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McCormick’s industrial business markets blended seasonings, spices and herbs, condiments, compound flavors and extracts, and coating systems to other food processors and to the away-from-home channel, both directly and through distributors and warehouse clubs.
For restaurant customers and other food processors, we develop and deliver consumer-preferred flavors. In fact, new products launched over the last three years accounted for 22% of 2004 sales.
<img src='content_image/16938.jpg'>
## COMPOUND FLAVORS
Beverage flavors Dairy flavors Confectionery flavors
## PROCESSED FLAVORS
Meat flavors Savory flavors
## SEASONINGS
Seasoning blends Salty snack seasonings Side dish seasonings (rice, pasta, potato) Sauces and gravies
## COATING SYSTEMS
Batters Breaders Marinades Glazes Rubs
## CONDIMENTS
Sandwich sauces Ketchup Mustards Jams and jellies Seafood cocktail sauces Salad dressings Flavored oils
## INGREDIENTS
Spices and herbs Extracts Essential oils and oleoresins Fruit and vegetable powders Tomato powder
## 2004 financial results
Net sales rose 7% in 2004. Volume, price and product mix increased 4%. Favorable foreign exchange added another 3%. Sales growth in the Americas resulted from new product successes, particularly with restaurant customers, as well as higher pricing for higher cost vanilla, dairy products and other raw materials. In Europe, growth in more value-added products was offset by reduced sales of ingredients. This shift in mix was driven by our decision to exit certain lower margin products and regions.
Operating income rose 4%. Higher sales, an improved product mix, and initiatives to reduce costs provided an offset to cost pressure from other areas including fuel and employee benefits. During 2004, we increased product development expense 18%.
## market position
Interest in flavors continues to grow. A report published by The Freedonia Group states that “flavors and flavor enhancers will continue to account for the largest share of overall food additives, due to their extensive use in many processed foods, dairy prod- ucts, baked goods and candy...opportunities are constantly being created by consumer demand for new flavors based on ethnic cuisines and more intense flavor preparations.”
With blended seasonings, spices and herbs, condi- ments, compound flavors and extracts, and coating systems,
<img src='content_image/16937.jpg'>
To further improve our productivity, a new formula management system introduced in 2004 will provide a running start on new projects and reduce the new product cycle time for delivery to our customers beginning in 2005.
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McCormick has the broadest range of flavor solutions in the industry. While there are many industrial competitors, most market only one or two of these five categories. And as a lead- ing supplier to food service distributors and warehouse clubs, McCormick is well-positioned to grow with these customers.
For all customers, new products are an essential element of growth. Our multifunctional sales teams work with customers to develop leading products that become marketplace winners.
Spending for research and development has more than doubled since 1998. Our focus has been on value-added, higher margin products. Together, our development, application, culinary and sensory areas enable us to deliver consumer-preferred flavors.
We develop flavorful coating systems for quick service restaurants. In 2004, U.S. sales of coating systems grew by more than 30%.
Chefs in China are adding flavor with our McCormick brand line of spices and seasonings. We grew sales of these food service products 8% in 2004.
## 2004 highlights
> Launched new products during the last 3 years that accounted for 22% of 2004 sales.
> In the U.S., increased sales of coating systems by more than 30%. Directed primarily to the quick service restaurant industry, our flavorful products drove sales for key customers.
> Doubled the sales of new products measured per each research and development professional in the past 5 years. Tripled cost savings per research and development professional in the past 3 years.
> By focusing on more profitable items, reduced SKUs (number of items sold) in the European market from more than 3,250 in 2003 to less than 2,750 in 2004. In 2005, we will streamline our business to fewer than 2,000 individual products in Europe.
Our customers have recognized McCormick for delivering innovation, quality products and reliable service.
> Grew sales of food service herbs and spices 8% in China, establishing the brand as the product of choice among high-end restaurants and catering outlets.
> Recognized by our customers for innovation, quality products and reliable service. For the tenth consecutive year, Sysco ranked McCormick among its top 100 suppliers. Fewer than 10 other suppliers to Sysco share this honor. Frito-Lay named McCormick its 2003 seasoning and ingredient supplier of the year.
> Completed a formula management system that will provide a running start on new projects and reduce new product cycle time delivery to our customers beginning in 2005.
> In the U.S., we are improving the quality of incoming materials through a rigorous vendor management program. This program led to a 36% reduction in incoming material defects during 2004.
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## growth initiatives
We are growing the industrial business by:
Supporting the global expansion of our industry-leading customers. Our customers are growing globally, and we are growing with them. Additional restaurant locations in China, product distribution into India, a new brand launched in Europe . . . each of these offers McCormick an opportunity for growth. We can supply much of this growth from existing facil- ities. We are also seeking to extend our global flavor capabilities into new regions through acquisitions.
Building current and new strategic partnerships. At the end of 2004, our top 15 customers accounted for approximately 70% of sales. They rely on us for consistent, high quality products and flawless service. We will increase our business with existing customers by working collaboratively to pursue growth oppor- tunities. We also have in place a team devoted to identifying and developing new strategic partners. These opportunities include large companies that we do not currently supply, as well as emerging businesses, such as restaurant chains, that are expe- riencing rapid growth.
Providing consumer-preferred value-added products. Innovative new products are in demand. With our breadth of flavor solutions, we can participate in the latest high growth area, whether it is dairy, confection, high fiber or low carb. Our culi- nary and flavor experts add value by including sophisticated flavors in coating systems, seasoning blends, condiments and other products. And our sensory teams conduct careful testing to measure consumer preferences. As our business shifts to more consumer-preferred value-added products, we are grow- ing sales and improving profit margins.
## outlook
Our growth initiatives are expected to drive 5% annual sales increases. The pace of growth may vary year to year due to acqui- sitions, foreign exchange and other factors. Our ongoing focus on value-added products will continue to boost profit margins.
For 2005, new products in the pipeline include flavored beverages, salty snack seasonings, and coating and grilling systems. With cost reduction activities helping the bottom line, profit margins for the industrial business will continue to improve.
We are building our leadership position in flavors. With our wide range of flavor solutions and ability to create consumer- preferred products, customers increasingly turn to McCormick for new product ideas and as a preferred supplier of great flavor solutions.
<img src='content_image/18392.jpg'>
With blended seasonings, spices and herbs, condiments, compound flavors and extracts, and coating systems, McCormick has the broadest range of flavor solutions in the industry.
Claudio Rattes Senior Food Technologist, Research & Development
” Ginger is commonly used in baking but my favorite use is to give a recipe some Asian character, especially with poultry and seafood. I like to add a spoonful of McCormick ground ginger per pound of fish along with some toasted sesame seeds in the breading. It will provide a very fresh taste, which may be com- plemented with lime juice (at the moment of serving) and will reduce any‘fishy’ aroma. ”
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## Q&A with Bob Lawless
## What are your most significant opportunities to grow sales?
On average, we expect to grow sales 5% annually, within a 3-7% range. We do this through innovation, acquisitions and extending our geographic reach. New products will continue to be a vital part of our sales growth. In recent years, at least 10% of annual sales came from new products launched in the prior three years. We continue to pursue acquisitions as an important avenue of growth. Geographically, we are excited about opportunities to further expand our branded products in China and to countries in Europe where we do not yet have a leading share.
In summary, sales growth will vary year to year based on acquisition activity, foreign currency exchange rates and other factors. However, over time we expect annual sales growth from the following sources: 2-3% from the base business, 1-2% from new products, 1-2% from acquisitions, 0-1% from distribu- tion expansion and 0-1% from pricing actions.
## How does concern about health and wellness impact your business?
Consumers are invited to visit www.mccormick.com where they will find healthy recipe and meal ideas in our new “Taste for Health” section. As a supplier of a broad range of flavors, McCormick can add taste to a variety of diets. For consumers on a low-carb diet who are eating more meat, poultry and seafood, we provide coatings, marinades and grilling seasonings. If one’s interest is in whole grains, we offer products that flavor
<img src='content_image/36168.jpg'>
bread, cereal and wholesome snack foods. All too often, diets that call for low-fat, low-salt or low-calorie are often low in flavor. And that’s where McCormick steps in – to add great taste.
## I’ve read that Americans are eating out more. Are they cooking less?
In October 2004, USA Today reported that 77% of meals are made at home based on research conducted by NPD. And the Food Marketing Institute has indicated that 84% of consumers ate a home-cooked meal at least three times a week compared to 74% in 2001. At the same time, Americans would like prepa- ration time to be less than thirty minutes according to Parade
enjoy something flavored by McCormick.
## Costs for many basic food ingredients such as soy oil and dairy products can fluctuate year to year. How does this affect your business?
We strive to maintain stability in costs and pricing. In our indus- trial business, many customers accept price adjustments that pass through commodity cost changes. In our consumer busi- ness, increases and decreases in the costs of spices, herbs and
Magazine’s “What America Eats” issue. McCormick makes cooking quick and easy with products like GrillMates, seafood sauces, and new seasoning mixes that offer both convenience and great flavor. We’re delivering flavor in new ways too, with grinders, salad products and dessert toppings that add taste at the table.
For many of those occasions when people prefer to eat out, grab a snack or heat up a prepared meal, McCormick continues to deliver the flavor! Through our industrial business, we add taste to the products offered in leading restaurants, food service distributors and food processors. In fact, whether you are at home or eating out you can
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other ingredients tend to offset one another during any particular year. In certain situations we increase prices to offset rapidly escalating costs. An exam- ple occurred in 2003 when vanilla bean costs rose steeply due to a crop shortage,
and we responded by increasing prices. We went even one step further. With our global sourcing capabilities, we were able to secure a strategic inventory of vanilla beans to guarantee a supply of vanilla extract for our customers.
## You have made several acquisitions in recent years. Are you looking for more?
Yes. Acquisitions which expand our flavor offerings or our geographic penetration are key components of growth.
For our consumer business, we are seeking leading brands of spices and seasonings in those markets where we do not have a strong presence, particularly in Europe. Silvo was an excel- lent example of acquiring a leading European brand. With a 63% market share, it was a great way to expand our business into the Netherlands with a highly regarded brand of spices and herbs. In established markets, we search for products that deliver distinct flavors. Here in the U.S., our 2003 acquisition of Zatarain’s is a great example of this; Zatarain’s unique New Orleans flavors appeal to consumers.
As for our industrial business, we have a broad range of flavor solutions for our U.S. customers and plan to expand our current capabilities in international markets through acquisi- tions. Regardless of the type of acquisition, a disciplined business plan, a detailed integration plan and a rigorous financial review are the keys to success.
<img src='content_image/9991.jpg'>
= Ethical Behavior Teamwork High Performance Innovation Concern for one another Success
deep knowledge of the business and excellent relationships with suppliers and customers. Careers are advanced through train- ing and challenging on-the-job experiences. Each of us has measurable goals, and our achievements are rewarded. Employee values are the foundation of our success.
Our leadership team is focused on growing this business. And throughout the Company, our high performance employees are delivering great results – to our customers, our consumers and our shareholders.
## How did you develop the “flavor forecast” at the front of this report?
This is our third edition of the “flavor forecast.” It is published for the benefit of our many customers and is shared with the food industry media throughout the U.S. The “forecasters” include chefs, culinary television personalities, cookbook authors and our own trend experts.
Our business at McCormick is all about flavor. We have the broadest range of flavor solutions in the industry and believe that no matter what you eat each day, you are likely to enjoy the taste of McCormick. Throughout this report, our develop-
ment team shares some ways to bring the latest trends into your home. Bon appetit!
## What do you consider to be the “key ingredient” to McCormick’s success?
Our “key ingredient” is without question the people of McCormick. Their enthusi- asm, values and drive to win are unmatched. Our employees possess a
<img src='content_image/9992.jpg'>
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## McCormick worldwide
## executive officers
Robert J. Lawless Chairman of the Board, President & Chief Executive Officer
Paul C. Beard Vice President – Finance & Treasurer
Francis A. Contino Executive Vice President – Strategic Planning & Chief Financial Officer
Robert G. Davey President – Global Industrial Group
H. Grey Goode, Jr. Vice President – Tax
Kenneth A. Kelly, Jr. Vice President & Controller
## CONSUMER BUSINESS
CONSOLIDATED OPERATIONS
JOINT VENTURES
LICENSEES
## INDUSTRIAL BUSINESS
CONSOLIDATED OPERATIONS
JOINT VENTURES
LICENSEES
MCCORMICK WORLD HEADQUARTERS – SPARKS, MARYLAND U.S.A.
LOCATIONS ARE NEW WITHIN THE LAST FIVE YEARS
From locations around the world, our consumer brands reach nearly 100 countries. Our industrial business provides a wide range of products to multinational restaurants and food processors. McCormick flavors span the globe.
Robert W. Skelton Senior Vice President, General Counsel & Secretary
Mark T. Timbie President – International Consumer Products Group
Karen D. Weatherholtz Senior Vice President – Human Relations
Alan D. Wilson President – U.S. Consumer Foods
Jeryl Wolfe Vice President – Supply Chain & Chief Information Officer
<img src='content_image/2948.jpg'>
” Cardamom reminds me of a zesty grapefruit! I like to add McCormick ground cardamom to tea for a citrus-like flavor. I also love to add cardamom to apples, either in pie, applesauce or healthy fresh sliced apples. The kids like fresh sliced apples with cinnamon- cardamom-sugar sprinkled on top (1 part cardamom, parts cinnamon, 5 parts sugar). Cardamom is one of my secret ingredients for a great apple pie! ” 2 pz
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More than 70% of sales are now value-added.
No matter where you look, you’ll discover that we are turning up the heat at McCormick.
Sales are sizzling, margins are rising, and we’ve spiced up our new product efforts. We’ve uncovered the hottest eating trends in our 2005 Flavor Forecast. At McCormick, we are fired up about our opportunities for growth.
Higher gross profit margins are fueling our growth.
We have increased gross profit margins 1.9 percentage points since 2001.
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## financial information
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” The cooling effect of mint reflects the Chinese philosophy of a life of balance. Heat is opposed in equal measure by the aromatic, sweet flavor of mint. Add McCormick mint leaves to a mixture of yogurt and cucumbers to make a light and refreshing dip/dressing (for variation: add a touch of McCormick curry powder and a hint of smoke flavor to the mixture for an interesting tandoori dip or burger dressing). ”
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## management’s discussion and analysis
## Executive Summary
## Business Overview
McCormick & Co. is a global leader in the manufacture, marketing and distribution of spices, herbs, seasonings and other flavors to the entire food industry. The Company’s major sales, distribution and production facili- ties are located in North America and Europe and its prod- ucts reach nearly 100 countries around the world. Additional facilities are based in Mexico, Central America, Australia, China, Singapore, Thailand and South Africa. In 2004, approximately 38% of sales were outside the U.S.
The Company operates in two business segments, con- sumer and industrial. In 2004, the consumer business accounted for 53% of sales and the industrial business accounted for 47% of sales. Consistent with market con- ditions in each segment, the consumer business has a higher overall profit margin than the industrial business.
The consumer business supplies a variety of retail out- lets that include grocery, drug, dollar and mass merchan- dise stores. In the U.S., these customers are serviced both directly and indirectly through food wholesalers. In international markets customers are serviced either directly or indirectly through distributors. Products for the consumer segment include spices, herbs, extracts, sea- soning blends, sauces, marinades and specialty foods. In 2004, 67% of net sales were in the Americas, 29% in Europe and 4% in the Asia/Pacific region. In its primary markets, the Company supplies both branded and private label products and has a leading share that is more than twice the size of the next largest competitor. The Company is growing the consumer business by develop- ing innovative products, increasing marketing effective- ness, expanding distribution and acquiring leading brands and niche products.
The industrial business supplies both food processors and the restaurant industry. Restaurant customers are sup- plied both directly and indirectly through distributors and warehouse club stores. Products for the industrial seg- ment include blended seasonings, spices, herbs, condi- ments, compound flavors and extracts, and coating systems. In 2004, 73% of net sales were in the Americas, 19% in Europe and 8% in the Asia/Pacific region. The Company has many competitors who also supply products to food processors, as well as restaurants, food service dis- tributors and warehouse clubs. The Company is driving sales for the industrial business by supporting the global expansion of its customers, building current and new strategic partnerships, and developing consumer-preferred value-added products. Through acquisitions, the Company seeks to expand its flavor solutions globally.
With its consumer and industrial segments, the Company has the customer base and product develop- ment skills to provide flavor solutions for all types of eating occasions, whether it is cooking at home, dining out, pur- chasing a quick service meal or enjoying a snack.
The Company purchases a significant amount of raw materials from areas throughout the world. The most signif- icant raw materials are vanilla, cheese, pepper, packaging supplies, garlic, onion and capsicums. Some of these are subject to price volatility caused by weather, market condi- tions, growing and harvesting conditions, governmental actions and other unpredictable factors. While future move- ments of raw material costs are uncertain, the Company responds to this volatility in a number of ways including strategic raw material purchases, purchases of raw mate- rial for future delivery and customer price adjustments.
## Strategy for Growth
The Company’s strategy is to improve margins, invest in the business and increase sales and profits.
Margins are being improved with new capabilities and processes introduced through McCormick’s B2K program, a global initiative that is significantly improving business processes through state-of-the-art technology. Utilizing B2K, employees are improving the supply chain through- out the Company. A goal to reduce costs by $70 million through 2006 was set early in 2004. In 2004, $24 million in cost savings were realized, comprised of $15 million of cost of goods sold and $9 million of selling, general and administrative expense savings. Margins are also improving as higher-margin more value-added products are introduced. Since 2001, gross profit margin has increased a total of 1.9 percentage points.
The Company is investing in areas such as product development and marketing support to drive sales. Research and development expense and advertising behind McCormick’s brands have increased significantly and consistently since 1999. In 2004, research and development expense increased 18% and advertising expense increased 43%.
The Company’s long-term financial objectives, first set in 2002, are to increase annual sales 3-7% and earnings per share 10-12%. With the opportunities to increase margins and the sales initiatives for the consumer and industrial businesses, the Company expects to continue to achieve these objectives. Early in 2004, an additional goal was set to generate $350-$400 million of cash flow from operations after dividends and net capital expendi- tures for the three-year period 2004-2006. In 2004, the first $206 million of this goal was achieved. With this cash the Company is seeking to acquire businesses and to repurchase shares.
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## management’s discussion and analysis
## Results of Operations – 2004 compared to 2003
<img src='content_image/126542.jpg'>
During 2004 and 2003, there were several acquisitions and divestitures that affected comparability of operating results. In November of 2004, the Company acquired Silvo, the market leader in the Dutch spices and herbs consumer market. Silvo is expected to generate approxi- mately $50 million in sales in 2005. In June of 2003, the Company acquired Zatarain’s, the leading U.S. brand of authentic New Orleans-style food. In January of 2003, Uniqsauces was acquired, which expanded condiment fla- vors and packaging formats for the Company.
During the third quarter of 2003, the Company sold its packaging business and the U.K. Jenks brokerage opera- tion. As a result, prior period sales and related expenses for these discontinued operations were reclassified and reported as “Net income from discontinued operations” in the consolidated statement of income. The consolidated balance sheet and consolidated statement of cash flows were also reclassified to present separately the assets, lia- bilities and cash flows of the discontinued operations.
For the year ended November 30, 2004, McCormick reported sales from continuing operations of $2.5 billion, an increase of 11.3% above 2003. Sales growth was the result of a 4.2% volume increase, 3.7% from favorable for- eign exchange rates, 2.2% in the first half of the year from the acquisition of Zatarain’s, and a 1.2% increase in pricing and product mix. The acquisition of Silvo on November 1, 2004 added $4.5 million in sales in 2004. During 2004, the Company achieved higher volume with new products, expanded distribution and more effective marketing.
Gross profit margin increased to 39.9% in 2004 from 39.6% in 2003. The gross profit margin increase was due to cost reductions achieved in the first year of a three-year $70 million cost reduction program began in 2004. Sale of more value-added products and pricing actions in our consumer business also improved gross profit margin. Higher costs of employee benefits, fuel and a competitive operating envi-
ronment in Europe during 2004 partly offset the gross profit margin increase.
Selling, general and administrative expenses were higher in 2004 than 2003 on both a dollar basis and as a percentage of net sales. These increases were primarily due to increased distribution expenses, higher advertising expenses and increased employee benefit costs. The increase in distribution expenses was primarily due to higher fuel costs, as well as freight and warehousing costs associated with new product introductions, and incre- mental distribution costs related to the acquired Zatarain’s business. The increase in employee benefit costs was mainly the result of higher pension costs in 2004 compared to 2003. In the consumer business, advertising expenses increased in order to launch several new products and to support the brand name.
Special charges were a credit of $2.5 million in 2004 compared to a charge of $5.5 million in 2003. This change was primarily due to a net gain of $8.7 million recorded in 2004 for funds received from a class action lawsuit that was settled in the Company’s favor.
Pension expense was $30.0 million and $22.1 million for the years ended November 30, 2004 and 2003, respec- tively. In connection with the valuation performed at the end of 2003, the discount rate was reduced from 7.0% to 6.0% and the expected long-term rate of return on assets was reduced from 9.0% to 8.5%. These changes along with the increased amortization of prior actuarial losses increased pension expense in 2004. Pension expense in 2005 is expected to increase approximately 6%.
Interest expense from continuing operations increased by $2.4 million. Higher average debt levels during 2004 contributed to this increase, partially offset by repayment of higher rate long-term debt.
Other income decreased to $2.1 million in 2004 com- pared to $13.1 million in 2003 due to two significant trans- actions recorded in 2003. In 2003, the Company benefited from $5.4 million of interest income received on the Ducros purchase price refund and a one-time gain of $5.2 million from the sale of an interest in non-strategic royalty agreements. The Company entered into the non-strategic royalty agreements in 1995 and since then had benefited modestly from tax credits and royalty income.
The effective tax rate was 30.3% in 2004 down from 30.9% in 2003. The decrease in the effective tax rate is due to mix of earnings among the different taxing jurisdic- tions in which the Company operates and the settlement of tax audits for less than amounts previously accrued. Due to the anticipated change in available net operating loss carryforwards in various jurisdictions and earnings mix, the Company anticipates the tax rate to increase by 1-2% in 2005.
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Income from unconsolidated operations decreased 11.0% in 2004 when compared to 2003. This decline is mainly attributable to lower income from the Company’s Signature Brands and Japan joint ventures. The Signature Brands business, a cake decorating business in the U.S., was impacted by a decline in the overall U.S. cake mix cat- egory. The Company’s retail joint venture in Japan moved its business to a new distributor in 2004 with the objective of building sales in this market over time. The joint venture in Japan is currently working through a period of start-up costs associated with the transition to this new distributor until a higher level of sales is achieved. Income from the company’s joint venture in Mexico was equal to last year.
Income from continuing operations was $214.5 million in 2004 compared to $199.2 million in 2003. Diluted earn- ings per share from continuing operations increased $0.12, comprised of $0.18 from higher sales and operating margin and a $0.02 benefit from fewer shares outstanding and lower tax rate, offset by a $0.05 decline in other income, a $0.02 increase in interest expense and minority interest, and a $0.01 decline in income from unconsoli- dated operations.
## Consumer Business
<img src='content_image/114534.jpg'>
In 2004, sales for the consumer business increased 15.3% compared to 2003. Higher volumes added 10.0% to sales, with 4.3% of the volume increase due to the impact, in the first half of the year, of the Zatarain’s busi- ness. Favorable foreign exchange added 4.3% and posi- tive price and product mix added 1.0%. Sales rose 16.1% in the Americas, with 14.6% of the sales increase from higher volume, 0.8% from price and product mix, and 0.7% from foreign exchange. New products, more effec- tive marketing and distribution gains drove an 8.1% vol- ume increase, with the remaining 6.5% attributable to the Zatarain’s acquisition. Price increases on certain products were partially offset by the change in mix of products sold. Sales in Europe rose 14.1%, with favorable foreign exchange contributing 11.7%, the Silvo acquisition in November 2004 adding 1.3%, and price and product mix adding 1.1%. Excluding the foreign exchange and Silvo sales benefits, sales in Europe remained relatively flat. New product and distribution gains were offset by more
intense competitive conditions, particularly in France. The spice and seasoning category in France was affected by private label and economy products, particularly with the expansion of discount retail chains into this market. Sales in the Asia/Pacific region increased 11.2%, with favorable foreign exchange contributing 10.4% and higher volume adding 2.7%, partially offset by a 1.9% decline due to unfavorable price and product mix. Volume was affected by an initiative in China to de-emphasize lower margin products. New private label business in Australia con- tributed to an unfavorable price and product mix.
Operating income for the consumer business increased 16.8% to $269.7 million, despite a $14.7 million increase in advertising expense. The operating income increase was driven by strong sales performance, cost reduction efforts and pricing actions. Operating income margin (operating income as a percentage of sales) increased from 19.9% in 2003 to 20.1% in 2004. Cost savings on supply chain initiatives more than offset increases in fuel, employee benefit, advertising costs, international reorgan- ization costs, as well as the difficult competitive environ- ment in Europe. Special charges in the consumer business decreased to $1.0 million in 2004 from $1.8 mil- lion in 2003. Special charges in the consumer business for 2004 consisted of additional costs associated with the finalization of the production facilities consolidation in Canada. Special charges in the consumer business for 2003 consisted of costs associated with the production facilities consolidation in Canada and the realignment of consumer sales operations in Australia.
As discussed previously, the Company sold its Jenks brokerage business in the U.K. on July 1, 2003 and accord- ingly, results of this business were classified as discontin- ued operations.
## Industrial Business
<img src='content_image/114533.jpg'>
For 2004, sales from the industrial business rose 7.1% as compared to 2003. Higher volumes added 2.7%, favor- able foreign exchange added 3.0% and price and product mix added 1.4%. Sales in the Americas rose 5.7% due to a 4.2% volume increase that was largely driven by sales of new products such as coating systems and sales of snack seasonings. Favorable price and product mix contributed 1.0% and foreign exchange added another 0.5%. Strength in warehouse club sales also contributed to sales growth and more than offset continued weakness in the
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## management’s discussion and analysis
food service distributor channel. Higher costs for certain raw materials including vanilla, cheese and soy oil were passed through in higher pricing. In Europe, sales rose 12.3% with foreign exchange contributing 12.0% of increase. A favorable price and product mix increase of 4.2% offset a 3.9% volume decline. A shift in emphasis from lower to higher margin products resulted in reduced sales of certain lower margin products. In the Asia/Pacific region, sales increased 8.8%, with 5.5% of increase from foreign exchange and 4.3% from higher volume, partially offset by a 1.0% unfavorable price and product mix. The volume increase related to higher sales to quick service restaurants and of snack seasonings.
Operating income for the industrial business rose 4.3% to $113.6 million, despite a $6.1 million increase in research and development costs. Operating income margin was 9.6% in 2004 down from 9.8% in 2003. Increases in operating margin due to emphasis on more value-added, higher margin products and cost reduction efforts were more than offset by certain cost increases. In the fourth quarter of 2004, a $6.2 million adjustment, which arose in prior quarters, was recorded after the Company identified and corrected the operational account- ing at an industrial plant in Scotland. Higher fuel, employee benefit costs and special charges as well as international reorganization costs also contributed to the decline. Special charges in the industrial business increased to $3.0 million in 2004 from $2.3 million in 2003. Special charges in the industrial business for 2004 con- sisted of additional costs associated with the consolida- tion of production facilities in Canada and additional costs related to the consolidation of manufacturing facilities in the U.K. Special charges in the industrial business for 2003 consisted of costs associated with the consolidation of production facilities in Canada and severance and other costs related to the consolidation of industrial manufactur- ing in the U.K.
