The Hershey Company — FY 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010. Although the request refers to 2010 Q4, this is an annual filing; it also reports unaudited fourth-quarter results. Hershey manufactures and sells chocolate and sugar confectionery, gum and mints, and pantry products. It reports as one segment and generated 15.2% of sales outside the United States.
Financial performance
| Metric | FY 2010 | FY 2009 | Change |
|---|---|---|---|
| Net sales | $5.671 billion | $5.299 billion | +7.0% |
| Gross profit / margin | $2.415 billion / 42.6% | $2.053 billion / 38.7% | Margin +3.9 percentage points |
| Operating income (EBIT) / margin | $905.3 million / 16.0% | $761.6 million / 14.4% | EBIT +18.9% |
| Net income | $509.8 million | $436.0 million | +16.9% |
| Diluted EPS, common stock | $2.21 | $1.90 | +16.3% |
| Adjusted diluted EPS (non-GAAP) | $2.55 | $2.17 | +17.5% |
| Operating cash flow | $901.4 million | $1.066 billion | Down $164.3 million |
Annual sales growth reflected approximately 4% volume gains, more than 2% favorable price realization and about 1% favorable foreign exchange. Gross-margin improvement reflected pricing and supply-chain productivity, partly offset by higher input and supply-chain costs. Selling, marketing and administrative expense rose 18.0% to $1.426 billion; advertising expense increased 62.2% to $391.1 million.
Fourth quarter: Sales were $1.483 billion versus $1.407 billion in Q4 2009; net income was $135.5 million versus $126.8 million. The filing does not provide a clear fourth-quarter year-over-year percentage comparison for these amounts.
Liquidity, debt and capital
- Year-end cash and cash equivalents were $884.6 million, versus $253.6 million a year earlier. Current assets were $2.005 billion and current liabilities $1.299 billion.
- Debt included $24.1 million of short-term debt and $1.803 billion of long-term debt, including its current portion. No commercial paper was outstanding at year-end; $1.1 billion was available under the revolving credit facility, and Hershey reported compliance with its covenants.
- In December, Hershey issued $350 million of 4.125% notes due 2020 and paid $63.4 million to repurchase $57.5 million of 6.95% notes due 2012, recording a $5.9 million premium as interest expense.
- Capital additions were $179.5 million; dividends paid were $283.4 million. The company forecast 2011 capital expenditures, including software, of $350–$370 million.
Material changes and unusual items
- Project Next Century began in 2010, moving production from the 19 East Chocolate Avenue plant to an expanded West Hershey facility. The plan is expected to reduce employment by approximately 500–600 positions and incur $140–$170 million of pre-tax charges and implementation costs over three years.
- FY 2010 included $98.6 million of net pre-tax business realignment and impairment charges. This included a $52.9 million goodwill impairment associated with Godrej Hershey Ltd. ($44.7 million after the noncontrolling-interest share), as well as Next Century costs. The Godrej impairment was non-cash and had no tax benefit.
- Cash from operations declined year over year despite higher earnings, in part because the 2009 comparison benefited from larger cash provided by changes in other assets and liabilities. The filing reports working-capital cash inflow of $96.9 million in 2010, versus $157.8 million in 2009.
- McLane Company represented approximately 22.1% of 2010 net sales, creating significant customer concentration; it is a primary distributor to Walmart.
Outlook, risks and contingencies
- For 2011, management expected net sales growth around the top of its 3%–5% long-term objective and adjusted diluted EPS growth around the top of its 6%–8% objective. Projected adjusted EPS was $2.70–$2.76; projected GAAP diluted EPS was $2.54–$2.63. Adjusted gross margin was expected to be approximately flat with 2010.
- Management anticipated significantly higher input costs in 2011, with productivity and cost savings expected to substantially offset them. Advertising was forecast to increase in the mid-single digits. Next Century was expected to incur $45–$55 million of charges in 2011 and deliver $60–$80 million of annual savings once fully implemented.
- Key exposures include volatile cocoa, sugar, dairy and other input costs; management noted dairy costs are difficult to hedge. Other risks include price elasticity, intense competition, product safety and supply-chain interruptions, international-market execution, and pension assumptions and funding.
- Hershey faced Canadian regulatory investigation and U.S. Department of Justice inquiry into alleged industry pricing practices, plus approximately 90 related U.S. and 14 Canadian civil antitrust suits. Management said the proceedings were not expected to materially adversely affect financial position, liquidity or results, but outcomes were uncertain.
- The pension plans were underfunded by $49.4 million at year-end. The filing stated expected pension costs would be slightly higher in 2011 and the expected return assumption would decrease from 8.5% to 8.0%.
Investor verification priorities
- Check whether 2011 sales, adjusted EPS and gross-margin expectations were achieved, and review the reconciliation of adjusted to GAAP results.
- Track commodity-cost pass-through, hedging coverage and whether productivity offsets higher input costs.
- Monitor Project Next Century spending, plant-transition execution, job reductions and realized savings against the disclosed ranges.
- Follow developments and potential financial exposure from the pricing investigations and antitrust litigation.
- Assess McLane customer concentration, year-end liquidity and upcoming debt maturities, particularly the $250 million of notes due in 2011.
- Review Godrej Hershey performance and the assumptions supporting its year-end fair value; the filing said fair value exceeded carrying value by approximately 7%.