The Hershey Company — Q2 2011 Form 10-Q
Business context and reporting period. The filing covers the three and six months ended July 3, 2011, compared with periods ended July 4, 2010. Hershey’s results are seasonal, and the company cautioned that first-half results may not indicate full-year performance. Financial amounts below are in millions of dollars, except per-share data.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $1,325.2 | $1,233.2 | $2,889.4 | $2,641.1 |
| Gross margin | 42.6% | 44.3% | 42.2% | 43.2% |
| Operating income (EBIT) | $228.4 | $124.4 | $504.9 | $377.8 |
| EBIT margin | 17.2% | 10.1% | 17.5% | 14.3% |
| Net income | $130.0 | $46.7 | $290.1 | $194.1 |
| Diluted EPS, Common Stock | $0.56 | $0.20 | $1.26 | $0.84 |
- Revenue and margins: Sales rose 7.5% in Q2 and 9.4% year to date. Q2 sales growth reflected approximately 4% higher volume, 3% net price realization and 0.5% favorable currency, with rounding and other effects. First-half volume increased about 8%; price realization and currency also contributed. Gross margin contracted as higher input and supply-chain costs outpaced productivity and pricing benefits.
- Cash flow: First-half operating cash flow was $286.7, up from $264.8. Capital additions and capitalized software totaled $180.0; dividends paid were $152.7 and share repurchases were $192.9. Cash declined $94.3 to $790.3, partly reflecting these uses and seasonal inventory investment.
- Debt and liquidity: July 3 current assets were $1,992.1 and current liabilities $1,221.8; management reported a 1.6:1 current ratio. Short-term debt was $34.5, current long-term debt $259.4 and long-term debt $1,541.4. The reported capitalization ratio was 64%, down from 66% at year-end 2010. No commercial paper was outstanding at quarter-end; the company reported compliance with covenants on its $1.1 billion revolving credit facility.
Material changes versus comparable periods
- Reported profit and EBIT increased substantially, but comparisons were materially affected by unusual realignment and impairment items. Q2 2010 included $85.1 of net charges, including a $44.7 noncash goodwill impairment at Godrej Hershey; Q2 2011 recorded $10.0 of net credits. For the first half, the corresponding figures were $85.1 of charges in 2010 and $8.1 of credits in 2011.
- Excluding realignment and impairment items, Q2 adjusted diluted EPS increased 9.8%; first-half adjusted diluted EPS increased 11.3%, according to management. Reported first-half diluted EPS rose 50.0%.
- Q2 gross margin fell 1.7 percentage points; management attributed a 1.3-point decline to higher input and supply-chain costs after excluding realignment effects. First-half gross margin decreased 1.0 point, including pressure from input costs and higher realignment charges.
- Advertising expense increased 8% in Q2 and 19.3% in the first half. Management cited higher advertising and employee-related expenses, partly offset by lower incentive compensation.
- Inventories increased to $659.2 from $533.6 at December 31, 2010, primarily reflecting seasonal patterns and preparations for production transitions under Project Next Century.
Outlook, commentary and risks
- For full-year 2011, management expected sales growth of around 6%, above its 3%–5% long-term objective, and adjusted diluted EPS growth of around 10%, above its 6%–8% long-term objective. Projected adjusted diluted EPS was $2.79–$2.82, excluding projected realignment charges of $0.11–$0.12 per share; projected reported diluted EPS was $2.67–$2.71.
- Management expected the effective tax rate to be approximately 35% for 2011, excluding the impact of realignment and impairment items. It expected elevated costs and volatile commodity markets to continue, while productivity improvements would partly mitigate input-cost pressure.
- The March 2011 wholesale price increase averaged approximately 9.7%, but management did not expect significant 2011 benefit; seasonal net price realization was not expected until Easter 2012. The company also expected full-year advertising expense to increase in the mid-single digits.
- Project Next Century is intended to transition production from the 19 East Chocolate Avenue plant to an expanded West Hershey facility. Estimated total pretax charges and implementation costs were $140–$160; 2011 charges were projected at $38–$43 and project capital expenditures at approximately $190–$200. Management reduced its estimate of employees leaving under severance plans to about 400 from 500–600.
- Key risks identified include commodity and energy costs and supply, the ability to pass on price increases without volume loss, product quality and safety, competition, supply-chain disruption, international operations, execution of acquisitions and joint ventures, pension costs, and Project Next Century timing and cost. Management said it did not anticipate tax audit adjustments having a significant financial impact; it expected approximately $22 of unrecognized tax benefits to reverse within 12 months.
Important facts for investors to verify
- How much of reported earnings growth reflects underlying operations versus the unusually favorable comparison in realignment and impairment items; confirm the assumptions and reconciliation for adjusted EPS.
- Whether pricing and productivity offset persistent commodity, supply-chain and product-obsolescence costs, and whether the expected price benefit begins as projected in 2012.
- Whether sales growth, adjusted EPS, advertising and tax-rate guidance remain achievable through the seasonal second half of the year.
- Project Next Century’s remaining charges, capital spending, production-transition schedule and severance estimates, including any effect on supply or costs.
- Cash conversion and liquidity as inventory builds and the company funds dividends, repurchases and capital spending; monitor debt maturities and revolving-credit covenants.