, driven by lower volume and product mix, most significantly in Vahiné homemade dessert products due to lapping last year's high demand across the region. This decline was partially offset by pricing actions. Constant currency consumer sales in the Asia Pacific region declined 6%, driven by the exit of lower-margin business in India. China's consumer and branded foodservice demand partially related to the Chinese New Year impact Laurence mentioned earlier, also contributed to the decline. These declines were partially offset by pricing actions. Turning to our Flavor Solutions segment on Slide 17. We grew first quarter constant currency sales 14%, including a 2% contribution from incremental FONA sales in December. As a reminder, we acquired FONA on December 30, 2020. The remaining increase was driven by higher volume and product mix as well as pricing actions. Compared to the first quarter of 2020, constant currency sales grew 18%, with double-digit growth in all 3 regions. In the Americas, flavor solutions constant currency sales grew 12%, with FONA contributing 2% and the remaining growth due to both pricing and the combination of volume and product mix. Higher sales to packaged food and beverage companies with particular strength in snack seasonings led the growth with the recovery of demand from branded foodservice customers also contributing. In the EMEA, we drove 24% constant currency sales growth with a 17% increase in volume and product mix and 7% related to pricing actions. EMEA's growth was led by the robust recovery of demand from QSRs and branded foodservice customers. In the Asia Pacific region, Flavor Solutions sales rose 5% in constant currency, driven by pricing actions and growth from higher volume and product mix. This growth was driven by our QSR customers, both in their core menu items as well as their limited time offers and promotional activities. As seen on Slide 21, adjusted operating income, which excludes transaction and integration costs related to the Cholula and FONA acquisitions as well as special charges declined 14% or in constant currency, 12% in the first quarter versus the year ago period. Adjusted operating income declined 12% in the Consumer segment with minimal impact from currency. And in the Flavor Solutions segment, it declined 17% or 11% in constant currency. Both segments were unfavorably impacted by higher inflation and distribution costs. Both of which accelerated in the second half of last year as well as incremental investment spending on our ERP program, which we expected to be higher earlier in 2022 versus 2021. CCI-led cost savings favorably impacted both segments. In the Consumer segment, lower sales, partially offset by a reduction in COVID-19-related costs also contributed to the decline. In the Flavor Solutions segment, higher sales were more than offset by the unfavorable drivers I just mentioned as well as costs related to supply chain investments, which will continue in the second quarter. As seen on Slide 22, adjusted gross profit margin declined 260 basis points in the first quarter versus the year ago period. This was driven by the net impact of cost pressures we are experiencing and the pricing actions we have taken. We estimate the dilutive impact of pricing to offset this dollar inflation increase was approximately 200 basis points in the first quarter. Additionally, a sales shift between segments also contributed to the margin decline. Our selling, general and administrative expense as a percent of net sales increased 20 basis points from the first quarter of last year due to higher distribution costs and a higher level of investment in our ERP program. This, combined with the adjusted gross margin compression, resulted in an adjusted margin decline of 280 basis points, in line with our expectations. Turning to income taxes on Slide 23. Our first quarter adjusted effective tax rate was 19.7% compared to 22.7% in the year ago period, driven by a higher level of discrete tax items this year. Adjusted income from unconsolidated operations declined 30% versus the first quarter of 2021, due to the elimination of higher earnings associated with minority interest as well as higher inflation costs impacting our McCormick de Mexico joint venture. At the bottom line, as shown on Slide 25, first quarter 2022 adjusted earnings per share was $0.63 as compared to $0.72 for the year ago period. The decrease was driven by our lower adjusted operating income. On Slide 26, we've summarized highlights for cash flow and the year-end balance sheet. Our cash flow from operations was an inflow of $18 million in the first quarter of 2022, compared to an outflow of $32 million in the first quarter of 2021. This increase was primarily driven by working capital improvements and lower payments for transaction and integration costs related to our Cholula and FONA acquisitions. We returned $99 million of cash to our shareholders through dividends and used $44 million for capital expenditures this quarter. We expect 2022 to be a year of strong cash flow driven by profit and working capital initiatives. 