The Hershey Company — Q3 2010 Form 10-Q
Reporting period: Quarter ended October 3, 2010; comparisons are with the quarter ended October 4, 2009. Financial statements are unaudited. The filing cautions that results for the first nine months may not indicate full-year results because of seasonality.
Financial performance
| Metric | Q3 2010 | Q3 2009 | First 9 months 2010 | First 9 months 2009 |
|---|---|---|---|---|
| Net sales | $1,547.1 million | $1,484.1 million | $4,188.2 million | $3,891.3 million |
| Gross profit / margin | $655.2 million / 42.4% | $589.1 million / 39.7% | $1,795.7 million / 42.9% | $1,482.6 million / 38.1% |
| EBIT / margin | $299.6 million / 19.4% | $279.6 million / 18.8% | $677.4 million / 16.2% | $549.2 million / 14.1% |
| Net income | $180.2 million | $162.0 million | $374.3 million | $309.2 million |
| Diluted EPS, Common Stock | $0.78 | $0.71 | $1.63 | $1.35 |
Quarterly sales rose 4.2%, reflecting core U.S. brand volume growth, new products, price realization and favorable currency. Nine-month sales rose 7.6%, driven by volume, pricing and currency. Q3 consumer takeaway increased 3.6% and measured-channel share rose 0.1 point; nine-month takeaway increased 4.7% and share rose 0.2 point.
Higher gross margins and lower net realignment charges supported operating profit. These gains were partly offset by greater selling, marketing and administrative spending: up 18.6% in Q3 and 18.4% year to date. Advertising expense increased 46% in Q3 and 53.5% year to date. Net interest expense was essentially unchanged. The effective tax rate was 35.0% in Q3 versus 37.0%; year to date it was 38.5% versus 35.6%.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $388.2 million, down from $635.5 million. The filing attributes the decline mainly to weaker cash contribution from other assets and liabilities and greater working-capital use. Working capital used $193.3 million, versus $58.3 million a year earlier, principally due to higher receivables and seasonal inventories.
- Investing cash outflow was $121.6 million; capital additions and capitalized software totaled $123.7 million. Financing cash outflow was $275.2 million, including $212.6 million of dividends and $133.4 million of share repurchases.
- Cash was $244.9 million at October 3, 2010, down $8.7 million from year-end 2009. Current assets were $1,664.8 million and current liabilities $1,270.1 million; the current ratio was 1.3, down from 1.5 at year-end.
- Total short- and long-term debt was approximately $1,527.5 million, versus $1,542.0 million at December 31, 2009. Long-term debt, including current maturities, had a $1,512.5 million carrying value and $1,745.9 million fair value. No commercial paper was outstanding at quarter-end. The $1.1 billion revolving credit facility, with a potential additional $400 million subject to lender agreement, expires in December 2012; the company reported compliance with its covenants.
Material changes and unusual items
- Year-to-date business realignment and impairment charges were $83.1 million on the income statement, including a $44.7 million noncash goodwill impairment for Godrej Hershey Ltd. and charges associated with Project Next Century. The impairment reflected operating performance and future cash-flow expectations below prior expectations; the filing reported no tax benefit for it.
- Project Next Century will shift production from Hershey’s 19 East Chocolate Avenue facility to an expanded West Hershey facility, with an expected reduction of approximately 500–600 jobs. Estimated total pretax charges and implementation costs are $140–$170 million over three years. The company expected $75–$85 million of program charges in 2010 and approximately $50 million of 2010 capital spending for the project.
- Share repurchases totaled $133.4 million year to date, primarily to replace treasury shares issued for compensation and option exercises; no open-market purchases under the public program were reported in the quarter. $100 million remained available under the program.
- On November 1, 2010, the board elected John P. Bilbrey Chief Operating Officer, effective November 2.
Guidance, management commentary and risks
For 2010, management continued to expect sales growth of about 7%, including approximately 1% from foreign exchange; diluted GAAP EPS of $2.09–$2.16; and adjusted diluted EPS of $2.52–$2.56. The adjusted outlook excludes business realignment and impairment charges; the filing’s reconciliation estimates these at $0.40–$0.43 per share for 2010, including the Godrej impairment. Management expected advertising investment to rise 50%–60%, elevated costs to persist, and productivity to support full-year margin improvement, though at a slower pace than in the first nine months. Capital additions were projected at $190–$210 million.
For 2011, management expected sales growth within its 3%–5% long-term target and adjusted diluted EPS growth of 6%–8%. The outlook cited higher anticipated input costs, partially mitigated by productivity and cost savings. Management described the economic environment as challenging and noted volatile commodity markets and a shift of some seasonal orders from Q4 2010 into Q1 2011. The filing’s reconciliation also showed projected 2011 GAAP diluted EPS of $2.55–$2.67 and adjusted diluted EPS of $2.67–$2.76.
Risks identified include commodity and energy prices and supply availability; pricing and consumer demand; competition; product quality and safety; supply-chain disruptions; execution of the restructuring and international joint ventures; foreign-exchange and market exposures; pension costs; and potential regulatory developments concerning alleged confectionery-industry pricing practices. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether volume, pricing and market-share gains continue to offset higher marketing expense and input costs.
- Whether operating cash flow recovers as seasonal receivables and inventory unwind, given the year-over-year deterioration in cash conversion.
- Actual costs, timing, workforce effects and expected savings from Project Next Century, including the distinction between project costs and the separate Godrej goodwill impairment.
- Progress and future cash-flow assumptions for Godrej Hershey Ltd., and whether further impairment is required.
- Delivery against 2010 and 2011 guidance, including the assumptions and exclusions underlying adjusted EPS.
- Debt maturities, interest-rate exposure and compliance with revolving-credit covenants.