The Hershey Company — Q3 2015 Form 10-Q
Business context and period: Unaudited results for the three and nine months ended October 4, 2015, compared with the corresponding 2014 periods. Hershey’s North America business generated more than 85% of consolidated revenue. Figures below are in U.S. dollars; financial statement amounts are converted from thousands to millions where shown.
Key financial results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $1,960.8m | $1,961.6m | $5,477.4m | $5,411.7m |
| Gross margin | 45.5% | 43.8% | 46.2% | 45.3% |
| Operating profit | $303.0m | $358.7m | $694.7m | $1,048.7m |
| Net income | $154.8m | $223.7m | $299.6m | $644.4m |
| Diluted EPS, common stock | $0.70 | $1.00 | $1.35 | $2.86 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $587.9m | $387.4m |
Q3 sales were essentially flat as price realization and acquisitions were offset by lower volume and adverse foreign exchange. Excluding currency, sales increased 2.0%. Q3 reported operating profit declined 15.5%, net income fell 30.8%, and diluted EPS fell 30.0%. For the first nine months, sales rose 1.2%, while operating profit declined 33.8%, net income 53.5%, and diluted EPS 52.8%.
Reported gross margin expanded 170 basis points in Q3 and 90 basis points year to date. Price realization and productivity helped, partly offset by commodity and input costs and unfavorable mix. Management’s non-GAAP Q3 gross margin was 46.0%, up from 43.8%; non-GAAP operating profit was up 9.1% in Q3 and 1.9% year to date. These adjusted measures exclude specified impairment, restructuring, acquisition, debt-extinguishment, and pension items.
Cash, debt, and liquidity
- Cash and equivalents were $343.9m at October 4, 2015, versus $374.9m at December 31, 2014; cash plus short-term investments declined $128.0m from the year-end balance.
- Nine-month investing cash use was $331.4m, including $218.7m for acquisitions; financing cash use was $287.4m. Cash dividends were $353.1m and common-stock repurchases were $567.5m.
- At quarter-end, short-term debt was $688.0m, current long-term debt $250.4m, and long-term debt $1,830.2m. Total reported debt was approximately $2.77bn, up from approximately $2.18bn at year-end 2014.
- Current assets were $2.21bn and current liabilities $2.24bn. Hershey maintained a $1.0bn revolving credit facility through November 2019, reported compliance with its covenants, and stated it had sufficient liquidity. About half of cash, cash equivalents, and short-term investments was held outside the U.S. and intended to remain invested abroad.
Material developments and unusual items
- China/SGM impairment and performance: Hershey recorded $280.8m of goodwill impairment in the first nine months: $266.4m relating to Shanghai Golden Monkey (SGM) and $14.4m relating to the China chocolate reporting unit. Q3 included $31.0m of impairment. SGM’s sales and earnings were well below pre-acquisition levels; the company continued to assess integration options and negotiate the timing and terms of buying the remaining 20% of SGM.
- International weakness: International and Other sales fell 15.2% in Q3 and 6.9% year to date; the segment reported a $13.5m Q3 loss and a $79.8m nine-month loss. China weakness, currency, lower volume, trade promotions, and acquisition-related costs weighed on results. North America sales rose 2.4% in both periods; Q3 segment income increased 11.7%.
- Restructuring: The 2015 productivity initiative is expected to reduce approximately 300 positions. Hershey incurred $64.3m of related Q3 charges and $90.3m year to date, and estimated total pre-tax program costs of about $120m, mostly cash. Remaining costs were expected over the next three quarters. Management projected annual pre-tax savings at the high end of $65m–$75m and an approximately $25m benefit to 2015 results. A possible pension settlement charge was not included in the estimate.
- Debt tender and refinancing: A Q3 tender offer to repurchase $71.6m of debt generated a $28.3m pre-tax early-extinguishment loss. Hershey also issued $300m of 1.60% notes due 2018 and $300m of 3.20% notes due 2025.
- Other transactions: Hershey acquired snack maker KRAVE for $220.0m cash paid to date, with up to $20.0m additional contingent consideration. It completed the purchase of the remaining 49% interest in Hershey do Brasil and sold Mauna Loa, receiving approximately $32.4m net proceeds.
- Tax: The nine-month reported effective tax rate was 50.5%, versus 34.5% in 2014, principally reflecting non-deductible goodwill impairment. Excluding that impairment, management reported a 34.5% rate. Tax-credit benefits were partly offset by a valuation allowance on SGM tax losses and an unfavorable geographic earnings mix.
Outlook, commentary, and risks
Management expected 2015 reported net sales to be approximately flat with 2014, including an estimated 1.0% net benefit from acquisitions and divestitures and at least a 1.5% adverse foreign-exchange impact. Excluding currency, it expected sales growth of approximately 1.5%–2.0%, reported gross-margin expansion of about 125 basis points, and reported diluted EPS of $2.22–$2.34. Adjusted diluted EPS was projected at approximately $4.10, the low end of the prior 3%–5% growth range; the outlook included about $0.35 per share of acquisition/divestiture dilution. Management expected increased Q4 North America advertising and customer programming to support seasonal sales and forecast sequential U.S. marketplace improvement.
Management cited pricing-related volume elasticity, lower U.S. retail trips and merchandising, China’s macroeconomic conditions and changing shopping behavior, commodity and energy costs, foreign exchange, competition, product safety, supply-chain disruption, and successful acquisition integration as risks. It said further China volatility was not expected to materially affect cash flows or financial position, but the outlook remained subject to uncertainty. The filing reported that the Third Circuit affirmed summary judgment for Hershey in U.S. direct-purchaser antitrust cases; the company did not expect dismissed cases to be reinstated. Hershey Canada had previously paid a roughly $4.0m fine in Canada. No other material pending legal proceedings were reported.
Important facts for investors to verify
- Whether SGM and China performance, remaining-stake negotiations, and integration assumptions improve enough to support the outlook.
- Whether 2015 sales, margin, and adjusted EPS guidance is achieved, particularly given currency, pricing elasticity, and China risks.
- Whether the productivity program delivers the projected savings and whether additional restructuring or pension-settlement costs arise.
- How higher debt, share repurchases, dividends, and cash held overseas affect liquidity and capital-allocation flexibility.
- How reported results compare with management’s non-GAAP measures and the specific adjustments excluded from those measures.