## Results of Operations – 2003 compared to 2002
<img src='content_image/129195.jpg'>
In June of 2003, the Company acquired Zatarain’s, the leading U.S. brand of authentic New Orleans-style food. In January of 2003, Uniqsauces was acquired, which expanded condiment flavors and packaging formats for the Company.
During the third quarter of 2003, the Company sold its packaging business and the U.K. brokerage operation. As a result, prior period sales and related expenses for these discontinued operations have been reclassified and reported as “Net income from discontinued operations” in the consolidated statement of income. The consolidated balance sheet and consolidated statement of cash flows were also reclassified to present separately the assets, lia- bilities and cash flows of the discontinued operations.
For the year ended November 30, 2003, McCormick reported sales from continuing operations of $2.3 billion, an increase of 11.0% above 2002. Sales benefited from the acquisition of the Zatarain’s and Uniqsauces busi- nesses, which accounted for 4.4% of the increase. Favorable foreign exchange rates added another 4.2%, and higher sales, particularly in the U.S. consumer busi- ness, contributed an additional 2.4% to sales.
Gross profit margin increased to 39.6% in 2003 from 39.1% in 2002. Gross profit margin was favorably impacted by global procurement efficiencies, cost reduc- tion initiatives and a mix of more consumer sales, which generally have a higher gross profit margin, compared to industrial sales. Increases in commodity costs such as vanilla were offset by price increases, and higher margins from the Zatarain’s business were offset by a lower gross profit margin from Uniqsauces.
Selling, general and administrative expenses were higher in 2003 than 2002 on both a dollar basis and as a percentage of net sales. These increases were primarily due to increased distribution expenses, decreased royalty income, increased employee benefit costs and higher advertising and promotional expenses. The increase in dis- tribution expenses was primarily due to the addition of higher distribution costs associated with the Zatarain’s business, higher fuel costs and higher costs necessary to service customers during the consolidation of facilities in Canada. The decrease in royalty income is due to lower sales in the McCormick de Mexico joint venture. The increase in employee benefit costs was mainly the result of higher pension costs in 2003 compared to 2002. In the consumer business, advertising and promotional expenses increased in support of the launch of several new products.
Pension expense was $22.1 million and $13.0 million for the years ended November 30, 2003 and 2002, respec- tively. In connection with the valuation performed at the
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end of 2003, the discount rate was reduced from 7.0% to 6.0% and the expected long-term rate of return on assets was reduced from 9.0% to 8.5%. These changes were reflective of poor market returns in recent years and a con- tinued low interest rate environment. The changes in assumptions along with investment returns below the assumed rate resulted in the increased pension expense in 2003 and will continue to impact expense going forward.
Interest expense from continuing operations decreased in 2003 versus 2002 due to favorable interest rates.
Other income increased to $13.1 million in 2003 com- pared to $0.7 million in 2002. In the second quarter of 2003, the Company received $5.4 million of interest income on the Ducros purchase price refund. Also, in the fourth quarter of 2003, the Company recorded a one-time gain of $5.2 million from the sale of an interest in non- strategic royalty agreements. The Company entered into these agreements in 1995 and since then had benefited modestly from tax credits and royalty income.
The effective tax rate for 2003 was 30.9%, down from 31.0% in 2002.
Income from unconsolidated operations decreased 26.8% in 2003 when compared to 2002. This decline is mainly attributable to lower income from the McCormick de Mexico joint venture during the first half of 2003 and to a lesser extent, the Signature Brands joint venture in the fourth quarter of 2003. The McCormick de Mexico busi- ness, which markets the leading brand of mayonnaise in Mexico, experienced profit pressure from aggressive com- petition, higher raw material costs and a weak peso versus the prior year. The Signature Brands business, a cake deco- rating business in the U.S., was impacted in part by the timing of customers’ purchases of holiday products.
Income from continuing operations was $199.2 million in 2003 compared to $173.8 million in 2002. Diluted earn- ings per share from continuing operations increased $0.18, comprised of $0.12 from higher sales and operating margin, $0.04 from acquisitions and $0.06 from other income, offset by a $0.04 decline in income from uncon- solidated operations.
Income from discontinued operations was $4.7 million in 2003 compared to $6.0 million in 2002. Income from dis- continued operations for 2003 included 7 months of the operating results of Jenks and 8 1/2 months of the operat- ing results of Packaging. Also included in discontinued oper- ations in 2003 was a net gain on the sale of discontinued operations of $9.0 million. This consisted of the gain on the
sale of Packaging of $11.6 million partially offset by the loss on the sale of Jenks of $2.6 million. All amounts included in discontinued operations were net of income taxes.
In the fourth quarter of 2003, the Company recorded a cumulative effect of an accounting change that reduced net income by $2.1 million, net of tax. This charge was recorded in accordance with the adoption of certain provi- sions of a new accounting interpretation that required the consolidation of the lessor of a leased distribution center. Previously, this entity was not consolidated and the distri- bution center was accounted for as an operating lease. Consolidation of this entity increased fixed assets by $11.2 million, long-term debt by $14.0 million and minority interest by $0.5 million. The effect of consolidation of this entity in prior years would have reduced net income in 2002 and 2001 by $0.3 million.
<img src='content_image/37002.jpg'>
In 2003, sales from continuing operations for the con- sumer business increased 16.9% compared to 2002. The acquisitions of Zatarain’s and Uniqsauces contributed 6.3% of the sales increase, and the impact of foreign exchange added another 5.8%. Sales rose 15.3% in the Americas, with Zatarain’s contributing 7.1% of sales increase and foreign exchange contributing 0.9% of increase. The remaining 7.3% of sales increase was due primarily to higher volumes in the U.S. and Canada. In 2003, the Company achieved new distribution in the dollar store channel and with a major grocery retailer in the U.S. Sales in Europe rose 21.7%, with foreign exchange con- tributing 16.9% of increase, and the remaining increase due to the acquisition of Uniqsauces. Sales in the Asia/Pacific region increased 12.3%, with foreign exchange contributing 11.7% of the increase. Sales in this region were adversely affected by competitive conditions in Australia and an initiative to discontinue certain lower margin products in China.
Operating income from continuing operations for the consumer business reached $230.9 million, an increase of 20.3%. Operating income margin (operating income as a percentage of sales) went up from 19.3% in 2002 to 19.9% in 2003. Pricing actions and cost savings on supply chain initiatives more than offset higher expenses of pen- sion, promotion and advertising, distribution and certain commodities. Special charges in the consumer business
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## management’s discussion and analysis
decreased to $1.8 million in 2003 from $2.7 million in 2002. Special charges in the consumer business for 2003 consisted of additional costs associated with the consoli- dation of production facilities in Canada and the realign- ment of consumer sales operations in Australia. Special charges in the consumer business for 2002 primarily con- sisted of severance, lease exit and relocation costs related to the workforce reduction and realignment of consumer sales operations in the U.S.
The Company sold its Jenks brokerage business in the U.K. on July 1, 2003 and accordingly, results of this busi- ness were reclassified from the consumer segment to discontinued operations.
## Industrial Business
<img src='content_image/5428.jpg'>
For the fiscal year 2003, sales from the industrial business rose 5.4% as compared to 2002. The acquisition of Uniqsauces contributed 2.7% of sales increase and for- eign exchange added another 2.6%. Sales rose 0.4% in the Americas, with foreign exchange contributing 0.5% of the increase. In the Americas, the restaurant industry was affected by a slowdown in consumer traffic in 2003. While this adversely affected the Company’s sales to food serv- ice distributors, direct sales to restaurant chains had strong growth resulting from successful new products and customer promotions of existing products. Sales to food processors were largely affected by lower pricing in response to a decrease in raw material costs, particularly for snack food seasonings. In Europe, sales rose 27.9% with Uniqsauces contributing 17.7% of increase and for- eign exchange contributing 12.0% of increase. The remaining decrease of 0.5% was due to lower demand for seasoning products, which more than offset strong condi- ment sales. In the Asia/Pacific region, sales increased 11.9%, with 5.9% of increase from foreign exchange and 6.0% from higher volume.
Operating income from continuing operations for the industrial business rose 1.5% to $108.9 million. Operating income margin was 9.8% in 2003 compared to 10.2% in 2002. The operating income increase was generally in line with the sales increase, excluding the Uniqsauces acquisi- tion. This acquisition was strategically made for its condi- ment production facility and certain of its customer relationships. In the industrial segment, commodity cost increases and decreases are generally offset by pricing actions. However, in 2003 vanilla had a negative effect on
operating income due to significant volatility in this com- modity. The savings on supply chain initiatives were offset by cost increases in pension and other benefit costs. Special charges in the industrial business increased to $2.3 million in 2003 from $1.8 million in 2002. Special charges in the industrial business for 2003 consisted of additional costs associated with the consolidation of production facili- ties in Canada and severance and other costs related to the consolidation of industrial manufacturing in the U.K. Special charges in the industrial business for 2002 primarily con- sisted of further severance and other costs related to the workforce reduction initiated in 2001 and further costs related to the closure of a U.S. distribution center.
## Financial Condition
Strong cash flows from operations enabled the Company to fund operating projects and investments that are designed to meet the Company’s growth objectives, to make strategic acquisitions and to repurchase stock.
In the consolidated statement of cash flows, the changes in operating assets and liabilities are presented excluding the effects of changes in foreign currency exchange rates, as these do not reflect actual cash flows. Accordingly, the amounts in the consolidated statement of cash flows do not agree with changes in the operating assets and liabilities that are presented in the consolidated balance sheet. In addition, the net cash flows from operat- ing, investing and financing activities are presented excluding the effects of discontinued operations.
In the consolidated statement of cash flows, net cash provided by continuing operating activities was $349.5 mil- lion in 2004 compared to $201.8 million in 2003 and $208.6 million in 2002. The significant increase in operating cash flow in 2004 is primarily the result of a reduction in inven- tory in 2004 as compared to 2003 when inventory increased, an increase in other liabilities in 2004 compared to a decrease in 2003 and the benefit of higher net income from continuing operations. These favorable cash flows were partially offset by increases in accounts receivable which are in line with increases in sales. The higher inven- tory in 2003 was due to the Company’s strategic decision to purchase vanilla beans in order to ensure an ongoing supply and manage the cost for this raw material. The Company decreased its vanilla bean inventory by $28 mil- lion in 2004 in anticipation of lower cost beans in 2005. The increase in other assets and liabilities in 2004 compared to a decrease in 2003 was due to the timing of liability pay- ments and a higher tax benefit on the exercise of stock options in 2004 compared to 2003. The Company gener- ally receives a tax deduction on the exercise of stock
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options. These deductions increased in 2004, due to the increase in both stock price and the exercise of stock options. When 2003 is compared with 2002, the major use of funds was the increase in inventory due to the purchase of vanilla beans. The timing of liability payments con- tributed to the decrease in other liabilities in 2003.
Net cash used in continuing investing activities was $141.5 million in 2004 versus $100.7 million in 2003 and $95.3 million in 2002. Net capital expenditures (capital expenditures less proceeds from the sale of fixed assets) were $67.0 million in 2004, $81.7 million in 2003 and $93.9 million in 2002. The decrease over the three year period is mainly due to lower B2K spending as 2002 was the peak year of software development expenditures. Net capital expenditures in 2005 are expected to be higher than in 2004 as the Company prepares for the B2K launch in Europe. Cash paid to acquire Silvo during 2004 was $74.5 million. Cash paid for the acquisitions of the Zatarain’s and Uniqsauces businesses during 2003 was $202.9 million. Cash received from the sale of the Packaging and Jenks businesses during 2003 was $133.9 million. The Company also received $55.4 million during 2003 from the Ducros purchase price adjustment, of which, $5.4 million represented interest and was included in net cash flows from continuing operating activities.
Net cash used in continuing financing activities was $178.4 million in 2004, $137.7 million in 2003 and $114.9 million in 2002. The Company’s total borrowings increased $19.3 million in 2004, compared to an increase of $16.4 million in 2003 and a decrease of $74.4 million in 2002. In the second quarter of 2004, the Company issued a total of $50 million in medium-term notes under its existing $375 million shelf registration. The $50 million of medium-term notes mature on April 15, 2009 and pay interest semi- annually at a rate of 3.35%. The proceeds of this issuance were used to pay down short-term debt. In 2004, the Company purchased 5.1 million shares of common stock for $173.8 million under its share repurchase programs versus 4.5 million shares of common stock for $119.5 mil- lion in 2003. In the second quarter of 2004, the Company completed its $250 million share repurchase authorization and began to buy against its $300 million authorization approved by the Board of Directors in September 2003. As of November 30, 2004, $147.7 million remained under the $300 million share repurchase program. Without sig- nificant acquisition activity, the Company expects this pro- gram to extend into 2006. The common stock issued in 2004, 2003 and 2002 relates to the Company’s stock com- pensation plans.
Dividend payments increased to $76.9 million in 2004, up 20.0% compared to $64.1 million in 2003. Dividends
paid in 2004 totaled $0.56 per share, up from $0.46 per share in 2003. In November 2004, the Board of Directors approved a 14.3% increase in the quarterly dividend from $0.14 to $0.16 per share. Over the last 5 years, dividends per share have risen at a compounded annual rate of 9.9%.
The Company’s pension plans had a shortfall of plan assets over accumulated benefit obligations at their 2004 and 2003 measurement dates of $162.8 million and $166.6 million, respectively. These shortfalls were due to the continued low interest rate environment and lower than assumed asset returns in 2001 and 2002. However, the shortfall decreased in 2004. As a result, the Company recorded a reduction in the minimum pension liability through a credit of $7.2 million ($4.4 million net of tax) to other comprehensive income in 2004. This compares to an increase in minimum pension liability recorded through a charge of $20.6 million ($14.4 million net of tax) to other comprehensive income in 2003. Cash payments to pen- sion plans were $30.6 million in 2004, $27.2 million in 2003 and $25.2 million in 2002. The Company plans to make 2005 pension plan contributions similar to those made in 2004. Future increases or decreases in pension liabilities and required cash contributions are highly dependent on changes in interest rates and the actual return on plan assets. The Company bases its investment of plan assets, in part, on the duration of each plan’s liabili- ties. Across all plans, 68% of assets are invested in equi- ties and 32% in fixed income investments.
The Company’s ratio of debt-to-total-capital (total capital includes debt, minority interest and shareholders’ equity) was 40.9% as of November 30, 2004, a decrease from 44.4% at November 30, 2003 and below the Company’s target range of 45-55%. The decrease was primarily the result of an increase in shareholders’ equity. Foreign cur- rency had the effect of increasing shareholders’ equity and accordingly, decreased the ratio of debt-to-total-capi- tal by 2.6% in 2004. In June 2004, S&P raised the Company’s short-term corporate credit and commercial paper ratings to”A-1” from “A-2” and long-term corporate credit and senior unsecured debt ratings to“A” from “A-”. During the year, the level of the Company’s short-term debt varies. However, it is usually lower at the end of the year. The average short-term borrowings outstanding for the year ended November 30, 2004 and 2003 were $295.2 million and $287.6 million, respectively.
The reported values of the Company’s assets and liabili- ties held in its non-U.S. subsidiaries and affiliates have been significantly affected by fluctuations in foreign exchange rates between periods. During the year ended November 30, 2004, the exchange rates for the Euro,
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## management’s discussion and analysis
British pound sterling, Canadian dollar and Australian dollar were substantially higher versus the U.S. dollar than in 2003. Exchange rate fluctuations resulted in an increase in accounts receivable of $21 million, inventory of $14 million, goodwill of $51 million and other comprehensive income of approximately $93 million since November 30, 2003.
The Company has available credit facilities with domes- tic and foreign banks for various purposes. The amount of unused credit facilities at November 30, 2004 was $466.1 million. Management believes that internally generated funds and the Company’s existing sources of liquidity under its credit facilities are sufficient to meet current liquidity needs and longer-term financing requirements. If the Company were to undertake an acquisition that requires funds in excess of its existing sources of liquidity, it would look to sources of funding from additional credit facilities or equity issuances.
## Acquisitions
On November 1, 2004, the Company purchased C.M. van Sillevoldt B.V. (Silvo), the market leader in the Dutch spices and herbs consumer market, for € 58 million in cash (equivalent to $74.5 million) funded with cash from opera- tions and current credit facilities. Silvo sells spices, herbs and seasonings under the Silvo brand in the Netherlands and the India brand as well as private label store brands in Belgium. The brand has a strong heritage and high recog- nition among consumers in the Netherlands. The acquisi- tion is consistent with the Company’s strategy to acquire established brands to complement the Company’s leader- ship position in the development and marketing of flavors for food. The business is achieving growth through innova- tive products and packaging with a focus on convenience, quality, and ethnic flavors. The acquisition was accounted for under the purchase method, and the results of opera- tions have been included in the Company’s consolidated results from the date of acquisition. The excess of the pur- chase price over the estimated fair value of the tangible net assets purchased was $59.4 million and is classified as goodwill in the consumer segment. The allocation of the purchase price is based on preliminary estimates, sub- ject to revision, after asset values have been finalized. Revisions to the allocation, which may be significant, will be reported as changes to various assets and liabilities. The Company does not anticipate significant amounts to be allocated to amortizable intangible assets and, there- fore, the amount of intangible asset amortization is not expected to be material to the results of operations in future periods.
In the second quarter of 2004, the Company completed the purchase price allocation for the Zatarain’s acquisition.
The excess of the purchase price over the estimated fair value of the net assets purchased was $176.2 million, which includes $3.4 million of fees directly related to the acquisition. An analysis of the various types of intangible assets resulted in a determination that the excess pur- chase price should be classified as the value of the acquired brand name and goodwill. No other intangible assets were identified as a result of this analysis. The Company has concluded that a substantial portion of the value of the excess purchase price resides in consumer trust and recognition of the Zatarain’s brand name as authentic New Orleans-style cuisine. As a result, the Company has assigned $106.4 million of the excess pur- chase price to this unamortizable brand based on an analysis of the premium value that is derived from con- sumer loyalty and trust in the brands’ quality. Zatarain’s brand name has been used since 1889, and the Company intends to use and support the brand name indefinitely. The Company will review this intangible asset for impair- ment annually using the discounted cash flow method. The remaining $69.8 million of intangible assets were allo- cated to goodwill in the consumer segment.
## Beyond 2000
Late in 1999, the Company initiated the B2K program as a global program of business process improvement. B2K is designed to re-engineer transactional processes, strengthen the product development process, extend col- laborative processes with trading partners, optimize the supply chain and generally enhance the Company’s capabil- ities to increase sales and profit. An integral part of B2K is the design and implementation of an enterprise wide state- of-the-art technology and information system platform.
In 2002, the Company implemented the initial phase of its B2K program and began using the new state-of-the-art technology and processes in a significant portion of U.S. operations, including its largest consumer operating unit. The rollout of B2K to the U.S. industrial operations was completed in 2004. The Company plans to rollout B2K to its international operations by 2006. The Company will continue to integrate and optimize all of its businesses through broader access to information and increased col- laboration with its trading partners. Through B2K, employee time devoted to transaction execution will be reduced and more time will be devoted to the growth and effectiveness of the business.
Overall levels of capital spending and expense have increased from historical levels to support the B2K effort. To date, $120 million of costs associated with B2K have been capitalized and $33 million has been expensed.
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## financial highlights
<img src='content_image/12850.jpg'>
## table of contents
4 letter to shareholders
6 board of directors
8 consumer business
12 industrial business
16 Q&A with Bob Lawless
18 McCormick worldwide & executive officers
19 community service
20 financial information
57 investor information
## business description
McCormick is a global leader in the manufacture, marketing and distribution of spices, herbs, seasonings and other flavors to the entire food industry. Customers range from retail outlets and food service providers to food processing businesses. Founded in 1889 and built on a culture of Multiple Management, McCormick has approximately 8,000 employees.
## vision statement
McCormick will be the leading global supplier of high value- added flavor solutions.
Building on strong brands and innovative products, we will provide superior quality and service to customers and consumers around the world.
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Additional capital spending of approximately $25 million and an additional expense of approximately $15 million is antici- pated under this program. Capital costs under the B2K pro- gram are for computer hardware, software and software development and are reflected in property, plant and equip- ment in the consolidated balance sheet. Costs expensed under the B2K program include costs of business re-engi- neering, data conversion and training and are reflected in both cost of sales and selling, general and administrative expense in the consolidated statement of income.
## Special Charges
In 2001, McCormick adopted a plan to further streamline its operations. This plan, adopted during the fourth quarter of 2001, included the consolidation of several distribution and manufacturing locations, the reduction of administra- tive and manufacturing positions, and the reorganization of several joint ventures. The estimated cost of the total plan is approximately $32.6 million ($25.6 million after-tax). Total cash expenditures in connection with these costs approxi- mates $16.7 million, which is funded through internally generated funds. The remaining $15.9 million of costs associated with the plan consist of write-offs of assets. The total cost of the plan includes $1.8 million of special charges related to Packaging and Jenks that have been classified as income from discontinued operations in the consolidated statement of income. Annualized cash sav- ings from the plan are expected to be approximately $8.0 million ($5.3 million after-tax), most of which have been realized to date. Savings under the plan are being used for spending on initiatives such as brand support and supply chain management. These savings are included within the cost of goods sold and selling, general and administrative expenses in the consolidated statement of income.
In 2001, the Company recorded $11.2 million ($7.4 mil- lion after-tax) of charges from continuing operations asso- ciated with the 2001 restructuring plan. Of this amount, $10.3 million was classified as special charges and $0.9 million as cost of goods sold in the consolidated state- ment of income. These charges related to the consolida- tion of manufacturing in Canada, a distribution center consolidation in the U.S., a product line elimination and a realignment of the Company’s sales operations in the U.K., and a workforce reduction which encompasses plans in all segments and across all geographic areas.
During the year ended November 30, 2002, the Company recorded $7.5 million ($5.5 million after-tax) of special charges associated with the 2001 restructuring plan, which could not be accrued at the time of the original announcement in 2001. These charges included the write- off of an investment in an industry purchasing consortium,
further costs of lease exit and relocation costs related to the workforce reduction and realignment of consumer sales operations in the U.S. and further severance and other costs related to the previously discussed workforce reduction. Also included in the 2002 charges were further costs related to the closure of a U.S. distribution center and further costs of the consolidation of manufacturing in Canada which included the disposition of a manufacturing facility. During 2002, total cash expenditures in connection with the plan were $6.3 million. The major components of the 2002 special charges include charges for employee termination benefits of $3.3 million, asset write-downs of $3.3 million, and other related exit costs of $0.9 million.
During the year ended November 30, 2003, the Company recorded special charges related to continuing operations of $5.5 million ($3.6 million after-tax). The costs recorded in 2003 included additional costs associated with the consolidation of production facilities in Canada, net of a gain on the sale of a manufacturing facility, severance and other costs related to the consolidation of industrial manufacturing in the U.K. and the realignment of the Company’s consumer sales operations in Australia. During 2003, total cash expenditures in connection with the plan were $4.7 million. The major components of the 2003 special charges include charges for employee termination benefits of $4.7 million, gain on the sale of assets of $(0.6) million, and other related exit costs of $1.4 million.
During the year ended November 30, 2004, the Company recorded special charges related to continuing operations of $6.2 million ($4.3 million after-tax). The costs recorded in 2004 primarily include costs related to the con- solidation of industrial manufacturing facilities in the U.K. and Canada, the reorganization of a consumer joint venture and additional severance costs for position elimi- nations. During 2004, total cash expenditures in connec- tion with the plan were $4.7 million. Also included in special charges/(credits) is a net gain of $8.7 million ($5.5 million after-tax) related to funds received from a class action lawsuit that was settled in the Company’s favor in the second quarter of 2004. This matter dated back to 1999 when a number of class action lawsuits were filed against manufacturers and sellers of various flavor enhancers for their violation of antitrust laws. The Company, as a purchaser of such products, participated as a member of the plaintiff class. In the second quarter of 2004, the Company received $11.1 million as a settlement of this claim and as a result of the settlement, was required to settle claims against the Company for a portion of this gross amount. The net gain recorded was $8.7 mil- lion. This amount was recorded as a special credit and was not allocated to the business segments.
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## management’s discussion and analysis
Costs yet to be incurred from the 2001 restructuring plan include the possible reorganization of a joint venture and completion of the reorganization of certain industrial manufacturing facilities in the U.K. These actions are expected to be completed in 2005. The total 2001 restruc- turing plan includes severance charges for 392 position reductions. As of November 30, 2004, 389 of the 392 planned position reductions had taken place.
Refer to note 4 of the notes to consolidated financial statements for further information.
## Discontinued Operations
On August 12, 2003, the Company completed the sale of substantially all the operating assets of its packaging seg- ment (Packaging) to the Kerr Group, Inc. Packaging manu- factured certain products used for packaging the Company’s spices and seasonings as well as packaging products used by manufacturers in the vitamin, drug and personal care industries. Under the terms of the sale agreement, Packaging was sold for $132.5 million in cash and possible additional future payments over five years contingent on the buyer meeting certain performance objectives. At the end of the first year of such possible con- tingent payment periods, no additional payment was due from the buyer for that year. The proceeds were used to pay off a substantial portion of the commercial paper bor- rowing related to the Zatarain’s acquisition in 2003.The final purchase price is also subject to other contingencies related to the performance of certain customer contracts which could result in a decrease in the sale price. The Company recorded a net gain on the sale of Packaging of $11.6 million (net of income taxes of $7.9 million) in the third quarter of 2003. Included in this gain was a net pen- sion and postretirement curtailment gain of $3.3 million and the write-off of goodwill of $0.7 million. The contingent consideration, if any, associated with the sale of Packaging will be recognized in the future as an adjustment to the gain based on the performance criteria established. The Company also entered into a multi-year, market priced agreement with the acquirer to purchase certain packaging products.
On July 1, 2003 the Company sold the assets of Jenks Sales Brokers (Jenks), a division of the Company’s wholly- owned U.K. subsidiary, to Jenks’ senior management for $5.8 million in cash. Jenks provided sales and distribution services for other consumer product companies and was previously reported as a part of the Company’s consumer segment. The Company recorded a net loss on the sale of
Jenks of $2.6 million (net of an income tax benefit of $0.6 million) in the third quarter of 2003. Included in this loss is a write-off of goodwill of $0.4 million.
The operating results of Packaging and Jenks were classified as “Income from discontinued operations, net” in the consolidated statement of income. Jenks was pre- viously included in the Company’s consumer segment, and Packaging was previously reported as a separate seg- ment. Certain fixed overhead charges previously allo- cated to Packaging have been reallocated to the other business segments. The cash flows of Packaging and Jenks were reported as “Net cash (used in)/provided by discontinued operations” in the consolidated statement of cash flows.
## Market Risk Sensitivity
The Company utilizes derivative financial instruments to enhance its ability to manage risk, including foreign exchange and interest rate exposures, which exist as part of its ongoing business operations. The Company does not enter into contracts for trading purposes, nor is it a party to any leveraged derivative instrument. The use of derivative financial instruments is monitored through regu- lar communication with senior management and the uti- lization of written guidelines. The information presented below should be read in conjunction with notes 7 and 8 of the notes to consolidated financial statements.
