Business context and reporting period
The Hershey Company’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2019, compared with the periods ended July 1, 2018. Hershey sells confectionery and snack products in North America and international markets; North America generated about 89% of sales. Results are seasonal and the company cautions that interim performance may not indicate full-year results.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $1,767.2m | $1,751.6m | $3,783.7m | $3,723.6m |
| Gross margin | 49.5% | 45.3% | 46.7% | 47.5% |
| Operating profit | $410.1m | $315.7m | $848.9m | $796.2m |
| Net income attributable to Hershey | $312.8m | $226.9m | $617.2m | $577.1m |
| Diluted EPS, common stock | $1.48 | $1.08 | $2.93 | $2.73 |
| Operating cash flow | Not provided separately for the quarter | $679.3m | $602.9m |
- Q2 sales rose 0.9%; higher pricing and volume were partly offset by currency and the net effect of acquisitions and divestitures. First-half sales rose 1.6%, including 1.1% volume growth and 0.8% favorable price realization, partly offset by currency.
- Q2 reported gross margin increased 420 basis points, principally reflecting a $55.3m favorable commodity-derivative mark-to-market impact, product mix and supply-chain productivity. First-half reported margin declined 80 basis points, including a $37.9m unfavorable year-over-year derivative impact.
- Reported Q2 diluted EPS was $1.48 versus non-GAAP EPS of $1.31; first-half figures were $2.93 and $2.89, respectively. The company’s non-GAAP adjustments include commodity-derivative mark-to-market effects and specified realignment, acquisition and impairment costs. These adjustments materially affect comparisons.
- North America Q2 sales were $1,568.0m, up 0.5%, and segment income was $470.9m, up 6.1%. International and Other sales were $199.2m, up 3.9%, and segment income was $21.9m, up 31.9%.
Cash flow, debt and liquidity
- First-half operating cash flow was $679.3m; capital additions, including software, were $176.3m, implying approximately $503.1m of operating cash flow less capital additions. Investing activities used $206.4m and financing activities used $698.7m.
- Cash was $366.0m at June 30, down from $588.0m at year-end 2018. Inventory increased to $958.0m from $784.9m, partly reflecting seasonal build. First-half dividends were $295.5m and share repurchases were $254.4m.
- Total debt, including short-term debt and current and long-term portions, was approximately $4.13bn, versus $4.46bn at year-end. Current liabilities exceeded current assets ($2.39bn versus $2.09bn). The filing says the company believes liquidity is sufficient, including for U.S. cash needs; approximately 60% of cash was held by foreign subsidiaries, with current plans to reinvest it abroad.
- On July 2, 2019, Hershey replaced its $1.4bn revolving facility with a $1.5bn facility, with an option to increase capacity by $500m subject to lender consent. The new facility is scheduled to mature in 2024, subject to extension options.
Changes, outlook, risks and unusual items
- Q2 earnings growth was substantially stronger than first-half growth, while the first-half reported gross margin declined year over year. Commodity-derivative mark-to-market gains boosted Q2 reported results; the company excludes such timing effects in certain non-GAAP comparisons.
- Management expected 2019 capital expenditures, including capitalized software, of approximately $330m–$350m. It said remaining Margin for Growth program spending should be minimal in 2019. The filing provides no specific full-year sales or EPS guidance.
- Q2 included $4.7m of long-lived asset impairment charges, mainly select land and a contingency arising after the 2018 Tyrrells divestiture; settlement payment was expected in 2019. Business realignment costs were $6.4m for the quarter. The Margin for Growth program had incurred $343.2m of charges to date, against an original estimate of $375m–$425m.
- Hershey expected to complete the sale of the remaining Lotte Shanghai Foods joint-venture business and certain Pennsylvania assets during 2019. Ordinary-course legal proceedings were not expected to have a material effect, individually or in aggregate.
- Principal disclosed risks include product quality and safety, raw-material and energy costs and availability, pricing and volume responses, competition, supply-chain disruption, acquisition integration, international-market performance, IT security and ERP implementation, and realizing planned cost savings. The company reported no material changes to its previously disclosed risk factors.
- Disclosure controls were assessed as effective at June 30, 2019. The multi-year ERP rollout continued; completed system transitions had not significantly changed internal financial controls.
Important facts for investors to verify
- How much of Q2 margin and earnings improvement reflects underlying operations versus commodity-derivative mark-to-market gains, and how do GAAP and non-GAAP results compare?
- Whether sales growth, pricing, volume and segment profitability remain durable, particularly in North America and international markets.
- How working-capital seasonality, higher inventory, capital spending, dividends and repurchases affect cash generation and liquidity.
- Debt maturities, commercial-paper reliance, covenant compliance and the availability and terms of the replacement revolving facility.
- Completion and proceeds of the pending asset and joint-venture sales, the Tyrrells-related contingency settlement, and remaining restructuring costs.