McCormick & Co. Inc. ( MKC - Analyst Report ) delivered strong second quarter 2012 earnings of 60 cents, which increased the prior-year quarter earnings by 9% or 5 cents per share. The results were driven by favorable operating income and tax rate, offset by lower income from unconsolidated operations and higher interest expense. Earnings in the quarter, however, lagged the Zacks Consensus Estimate by a penny.

Sales and Margin Details

Total revenue in the quarter grew 11% year over year to $984 million. Revenue also exceeded the Zacks Consensus Estimate of $968.0 million.

On a currency basis, revenue increased 13%, where half of the increase was contributed by the acquisitions completed in 2011 (acquisition of Poland-based Kamis S.A. and Kitchen Basics, a leading brand of liquid stock; and a joint venture with India-based Kohinoor Foods Ltd.). McCormick’s price increase in response to high input costs, volume and product mix also contributed to the overall revenue growth.

Gross margins contracted 20 basis points to 39.5% in the reported quarter, owing to material cost inflation. Operating income increased 11% in the second quarter 2012 to $121.0 million, driven by favorable impact of higher sales and cost savings under the company’s Comprehensive Continuous Improvement (CCI) program. However, the results were negatively impacted by a sharp rise in material costs and a $4 million increase in brand marketing expenses.

Segment Details

Consumer Business: Segment revenue surged 14% year over year to $568.8 million in the reported quarter. On a currency basis, revenue increased 15%, majorly driven by benefit from acquisitions, and contribution from price increases, favorable volume and product mix.

Like increase in revenues, operating income for the segment also increased 15% to $88.6 million in the quarter, supported by increases in brand marketing spending.

Industrial Business: Segment revenue climbed 8% year over year to $415.2 million in the second quarter of 2012. On a currency basis, segment revenue increased 10% attributable to increased prices, favorable volume and product mix.

Operating income for the McCormick’s segment increased marginally to $32.7 million from $32.3 million, mainly from increased sales growth and higher CCI cost savings.

Capital Structure

The global leader in flavors, McCormick generated high inventory at the end of May 31, 2012, due to higher material costs and acquisitions, but declined from inventory on the balance sheet at the end of the first quarter of 2012. Due to the seasonality of McCormick’s business, cash flow from operations typically increased significantly in the second half of the fiscal year.

Guidance

For fiscal 2012, McCormick continues to forecast a difficult global economy and volatility in material costs. However, the company expects to grow sales, generate cost savings, invest in brand marketing support and deliver solid profit growth.

McCormick reiterates its sales guidance growth of 9% to 11%, which includes an expected 4% tailwind from the acquisitions completed in 2011. The company, however, expects foreign currency exchange rates to lower sales growth by 2%. McCormick also reaffirms its operating income growth of 9% to 11%, which includes approximately $15 million of incremental brand marketing support.

For fiscal year 2012, management re-affirmed its earnings guidance in a range of $3.01 to $3.06 per share, reflecting the higher operating income offset partially by lower income from unconsolidated operations.

Our Recommendation

We are impressed by the company’s results in the second quarter. Even though the company has completed multiple acquisitions and expanded its product portfolio in 2011, we remain concerned with the inherent risks involved. Additionally, we expect a tough environment ahead with rising cost pressures.

McCormick which competes with ConAgra Foods, Inc. ( CAG - Analyst Report ) and Kraft Foods Inc. ( ) currently holds a Zacks #3 Rank (a short-term Hold rating). Over the long term, we provide a Neutral recommendation on the stock.