Foreign Exchange Risk – The Company is exposed to fluctuations in foreign currency in the following main areas: cash flows related to raw material purchases; the translation of foreign currency earnings to U.S. dollars; the value of foreign currency investments in subsidiaries and unconsolidated affiliates and cash flows related to repatri- ation of these investments. Primary exposures include the U.S. dollar versus functional currencies of the Company’s major markets (Euro, British pound sterling, Australian dol- lar, Canadian dollar, Mexican peso, Japanese yen, and Chinese renminbi). The Company enters into foreign cur- rency exchange contracts to facilitate managing foreign currency risk.
The following table summarizes the foreign currency exchange contracts held at November 30, 2004. All con- tracts are valued in U.S. dollars using year-end 2004 exchange rates and have been designated as hedges of foreign currency transactional exposures, firm commit- ments or anticipated transactions, all with a maturity period of less than one year.
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## Foreign Currency Exchange Contracts
<img src='content_image/64738.jpg'>
The Company has a number of smaller contracts with an aggregate notional value of $2.5 million to purchase or sell various other currencies, such as the Australian dollar, Japanese yen, and South African rand as of November 30, 2004. The aggregate fair value of these contracts was $(0.2) million at November 30, 2004.
At November 30, 2003, the Company had foreign currency exchange contracts for the Euro, British pound sterling, Canadian dollar, Australian dollar, Japanese yen and South African rand with a notional value of $58.9 million, all of which matured in 2004. The fair value of these contracts was $(1.7) million at November 30, 2003.
Contracts with durations which are less than 5 days and used for short-term cash flow funding within the Company are not included in the notes or table above.
During 2004, the foreign currency translation compo- nent in other comprehensive income was principally related to the impact of exchange rate fluctuations on the Company’s net investments in France, the U.K., Canada, and Australia. The Company did not hedge its net invest- ments in subsidiaries and unconsolidated affiliates in 2004, 2003, or 2002.
Interest Rate Risk – The Company’s policy is to man- age interest rate risk by entering into both fixed and variable rate debt. The Company also uses interest rate
## Year of Maturity at November 30, 2004
swaps to minimize worldwide financing costs and to achieve a desired mix of its fixed and variable rate debt.
The table that follows provides principal cash flows and related interest rates, excluding the effect of interest rate swaps, by fiscal year of maturity at November 30, 2004 and 2003. For foreign currency-denominated debt, the information is presented in U.S. dollar equivalents.
Variable interest rates are based on the weighted- average rates of the portfolio at the end of the year presented.
<img src='content_image/64742.jpg'>
## Year of Maturity at November 30, 2003
<img src='content_image/64739.jpg'>
Note: The table above displays the debt by the terms of the original debt instrument without consideration of interest rate swaps. These swaps have the following effects. The variable interest rate on $75 million of commercial paper is hedged by interest rate swaps through 2011. Net interest payments on the $75 million will be fixed at 6.35% during this period. Interest rate swaps, settled upon the issuance of the medium-term notes maturing in 2006 and 2008, effectively fixed the interest rate on $294 million of the notes at a weighted-average fixed rate of 7.62%. The fixed interest rate on $100 million of the 6.4% medium-term notes due in 2006 is effectively converted to a variable rate by interest rate swaps through 2006. Net interest payments on these notes are based on LIBOR plus 3.595% during this period. The fixed interest rate on $50 million of 3.35% medium-term notes due in 2009 is effectively converted to a variable rate by interest rate swaps through 2009.
Net interest payments are based on LIBOR minus .21% during this period.
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## management’s discussion and analysis
Commodity Risk – The Company purchases certain raw materials which are subject to price volatility caused by weather, market conditions, growing and harvesting conditions, governmental actions and other unpredictable factors. While future movements of raw material costs are uncertain, the Company responds to this volatility in a number of ways, including strategic raw material pur- chases, purchases of raw material for future delivery and customer price adjustments. Generally, the Company does not use derivatives to manage the volatility related to this risk.
Credit Risk – The customers of the consumer busi- ness are predominantly food retailers and food whole- salers. Recently, consolidations in these industries
## Contractual Cash Obligations Due by Year
have created larger customers, some of which are highly leveraged. This has increased the Company’s exposure to credit risk. Several customers over the past two years have filed for bankruptcy protection; however, these bankruptcies have not had a material effect on the Company’s results. The Company feels that the risks have been adequately provided for in its bad debt allowance.
## Contractual Obligations and Commercial Commitments
The following table reflects a summary of the Company’s contractual obligations and commercial commitments as of November 30, 2004:
<img src='content_image/19112.jpg'>
(a) Raw material purchase obligations outstanding as of year-end may not be indicative of outstanding obligations throughout the year due to the Company’s response to varying raw material cycles.
(b) Other purchase obligations primarily consist of advertising media commitments.
Note: In 2005, the Company’s pension and postretirement funding is expected to be approximately $43 million. Pension and postretirement funding can vary significantly each year due to changes in legislation and the Company’s significant assumptions. As a result, the Company has not presented pension and postretirement funding in the table above.
## Commercial Commitments Expiration by Year
<img src='content_image/19111.jpg'>
Note: In January 2005, the Company entered into a new five-year, $400 million credit facility, which expires in January 2010. This facility replaces the line of credit of $350 million existing at year end of which $125 million would have expired in June 2005 and $225 million would have expired in June 2006.
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## Off-Balance Sheet Arrangements
The Company had no off-balance sheet arrangements as of November 30, 2004. In 2003, the Company consolidated the lessor of a leased distribution center and, as a result, the entity is reflected in the consolidated balance sheet.
## Recently Issued Accounting Pronouncements
In January 2003, the FASB issued and subsequently revised Interpretation No. 46, “Consolidation of Variable Interest Entities.” The Company adopted Interpretation No. 46 as it relates to special purpose entities in the fourth quarter of 2003. The Company consolidated the lessor of a leased distribution center used by the Company and recorded a cumulative effect of an accounting change of $2.1 million (net of income tax benefit of $1.2 million). Consolidation of this entity increased assets by $11.2 mil- lion, long-term debt by $14.0 million and minority interest by $0.5 million. The effect of consolidation of this entity in prior years would have reduced net income in 2002 by $0.3 million. In the third quarter of 2004, the Company adopted the remaining provisions of Interpretation No. 46 and there was no material effect upon adoption of this statement.
In May 2004, the FASB issued Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and Modernization Act of 2003” which provides guidance on the accounting for the effects of the Act. FASB Staff Position 106-2 is effective for the first interim or annual period beginning after June 15, 2004. The Company adopted FASB Staff Position 106-2 in the third quarter of 2004. See Note 10 for impact of adoption.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” an amendment to ARB No. 43, Chapter 4, “Inventory Pricing.” SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company believes there will be no material effect upon adoption of this statement.
In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment,” a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and super- seding APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123R requires the Company to expense grants made under the stock option and employee stock purchase plan programs. That cost will be recognized over the vesting period of the plans. SFAS No. 123R is
effective for the first interim or annual period beginning after June 15, 2005. Upon adoption of SFAS No. 123R, amounts previously disclosed under SFAS No. 123 will be recorded in the consolidated income statement. The Company is evaluating the alternatives allowed under the standard, which the Company is required to adopt begin- ning in the fourth quarter of 2005.
## Critical Accounting Estimates and Assumptions
In preparing the financial statements in accordance with United States generally accepted accounting principles (GAAP), management is required to make estimates and assumptions that have an impact on the assets, liabilities, revenue, and expense amounts reported. These esti- mates can also affect supplemental information disclosed by the Company, including information about contingen- cies, risk, and financial condition. The Company believes, given current facts and circumstances, its estimates and assumptions are reasonable, adhere to GAAP, and are consistently applied. Inherent in the nature of an estimate or assumption is the fact that actual results may differ from estimates and estimates may vary as new facts and circumstances arise. In preparing the financial statements, the Company makes routine estimates and judgments in determining the net realizable value of accounts receiv- able, inventory, fixed assets, and prepaid allowances. Management believes the Company’s most critical accounting estimates and assumptions are in the follow- ing areas:
## Customer Contracts
In several of its major markets, the consumer business sells its products by entering into annual or multi-year con- tracts with its customers. These contracts include provi- sions for items such as sales discounts, marketing allowances and performance incentives. The discounts, allowances, and incentives are expensed based on certain estimated criteria such as sales volume of indirect cus- tomers, customers reaching anticipated volume thresh- olds, and marketing spending. The Company routinely reviews these criteria and makes adjustments as facts and circumstances change.
## Goodwill and Brand Name Asset Valuation
The Company reviews the carrying value of goodwill and brand name assets annually utilizing discounted cash flow models. Changes in estimates of future cash flows caused by items such as unforeseen events or changes in market
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## management’s discussion and analysis
conditions could negatively affect the reporting unit’s brand name assets’ fair value and result in an impairment charge. The Company cannot predict the occurrence of events that might adversely affect the reported value of goodwill and brand name assets that totaled $819.3 million at November 30, 2004. However, the current fair values of the Company’s reporting units and brand name are signifi- cantly in excess of carrying values, and accordingly man- agement believes that only significant changes in the cash flow assumptions would result in impairment.
## Income Taxes
The Company files income tax returns and estimates income taxes in each of the taxing jurisdictions in which it operates. The Company is subject to tax audits in each of these jurisdictions, which could result in changes to the estimated taxes. The amount of these changes would vary by jurisdiction and would be recorded when known. Management has recorded valuation allowances to reduce its deferred tax assets to the amount that is more likely than not to be realized. In doing so, management has con- sidered future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance.
## Pension and Postretirement Benefits
Pension and other postretirement plans’ costs require the use of assumptions for discount rates, investment returns, projected salary increases, mortality rates, and health care cost trend rates. The actuarial assumptions used in the Company’s pension and postretirement benefit reporting are reviewed annually and compared with external benchmarks to ensure that they appropriately account for the Company’s future pension and postretirement benefit obligations. While the Company believes that the assumptions used are appro- priate, differences between assumed and actual experience may affect the Company’s operating results. A 1% change in the actuarial assumption for discount rate would impact pension and postretirement benefit expense by approxi- mately $12 million. A 1% change in the expected return on plan assets would impact pension expense by approxi- mately $4 million. In addition, see the preceding sections of the MD&A and notes 9 and 10 of notes to consolidated financial statements for a discussion of these assumptions and the effects on the financial statements.
## Forward-Looking Information
Certain information contained in this report includes “for- ward-looking statements” within the meaning of section 21(E) of the Securities Exchange Act. The Company intends the forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in this section. All statements regarding the Company’s expected financial plans, future capital requirements, fore- casted, demographic and economic trends relating to its industry, ability to complete internal restructuring programs and to realize anticipated cost savings from such programs, ability to complete acquisitions, to realize anticipated cost savings and other benefits from acquisitions, to recover acquisition-related costs, and similar matters are forward- looking statements. In some cases, these statements can be identified by the Company’s use of forward-looking words such as “may,” “will,” “should,” “anticipate,” “estimate,” “expect,” “plan,” “believe,” “predict,” “potential,” or “intend.” The forward-looking information is based on various factors and was derived using numerous assumptions. However, these statements only reflect the Company’s predictions. These statements are subject to known and unknown risks, uncertainties, and other factors that could cause the Company’s actual results to differ materially from the statements. Important factors that could cause the Company’s actual results to be materially different from its expectations include actions of competi- tors, customer relationships, market acceptance of new products, actual amounts and timing of special charge items, removal and disposal costs, final negotiations of third-party contracts, the impact of stock market conditions on its share repurchase program, fluctuations in the cost and availability of supply chain resources, global economic conditions, including interest and currency rate fluctua- tions, and inflation rates. The Company undertakes no obli- gation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
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## report of management
We are responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report. The consolidated financial statements were prepared in conformity with United States generally accepted accounting principles and include amounts based on management’s estimates and judgments. All other financial information in this report has been presented on a basis consistent with the information included in the financial statements.
We are also responsible for establishing and maintaining adequate internal controls over financial reporting. We maintain a system of internal controls that is designed to provide reason- able assurance as to the fair and reliable preparation and presentation of the consolidated financial statements, as well as to safeguard assets from unauthorized use or disposition.
Our control environment is the foundation for our system of internal controls over financial reporting and is embodied in our Business Ethics Policy. It sets the tone of our organization and includes factors such as integrity and ethical values. Our internal controls over financial reporting are supported by formal policies and procedures which are reviewed, modified and improved as changes occur in business conditions and operations.
The Audit Committee of the Board of Directors, which is composed solely of outside directors, meets periodically with members of management, the internal auditors and the inde- pendent auditors to review and discuss internal controls over financial reporting and accounting and financial reporting matters. The independent auditors and internal auditors report to the Audit Committee and accordingly have full and free access to the Audit Committee at any time.
We conducted an evaluation of the effectiveness of our internal controls over financial reporting based on the frame- work in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documenta- tion of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Although there are inherent limitations in the effectiveness of any system of internal controls over financial reporting, based on our evaluation, we have concluded that our internal controls over financial reporting were effective as of November 30, 2004.
Ernst & Young LLP, an independent registered public accounting firm, has issued an attestation report on manage- ment’s assessment of internal control over financial reporting, which is included herein.
<img src='content_image/37877.jpg'>
<img src='content_image/37878.jpg'>
<img src='content_image/37879.jpg'>
## report of independent registered public accounting firm
## internal control over financial reporting
## The Board of Directors and Shareholders of McCormick & Company, Incorporated
We have audited management’s assessment, included in the accompanying Report of Management, that McCormick & Company, Incorporated and subsidiaries maintained effective internal control over financial reporting as of November 30, 2004, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over finan- cial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understand- ing of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of finan- cial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as neces- sary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accor- dance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a mate- rial effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
Continued on page 36
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Continued from page 35
periods are subject to the risk that controls may become inade- quate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that McCormick & Company, Incorporated and subsidiaries main- tained effective internal control over financial reporting as of November 30, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also in our opinion, McCormick & Company, Incorporated and subsidiaries maintained, in all mate- rial respects, effective internal control over financial reporting as of November 30, 2004, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of McCormick & Company, Incorporated and subsidiaries as of November 30, 2004 and 2003 and the related statements of income, shareholders’ equity and cash flows for each of the years in the three-year period ended November 30, 2004, and our report dated January 25, 2005 expresses an unqualified opinion on these statements.
<img src='content_image/28698.jpg'>
## report of independent registered public accounting firm
## consolidated financial statements
The Board of Directors and Shareholders of McCormick & Company, Incorporated
We have audited the accompanying consolidated balance sheets of McCormick & Company, Incorporated and subsidiaries as of November 30, 2004 and 2003, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended November 30, 2004. These financial statements are the respon- sibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the finan- cial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluat- ing the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of McCormick & Company, Incorporated and subsid- iaries at November 30, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended November 30, 2004, in conformity with United States generally accepted accounting principles.
As discussed in note 1 of the notes to consolidated finan- cial statements, the Company changed the manner in which it accounts for a variable interest entity upon adoption of certain provisions of Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46) on September 1, 2003. The Company adopted the remaining provisions of FIN 46 effective May 31, 2004.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of McCormick & Company and subsidiaries’ internal control over financial reporting as of November 30, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated January 25, 2005 expressed an unqualified opinion thereon.
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## consolidated statement of income
<img src='content_image/107072.jpg'>
See Notes to Consolidated Financial Statements, pages 41-55.
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## consolidated balance sheet
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For the five years ended 11/30/04, McCormick’s total annual shareholder return has exceeded the S&P 500 Stock Index and S&P 500 Food Products Index.
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## consolidated statement of cash flows
<img src='content_image/75442.jpg'>
See Notes to Consolidated Financial Statements, pages 41-55.
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## consolidated statement of shareholders’ equity
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See Notes to Consolidated Financial Statements, pages 41-55.
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## notes to consolidated financial statements
## 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
## Consolidation
The consolidated financial statements include the accounts of the Company and its majority-owned or controlled subsidiaries. Significant intercompany transactions have been eliminated. Investments in unconsolidated affiliates, over which the Company exercises significant influence, but not control, are accounted for by the equity method. Accordingly, the share of net income or loss of such unconsolidated affil- iates is included in consolidated net income. The implications of the Financial Accounting Standards Board (FASB) Interpretation No. 46, “Consolidation of Variable Interest Entities” on the Company’s consolidation policy are discussed later in this note.
## Use of Estimates
Preparation of financial statements in conformity with account- ing principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial state- ments and accompanying notes. Actual amounts could differ from these estimates.
## Cash and Cash Equivalents
All highly liquid investments purchased with an original matu- rity date of 3 months or less are classified as cash equivalents.
## Inventories
Inventories are stated at the lower of cost or market. Cost is determined using standard or average costs which approxi- mate the first-in, first-out costing method.
## Property, Plant and Equipment
Property, plant and equipment is stated at historical cost and depreciated over its estimated useful life using the straight-line method for financial reporting and both acceler- ated and straight-line methods for tax reporting. The estimated useful lives range from 20 to 40 years for build- ings and 3 to 12 years for the Company’s machinery, equipment and computer software.
Repair and maintenance costs incurred to restore or keep capital assets at an acceptable level of operating condition, but without an increase in the previously estimated useful life or capacity of the asset are expensed as incurred.
## Software Development Costs
The Company capitalizes costs associated with software developed or obtained for internal use in accordance with American Institute of Certified Public Accountants Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Capitalized internal use software development costs include only (1) external direct costs of materials and services consumed in developing or obtaining the software, (2) payroll and payroll- related costs for employees who are directly associated with
and who devote time to the project, and (3) interest costs incurred, when material, while developing the software. Capitalization of these costs ceases when the project is substantially complete and ready for its intended purpose. Capitalized internal use software development costs are amortized using the straight-line method over a range of 3 to 8 years, but not exceeding the expected life of the product. The Company capitalized $14.1 million of software and software development costs during the year ended November 30, 2004 and $25.1 million during the year ended November 30, 2003.
In the fourth quarter of 2004, the Company changed its esti- mated useful life of certain software costs from 5 to 8 years. This change was due to the vendor stating their support for the software for a period longer than originally anticipated. In accordance with APB 20, “Accounting Changes,” this change was made beginning in the fourth quarter of 2004. The 2004 favorable impact to depreciation expense as a result of this change is $1.1 million ($0.8 million after-tax) and is reflected in the consolidated statement of income.
## Goodwill and Other Intangible Assets
In accordance with Statement of Financial Accounting Standard (SFAS) No. 142, ”Goodwill and Other Intangible Assets,“ goodwill and indefinite-lived intangible assets are reviewed at least annually for impairment using the discounted cash flow method. Separable intangible assets that have finite useful lives are amortized over their useful lives. An impaired intangible asset would be written down to fair value, using the discounted cash flow method.
## Prepaid Allowances
Prepaid allowances arise when the Company prepays sales discounts and marketing allowances to certain customers in connection with multi-year sales contracts. These costs are capitalized and amortized against net sales. The majority of the Company’s contracts are for a specific committed customer sales volume while others are for a specific time duration. Prepaid allowances on volume based contracts are amortized based on the actual volume of customer purchases, while prepaid allowances on time based contracts are amor- tized on a straight-line basis over the life of the contract. The amounts reported in the consolidated balance sheet are stated at the lower of unamortized cost or management’s esti- mate of the net realizable value of these allowances.
## Revenue Recognition
Revenue is recognized when it is realized or realizable and has been earned. The Company recognizes revenue when it has persuasive evidence of an arrangement, the product has been delivered to the customer, the sales price is fixed or deter- minable and collectibility is reasonably assured. The Company
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## notes to consolidated financial statements
reduces revenue for estimated product returns, allowances and price discounts based on historical experience.
Trade allowances, consisting primarily of customer pricing allowances, merchandising funds and consumer coupons, are offered through various programs to customers and consumers. Revenue is recorded net of trade allowances.
Receivables consist of amounts billed and currently due from customers. The Company has an allowance for doubt- ful accounts to reduce its receivables to their net realizable value. Management estimates the allowance for doubtful accounts based on factors including aging of receivables and historical collection experience.
## Shipping and Handling
Shipping and handling costs are included in the selling, general and administrative expense caption in the consoli- dated statement of income. Shipping and handling expense was $75.3 million, $60.9 million, and $52.4 million for the years ended November 30, 2004, 2003 and 2002, respectively.
## Research and Development
Research and development costs are expensed as incurred and are included in the selling, general and administrative expense caption in the consolidated statement of income. Research and development expense was $39.3 million, $33.2 million, and $31.4 million for the years ended November 30, 2004, 2003 and 2002, respectively.
## Advertising
Advertising costs, which include the development and produc- tion of advertising materials and the communication of this material through various forms of media, are expensed in the period the advertising first takes place. Advertising expense is included in the selling, general and administrative expense caption in the consolidated statement of income. Advertising expense was $49.2 million, $34.5 million, and $27.4 million for the years ended November 30, 2004, 2003 and 2002, respectively.
## Stock-Based Compensation
The Company uses the intrinsic value method as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for stock options issued to employees and directors. Accordingly, no compen- sation expense is recognized for these stock options since all options granted have an exercise price equal to the market value of the underlying stock on the grant date. During 2003, the Company recorded $1.2 million (net of income taxes of $0.5 million) of stock compensation expense in discontinued operations as a result of accelerated vesting of certain options related to the employees of the discontinued operations. The following table illustrates the effect on net income and earn- ings per common share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.
<img src='content_image/119888.jpg'>
The per share weighted-average fair value of options granted was $6.79, $4.70, and $4.99 in 2004, 2003 and 2002, respectively. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following range of assumptions for the Company’s various stock option plans and Employee Stock Purchase Plans:
<img src='content_image/119889.jpg'>
## Recently Issued Accounting Pronouncements
In January 2003, the FASB issued and subsequently revised Interpretation No. 46, “Consolidation of Variable Interest Entities.” The Company adopted Interpretation No. 46 as it relates to special purpose entities in the fourth quarter of 2003. As a result, the Company consolidated the lessor of a leased distribution center used by the Company and recorded a cumulative effect of an accounting change of $2.1 million (net of income tax benefit of $1.2 million). Consolidation of this entity increased assets by $11.2 million, long-term debt by $14.0 million and minority interest by $0.5 million. The effect of consolidation of this entity in prior years would have reduced net income in 2002 by $0.3 million. In 2004, the Company adopted the remaining provisions of Interpretation No. 46 and there was no material effect on the consolidated financial statements.
In May 2004, the FASB issued Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and Modernization Act of 2003” which provides guidance on the accounting for the effects of the Act. FASB Staff Position 106-2 is effective for the first interim or annual period beginning after June 15, 2004. The Company adopted FASB Staff Position 106-2 in the third quarter of 2004. See Note 10 for impact of adoption.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” an amendment to ARB No. 43, Chapter 4,“Inventory Pricing.” FAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company believes there will be no material effect upon adoption of this statement.
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In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment,” a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and super- seding APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123R requires the Company to expense grants made under the stock option and employee stock purchase plan programs. That cost will be recognized over the vesting period of the plans. SFAS No. 123R is effec- tive for the first interim or annual period beginning after June 15, 2005. Upon adoption of SFAS No. 123R, amounts previ- ously disclosed under SFAS No. 123 will be recorded in the consolidated income statement. The Company is evaluating the alternatives allowed under the standard, which the Company is required to adopt beginning in the fourth quarter of 2005.
## Reclassifications
Certain amounts in prior years have been reclassified to conform to the current year presentation. The effect of these reclassifications is not material to the consolidated financial statements.
## 2. ACQUISITIONS
On November 1, 2004, the Company purchased C.M. van Sillevoldt B.V. (Silvo), the market leader in the Dutch spices and herbs consumer market, for € 58 million in cash (equiva- lent to $74.5 million) funded with cash from operations and current credit facilities. Silvo sells spices, herbs and season- ings under the Silvo brand in the Netherlands and the India brand as well as private label store brands in Belgium. The brand has a strong heritage and high recognition among consumers in the Netherlands. The acquisition is consistent with the Company’s strategy to acquire established brands to complement the Company’s leadership position in the devel- opment and marketing of flavors for food. The acquisition was accounted for under the purchase method, and the results of operations have been included in the Company’s consoli- dated results from the date of acquisition. The excess of the purchase price over the estimated fair value of the net tangi- ble assets purchased was $59.4 million and is classified as goodwill in the consumer segment. The allocation of the purchase price is based on preliminary estimates, subject to revision, after asset values have been finalized. Revisions to the allocation, which may be significant, will be reported as changes to various assets and liabilities. The Company does not anticipate significant amounts to be allocated to amortiz- able intangible assets and, therefore, the amount of intangible asset amortization is not expected to be material to the results of operations in future periods.
On June 4, 2003, the Company purchased Zatarain’s, the leading New Orleans-style food brand in the United States, for $180.0 million in cash funded with commercial paper borrowings. Zatarain’s manufactures and markets flavored rice
and dinner mixes, seafood seasonings and many other products that add flavor to food. The acquisition was accounted for under the purchase method, and the results of operations have been included in the Company’s consolidated results from the date of acquisition. The excess of the purchase price over the estimated fair value of the net assets purchased was $176.2 million, which includes $3.4 million of fees directly related to the acquisition. In the second quarter of 2004, the Company completed the purchase price allocation for the Zatarain’s acquisition. An analysis of the various types of intangible assets resulted in the determination that the excess purchase price should be classified as the value of the acquired brand name and goodwill. No other intangible assets were identified as a result of this analysis. The Company has concluded that a substantial portion of the value of the excess purchase price resides in consumer trust and recognition of the Zatarain’s brand name as authentic New Orleans-style cuisine. As a result, the Company has assigned $106.4 million of the excess purchase price to this unamortizable brand based on an analysis of the premium value that is derived from consumer loyalty and trust in the brand quality. Zatarain’s brand name has been used since 1889, and the Company intends to use and support the brand name indefinitely. The Company will review this intangible asset for impairment annually using the discounted cash flow method. The remaining $69.8 million of intangible assets was allocated to goodwill in the consumer segment.
On January 9, 2003, the Company acquired the Uniqsauces business, a condiment business based in Europe, for $19.5 million in cash. Uniqsauces manufactures and markets condiments to retail grocery and food service customers, including quick service restaurants. The acquisition was accounted for under the purchase method, and the results of operations have been included in the Company’s consolidated results from the date of acquisition. The purchase price of this acquisition was allocated entirely to fixed assets and working capital. No goodwill was recorded as a result of this acquisition.
On August 31, 2000, the Company acquired Ducros, S.A. and Sodis, S.A.S. (Ducros) from Eridania Beghin-Say, for 2.75 billion French francs (equivalent to $379 million). In conjunc- tion with this acquisition, the Company recorded $11.4 million of liabilities for the reorganization of resources in the Ducros organization in Europe. Actions under this plan, which included the consolidation of sales areas and offices and the exit from certain smaller markets, were completed during 2003.
The Ducros purchase contract provided for a potential adjustment to the purchase price with interest from the date of purchase. On April 29, 2003, the Company settled the purchase price adjustment with the prior owners of Ducros.
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The Company received payment of € 49.6 million (equivalent to $55.4 million). Of the $55.4 million received, $5.4 million represented interest earned on the settlement amount from the date of acquisition in accordance with the terms of the original purchase agreement. The interest income was included in “Other income, net” in the consolidated statement of income for the year ended November 30, 2003. The remain- ing $50.0 million of the settlement amount was recorded as a reduction to goodwill related to the acquisition.