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 27. First, I would like to provide some additional perspective on some of the current conditions Lawrence mentioned earlier. As we have said, we are currently not operating in Russia and the Ukraine. And while the impact is not fully known, our business in these markets is small with the combined sales across both segments totaling less than 1% of total company sales last year. Additionally, we have no manufacturing in either country. Any operating profit impact would include those related to the impact on sales as well as potential expenses stemming from the current situation. Regarding cost inflation, we are revising our outlook and are now projecting inflationary pressure in the mid- to high teens as compared to mid-teens increase in our previous guidance. We expect cost inflation to remain persistent, especially as it relates to transportation, and we are continuing actions to mitigate these costs, including pricing. Again, as Lawrence mentioned, we recognize these dynamics will have some impacts on our results, certainly in the second quarter. While we continue to monitor impacts on the broader economy and will adapt as necessary we are reiterating our 2022 sales and profit outlook that we previously shared in our January earnings call. We are projecting strong top line growth and operating performance with earnings growth partially offset by a higher projected effective tax rate. We also expect there will be an estimated 1 percentage point unfavorable impact of currency rates on sales, adjusted operating income and adjusted earnings per share. On the top line, we expect to grow constant currency sales 4% to 6%. We expect pricing to be a significant driver of our growth with volume and product mix to be impacted by elasticities although at a lower level than we have experienced historically. We plan to drive growth through the strength of our brands as well as our category management, brand marketing, new product and customer engagement growth plans. Our volume and product mix will also continue to be impacted by the cooling of lower margin business from our portfolio. Our 2022 adjusted gross margin is projected to range between comparable to 2021 to 50 basis points lower than 2021. This adjusted gross margin compression reflects the anticipated impact of a mid- to high-teens increase in cost inflation, an unfavorable impact of sales mix between segments, a favorable impact from pricing and CCI-led cost savings. As a reminder, we price to offset dollar cost increases, we do not margin up. This has a dilutive impact on our adjusted gross margin and is the primary driver of our projected compression. We expect to grow our adjusted operating income 8% to 10% in constant currency, which reflects our robust operating momentum, a reduction in COVID-19-related costs and our continuing investment in ERP business transformation. This projection includes inflationary pressure in the mid- to high teens, a low single-digit increase in brand marketing investments, and our CCI-led cost savings target of approximately $85 million. As we shared on our last earnings call, we expect our profit growth to be weighted to the second half of the year. During the second quarter, we are phasing in pricing actions and with costs continuing to escalate, we'll raise prices again as appropriate. While we plan to cover the cost pressures due to the recent acceleration of inflation, there will be a lag. And as a result, our profit will now be weighted to the second half of the year, even more than originally expected. And as a reminder, we expect our ERP investment to be higher earlier in the year versus 2021. Our 2022 adjusted effective income tax rate is projected to be 22% to 23% based upon our estimated mix of earnings by geography as well as factoring in a level of discrete impacts. This outlook versus our 2021 adjusted effective tax rate is expected to be a headwind to our 2022 adjusted earnings per share growth of approximately 3%. Our 2022 adjusted earnings per share expectations reflect strong operating growth of 8% to 10% in constant currency, partially offset by the tax headwind I just mentioned. This resulted in an increase of 4% to 6% or 5% to 7% in constant currency. Our guidance range for adjusted earnings per share in 2022 is $3.17 to $3.22 compared to $3.05 of adjusted earnings per share in 2021. In summary, we are well positioned with our broad and advantaged flavor portfolio and effective growth strategies to continue to accelerate our operating momentum and drive another year of strong growth and performance.
Lawrence Kurzius: Thank you, Mike. Now that Mike has shared our financial results and outlook in more detail, I would like to recap the key takeaways as seen on Slide 28. We delivered solid first quarter results in line with our expectations with strong sales growth on top of our 20% constant currency growth last year. We are confident that the hard work and dedication of our employees will continue to drive momentum. We recognize we're operating in a challenging global environment. Through the execution of our strategies, we've successfully grown long-term value environment over the years regardless of the environment. Our long-term fundamentals that drove our performance are stronger than ever. The strength of our business model, the value of our products and capabilities, our alignment with long-term consumer trends that are in our favor and the attractive categories we are in, provide a strong foundation for long-term sustainable growth. We're confident that our broad and advantaged flavor portfolio, our robust operating momentum and effective growth strategies will drive another year of strong growth in 2022 and build value for our shareholders. Now let's turn to your questions.
