The Hershey Company (10-Q): Third Quarter 2011
Reporting period: Quarter and nine months ended October 2, 2011; comparisons are with the periods ended October 3, 2010. Figures below are in U.S. dollars; financial amounts are in millions unless otherwise noted. The statements are unaudited.
Business context and results
Hershey reported growth in sales and earnings, supported by pricing, new products and higher sales volumes year to date. In the third quarter, pricing and favorable currency more than offset modest U.S. volume declines. Management noted that results are seasonal and the nine-month performance may not indicate full-year results.
Key financial metrics
| Metric | Third quarter 2011 | Change year over year | Nine months 2011 | Change year over year |
|---|---|---|---|---|
| Net sales | $1,624.2 | +5.0% | $4,513.6 | +7.8% |
| Gross profit | $680.2 | +3.8% | $1,900.7 | +5.8% |
| Gross margin | 41.9% | 42.4% prior year | 42.1% | 42.9% prior year |
| Income before interest and taxes (EBIT) | $321.1 | +7.2% | $826.0 | +21.9% |
| Net income | $196.7 | +9.2% | $486.8 | +30.1% |
| Diluted EPS, Common Stock | $0.86 | $0.78 prior year | $2.12 | $1.63 prior year |
| Operating cash flow | Not presented separately for quarter | $257.2 | $388.2 prior year |
Third-quarter adjusted diluted EPS, excluding the trademark gain and realignment charges, rose 6.3% to $0.85, according to management. Nine-month adjusted diluted EPS increased 9.8% to $2.14. These are non-GAAP measures.
For the nine months, cash used in investing activities was $251.1 million, including $251.2 million of capital additions and $14.4 million of capitalized software spending. Cash used in financing activities was $598.4 million, including $254.8 million of long-term debt repayment, $228.4 million of dividends and $357.7 million of share repurchases; stock-option exercises provided $171.6 million. Cash decreased $592.3 million to $292.3 million.
At October 2, 2011, total debt was approximately $1.64 billion, versus $1.83 billion at December 31, 2010. Current assets were $1.81 billion and current liabilities $1.18 billion; the reported current ratio was 1.5. The company had no commercial paper outstanding at quarter end. The capitalization ratio declined to 63% from 66% at year-end.
Material changes and drivers
- Third-quarter sales growth reflected approximately 5.4% net price realization and 0.6% favorable currency, partly offset by about a 1% U.S. volume decline, which management associated primarily with pricing elasticity. New products, including Reese’s Minis and Hershey’s Drops, helped offset core-brand declines.
- Year-to-date sales growth reflected volume growth of approximately 4.5%, price realization of about 3%, and favorable currency of about 0.6%. Consumer takeaway increased 8.7% for the quarter and 8.3% year to date; market share in measured channels rose 1.0 percentage point in both periods.
- Gross margin declined as higher input and supply-chain costs outweighed some productivity gains and pricing. Nine-month cost of sales also rose with higher volume. Advertising expense increased 7% in the quarter and 14.5% year to date.
- The $17.0 million pretax gain on sale of non-core trademark licensing rights benefited third-quarter results; proceeds were $20.0 million. The gain contributed about $0.05 per diluted share after tax.
- The nine-month comparison benefited from substantially lower realignment and impairment charges than in 2010, which included a $44.7 million non-cash goodwill impairment for Godrej Hershey Ltd. The 2011 income statement recorded a $5.9 million net credit in the separate realignment line, while total 2011 realignment-program charges across expense lines were $21.4 million.
Outlook, commentary and risks
- For 2011, management expected net sales growth of about 7%, GAAP diluted EPS of $2.72–$2.76 and adjusted diluted EPS of $2.79–$2.82, implying adjusted EPS growth of about 10%. The price increase announced in March was not expected to have a significant 2011 impact; seasonal net price realization was expected from Easter 2012.
- For 2012, management expected sales growth of 3%–5% and adjusted diluted EPS growth of 6%–8%, while anticipating significantly higher input costs. It said 2011 pricing, productivity and cost-saving initiatives should help mitigate inflation.
- Management expected 2011 Project Next Century charges of $38–$43 million and capital expenditures of approximately $190–$200 million for the program. Total program charges and implementation costs were estimated at $140–$160 million over three years. The project involves transitioning production from the 19 East Chocolate Avenue facility to an expanded West Hershey facility.
- The company received $47.6 million net proceeds under a sale-and-lease arrangement for the 19 East facility and recorded a $50.0 million lease-financing obligation. Because of continuing use and involvement, it remained the accounting owner; the initial lease term runs to 2041.
- Key stated risks include commodity and energy costs and availability, pricing-related volume declines, product safety or quality issues, competition, supply-chain disruption, international operations, execution of the supply-chain program and acquisitions or joint ventures, and potential effects of a regulatory investigation into alleged confectionery-industry pricing practices.
Most important facts for investors to verify
- Whether the 2011 pricing actions translate into the expected 2012 realization without further material volume or promotional pressure.
- Whether elevated commodity and supply-chain costs are offset by pricing and productivity, and how margins evolve.
- Whether operating cash flow recovers from the year-to-date decline as seasonal working capital reverses; inventory and receivables consumed significant cash.
- Actual Project Next Century costs, capital spending, timing, savings and production-transition execution, including obligations under the facility lease.
- Reported versus adjusted EPS: quantify the trademark-sale gain and realignment items when assessing underlying performance.
- Debt, liquidity and covenant compliance under the new five-year $1.1 billion revolving facility, including its optional additional $400 million capacity and minimum 2.0-to-1 interest-coverage covenant.