The Hershey Company — Q1 2016 Form 10-Q
Reporting period: Three months ended April 3, 2016; unaudited. Comparisons are with the three months ended April 5, 2015, unless noted. Hershey’s business is seasonal, and the company cautions that quarterly results may not indicate full-year performance.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $1.829 billion | $1.938 billion | Down 5.6%; down 4.4% at constant currency |
| Operating profit | $339.5 million | $384.2 million | Down 11.6% |
| Operating margin | 18.6% | 19.8% | Down 1.2 percentage points |
| Net income | $229.8 million | $244.7 million | Down 6.1% |
| Diluted EPS, common stock | $1.06 | $1.10 | Down 3.6% |
| Reported gross margin | 44.7% | 46.5% | Down 1.8 percentage points |
| Non-GAAP gross margin | 46.8% | 46.6% | Up 0.2 percentage points |
| Operating cash flow | $257.1 million | $259.2 million | Down $2.1 million |
Reported results included $34.9 million of unallocated commodity-derivative mark-to-market losses, $14.4 million of business realignment charges, and a $26.7 million gain from settling the Shanghai Golden Monkey (SGM) purchase liability. Non-GAAP diluted EPS was $1.10 versus $1.09 a year earlier; these measures exclude specified items and are not GAAP results.
Cash, debt and liquidity
- Cash and equivalents were $286.0 million at quarter-end, down from $346.5 million at December 31, 2015.
- Total debt was approximately $2.592 billion, comprising $520.6 million of short-term debt and $2.071 billion of long-term debt, including its current portion. Approximately $500 million of long-term debt was classified as current.
- Operating cash flow was $257.1 million; investing activities used $49.2 million and financing activities used $271.2 million. Financing uses included $304.0 million of share repurchases, $122.4 million of dividends, and $35.8 million to buy the remaining SGM interest, partly offset by increased short-term borrowing.
- The company had a $1.0 billion revolving credit facility, expiring in November 2020, and reported compliance with its covenants. It said it had sufficient liquidity. About two-thirds of cash was held by foreign subsidiaries and intended to remain invested abroad.
- 2016 capital expenditures, including capitalized software, were expected to be approximately $285 million to $295 million.
Changes and business developments
- Sales declined on lower volume, unfavorable currency and slightly unfavorable net price realization. Management attributed lower North American volume largely to the shorter Easter season and lighter non-seasonal activity ahead of planned launches and merchandising; China sales were also weaker.
- North America sales fell 4.3%; segment income fell 4.5% to $529.4 million. International and Other sales fell 15.4% to $195.3 million, while its segment loss narrowed to $13.2 million from $21.8 million.
- Reported gross margin was pressured by commodity derivative mark-to-market losses and higher supply-chain costs. Excluding specified items, productivity savings and lower commodity costs lifted gross margin by 0.2 percentage points.
- On February 3, Hershey acquired the remaining 20% of SGM for $35.8 million; the revised settlement generated the $26.7 million gain. On April 26, after quarter-end, Hershey completed its acquisition of barkTHINS owner Ripple Brand Collective; the filing provides no purchase price.
- The company repurchased 3.37 million shares for $304.0 million. A new $500 million authorization was approved in February; approximately $216 million remained available at quarter-end.
Outlook, commentary and risks
- Management projected 2016 constant-currency sales growth of approximately 2.5%, including a 0.5% net benefit from acquisitions and divestitures, and an approximately 1.0% unfavorable currency impact. Excluding currency and barkTHINS, expected sales growth was about 2.0%, down from the prior 3.0% estimate due primarily to weaker-than-expected non-seasonal growth.
- Non-GAAP gross margin was expected to be slightly below 2015, reflecting unfavorable sales mix. Management expected to exceed its initial productivity and cost-savings target by $10 million to $15 million, while increasing consumer marketing investment.
- Adjusted 2016 diluted EPS was projected at $4.24–$4.28, growth of 3%–4%, including estimated barkTHINS dilution of $0.05–$0.06 per share. The projection excludes future commodity-derivative mark-to-market effects until related inventory is sold.
- Management expected new products, advertising and in-store activity to support sales acceleration later in the year. The China business and workforce structure was being optimized; the company was also assessing potential excess capacity and long-lived asset values in the region.
- Business realignment charges were $14.4 million in Q1. The 2015 Productivity Initiative was expected to cost about $110 million in total before any additional 2016 pension-settlement costs; remaining costs were expected over the next two quarters. China restructuring costs began in Q1.
- Key stated risks include commodity and energy costs and availability, pricing and demand, competition, product safety, supply-chain disruption, acquisition integration (including SGM), international growth, regulation, economic conditions and information-technology security. Pending legal matters were not expected to have a material effect.
- Disclosure controls were deemed effective. The filing describes a previously disclosed material weakness in hedge-accounting compliance for cocoa derivatives; Hershey no longer designates commodity derivatives for hedge accounting, so the related controls were considered no longer relevant and remediation was not planned.
Most important facts for investors to verify
- Whether sales and volume recover as planned, especially in North America after seasonal timing effects and in China amid weak demand and competition.
- Whether the stated 2016 sales, margin, productivity and adjusted EPS outlook is achieved, including the impact of mix, marketing spending and barkTHINS.
- Commodity-derivative accounting and volatility: Q1 reported results included significant mark-to-market losses, while management’s adjusted measures exclude specified effects.
- Debt maturities and liquidity, including the approximately $500 million current portion of long-term debt, short-term borrowing levels and overseas cash availability.
- Execution and costs of the SGM integration, China restructuring and 2015 Productivity Initiative, as well as the post-quarter barkTHINS acquisition terms and performance.