## 3. DISCONTINUED OPERATIONS
Following a review in 2002, the packaging business and the U.K. Jenks brokerage operation were determined to be non- core to the Company. On August 12, 2003, the Company completed the sale of substantially all the operating assets of its packaging segment (Packaging) to the Kerr Group, Inc. Packaging manufactured certain products used for packaging the Company’s spices and seasonings as well as packaging products used by manufacturers in the vitamin, drug and personal care industries. Under the terms of the sale agree- ment, Packaging was sold for $132.5 million in cash and possible additional future payments over five years contingent on the buyer meeting certain performance objectives. At the end of the first year of such possible contingent payment peri- ods, no additional payment was due from the buyer for that year. The proceeds were used to pay off a substantial portion of the commercial paper borrowing related to the Zatarain’s acquisition. The final purchase price is also subject to other contingencies related to the performance of certain customer contracts which could result in a decrease in the sale price. The Company recorded a net gain on the sale of Packaging of $11.6 million (net of income taxes of $7.9 million). Included in this gain was a net pension and postretirement curtailment gain of $3.3 million and the write-off of goodwill of $0.7 million. The contingent consideration, if any, associated with the sale of Packaging will be recognized in the future as an adjustment to the gain based on the performance criteria established. The Company also entered into a multi-year, market priced, agreement with the acquirer to purchase certain packaging products.
On July 1, 2003, the Company sold the assets of Jenks Sales Brokers (Jenks), a division of the Company’s wholly- owned U.K. subsidiary, to Jenks’ senior management for $5.8 million in cash. Jenks provided sales and distribution serv- ices for consumer product companies, including the Company, and was previously reported as a part of the Company’s consumer segment. The Company recorded a net loss on the sale of Jenks of $2.6 million (net of an income tax benefit of $0.6 million) in 2003. Included in this loss is a write-off of good- will of $0.4 million.
The operations of Packaging and Jenks were reported as “Income from discontinued operations, net” in the consoli-
dated statement of income in accordance with the provi- sions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Interest expense was allo- cated to discontinued operations based on the ratio of the net assets of the discontinued operations to the total net assets of the Company. The cash flows of Packaging and Jenks were reported as “Net cash (used in)/provided by discontin- ued operations” in the consolidated statement of cash flows. The disclosures in the notes to consolidated financial state- ments exclude discontinued operations.
Summary operating results for the discontinued businesses were as follows:
<img src='content_image/56858.jpg'>
The following table presents summarized cash flow infor- mation of the discontinued operations for the years ended November 30, 2003, and 2002:
<img src='content_image/56857.jpg'>
## 4. SPECIAL CHARGES
During the fourth quarter of 2001, the Company adopted a plan to further streamline its operations. This plan included the consolidation of several distribution and manufacturing loca- tions, the reduction of administrative and manufacturing positions, and the reorganization of several joint ventures. The estimated cost of the total plan is approximately $32.6 million ($25.6 million after-tax). Total cash expenditures in connection with these costs approximate $16.7 million, which are funded through internally generated funds. The remaining $15.9 million of costs associated with the plan consist of write-offs of assets. The total cost of the plan includes $1.8 million of costs related to Packaging and Jenks that have been classi- fied as income from discontinued operations in the consolidated statement of income. Annualized cash savings are expected to be approximately $8.0 million ($5.3 million after-tax), most of which have been realized to date. Savings
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under the plan are being used for spending on initiatives such as brand support and supply chain management. These savings are included within the cost of goods sold and sell- ing, general and administrative expenses in the consolidated statement of income.
In 2001, the Company recorded $11.2 million ($7.4 million after-tax) of charges from continuing operations associated with the 2001 restructuring plan. Of this amount, $10.3 million was classified as special charges and $0.9 million as cost of goods sold in the consolidated statement of income. These charges related to the consolidation of manufacturing in Canada, a distribution center consolidation in the U.S., a product line elimination and a realignment of the Company’s sales operations in the U.K., and a workforce reduction which encompasses plans in all segments and across all geographic areas.
During the year ended November 30, 2002, the Company recorded $7.5 million ($5.5 million after-tax) of special charges from continuing operations associated with the 2001 restruc- turing plan, which could not be accrued at the time of the original announcement in 2001. These charges included the write-off of an investment in an industry purchasing consor- tium, further lease exit and relocation costs related to the workforce reduction and realignment of the Company’s consumer sales operations in the U.S. and further severance and other costs related to the previously discussed workforce reduction. Also included in the 2002 charges were further costs related to the closure of a U.S. distribution center and further costs of the consolidation of manufacturing in Canada, which included the disposition of a manufacturing facility. During 2002, total cash expenditures in connection with the plan were $6.3 million.
During the year ended November 30, 2003, the Company recorded special charges related to continuing operations of $5.5 million ($3.6 million after-tax). The costs recorded in 2003 included additional costs associated with the consoli- dation of production facilities in Canada, net of a gain on the sale of a manufacturing facility, severance and other costs related to the consolidation of industrial manufacturing in the U.K. and the realignment of the Company’s consumer sales operations in Australia. During 2003, total cash expenditures in connection with the plan were $4.7 million.
During the year ended November 30, 2004, the Company recorded special charges related to continuing operations of $6.2 million ($4.3 million after-tax). The costs recorded in 2004 primarily include costs related to the consolidation of industrial manufacturing facilities in the U.K. and Canada, the reorganization of a consumer joint venture and additional severance costs for position eliminations. During 2004, total cash expenditures in connection with the plan were $4.7 million. Also included in special charges/(credits) is a net gain of $8.7 million ($5.5 million after-tax) related to funds received
from a class action lawsuit that was settled in the Company’s favor in the second quarter of 2004. This matter dated back to 1999 when a number of class action lawsuits were filed against manufacturers and sellers of various flavor enhancers for their violation of antitrust laws. The Company, as a purchaser of such products, participated as a member of the plaintiff class. In the second quarter of 2004, the Company received $11.1 million as a settlement of this claim and as a result of the settlement, was required to settle claims against the Company for a portion of this gross amount. The net gain recorded was $8.7 million. This amount was recorded as a special credit and was not allocated to the business segments.
Costs yet to be incurred from the 2001 restructuring plan include the possible reorganization of a joint venture and additional costs related to completion of the reorganization of certain industrial manufacturing facilities in the U.K. These actions are expected to be completed in 2005. The total 2001 restructuring plan, includes severance charges for 392 posi- tion reductions. As of November 30, 2004, 389 of the 392 planned position reductions had taken place.
The major components of the special charges and the remaining accrual balance relating to the 2001 restructuring plan as of November 30, 2002, 2003 and 2004 follow:
<img src='content_image/109796.jpg'>
## 5. GOODWILL AND INTANGIBLE ASSETS
Effective December 1, 2001, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which estab- lished financial accounting and reporting for acquired goodwill and other intangible assets. Under SFAS No. 142, goodwill and indefinite-lived intangible assets are no longer amortized but are reviewed at least annually for impairment. Separable intangible assets that have finite useful lives continue to be amortized over their useful lives.
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## notes to consolidated financial statements
As of November 30, 2004 and 2003, the Company tested for impairment of goodwill and non-amortizable intangibles using discounted cash flow models. As a result of these tests, the Company was not required to recognize any impairment.
The following table displays the intangible assets that continue to be subject to amortization and intangible assets not subject to amortization as of November 30, 2004 and 2003:
<img src='content_image/88096.jpg'>
The changes in the carrying amount of goodwill by segment for the years ended November 30, 2004 and 2003 are as follows:
<img src='content_image/88098.jpg'>
The Zatarain’s brand was transferred from goodwill to other intangibles in 2004 when the purchase price allocation was completed. The excess of the purchase price over net tangi- ble assets recorded as part of the Silvo acquisition in 2004 above is still subject to finalization of purchase price allocation. The table above excludes $0.7 million of goodwill that was disposed of in connection with the sale of Packaging in 2003.
## 6. INVESTMENTS IN AFFILIATES
Summarized year-end information from the financial state- ments of unconsolidated affiliates representing 100% of the businesses follows:
<img src='content_image/88102.jpg'>
The Company’s share of undistributed earnings of the affil- iates was $50.3 million at November 30, 2004. Royalty income from unconsolidated affiliates was $9.7 million, $9.3 million and $10.0 million for 2004, 2003, and 2002, respectively.
## 7. FINANCING ARRANGEMENTS
The Company’s outstanding debt is as follows:
<img src='content_image/88106.jpg'>
(1) The variable interest rate on $75 million of commercial paper is hedged by interest rate swaps through 2011. Net interest payments are fixed at 6.35% during this period.
(2) Interest rate swaps, settled upon the issuance of the medium-term notes, effectively fixed the interest rate on $294 million of the notes at a weighted average fixed rate of 7.62%.
(3) The fixed interest rate on $100 million of 6.40% medium-term notes due in 2006 is effectively converted to a variable rate by interest rate swaps through 2006. Net interest payments are based on LIBOR plus 3.595% during this period.
(4) The fixed interest rate on $50 million of 3.35% medium-term notes due in 2009 is effectively converted to a variable rate by interest rate swaps through 2009. Net interest payments are based on LIBOR minus .21% during this period.
Maturities of long-term debt during the years subsequent to November 30, 2005 are as follows (in millions):
<img src='content_image/88108.jpg'>
On April 1, 2004, the Company issued $50 million of medium-term notes under its existing $375 million shelf regis- tration statement filed with the Securities and Exchange Commission in January 2001. The $50 million of medium-term notes mature on April 15, 2009 and pay interest semi-annu- ally at a rate of 3.35%. The proceeds from the new issuance were used to pay off commercial paper debt.
The Company has available credit facilities with domestic and foreign banks for various purposes. The amount of unused credit facilities at November 30, 2004 was $466.1 million, of
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which $350.0 million supports a commercial paper borrowing arrangement. Of these unused facilities, $241.1 million expire in 2005 and $225.0 million expire in 2006. Some credit facil- ities in support of commercial paper issuance require a commitment fee. Annualized commitment fees at November 30, 2004 and 2003 were $0.3 million.
Rental expense under operating leases was $23.5 million in 2004, $23.0 million in 2003 and $18.1 million in 2002. Future annual fixed rental payments for the years ending November 30 are as follows (in millions):
<img src='content_image/52871.jpg'>
At November 30, 2004, the Company had guarantees of $6.6 million with terms ranging from 1 to 5 years. At November 30, 2004 and 2003, the Company had outstanding letters of credit of $12.3 million and $24.3 million, respectively. These letters of credit typically act as a guarantee of payment to certain third parties in accordance with specified terms and conditions. The unused portion of the Company’s letter of credit facility was $33.7 million at November 30, 2004.
## 8. FINANCIAL INSTRUMENTS
The Company utilizes derivative financial instruments to enhance its ability to manage risk, including foreign currency and interest rate exposures, which exist as part of its ongoing business operations. The Company does not enter into contracts for trading purposes, nor is it a party to any leveraged derivative instrument. The use of derivative financial instruments is monitored through regular communication with senior management and the utilization of written guidelines.
All derivatives are recognized at fair value in the consoli- dated balance sheet. In evaluating the fair value of financial instruments, including derivatives, the Company uses third- party market quotes or calculates an estimated fair value on a discounted cash flow basis using the rates available for instruments with the same remaining maturities.
## Foreign Currency
The Company is potentially exposed to foreign currency fluc- tuations affecting net investments, transactions and earnings denominated in foreign currencies. The Company selectively hedges the potential effect of these foreign currency fluctu- ations by entering into foreign currency exchange contracts with highly-rated financial institutions.
Contracts which are designated as hedges of anticipated purchases denominated in a foreign currency (generally purchases of raw materials in U.S. dollars by operating units outside the U.S.) are considered cash flow hedges. The gains
and losses on these contracts are deferred in other compre- hensive income until the hedged item is recognized in cost of goods sold, at which time the net amount deferred in other comprehensive income is also recognized in cost of goods sold. Gains and losses from hedges of assets, liabili- ties or firm commitments are recognized through income, offsetting the change in fair value of the hedged item.
At November 30, 2004, the Company had foreign currency exchange contracts maturing within one year to purchase or sell $51.1 million of foreign currencies versus $58.9 million at November 30, 2003. All of these contracts were designated as hedges of anticipated purchases denominated in a foreign currency to be completed within one year or hedges of foreign currency denominated assets or liabilities. Hedge ineffec- tiveness was not material.
## Interest Rates
The Company finances a portion of its operations with both fixed and variable rate debt instruments, primarily commer- cial paper, notes and bank loans. The Company utilizes interest rate swap agreements to minimize worldwide financing costs and to achieve a desired mix of its variable and fixed rate debt.
In 2004, the Company entered into an interest rate swap contract with a total notional amount of $50 million to receive interest at 3.356% and pay a variable rate of interest based on six-month LIBOR minus .21%. The Company designated this swap, which expires on April 15, 2009, as a fair value hedge of the changes in fair value of the $50 million of medium-term notes maturing on April 15, 2009. No hedge ineffectiveness is recognized as the interest rate swap’s provisions match the applicable provisions of the debt.
In 2003, the Company entered into interest rate swap contracts for a total notional amount of $100 million to receive interest at 6.4% and pay a variable rate of interest based on six-month LIBOR plus 3.595%. The Company designated these swaps, which expire on February 1, 2006, as fair value hedges of the changes in fair value of $100 million of the $150 million 6.40% fixed rate medium-term notes maturing on February 1, 2006. No hedge ineffectiveness is recognized as the interest rate swaps’ provisions match the applicable provi- sions of the debt.
The variable interest on $75 million of commercial paper was hedged by forward starting interest rate swaps for the period through 2011. Net interest payments on this commer- cial paper will be effectively fixed at 6.35% during the period. The unrealized gain or loss on these swaps is recorded in other comprehensive income, as the Company intends to hold these interest rate swaps until maturity. Hedge ineffective- ness was not material.
Subsequent to the starting date of these swaps, the net cash settlements are reflected in interest expense in the applicable period.
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## notes to consolidated financial statements
The Company incurred a $14.7 million loss on the settlement of swaps used to hedge the 2001 issuance of $294 million of medium-term notes. The loss on these swaps was deferred in other comprehensive income and is being amortized over the five to seven year life of the medium-term notes as a component of interest expense. Amounts reclassified from other comprehensive income to interest expense for settled interest rate swaps were $2.5 million in 2004 and 2003 and are included in the net change in unrealized gain or loss on derivative financial instruments in the statement of share- holders’ equity.
## Fair Value of Financial Instruments
The carrying amount and fair value of the Company’s financial instruments at November 30, 2004 and 2003 are as follows:
<img src='content_image/110573.jpg'>
Because of their short-term nature, the amounts reported in the consolidated balance sheet for cash and cash equiva- lents, receivables, short-term borrowings and trade accounts payable approximate fair value. The fair value of long-term debt and derivative financial instruments are based on quoted market prices.
Investments in affiliates are not readily marketable, and it is not practicable to estimate their fair value. Other invest- ments are comprised of fixed income and equity securities held on behalf of employees in certain employee benefit plans and are stated at fair value. The cost of these invest- ments was $28.6 million and $24.0 million at November 30, 2004 and 2003, respectively.
## Concentrations of Credit Risk
The Company is potentially exposed to concentrations of credit risk with trade accounts receivable, prepaid allowances and financial instruments. Because the Company has a large and diverse customer base with no single customer account- ing for a significant percentage of trade accounts receivable and prepaid allowances, there was no material concentration of credit risk in these accounts at November 30, 2004. The Company evaluates the credit worthiness of the counterpar- ties to financial instruments and considers nonperformance credit risk to be remote.
## 9. PENSION AND 401(k) RETIREMENT PLANS
The Company sponsors defined benefit pension plans in the U.S. and certain foreign locations. In addition, it sponsors 401(k) retirement plans in the U.S. and contributes to govern- ment-sponsored retirement plans in locations outside the U.S.
## Defined Benefit Pension Plans
A September 30th measurement date is utilized to value plan assets and obligations for all of the Company’s defined benefit pension plans.
The significant assumptions used to determine benefit obligations are as follows:
<img src='content_image/110572.jpg'>
The expected long-term rate of return on assets assump- tion is based on weighted-average expected returns for each asset class. Expected returns reflect a combination of histor- ical performance analysis and the forward-looking views of the financial markets, and include input from actuaries, investment service firms and investment managers.
The Company’s pension expense is as follows:
<img src='content_image/110571.jpg'>
Rollforwards of the benefit obligation, fair value of plan assets and a reconciliation of the pension plans’ funded status at the measurement date, September 30, follow:
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## letter to shareholders
## fellow shareholders,
2004 was a terrific year at McCormick. Sales reached a record $2.5 billion. We completed the implementation of our B2K program in the U.S. The goal for the first year of our $70 million cost reduction program was exceeded. We reached $1.0 billion in gross profit and increased gross profit margin 0.3 percentage points. With $350 million in cash from operations we paid $77 million in dividends, repurchased $175 million of shares and acquired Silvo, the leading brand of spices and herbs in the Netherlands, for $75 million.
<img src='content_image/9609.jpg'>
Now in our 115th year, we continue to build shareholder value. In fact, total annual return for our shareholders has been 20% during the past five years, twice that of our peer compa- nies. Everywhere you look, you’ll discover that McCormick is turning up the heat.
## record results for 2004
At the beginning of 2004, with confidence in our business and ability to perform, we set several financial goals.
Our first objective was to grow sales 7-9%. We achieved sales growth of 11%. This was the result of launching successful
new products, introducing effective promotions and acquiring Zatarain’s mid-year in 2003. We also benefited from higher pricing for vanilla and favorable foreign currency. Sales for our consumer business rose 15%, following a 17% increase in 2003. Our industrial business picked up steam with a 7% sales increase following a 5% increase in 2003.
Second, we set a range for earnings per share of $1.51 to $1.54. We ended the year with earnings per share of $1.52. With higher sales, improved gross profit margins, cost reduction savings and the proceeds from the settlement of a lawsuit
profits...we are turning up the heat!
A key to margin improvement is our B2K program, a global initiative that is significantly improving our business processes through state-of-the-art technology. With the implementation for the U.S. complete, our plan is to move international businesses onto this platform by 2006. Utilizing the power of B2K, employees are improving the supply chain throughout the Company. As a result, we significantly reduced costs in 2004, exceeding our $15 million objective. In 2005 we expect to reduce costs an additional $25 million and in 2006 an additional $30 million.
Margin improvement fuels our growth. We will use a portion
claim, we were able to offset some cost increases in areas including employee bene- fits and fuel. More importantly, we were able to invest in the business for future growth, increasing advertising and product develop- ment expense during 2004.
Our third target was to generate $350- $400 million from 2004 to 2006 in cash flow from operations, after net capital expenditures and dividends. Our 2004 result of $206 million has us well on our way toward meeting this target. We generated higher cash from a number of sources including higher net income, reduced inventory and lower prepaid allowances. During 2004, we increased divi- dends paid by 20% to $77 million from $64 million in 2003.
## turning up the heat
For each step of our strategy: improve margins, invest in the business and increase sales and
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<img src='content_image/9129.jpg'>
Included in the United States in the preceding table is a benefit obligation of $36.0 million and $32.4 million for 2004 and 2003, respectively, related to an unfunded pension plan. The accrued liability related to this plan was $31.7 million and $27.6 million as of November 30, 2004 and 2003, respectively. The assets related to this plan are held in a Rabbi Trust and accordingly have not been included in the preceding table. These assets were $19.0 million and $14.4 million as of November 30, 2004 and 2003, respectively.
Amounts recognized in the consolidated balance sheet consist of the following:
<img src='content_image/9128.jpg'>
The accumulated benefit obligation is the present value of pension benefits (whether vested or unvested) attributed to employee service rendered before the measurement date and
based on employee service and compensation prior to that date. The accumulated benefit obligation differs from the projected benefit obligation in that it includes no assumption about future compensation levels. The accumulated benefit obligation for the U.S. pension plans was $299.1 million and $281.2 million as of September 30, 2004 and 2003, respectively. The accumulated benefit obligation for the international pension plans was $124.9 million and $98.9 million as of November 30, 2004 and 2003, respectively.
Minimum pension liability adjustments result when the accumulated benefit obligation exceeds the fair value of plan assets and are recorded so that the recorded pension liabil- ity is at a minimum equal to the accumulated benefit obligation. Minimum pension liability adjustments are non- cash adjustments that are reflected as an increase (or decrease) in the pension liability and an offsetting charge to shareholders’ equity, net of tax, through comprehensive income rather than net income.
At the September 30, 2004 measurement date, the defi- ciency of the pension plans’ assets compared to the accumulated benefit obligations decreased resulting in a decrease in the minimum pension liability of $7.3 million. This amount was recorded as a decrease in accrued pension liability, a $4.4 million increase in other comprehensive income, a $2.8 million decrease in deferred taxes, and $0.1 million decrease in intangible assets. At the September 30, 2003 measurement date, the deficiency of the pension plans’ assets compared to the accumulated benefit obligations increased resulting in an increase in the minimum pension liability of $20.6 million. This amount was recorded as an increase in accrued pension liability, a $14.4 million decrease in other comprehensive income, a $6.4 million increase in deferred taxes and a $0.2 million decrease in intangible assets.
The Company’s actual and target weighted-average asset allocations of U.S. pension plan assets as of September 30, 2004 and 2003, by asset category, are as follows:
<img src='content_image/9127.jpg'>
The average actual and target asset allocations of the inter- national pension plans’ assets as of November 30, 2004 and 2003, by asset category, are as follows:
<img src='content_image/9126.jpg'>
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## notes to consolidated financial statements
The investment objectives of the pension benefit plans are to secure the benefit obligations to participants at a reasonable cost to the Company. The goal is to optimize the long-term return on plan assets at a moderate level of risk, by balancing higher-returning assets such as equity securities, with less volatile assets, such as fixed income securities. The assets are managed by professional investment firms and performance is evaluated quarterly against specific benchmarks.
Equity securities in the U.S. plan included the Company’s stock with a fair value of $33.6 million (0.9 million shares and 13.5% of total U.S. pension plan assets) and $26.4 million (0.9 million shares and 12.4% of total U.S. pension plan assets) at November 30, 2004 and 2003, respectively. Dividends paid on these shares were $0.5 million in 2004 and $0.4 million in 2003.
Pension benefit payments are made from assets of the pension plans. It is anticipated that future benefit payments for the U.S. plans will be as follows:
<img src='content_image/81890.jpg'>
It is anticipated that future benefit payments for the inter- national plans will be as follows:
<img src='content_image/81891.jpg'>
The Company expects to contribute approximately $28 million to its U.S. pension plans and $9 million to its international pension plans in 2005.
## 401(k) Retirement Plans
Effective March 22, 2002, the U.S. McCormick 401(k) Retirement Plan was amended to provide that the McCormick Stock Fund investment option be designated an employee stock ownership plan (ESOP). This designation allows partic- ipants investing in McCormick stock to elect to receive, in cash, dividends that are paid on McCormick stock held in their 401(k) Retirement Plan accounts. Dividends may also continue to be reinvested.
For the U.S. McCormick 401(k) Retirement Plan, the Company matches 100% of the participant’s contribution up to the first 3% of the participant’s salary, and 50% of the next 2% of a participant’s salary. Certain U.S. subsidiaries sponsor separate 401(k) retirement plans. Company contributions
charged to expense under all 401(k) Retirement Plans were $5.7 million, $5.4 million and $5.5 million in 2004, 2003 and 2002, respectively.
At the participant’s election, all 401(k) Retirement Plans held 4.0 million shares, with a fair value of $144.2 million, of the Company’s stock at November 30, 2004. Dividends paid on these shares in 2004 were $2.3 million.
## 10. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
During 2002, the Company changed certain postretirement benefits for employees who retire on or after January 1, 2004. Life insurance benefits changed to a fixed amount, Medicare eligible retirees have a fixed amount for medical plan cover- age and the medical cost sharing for dependents increased.
The Company currently provides postretirement medical and life insurance benefits to certain U.S. employees who were covered under the active employees’ plan and retire after age 55 with at least 10 years of service (earned after age 45). The benefits provided under these plans are based prima- rily on age at date of retirement.
The Company’s other postretirement benefit expense follows:
<img src='content_image/81892.jpg'>
Rollforwards of the benefit obligation, fair value of plan assets and a reconciliation of the plans’ funded status at November 30, the measurement date, follow:
<img src='content_image/81894.jpg'>
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Estimated future benefit payments for the next 10 years are as follows:
<img src='content_image/94813.jpg'>
The assumed discount rate was 6.0% for 2004 and 2003, respectively.
The assumed annual rate of increase in the cost of covered health care benefits is 8.0% for 2005. It is assumed to decrease gradually to 4.5% in the year 2011 and remain at that level thereafter. Changing the assumed health care cost trend would have the following effect:
<img src='content_image/94814.jpg'>
In December of 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Act) was enacted in the U.S. The Act introduced a prescription drug benefit under Medicare as well as a federal subsidy of 28% of drug costs between $250 and $5,000, tax-free (the Subsidy), to sponsors of retiree health benefit plans that provide a benefit that meets certain criteria. The Company’s other postretirement plans covering U.S. retirees currently provide certain prescription benefits to eligible participants. The Company’s actuaries have determined that one of the Company’s prescription drug plans for retirees and their dependents retired prior to January 1, 2004 provides a bene- fit that is at least actuarially equivalent to Medicare Part D under the Act.
In connection with the adoption of FASB Staff Position 106-2, the Act had the effect of reducing the accumulated postretirement benefit obligation by $3.0 million. This resulted in an unrecognized net gain to the plan, which is currently being amortized. The annual reduction in the Company’s other postretirement benefits expense due to the Subsidy is expected to be approximately $0.4 million, which includes the amortization of the unrecognized net gain. The provisions of the Act do not have a material effect on the consolidated finan- cial statements.
## 11. INCOME TAXES
The provision for income taxes consists of the following:
<img src='content_image/94815.jpg'>
The components of income from consolidated continuing operations before income taxes follow:
<img src='content_image/94816.jpg'>
A reconciliation of the U.S. federal statutory rate with the effective tax rate follows:
<img src='content_image/94817.jpg'>
Deferred tax assets and liabilities are comprised of the following:
<img src='content_image/94818.jpg'>
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## notes to consolidated financial statements
At November 30, 2004, non-U.S. subsidiaries of the Company have tax loss carryforwards of $22.0 million. Of these carryforwards, $11.6 million expire through 2014 and $10.4 million may be carried forward indefinitely. The current statutory rates in these countries range from 19% to 35%.
At November 30, 2004, non-U.S. subsidiaries of the Company have capital loss carryforwards of $15.8 million. Of these carryforwards, $2.9 million expire in 2009 and $12.9 million may be carried forward indefinitely. The current statu- tory rates in these countries range from 30% to 35%.
A valuation allowance has been provided to record deferred tax assets at their net realizable value. The 2004 net change in valuation allowance for deferred tax assets was an increase of $6.3 million. During 2004, the Company utilized $2.5 million of non-U.S. subsidiary tax loss carryforwards which previously had valuation allowances. This was offset by $8.8 million of additions to the valuation allowance for tax assets added in 2004 which may not be realized in future periods.
U.S. income taxes are not provided for unremitted earnings of international subsidiaries and affiliates where the Company’s intention is to reinvest these earnings perma- nently or to repatriate the earnings when it is tax effective to do so. Accordingly, the Company believes that any U.S. tax on repatriated earnings would be substantially offset by U.S. foreign tax credits. Unremitted earnings of such entities were $230.5 million at November 30, 2004.
12. EMPLOYEE STOCK OPTION AND PURCHASE PLANS
Under the Company’s various stock option plans, options to purchase shares of the Company’s common stock were granted to employees and directors. The option price for shares granted under these plans is the fair market value on the grant date and the grants have ten-year terms.
