The Hershey Company — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended July 1, 2012; comparisons are with the periods ended July 3, 2011. Unaudited interim results; the company cautions that seasonality means six-month results may not indicate full-year performance.
Financial performance
| Metric | Q2 2012 | Q2 2011 | First six months 2012 | First six months 2011 |
|---|---|---|---|---|
| Net sales | $1,414.4 million | $1,325.2 million | $3,146.5 million | $2,889.4 million |
| Gross margin | 43.7% | 42.6% | 43.3% | 42.2% |
| EBIT | $222.3 million | $228.4 million | $556.8 million | $504.9 million |
| EBIT margin | 15.7% | 17.2% | 17.7% | 17.5% |
| Net income | $135.7 million | $130.0 million | $334.3 million | $290.1 million |
| Diluted EPS, Common Stock | $0.59 | $0.56 | $1.46 | $1.26 |
| Effective tax rate | 31.4% | 36.6% | 34.2% | 36.5% |
Q2 sales rose 6.7%, primarily from 6.6% net price realization; volume fell 1.1%, foreign exchange reduced growth by 1.2%, and Brookside added 2.4%. For the first half, sales rose 8.9%, primarily from 8.7% net price realization; volume fell 0.5%, foreign exchange reduced growth by 0.8%, and Brookside added 1.5%. U.S. consumer takeaway and measured-channel share increased in both the quarter and year-to-date period.
Gross-margin gains reflected pricing and supply-chain productivity, partly offset by higher input and supply-chain costs and increased restructuring charges. Q2 EBIT declined 2.7% as higher selling, marketing and administrative costs and realignment charges outweighed gross-profit growth. First-half EBIT increased 10.3%. Q2 net income and EPS benefited from a lower tax rate, including an approximately $11.5 million tax benefit from the conclusion of tax audits.
Cash, liquidity and debt
- First-half operating cash flow was $314.2 million, compared with $286.7 million. Investing used $336.6 million and financing used $81.5 million; cash decreased $103.9 million to $589.8 million.
- Investing included $172.9 million for Brookside, $147.8 million in capital additions and software, and a $16.0 million loan to an affiliate. Financing included $218.3 million of common-stock repurchases and $167.1 million of dividends.
- At July 1, cash was $589.8 million; current assets were $2,093.6 million and current liabilities $1,447.0 million. The current ratio was 1.4, versus 1.7 at year-end 2011.
- Short-term debt was $139.4 million, current long-term debt $347.3 million, and long-term debt $1,498.7 million, or approximately $1,985.3 million combined. The filing reports a 65% capitalization ratio, down from 68% at year-end.
- Inventory increased to $791.8 million from $649.0 million, reflecting higher ingredient costs, seasonal timing, anticipated sales and new products. The company said it complied with its credit-agreement covenants.
Material changes, outlook and risks
- Acquisitions: Hershey acquired Brookside Foods for approximately $172.9 million in January 2012; its annual sales were approximately $90 million. It also obtained control of Tri-US, increasing its stake to approximately 69%. Brookside purchase accounting remained preliminary.
- Realignment: Project Next Century charges and implementation costs are now expected to total $160 million–$180 million. The company expects $55 million–$65 million of charges in 2012 and, when fully implemented, annual savings of $65 million–$80 million. A possible pension settlement loss is excluded from the estimate.
- 2012 guidance: Reported sales growth of approximately 7%–9%, including a 1.5 percentage-point Brookside contribution; reported diluted EPS of $2.88–$2.98; reported gross-margin expansion of 120–130 basis points. Adjusted gross-margin expansion is expected at 100–120 basis points, and adjusted diluted EPS growth at 12%–14% versus the company’s new long-term target of 8%–10%. Adjusted EPS guidance is $3.17–$3.23 and excludes specified acquisition costs, realignment charges and non-service pension expense.
- Management expected challenging economic conditions to continue, but anticipated stronger organic volume in the second half and positive full-year organic volume growth. It planned low-double-digit percentage growth in advertising expense for 2012 and continued investment in brands, new products and international markets. Input costs were expected to remain above the prior year.
- Key risks include commodity and energy costs and availability, price elasticity and volume response, competition, product safety and recalls, supply-chain disruption, acquisition integration, international-market conditions, regulatory matters, pension costs, and execution or cost overruns on Project Next Century. The company expected no significant effect from potential tax adjustments, but tax audits and contingencies remain relevant.
- Other notable items: The CEO entered into an employment agreement on August 7, 2012, after quarter-end. It provides for severance of twice base salary and annual incentive target upon specified qualifying termination, with no excise-tax gross-up. Management concluded disclosure controls were effective.
Important facts for investors to verify
- Whether pricing continues to offset input-cost inflation without worsening volume declines, and whether the expected second-half organic volume recovery materializes.
- Progress against reported and adjusted 2012 sales, margin and EPS guidance; confirm the stated adjustments and their comparability with GAAP results.
- Brookside integration, realized contribution to growth, preliminary purchase-price allocation and acquisition-related costs.
- Project Next Century’s remaining charges, possible pension settlement costs, completion timing and delivery of projected annual savings.
- Working-capital and inventory trends, cash generation, debt maturities and the company’s capacity to sustain dividends and repurchases.
- Commodity-hedge effects: the filing expected approximately $37 million of after-tax net hedge losses to be reclassified into earnings over the next 12 months.