The Hershey Company — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended October 2, 2016; comparisons are with periods ended October 4, 2015. Unaudited. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Business context and results
Hershey’s North America segment generated about 88% of third-quarter sales; International and Other includes the company’s remaining geographic, retail and licensing businesses. Q3 sales growth reflected higher North American volume, brand promotions and product launches, favorable international price realization, and the barkTHINS acquisition, partly offset by currency.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $2,003.5m | $1,960.8m | $5,469.9m | $5,477.4m |
| Operating profit | $374.0m | $303.0m | $976.3m | $694.7m |
| Net income | $227.4m | $154.8m | $603.2m | $299.6m |
| Diluted EPS, common stock | $1.06 | $0.70 | $2.80 | $1.35 |
| Reported gross margin | 42.5% | 45.5% | 44.2% | 46.2% |
| Reported operating margin | 18.7% | 15.5% | 17.8% | 12.7% |
Q3 sales rose 2.2% (2.4% excluding currency); nine-month sales declined 0.1% as reported but grew 0.6% at constant currency. Q3 reported gross margin fell 300 basis points, while management’s adjusted, non-GAAP gross margin fell 40 basis points. Adjusted diluted EPS was $1.29 for Q3 and $3.24 year to date, versus $1.17 and $3.04, respectively. These non-GAAP measures exclude specified items and should be considered alongside GAAP results.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $422.5m, down from $595.1m. Capital additions were $168.2m; operating cash flow less capital additions was approximately $254.3m, a simple derived measure rather than company-reported free cash flow.
- Cash and equivalents were $333.3m at quarter-end, versus $346.5m at year-end 2015. Current assets were $2,130.5m and current liabilities $2,017.0m.
- At October 2, short-term debt was $612.4m, current long-term debt $250.0m, and long-term debt $2,362.5m. In August, Hershey issued $500m of 2.30% notes due 2026 and $300m of 3.375% notes due 2046; it repaid $250m of notes at maturity in September. The company said it complied with credit covenants and believed liquidity was sufficient.
- Nine-month investing cash outflow was $486.0m, including $285.4m for the barkTHINS acquisition. Financing provided $49.8m; dividends paid were $371.7m and share repurchases were $452.6m.
- About two-thirds of quarter-end cash was held outside the U.S. and intended to be indefinitely reinvested abroad. Repatriation would generally incur U.S. federal taxes, subject to foreign tax credits.
Material changes, outlook and notable items
- Reported profit comparisons benefited substantially from 2015 charges: nine-month 2015 included $280.8m of goodwill impairment, and Q3 2015 included a $31.0m impairment and substantial productivity-program charges. 2015 also included a $28.3m debt extinguishment loss. Accordingly, reported earnings growth overstates the improvement in underlying performance.
- Q3 cost of sales included $35.8m of unallocated commodity-derivative mark-to-market losses; nine-month amount was $30.9m. Management cited higher supply-chain costs and unfavorable mix as additional margin pressures, partly offset by productivity savings. The company no longer applies hedge accounting to commodity derivatives, creating timing volatility before the related inventory is sold.
- Hershey acquired barkTHINS in April for approximately $285.4m; the brand was expected to generate 2016 sales of $65m–$75m. It also completed its purchase of the remaining 20% of Shanghai Golden Monkey (SGM), recording a $26.7m settlement gain.
- The Operational Optimization Program is expected to cost about $120m over three years, including approximately $65m of non-cash incremental depreciation, and generate about $45m of annual savings by 2018. The completed 2015 Productivity Initiative had total costs of $125.0m.
- Management forecast 2016 sales growth of about 1.0%, including a 0.5% net acquisition/divestiture benefit and a 0.75% unfavorable currency effect. It projected reported diluted EPS of $3.82–$3.90 and adjusted diluted EPS of $4.28–$4.32, with adjusted EPS growth of 4%–5%; the adjusted forecast included $0.05–$0.06 per share of barkTHINS dilution. Capital spending was expected at $265m–$275m.
- Management cited promotional execution and new products as supports, while noting challenging conditions and competition in China. Key disclosed risks include commodity costs and availability, pricing and demand, competition, supply-chain disruption, acquisition integration, international-market performance, regulation and IT security. Ordinary-course legal matters were not expected to have a material effect. A new New York City retail lease beginning in 2017 carries approximately $228m of minimum payments over a 20-year base term.
Investor verification priorities
- Reconcile reported earnings and margins to the company’s adjusted measures, especially commodity derivative timing, restructuring, pension and prior-year impairment effects.
- Assess working-capital cash use, the expected conversion of inventory and the sustainability of operating cash flow and planned capital spending.
- Review debt maturities, interest-rate exposure, cash held overseas and the impact of acquisitions, dividends and repurchases on leverage and liquidity.
- Track execution and realized savings from the Operational Optimization Program, barkTHINS integration, and performance in China and other international markets.
- Compare actual full-year sales, reported and adjusted EPS, and currency impacts with management’s stated 2016 outlook.