The Company has Employee Stock Purchase Plans (ESPP) enabling employees in the U.S. and certain other countries to purchase the Company’s Common Stock Non-Voting at the lower of the stock price on the grant date or the exercise date. Similarly, options are granted for certain foreign-based employ- ees in lieu of their participation in the ESPP. Options granted under these plans have two- or three-year terms.
A summary of the Company’s stock option activity for the years ended November 30, 2004, 2003 and 2002 follows:
<img src='content_image/112141.jpg'>
A summary of the Company’s stock options outstanding at November 30, 2004 follows:
<img src='content_image/112139.jpg'>
Under all stock purchase and option plans, there were 12.6 million and 9.8 million shares reserved for future grants at November 30, 2004 and 2003, respectively.
Included in stock options exercised are non-cash option swaps and taxes paid with shares of $12.8 million, $1.1 million and $1.7 million for November 30, 2004, 2003 and 2002, respectively. These amounts have been excluded from common stock issued and acquired by purchase in the consol- idated cash flow statement as these are non-cash transactions.
13. EARNINGS PER SHARE
The reconciliation of shares outstanding used in the calcula- tion of basic and diluted earnings per share for the years ended November 30, 2004, 2003 and 2002 follows:
<img src='content_image/112140.jpg'>
14. CAPITAL STOCKS
Holders of Common Stock have full voting rights except that (1) the voting rights of persons who are deemed to own beneficially 10% or more of the outstanding shares of Common Stock are limited to 10% of the votes entitled to be cast by all holders of shares of Common Stock regardless of how many shares in excess of 10% are held by such person; (2) the Company has the right to redeem any or all shares of stock owned by such person unless such person acquires more than 90% of the outstanding shares of each class of the Company’s common stock; and (3) at such time as such person controls more than 50% of the vote entitled to be cast by the holders of outstanding shares of Common Stock, auto- matically, on a share-for-share basis, all shares of Common Stock Non-Voting will convert into shares of Common Stock.
Holders of Common Stock Non-Voting will vote as a sepa- rate class on all matters on which they are entitled to vote. Holders of Common Stock Non-Voting are entitled to vote on reverse mergers and statutory share exchanges where the capital stock of the Company is converted into other securi- ties or property, dissolution of the Company and the sale of substantially all of the assets of the Company, as well as forward mergers and consolidation of the Company.
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## 15. COMMITMENTS AND CONTINGENCIES
The Company is a party to various pending legal proceedings and claims, tax issues and other matters arising out of the normal course of business. Although the results of pending claims and litigation cannot be predicted with certainty, in management’s opinion, the final outcome of these proceed- ings and claims, tax issues and other matters will not have a material effect on the consolidated results of operations, financial position or cash flows of the Company.
## 16. BUSINESS SEGMENTS AND GEOGRAPHIC AREAS
## Business Segments
The Company operates in two business segments: consumer and industrial. The Company sold its packaging segment during the third quarter of 2003 (see Note 3). The consumer and industrial segments manufacture, market and distribute spices, herbs, seasonings, condiments and other flavors throughout the world. The consumer segment sells to retail outlets, including grocery, drug, dollar and mass merchandise stores under a variety of brands, including McCormick and Zatarain’s in the U.S., Ducros, Vahine and Silvo in continental Europe, Club House in Canada, and Schwartz in the U.K. The industrial segment sells to other food processors and the restaurant industry both directly and through distributors and warehouse clubs.
In each of its segments, the Company produces and sells many individual products which are similar in composition and nature. It is impractical to segregate and identify profits for each of these individual product lines.
The Company measures segment performance based on operating income. Although the segments are managed sepa- rately due to their distinct distribution channels and marketing strategies, manufacturing and warehousing are often inte- grated to maximize cost efficiencies. Management does not segregate jointly utilized assets by individual segment for internal reporting, evaluating performance or allocating capi- tal. Asset-related information has been disclosed in aggregate.
Accounting policies for measuring segment operating income and assets are substantially consistent with those described in Note 1, “Summary of Significant Accounting Policies.” Because of manufacturing integration for certain products within the segments, products are not sold from one segment to another but rather inventory is transferred at cost. Intersegment sales are not material. Corporate and other includes general corporate expenses and charges not directly attributable to the segments. Corporate assets include cash, deferred taxes, certain investments and fixed assets.
Segment information for the years ended November 30, 2003 and November 30, 2002 has been restated to exclude discontinued operations. Certain fixed overhead charges previ- ously allocated to Packaging were reallocated to other segments.
<img src='content_image/98573.jpg'>
(a) 2002 amount does not include $140.7 million of assets related to discontinued operations.
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## notes to consolidated financial statements
## Geographic Areas
The Company has net sales and long-lived assets in the following geographic areas:
<img src='content_image/127975.jpg'>
(1) Long-lived assets include property, plant and equipment, goodwill and intangible assets, net of accumulated depreciation and amortization.
## 17. SUPPLEMENTAL FINANCIAL STATEMENT DATA
In 2003, the Company sold its interest in non-strategic royalty agreements for $5.2 million in cash. This sale resulted in a one- time gain of $5.2 million which is included in “Other income, net” in the consolidated statement of income for 2003.
Supplemental income statement, balance sheet and cash flow information is as follows:
<img src='content_image/127973.jpg'>
<img src='content_image/127976.jpg'>
<img src='content_image/127977.jpg'>
Dividends paid per share were $0.56 in 2004, $0.46 in 2003 and $0.42 in 2002.
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## 18. SELECTED QUARTERLY DATA (UNAUDITED)
<img src='content_image/94544.jpg'>
In the second quarter of 2004, the Company settled a class action lawsuit in the Company’s favor, resulting in a net one- time gain of $8.7 million, included in special charges/(credits). See Note 4 for further information.
In the fourth quarter of 2003, the Company consolidated the lessor of a leased distribution center in accordance with the provisions of FASB Interpretation No. 46, resulting in a cumulative effect of an accounting change of $(2.1) million, net of tax. See Note 1 for further information. Also in the fourth quarter of 2003, the Company sold its interest in non-strategic royalty agreements, which resulted in a one-time gain of $5.2 million.
In the third quarter of 2003, the Company disposed of its U.K. brokerage business and its packaging segment, result- ing in a net gain of $9.0 million. Financial information for previous quarters was reclassified to present the results of these discontinued operations separately from continuing operations. Refer to Note 3 for further information.
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## historical financial summary
<img src='content_image/10539.jpg'>
(1) In 2002, the Company implemented EITF 01-09. Results have been reclassified for 2001 and 2000.
(2) The Company sold both Gilroy Foods, Incorporated and Gilroy Energy Company, Inc. in 1996.
(3) In 1999, the Company changed its actuarial method for computing pension expense.
(4) In 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” Prior year results have not been adjusted.
(5) In 2003, the Company sold its packaging segment and Jenks Sales Brokers in the U.K. All years have been restated for the sale of the packaging segment. Only 2002 and 2001 have been restated for the sale of Jenks.
(6) In 2003, the Company consolidated the lessor of a leased distribution center in accordance with FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” as revised.
(7) All share data adjusted for 2-for-1 stock split effective April 2002.
(8) Includes fourth quarter dividends which, in some years, were declared in December following the close of each fiscal year.
(9) Total capital includes debt, minority interest and shareholders’ equity.
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## investor information
## World Headquarters
McCormick & Company, Incorporated 18 Loveton Circle Sparks, MD 21152-6000 U.S.A. (410) 771-7301 www.mccormick.com
## Stock Information
New York Stock Exchange Symbol: MKC
<img src='content_image/96683.jpg'>
## Anticipated Dividend Dates – 2005
<img src='content_image/96680.jpg'>
McCormick has paid dividends for 80 consecutive years.
## Independent Auditors
Ernst & Young LLP 621 East Pratt Street Baltimore, MD 21202
## Certifications
The Company has filed the Chief Executive Officer and Chief Financial Officer certifications required by Section 302 of the Sarbanes-Oxley Act in its Form 10-K. Additionally, the Chief Executive Officer has provided the required annual certifications to the New York Stock Exchange.
## Investor Inquiries
Our website www.mccormick.com has our corporate governance principles, as well as annual reports, SEC filings, press releases, webcasts and other useful Company information.
To obtain without cost a copy of the annual report filed with the Securities & Exchange Commission (SEC) on Form 10-K or for general questions about McCormick or information in our annual or quarterly reports, contact Investor Relations at the world headquarters address, website or telephone:
Report ordering: (800) 424-5855 or (410) 771-7537 Investor and securities analysts’ inquiries: (410) 771-7244
## Registered Shareholder Inquiries
For questions on your account, statements, dividend payments, reinvestment and direct deposit, and for address changes, lost certificates, stock transfers, ownership changes or other administrative matters, contact our transfer agent.
## Transfer Agent and Registrar
Wells Fargo Bank, N.A. Shareowner Services 161 North Concord Exchange Street, South St. Paul, MN 55075-1139 (877) 778-6784, or (651) 450-4064 www.wellsfargo.com/shareownerservices
You may access your account information via the Internet at www.shareowneronline.com
## Investor Services Plan (Dividend Reinvestment and Direct Purchase Plan)
The Company offers an Investor Services Plan which provides shareholders of record the opportunity to automatically reinvest dividends, make optional cash purchases of stock through the Company, place stock certificates into safekeeping and sell shares through the Plan. Individuals who are not current shareholders may purchase their initial shares directly through the Plan. All transactions are subject to the limitations set forth in the Plan prospectus, which may be obtained by contacting Wells Fargo Shareowner Services at: (877) 778-6784 or (651) 450-4064 www.wellsfargo.com/shareownerservices
## Stock Price History
<img src='content_image/96679.jpg'>
## Annual Meeting
The annual meeting of shareholders will be held at 10 a.m., Wednesday, March 23, 2005, at Marriott’s Hunt Valley Inn, 245 Shawan Road (Exit 20A off I-83 north of Baltimore), Hunt Valley, Maryland 21031.
## Online Receipt of Annual Report and Proxy Statement
If you are a registered shareholder and would like to access next year’s proxy statement and annual report over the Internet, go to www.econsent.com/mkcv/ to enroll for this service.
## Trademarks
Use of ® or TM in this annual report indicates trademarks owned or used by McCormick & Company, Incorporated and its subsidiaries and affiliates.
<img src='content_image/96697.jpg'>
## Debbie Calver
European Technical Manager, Flavour Group
” I often sprinkle McCormick curry powder along with McCormick coarse sea salt and McCormick cracked black pepper on roasted winter vegetables. This adds interest and excitement to an otherwise bland dish. The curry note works particularly well with a mix of sweet potatoes and bell peppers, and you can use any of the McCormick curry blends depending on your preference for hot or aromatic flavor . ”
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McCormick & Company, Incorporated 18 Loveton Circle Sparks, Maryland 21152-6000 U.S.A. 410-771-7301
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of this fuel to invest in the business. We are accelerating the marketing support behind our powerful brands. We have more than doubled advertising expense since 1999. We invested in a promotional analysis process that in its first year significantly increased the effectiveness of our 2004 U.S. trade promotion dollars. Product development expense increased another 18% in 2004 and 84% since 1999. In addition to increasing our resources behind product development, we’ve increased productivity. New product sales as measured per each R&D professional have doubled in the past five years. A formula management system will be available in 2005 that will give our teams a running start on new products and further reduce the development cycle time for our customers.
Improved margins provide the fuel for business invest- ments...investments designed to increase sales and profits. Throughout the Company we are seeing signs of success in a great number of new products. One product line is grinders. A functional, consumer-oriented package that originated under the Ducros brand in France is being taken to other markets.
Worldwide sales of grinders were up 36% in 2004, and new blends and an improved package are in the pipeline for 2005. For several years now, sales to restaurant chains have been strong. Most recently, we have significantly increased sales of coating systems. We have also increased sales and profits with strate- gic acquisitions. Since its addition to the McCormick family in June 2003, the performance of Zatarain’s has exceeded our expectations. At the end of 2004, we completed the acquisition of another excellent brand, Silvo. This leading brand extends our European reach into the Netherlands and will add nearly $50 million of sales in 2005.
We continue to reaffirm the long-term goals that we set in 2002: to grow sales 5% annually with a range of 3-7% and to increase earnings per share 10-12%. In a tough environment, these are aggressive goals for McCormick and, for that matter, any packaged food company. But we like a challenge at McCormick and have established a strong track record in meeting our goals. In the coming years, we intend to continue our record of superior financial results and increased shareholder value.
## leadership at McCormick
Early in 2004, a Management Committee was formed that expanded the former Executive Committee to include leaders
of our consumer business. The Management Committee has responsibility for setting strategy, executing growth initiatives, allocating Company resources and for developing and advanc- ing our employees. I believe that our Board of Directors, Management Committee and leadership throughout McCormick are among the best in the food industry.
Toward the end of 2004, Jerry Wolfe was promoted to Vice President – Supply Chain and Chief Information Officer. Fran Contino was named Executive Vice President –Strategic Planning and CFO. Throughout the Company, we continue to challenge and develop our people while tapping into their experience, knowledge and enthusiasm.
We like our business: flavor. Demand for great taste has few boundaries. Kid-friendly flavors, bold and zesty flavors, ethnic flavors and flavors for those on a reduced calorie, low-carb, low- fat, or low-salt diet. From molecule to menu, McCormick has the broadest range of flavor solutions in the industry.
I believe we have a great team at McCormick and a winning strategy that continues to deliver record financial performance year after year. Our core values define the way we work with one another, how we value and serve our customers, and our ultimate responsibility to McCormick shareholders. These values are fundamental to our success.
Thank you to our employees for making our goals a reality. All of us at McCormick are committed to building shareholder value. I am confident of our future success.
our core values
We believe…
> our people are the most important ingredient of our success.
> our top priority is to continuously add value for our shareholders.
> customers are the reason we exist.
> our business must be conducted honestly and ethically.
> the best way to achieve our goals is through teamwork.
<img src='content_image/117613.jpg'>
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## board of directors
Barry H. Beracha 62 Executive Vice President Sara Lee Corporation (retired) Chief Executive Officer Sara Lee Bakery Group (retired) Chicago, Illinois Food, household and body care products and apparel Director since 2000 Compensation Committee member
James T. Brady 64 Managing Director, Mid-Atlantic Ballantrae International, Ltd. Ijamsville, Maryland International management consultants Director since 1998 Audit Committee member
Francis A. Contino 59 Executive Vice President – Strategic Planning and Chief Financial Officer McCormick & Company, Inc. Director since 1998
Robert G. Davey 55 President – Global Industrial Group McCormick & Company, Inc. Director since 1994
Edward S. Dunn, Jr. 61 President, Dunn Consulting Retail grocery and related industries, business strategy and marketing consultant Williamsburg, Virginia Director since 1998 Compensation Committee member
J. Michael Fitzpatrick 58 President & Chief Operating Officer Rohm and Haas Company (retired) Philadelphia, Pennsylvania Paints and coatings, electronic devices and personal computers, packaging and construction materials, household and personal care products, grocery items Director since 2001 Compensation Committee member Nominating /Corporate Governance Committee member
Freeman A. Hrabowski, III 54 President University of Maryland Baltimore County Baltimore, Maryland Director since 1997 Nominating /Corporate Governance Committee member
Robert J. Lawless 58 Chairman of the Board, President and Chief Executive Officer McCormick & Company, Inc. Director since 1994
Margaret M.V. Preston 47 Executive Vice President Mercantile Private Wealth Management Mercantile Safe Deposit & Trust Company Baltimore, Maryland Director since 2003 Audit Committee member
William E. Stevens 62 Chairman, BBI Group St Louis, Missouri Mergers and acquisitions Director since 1988 Audit Committee member
Karen D. Weatherholtz 54 Senior Vice President – Human Relations McCormick & Company, Inc. Director since 1992
## Corporate Governance
McCormick’s mission is to enhance share- holder value. McCormick employees conduct business under the leadership of the chief executive officer subject to the oversight and direction of the Board of Directors. Both management and the Board of Directors believe that the creation of long-term shareholder value requires us to conduct our business honestly and ethically and in accordance with applicable laws. We also believe that shareholder value is well served if the interests of our employees, customers, suppliers, consumers, and the communities in which we live, are appropriately addressed.
McCormick’s success is grounded in its value system as evidenced by our core values.
We are open and honest in business dealings inside and outside the Company. We are dependable and truthful and keep our promises.
Our employees and our Board of Directors are committed to growing our business in accordance with our governance structure and principles and code of ethics.
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## consumer business
## financial results
(in millions)
<img src='content_image/104494.jpg'>
## 2004 net sales by region
<img src='content_image/104498.jpg'>
Interest in flavors continues to grow as consumers all over the world are exposed to different cuisines than their own. But food preparation must be quick and easy. McCormick is satisfying this appetite for outstanding flavor and simple preparation with leading brands in key markets around the world.
Victor Sy Vice President and Managing Director – Consumer – McCormick Asia
Iwan Williams President – Europe, Middle East & Africa
Alan Wilson President – U.S. Consumer Foods
Mark Timbie President – International Consumer Products Group
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1680 Capital One Drive McLean, VA 22102 (703) 720-1000
www.capitalone.com
<img src='content_image/121387.jpg'>
# Measures of Success
1998 $ 275.2 million earnings
1999 $ 363.1 million
2000 $ 469.6 million
2001 $642 million
2002 $899.6 million earnings
<img src='content_image/121386.jpg'>
Annual Report 2002
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We continue to ask
“What’s in your wallet?”
And the answer keeps getting better.
## Capital One is now in a league with the best-known brands in financial services.
We’ve always offered the most innovative products, the best prices and hassle-free service, but Capital One wasn’t a household name until we started marketing our brand with the same energy we put into marketing credit cards and loans. Now 96% of Americans know who we are.
In 2002 we reached 95% of American households an average of 70 times with our award-winning “What’s in your wallet?” SM ads, which air during top-rated TV series and high-profile events, including college football games. We also became the sole title sponsor of the former Capital One Florida Citrus Bowl, which is now the Capital One Bowl. SM
We have positioned Capital One as a maverick brand for smart consumers looking for great value, a strategy that supports our growth and gives the brand a cachet with consumers in all credit and income brackets.
There’s more than advertising behind the success of Capital One’s brand building. Consumers trust the brand because they know it’s backed by first-rate products and performance. We promise great prices and great service, and we deliver. Our “No-Hassle” SM credit cards and loans are truly hassle-free. We see every interaction with consumers as an opportunity to build the brand, and through millions of encounters each day, we continue to show that Capital One is a company that really does put customers first.
A powerful brand is a powerful competitive advantage. It differentiates Capital One from hundreds of look-alike MasterCard and Visa issuers. It wins customers and keeps them. It’s a great asset as we continue our diversification beyond credit cards. It helps us form mutually profitable alliances with leading companies in other industries. And it draws top-flight talent to Capital One.
<img src='content_image/161.jpg'>
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## 2000
3 billion in international loans
## 2001
4 billion
## 2002
5.4 billion in international loans
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## Our internationalmenu grew to $5.4 billion in 2002.
## By exporting our know-how in consumer credit, we're capitalizing on a tremendous long-term opportunity. Our challenge is to learn what consumers around the world want in their wallets and create products that meet their needs, country by country.
Outside the United States, Capital One ® now has businesses in the U.K., Canada, South Africa and France. At year-end, international balances represented 9% of our loan portfolio.
After six years in the U.K., we’re one of the largest card issuers and one of the top two in terms of account growth, making steady gains in market share. Charge-offs are low, and U.K. customers have been highly responsive to our cross-selling efforts. Our “What’s in your wallet?” SM ad campaign, launched in the U.K. during 2002, is beginning to connect with consumers.
The Canadian credit card market is small, but our business in Canada is profitable and growing. Charge-offs are low and interest rates in the Canadian market are relatively high—attractive fundamentals in our business.
We’re in the early stages of establishing Capital One in France and South Africa, and we continue to explore other markets. Many of the world’s economies are growing fast, and the consumer credit markets of Europe and Asia currently yield greater returns than the U.S. market.
While a strong international franchise can’t be built in a day, our experience shows that the great flexibility of Capital One’s information-based strategy will help us to develop profitable financial services products for a diverse range of markets around the world. Cultures vary, but the growing need for accessible, affordable credit is a global phenomenon.
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Q1—2002
## 10403.94
Dow Jones 30 Industrials
Q1—2002
## 110.7
Consumer Confidence Index
Q2—2002
## 9243.26
Q3—2002
## 7591.93
Q2—2002
## 106.3
Q3—2002
## 93.7
Q4—2002
## 8341.63
Dow Jones 30 Industrials
Q4—2002
## 80.7
Consumer Confidence Index
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## We were well-prepared for the economic downturn in 2002.
## In fact, we have been since 1994.
Capital One ® is built for change—wired to innovate at high speed and turn on a dime to pursue new opportunities and adapt to changing market conditions.
Capital One is also built to last. We know we can’t predict the future, but we believe we can be ready for whatever it brings. Recessions are inevitable, and interest rates are unpredictable, so we always factor recessions into our plans and hedge our interest rate risk. Because ups and downs in the capital markets are also inevitable, we have well-diversified sources of funding, including a large and growing pool of consumer deposits. And to be ready for the unexpected, we keep the Company in peak financial condition. Underwriting standards are rigorous. Credit lines are low. Accounts are closely managed. Conservatism is the hallmark of our accounting practices, and our capital now stands at an all-time high—7.9% of managed assets.
While our core business, marketing credit cards to U.S. consumers, is strong and growing, we are steadily and successfully diversifying beyond it, broadening our customer base by creating profitable new products and entering new geographies. More than 27% of our current loan portfolio was generated in markets we did not serve six years ago, and we expect the proportion to rise as we continue to diversify.
Although 2002 presented big challenges, Capital One turned in another record year. Because of its strategic focus on creating long-term value, we believe the Company has an exceptional capacity to weather the unexpected.
All the pieces are in place for continued success. Our associates are world-class. We have a powerful brand. Our highly flexible information-based strategy allows for steady diversification and rapid innovation in our existing businesses. We’re succeeding in other geographies, in auto finance and in several lending sectors new to us. All of these sectors are growing, and many are larger by far than the credit card market. We have as much confidence as ever in Capital One’s prospects, short term and long.
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We love to shower our associates with accolades.
But others keep beating us to it.
Capital One ® is a great place to work.
In 2002 we again made the FORTUNE ® Most Admired Companies list and the Forbes ® Platinum 400, the magazine’s list of the best big companies in America, and Computerworld ® and The Sunday Times ® of London continue to include us on their “best places to work” lists, and in 2002 the Society of Hispanic Professional Engineers, ® The Black Collegian ™ magazine and MBA Minority SM magazine cited Capital One as a top employer. We’re committed to hiring talented people of all backgrounds. Diversity strengthens our competitiveness and enriches us as an employer.
The Company’s commitment to the professional development of all associates has won us top honors from Training ® magazine. Our compensation and promotion philosophy is simplicity itself: great performance, great rewards.
Now a brand leader in financial services, Capital One is also a recognized leader in community service. We focus on youth at risk, education, community development and health. In 2002 more than 60% of our associates volunteered their time and talents to nonprofit organizations, collectively contributing more than 54,000 hours, 80 tons of food and 3,600 holiday gifts to children in need. Since 1996, Capital One associates have built 27 houses with Habitat for Humanity. ® We also volunteer managerial expertise and technical assistance to help nonprofits make the most of their resources.
Supported by Capital One, 199 Kids’ Café ® after-school centers in seven cities provide hot meals and homework assistance to 12,000 children a day. The Company also makes significant financial contributions to programs providing affordable housing, job training and health care.
A career at Capital One is an ever-expanding opportunity to work with people who thrive on trying the untried, people who want to realize their full potential—and Capital One’s.
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## 2002 Financial Presentation 2002
19 Selected Financial and Operating Data
20 Management’s Discussion and Analysis of Financial Condition and Results of Operations
45 Selected Quarterly Financial Data
46 Management’s Report on Consolidated Financial Statements and Internal Controls Over Financial Reporting
47 Report of Independent Auditors
48 Consolidated Financial Statements
52 Notes to Consolidated Financial Statements
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Capital One ® is a leader in the direct marketing of MasterCard ® and Visa ® credit cards, auto loans and other consumer financial services. With more than 47 million accounts, it has one of the world’s largest financial services franchises. Through a proprietary information-based strategy (IBS), the Company scientifically tests its ideas before taking them to market and customizes the terms of each account, delivering superior value to consumers and profitable growth for Capital One. Headquartered in McLean, Virginia, Capital One Financial Corporation is a holding company operating through three principal subsidiaries: Capital One Bank; Capital One, F.S.B.; and Capital One Auto Finance, Inc. Its common stock trades on the New York Stock Exchange ® under the symbol COF.
The company cautions that its current expectations for future earnings, future charge-off rates and other future performance measures are forward looking statements and actual results could differ materially from current expectations due to a number of factors, including: competition in the credit card industry; the actual account and balance growth achieved by the company; the company’s ability to access the capital markets at attractive rates and terms to fund its operations and future growth; changes in regulation; and general economic conditions affecting consumer income and spending domestically and internationally, which may affect consumer bankruptcies, defaults and charge-offs. A discussion of these and other factors can be found in Capital One’s annual and other reports filed with the Securities and Exchange Commission, including, but not limited to, Capital One’s report on Form 10-K for the year ended December 31, 2002.
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## Selected Financial and Oper ating Data
<img src='content_image/49750.jpg'>
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## Management’s Discuss ion and Analysis of Financial Condition and Results of Operations
## INTRODUCTION
Capital One Financial Corporation (the “Corporation”) is a holding company whose subsidiaries market a variety of financial products and services to consumers using its Information-Based Strategy (“IBS”). The Corporation’s principal subsidiaries are Capital One Bank (the “Bank”), which offers credit card products, Capital One, F.S.B. (the “Savings Bank”), which offers consumer lending (including credit cards) and deposit products, and Capital One Auto Finance, Inc. (“COAF”), which offers auto lending products. The Corporation and its subsidiaries are hereafter collectively referred to as the “Company.” As of December 31, 2002, the Company had 47.4 million accounts and $59.7 billion in managed consumer loans outstanding and was one of the largest providers of MasterCard and Visa credit cards in the world.
The Company’s profitability is affected by the net interest income and non- interest income generated on earning assets, consumer usage patterns, credit quality, levels of marketing expense and operating efficiency. The Company’s revenues consist primarily of interest income on consumer loans (including past-due fees) and securities, and non-interest income consisting of servicing income on securitized loans, fees (such as annual membership, cash advance, cross-sell, interchange, overlimit and other fee income, collectively “fees”) and gains on the securitizations of loans. Loan securitization transactions qualifying as sales under accounting principles generally accepted in the United States (“GAAP”) remove the loan receivables from the consolidated balance sheet. However, the Company continues to own and service the account. The Company generates earnings from its managed loan portfolio that includes both on-balance sheet and off-balance sheet loans. Interest income, interchange income, fees, and recoveries in excess of the interest paid to investors and charge-offs generated from off-balance sheet loans are recognized as servicing and securitization income.
The Company’s primary expenses are the costs of funding assets, provision for loan losses, operating expenses (including salaries and associate benefits), marketing expenses and income taxes. Significant marketing expenses (e.g., advertising, printing, credit bureau costs and postage) to implement the Company’s new product strategies are incurred and expensed prior to the acquisition of new accounts while the resulting revenues are recognized over the life of the acquired accounts. Revenues recognized are a function of the response rate of the initial marketing program, usage and attrition patterns, credit quality of accounts, product pricing and effectiveness of account management programs.