Operator: And our first question today will be coming from the line of Andrew Lazar with Barclays.
Andrew Lazar: McCormick reiterated its full year outlook, right, despite a worsening in inflation outlook and still dynamic operating environment. And as you noted, now requires an even more significant margin inflection in the back half of the year to stay within sort of your full year gross margin guidance. So I was hoping you could speak a little bit to what gives you the visibility that is playing out. And I know you detailed some items on the last call, such as pricing and lapping COVID costs, smoother cadence of ERP spend and CCI saves and such. So perhaps you can remind us of these and share if there are any additions or changes to the above?
Lawrence Kurzius: Thanks, Andrew. I'll start on this and then let Mike follow up and talk about those specific items. But first of all, I want to emphasize that first quarter is really right up in the middle with our expectations. And it all starts with strong demand and strong top line performance. We expect to see continued strong demand as we go through the year. And as we go through the second quarter, in particular, more pricing action goes into effect, which on top of that strong demand and with the relatively low elasticity that we're seeing will translate into both strong top line and strong bottom line growth in the second half of the year. This is in line with the guidance that we talked about on our last call at the end of -- when we gave guidance for the year initially. Mike, you want to talk about those specific guidance.
Mike Smith: Yes. I think the thing that's really changed since the first quarter for the year-end call when we talked about the inflation moving from mid-teens to mid to high teens. Really, there's been a bit of an acceleration in things like fuel cost that will impact our second quarter. But we see on average across the year, that cost inflation around the same mid- to high single teens, but it's been moved forward into the second quarter. Pricing, though, is continuing to build, as Lawrence said. For the full year, before we said on the last call, mid- to high pricing impact, we're at the high -- we'll be at the high end of that now. And actually, in the second 6, we'll be in a low double-digit pricing impact range, which gives us more confidence about the second half profit realization. As you mentioned, there were some other factors. ERP spending is up in the first versus last year. Investments in supply chain, we just announced some of the transition of production over to the Peterborough facility in the U.K. There are start-up costs that have hit us in the first quarter. There will be more of that in the second quarter, really hitting the Flavor Solutions segment. So we do see some of those negative impacts in Q2, but really feel confident about the second 6 with some of the actions that we've identified.
Andrew Lazar: And then just quickly, you've talked about the capacity coming online. And I think you mentioned you shipped essentially or closer to consumption this quarter, so sort of making progress there, and we've seen that in the market share improvements. But it doesn’t sound like you’ve yet had the ability to sort of really re-build retail or inventories. And I assume there's still some opportunity for that as you go forward through this year? And perhaps you could just update us on that.
Lawrence Kurzius: I think that this is a work in progress. Supply chain continues to get better. It's not perfect as our -- some of our customers will remind us. But the disruptions that we are seeing are much more discrete and specific rather than the third quarter of last year, it seemed like everything was a problem. So supply chain has gotten better, our ability to meet that demand has really gotten better. And although make that remark about certain customers a minute ago. The fact is our customers tell us that, generally, we are performing better than our competitive set, and this is allowing us to win new business. So we really feel pretty good about how that has improved. And I think you'll continue to see us build share performance consecutively as we have been for the last several quarters with our ability to supply, and that additional capacity coming on has really made the difference.
Operator: The next question is coming from the line of Alexia Howard with Bernstein.
Alexia Howard: Can I ask, first of all, about the private label dynamics because we're looking at the level of price inflation really across the grocery store. And under normal circumstances, you would expect to trade down to private label. But I know that you mentioned that your private label sales are actually down year-on-year. I'm just wondering what's driving that. Is it supply chain related? Is it retail-driven? Or is it simply that consumers are feeling -- still feeling reasonably flash and able to afford the branded products? And then I have a follow-up.
