The Hershey Company — Q2 2017 Form 10-Q
Business context and period. Hershey reported the quarter and six months ended July 2, 2017; comparisons are with the periods ended July 3, 2016. North America generates about 89% of sales. The company cautions that seasonal effects mean interim results may not indicate full-year performance. Dollar amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $1.663 billion | $1.638 billion | $3.543 billion | $3.466 billion |
| Gross margin, reported | 45.9% | 45.6% | 47.1% | 45.1% |
| Operating profit | $315.3 million | $262.8 million | $507.3 million | $602.3 million |
| Net income attributable to Hershey | $203.5 million | $146.0 million | $328.5 million | $375.8 million |
| Diluted EPS, common stock | $0.95 | $0.68 | $1.53 | $1.74 |
| Operating cash flow | Not separately presented | Not separately presented | $335.7 million | $368.7 million |
Q2 sales rose 1.5% (1.8% excluding foreign exchange), and diluted EPS rose 39.7%. Q2 adjusted diluted EPS, a non-GAAP measure, was $1.09 versus $0.85. For the first six months, sales rose 2.2%, but reported operating profit fell 15.8%, net income fell 12.6%, and diluted EPS fell 12.1%; results included a substantial China-related impairment charge.
Q2 reported operating margin was 19.0%, up from 16.0%; six-month margin was 14.3%, down from 17.4%. Q2 non-GAAP gross margin was 47.1% versus 45.5%, and non-GAAP operating margin was 20.8% versus 18.1%. These adjusted measures exclude specified items and are not GAAP results.
Liquidity, debt and cash flow
- At July 2, cash and cash equivalents were $214.1 million, versus $297.0 million at year-end 2016. Current assets were $1.912 billion and current liabilities $1.742 billion.
- Short-term debt was $622.0 million and long-term debt was $2.350 billion, or about $2.972 billion combined. The company had $479.4 million of commercial paper outstanding and $142.5 million of short-term foreign bank loans. It reported compliance with its credit-facility covenants.
- Six-month operating cash flow was $335.7 million; investing activities used $106.2 million and financing activities used $315.1 million. Cash declined $82.9 million. Working capital used $200.8 million, chiefly reflecting seasonal inventory build and payment timing.
- Six-month cash dividends were $256.1 million and share repurchases were $100.0 million, primarily to offset shares issued for employee compensation.
Changes, outlook and management commentary
- Q2 sales growth was driven by North America, including innovation and barkTHINS, with some benefit from new packaging timing and retailer distributor changes that increased retail inventory. North America sales rose 2.2%; International and Other sales fell 3.6%, mainly amid continued weakness in China. Greater China sales declined 31.2% in the quarter.
- Management attributed Q2 margin improvement to lower realignment costs and productivity, partly offset by commodity-related mark-to-market losses and higher supply-chain costs. Q2 SM&A expense declined 3.6%, reflecting savings and efficiency measures.
- For full-year 2017, management projected net sales growth of approximately 1%, reported diluted EPS of $3.41–$3.60, and adjusted diluted EPS of $4.72–$4.81, with adjusted EPS expected toward the high end of the range. Management cited lower input costs, productivity and cost savings, and a lower expected tax rate. Advertising and consumer marketing spending was expected to be meaningfully higher over the remainder of the year; management also expected retail-industry challenges to persist.
- The Margin for Growth program is expected to generate $375–$425 million of pretax charges over three years, including $175–$200 million cash costs, and approximately $150–$175 million of ongoing annual savings by completion in 2019. The program is expected to reduce the global workforce by about 15%. Management expected 2017 capital expenditures of $270–$290 million.
- First-half 2017 included $208.7 million of long-lived asset impairment charges, primarily related to China operations and assets associated with the SGM acquisition, and $46.0 million of business realignment costs. In 2016, first-half results included a $26.7 million gain from settlement of the SGM liability.
Risks and contingencies
Disclosed risks include commodity and energy costs and supply availability, pricing and demand, competition, supply-chain disruption, international-market weakness, and whether restructuring delivers expected savings. The filing adds implementation risks for the company’s multi-year ERP system, including potential delays, added costs and effects on operations or internal controls. The company said pending ordinary-course legal matters were not expected to have a material effect. It also reported foreign-exchange, interest-rate and commodity-derivative exposures; commodity mark-to-market effects can make reported results more volatile.
Investor verification points
- Track whether full-year sales and EPS guidance is achieved, and distinguish reported from adjusted EPS.
- Assess China sales, impairment and restructuring progress, including whether projected program savings materialize.
- Monitor inventory, working-capital use, operating cash flow and seasonal cash requirements.
- Review commodity derivative mark-to-market effects and the timing of losses moving into segment results.
- Check the ERP implementation and any developments in legal, tax or other contingencies.