The Hershey Company — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended July 3, 2016; comparisons are with the periods ended July 5, 2015. Hershey’s business is seasonal, and the filing cautions that interim results may not indicate full-year performance. North America generates more than 85% of annual revenue.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First six months 2016 | First six months 2015 |
|---|---|---|---|---|
| Net sales | $1,637.7m (+3.7%) | $1,578.8m | $3,466.5m (-1.4%) | $3,516.6m |
| Gross margin, reported | 45.6% | 46.6% | 45.1% | 46.5% |
| Operating profit | $262.8m | $7.5m | $602.3m | $391.7m |
| Net income (loss) | $146.0m | $(99.9)m | $375.8m | $144.8m |
| Diluted EPS, common stock | $0.68 | $(0.47) | $1.74 | $0.65 |
| Cash from operations | Not separately provided for the quarter | $347.1m | $486.3m |
- Q2 sales growth reflected higher volume, favorable net pricing and the barkTHINS acquisition, partly offset by foreign exchange. Constant-currency sales increased 4.5%.
- Reported Q2 operating profit and earnings comparisons are heavily affected by the $249.8m non-cash SGM goodwill impairment recorded in Q2 2015. Excluding specified items, Q2 adjusted diluted EPS was $0.85 versus $0.78; adjusted net income rose 6.2%.
- Q2 reported gross margin declined 100 basis points; non-GAAP gross margin declined 120 basis points. Higher commodity and supply-chain costs and unfavorable mix pressured margins, partly offset by productivity savings and commodity derivative gains.
- For the first six months, adjusted diluted EPS was $1.95 versus $1.87. Adjusted operating profit rose 0.9%; these non-GAAP measures exclude specified unusual and non-operating items.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $250.2m, down from $346.5m at year-end 2015. Current assets were $1.81bn versus current liabilities of $2.67bn.
- Total debt was approximately $3.07bn, including $997.1m short-term debt, $500.1m current long-term debt and $1.57bn long-term debt. Short-term debt rose from $363.5m at year-end, including $795.4m of commercial paper outstanding at a 0.44% weighted-average rate.
- The company generated $347.1m of operating cash, used $404.6m in investing activities and used $40.6m in financing activities during the six-month period. Operating cash flow fell $139.2m year over year, principally due to working-capital needs and lower receipts from commodity derivative activity.
- Investing cash outflow included $285.4m for the barkTHINS acquisition. Capital additions were $104.1m; full-year capital expenditure guidance was $265m–$275m.
- Cash dividends paid were $243.1m and share repurchases were $452.6m in the first six months. $100m remained under the $500m repurchase authorization at July 3, 2016. The company stated that it had sufficient liquidity and was in compliance with credit-facility covenants.
Changes, outlook and notable items
- Q2 North America sales rose 3.2%, but segment income declined 7.6% to $425.7m and segment margin fell to 29.5% from 32.9%, reflecting promotions, commodity costs, mix and increased advertising. U.S. confectionery takeaway fell 1.1% and market share declined 0.7 percentage points in the 12-week period reported.
- International and Other Q2 sales increased 7.6% to $192.8m, while the segment remained loss-making at $3.5m. China faced macroeconomic and competitive challenges; lower trade spending and allowances improved comparisons. Six-month segment sales fell 5.3% and the segment loss was $16.7m.
- Hershey acquired barkTHINS in April for approximately $285.4m; the brand was expected to contribute $65m–$75m of 2016 annual sales. The purchase-price allocation was preliminary. The company also completed its purchase of the remaining 20% of Shanghai Golden Monkey (SGM), recording a $26.7m settlement gain.
- A new Operational Optimization Program is expected to cost approximately $120m over three years, including about $65m of non-cash asset-related depreciation, and generate approximately $45m in annual savings by 2018. The separate 2015 Productivity Initiative had incurred $122.0m through the period; remaining costs were expected in Q3 2016.
- Full-year 2016 net sales growth was projected at approximately 1%, including a 0.5% net benefit from acquisitions and divestitures and a 1.0% foreign-exchange headwind; constant-currency growth was expected to be approximately 2%, below the prior 2.5% estimate. Management cited weaker expected U.S. candy, mint and gum category growth and China macroeconomic pressures.
- Management expected full-year gross margin to be slightly below 2015 levels. Adjusted diluted EPS guidance was $4.24–$4.28, up 3%–4% versus 2015, including $0.05–$0.06 of barkTHINS acquisition dilution. Reported diluted EPS was projected at $3.77–$3.86, with the difference reflecting specified adjustments.
- Commodity derivatives ceased to receive hedge accounting treatment on specified dates. Their fair-value changes are recorded before the related inventory is sold, creating reported volatility; management’s segment measures defer those effects until the underlying inventory is sold.
- Other risks include commodity and energy costs, pricing and volume sensitivity, competition, product safety, supply-chain disruption, acquisition integration, foreign exchange, and political and economic conditions in international markets. Pending legal matters were not expected by management to have a material effect.
Investor facts to verify
- Whether second-half sales and category performance support the revised full-year sales outlook, particularly in the U.S. and China.
- Whether gross-margin pressure, promotional spending and commodity costs persist, and how derivative mark-to-market timing affects reported results.
- Progress, costs and expected savings from the Operational Optimization Program and remaining 2015 Productivity Initiative charges.
- Debt levels, short-term borrowing needs, liquidity and planned capital returns, including remaining repurchase authorization.
- The final purchase-price allocation and realized contribution of barkTHINS, alongside SGM integration and international-market performance.