The Hershey Company — Q1 2018 Form 10-Q
Reporting period: Three months ended April 1, 2018; comparisons are with the three months ended April 2, 2017. Amounts are in U.S. dollars.
Business context and results
Hershey makes and sells confectionery, grocery and snack products. North America generated 88.8% of quarterly sales. On January 31, 2018, Hershey acquired Amplify Snack Brands, including SkinnyPop, for total consideration of approximately $968.8 million. Amplify’s results are included in North America from the acquisition date.
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $1,972.0 million | $1,879.7 million |
| Gross profit / reported gross margin | $974.1 million / 49.4% | $909.4 million / 48.4% |
| Operating profit / reported operating margin | $480.5 million / 24.4% | $197.2 million / 10.5% |
| Net income attributable to Hershey | $350.2 million | $125.0 million |
| Diluted EPS, common stock | $1.65 | $0.58 |
| Cash provided by operating activities | $352.1 million | $234.5 million |
Material changes and underlying performance
- Sales rose 4.9% (4.4% excluding foreign exchange). Management attributed growth to Amplify (3.4%), volume (2.4%) and favorable currency (0.5%), partly offset by unfavorable price realization (1.4%).
- Reported earnings comparisons were substantially affected by the prior-year $208.7 million long-lived asset impairment charge. Q1 2018 also included a $96.3 million unallocated commodity-derivative mark-to-market gain, versus a $17.1 million gain in Q1 2017.
- On Hershey’s non-GAAP basis, adjusted net income was $298.0 million, up 6.7%, and diluted adjusted EPS was $1.41, up 8.5%. Adjusted gross margin declined to 44.9% from 47.5%, and adjusted operating margin to 21.7% from 23.2%. The company cites unfavorable mix, higher freight and logistics costs, and increased trade promotions and packaging investments.
- North America sales increased 4.4%, but segment income fell 3.3% to $534.4 million. International and Other sales increased 8.8%, and segment income rose to $17.7 million from $1.7 million.
- The effective tax rate fell to 21.9% from 41.6%, reflecting U.S. tax reform and, in the prior-year comparison, non-benefited realignment costs.
Cash, debt and liquidity
- Cash and cash equivalents were $476.4 million at April 1, 2018, up from $380.2 million at year-end; approximately 80% was held by foreign subsidiaries and management intends to reinvest those funds abroad.
- Investing activities used $981.8 million, primarily reflecting $915.5 million paid for Amplify net of cash acquired and $60.1 million of capital additions. Financing activities provided $725.9 million, including a $1.7 billion net increase in short-term debt.
- Short-term debt was $2.246 billion, including $2.146 billion of commercial paper; long-term debt was $2.060 billion, plus a $303.1 million current portion. The increase in short-term borrowing primarily funded the Amplify acquisition and repayment of acquired debt.
- Current assets were $2.270 billion versus current liabilities of $3.706 billion, with short-term debt contributing materially to current liabilities. Hershey reported compliance with credit-facility covenants and said it had sufficient liquidity for its needs.
- Hershey paid $134.3 million in dividends and repurchased $178.1 million of common stock during the quarter.
Outlook, risks and unusual items
- The filing does not provide a clear full-year sales or EPS guidance figure. Management expected 2018 capital expenditures, including capitalized software, of approximately $355–$375 million.
- The Margin for Growth program is expected to incur total pretax charges of $375–$425 million during 2017–2019, with $150–$175 million estimated to be cash charges. The program is expected to reduce the global workforce by approximately 15%. Hershey also expected approximately $7.7 million of additional cash costs over the next nine months to complete remaining Operational Optimization Program facility consolidations.
- Amplify purchase-price allocation remained preliminary; the company expected to finalize it by year-end 2018. The acquisition added substantial goodwill and intangible assets, and integration and valuation estimates remain relevant.
- Key disclosed risks include raw-material and energy costs, pricing and demand, competition, product safety, supply-chain disruption, acquisition integration, international performance, ERP implementation, and realizing restructuring savings. The company reported no material change to its previously disclosed risk factors and said pending legal matters were not expected to materially affect financial condition, results or cash flows.
- Hershey adopted revenue-recognition guidance in Q1 2018 with no opening retained-earnings adjustment. Adoption of the new lease standard, effective for Hershey in 2019, was expected to materially increase lease assets and liabilities, but not significantly affect income or cash flows.
Investor verification priorities
- Assess how much sales growth and future profitability depend on Amplify, and track integration costs, acquired-brand performance and final purchase accounting.
- Separate recurring operating performance from commodity-derivative mark-to-market gains and restructuring, impairment and acquisition-related items; compare GAAP and adjusted margins.
- Monitor commercial-paper borrowing, refinancing and liquidity, particularly given the acquisition-related increase in short-term debt and the large offshore cash balance.
- Check whether North America’s higher promotional, logistics and mix costs ease, and whether International and Other segment improvement continues.
- Track capital spending, restructuring charges and realized savings, as well as the ERP rollout and expected lease-accounting balance-sheet impact.