The Hershey Company — Form 10-Q Summary
Business context and period: Hershey reported unaudited results for the quarter and six months ended June 29, 2014, compared with the periods ended June 30, 2013. The company manufactures and sells confectionery and other snack products. Management cautions that results may be affected by seasonal patterns.
Key financial results
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net sales | $1,578.4 million | $1,508.5 million | $3,450.2 million | $3,335.9 million |
| Gross margin | 45.5% | 47.6% | 46.1% | 47.0% |
| EBIT | $277.5 million | $268.9 million | $681.1 million | $660.7 million |
| EBIT margin | 17.6% | 17.8% | 19.7% | 19.8% |
| Net income | $168.2 million | $159.5 million | $420.7 million | $401.4 million |
| Diluted EPS, Common Stock | $0.75 | $0.70 | $1.86 | $1.77 |
| Net cash from operations | Not provided for quarter | Not provided for quarter | $171.9 million | $349.4 million |
- Q2 growth and profitability: Sales rose 4.6% (5.3% excluding foreign exchange); net income increased 5.4% and diluted EPS increased 7.1%. Gross margin fell 210 basis points, primarily from higher input costs—especially dairy—and unfavorable mix. Lower selling, marketing and administrative expense and fewer realignment charges partly offset that pressure.
- First-half performance: Sales increased 3.4% (4.2% excluding foreign exchange), net income rose 4.8%, and diluted EPS rose 5.1%. Gross margin declined 90 basis points; EBIT margin declined 10 basis points.
- Cash flow and liquidity: First-half operating cash flow was $171.9 million, down $177.5 million year over year, mainly due to lower accrued liabilities and higher income-tax payments. Capital additions and software additions totaled $149.1 million. Cash and equivalents were $562.6 million and short-term investments were $97.2 million at June 29, 2014.
- Debt: Short-term debt was $197.0 million; current and long-term debt totaled approximately $1.796 billion. The $1.0 billion revolving credit facility expires in November 2018; Hershey reported covenant compliance and no commercial-paper borrowings at quarter-end.
- Capital returns: First-half dividends paid were $209.9 million and share repurchases were $436.3 million. The company completed its prior $250 million repurchase authorization and had a new $250 million authorization available at quarter-end. The board later declared increased quarterly dividends payable September 15, 2014.
Material changes and notable items
- Volume and new products drove sales growth; new products contributed 60% of Q2 volume growth. U.S. everyday instant-consumable volume growth moderated amid stronger in-store competition. First-half U.S. confectionery retail takeaway rose 2.2%, with measured-channel share unchanged at 31.1%.
- Hershey increased ownership of Lotte Shanghai Food Company to 50% and obtained operational control in March 2014, leading it to consolidate the venture. The transaction produced a $4.6 million gain and added a 50% noncontrolling interest. Purchase accounting remained preliminary.
- Inventories rose to $855.2 million from $659.5 million at year-end, reflecting production and seasonal requirements as well as inclusion of Lotte Shanghai inventory.
- First-half cash declined by $555.9 million, principally reflecting financing outflows, including repurchases and dividends, and investing outflows including purchases of short-term investments.
- On July 15, 2014, Hershey announced an approximately 8% weighted-average wholesale price increase across much of its U.S., Puerto Rico and export portfolio. Management said seasonal net price realization was not expected until Halloween 2015 and that most benefit would accrue in 2015.
Outlook, risks and contingencies
- Management expected 2014 sales growth around the low end of its 5%–7% long-term annual target, including foreign exchange effects, supported by seasonal sales and product launches. Commodity costs were expected to exceed 2013 levels, with adjusted gross margin slightly lower than 2013.
- 2014 GAAP diluted EPS guidance was $3.98–$4.08; adjusted diluted EPS guidance was $4.05–$4.13, described as around the low end of the long-term adjusted growth target of 9%–11%. Adjusted guidance excluded estimated Shanghai Golden Monkey operating results. Acquisition completion was expected in the second half of 2014, subject to approvals; its 2014 adjusted impact was expected to be minimal, excluding integration and transition costs.
- Key risks include raw-material and energy cost inflation and availability, whether price increases offset costs without reducing volume, competitive activity, product safety, supply-chain disruption, international-market execution, acquisition integration, and currency and commodity exposures.
- Canadian antitrust matters included a 2013 guilty plea by Hershey Canada and an approximately $4.0 million fine. In U.S. civil cases, the court granted summary judgment for Hershey on direct-purchaser claims in February 2014; plaintiffs appealed, while other plaintiff groups dismissed their cases subject to possible reinstatement. Management said potential consequences were not expected to materially affect financial position or liquidity, but could affect results and cash flows if fines, settlements or judgments arise.
- Tax matters included approximately $74.4 million accrued for proposed Canadian audit adjustments and a related $66.7 million non-current receivable tied to anticipated competent-authority resolution. Management did not expect potential tax adjustments to materially affect financial position or results.
Important facts for investors to verify
- Whether price increases and new product launches offset dairy and other input-cost inflation without impairing volume or mix.
- Progress toward full-year sales and EPS guidance, including the timing and financial effect of Shanghai Golden Monkey closing and integration.
- Cash conversion and working-capital trends, particularly inventory, accrued liabilities and tax payments.
- Developments in the U.S. antitrust appeal and Canadian tax audit resolution.
- Changes in foreign-exchange and commodity exposures; the filing reported higher hypothetical market-risk sensitivity for currency contracts and commodity positions versus year-end.