Lawrence Kurzius: Sure. I think 2 things. First of all, we have not yet seen significant movement in private label as a trend in either direction. Some of the recent market data shows some increase and -- but it's really slight in our categories. There's a dynamic you have to watch out for private label, the costs are going up for everybody. And it's driven by raw material, packaging and transportation, and the same penny cost increase that's impacting brands is also impacting private label. And so when you put that same amount of cost increase through to private label, percent of increase is bigger, and it creates an uptick of private label growing faster on a dollar basis. It's again, it's that cost pass-through. So I want to make that clear. The second point that I want to make, though, is that we are believers that there's a role for both our brand and private label, especially in the urban spice category and we provide both to our customers and the best competitive environment for us as a company. It's when both our brand and private label are obtaining share, putting pressure on everybody else.
Alexia Howard: Great. and as a follow-up, obviously, Russia and Ukraine is a very difficult situation right now. Can you share what percentage of sales that is to you? I'm pretty sure it's fairly low. But what do you see as the risks around the world if the situation persists? And I'm really talking about when we've gone through previous commodity cycles, we've seen problems because of the inaffordability of basic food stuff like bread in Egypt and so on. Would your supply chain -- I mean, given what you've seen in the past when we see these grain cycles, are there particular ingredients that you think might be more challenged? I'm just trying to get at the risks there.
Mike Smith: Alexia. It's Mike. I'll start the answer. We have said in our 8-K, sales for Russia and Ukraine are less than 1% of our total sales. So that's -- and so that's grossed in. It will have an impact in the second quarter, obviously, because that's when the crisis has unfolded. As far as your question about broader impacts, primarily inflation, I think you've seen in the last couple of weeks, and part of the reasons we've taken our inflation expectations up and discussed pricing is because of some of those impacts. From a commodity perspective, I mean, our market basket is a lot different than a lot of other food companies. I mean there are products that could be impacted, we source mustard from that part of the world, but we have secondary sourcing capabilities there, which we've moved to. So I think our global supply chain, 1 of the strengths we have is it's deep and has a long history and there's alternative markets for a lot of our materials. And no one raw material makes up more than 5% of our total cost of goods sold. So I think that diversity really helps us.
Lawrence Kurzius: And I would say we're less exposed to the green complex. Most of our peer companies would be. I think our concern and part of what we're considering in our inflationary outlook is cost of energy, which now looks like it's going to remain higher than perhaps it might have otherwise. That flows through the packaging to the plastic resins and things like that.
Operator: Our next question comes from the line of with JPMorgan.
Unidentified Analyst: In light of some of the incremental cost pressures you're facing, the year-on-year decline we saw in the first quarter gross margin, is this a reasonable level of decline to think about in the second quarter as well? Or was -- where should we think about the first quarter as the low point in terms of progression?
Mike Smith: I'd say between the first half and the second half, you're going to have that big change due to the pricing dynamic I mentioned before and some of the one-timers in the first 6. The things we've laid out as far as cost increasing versus our original expectations in the second quarter. I think it's probably a pretty good estimate that in that range of gross margin, what we did in the first quarter is probably close. We do have the additional Peterburg supply chain investment costs I talked about for dual running costs and things like that. So I don't think you're far out of the ballpark there.
Unidentified Analyst: Great. That's helpful. And then I just wanted to switch to -- ask about pricing in consumer EMEA. The pricing remained like fairly muted in the quarter. So can you walk us through what to expect from pricing in this region as the year progresses? And what some of the challenges are, if any, to taking pricing here?
Lawrence Kurzius: Well, I'd say that we've said we're going to take pricing as appropriate. And so different regions are going to have different levels of inflationary impact and different levels of pricing and different timings in which those pricing actions might take effect. And so I don't -- and then even within regions, there are going to be differences from country to country, especially in the region.
Mike Smith: Even within the segments.
