The Hershey Company — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are to the periods ended October 1, 2017. Unaudited consolidated results. Amounts below are in millions of dollars, except per-share data.
Business context and reporting period
Hershey’s North America business generated about 89% of sales. The quarter’s sales growth reflected the January acquisition of Amplify Snack Brands, including SkinnyPop; the company sold Tyrrells and Shanghai Golden Monkey (SGM) in July. Hershey completed its acquisition of Pirate Brands after quarter-end, on October 17.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $2,079.6 | $2,033.1 | $5,803.2 | $5,575.8 |
| Gross profit | $863.5 | $942.9 | $2,631.0 | $2,618.1 |
| Gross margin | 41.5% | 46.4% | 45.3% | 47.0% |
| Operating profit | $406.3 | $461.5 | $1,202.5 | $979.2 |
| Net income attributable to Hershey | $263.7 | $273.3 | $840.8 | $601.8 |
| Diluted EPS, common stock | $1.25 | $1.28 | $3.99 | $2.81 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $892.9 | $625.9 |
- Q3 sales rose 2.3% (3.0% excluding unfavorable currency); reported operating profit fell 12.0%, and diluted EPS fell 2.3%. Adjusted, non-GAAP Q3 EPS was $1.55, up from revised $1.29.
- Nine-month sales increased 4.1% (4.2% constant currency); reported net income rose 39.7% and diluted EPS 42.0%. Lower impairment and restructuring charges and a lower tax rate contributed to the comparison.
- Q3 reported gross margin declined 490 basis points. The company cited a $69.6 million unfavorable year-over-year commodity-derivative mark-to-market impact, higher freight and logistics, plant costs, trade promotions and packaging; productivity and favorable mix partly offset these pressures. Non-GAAP gross margin was 44.0%, down 130 basis points.
- Nine-month operating cash flow was $892.9; investing used $972.2 and financing provided $529.0. Capital expenditures were $241.2. Cash increased $443.6 from year-end 2017 to $823.8.
- At September 30, current assets were $2,794.0 and current liabilities $2,758.8. Short-term debt was $1,449.2 and long-term debt, including current portion, was $3,257.0. Total debt was approximately $4,706.2, compared with approximately $2,919.4 at year-end 2017.
- Dividends paid in the first nine months were $415.2; share repurchases totaled $199.7.
Material changes and unusual items
- Amplify’s acquisition consideration was $968.8 million; cash paid net of acquired cash was $915.5 million. The acquisition substantially increased goodwill and intangibles and was funded initially with commercial paper. Acquisition-related costs were $36.4 million for the nine-month period.
- Hershey issued $1.2 billion of notes in May, repaid $300 million of notes at maturity in August, and repaid $607 million of Amplify debt. Higher borrowing contributed to increased net interest expense: $101.2 million for nine months versus $72.5 million.
- Q3 included $1.6 million of impairment charges; nine-month impairment charges were $28.8 million, primarily related to SGM and Tyrrells disposals. Nine-month business realignment costs were $42.7 million, versus $69.7 million a year earlier.
- The nine-month effective tax rate was 21.3%, compared with 32.4%, reflecting U.S. tax reform and other tax items. The Q3 rate was 25.6%, versus 31.6%.
- Pirate Brands was acquired after quarter-end for approximately $420 million; the filing said it was expected to generate about $90 million in annualized sales. Purchase-price allocation was still in progress.
Outlook, commentary and risks
Management said its outlook for the remainder of 2018 was unchanged and reiterated focus on financial targets previously outlined, but this filing does not state specific full-year sales or earnings guidance. It expected full-year capital expenditures of approximately $355 million to $375 million. Management highlighted continued investment in core brands, holiday programs, product launches, and expected sales and profit trends in international markets.
Key disclosed risks include commodity and energy costs and supply availability; pricing and volume sensitivity; product quality and safety; competition and demand; manufacturing or supply-chain disruption; acquisition and divestiture integration; international-market performance; information-technology and ERP implementation; and realization of restructuring savings. Commodity contracts had $823.8 million notional value; a hypothetical 10% commodity-price decline would increase unrealized losses by $77.4 million, generally offset by lower underlying purchase costs. Management said pending legal matters were not expected to have a material effect. No material changes to previously disclosed risk factors were reported.
Investor verification priorities
- Assess how much sales growth and earnings from Amplify and Pirate Brands can be sustained, and confirm integration progress and acquisition economics.
- Track gross-margin recovery, especially commodity-derivative mark-to-market swings, freight, plant costs, promotional spending and packaging costs.
- Verify debt growth, refinancing needs, interest expense and liquidity after acquisitions; note that cash balances included substantial funds held by foreign subsidiaries.
- Monitor North America pricing, consumer takeaway and market share: U.S. candy, mint and gum takeaway was flat and market share declined about 13 basis points in the reported measurement period.
- Review the assumptions and exclusions behind non-GAAP results, restructuring charges, impairments and the lower tax-rate comparison.