The Hershey Company — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 29, 2013; filed November 1, 2013. The company sells confectionery products in the U.S. and internationally. Financial amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $1,853.9 | $1,746.7 | $5,189.8 | $4,893.2 |
| Gross margin | 46.1% | 42.5% | 46.7% | 43.0% |
| EBIT | $370.6 | $301.7 | $1,031.4 | $858.5 |
| EBIT margin | 20.0% | 17.3% | 19.9% | 17.5% |
| Net income | $233.0 | $176.7 | $634.4 | $511.1 |
| Diluted Common Stock EPS | $1.03 | $0.77 | $2.79 | $2.23 |
- Q3 sales rose 6.1%; management attributed growth primarily to volume, including core brands, new products and Brookside. Net price realization added 0.5%, offset by unfavorable foreign exchange of 0.5%. Sales outside the U.S. and Canada increased 14.2% in Q3.
- Gross margin improved 3.6 percentage points in Q3 and 3.7 points year to date. Lower input costs, supply-chain productivity and favorable mix were key contributors; inflation partly offset these benefits.
- SM&A increased 14.5% in Q3 and 13.2% year to date, reflecting higher marketing, employee-related and other expenses. Advertising and consumer-promotion spending increased 21.0% in Q3 and 20.1% year to date.
- Operating cash flow was $623.7 for the first nine months, versus $605.9 in 2012. Investing used $229.2, including $215.3 of capital additions; financing used $421.5. Cash declined $26.9 to $701.3.
- At September 29, current assets were $2,375.7 and current liabilities $1,260.8; the reported current ratio was 1.9, up from 1.4 at year-end 2012. Total debt was approximately $1,906.4, comprising $107.1 short-term debt, $3.1 current long-term debt and $1,796.3 long-term debt. No commercial paper was outstanding.
Material changes and notable items
- Net income increased 31.8% in Q3 and 24.1% year to date; diluted Common Stock EPS increased 33.8% and 25.1%, respectively. Year-to-date share averages were lower than in 2012.
- Reported business realignment and impairment charges were $2.9 in Q3 and $13.4 year to date, versus $20.1 and $28.2. The 2012 comparison included a $13.1 pension settlement loss. 2013 charges primarily related to demolition under the Next Century program.
- In May 2013, Hershey issued $250.0 of 2.625% notes due 2023, after repaying $250.0 of 5.0% notes due 2013. The company reported a 59% capitalization ratio, down from 65% at year-end 2012.
- Q3 diluted EPS growth was 19.5% excluding specified realignment, acquisition and non-service pension items; year-to-date growth on the company’s comparable adjusted basis was 14.4%. These are non-GAAP comparisons.
Outlook, risks and contingencies
- For 2013, management expected net sales growth of about 7%, reported gross-margin expansion of 310–320 basis points and adjusted gross-margin expansion of 240–250 basis points. It projected GAAP diluted EPS of $3.60–$3.65 and adjusted diluted EPS of $3.68–$3.71. Adjusted EPS excludes specified charges.
- Management expected 2013 advertising to increase approximately 22%–23%; SM&A excluding advertising was expected to grow faster than sales. The full-year tax rate was expected to be approximately 34.5%.
- For 2014, the company projected sales growth within its 5%–7% long-term target, reported diluted EPS growth of 10%–12%, and adjusted diluted EPS growth of 9%–11%. It raised its long-term adjusted EPS growth target to 9%–11% annually.
- Management cited product demand, competition, raw-material and energy prices and availability, pricing and volume sensitivity, supply-chain disruption, international operations, acquisition execution, regulation, pension costs, and IT security among risks. The filing also references government investigations of alleged confectionery-industry pricing practices and related U.S. civil antitrust litigation; details are referred to prior filings.
- U.S. federal tax audits for 2009–2011 were underway, and Canadian audits for 2006–2009 and 2010–2012 were noted. Management did not expect potential tax adjustments to materially affect results or financial position and expected about $6.4 of unrecognized tax benefits to reverse within 12 months.
- The company reported compliance with credit-agreement covenants and effective disclosure controls. Results are seasonal and interim performance may not indicate full-year results.
Important facts for investors to verify
- Whether 2013 sales, gross-margin and EPS targets were achieved, and how reported results compare with the stated adjusted measures and exclusions.
- Whether volume growth and international expansion continued to offset rising marketing spending, supply-chain inflation and foreign-exchange effects.
- Cash conversion and working-capital trends, especially the increases in receivables and inventories, alongside planned capital investment and shareholder distributions.
- Debt maturities, interest costs and liquidity, including the implications of the 2023 note issuance and seasonal working-capital needs.
- Developments in the referenced antitrust matters, tax audits, commodity and currency exposures, and Next Century program costs.