The Hershey Company — Q3 2019 Form 10-Q
Reporting period: Quarter ended September 29, 2019; comparisons are with the quarter ended September 30, 2018. Year-to-date figures cover the first nine months of each year. Amounts are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Business context
Hershey sells confectionery, pantry and snack products in approximately 90 countries. North America generates about 89% of revenue. In September 2019, Hershey acquired ONE Brands, a U.S. nutrition-bar business, for approximately $401.5 million. Management expects ONE Brands to generate annualized net sales of approximately $100 million.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | First 9 months 2019 | First 9 months 2018 |
|---|---|---|---|---|
| Net sales | $2,134.4 million | $2,079.6 million | $5,918.1 million | $5,803.2 million |
| Gross profit | $943.3 million | $863.5 million | $2,710.6 million | $2,631.0 million |
| Gross margin | 44.2% | 41.5% | 45.8% | 45.3% |
| Operating profit | $460.8 million | $406.3 million | $1,309.8 million | $1,202.5 million |
| Operating margin | 21.6% | 19.5% | 22.1% | 20.7% |
| Net income attributable to Hershey | $325.3 million | $263.7 million | $942.5 million | $840.8 million |
| Diluted EPS, common stock | $1.54 | $1.25 | $4.47 | $3.99 |
| Operating cash flow | Not presented separately for the quarter | Not presented separately for the quarter | $993.4 million | $892.9 million |
At September 29, 2019, cash and cash equivalents were $302.6 million; short-term debt was $1,275.4 million, current long-term debt was $353.0 million, and long-term debt was $2,892.3 million. Total debt was approximately $4.52 billion. The company had a $1.5 billion revolving credit facility, was in compliance with its covenants, and reported no significant restrictions on funds. Approximately 85% of cash was held by foreign subsidiaries; management said it did not currently expect to need repatriation to fund U.S. operations.
Year-to-date investing cash use was $697.6 million, including the ONE Brands acquisition; financing cash use was $582.8 million. Cash declined $285.4 million from year-end 2018. Dividends paid were $453.2 million and share repurchases were $445.9 million in the first nine months.
Material changes versus the prior comparable period
- Q3 sales rose 2.6%; management attributed the increase to 1.1% favorable price realization, 1.2% from net acquisitions and divestitures, and 0.5% volume growth, partly offset by 0.2% foreign-exchange headwind.
- Q3 diluted EPS increased 23.2% and net income attributable to Hershey increased 23.4%. Higher operating profit and a lower effective tax rate were the primary drivers.
- Q3 gross margin expanded 270 basis points. Management cited favorable commodity-derivative mark-to-market impacts, supply-chain productivity, pricing and mix; higher freight and logistics costs partly offset the gains.
- For the first nine months, sales increased 2.0%, operating profit 8.9%, and diluted EPS 12.0%. The effective tax rate declined to 19.2% from 21.3%.
- Year-to-date North America sales rose 2.2% and segment income rose 4.7%. International and Other sales were nearly flat, while segment income increased 24.8%, supported by margin initiatives and growth in markets including Mexico and India.
Outlook, commentary, risks and unusual items
- Management expected 2019 capital expenditures, including capitalized software, to be approximately $350 million. The filing does not provide a clear full-year revenue or earnings guidance figure.
- Management noted that quarterly results may not indicate full-year results because of seasonal effects. It described U.S. retail takeaway growth and confectionery market-share gains in Q3, while reporting increased North America advertising spending and higher freight and logistics costs.
- Commodity derivatives materially affected reported comparisons: Q3 included a $62.0 million favorable year-over-year mark-to-market impact on cost of sales. Year-to-date, the favorable impact was $24.2 million. These mark-to-market effects can reverse or shift as hedged inventory is sold; $53.8 million of cumulative commodity-derivative gains had been recognized but not yet allocated to segment results.
- ONE Brands’ preliminary purchase-price allocation included $178.2 million of goodwill and $206.8 million of intangible assets; valuation remained subject to finalization. Year-to-date acquisition-related costs were $8.0 million.
- Year-to-date unusual charges included $4.7 million of asset impairments and $8.5 million of business realignment costs. Q3 also included pension settlement charges; the filing reports $4.8 million for the quarter. Equity-investment write-downs were $18.6 million year to date.
- Key disclosed risks include product quality and safety, raw-material and energy costs and availability, pricing and demand, competition, supply-chain disruption, acquisition integration, international performance, IT security and ERP implementation, and realization of restructuring savings. The company said pending legal matters were not expected to have a material effect and reported no material changes to its previously disclosed risk factors.
Important facts for investors to verify
- How much of the margin and earnings improvement is recurring versus attributable to commodity-derivative mark-to-market effects, tax benefits and lower prior-year impairment or restructuring charges.
- ONE Brands’ final purchase-price allocation, integration progress and realized contribution relative to management’s approximately $100 million annualized sales expectation.
- Working-capital trends, particularly seasonal receivables and inventory, alongside cash conversion and the effect of foreign-held cash on liquidity planning.
- Debt maturities, refinancing needs and interest-rate exposure; the filing estimates that a 100-basis-point increase applied to short-term variable-rate debt would increase nine-month interest expense by approximately $5.5 million.
- Progress toward the stated 2019 capital-spending estimate and completion of remaining asset sales and realignment activities.