## SIGNIFICANT ACCOUNTING POLICIES
The Notes to the Consolidated Financial Statements contain a summary of the Company’s significant accounting policies, including a discussion of recently issued accounting pronouncements. Several of these policies are
considered to be important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgements, some of which may relate to matters that are inherently uncertain. These policies include determination of the level of allowance for loan losses, accounting for securitization transactions, and finance charge and fee revenue recognition.
Additional information about accounting policies can be found in Note A to the Consolidated Financial Statements.
## Allowance for Loan Losses
The allowance for loan losses is maintained at the amount estimated to be sufficient to absorb probable losses, net of principal recoveries (including recovery of collateral), inherent in the existing reported loan portfolio. The provision for loan losses is the periodic cost of maintaining an adequate allowance. The amount of allowance necessary is determined primarily based on a migration analysis of delinquent and current accounts and forward loss curves. The entire balance of an account is contractually delinquent if the minimum payment is not received by the payment due date. In evaluating the sufficiency of the allowance for loan losses, management takes into consideration the following factors: recent trends in delinquencies and charge-offs including bankrupt, deceased and recovered amounts; forecasting uncertainties and size of credit risks; the degree of risk inherent in the composition of the loan portfolio; economic conditions; credit evaluations and underwriting policies. To the extent credit experience is not indicative of future performance or other assumptions used by management do not prevail, loss experience could differ significantly, resulting in either higher or lower future provision for loan losses, as applicable.
## Accounting for Securitization Transactions
Loan securitization involves the sale, generally to a trust or other special purpose entity, of a pool of loan receivables and is accomplished primarily through the public and private issuance of asset-backed securities by the special purpose entity. The Company removes loan receivables from the consolidated balance sheet for those asset securitizations that qualify as sales in accordance with Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125 (“SFAS 140”). The trusts are qualifying special purpose entities as defined by SFAS 140. For those asset securitizations that qualify as sales in accordance with SFAS 140, the trusts to which the loans were sold are not subsidiaries of the Company, and are not included in the Company’s consolidated financial statements in accordance with GAAP. Gains on securitization transactions, fair value adjustments and earnings on the Company’s securitizations are included in servicing and securitizations income in the consolidated statement of income and amounts due from the trusts are included in accounts receivable from securitizations on the consolidated balance sheet.
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Gains on securitization transactions represent the present value of estimated excess cash flows the Company will receive over the estimated life of the receivables. This excess cash flow essentially represents an interest-only strip, consisting of the following estimates: interest rate movements on yields of receivables and securities issued to determine the excess of finance charges and past-due fees over the sum of the return paid to investors, contractual servicing fees and credit losses. To the extent assumptions used by management do not prevail, fair value estimates of the interest-only strip could differ significantly, resulting in either higher or lower future income from servicing and securitization non-interest income, as applicable.
## Finance Charge and Fee Revenue Recognition
Consistent with its practice since the fourth quarter of 1997, as a revenue recognition policy, the Company reduces reported revenue (including both interest and non-interest income components of reported revenue) for the portion of finance charge and fees billed to customers that it deems uncollectible. In addition, the Company reduces consumer loans outstanding for such uncollectible amounts. As discussed below, the 2002 change in recoveries estimate resulted in an $82.7 million reduction of finance charges and fees deemed uncollectible for the year ended December 31, 2002.
## Change in Recoveries Classification
During 2002, the Company changed its financial statement presentation of recoveries of charged-off loans. The change was made in response to guidelines that were published by the Federal Financial Institutions Examination Council (“FFIEC”) with respect to credit card account management. Previously, the Company recognized all recoveries of charged- off loans in the allowance for loan losses and provision for loan losses. The Company now classifies the portion of recoveries related to finance charges and fees as revenue. All prior period recoveries have been reclassified to conform to the current financial statement presentation of recoveries. This reclassification had no impact on prior period earnings.
The change in the classification of recoveries resulted in a change to the recoveries estimate used as part of the calculation of the Company’s allowance for loan losses and finance charge and fee revenue. The change in the recoveries estimate resulted in an increase to the allowance for loan losses and a reduction of the amount of finance charges and fees deemed uncollectible under the Company’s revenue recognition policy for the year ended December 31, 2002. The change in estimate resulted in an increase of $38.4 million (pre-tax) to interest income and $44.4 million (pre-tax) to non- interest income offset by an increase in the provision for loan losses of $133.4 million (pre-tax) for the year ended December 31, 2002. Therefore, net income for the year ended December 31, 2002, was negatively impacted by $31.4 million or $.14 per diluted share as a result of the change in estimate.
## CONSOLIDATED EARNINGS SUMMARY
The following discussion provides a summary of 2002 results compared to 2001 results and 2001 results compared to 2000 results. Each component is discussed in further detail in subsequent sections of this analysis.
## Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Net income increased to $899.6 million, or $3.93 per share, for the year ended December 31, 2002, compared to net income of $642.0 million, or $2.91 per share, in 2001. This represents 40% net income growth and 35% earnings per share growth in 2002. The growth in earnings for 2002 was primarily attributable to the growth in the Company’s managed loan
portfolio, combined with gains on sale of securities and the repurchase of senior notes, offset by a reduction in the managed net interest margin, significant increases in the provision for loan losses, write-downs of interest- only strips, certain one-time charges, and the impact of the change in recoveries classification.
Managed loans consist of the Company’s reported loan portfolio combined with the off-balance sheet securitized loan portfolio. The Company has retained servicing rights for its securitized loans and receives servicing fees in addition to the excess spread generated from the securitized loan portfolio. Average managed loans increased 48% to $52.8 billion for 2002 from $35.6 billion for 2001. Total managed loans increased 32% to $59.7 billion at December 31, 2002 from $45.3 billion at December 31, 2001.
During 2002, the Company realized after-tax gains on the sale of securities totaling $48.1 million, compared with similar after tax gains in 2001 of $8.4 million. In addition, during 2002 the Company realized after-tax gains on the repurchase of senior notes of $16.7 million.
The managed net interest margin for the year ended December 31, 2002, decreased to 9.23% from 9.40% for the year ended December 31, 2001. This decrease was primarily the result of a 124 basis point decrease in consumer loan yield to 14.64% for 2002, from 15.88% in 2001, largely offset by a decrease in the cost of funds. This decline in yield was due to a shift in the mix of the managed portfolio to lower yielding, higher credit quality loans, an increase in low introductory rate accounts as compared to the prior year and reduced pricing on many of the Company’s new loans in response to lower funding costs and increased competitive pressure.
During 2002, the provision for loan losses increased by $1.0 billion over 2001. The ratio of allowance for loan losses to reported loans increased to 6.18% at December 31, 2002, compared to 4.02% at December 31, 2001.
The increase in the provision for loan losses and corresponding build in the allowance for loan losses reflects an increase in the reported loan portfolio of $7.0 billion or 33% over 2001, the change in the treatment of recoveries of charged-off accounts, the adoption of a revised application of regulatory guidelines related to subprime loans, as well as an increase in forecasted charge-off rates.
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During 2002, the fair value of the Company’s interest-only strips decreased $33.1 million, including both the impact of gains from securitization transactions and changes to key fair value assumptions. Comparatively, the fair value of the Company’s interest-only strips increased $150.0 million in 2001, including both the impact of gains associated with securitization transactions and changes to key fair value assumptions. The 2002 decrease in the fair value of the interest-only strips primarily relates to the addition of introductory rate loans to the trusts, the reduced interest rate environment, and increasing charge-off rates. (See Note R to the Consolidated Financial Statements)
During 2002, marketing expenses increased a modest 13% over 2001, reflecting a shift in strategy to reduce loan growth during the second half of the year. During 2002, operating expenses increased 18%, compared with managed loan growth of 32%, reflecting lower account growth and increased operating efficiencies, offset by $110.0 million of one-time charges.
## Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Net income of $642.0 million, or $2.91 per share, for the year ended December 31, 2001, compared to net income of $469.6 million, or $2.24 per share, in 2000. This represents 37% net income growth and 30% earnings per share growth in 2001. The growth in earnings for 2001 was primarily attributable to the growth in the Company’s managed loan portfolio, offset by a reduction in the managed net interest margin, increases in the provision for loan losses, and higher non-interest expenses.
Average managed loans increased 58% to $35.6 billion for 2001 from $22.6 billion for 2000. Total managed loans increased 54% to $45.3 billion at December 31, 2001 from $29.5 billion at December 31, 2000.
The managed net interest margin for the year ended December 31, 2001, decreased to 9.40% from 11.11% for the year ended December 31, 2000. This decrease was primarily the result of a 237 basis point decrease in consumer loan yield to 15.88% for 2001, from 18.25% in 2000. The decrease in consumer loan yield was due to a shift in the mix of the managed portfolio to lower yielding, higher credit quality loans, as well as an increase in the amount of low introductory rate balances as compared to the prior year.
During 2001, the provision for loan losses increased by $307.6 million or 38% over 2000. The ratio of allowance for loan losses to reported loans increased to 4.02% at December 31, 2001 compared to 3.49% at December 31, 2000. The increase in the provision for loan losses and corresponding build in the allowance for loan losses reflects the growth in the reported loan portfolio of $5.8 billion or 38% over 2000, offset by a reduction in the reported net charge-off rate to 4.76% for 2001 compared to 5.46% in 2000.
Marketing expenses increased $176.8 million, or 20%, to $1.1 billion, reflecting the Company’s increase in marketing investment in existing and new product opportunities. Salaries and associate benefits expense increased $368.7 million, or 36%, to $1.4 billion as a direct result of the cost of operations and expansion to manage the growth in the Company’s accounts and products offered. In 2001, average accounts grew 39% over 2000 as a result of the continued success of the Company’s marketing and account management strategies.
## CONSOLIDATED STATEMENTS OF INCOME
## Net Interest Income
Net interest income is interest and past-due fees earned from the Company’s consumer loans and securities less interest expense on borrowings, which includes interest-bearing deposits, borrowings from senior notes and other borrowings.
Reported net interest income for the year ended December 31, 2002, was $2.7 billion compared to $1.8 billion for 2001, representing an increase of $968.9 million, or 55%. Net interest income increased primarily as a result of growth in the Company’s earning assets. Average earning assets increased 50% for the year ended December 31, 2002, to $31.1 billion from $20.7 billion for the year ended December 31, 2001. The reported net interest margin increased to 8.73% in 2002, from 8.45% in 2002. The increase is primarily due to a 93 basis point decrease in the cost of funds, offset by a 64 basis point decrease in the yield on consumer loans to 15.15% for the year ended December 31, 2002, from 15.79% for the year ended December 31, 2001. The yield on consumer loans decreased primarily due to a shift in the mix of the reported portfolio toward a greater composition of lower yielding, higher credit quality loans as compared to the prior year. $38.4 million of the increase in net interest income, representing a 12 basis point increase in the net interest margin in 2002, relates to the one-time impact of the change in recoveries estimate (see “Change in Recoveries Classification” above).
Reported net interest income for the year ended December 31, 2001, was $1.8 billion compared to $1.7 billion for 2000, representing an increase of $97.2 million, or 6%. Net interest income increased as a result of the growth in earning assets. Average earning assets increased 56% for the year ended December 31, 2001, to $20.7 billion from $13.3 billion for the year ended December 31, 2000. The reported net interest margin decreased to 8.45% in 2001, from 12.47% in 2000, and was primarily attributable to a 467 basis point decrease in the yield on consumer loans to 15.79% for the year ended December 31, 2001, from 20.46% for the year ended December 31, 2000. The yield on consumer loans decreased primarily due to a shift in the mix of the reported portfolio toward a greater composition of lower yielding, higher credit quality loans, a decrease in the frequency of past-due fees and a selective increase in the use of low introductory rates as compared to the prior year.
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Table 1 provides average balance sheet data, and an analysis of net interest income, net interest spread (the difference between the yield on earning assets and the cost of interest-bearing liabilities) and net interest margin for each of the years ended December 31, 2002, 2001 and 2000.
<img src='content_image/103024.jpg'>
## Liabilities and Equity:
Interest-bearing liabilities
<img src='content_image/103025.jpg'>
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Net interest income is affected by changes in the average interest rate generated on earning assets and the average interest rate paid on interest-bearing liabilities.
In addition, net interest income is affected by changes in the volume of earning assets and interest-bearing liabilities. Table 2 sets forth the dollar amount of the increases and decreases in interest income and interest expense resulting from changes in the volume of earning assets and interest-bearing liabilities and from changes in yields and rates.
## Table 2: Interest Variance Analysis
<img src='content_image/21141.jpg'>
(1) The change in interest due to both volume and rates has been allocated in proportion to the relationship of the absolute dollar amounts of the change in each. The changes in income and expense are calculated independently for each line in the table. The totals for the volume and yield/rate columns are not the sum of the individual lines. (2)
The change in interest income includes $38.4 million related to the one-time impact of the change in recoveries assumption for the year ended December 31, 2002.
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## Servicing and Securitization Income
In accordance with SFAS 140, the Company records gains or losses on the off- balance sheet securitizations of consumer loan receivables on the date of sale based on the estimated fair value of assets sold and retained and liabilities incurred in the sale. Retained interests in securitized assets include interest- only strips, retained subordinated interests in the transferred pool of receivables, cash collateral accounts and accrued interest and fees on the investors’ share of the pool of receivables. Gains represent the present value of estimated excess cash flows the Company will receive over the estimated life of the receivables and are included in servicing and securitizations income. This excess cash flow essentially represents an interest-only strip, consisting of the following estimates: the excess of finance charges and past-due fees over the sum of the return paid to investors, contractual servicing fees and credit losses. The credit risk exposure on retained interests exceeds the pro rata share of the Company’s interest in the pool of receivables. However, exposure to credit losses on the securitized loans is contractually limited to the retained interests.
Servicing and securitizations income represents servicing fees, excess spread and other fees relating to consumer loan receivables sold through securitization and other sale transactions, as well as gains and losses recognized as a result of the securitization transactions, and fair value adjustments to the interest-only strips. Servicing and securitizations income increased $364.4 million, or 15%, to $2.8 billion for the year ended December 31, 2002, from $2.4 billion in 2001. This increase was primarily due to a 49% increase in the average off-balance sheet loan portfolio offset in part by a reduction in the excess spread generated by the securitized loan portfolio and a $33.1 million decrease in the fair value of interest-only strips.
Servicing and securitizations income increased $1.3 billion, or 112%, to $2.4 billion for the year ended December 31, 2001, from $1.2 billion in 2000. This increase was primarily due to a 64% increase in the average off-balance sheet loan portfolio and a shift in the mix of that portfolio towards higher yielding, lower credit quality loans to more closely reflect the composition of the managed portfolio.
Certain estimates inherent in the determination of the fair value of the retained interests are influenced by factors outside the Company’s control, and as a result, such estimates could materially change in the near term. Any future gains that will be recognized in accordance with SFAS 140 will be dependent on the timing and amount of future securitizations. The Company intends to continuously assess the performance of new and existing securitization transactions, and therefore the valuation of retained interests, as estimates of future cash flows change.
## Service Charges and Other Customer-Related Fees
Service charges and other customer-related fees increased by $401.4 million, or 26%, to $1.9 billion for the year ended December 31, 2002. The increase primarily reflects an increase in the reported loan portfolio of $7.0 billion or 33% over 2001 and a $44.4 million increase related to the one-time impact of the 2002 change in the recoveries estimate (see “Change in Recoveries Classification” above) offset by a shift in the mix of the reported loan portfolio toward a greater composition of lower fee-generating loans.
Service charges and other customer-related fees decreased by $110.3 million, or 7%, to $1.5 billion for the year ended December 31, 2001. This decrease was primarily due to the shift in the mix of the reported loan portfolio toward a greater composition of lower fee-generating loans, offset by a 39% increase in the average number of accounts in 2001.
## Interchange Income
Interchange income increased $68.0 million, or 18%, to $447.8 million for the year ended December 31, 2002, from $379.8 million in 2001. This increase is primarily attributable to an increase in annual purchase volume. Total interchange income is net of $104.9 million of costs related to the Company’s rewards programs for the year ended December 31, 2002.
Interchange income increased $142.0 million, or 60%, to $379.8 million for the year ended December 31, 2001, from $237.8 million in 2000. This increase was a result of increased annual purchase volume and new account growth for the year ended December 31, 2001. Total interchange income was net of $110.9 of costs related to the Company’s rewards programs for the year ended December 31, 2001.
## Other Non-Interest Income
Other non-interest income includes gains on sale of securities, gains related to the repurchase of senior notes, gains or losses associated with hedging transactions, service provider revenue generated by the Company’s medical procedures lending business and income earned related to the reaffirmation of purchased charged-off loan portfolios.
Other non-interest income increased $169.4 million or 159% to $275.9 million for 2002 compared to $106.5 million for 2001. The increase in other non-interest income was primarily due to $77.5 million of gains on sales of securities realized in 2002 in connection with the Company’s rebalancing of its liquidity portfolio compared to $13.5 million realized in 2001. Other factors in the increase included gains related to senior note repurchases of $27.0 million realized during 2002, an increase in service provider revenue of $9.4 million and an increase in income earned from reaffirmed purchased charged-off loans of $24.1 million during the year ended December 31, 2002.
Other non-interest income increased $78.1 million or 275% to $106.5 million for 2001 compared to $28.4 million in 2000. The increase was primarily due to an increase in income earned on reaffirmed purchased charged-off loans of $26.2 million, gains on sales of securities earned in 2001 of $13.5 million compared with no gains in 2000 and a $16.3 million increase in service provider revenue generated by the Company’s medical procedures lending business.
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overall_image/76f31e05d66d16f36745072dc57f390c689a85656d0c3d6621a8d3339ba64636.png
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## Non-Interest Expense
<img src='content_image/38949.jpg'>
million, or 36%, to $1.4 billion in 2001. The decrease in the salaries and associate benefit growth rate as well as a decrease in marketing expenses of $12.4 million compared to 2001, was the result of the Company’s efforts to slow loan growth to more historical levels. All other non-interest expenses increased $374.1 million, or 24%, to $2.0 billion for the year ended December 31, 2002, from $1.6 billion in 2001. This increase was the result of a 23% increase in the average number of accounts as compared to the prior year and $110.0 million of one-time charges incurred in 2002. Of the $110.0 million: $38.8 million related to unused facility capacity, early termination of facility leases, and the accelerated depreciation of fixed assets; $14.5 million related to the accelerated vesting of restricted stock issued in connection with the PeopleFirst, Inc. (“PeopleFirst”) acquisition; and $12.5 million related to the realignment of certain aspects of its European operations. The remaining amounts related to investment company valuation adjustments, increases in associate related costs and accruals for contingent liabilities.
Non-interest expense for the year ended December 31, 2001, increased $910.4 million, or 29%, to $4.1 billion from $3.1 billion for the year ended December 31, 2000. Contributing to the increase in non-interest expense were marketing expenses, which increased $176.8 million, or 20%, to $1.1 billion in 2001, from $906.1 million in 2000. The increase in marketing expenses during 2001 reflected the Company’s continued identification of and investments in opportunities for growth, as well as its marketing extension into television advertisements. Salaries and associate benefits increased $368.7 million, or 36%, to $1.4 billion in 2001, from $1.0 billion in 2000, as the Company added approximately 2,400 net new associates to its staffing levels to manage the growth in the Company’s accounts. All other non-interest expenses increased $364.8 million, or 30%, to $1.6 billion for the year ended December 31, 2001, from $1.2 billion in 2000. The increase in other non-interest expenses was primarily composed of increased depreciation expense due to premises and equipment growth, increased collections costs as a result of increased collection and recovery efforts, and non-recurring expenses such as the write-off of an investment in an ancillary business as well as costs associated with the mailing of amendments to customer account agreements. The increase was also driven by the 39% increase in average accounts.
Non-interest expense for the year ended December 31, 2002, increased $527.6 million, or 13%, to $4.6 billion from $4.1 billion for the year ended December 31, 2001. Contributing to the increase was salaries and associate benefits, which increased $165.8 million, or 12%, to $1.6 billion in 2002, from an increase of $368.7
## Income Taxes
The Company’s income tax rate was 38% for the years ended December 31, 2002, 2001 and 2000, respectively. The effective rate includes both state and federal income tax components.
## MANAGED CONSUMER LOAN PORTFOLIO
The Company’s managed consumer loan portfolio is comprised of reported and off-balance sheet loans. Off-balance sheet loans are those which have been securitized and accounted for as sales in accordance with SFAS 140, and are not assets of the Company.
The Company analyzes its financial performance on a managed consumer loan portfolio basis. Managed consumer loan data adds back the effect of off- balance sheet consumer loans. The managed consumer loan portfolio includes securitized loans for which the Company has retained significant risks and rewards.
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Table 3 summarizes the Company’s managed consumer loan portfolio.
<img src='content_image/1642.jpg'>
The Company actively engages in off-balance sheet consumer loan securitization transactions. Securitizations involve the transfer of a pool of loan receivables by the Company to an entity created for securitizations, generally a trust or other special purpose entity (“the trusts”). The credit quality of the receivables is supported by credit enhancements, which may be in various forms including interest-only strips, subordinated interests in the pool of receivables, cash collateral accounts, and accrued interest and fees on the investor’s share of the pool of receivables. Securities ($31.9 billion outstanding as of December 31, 2002) representing undivided interests in the pool of consumer loan receivables are sold to the public through an underwritten offering or to private investors in private placement transactions. The Company receives the proceeds of the sale as payment for the receivables transferred. In certain securitizations, the Company retains an interest in the entity to which it transferred receivables (“seller’s interest”)
equal to the amount of the outstanding receivables transferred to the trust in excess of the principal balance of the securities outstanding. For securitizations backed by a revolving pool of assets, the Company’s seller’s interest varies as the amount of the excess receivables in the trusts fluctuates as the accountholders make principal payments and incur new charges on the selected accounts. A securitization backed by non-revolving amortizing assets, such as auto loans, generally does not include a seller’s interest, as obligor principal payments are generally paid to investors on a monthly basis. A securitization accounted for as a sale in accordance with SFAS 140 results in the removal of the receivables, other than any applicable seller’s interest, from the Company’s balance sheet for financial and regulatory accounting purposes and recording of any additional retained interests.
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"content_image/17998.jpg",
"content_image/17991.jpg"
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Collections received from securitized receivables are used to pay interest to investors, servicing and other fees, and are available to absorb the investors’ share of credit losses. For revolving securitizations, amounts collected in excess of that needed to pay the above amounts are remitted to the Company, as described previously in “Servicing and Securitizations Income.” For amortizing securitizations, amounts in excess of the amount that is used to pay interest, fees and principal are generally remitted to the Company, but may be paid to investors in further reduction of their outstanding principal as described below.
Investors in the Company’s revolving securitization program are generally entitled to receive principal payments either in one lump sum after an accumulation period or through monthly payments during an amortization period. Amortization may begin sooner in certain circumstances, including the possibility of the annualized portfolio yield (generally consisting of interest and fees) for a three-month period dropping below the sum of the security rate payable to investors, loan servicing fees and net credit losses during the period. Increases in net credit losses and payment rates could significantly decrease the spread and cause early amortization. This early amortization would have a significant effect on the ability of the Bank and the Savings Bank to meet the capital adequacy requirements as all off-balance sheet loans experiencing such early amortization would have to be recorded on the balance sheet. At December 31, 2002, the annualized portfolio yields on the Company’s off-balance sheet securitizations sufficiently exceeded the sum of the related security rates payable to investors, loan servicing fees and net credit losses, and as such, early amortizations of its off-balance sheet securitizations was not indicated or expected.
In revolving securitizations, prior to the commencement of the amortization or accumulation period, the investors’ shares of the principal payments received on the trusts’ receivables are reinvested in new receivables to maintain the principal balance of the securities. During the amortization period, the investors’ share of principal payments is paid to the security holders until the securities are repaid. When the trust allocates principal payments to the security holders, the Company’s reported consumer loans increase by the amount of any new activity on the accounts. During the accumulation period, the investors’ share of principal payments is paid into a principal funding account designed to accumulate principal collections so the securities can be paid in full on the expected final payment date.
## NET INTEREST MARGIN (%)
<img src='content_image/17996.jpg'>
## LOAN YIELD (%)
<img src='content_image/17998.jpg'>
## Table 4: Comparison of Managed and Reported Operating Data and Ratios
<img src='content_image/17991.jpg'>
(1) Reported and managed net interest margin increased 12 basis points and 7 basis points, respectively as a result of the one-time impact of the change in recoveries assumption for the year ended December 31, 2002. (2)
Reported and managed loan yield increased 15 basis points and 7 basis points, respectively as a result of the one-time impact of the change in recoveries assumption for the year ended December 31, 2002.
## Risk Adjusted Revenue Margin
The Company’s products are designed with the objective of maximizing customer value while optimizing revenue for the level of risk undertaken. Management believes that comparable measures for external analysis are the risk adjusted revenue and risk adjusted margin of the managed portfolio. Risk adjusted revenue is defined as net interest income and non-interest income less net charge-offs. Risk adjusted margin measures risk adjusted revenue as a percentage of average earning assets. These measures consider not only the loan yield and net interest margin, but also the fee income associated with these products. By deducting net charge-offs, consideration is given to the risk inherent in the Company’s portfolio.
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Nigel Morris President and Chief Operating Officer
1999 20.2 billion
1998 17.4 billion managed loans
2000 29.5 billion
2001 45.3 billion
2002 59.7 billion managed loans
Richard D. Fairbank Chairman and Chief Executive Officer
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"content_image/2250.jpg"
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<img src='content_image/2244.jpg'>
ability to reprice individual accounts upwards or downwards based on the consumer’s performance. In addition, since 1998, the Company has aggressively marketed low non-introductory rate cards to consumers with the best established credit profiles to take advantage of the favorable risk return characteristics of this consumer type. Industry competitors have continuously solicited the Company’s customers with similar interest rate strategies. Management believes the competition has placed, and will continue to place, pressure on the Company’s pricing strategies.
The Company markets its card products to specific consumer populations. The terms of each card product are actively managed to achieve a balance between risk and expected performance, while obtaining the expected return. For example, card product terms include the
<img src='content_image/2245.jpg'>
do not have a significant, immediate impact on managed loan balances; rather they typically consist of lower credit limit accounts and balances that build over time. The terms of these customized card products tend to include membership fees and higher annual finance charge rates. The profile of the consumer populations that these products are marketed to, in some cases, may also tend to result in higher account delinquency rates and consequently higher past-due and overlimit fees as a percentage of loan receivables outstanding than the low non-introductory rate products.
The Company also offers other credit card products. Examples of such products include secured cards, lifestyle cards, co-branded cards, student cards and other cards marketed to certain consumer populations that the Company believes are underserved by its competitors. These products
Table 5 provides income statement data and ratios for the Company’s managed consumer loan portfolio. The causes of increases and decreases in the various components of risk adjusted revenue are discussed in sections previous to this analysis.
## Table 5: Managed Risk Adjusted Revenue
<img src='content_image/2250.jpg'>
(1) As a percentage of average managed earning assets. (2)
Net interest income and non-interest income include $38.4 million and $44.4 million, respectively, related to the one-time impact of the change in recoveries assumption. This resulted in a 7 basis point increase in the managed net interest margin, a 7 basis point increase in non-interest income and a 14 basis point increase in the risk adjusted margin.
