The Hershey Company — Q1 2017 Form 10-Q
Reporting period: Three months ended April 2, 2017, compared with the three months ended April 3, 2016. Unaudited results may be affected by seasonal patterns and are not necessarily indicative of full-year results.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $1,879.7 million | $1,828.8 million | +2.8% reported; +2.7% constant currency |
| Gross profit / margin | $906.6 million / 48.2% | $817.4 million / 44.7% | Margin +350 bps reported; +70 bps non-GAAP |
| Operating profit / margin | $191.9 million / 10.2% | $339.5 million / 18.6% | -43.5% |
| Net income attributable to Hershey | $125.0 million | $229.8 million | -45.6% |
| Diluted EPS | $0.58 | $1.06 | -45.3% |
| Adjusted net income / diluted EPS | $282.1 million / $1.31 | $238.9 million / $1.10 | +18.1% / +19.1% |
| Operating cash flow | $234.5 million | $269.5 million | Down $35.0 million |
| Cash and equivalents | $235.0 million | $297.0 million at Dec. 31, 2016 | Down $62.0 million |
Reported earnings were weighed down by $208.7 million of long-lived asset impairment charges and $47.0 million of business realignment costs. Adjusted measures exclude specified items and are non-GAAP. The 2016 comparison included a $26.7 million gain from settling the SGM purchase liability, which benefited prior-year reported results.
Gross-margin improvement reflected lower commodity costs, favorable commodity-derivative mark-to-market effects, lower promotional spending and productivity savings, partly offset by higher supply-chain costs. The reported gross-margin increase was substantially larger than the adjusted increase because of these derivative effects.
Segments and material changes
- North America: Sales of $1,677.1 million, up 2.7%; segment income of $553.1 million, up 4.5%. Pricing, seasonal sales and barkTHINS contributed; everyday-product volume and challenging consumer packaged-goods trends were offsets.
- International and Other: Sales of $202.5 million, up 3.7%; segment income was $1.7 million versus a $13.2 million loss. Lower trade spending and returns in China helped, while China category softness contributed to a 4.5% volume decline in the segment.
- Consolidated sales growth reflected 2.0% favorable price realization and a 0.9% acquisition benefit, partly offset by a 0.2% volume decline; foreign exchange added 0.1%. barkTHINS was acquired in 2016.
- Operating cash flow declined as working capital used $188.3 million, versus $67.8 million in the prior-year quarter, mainly due to receivable timing, inventory builds and payments of payables/accruals.
Liquidity, debt and cash flow
At April 2, 2017, total current assets were $1,873.9 million and current liabilities were $1,710.9 million. Short-term debt was $487.5 million, current long-term debt $0.2 million, and long-term debt $2,350.9 million. Cash was $235.0 million. The company had a $1.0 billion revolving credit facility, expiring in November 2020, and reported compliance with its covenants. Approximately 70% of cash was held by foreign subsidiaries and intended to remain permanently invested abroad.
Q1 investing cash outflow was $40.7 million, including $33.3 million of capital additions. Financing cash outflow was $256.9 million, including $128.0 million of dividends; short-term debt declined by $146.6 million. There were no common-stock repurchases in the quarter. Expected 2017 capital expenditures, including software, were approximately $270–$290 million.
Outlook, management commentary and risks
- Management expected full-year 2017 sales growth toward the low end of its 2%–3% outlook, including an estimated 0.5% net benefit from acquisitions; foreign-exchange impact was expected to be minimal. Key headwinds cited were U.S. non-seasonal category trends and continued macroeconomic challenges in China.
- Full-year reported diluted EPS guidance was $3.31–$3.55; adjusted diluted EPS guidance was $4.72–$4.81, with management expecting results toward the high end. Adjusted EPS growth was projected at 7%–9%, supported by productivity, cost savings and a lower expected effective tax rate. Adjusted guidance excludes specified items and does not forecast commodity-derivative mark-to-market effects.
- The Margin for Growth program, launched in February 2017, was estimated to incur $375–$425 million in pretax charges over three years, including $175–$200 million cash costs. Management expected annual savings of $150–$175 million by completion in 2019 and a global workforce reduction of about 15%, mostly hourly positions outside the U.S. Q1 impairment charges included assets related to China operations.
- Risks highlighted include product safety and recalls, input-cost and supply availability, pricing elasticity, demand and competition, supply-chain disruption, international-market performance, execution of restructuring and expected savings, and information-technology security. Pending ordinary-course legal matters were not expected by management to have a material effect.
- The effective tax rate was 41.6%, versus 32.3% a year earlier; the current-quarter rate reflected non-benefited program costs, while the prior-year rate benefited from the SGM settlement gain. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the $208.7 million impairment and restructuring charges, particularly those tied to China, lead to further asset write-downs or costs.
- Progress against the Margin for Growth program’s $375–$425 million charge estimate, $150–$175 million annual savings target and workforce-reduction plan.
- Whether sales and EPS meet guidance, given U.S. non-seasonal category softness, Easter timing and ongoing China challenges.
- Cash conversion and working-capital trends, including inventory build, receivables timing and the implications of overseas cash being designated for permanent reinvestment.
- Commodity, foreign-exchange and interest-rate exposures; the filing disclosed $609.2 million in open commodity derivative notional value and $350 million of interest-rate swaps.