Lawrence Kurzius: Even within our segments, certainly, I can say though that broadly, we have -- our current pricing actions -- our pricing actions that we've spoken about are very much on track. We have pricing going into effect in second quarter in several markets. I know your question is about the EMEA, but they'll be more specific about our U.S. consumer business because increases are going into effect this week for the next round. In our Flavor Solutions segment, broadly, the branded foodservice part of the portfolio moves with consumer pricing. And the rest of the flavor solutions business, pricing is based on contractual windows and the timing is going to vary tremendously based on the windows of reassessing the pricing. And I'd say that in EMEA and APZ, the pricing actions are on track and are going to be phased in through the first half of the year. So it is -- pricing is always an ongoing discussion, and we would not get too specific as of now for both the customer and for competitive reasons.
Mike Smith: Yes, I think you'll see the same trends across the regions that pricing will build during the year.
Operator: Next question is coming from the line of Robert Moskow with Credit Suisse.
Robert Moskow: Thanks for the question. I guess it's in 2 parts. I wanted to confirm what I heard about the level of pricing you think, Mike, that will show up in your P&L by the end of the year. I thought I heard you say low teens, but I could have gotten that wrong. Is it scaling up that much? And then the second part is, I think, Laurence, you said that you're operating from a higher baseline because you brought in a lot of consumers to the franchise and the category has expanded perhaps structurally. But the category is declining in the U.S. modestly. It's declining a lot in Europe from what I can tell. Is there a risk here that as consumers regain more mobility and they're gaining it very quickly right now that the consumer category might not be at the right baseline that there might be a lower baseline out there than what you would expect
Lawrence Kurzius: Rob, but I think we'll start with the pricing --
Mike Smith: Let me answer that. When I say then, just to be clear, we have given guidance that pricing for the full year was going to be mid to high single digit based on -- with the new based on the -- we're moving to the high end of that based on the price -- based on the recent cost increases. Obviously, single digit. I'm getting confused. Mid to high single digit. We moved to high based on some of this recent cost inflation, I talked about primarily impacting the second quarter. When I said about first half, second half, in the second half, if you look at that in particular, back to Andrew's question, we are going to see low single -- low double-digit price increases, which are cumulatively coming through for the third and fourth quarter. So it builds during the year, to my point before, not for the full year but for the second 6.
Robert Moskow: Yes. Yes. Okay. That's a big price increase in the back half of the year.
Mike Smith: Well, I think you're lapping and you're lapping last year in the Americas, particularly pricing in the fourth quarter last year. So you do get that cumulative impact of several price increases, 3 of them actually.
Robert Moskow: Okay. And then the risk to the baseline?
Lawrence Kurzius: Well, of course, there was elevated demand because consumers were forced to stay at home to cook. And we never expected all of it to remain. But we do believe that consumers have moved to a higher level of consumption and at a higher level of cooking at home structurally. All of our research points in that direction. Just the logic of people still cooking at home.And it starts from working from home in part. Lunch is going to be a meal occasion. That is consumed more at home. The breakfast because of work from home, people are actually cooking breakfast instead of using more ready-to-eat solutions. And there's kind of both the qualitative and the quantitative work at that point to say consumption at home is going to continue to remain elevated. I mean 88% of consumers say they're going to cook as much at home or as much or more at home than they did during the pandemic. To the extent there's economic pressure on us from a recession, that also reinforces the whole cook at home. And we know, in particular, our categories and our brands performed well during processionary periods during both of the last 2 recessions. Our brand growth was right in line with our long-term guidance. We are seeing a difference in our consumer business in the U.S. versus Europe. But the biggest factor there is actually that Europe has -- in our European business, we have a significant component that is making, particularly with our Botanical brand in France. And so we've seen baking return to more of a baseline level. But we do believe that there's been a step up in our other categories.
Mike Smith: Yes. I mean you just look at total McCormick consumer in the last 2 years, we were lapping a really tough quarter last year in Q1. We're up 30% in 2 years constant currency consumer sales. That's pretty amazing. That's that step-up that Lawrence was talking about.
Robert Moskow: And maybe 1 last follow-up, if I could. If pricing is up low double digit, let's say, it's like 12% in the back half of the year. It's probably not unheard of to expect a volume decline of like negative 5%, negative 6%. Is that close to how you're thinking about elasticity? Number one. And if volume is that -- down that much, does that have any implications for your fixed cost leverage? Or what does it do to your -- the rest of your P&L, if anything?