## ASSET QUALITY
The asset quality of a portfolio is generally a function of the initial underwriting criteria used, levels of competition, account management activities and demographic concentration, as well as general economic conditions. The seasoning of the accounts is also an important factor in the delinquency and loss levels of the portfolio. Accounts tend to exhibit a rising trend of delinquency and credit losses as they season. As of December 31, 2002 and 2001, 45% and 58% of managed accounts, respectively, each representing 51% of the total managed loan balance, were less than eighteen months old. Accordingly, it is likely that the Company’s managed loan portfolio could experience increased levels of delinquency and credit losses as the average age of the Company’s accounts increases during 2003.
Changes in the rates of delinquency and credit losses can also result from a shift in the product mix. As discussed in “Risk Adjusted Revenue and Margin,” certain customized card products have, in some cases, higher delinquency and higher charge-off rates. In the case of secured card loans, collateral, in the form of cash deposits, reduces any ultimate charge-offs. The costs associated with higher delinquency and charge-off rates are considered in the pricing of individual products.
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## Delinquencies
Table 6 shows the Company’s consumer loan delinquency trends for the years presented on a reported and managed basis. The entire balance of an account is contractually delinquent if the minimum payment is not received by the payment due date. Delinquencies not only have the potential to impact earnings if the account charges off, but they also result in additional costs in terms of the personnel and other resources dedicated to resolving the delinquencies.
## Table 6: Delinquencies
The 30-plus day delinquency rate for the managed consumer loan portfolio was 5.60% as of December 31, 2002, up 65 basis points from 4.95% as of December 31, 2001. The 30-plus day delinquency rate for the reported consumer loan portfolio increased to 6.51% as of December 31, 2002, from 4.84% as of December 31, 2001. Both reported and managed consumer loan delinquency rate increases as of December 31, 2002, as compared to December 31, 2001, principally reflect a continued seasoning of a portion of subprime accounts added during 2001 and the first quarter of 2002, along with slower growth of the portfolio during the second half of 2002 as the mix changed towards more lower yielding, higher credit quality loans.
<img src='content_image/122116.jpg'>
Reported and managed delinquency rates include 28 basis point and 13 basis point increases, respectively, related to the one-time impact of the 2002 change in recoveries assumption.
## Net Charge-Offs
Net charge-offs include the principal amount of losses (excluding accrued and unpaid finance charges, fees and fraud losses) less current period principal recoveries. The Company charges off credit card loans (net of any collateral) at 180 days past the due date and generally charges off other consumer loans at 120 days past the due date. Costs to recover previously charged-off accounts are recorded as collection expenses in non-interest expense. During the year, the Company changed its financial statement presentation of recoveries of charged-off loan balances in accordance with the guidelines that were published by the FFIEC. Under the new presentation, principal amounts collected on previously charged-off accounts reduce
current period charge-offs and recoveries of finance charges and fees are treated as revenue and are reflected in the appropriate income statement line item. All periods in the accompanying consolidated financial statements have been adjusted to properly account for this change in presentation.
## 30 + DAY DELINQUENCY RATE (%)
<img src='content_image/122118.jpg'>
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For the year ended December 31, 2002, the managed net charge-off rate increased 59 basis points to 5.24% compared to the prior year. For the year ended December 31, 2002, the reported net charge-off rate increased 17 basis points to 4.93%. The increase in both the managed and reported net charge- off rates was the result of a seasoning of subprime loans added in the fourth quarter 2001 and early 2002 to the Company’s portfolio and slower loan
growth. Table 7 shows the Company’s net charge-offs for the years presented on a reported and managed basis.
The Company takes measures as necessary, including requiring collateral on certain accounts and other marketing and account management techniques, to maintain the Company’s credit quality standards and to manage the risk of loss on existing accounts. See “Risk Adjusted Revenue and Margin” for further discussion.
<img src='content_image/47333.jpg'>
## Provision For Loan Losses
The allowance for loan losses is maintained at an amount estimated to be sufficient to absorb probable losses, net of principal recoveries (including recovery of collateral), inherent in the existing reported loan portfolio. The provision for loan losses is the periodic cost of maintaining an adequate allowance. Management believes that, for all relevant periods, the allowance for loan losses was adequate to cover anticipated losses in the total reported consumer loan portfolio under then current conditions, met applicable legal and regulatory guidance and was consistent with GAAP. There can be no assurance as to future credit losses that may be incurred in connection with the Company’s consumer loan portfolio, nor can there be any assurance that the loan loss allowance that has been established by the Company will be sufficient to absorb such future credit losses. The allowance is a general allowance applicable to the reported homogeneous consumer loan portfolio. The amount of allowance necessary is determined primarily based on a migration analysis of delinquent and current accounts and forward loss curves. In evaluating the sufficiency of the allowance for loan losses, management also takes into consideration the following factors: recent trends in delinquencies and charge-offs including bankrupt, deceased and recovered amounts; forecasting uncertainties and size of credit risks; the degree of risk inherent in the composition of the loan portfolio; economic conditions; legal and regulatory guidance (including the “Expanded Guidance for Subprime Lending Programs” (“Subprime Guidelines”) issued by the four federal banking agencies); credit evaluations and underwriting policies.
<img src='content_image/47334.jpg'>
For the year ended December 31, 2002, the provision for loan losses increased to $2.1 billion, or 92%, from the 2001 provision for loan losses of $1.1 billion. This increase is primarily a result of the 48% increase in average reported loans, a rise in net charge-offs, the revised application of the Subprime Guidelines, and the aforementioned one-time impact of the $133.4 million change in recoveries estimate (see “Change in Recoveries Classification” above). The Company applied its allowance models, including these factors, and increased the allowance for loan losses by a total of $880.0 million during 2002.
For the year ended December 31, 2001, the provision for loan losses increased to $1.1 billion, or 38%, from the 2000 provision for loan losses of $812.9 million. This increase is primarily a result of the 50% increase in average reported loans, offset by a 70 basis point, or 13%, decrease in the reported net charge-off rates as a result of the shift in the mix of the composition of the reported portfolio. As a result of these factors, the Company increased the allowance for loan losses by $313.0 million during 2001.
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Table 8 sets forth the activity in the allowance for loan losses for the periods indicated. See “Asset Quality,” “Delinquencies” and “Net Charge-Offs” for a more complete analysis of asset quality.
<img src='content_image/17631.jpg'>
## REPORTABLE SEGMENTS
The Company manages its business by three distinct operating segments: Consumer Lending, Auto Finance and International. The Consumer Lending, Auto Finance and International segments are considered reportable segments based on quantitative thresholds applied to the managed loan portfolio for reportable segments provided by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Management decision making is performed on a managed portfolio basis, and such information about reportable segments is provided on a managed basis.
<img src='content_image/17635.jpg'>
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## Consumer Lending Segment
The Consumer Lending segment consists primarily of domestic credit card and installment lending activities. Total Consumer Lending segment loans increased 27% to $47.3 billion at December 31, 2002, compared to $37.3 billion at December 31, 2001. The achieved loan growth in this segment reflects the Company’s substantial opportunity to grow loans using IBS.
Net charge-offs of Consumer Lending segment loans increased $875.8 million, or 60%, while average Consumer Lending segment loans for the year ended December 31, 2002 grew 41% compared to the same period in the prior year. For the year ended December 31, 2002, the Consumer Lending segment’s net charge-offs as a percentage of average Consumer Lending segment loans outstanding were 5.54%, compared to 4.87% for the prior year. This increase was consistent with management’s expectations and was driven by the seasoning of loans in the portfolio and the relatively lower loan growth experienced in the second half of 2002.
The 30-plus day delinquency rate for the Consumer Lending segment was 5.54% as of December 31, 2002, up 54 basis points from 5.00% as of December 31, 2001. The increase in delinquencies is due to the seasoning of the portfolio in addition to the recent downturn in the U.S. economy and increased unemployment rates.
During the third quarter of 2002, the Company expensed $38.8 million related to the early termination of leases, unused facility capacity, and accelerated depreciation of related fixed assets. The Company allocated $35.5 million of these expenses to the Consumer Lending segment.
## Auto Finance Segment
The Auto Finance segment consists of automobile lending activities. Total Auto Finance segment loans outstanding increased 77% to $7.0 billion at December 31, 2002, compared to $4.0 billion at December 31, 2001. The increase in auto loans outstanding was the result of expanded organizational capabilities and increased reliance on proven IBS concepts, which attracted new dealer-sourced and direct loan volume.
Net charge-offs of Auto Finance segment loans increased $132.9 million, or 154%, while average Auto Finance loans for the year ended December 31, 2002 grew 183%, compared to the same period in the prior year. For the year ended December 31, 2002, the Auto Finance segment’s net charge-offs as a percentage of average Auto Finance segment loans outstanding were 3.82% compared to 4.25% for the prior year. The decrease is primarily the result of improved credit quality on the Company’s average loan portfolio for 2003. The decrease occurred despite deterioration in used car values, which caused higher loss severity.
The 30-plus day delinquency rate for the Auto Finance segment was 7.15% as of December 31, 2002, up 156 basis points from 5.59% as of December 31, 2001. The increase in delinquencies was primarily the result of an increase in higher yielding, lower credit quality loans and higher unemployment.
During the year, the Company sold $1.5 billion of auto loans to multiple buyers. These transactions resulted in gains of $28.2 million for the Auto Finance segment. These gains were offset in part by compensation expense of $14.5 million ($9.0 million after taxes) that was recognized and allocated to the Auto Finance segment for the accelerated vesting provisions of certain restricted stock issued in connection with the acquisition of PeopleFirst.
## International Segment
The International segment consists of all non-domestic consumer lending activities. Total International segment loans outstanding increased 34% to $5.3 billion at December 31, 2002, compared to $4.0 billion at December 31, 2001. The increase in total outstandings was principally the result of the successful application of its IBS to originate loans in the United Kingdom and Canada.
Net charge-offs of International segment loans increased $61.3 million, or 53% while average International segment loans for the year ended December 31, 2002 grew 46%, compared to the same period in the prior year. For the year ended December 31, 2002, the International segment’s net charge-offs as a percentage of average International segment loans outstanding were 3.76% compared to 3.59% for the prior year. The increase was driven primarily by greater charge-offs compared to loan growth for the Canadian market.
The 30-plus day delinquency rate for the International segment was 4.18% as of December 31, 2002, up 34 basis points from 3.84% as of December 31, 2001. International delinquencies increased primarily as a result of the seasoning of the Canadian credit portfolio and slower Canadian loan growth.
During 2002, the Company realigned certain aspects of its European operations. Charges related to the realignment of $12.5 million were recognized and allocated to the International segment.
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## FUNDING
## Funding Availability
The Company has established access to a variety of funding alternatives in addition to securitization of its consumer loans. Table 10 illustrates the Company’s unsecured funding sources.
<img src='content_image/36099.jpg'>
(1) All funding sources are non-revolving except for the Multicurrency Credit Facility, the Domestic Revolving Credit Facility and the Collateralized Revolving Credit Facility.
Funding availability under the credit facilities is subject to compliance with certain representations, warranties and covenants.
Funding availability under all other sources is subject to market conditions.
(2) The global senior and subordinated bank note program has original terms of three to five years. (3)
The senior domestic bank note program has original terms of one to ten years. (4)
US dollar equivalent based on the USD/Euro exchange rate as of December 31, 2002. (5)
Maturity date refers to the date the facility terminates, where applicable.
<img src='content_image/36098.jpg'>
The Senior and Subordinated Global Bank Note Program gives the Bank the ability to issue securities to both U.S. and non-U.S. lenders and to raise funds in foreign currencies. The Senior and Subordinated Global Bank Note Program had $2.7 billion outstanding at December 31, 2002. In January 2003, the Bank increased its capacity under the Senior and Subordinated Global Bank Note Program to $8.0 billion. Prior to the establishment of the Senior and Subordinated Global Bank Note Program, the Bank issued senior unsecured debt through its $8.0 billion Senior Domestic Bank Note Program, of which $1.3 billion was outstanding at December 31, 2002. The Bank did not renew the Senior Domestic Bank Note Program for future issuances.
In July 2002, the Company repurchased senior bank notes in the amount of $230.4 million, resulting in a pre-tax gain of $27.0 million.
The Domestic Revolving Credit Facility (the “Credit Facility”) is available for general corporate purposes of the Company. The Credit Facility is comprised of two tranches: a $810.0 million Tranche A facility available to the Bank and the Savings Bank, including an option for up to $250.0 million in multicurrency availability; and a $390.0 Tranche B facility available to the Corporation, the Bank and the Savings Bank, including an option for up to $150.0 million in multicurrency availability. All borrowings under the Credit Facility are based on varying terms of LIBOR. The Bank has irrevocably undertaken to honor any demand by the lenders to repay any borrowings which are due and payable by the Savings Bank but have not been paid.
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The Multicurrency Facility is available for general Company purposes of the Bank’s business in the United Kingdom. The Corporation and the Bank serve as guarantors of all borrowings by Capital One Bank (Europe) plc under the Multicurrency Facility. Internationally, the Company has funding programs designed for foreign investors or to raise funds in foreign currencies allowing the Company to borrow from U.S. and non-U.S. lenders, including foreign currency funding options under the Credit Facility discussed above. The Company funds its foreign assets by directly or synthetically borrowing or securitizing in the local currency to mitigate the financial statement effect of currency translations.
In April 2002, COAF entered into a $2.2 billion collateralized revolving warehouse credit facility collateralized by a security interest in certain consumer loan assets. The collateralized revolving warehouse credit facility has several participants each with a separate renewal date. The facility does not have a final maturity date. Instead, each participant may elect to renew the commitment for another set period of time. All participants have renewal dates occurring in 2003. Interest on the facility is based on commercial paper rates. At December 31, 2002, $894.0 million was outstanding under the facility.
As of December 31, 2002, the Corporation had two effective shelf registration statements under which the Corporation from time to time may offer and sell senior or subordinated debt securities, preferred stock, common stock, common equity units and stock purchase contracts.
On November 11, 2002, the Corporation issued shares of its common stock having an aggregate value of $54.9 million to certain former shareholders of AmeriFee Corporation (“AmeriFee”) in connection with the termination of the stock purchase agreement relating to the Corporation’s acquisition of AmeriFee. Of this amount, $43.9 million of the Corporation’s common stock was issued through its shelf registration statement and $11.0 million was issued in an unregistered offering.
In April 2002, the Corporation completed a public offering of mandatory convertible debt securities (the “Upper Decs ® ”), that resulted in net proceeds of approximately $725.0 million. The net proceeds were used for general corporate purposes. Each Upper Dec ® initially consists of and represents (i) a senior note due May 17, 2007 with a principal amount of $50, on which the Company will pay interest quarterly at the initial annual rate of 6.25%, and (ii) a forward purchase contract pursuant to which the holder has agreed to purchase, for $50, shares of the Company’s common stock on May 17, 2005 (or earlier under certain conditions), with such number of shares to be determined based upon the average closing price per share of the Company’s common stock for 20 consecutive trading days ending on the third trading day immediately preceding the stock purchase date at a minimum per share price of $63.91 and a maximum per share price of $78.61.
In January 2002, the Corporation issued $300.0 million of five-year senior notes with a coupon rate of 8.75%.
The Company continues to expand its retail deposit gathering efforts through both direct and broker marketing channels. The Company uses its IBS capabilities to test and market a variety of retail deposit origination strategies, including via the Internet, as well as to develop customized account management programs. As of December 31, 2002, the Company had $17.3 billion in interest-bearing deposits of which $7.2 billion represents large denomination certificates of $100 thousand or more, with original maturities up to ten years. The use of these deposits to fund the Company’s asset growth may be limited based upon whether such deposits originated at the Bank or the Savings Bank.
Table 11 shows the maturities of domestic time certificates of deposit in denominations of $100 thousand or greater (large denomination CDs) as of December 31, 2002.
<img src='content_image/107503.jpg'>
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Table 12 reflects the costs of other borrowings of the Company as of and for each of the years ended December 31, 2002, 2001 and 2000.
<img src='content_image/102848.jpg'>
Additional information regarding funding can be found in Note F to the Consolidated Financial Statements.
## Funding Obligations
Table 13 summarizes the amounts and maturities of the contractual funding obligations of the Company, including off-balance sheet funding.
<img src='content_image/102852.jpg'>
The terms of the lease and credit facility agreements related to certain other borrowings and operating leases in Table 13 require several financial covenants (including performance measures and equity ratios) to be met. If these covenants are not met, there may be an acceleration of the payment due dates noted above. As of December 31, 2002, the Company was not in default of any such covenants.
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## DERIVATIVE INSTRUMENTS
The Company enters into interest rate swap agreements in order to manage interest rate exposure. In most cases, this exposure is related to the funding of fixed rate assets with floating rate obligations, including off-balance sheet securitizations. The Company also enters into forward foreign currency exchange contracts and cross currency swaps to reduce sensitivity to changing foreign currency exchange rates. The hedging of foreign currency exchange rates is limited to certain intercompany obligations related to international operations. These derivatives expose the Company to certain credit risks. The Company has established policies and limits, as well as collateral agreements, to manage credit risk related to derivative instruments.
Additional information regarding derivative instruments can be found in Note S to the Consolidated Financial Statements.
## RISK MANAGEMENT
Risk is an inherent part of the Company’s business and activities. The Company’s ability to properly and effectively identify, assess, monitor and manage risk in its business activities is critical to its safe and sound operation and profitability. The Company’s business activities generate credit risk, liquidity risk, interest rate risk and operational risk, each of which is described below.
## Credit Risk
Credit risk is one of the Company’s most important risk categories. Consequently, as part of the Company’s risk management process, stronger central control of credit policies and programs has been established, while maintaining the ability of the Company’s operating units to respond flexibly to changing market and competitive conditions. In 2002, the Company appointed a dedicated Chief Credit Officer, expanded its central Credit Risk Management staff and strengthened its Credit Policy Committee. The credit committee and staff group ensure that the Company’s credit decisions are made on a conservative basis, that each of its operating units apply best practices in measuring and managing credit risk, and that all relevant factors, including credit outlook, profitability, and the competitive, economic and regulatory environment are considered in making credit decisions.
In addition to strong governance, another key element in the Company’s management of credit risk is its use of IBS. In its credit policy, the Company has identified six key principles which govern the use of IBS in credit management. These principles are: (1) Empirical Evidence - that all decisions shall be made on the basis of the best available data; (2) Inseparability - that it is impossible to separate credit decisions from product terms and marketing channels; (3) Expectation of Volatility - that the expectation that future credit performance could be worse than past credit performance should be explicitly factored into underwriting decisions; (4) Positive Net Present Value - that all prospective and existing pools of accounts need to have a positive net present value when solicited or when the terms of the loans are adjusted; (5) Earnings Stability - that a loan shall only be booked if the Company will be satisfied with the loan’s performance during each discrete period of the loan’s life; and (6) Constrained Optimization - that individual credit programs will sometimes be limited to insure that the overall portfolio and specific individual account characteristics conform to limits established by the Company and its Board of Directors.
These principles are the foundation of the Company’s credit decision making approach. They govern the selection of customers, and the approach to pricing, credit line management, customer management, collections and recoveries. They provide a framework in which the Company can apply a very high degree of analytical rigor to decision making while preserving the flexibility to respond quickly to changing market and economic conditions.
The Company’s credit risk profile is managed to maintain better than average credit quality, strong risk-adjusted returns and increased diversification. This is accomplished by increasing growth in the prime and superprime card business, while reducing growth in the subprime card business, by customizing credit lines and product terms to each consumer segment to ensure appropriate returns, by diversification into consumer lending, products such as automobile financing and unsecured installment lending and by international expansion. The centralized Credit Risk Management group monitors overall composition and quality of the credit portfolio. The Company takes into consideration potential future economic conditions when monitoring and assessing its credit portfolio to understand its credit risk profile under various stressful conditions.
The Company’s guiding principles, strengthened central governance and Board-directed risk tolerances, ensure that senior executives are well-informed of credit trends and can make appropriate credit and business decisions for the Company. The Company ensures day-to-day market responsiveness and flexibility by empowering its business line managers to develop credit strategies and programs aligned with the objective of long-term business profitability. The credit program development process considers the evolving needs of the target market, the competitive environment and the economic outlook. It is highly analytical and uses the Company’s extensive database of past test results. Senior Credit Officers, who are appointed by the Credit Policy Committee, oversee all credit program development. Large new programs or program changes are reviewed by the Credit Policy Committee or its subcommittee.
Most of the Company’s credit strategies rely heavily on the use of sophisticated proprietary scoring models. These models consider many variables, including credit scores developed by nationally recognized scoring firms. The models are validated, monitored and maintained in accordance with detailed policies and procedures to ensure their continued validity.
## Interest Rate Risk
Interest rate risk refers to changes in earnings or the net present value of assets and off-balance sheet positions less liabilities (termed “economic value of equity”) due to interest rate changes. To the extent that managed interest income and expense do not respond equally to changes in interest rates, or that all rates do not change uniformly, earnings and economic value of equity could be affected. The Company’s managed net interest income is affected primarily by changes in LIBOR, as variable rate card receivables, securitization bonds and corporate debts are repriced. The Company manages and mitigates its interest rate sensitivity through several techniques, which include, but are not limited to, changing the maturity, repricing and distribution of assets and liabilities and by entering into interest rate swaps.
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The Company measures interest rate risk through the use of a simulation model. The model generates a distribution of 12-month managed net interest income outcomes based on a plausible set of interest rate paths, which are generated from an industry-accepted term structure model. The consolidated balance sheet and all off-balance sheet positions are included in the analysis. The Company’s Asset/Liability Management Policy requires that based on this distribution there be no more than a 5% probability of a reduction in 12-month net interest income of more than 3% of base net interest income. The interest rate scenarios evaluated as of December 31, 2002 included scenarios in which short-term interest rates rose by over 300 basis points or fell by as much as 140 basis points over the 12 months.
The Asset/Liability Management Policy also limits the change in 12-month net interest income and economic value of equity, due to instantaneous parallel rate shocks.
As of December 31, 2002, the Company was in compliance with all interest rate risk management policies. The measurement of interest rate sensitivity does not consider the effects of changes in the overall level of economic activity associated with various interest rate scenarios or reflect the ability of management to take action to further mitigate exposure to changes in interest rates. This action may include, within legal and competitive constraints, the repricing of interest rates on outstanding credit card loans.
Table 14 reflects the interest rate repricing schedule for earning assets and interest-bearing liabilities as of December 31, 2002.
<img src='content_image/53591.jpg'>
## Liquidity Risk
Liquidity risk refers to the Company’s inability to meet its cash needs. The Company meets its cash requirements by securitizing assets, gathering deposits and issuing debt and equity. As discussed in “Managed Consumer Loan Portfolio,” a significant source of liquidity for the Company has been the securitization of consumer loans. Maturity terms of the existing securitizations vary from 2003 to 2008, and for revolving securitizations have accumulation periods during which principal payments are aggregated to make payments to investors. As payments on the loans are accumulated and are no longer reinvested in new loans, the Company’s funding requirements for such new loans increase accordingly. The occurrence of certain events may cause the securitization transactions to amortize earlier than scheduled, which
would accelerate the need for funding. Additionally, this early amortization would have a significant effect on the ability of the Bank and the Savings Bank to meet the capital adequacy requirements as all off-balance sheet loans experiencing such early amortization would have to be recorded on the balance sheet.
The amounts of investor principal from off-balance sheet consumer loans that are expected to amortize into the Company’s consumer loans, or be otherwise paid over the periods indicated, based on outstanding off-balance sheet consumer loans as of January 1, 2003 are summarized in Table 13. As of December 31, 2002 and 2001, 53% and 54%, respectively, of the Company’s total managed loans were included in off-balance sheet securitizations.
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Managed loans are comprised of reported loans and off-balance sheet securitized loans.
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As such amounts amortize or are otherwise paid, the Company believes it can securitize additional consumer loans, gather deposits, purchase federal funds and establish other funding sources to fund new loan growth, although no assurance can be given to that effect. Additionally, the Company maintains a portfolio of high-quality securities such as U.S. Treasuries and other U.S. government obligations, commercial paper, interest-bearing deposits with other banks, federal funds and other cash equivalents in order to provide adequate liquidity and to meet its ongoing cash needs. As of December 31, 2002, the Company had $5.3 billion of such securities.
Liability liquidity is measured by the Company’s ability to obtain borrowed funds in the financial markets in adequate amounts and at favorable rates. As of December 31, 2002, the Company, the Bank and the Savings Bank collectively had over $2.8 billion in unused commitments under various credit facilities available for liquidity needs.
## Operational Risk
The Company is exposed to numerous types of operational risk. Operational risk generally refers to the risk of loss resulting from the Company’s operations, including, but not limited to, the risk of fraud by employees or persons outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control, system and compliance requirements. This risk of loss also includes the potential legal actions that could arise as a result of the operational deficiency or as result of noncompliance with applicable regulatory standards.
The Company operates in a number of different businesses and markets and places reliance on the ability of its employees and systems to process a high number of transactions. In the event of a breakdown in the internal control systems, improper operation of systems or improper employee actions, the Company could suffer financial loss, face regulatory action and suffer damage to its reputation. In order to address this risk, management maintains a system of internal controls with the objective of providing proper transaction authorization and execution, safeguarding of assets from misuse or theft, and ensuring the reliability of financial and other data.
The Company maintains systems of control that provide management with timely and accurate information about the operations of the Company. These systems have been designed to manage operational risk at appropriate levels given the Company’s financial strength, the environment in which it operates, and considering factors such as competition and regulation. The Company has also established procedures that are designed to ensure that policies relating to conduct, ethics and business practices are followed on a uniform basis. Management continually monitors and improves its internal controls systems and Company-wide processes and procedures to reduce the likelihood of losses related to operational risk.
## CAPITAL ADEQUACY
The Bank and the Savings Bank are subject to capital adequacy guidelines adopted by the Federal Reserve Board (the “Federal Reserve”) and the Office of Thrift Supervision (the “OTS”) (collectively, the “regulators”), respectively. The capital adequacy guidelines and the regulatory framework for prompt
corrective action require the Bank and the Savings Bank to maintain specific capital levels based upon quantitative measures of their assets, liabilities and off-balance sheet items.
The most recent notifications received from the regulators categorized the Bank and the Savings Bank as “well-capitalized.” As of December 31, 2002, there were no conditions or events since these notifications that management believes would have changed either the Bank or the Savings Bank’s capital category.
Since early 2001, the Bank and Savings Bank have treated a portion of their loans as “subprime” under the Subprime Guidelines and have assessed their capital and allowance for loan losses accordingly. In the second quarter of 2002, the Company adopted a revised application of the Subprime Guidelines, the result of which was to require more capital and allowance for loan losses to be held against subprime loans. Under the revised application of the Subprime Guidelines, the Company has, for purposes of calculating capital ratios, risk weighted subprime loans in targeted programs at 200%, rather than the 100% risk weighting applied to loans not in targeted subprime programs. The company has addressed the additional capital requirements with available resources. Under the revised application of the Subprime Guidelines, each of the Bank and Savings Bank exceeds the requirements for a “well-capitalized” institution as of December 31, 2002.
For purposes of the Subprime Guidelines, the Company has treated as “subprime” all loans in the Bank’s and the Savings Bank’s targeted subprime programs to customers either with a FICO score of 660 or below or with no FICO score. The Bank and the Savings Bank hold on average 200% of the total risk-based capital charge that would otherwise apply to such assets. This results in higher levels of regulatory capital at the Bank and the Savings Bank. As of December 31, 2002, approximately $5.3 billion or 28.0% of the Bank’s, and $3.8 billion or 32.4% of the Savings Bank’s, on-balance sheet assets were treated as “subprime” for purposes of the Subprime Guidelines.
