The Hershey Company — Q2 2018 Form 10-Q
Reporting period: Three and six months ended July 1, 2018; comparison with the periods ended July 2, 2017. Hershey sells confectionery, grocery and snack products, primarily in North America. Results are unaudited and subject to seasonality.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First six months 2018 | First six months 2017 |
|---|---|---|---|---|
| Net sales | $1,751.6 million (+5.3%) | $1,663.0 million | $3,723.6 million (+5.1%) | $3,542.7 million |
| Gross margin, reported | 45.3% | 46.1% | 47.5% | 47.3% |
| Operating profit | $315.7 million (-1.5%) | $320.5 million | $796.2 million (+53.8%) | $517.7 million |
| Operating margin, reported | 18.0% | 19.3% | 21.4% | 14.6% |
| Net income attributable to Hershey | $226.9 million (+11.5%) | $203.5 million | $577.1 million (+75.6%) | $328.5 million |
| Diluted EPS, common stock | $1.08 | $0.95 | $2.73 | $1.53 |
| Operating cash flow | Not separately provided | Not separately provided | $602.9 million | $335.7 million |
- Q2 net sales growth reflected a 5.9% contribution from Amplify and 1.0% volume growth, partly offset by 1.6% unfavorable price realization; foreign exchange had no net impact. For the first half, growth included 4.6% from Amplify, 1.8% volume growth and 0.2% favorable currency, offset by 1.5% unfavorable price realization.
- Q2 reported gross margin fell 80 basis points. Management cited higher freight and logistics costs, unfavorable mix, new production-line costs, trade promotions and packaging costs; commodity-derivative mark-to-market gains and productivity partly offset these pressures. Non-GAAP gross margin was 44.5%, down 260 basis points year over year. First-half non-GAAP gross margin was 44.7%, versus 47.3%.
- Q2 net income benefited from higher gross profit and a lower tax rate, partly offset by higher selling, marketing and administrative expense, impairment charges and interest expense. First-half earnings also benefited from substantially lower impairment and realignment charges than in 2017.
- Effective tax rates were 14.1% for Q2 and 19.1% for the first half, versus 27.9% and 33.0%, respectively, in 2017. The lower 2018 rates primarily reflected U.S. tax reform, along with investment tax credits and favorable foreign rate differentials.
Cash, debt and liquidity
- Cash and cash equivalents were $467.4 million at July 1, 2018, up from $380.2 million at December 31, 2017. About 90% was held by non-U.S. subsidiaries; Hershey said it intended to reinvest these funds abroad and believed it had adequate liquidity for U.S. needs.
- First-half cash flows were $602.9 million provided by operations, $1,064.3 million used in investing and $553.2 million provided by financing. Investing included $915.5 million, net of acquired cash, for Amplify and $135.9 million of capital additions.
- At July 1, short-term debt was $1,046.9 million, current long-term debt $304.4 million and long-term debt $3,249.7 million. Debt increased from year-end, principally reflecting Amplify financing. Hershey issued $1.2 billion of notes in May and had $933.4 million of commercial paper outstanding at a weighted-average rate of 2.0%. The company reported compliance with credit-facility covenants.
- First-half dividends paid were $267.9 million and share repurchases were $199.7 million. A further $500 million share-repurchase authorization was approved in July, to begin after the prior authorization is completed.
Material changes, outlook and risks
- Hershey acquired Amplify Snack Brands on January 31 for total consideration of $968.8 million, expanding its snacks portfolio with brands including SkinnyPop. Amplify results are included in North America from the acquisition date. The company recorded $32.7 million of first-half acquisition-related costs.
- The company classified four disposal groups as held for sale. It recorded $27.2 million of impairment charges related to Shanghai Golden Monkey and Tyrrells; Tyrrells was sold July 5 and Shanghai Golden Monkey was sold July 24, after quarter-end. The filing also reports a $2.7 million gain on the sale of non-core licensing rights.
- Management expected North America performance to improve in the second half, citing continued core-brand investment, retailer-space initiatives, the expanded Reese’s Outrageous rollout and visibility into strong Halloween and Holiday orders. It expected international sales and profit trends to continue. Full-year 2018 capital expenditures were expected to be approximately $355 million to $375 million. No full-year revenue or EPS guidance is stated in the provided filing text.
- The Margin for Growth program was estimated to incur total pre-tax charges of $375 million to $425 million from 2017 to 2019, including $150 million to $175 million cash costs; the company expected workforce reductions of approximately 15%. It anticipated about $7 million of additional cash costs over six months to complete remaining Operational Optimization activities.
- Key disclosed risks include commodity and energy costs, supply availability, pricing and demand, competition, manufacturing or supply-chain disruption, acquisition integration, international performance, ERP implementation, cybersecurity and realizing restructuring savings. Pending legal matters were not expected to have a material effect. The filing reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether North America can recover margins amid freight, promotional, mix and production-cost pressures, and whether recent U.S. confectionery takeaway and market-share trends improve.
- Amplify’s contribution to sales, integration costs, expected synergies and the effect of acquisition funding on debt and interest expense.
- Completion and financial effects of the Tyrrells and Shanghai Golden Monkey sales, and any remaining held-for-sale or tax-related valuation adjustments.
- Whether operating cash flow, overseas cash availability, capital spending and debt levels support dividends and repurchases while maintaining liquidity.
- Execution of the Margin for Growth program and ERP rollout, along with exposure to commodity prices, supply-chain costs and other stated risks.