Lawrence Kurzius: Well, I'm not going to get too specific on our exact elasticity modeling. But we do model elasticity. These price increases are really outside the range of those models. And the environment is different from the environment in which those models were built. So I think that all of us are in a little bit uncharted territory right now. But we've assumed a level of elasticity is so far so good in the sense that elasticity that we're actually seeing is actually at the low end of what we've been modeling. So that gives us some encouragement. And again, elasticity is probably based on substitutability and everything is going up. And so kind of -- even though our prices are going up, the consumers’ perspective about the kind of relative frame of preference, it's in a context for all the substitutes and everything that products are used on it's going up as well. And again, as we tried to say in our prepared remarks and which we've seen and heard from consumers in the past is that our products are a very small part of the cost of their meal. And in many cases, are part of them solving their whole grocery basket inflation problem. They've got a NIM going up 40% the increase on spices sales by comparison and using even more spice to substitute a lower cost got to meet a real behavior that we see in consumer.
Mike Smith: Let's read about the fixed cost in our supply chain. I mean we manage ups and downs all the time. So if there happens to be some volume decrease there's been a large investment in capacity in the last couple of years and we've gotten out a lot of these co-pack costs from COVID. So we would absorb that.
Lawrence Kurzius: Yes. And I would say we're still -- in order to meet the high level of demand the volumes came down a little bit, it actually won't even benefit us.
Operator: Next question is coming from the line of Adam Samuelson with Goldman Sachs.
Adam Samuelson: So I was hoping to dig in on the Flavor Solutions growth a little bit and really trying to think about the performance in some of the different buckets and very different comp layout in that part of the business than in the consumer segment, where you were still lapping some easy foodservice and quick service comps a year ago. Those get notably tougher, your packaged food customers, especially in North America might kind of -- or probably wrestle with a lot of the same demand elasticity questions that Rob and others have been asking about already. So I'm just trying to think about how we should think about the volume growth, whether it's by region or by the different parts of that business over the balance of the year?
Lawrence Kurzius: I'll start off to say that Flavor Solutions growth for the total company was really strong. And for Americas and EMEA, it was likewise really, really strong. And even Asia Pacific and where the growth was a little bit lighter, I'm not going to complain about the amount of growth that we recognize over there as well. The food away from home components, slightly trailed food at home overall, but those results were really different by region. That whole – our whole flavor and seasoning business has really been robust in the Americas, and that drove a lot of the growth. And quick service restaurant recovery has continued to be strong. And branded food service is now reopening. So we're seeing solid growth there. I mean it's hard to say what's not, -- I mean, I couldn't tell you what we're not growing.
Mike Smith: Yes, not only the secular trends, but we're winning business. I mean it's the thing that we talked about -- 1 acquisition that has unlocked across the flavor business and some of these high-growing categories, we talked about it in CAGNY. So I think you're seeing a lot of good trends across Flavor Solutions.
Adam Samuelson: Right. I know I get that. I'm just trying to think about this on the go forward, the comp layout on volumes is just very different from an activity level than our consumer business. And I'm trying to think about, especially if there's risks of maybe a bit lower economic growth, especially in EMEA, you got COVID lockdowns in Asia or in China specifically, just how do we -- how you're thinking about that business as we go into the balance of the year?
Mike Smith: Well, I think -- Gosh. I mean all companies are struggling like this. But I think in times when other of our, say, package food companies are trying to come up with innovation, maybe take cost out where our products are such a small percentage of the total product they sell to the consumer, it's actually an opportunity for us to work with them. So I'm less concerned about some of the elasticity they're seeing, things like that. You've said we're small component, just like on the consumer side of that meal, whether you're a branded foodservice or whether you're buying a snack seasoning.
Lawrence Kurzius: And on China specifically, we're watching this. But I'd say it's within the -- there are always puts and takes in pressures within the business. I'd say that what we're seeing at least so far is within that range.
