The Hershey Company — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods. Hershey manufactures and sells confectionery and related products. Results are unaudited, prepared under U.S. GAAP, and subject to seasonal effects.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $1,746.7 million | $1,624.3 million | $4,893.2 million | $4,513.6 million |
| Gross margin | 42.5% | 41.9% | 43.0% | 42.1% |
| EBIT | $301.7 million | $321.1 million | $858.5 million | $826.0 million |
| EBIT margin | 17.3% | 19.8% | 17.5% | 18.3% |
| Net income | $176.7 million | $196.7 million | $511.1 million | $486.8 million |
| Diluted EPS, common stock | $0.77 | $0.86 | $2.23 | $2.12 |
Q3 sales rose 7.5%, while net income fell 10.2%. Nine-month sales increased 8.4% and net income 5.0%. Q3 sales growth reflected net price realization of 3.9%, volume growth of 2.1%, Brookside's contribution of 2.3%, and a 0.8% adverse foreign-exchange impact. Year-to-date, price realization was 6.8%, volume growth 0.6%, Brookside contributed 1.8%, and foreign exchange reduced sales by 0.8%.
Gross margin improved in both periods, supported by pricing and supply-chain productivity, but Q3 EBIT and earnings declined as higher selling, marketing and administrative costs and business realignment charges outweighed gross-profit growth. Q3 diluted EPS included a $0.07-per-share impact from realignment charges, $0.02 from Brookside closing and integration costs, and $0.01 from higher non-service pension expense. Excluding those items, management said Q3 diluted EPS increased 3.6% year over year; nine-month adjusted EPS increased 17.4%.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $605.9 million, versus $257.2 million in 2011. Management attributed the increase principally to changes in other assets and liabilities, realignment charges and higher net income; the year-over-year change in other assets and liabilities included a $250 million hedging-related effect.
- Investing cash outflow was $402.4 million, including $201.0 million of capital additions, $13.0 million of capitalized software and $172.9 million for Brookside. Financing cash outflow was $430.9 million, including $497.6 million of common-stock repurchases and $249.8 million of dividends, partly offset by stock-option exercise proceeds and increased short-term debt.
- Cash declined to $466.2 million from $693.7 million at December 31, 2011. Current assets were $2,136.0 million and current liabilities $1,553.0 million; the current ratio was 1.4, down from 1.7 at year-end.
- Short-term debt was $208.4 million and long-term debt, including its current portion, was approximately $1,767.5 million. The debt capitalization ratio was 67%, versus 68% at year-end. The company reported compliance with its credit-agreement covenants and $50 million of commercial paper outstanding.
Material changes and notable items
- Brookside Foods was acquired in January for approximately $172.9 million; its business had approximately $90 million in annual sales at acquisition. Purchase accounting was preliminary, and the company expected to finalize it by year-end 2012.
- Hershey acquired the remaining 49% of Godrej Hershey in September for approximately $15.9 million. It also increased its ownership of Tri-US to approximately 69% in January.
- Q3 2012 included $20.1 million of business realignment and impairment charges in the income statement; total pre-tax charges and implementation costs recorded for the quarter were $25.8 million. The nine-month income-statement charge was $28.2 million, while total pre-tax charges were $68.4 million. The 2011 comparator included a $17 million gain on trademark licensing rights that reduced reported selling, marketing and administrative expense.
- The Next Century supply-chain program estimate increased to $190–$200 million in total pre-tax charges and implementation costs, including $170–$180 million of charges and about $20 million of implementation and start-up costs. The increase reflected a $13.1 million non-cash pension settlement loss in Q3 and an additional settlement loss expected in Q4.
- Q3 effective tax rate was 36.2%, versus 34.0%, reflecting Pennsylvania tax legislation, discrete tax items and jurisdictional income mix. The nine-month rate was 34.9%, versus 35.5%.
Outlook, risks and contingencies
- For 2012, management expected net sales growth of about 8%–9%, including a 1.75–2.0 percentage-point Brookside contribution; full-year organic volume was expected to be positive. Reported diluted EPS guidance was $2.87–$2.92; adjusted diluted EPS guidance was raised to $3.22–$3.25, a 14%–15% increase over 2011 adjusted EPS.
- Management expected 2012 adjusted gross-margin expansion of 120–140 basis points, advertising growth of 13%–15%, and continued higher input costs versus 2011. It forecast 2013 sales growth of 5%–7%, gross-margin expansion and adjusted diluted EPS growth of 8%–10%. These are forward-looking estimates, not guarantees.
- Next Century was expected to incur $80–$85 million of charges in 2012, require $65–$70 million of 2012 capital spending, and generate $65–$80 million of annual efficiency savings. Management also expected $10–$15 million of program charges in 2013.
- Risks identified include commodity and energy costs and availability, pricing elasticity, demand and competition, product quality and safety, supply-chain disruption, acquisition integration, international operations, regulatory or legal developments, pension costs, and whether expected transformation savings are achieved.
- The company said it did not expect potential tax audit adjustments to materially affect financial position or results, and expected approximately $10.3 million of reductions in unrecognized tax benefits within 12 months. It reported no significant credit-agreement covenant issues.
Key facts for investors to verify
- Whether sales and volume momentum persist, including the contribution and integration costs of Brookside.
- Whether price realization and productivity continue to offset inflation, supply-chain costs and product obsolescence.
- Actual 2012 reported and adjusted EPS versus guidance, including Next Century and pension charges; confirm the company’s non-GAAP adjustments.
- Cash conversion and working-capital trends, especially the hedging-related contribution to operating cash flow, alongside repurchases, dividends and debt levels.
- Progress, remaining costs, capital needs and realized savings from the Next Century program, plus any material developments in tax, regulatory or other disclosed risks.