The Hershey Company — Q2 2013 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods. Hershey noted that its seasonal business means first-half results may not indicate full-year performance.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net sales | $1,508.5 million | $1,414.4 million | $3,335.9 million | $3,146.5 million |
| Gross margin | 47.6% | 43.7% | 47.0% | 43.3% |
| EBIT | $268.9 million | $222.3 million | $660.7 million | $556.8 million |
| EBIT margin | 17.8% | 15.7% | 19.8% | 17.7% |
| Net income | $159.5 million | $135.7 million | $401.4 million | $334.3 million |
| Diluted EPS, common stock | $0.70 | $0.59 | $1.77 | $1.46 |
| Net interest expense | $21.1 million | $24.3 million | $44.7 million | $48.4 million |
Q2 sales rose 6.7%, principally on 6.6% higher volume; favorable foreign exchange contributed 0.1%. First-half sales increased 6.0%, reflecting volume growth, including expanded U.S. distribution of Brookside products. Management attributed gross-margin improvement to lower input costs, supply-chain productivity, favorable mix and lower fixed costs as a share of sales; inflation partly offset those benefits. SM&A expense rose 14.0% in Q2 and 12.5% year to date, including higher marketing, employee-related, legal and incentive compensation costs. Advertising expense increased 22.4% in Q2 and 22.0% in the first half.
Cash, debt and liquidity
- Operating cash flow for the first six months was $349.4 million, versus $314.2 million a year earlier. Investing activities used $159.5 million and financing activities used $349.9 million.
- Cash declined $159.9 million from year-end to $568.4 million. First-half capital additions were $151.7 million; cash dividends were $182.9 million and common-stock repurchases were $305.6 million.
- At June 30, current assets were $1,998.9 million and current liabilities were $1,084.2 million; the current ratio was 1.8, versus 1.4 at year-end. Short-term debt was $99.1 million, with no commercial-paper borrowings reported.
- Total short-term and long-term debt was approximately $1,896.9 million. The company repaid $250 million of 5.0% notes due in 2013 and issued $250 million of 2.625% notes due in 2023. The capitalization ratio was 63%, compared with 65% at year-end.
Outlook, risks and unusual items
- Hershey projected 2013 net sales growth of about 7%, including foreign-exchange effects, and GAAP diluted EPS of $3.60–$3.65, implying 24%–26% growth versus 2012. Adjusted diluted EPS guidance was $3.68–$3.71, or about 14% growth.
- Management expected reported gross margin to expand 300–310 basis points and adjusted gross margin to expand 220–230 basis points. Advertising was expected to increase about 20%; SM&A excluding advertising was expected to grow faster than sales, particularly in Q3.
- Management cited continued investment in core brands, new products, Brookside distribution and international capabilities. The company estimated $10–$15 million of 2013 Next Century program charges; its longer-term estimate for that program was $190–$200 million in total charges and implementation costs.
- Q2 effective tax rate was 35.6%, compared with 31.4% a year earlier; the prior-year quarter benefited from an approximately $11.5 million tax-audit adjustment. The company expected a full-year 2013 tax rate of about 35%.
- Hershey Canada pleaded guilty to one count of price fixing related to 2007 competitor communications and paid an approximately $4 million fine in June 2013. The filing also identifies pending U.S. antitrust proceedings as a risk.
- Other disclosed risks include raw-material and energy costs and availability, pricing and demand, competition, supply-chain disruption, product quality and safety, international operations, acquisitions, regulatory changes, information-technology disruptions and pension funding. The company reported compliance with its credit-agreement covenants and effective disclosure controls.
Important facts for investors to verify
- Whether volume-led sales growth and market-share gains persist, and whether the projected 7% full-year sales growth is achieved.
- Whether gross-margin expansion offsets supply-chain inflation and the planned increase in advertising and other commercial spending.
- Progress toward full-year GAAP and adjusted EPS guidance, including the effects of tax rates and program charges.
- Cash generation and capital allocation, particularly the substantial first-half share repurchases and dividends relative to operating cash flow.
- Developments in the Canadian and U.S. antitrust matters and any resulting financial or reputational consequences.