Adam Samuelson: Okay. And then -- and if I quickly follow up on the commodity cost inflation point, and I appreciate your basket looks very different than a lot of other food companies. You guys also are much more diverse just in terms of despite the seasoning herbs that are going to have a lot of emerging market kind of growers, very smallholder farmers. Can you talk about the contracting of that? How much when you actually will agree to price with those growers through the year? Just they're going to be facing some pretty dramatic input cost inflation. I'm wondering how that will impact the price that you're paying for that basket of commodities, is that really more of a fiscal '23 event as we think about their costs throwing up to your return --
Mike Smith: I think most -- the impact we've talked about, especially recently is more on the transportation and the packaging side. There's exposures to the resins and oil costs and things like that. Input commodities, we have a long history of relationships with partners and joint ventures that secure commodities over time. And you can look at our balance sheet, we have more raw materials now than we did last year. So that's part of the way we protect our future supply.
Lawrence Kurzius: Right. And I think that we couldn’t get into too much detail here. I would say that our global sourcing and our foods on the ground and our long relationships with producers in these markets and kind of the strategic partnership that in some cases are multigenerational have really advantaged us in this area and this has actually been an area that -- where I think that we've demonstrated tremendous competitive advantage and is giving us some buffer and I think that others are probably experiencing even greater cost inflation pressure for some of these same components. It is an area where scale really matters.
Operator: Our next question is from the line of Steve Powers with Deutsche Bank.
Steve Powers: Perhaps, building on your comments in response to Alexia's question on private label and Rob's questions as well, it seems there's an increased focus in your comments this morning on entry price points for affordability maybe that just limited the private label, but generally and value offerings such as the larger pack sizes. I guess I just want to validate that I'm picking up on a fair evolution in tone since the start of the year, number one. And then number two, maybe some comments around how that's altered your outlook for volume versus product mix alongside the increases in pricing. Clearly, you haven't altered the top line outlook and you've mentioned the incremental price anticipated so we can solve for the difference. But within that, I'm curious how you're thinking about volume versus mix trade-offs. It sounds like you expect the response to skew more towards mix versus a unit volume decline. But I just want to validate that and would love some incremental thoughts.
Mike Smith: I mean I'll start with this. There's a lot to unpack. I mean the nice thing in our consumer business is, whether you're buying recipe mixes or bottles of spices or Frank's RedHot Sauce, the margins are very solid. So we have a real -- we have a broad -- for all portfolio of products of Flavor things, but really high-margin business across the board. So I don't think -- I don't think there's going to be an impact there from a shift. I mean you may see in previous recessions, like we've talked about, I don't think we're shifting the message. I think we've talked about very consistently in the recessionary periods such as 2001, 2009, our products do really well. We show volume growth and pricing growth that we need to. So there may be a shift in products from gourmet to recipe mixes because people are going down the value chain, but the margins are there and the use of the 1 pack of dry seasoning mix versus a bottle actually helps us in some way. So I don't -- I think the fear that you're raising isn't fair, right?
Lawrence Kurzius: Yes, we're not trying to signal anything when we talk about it. We offer the whole range of price points from all the way from super premium and to mid-tier to entry price point. And at a time when, when we -- and everybody are taking pricing actions, we also want to make sure that our products are accessible to lower-income consumers and value-conscious consumer. And that's how we're really trying to provide reassurance in that area. It's not an anticipation of some change or it's not a shift in strategy or focus for us.
Operator: Next question is from the line of Chris Growe with Stifel.
Chris Growe: Just had a couple of quick questions. I think these have become pretty much follow-ups at this point, but just to be clear on a couple of points. But given the higher inflationary outlook, you mentioned you do have more pricing coming online in the second quarter. Is that new pricing? Or is that pricing that was expected to pick up from some of your actions, I think you put in place in the fourth quarter.
Lawrence Kurzius: I can tell you, we -- this is pricing that has been planned. We -- these price increases in order for them to be effective now were presented before our last call, I can assure you, so these are not new. And the additional pricing that we're planning later in the year was planned, the magnitude of that pricing was still flexible and we're locking that in now.
Chris Growe: Okay. Got it. And then I just want to be clear on the cost inflation, that accelerates in the second quarter. Even though pricing’s accelerating, it sounds like there’s going to be some extra cost, so there’d be ERP and the new -- and the facility costs in peers forward. That would be factors that would keep the gross margin from including much sequentially, but the second half should show that improvement as more of the pricing comes through. Is that the right way to think about that between pricing inflation?
