Business context and reporting period
The Hershey Company’s unaudited Form 10-Q covers the three and nine months ended October 1, 2017, compared with periods ended October 2, 2016. North America generates about 89% of revenue; the remaining operations are reported as International and Other. Results are seasonal and may not indicate full-year performance.
Financial performance
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $2,033.1 | $2,003.5 | $5,575.8 | $5,469.9 |
| Gross margin, reported | 46.2% | 42.5% | 46.8% | 44.2% |
| Operating profit | $439.0 | $374.0 | $946.3 | $976.3 |
| Operating margin, reported | 21.6% | 18.7% | 17.0% | 17.8% |
| Net income attributable to Hershey | $273.3 | $227.4 | $601.8 | $603.2 |
| Diluted EPS, common stock | $1.28 | $1.06 | $2.81 | $2.80 |
| Operating cash flow | — | $625.9 | $450.8 |
Q3 sales rose 1.5% (1.1% excluding foreign exchange), supported by North America volume and innovation. Q3 reported gross margin increased 370 basis points, but non-GAAP gross margin declined 30 basis points to 45.3%; management cited freight and other supply-chain costs as offsets to productivity and lower input costs. Q3 adjusted diluted EPS was $1.33 versus $1.29. For the first nine months, adjusted diluted EPS was $3.73 versus $3.24, while reported diluted EPS was $2.81 versus $2.80.
Cash, debt and liquidity
Cash and equivalents were $275.1 at October 1, 2017, down from $297.0 at year-end 2016. Current assets were $2,214.5 and current liabilities $2,337.7. Debt comprised $815.6 short-term, $300.1 current long-term and $2,054.1 long-term, approximately $3,169.8 in total. Hershey reported compliance with covenants and maintained a $1.0 billion revolving credit facility, expiring in November 2020. About 80% of cash was held by foreign subsidiaries and management intended to reinvest it abroad.
Nine-month investing cash use was $187.1, including $148.9 of capital additions; financing cash use was $465.7, including $391.8 of dividends and $300.3 of share repurchases. Working capital used substantial cash, principally because of seasonal inventory builds. 2017 capital expenditures were expected to be approximately $260–$275.
Material changes versus prior period
- Q3 reported net income increased 20.2% and diluted EPS increased 20.8%, mainly reflecting higher gross margin and favorable commodity-derivative mark-to-market effects.
- Nine-month operating profit fell 3.1%, mainly due to $208.7 of long-lived-asset impairment charges and higher realignment costs. Nine-month reported net income was nearly flat; diluted EPS rose slightly, aided by fewer diluted shares.
- International and Other sales were nearly flat year to date, with China weakness offsetting growth in Mexico, Brazil and India. North America sales rose 2.1% year to date.
- Operating cash flow increased year over year, while cash declined modestly after investment and shareholder distributions.
Outlook, commentary and risks
Management maintained its full-year 2017 sales-growth estimate at approximately 1.25%, with minimal expected foreign-exchange impact. It projected reported diluted EPS of $3.54–$3.68 and adjusted diluted EPS of $4.72–$4.81, expecting adjusted EPS toward the high end, supported by productivity, cost savings and a lower effective tax rate. The outlook excluded unforeseeable commodity-derivative mark-to-market effects.
The Margin for Growth program, launched in 2017, is expected to generate $375–$425 in pre-tax charges over three years, including $175–$200 cash costs, and approximately $150–$175 of annual savings by completion in 2019. It includes workforce reductions of about 15% and China manufacturing optimization. The China-related review led to $208.7 of impairment charges in the first quarter. Management also cited higher freight, warehousing and manufacturing costs, China softness, commodity and energy cost exposure, pricing and demand uncertainty, competition, supply-chain disruption, and execution risks for savings and restructuring. It did not expect pending legal proceedings, individually or collectively, to materially affect financial condition, results or cash flows.
Most important facts for investors to verify
- Whether the Margin for Growth program achieves its projected savings and stays within its stated cost range.
- Whether China sales and asset utilization stabilize after the impairment and manufacturing changes.
- How seasonal inventory requirements and working-capital use affect cash generation and short-term borrowing.
- Whether higher freight and supply-chain costs, commodity prices and derivative timing continue to affect reported versus adjusted margins.
- Whether the full-year sales and EPS outlook is achieved; reported and adjusted figures exclude different unusual items.