Hansen Natural Corporation (now Monster Beverage Corporation) — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. The filing is by Hansen Natural Corporation, the company’s name at the time. Financial statements are unaudited; amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2010 | Q3 2009 | First 9 months 2010 | First 9 months 2009 |
|---|---|---|---|---|
| Net sales | $381.5 million | $307.9 million | $985.3 million | $852.4 million |
| Gross profit | $197.9 million | $165.0 million | $515.8 million | $457.0 million |
| Operating income | $107.6 million | $92.9 million | $268.0 million | $251.5 million |
| Net income | $66.5 million | $56.5 million | $162.9 million | $155.4 million |
| Diluted EPS | $0.72 | $0.60 | $1.75 | $1.63 |
| Operating cash flow | Not presented for the quarter | $170.8 million | $123.2 million |
- Q3 net sales grew 23.9%, operating income 15.8%, and net income 17.7% year over year. For the nine months, growth was 15.6%, 6.6%, and 4.9%, respectively.
- Gross margin declined to 51.9% from 53.6% in Q3 and to 52.4% from 53.6% for the nine months. Operating margin fell to 28.2% from 30.2% and to 27.2% from 29.5%, respectively. Nine-month net margin was 16.5%, versus 18.2%.
- Case sales increased 27.0% in Q3 and 18.7% for the nine months. Average net sales per case declined 2.5% and 2.6%, respectively, to $10.08 and $10.06.
Liquidity, cash flow and debt
- At September 30, cash and cash equivalents were $509.6 million; short- and long-term investments totaled $70.2 million. Current assets were $842.5 million and current liabilities $139.8 million.
- Nine-month operating cash flow of $170.8 million exceeded net income, but working capital absorbed cash, including $40.6 million for inventory and $27.9 million for accounts receivable. Cash increased $181.3 million to $509.6 million.
- The balance sheet reported $0.244 million of current debt. The company had a $10 million revolving credit facility, no borrowings outstanding, and $0.3 million of letters of credit. It reported covenant compliance.
- Management expected available cash, operating cash flow and the facility to cover needs for at least 12 months, and estimated capital expenditures below $30 million through September 2011. This is management’s estimate, not formal earnings guidance.
Business context and material changes
- The Direct Store Delivery segment, principally energy drinks, generated 93.5% of Q3 net sales; the Warehouse segment, principally juice-based and soda beverages, generated 6.5%. Monster Energy volume growth and Peace Tea sales drove Q3 growth; Warehouse sales declined 6.8%.
- For the first nine months, energy drinks generated $887.0 million of sales, compared with $770.7 million a year earlier. Non-carbonated beverages rose to $62.2 million from $46.3 million; carbonated beverages were $26.0 million versus $25.0 million.
- Nine-month sales growth was partly offset by advance customer purchases in Q4 2009, associated with a new distributor marketing contribution program and the planned SAP transition. Management had estimated those advance purchases raised Q4 2009 gross sales by approximately 4%–6%.
- One customer, Coca-Cola Enterprises (CCE), accounted for 33% of Q3 and 35% of nine-month net sales. On October 2, 2010, Coca-Cola completed its acquisition of CCE’s North American operations, which became Coca-Cola Refreshments USA; the filing identifies the acquisition’s impact as uncertain.
Management commentary, risks and unusual items
- Management attributed lower gross margins primarily to product and geographic mix, plus promotional activity and higher Warehouse costs. Operating expenses rose 25.3% in Q3 and 20.6% for the nine months, including higher payroll, professional fees, freight, sponsorships and point-of-sale spending. The 2009 comparison included a $4.7 million insurance reimbursement for legal expenses.
- Warehouse contribution margin was negative $1.9 million in Q3, compared with positive $1.4 million a year earlier; it was $0.2 million for the nine months, down from $3.6 million.
- A foreign-subsidiary deferred tax asset valuation allowance increased tax expense by $4.5 million for the nine months. The effective tax rate was 39.5%, versus 37.7%.
- Auction-rate securities remained illiquid after failed auctions. The portfolio had $81.5 million face value and $70.2 million fair value; management used Level 3 mark-to-model valuations with significant assumptions. The company recorded $7.2 million of impairment, including $5.0 million deemed other-than-temporary, and reported a $3.8 million fair value for its put option. Further impairment was possible; management did not expect current illiquidity to materially affect liquidity or working capital.
- Significant disclosed matters included a certified consumer class action over Blue Sky product-origin labeling, a Canadian proposed class action concerning Monster Energy labeling, and amended securities and derivative lawsuits alleging, among other things, channel stuffing. The company said it believed the claims lacked merit and intended to defend them; outcomes were uncertain. It also pursued FINRA arbitration relating to its auction-rate securities purchases.
- Other risks identified included competition and pricing pressure, dependence on key products and a major customer, distributor and co-packer performance, commodity and packaging costs, international expansion and foreign exchange exposure, regulatory matters, and product-related criticism. The company did not hedge commodity or foreign-currency exposure.
Most important facts for investors to verify
- Whether sales and case-volume growth continued after accounting for Q4 2009 advance purchases, lower average price per case, and product mix.
- Whether gross-margin and operating-margin pressure persists, particularly in the Warehouse segment and as operating expenses increase.
- How the CCE acquisition affects distribution arrangements, customer concentration and sales.
- Recoverability and valuation of auction-rate securities and the put option, including potential future impairment.
- Developments and potential financial exposure from the consumer, Canadian, securities and derivative litigation.
- Execution of international growth plans and whether foreign operating losses, supply costs or regulatory risks change materially.