The Hershey Company — Q3 2009 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended October 4, 2009; comparisons are to the periods ended September 28, 2008. Hershey reported that seasonal effects mean nine-month results may not indicate full-year performance.
Financial performance
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net sales | $1,484.1 million | $1,489.6 million | $3,891.3 million | $3,755.4 million |
| Gross margin | 39.7% | 33.6% | 38.1% | 33.6% |
| Income before interest and taxes (EBIT) | $279.6 million | $220.0 million | $549.2 million | $436.5 million |
| EBIT margin | 18.8% | 14.8% | 14.1% | 11.6% |
| Net income | $162.0 million | $124.5 million | $309.2 million | $229.3 million |
| Diluted EPS, Common Stock | $0.71 | $0.54 | $1.35 | $1.00 |
| Net interest expense | $22.3 million | $24.9 million | $68.9 million | $72.9 million |
Q3 sales decreased 0.4%, while nine-month sales rose 3.6%. Nine-month net income increased 34.9%. Management attributed stronger profitability principally to pricing and supply-chain productivity, partly offset by higher input, pension, advertising and other selling, marketing and administrative expenses. Nine-month business realignment charges were $58.8 million, versus $34.7 million a year earlier; however, total net pre-tax charges associated with the initiatives were $72.7 million versus $101.0 million.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $635.5 million, compared with $248.6 million in 2008. Investing cash outflow was $117.2 million and financing cash outflow was $436.2 million.
- Cash and cash equivalents increased to $119.3 million from $37.1 million at year-end 2008. Cash generation funded $255.3 million of net short-term debt repayment, $197.4 million of dividends, $106.9 million of capital and software additions, and the $15.2 million Van Houten acquisition.
- At October 4, 2009, short-term debt was $227.4 million, current long-term debt $15.6 million, and long-term debt $1,503.4 million. Total debt including current maturities was approximately $1.75 billion, down from approximately $2.01 billion at December 31, 2008.
- Current assets were $1.46 billion and current liabilities $1.11 billion; the reported current ratio was 1.3:1, compared with 1.1:1 at year-end. The debt-to-capitalization ratio was 73%, down from 85%.
- The company had a $1.1 billion revolving credit facility, with an option to increase it by $400 million subject to lender concurrence; it reported compliance with covenants.
Material changes and management commentary
- Pricing raised sales by more than 10% in Q3, but was substantially offset by lower volume and price elasticity. Foreign exchange reduced Q3 sales by about 1.1%; the Van Houten acquisition added $3.9 million.
- U.S. consumer takeaway increased 4.8% in Q3 and 7.8% in the first nine months. Market share was flat in Q3 and up 0.3 percentage points for the nine-month period in measured channels.
- Management continued the global supply-chain transformation, including facility closures and consolidation. It estimated total program charges and non-recurring implementation costs at $640 million–$665 million. Expected 2009 business realignment and impairment charges were $100 million–$120 million, including significant non-cash pension settlement losses.
- Management expected full-year 2009 sales growth within its 3%–5% long-term objective. It forecast adjusted diluted EPS of $2.12–$2.14, excluding expected realignment charges of $0.26–$0.32 per share; the corresponding GAAP diluted EPS outlook was $1.80–$1.88. It expected a 36.0% full-year effective tax rate, excluding the tax impact of realignment charges.
- For the remainder of 2009, management expected price realization to have less impact than for the full year, ongoing volume pressure from prior price increases, and lower sales from closing its online gifts business. It expected commodity costs to rise significantly year over year, though less than initially estimated, and advertising expense to increase 50% for the year.
Risks, contingencies and unusual items
- Management cited risks from raw-material and energy costs, price-driven volume declines, competition, demand, international markets, product quality and safety, regulation, pension costs, and execution, timing and cost of the supply-chain program.
- The company expected an additional $30 million–$40 million of pension settlement losses during the remainder of 2009 and 2010, with about $30 million expected in Q4 2009. These losses are non-cash charges.
- A $16.2 million receivable related to recovery of damages from a 2006 product recall and temporary Canadian plant closure remained recorded as a current asset. The company was in litigation with the ingredient supplier; recovery and timing are uncertain.
- Net after-tax losses of approximately $10.7 million on cash-flow hedges were expected to be reclassified into earnings over the next 12 months, primarily relating to commodity futures.
- The company reported effective disclosure controls and no subsequent events requiring recognition or disclosure through November 12, 2009.
Important facts for investors to verify
- Whether pricing continues to offset volume declines and whether consumer takeaway and market share trends persist.
- Progress against the 2009 sales and adjusted EPS outlook, including the reconciliation of non-GAAP adjusted EPS to GAAP EPS.
- Actual commodity, pension and advertising costs, and whether supply-chain savings offset these pressures.
- Final costs, timing and cash versus non-cash components of the transformation program and pension settlements.
- Recoverability and timing of the $16.2 million product-recall litigation receivable.
- Working-capital and operating-cash-flow sustainability, given the substantial year-over-year change in cash from other assets and liabilities.