The Hershey Company (NYSE: HSY) — 2012 Form 10-K
Business context and reporting period. Hershey is a global confectionery company, with its principal market in North America, and reports as one segment. This 10-K covers the fiscal year ended December 31, 2012; it also provides unaudited fourth-quarter results. Amounts below are in U.S. dollars.
Financial performance
| Metric | FY 2012 | FY 2011 | Change |
|---|---|---|---|
| Net sales | $6,644.3 million | $6,080.8 million | +9.3% |
| Gross profit / margin | $2,859.9 million / 43.0% | $2,531.9 million / 41.6% | Margin +1.4 percentage points |
| Operating income (EBIT) / margin | $1,111.1 million / 16.7% | $1,055.0 million / 17.4% | EBIT +5.3%; margin -0.7 points |
| Net income | $660.9 million | $629.0 million | +5.1% |
| Diluted EPS, Common Stock | $2.89 | $2.74 | +5.5% |
| Operating cash flow | $1,094.8 million | $587.9 million | +$506.9 million |
| Capital additions and software | $278.0 million | $347.6 million | Lower year over year |
Management’s adjusted non-GAAP results were EBIT of $1,228.9 million, net income of $740.0 million and diluted EPS of $3.24. Adjusted EPS increased 14.5%; adjusted EBIT margin expanded 60 basis points. These measures exclude specified realignment and impairment costs, non-service pension expenses, Brookside acquisition costs and, for 2011, a trademark-licensing gain.
Fourth quarter
Fourth-quarter net sales were $1,751.0 million versus $1,567.1 million a year earlier; gross profit was $755.2 million versus $631.2 million; net income was $149.9 million versus $142.1 million; and diluted Common Stock EPS was $0.66 versus $0.62. Sales and gross profit increased, while net income and EPS grew more modestly.
Liquidity and capital structure
At year-end, cash and cash equivalents were $728.3 million, current assets $2,113.5 million and current liabilities $1,471.1 million. Short-term debt and current maturities of long-term debt totaled $375.9 million; long-term debt was $1,531.0 million. Total debt on this basis was approximately $1,906.9 million, compared with approximately $1,888.2 million in 2011. Stockholders’ equity was $1,048.4 million.
The company had $1.1 billion available under its revolving credit facility and reported compliance with its covenants. Cash dividends paid were $341.2 million, and common-stock repurchases used $510.6 million. Contractual obligations totaled $4.094 billion, including $2.168 billion of purchase obligations, principally commodity commitments.
Material changes and operating drivers
- Sales growth reflected net price realization of approximately 5.7%, volume growth of approximately 2.2%, and a 1.9% contribution from Brookside; foreign exchange reduced growth by approximately 0.5%.
- Gross margin improved on price realization and supply-chain productivity, partly offset by higher input and supply-chain costs. Cocoa futures prices moderated in 2012; commodity costs remain subject to hedging, purchasing timing and market volatility.
- SG&A rose 15.3%, including higher advertising, marketing research, promotions, employee costs and Brookside-related expenses. Advertising expense increased 15.9%.
- GAAP EBIT margin declined despite higher gross margin, as increased SG&A and realignment and impairment charges outweighed the gross-margin improvement. FY 2012 net business realignment and impairment charges were $44.9 million, versus a $0.9 million credit in 2011.
- Operating cash flow rose substantially, but was affected by working-capital movements and changes in other assets and liabilities, including hedging and tax-related items. Investing cash outflow was $473.4 million, including the Brookside acquisition; financing cash outflow was $586.9 million.
Outlook, commentary and risks
Management described 2012 results as strong and cited brand investment, innovation, productivity and cost savings. For 2013, it forecast net-sales growth of 5%–7%, reported gross-margin expansion of 250–270 basis points, and adjusted gross-margin expansion of 180–200 basis points. Advertising was expected to rise approximately 20%. Forecast diluted EPS was $3.47–$3.56 on a GAAP basis and $3.56–$3.63 adjusted; management expected adjusted EPS growth of 10%–12%. It also expected approximately $300 million of 2013 capital expenditures, including capitalized software.
- Project Next Century: The production transition from the 19 East Chocolate Avenue facility was completed in 2012. Total program charges and implementation costs were estimated at $190–$200 million; management expected annual efficiency savings of $65–$80 million. The company forecast another $10–$15 million of program charges in 2013.
- Acquisitions and unusual items: Brookside was acquired for approximately $172.9 million. Hershey also recorded approximately $7.5 million of non-cash impairment charges after deciding to close Tri-US, citing operating difficulties, quality issues and competitive constraints.
- Legal contingencies: Canadian civil antitrust cases were settled in 2012; a Canadian government investigation remained pending, with a tentative settlement and an accrued liability. U.S. antitrust litigation continued, with plaintiffs seeking actual and treble damages; the company said it could not estimate a reasonably possible liability range.
- Key exposures: Commodity and energy costs and availability, pricing and volume elasticity, intense competition, product safety and recalls, supply-chain disruption, international and currency risks, pension funding and litigation. McLane represented 22.2% of 2012 net sales, making customer concentration a consideration.
Investor verification priorities
- Confirm the FY 2012 GAAP results and the basis and exclusions used in management’s adjusted metrics and 2013 guidance.
- Assess whether 2013 sales, margin and EPS forecasts depended on expected pricing, productivity, raw-material costs, advertising and Brookside distribution.
- Review the U.S. antitrust case status, the accrued Canadian settlement liability and any subsequent changes in estimated exposure.
- Track debt maturities, refinancing needs, share repurchases, dividends and liquidity after the Brookside acquisition and capital spending.
- Evaluate the realized savings and remaining costs of Project Next Century, and the financial implications of the Tri-US closure.
- Consider the effects of McLane customer concentration, pension assumptions and commodity hedging on earnings and cash flows.