Mike Smith: For second half as I said, for the reasons you mentioned, but also the fact that, that cost acceleration for the fuel costs and things like that into the second quarter in addition to some of the things we made out before with some of the supply chain. So yes, you're right.
Chris Growe: Okay. And I just got a question -- go ahead, sorry.
Lawrence Kurzius: I would just say I think you got it.
Chris Growe: Okay. Great. One quick question on Flavor Solutions. You talked about some strategic investment spending. Is that related to future demand? Or is that related to Peterborough, for example, are things you're moving around? I'm just curious what that referred to.
Mike Smith: That's specifically reflecting -- the majority of it is related to the Peterborough start-up costs and redundant running costs there.
Chris Growe: Okay.
Mike Smith: Which is a great new facility of net carbon 0 and manufacturing and then running, it's going to be fantastic long term, but there is a start-up cost, yes.
Operator: Our final question is from the line of Peter Galbo with Bank of America.
Peter Galbo: Just wanted to circle back, I think, to some comments you made maybe a few years ago around China and make sure some of the numbers we're working with are still okay. But I believe, in the past, you've disclosed that China is sub-10% of the business. And I think about half of that business is away from home just as we're thinking about 2Q impact of potential walk-downs.
Lawrence Kurzius: You're right about less than 10%. It's -- I think that's close enough.
Mike Smith: Taken out – I mean away from at homes, but --
Lawrence Kurzius: Yes, that's how -- I mean --
Mike Smith: Yes. I mean you have to remember, within our consumer business, we have -- there's products we sell that are used for both -- in foodservice that we classify them as part of the consumer, which is a little different than other parts of the world just because of the fact they could be used in both channels.
Peter Galbo: Right. Okay. Okay. And then maybe just as a follow-up, Mike. And I know we've kind of gone over this on the cost inflation side and pricing. But I just -- on reconciling the gross margin guidance specifically for the year, given kind of the hole you're working out of 1Q, some of the lasting impacts in 2Q and not margining up when you take price in the back half of the year, just -- how do you kind of still get to a flat to down 50 basis points gross margin number as you're looking at it internally? Just can you help us there?
Mike Smith: I think you have to remember, first quarter is historically the smallest quarter. So -- and the back half of the year is traditionally our biggest quarter. So there you get a math thing going that helps us as we have increased volumes and pricing and things like that. We've talked about that help fill some of that gap you're talking about. I mean we're always looking -- we talked at CAGNY, we talked on the earnings call about the things that are going to help us, whether it's CCI. People forget about the reduction in COVID costs. We spent $60 million in COVID costs last year, of which some of that still remains in the underlying business, but that was -- that's a big tailwind for us to help offset some of the segment mix we've talked about, the pricing compression that we've talked about, which is the main driver. So there's other things we're doing, whether it's rev management, to shift to higher-margin products, both on the Flavor Solutions side and Consumer that we're intentionally doing. So there's a lot of things -- there's a lot of puts and takes within that 0 to 50% -- or 50 basis points for the full year. But we're 1 quarter in, and it's just too early to move. And things will move in that range, too, as things change with Ukraine and Russia, commodity costs, pricing. So we're comfortable with where we are right now.
Operator: I'll now turn the floor right to Lawrence Kurzius for closing remarks.
Lawrence Kurzius: Great. Thank you. McCormick is differentiated by the breadth and reach of our balanced portfolio, which has positioned us for sustainable growth. We're very proud of our solid first quarter operating performance, our disciplined and our focus on the right opportunities and investing in our business. We're continuing to accelerate our momentum and drive further growth as we successfully execute on our long-term strategies, actively respond to changing consumer behavior and capitalize on opportunities from our relative strength. We are well positioned for continued success and remain committed to driving long-term value for our shareholders.
Kasey Jenkins: Thank you, Lawrence. Thank you to everybody for joining today's call. If you have any further questions about today's information, please feel free to contact me. This concludes this morning's call. Have a nice day.