In November 2001, the Agencies adopted an amendment to the regulatory capital standards regarding the treatment of certain recourse obligations, direct credit substitutes (i.e., guarantees on third-party assets), residual interests in asset securitizations, and certain other securitized transactions. Effective January 1, 2002, this rule amended the Agencies’ regulatory capital standards to create greater differentiation in the capital treatment of residual interests. On May 17, 2002, the Agencies issued an advisory interpreting the application of this rule to a residual interest commonly referred to as an accrued interest receivable (the “AIR Advisory”). The effect of this AIR Advisory is to require all insured depository institutions, including the Bank an the Savings Bank, to hold significantly higher levels of regulatory capital against accrued interest receivables beginning December 31, 2002. The Bank and the Savings Bank have met this capital requirement and remain well capitalized as the AIR Advisory became effective as of December 31, 2002.
The Company currently expects to operate each of the Bank and Savings Bank in the future with a total capital ratio of at least 12%. The Corporation has a number of alternatives available to meet any additional regulatory capital needs of the Bank and the Savings Bank, including substantial liquidity held at the Corporation and available for contribution.
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In August 2000, the Bank received regulatory approval and established a subsidiary bank in the United Kingdom. In connection with the approval of its former branch office in the United Kingdom, the Company committed to the Federal Reserve that, for so long as the Bank maintains a branch or subsidiary bank in the United Kingdom, the Company will maintain a minimum Tier 1 Leverage ratio of 3.0%. As of December 31, 2002 and 2001, the Company’s Tier 1 Leverage ratio was 11.95% and 11.93%, respectively.
Additionally, federal banking law limits the ability of the Bank and Savings Bank to transfer funds to the Corporation. As of December 31, 2002, retained earnings of the Bank and the Savings Bank of $924.4 million and $408.4 million, respectively, were available for payment of dividends to the Corporation without prior approval by the regulators. The Savings Bank, however, is required to give the OTS at least 30 days advance notice of any proposed dividend and the OTS, in its discretion, may object to such dividend.
Additional information regarding capital adequacy can be found in Note O to the Consolidated Financial Statements.
## Dividend Policy
Although the Company expects to reinvest a substantial portion of its earnings in its business, the Company also intends to continue to pay regular quarterly cash dividends on its common stock. The declaration and payment of dividends, as well as the amount thereof, are subject to the discretion of the Board of Directors of the Company and will depend upon the Company’s results of operations, financial condition, cash requirements, future prospects and other factors deemed relevant by the Board of Directors. Accordingly, there can be no assurance that the Corporation will declare and pay any dividends. As a holding company, the ability of the Corporation to pay dividends is dependent upon the receipt of dividends or other payments from its subsidiaries. Applicable banking regulations and provisions that may be contained in borrowing agreements of the Corporation or its subsidiaries may restrict the ability of the Corporation’s subsidiaries to pay dividends to the Corporation or the ability of the Corporation to pay dividends to its stockholders.
## LEGISLATIVE AND REGULATORY MATTERS
## Informal Memorandum of Understanding
As described in the Company’s report on Form 10-Q, dated August 13, 2002, the Company has entered into an informal memorandum of understanding with the bank regulatory authorities with respect to certain issues, including capital, allowance for loan losses, finance charge and fee reserves and policies, procedures, systems and controls. A memorandum of understanding is characterized by regulatory authorities as an informal action, that is not published or publicly available. The Company has implemented levels of capital, reserves and allowances that it believes satisfy the memorandum of understanding.
In addition, as required under the memorandum of understanding, the Company has continued to take actions, among others, to enhance its enterprise risk management framework and legal entity business plans. As
part of the ongoing supervision of the Bank and the Savings Bank, the Company will periodically report to, and consult with, the regulators on all the matters addressed under the informal memorandum of understanding. While the Company has delivered on the principal requirements of the informal memorandum of understanding, it expects its regulators to monitor its ongoing execution for some period of time. Hence, the Company is unable to predict the exact timing for conclusion or termination of the informal memorandum of understanding.
## FFIEC
On January 8, 2003 the FFIEC released Account Management and Loss Allowance Guidance (the “Guidance”). The Guidance applies to all credit lending of regulated financial institutions and generally requires that banks properly manage several elements of their credit-card lending programs, including line assignments, over-limit practices, minimum payment and negative amortization, workout and settlement programs and the accounting methodology used for various assets and income items related to credit card loans.
The Company believes that its credit card account management and loss allowance practices are prudent and appropriate and, therefore, consistent with the Guidance. Based on this review and these discussions, the Company believes the Guidance will not have a material adverse effect on its financial condition or results of operations. The Company cautions, however, that similar to the Subprime Guidelines, the Guidance provides wide discretion to bank regulatory agencies in the application of the Guidance to any particular institution and its account management and loss allowance practices. Accordingly, under the Guidance, bank examiners could require changes in the Company’s account management or loss allowance practices in the future.
## Sarbanes-Oxley
On July 30, 2002, the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) was passed into law. The Sarbanes-Oxley Act applies to all companies that are required to file periodic reports with the Securities Exchange Commission (“SEC”) and contains a number of significant changes relating to the responsibilities of directors and officers and reporting and governance obligations of SEC reporting companies. Certain provisions of the Sarbanes- Oxley Act were effective immediately without action by the SEC; however many provisions became effective over the months following its passage and required the SEC to issue implementing rules. Following the passage of the Sarbanes-Oxley Act, the Company has taken steps which it believes places it in substantial compliance with the effective provisions of the Sarbanes-Oxley Act and it continues to monitor SEC rulemaking to determine if additional changes are needed to comply with provisions that will become effective over the following months. During the course of its compliance efforts, the Company has identified no significant changes which must be made to its organizational and control structures or existing processes as a result of this legislation and the currently effective rules issued by the SEC and other regulatory bodies.
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## BUSINESS OUTLOOK
This business outlook section summarizes the Company’s expectations for earnings for 2003, and its primary goals and strategies for continued growth. The statements contained in this section are based on management’s current expectations. Certain statements are forward looking, and therefore actual results could differ materially. Factors that could materially influence results are set forth throughout this section and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 (Part I, Item 1, Risk Factors).
## Earnings Goals
The Company has historically targeted an annual growth in earnings per share of at least 20%, with 2002 marking the eighth consecutive year that this goal has been achieved. Looking forward, the Company anticipates earnings per share results of approximately $4.55 in 2003, which is approximately 16% growth over the $3.93 earnings per share achieved in 2002. The Company continues to target long-term earnings per share growth of 20%.
The Company’s 2003 earnings per share growth target results from our decision in mid-2002 to moderate the growth of our managed loans outstanding to 20-25% in 2003 from 32%, 53% and 46% in 2002, 2001 and 2000, respectively. To slow the growth of the Company’s managed loans outstandings, it reduced marketing spending from $674.0 million in the first half of 2002 to $396.6 million in the second half of 2002. This reduction in spending led to an increase in earnings per share growth in 2002 to 35% from the 20% growth originally forecasted. In 2003, the Company expects marketing spending to increase to approximately $300.0 million per quarter.
The Company expects to achieve these results based on the continued success of its business strategies and its current assessment of the competitive, regulatory and funding market environments that it faces (each of which is discussed elsewhere in this Annual Report), as well as the expectation that the geographies in which the Company competes will not experience significant consumer credit quality erosion, as might be the case in an economic downturn or recession.
The Company’s earnings are a function of our revenues (net interest income and non-interest income), consumer usage, payment and attrition patterns, credit quality of our earning assets (which affects fees and chargeoffs) and the Company’s marketing and operating expenses. An overview of trends in these metrics, as well as a discussion of our core IBS and the competitive dynamics of the Company’s three operating segments follow.
## Revenue
Revenues are expected to grow approximately 14-16% in 2003. Net interest margin is expected to fluctuate somewhat due to the scheduled repricings of certain introductory rate credit card products and a gradual shift towards superprime assets, but is expected to stabilize at approximately 9-10% in 2003. Non-interest income is expected to remain stable in 2003 compared to 2002, consistent with a gradual shift towards higher credit quality assets, which generate less fee income than assets generated by customers at the lower end of the credit spectrum. Risk adjusted margin should also fluctuate as a result of underlying revenue and charge-off dynamics, but is expected to stabilize at approximately 10% in 2003.
## Marketing Investment
As stated previously, marketing expense is expected to be on average approximately $300.0 million per quarter in 2003. A portion of this marketing spending will continue to support our efforts to build a strong brand for the Company. Our “What’s in Your Wallet?” campaign has resulted in the Company achieving brand awareness and brand equity scores among the highest in the credit card industry, as measured by third-party firms. The Company believes the branded franchise that it is building strengthens and enables its IBS and mass customization strategies across product lines. The Company cautions however, that an increase or decrease in marketing expense or brand awareness does not necessarily correlate to a comparable increase or decrease in outstandings balances or accounts due to, among other factors, the long-term nature of brand building, consumer attrition and utilization patterns, and shifts over time in targeting customers and/or products that have varying marketing acquisition costs.
Management expects to vary its marketing across its credit card, installment lending and auto lending products depending on the competitive dynamics of the various markets in which it participates. Currently, among the Company’s various product lines, U.S. credit cards marketed to consumers with the most favorable credit profiles are facing the highest degree of intensity of competition. Accordingly, the Company expects to focus a larger proportion of its marketing expenditures on other products marketed to similar consumer bases, such as installment loans and U.K. credit cards, in the short term. The Company expects to adjust its marketing allocations, however, to target specific product lines that it believes offer the highest response rates and opportunities from time to time.
As a result of overall marketing spending increasing over levels realized in the second half of 2002, the Company expects account growth to resume in 2003, and to result in annual growth of approximately 5-10%. The Company also expects managed loans outstanding to increase by approximately 20-25% in 2003, comprising approximately 25% growth in prime and superprime assets, and approximately 10-15% growth in subprime assets.
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## Operating Cost Trends
Management believes one of its competitive advantages is its low operating cost structure, and we measure operating efficiency using a variety of metrics which vary by specific department or business unit. The Company believes that overall operating cost per account (defined as all non-interest expense less marketing, divided by the average annual number of accounts) is an appropriate gauge of the operating efficiency of the enterprise as a whole. Operating cost per account is expected to rise slightly but remain in the mid to high $70’s in 2003.
## Impact of Delinquencies, Charge-offs and Attrition
The Company’s earnings are particularly sensitive to delinquencies and charge-offs in our portfolio. As delinquency levels fluctuate, the resulting amount of past due and overlimit fees (which are significant sources of revenue) will also fluctuate. Furthermore, the timing of revenues from increasing or decreasing delinquencies precedes the related impact of higher or lower charge-offs that can ultimately result from these varying levels of delinquencies. Delinquencies and charge-offs are impacted by a number of factors such as general economic trends affecting consumer credit performance, regulatory and legislative developments affecting bankruptcy and fee assessment or recognition policies, the degree of seasoning of the portfolio, the product mix and the success of the Company’s collections efforts.
The Company’s earnings are also sensitive to the level of customer and/or balance attrition that it experiences. Fluctuation in attrition levels can occur due to the level of competition within the industries in which the Company competes, as well as competition from outside of the Company’s industries, such as consumer debt consolidation that may occur during a mortgage refinancing.
## Our Core Strategy: IBS
The Company’s core strategy has been, and is expected to continue to be, to apply its proprietary IBS to the businesses in which it competes, principally focused on consumer lending products. The Company continues to seek to identify new product and new market opportunities, and to make investment decisions that are informed by the Company’s intensive testing and analysis to be profitable, for the enterprise to pursue.
At its core, IBS is an organizational culture, a pool of analytically oriented employees, a flexible information technology and a series of scientific testing processes followed by rigorous analysis and optimization. The Company applies IBS to all aspects of our business, including marketing copy and response optimization, underwriting and risk management and modeling, and servicing, cross-sell, and collections and recoveries optimization. The result is a series of mass customized products and services delivered to customers based on their individual needs, but also intended to drive profitability for the Company.
Additionally, the Company believes it garners additional competitive advantage by competing across the full credit spectrum in the industries and geographies in which it competes. Some of the benefits of competing across the full credit spectrum are economies of scale and scope in marketing and servicing, cross-fertilization of risk modeling and risk management insights derived by testing and analyzing risk strategies for customers of different credit quality, and the flexibility to divert marketing spending away from products experiencing heavy competition and towards those products with moderate competitive intensity in order to maximize returns over time, as described above.
The Company’s lending products and other products are subject to intense competitive pressures which management anticipates will continue to increase as our markets mature, which could affect the economics of decisions that the Company has made or will make in the future in ways which it did not anticipate, test or analyze.
## Consumer Lending Segment
This segment consists of $47.4 billion of U.S. credit card and installment loan receivables, marketed to customers across the full credit spectrum.
The competitive environment is currently intense for credit card products marketed to consumers with the best credit profiles. The Federal Reserve’s recent lowering of interest rates has allowed many issuers to enter the market with fixed annual percentage rate (“APR”) credit cards below 10%. Prior to these interest rate reductions, the Company was the only major issuer to be heavily marketing fixed rates cards below 10%. As interest rates have fallen, the Company has offered 0% introductory rates, followed by low long-term fixed rates. At the same time, industry mail volume increased substantially in mid-2002, putting downward pressure on response rates to our new customer solicitations. Additionally, competition has increased the attrition levels in our existing superprime portfolio, although they still remain well below the attrition levels realized in the prime and subprime segments.
The Company markets six principal superprime products across a variety of segments and geographies. Four of these are managed within the U.S. Consumer Lending Segment: “No-Hassle” credit cards, Lifestyle credit cards, Rewards credit cards, and Installment loans. The remaining two superprime products, auto loans and credit cards in the United Kingdom (“U.K.”) are discussed elsewhere. Overall, management expects to grow its prime and superprime assets, across all products and geographies, at an annual rate of 20% to 25%.
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Likewise, the Company’s credit card products marketed to consumers with less established or higher risk credit profiles continue to experience steady competition. These products generally feature higher annual percentage rates, lower credit lines, and annual membership fees. Additionally, since these borrowers are viewed by issuers as higher risk, they tend to be more likely to pay late or exceed their credit limit, which results in additional fees assessed to their accounts. The Company’s strategy has been, and is expected to continue to be, to offer APRs and annual membership, late and overlimit fees on these accounts that are below those of its competition.
## Auto Finance Segment
This segment consists of $7.0 billion of U.S. auto loan receivables, marketed to both superprime and subprime customers, via direct and indirect marketing channels. The Company originated approximately two-thirds of our 2002 auto loan growth via direct channels such as the Internet and direct mail, and the remaining one-third via the indirect auto dealer channel. The Company is also testing the auto lending prime market and have an immaterial amount of receivables in this portion of the credit spectrum at this time. It is the Company’s goal to become a full spectrum auto finance lender, much like it has achieved in the U.S. credit card industry. In addition to the competitive advantages of being a full credit spectrum lender discussed above, the scale sensitive nature of the auto finance business generates additional economic leverage for full spectrum competitors. Additionally in 2002, the Company sold $1.5 billion of superprime auto assets in whole loan sale transactions to multiple buyers. The high credit quality of these borrowers leads to very low loss rates on these assets (averaging 15-20 basis points per annum). Additionally, the Company is continuing to service these assets for a fee.
In the fourth quarter of 2002, the Company entered into a forward flow agreement with a purchaser to sell subprime auto loans originated via our subprime auto dealer network. These assets are sold at a premium, servicing released, no recourse, and have an additional performance payment in the future depending on asset performance over time. These assets are originated using the Company’s underwriting policies, and allow for the sale of $65.0 million to $110.0 million of assets per month. The Company expects to sell between $500.0 million and $900.0 million of subprime auto loans under this agreement in 2003.
Going forward, the Company anticipates that it will continue to sell auto loans. The benefits of selling our excess origination volume are twofold. First, the Company continues to generate more scale economies from the additional volume. Second, the Company is able to sell loans for a price that exceed the cost of origination, thus whole loan sales have become a profit center for Capital One.
Credit quality in the superprime auto finance segment has remained strong, with net chargeoffs in the 15-20bp range in 2003. Net chargeoffs in the sub- prime auto segment have continued to improve, on a static pool basis, in each year that Capital One has participated in the sector. This steady
improvement is in spite of the weakness in the U.S. economy over the last few years, as well as softness in the prices of used cars the company has been able to garner in the wholesale used car market when selling repossessed vehicles. However, U.S. unemployment statistics have been rising recently, which could have an adverse impact on our default rates going forward. Despite these pressures, Capital One remains cautiously optimistic that it can continue to steadily and profitably grow market share and profits in the auto finance segment.
## International Segment
This segment consists of $5.4 billion of credit card receivables, principally originated and operated in the U.K. and Canada. Additionally, the Company has been testing and plans to continue to test new geographic markets.
The improvement in the Company’s financial performance over the past twelve months is due to the maturation of the Company’s businesses in the U.K. and Canada. Both of these businesses are generating profitable portfolio growth, realizing lower operating expenses and steadily improving risk management. Additionally, price competition in the superprime card business in 2002 appears to have subsided somewhat from the intense levels experienced in 2001 and 2000.
In 2002, the Company also launched its “What’s in Your Wallet?” and “No- Hassle” brand campaigns in the U.K. This strong focus on brand marketing activity, combined with industry leading rates and products, has enabled our U.K. business to continually rank among the top three issuers of new credit cards in the U.K. market in terms of managed loans outstanding.
The Company is highly committed to diversifying into new geographies and sees the continued success of our International segment as an indication of the global potential of our core IBS strategy.
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## Cautionary Factors
The strategies and objectives outlined above, and the other forward-looking statements contained in this section, involve a number of risks and uncertainties. The Company cautions readers that any forward-looking information is not a guarantee of future performance and that actual results could differ materially. In addition to the factors discussed above, among the other factors that could cause actual results to differ materially are the following:
• continued intense competition from numerous providers of products and services that compete with our businesses;
• an increase in credit losses (including increases due to a worsening of general economic conditions);
• our ability to continue to securitize our credit cards and consumer loans consistent with current accounting and other practices and to otherwise access the capital markets at attractive rates and terms to capitalize and fund our operations and future growth;
• financial, legal, regulatory, accounting or other changes that may affect investment in, or the overall performance of, a product or business, including changes in existing law and regulation affecting the credit card and consumer loan industry, in particular (including any further federal bank examiner guidance affecting credit card and/or subprime lending) and the financial services industry, in general (including the ability of financial services companies to obtain, use and share consumer data);
• with respect to financial and other products, changes in our aggregate accounts or consumer loan balances and the growth rate thereof, including changes resulting from factors such as shifting product mix, amount of our actual marketing expenses and attrition of accounts and loan balances;
• the amount of, and rate of growth in, our expenses (including salaries and associate benefits and marketing expenses) as our business develops or changes or as we expand into new market areas;
• our ability to build the operational and organizational infrastructure necessary to engage in new businesses or to expand internationally;
• our ability to recruit experienced personnel to assist in the management and operations of new products and services;
• any significant disruption of, or loss of public confidence in, the U.S. mail system affecting response rates or customer payments; and
• other factors listed from time to time in the our SEC reports, including, but not limited to, the Annual Report on Form 10-K for the year ended December 31, 2002 (Part I, Item 1, Risk Factors).
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https://cdla.io/permissive-1-0/
|
[
"content_image/35599.jpg"
] |
overall_image/e89bb2da69e984854ab309bf1f54bf75ce5adec80ccae480deb8cbde4cb061a0.png
|
## Selected Quarterly Financial Dat a
<img src='content_image/35599.jpg'>
The above schedule is a tabulation of the Company’s unaudited quarterly results for the years ended December 31, 2002 and 2001. The Company’s common shares are traded on the New York Stock Exchange under the symbol COF. In addition, shares may be traded in the over-the-counter stock market. There were 10,227 and 10,065 common stockholders of record as of December 31, 2002 and 2001, respectively.
|
801 |
{
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"doc_id": "NYSE_COF_2002.pdf",
"page_id": "47",
"date_download": "2024-3-24",
"oi_source": "ori",
"source_dataset": "DocLayNet"
}
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{
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|
https://cdla.io/permissive-1-0/
|
[
"content_image/22480.jpg",
"content_image/22478.jpg",
"content_image/22479.jpg"
] |
overall_image/0468ea9fbf78589e04fe417d9eeca05a1056c75e59ce142bf76368f63483ece6.png
|
## MANAGEMENT’S REPORT ON CONSOLIDATED FINANCIAL STATEMENTS AND INTERNAL CONTROLS OVER FINANCIAL REPORTING
The Management of Capital One Financial Corporation is responsible for the preparation, integrity and fair presentation of the financial statements and footnotes contained in this Annual Report. The Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States and are free of material misstatement. The Company also prepared other information included in this Annual Report and is responsible for its accuracy and consistency with the financial statements. In situations where financial information must be based upon estimates and judgments, they represent the best estimates and judgments of Management.
The Consolidated Financial Statements have been audited by the Company’s independent auditors, Ernst & Young LLP, whose independent professional opinion appears separately. Their audit provides an objective assessment of the degree to which the Company’s Management meets its responsibility for financial reporting. Their opinion on the financial statements is based on auditing procedures, which include reviewing accounting systems and internal controls and performing selected tests of transactions and records as they deem appropriate. These auditing procedures are designed to provide reasonable assurance that the financial statements are free of material misstatement.
Management depends on its accounting systems and internal controls in meeting its responsibilities for reliable financial statements. In Management’s opinion, these systems and controls provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with Management’s authorizations. As an integral part of these systems and controls, the Company maintains a professional staff of internal auditors that conducts operational and special audits and coordinates audit coverage with the independent auditors.
The Audit Committee of the Board of Directors, composed solely of outside directors, meets periodically with the internal auditors, the independent auditors and Management to review the work of each and ensure that each is properly discharging its responsibilities. The independent auditors have free access to the Committee to discuss the results of their audit work and their evaluations of the adequacy of accounting systems and internal controls and the quality of financial reporting.
There are inherent limitations in the effectiveness of internal controls, including the possibility of human error or the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurance with respect to reliability of financial statements and safeguarding of assets. Furthermore, because of changes in conditions, internal control effectiveness may vary over time.
The Company assessed its internal controls over financial reporting as of December 31, 2002, in relation to the criteria described in the “Internal Control- Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, the Company believes that as of December 31, 2002, in all material respects, the Company maintained effective internal controls over financial reporting.
<img src='content_image/22480.jpg'>
<img src='content_image/22478.jpg'>
<img src='content_image/22479.jpg'>
|
802 |
{
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"oi_exist": true,
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"doc_id": "NYSE_COF_2002.pdf",
"page_id": "48",
"date_download": "2024-3-24",
"oi_source": "ori",
"source_dataset": "DocLayNet"
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{
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|
https://cdla.io/permissive-1-0/
|
[
"content_image/61639.jpg"
] |
overall_image/992d2c81a9ebf9a58875857b2d0ec296c771e010c584f3c5f354eae9cedfa871.png
|
## REPORT OF INDEPENDENT AUDITORS
## The Board of Directors and Stockholders Capital One Financial Corporation
We have audited the accompanying consolidated balance sheets of Capital One Financial Corporation as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Capital One Financial Corporation at December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States.
McLean, Virginia January 16, 2003
<img src='content_image/61639.jpg'>
|
803 |
{
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"oi_exist": true,
"ori_meta": null,
"doc_id": "NYSE_COF_2002.pdf",
"page_id": "49",
"date_download": "2024-3-24",
"oi_source": "ori",
"source_dataset": "DocLayNet"
}
|
{
"image_text_interleaving_count": 3,
"text_block_count": 3,
"avg_text_block_length": 34.333333333333336,
"total_token_count": 44,
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"doc_length": 188
}
|
https://cdla.io/permissive-1-0/
|
[
"content_image/104903.jpg",
"content_image/104906.jpg"
] |
overall_image/766f4650551c120f9833809e65a69288f2b4c335c231a5ff0f2dcb962aad8d27.png
|
<img src='content_image/104903.jpg'>
## Commitments and Contingencies
## Stockholders’ Equity:
<img src='content_image/104906.jpg'>
See Notes to Consolidated Financial Statements.
|
804 |
{
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"oi_exist": true,
"ori_meta": null,
"doc_id": "NYSE_COF_2002.pdf",
"page_id": "5",
"date_download": "2024-3-24",
"oi_source": "ori",
"source_dataset": "DocLayNet"
}
|
{
"image_text_interleaving_count": 0,
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"total_token_count": 10,
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"doc_length": 37
}
|
https://cdla.io/permissive-1-0/
|
[
"content_image/58387.jpg"
] |
overall_image/a9f5640a5bce81aa7db0caf63a10ca376a3e62dba2007cc4e7d6ff5179a47eb2.png
|
<img src='content_image/58387.jpg'>
|
805 |
{
"language": "en",
"oi_exist": true,
"ori_meta": null,
"doc_id": "NYSE_COF_2002.pdf",
"page_id": "50",
"date_download": "2024-3-24",
"oi_source": "ori",
"source_dataset": "DocLayNet"
}
|
{
"image_text_interleaving_count": 2,
"text_block_count": 2,
"avg_text_block_length": 42.5,
"total_token_count": 29,
"bold_char_count": 0,
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"title_count": 1,
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"doc_length": 129
}
|
https://cdla.io/permissive-1-0/
|
[
"content_image/134009.jpg"
] |
overall_image/01d072846ab4571118fbea561b6433c39eeb5e5eddc95d20600e6e76ea23b372.png
|
## Cons olidat ed Statements of Income
<img src='content_image/134009.jpg'>
See Notes to Consolidated Financial Statements.
|
806 |
{
"language": "en",
"oi_exist": true,
"ori_meta": null,
"doc_id": "NYSE_COF_2002.pdf",
"page_id": "51",
"date_download": "2024-3-24",
"oi_source": "ori",
"source_dataset": "DocLayNet"
}
|
{
"image_text_interleaving_count": 2,
"text_block_count": 2,
"avg_text_block_length": 55,
"total_token_count": 34,
"bold_char_count": 0,
"italic_char_count": 0,
"title_count": 1,
"avg_tokens_per_text_block": 17,
"doc_length": 153
}
|
https://cdla.io/permissive-1-0/
|
[
"content_image/94576.jpg"
] |
overall_image/a693ce48fe808f518182134f0590527cf21316813d544be097b9b70ff0bf6556.png
|
## Cons olidat ed Statements of Changes in Stockholders’ Equity
<img src='content_image/94576.jpg'>
See Notes to Consolidated Financial Statements.
|
807 |
{
"language": "en",
"oi_exist": true,
"ori_meta": null,
"doc_id": "NYSE_COF_2002.pdf",
"page_id": "52",
"date_download": "2024-3-24",
"oi_source": "ori",
"source_dataset": "DocLayNet"
}
|
{
"image_text_interleaving_count": 2,
"text_block_count": 2,
"avg_text_block_length": 44.5,
"total_token_count": 31,
"bold_char_count": 0,
"italic_char_count": 0,
"title_count": 1,
"avg_tokens_per_text_block": 15.5,
"doc_length": 132
}
|
https://cdla.io/permissive-1-0/
|
[
"content_image/66092.jpg"
] |
overall_image/b570038c545620b354962eb8d5b9da6f248c65b0217fba7031a792e66672191e.png
|
## Cons olidat ed Statements of Cash Flows
<img src='content_image/66092.jpg'>
See Notes to Consolidated Financial Statements.
|
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