The Hershey Company — Q1 2012 Form 10-Q
Reporting period: Three months ended April 1, 2012; comparisons are with the three months ended April 3, 2011. The company cautions that seasonal results may not indicate full-year performance.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Net sales | $1.732 billion | $1.564 billion | +10.7% |
| Gross profit / gross margin | $743.4 million / 42.9% | $656.2 million / 41.9% | Margin +1.0 percentage point |
| Income before interest and taxes (EBIT) / EBIT margin | $334.5 million / 19.3% | $276.5 million / 17.7% | EBIT +21.0% |
| Net income | $198.7 million | $160.1 million | +24.1% |
| Diluted EPS, Common Stock | $0.87 | $0.70 | +24.3% |
| Operating cash flow | $275.8 million | $159.4 million | +$116.4 million |
Sales growth primarily reflected 10.9% net price realization, partly offset by a 0.5% volume decline and 0.4% unfavorable currency impact. International sales rose approximately 15.3%; Brookside contributed 0.7% to the sales increase. U.S. consumer takeaway rose 6.4%, or 3.3% excluding Easter effects, while measured-channel market share was flat.
Gross-margin improvement reflected price realization and supply-chain productivity, partly offset by higher input and supply-chain costs. Input costs increased cost of sales by about 3%; higher supply-chain costs added about 2% net of productivity. Advertising expense rose 13.7%. The effective tax rate was 36.0%, versus 36.5%.
Cash, liquidity, and debt
Cash and cash equivalents were $567.3 million at April 1, down $126.3 million from year-end. Operating cash flow was $275.8 million; investing activities used $264.6 million, including $172.9 million for acquisitions and $91.7 million for capital additions and software. Financing activities used $137.6 million, including $218.3 million of share repurchases and $83.5 million of dividends. Cash flow benefited from a $129.4 million contribution from other assets and liabilities, including hedging-related effects; working capital used $129.7 million.
Total short- and long-term debt was approximately $1.993 billion, including $146.7 million of short-term debt. Long-term debt, including current maturities, was $1.846 billion. The current ratio declined to 1.5 from 1.7 at December 31, 2011; debt as a share of total debt plus equity increased to 69% from 68%. The company reported compliance with its credit-agreement covenants. Its revolving credit agreement and commercial paper or bank borrowing are available for short-term financing; it reported no commercial paper borrowings during the quarter.
Material developments and unusual items
- In January, Hershey acquired Brookside Foods for approximately $172.9 million. Brookside’s annual sales were approximately $90 million; the purchase-price allocation remained preliminary. The company also acquired control of Tri-US, increasing its ownership to approximately 69%.
- Project Next Century charges were $23.6 million in the quarter, including $19.5 million in cost of sales. The program involves transitioning production from the East Hershey facility to the expanded West Hershey facility, primarily during Q2 2012. A $17.8 million employee-separation liability remained at quarter-end.
- Net income included a $14.9 million reduction from business realignment and impairment charges, a $3.8 million reduction from Brookside closing and integration costs, and a $2.6 million reduction from higher non-service pension expense, as described by management.
- Share repurchases totaled $218.3 million; $125.1 million remained under the $250 million authorization at April 1. Dividends paid were $83.5 million.
- Approximately $44.6 million after tax of net cash-flow-hedge losses were expected to be reclassified into earnings during the next 12 months, primarily related to commodity derivatives.
Outlook, commentary, and risks
Management expected full-year 2012 net sales growth of about 7%–9%, including Brookside and currency effects, and slightly higher volume excluding Brookside. Reported diluted EPS guidance was $2.82–$2.92; adjusted diluted EPS guidance was $3.11–$3.17, or growth of 10%–12%. Adjusted guidance excludes specified acquisition costs, Project Next Century charges, and non-service pension expense. Management projected reported gross-margin expansion of 90–100 basis points, expected input costs to remain above 2011 levels, and planned low-double-digit percentage growth in advertising expense.
Project Next Century was expected to incur $55–$65 million of charges in 2012, with $65–$70 million of capital expenditures; completed implementation was expected to yield annual savings of $65–$80 million. Management cited a challenging economic environment and identified risks including commodity and energy costs, pricing and volume effects, competition, product safety, supply-chain disruption, acquisition execution, international and currency exposure, pension costs, and execution or savings shortfalls from the transformation program. The filing also cited potential effects from a government investigation into alleged confectionery-industry pricing practices. Management did not anticipate tax-audit adjustments having a significant effect and expected about $16 million of unrecognized-tax-benefit liability reductions within 12 months.
Important facts for investors to verify
- Whether price realization and productivity continue to offset inflation without further volume or market-share deterioration.
- Whether the 7%–9% sales and EPS guidance, including its adjusted-versus-reported reconciliation, remains achievable.
- Brookside integration, final purchase-price allocation, and the contribution of the acquisition to growth and earnings.
- Project Next Century’s remaining charges, transition timing, capital needs, and delivery of projected annual savings.
- Cash-flow sustainability, given quarter-to-quarter working-capital and hedging effects, alongside ongoing buybacks, dividends, and debt levels.
- Commodity and foreign-exchange exposures, expected hedge-loss reclassifications, and developments in tax audits and the cited industry-pricing investigation.