Business Context and Reporting Period
Company: The Hershey Company
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and six months ended July 3, 2005
Business Overview: The Company is a leading manufacturer of confectionery and snack products. The reporting period covers the second quarter of 2005, a seasonally significant period for the business.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended July 3, 2005 |
6 Months Ended July 3, 2005 |
|---|---|---|
| Net Sales | $988,447 | $2,114,861 |
| Net Income | $97,361 | $215,582 |
| Diluted EPS | $0.39 | $0.86 |
| Gross Margin | 39.8% | 39.0% |
| Operating Cash Flow (6 mo) | $35,789 | |
| Cash & Equivalents | $24,712 (as of July 3, 2005) | |
| Short-Term Debt | $682,164 | |
| Long-Term Debt | $690,060 | |
| Current Ratio | 0.9:1 |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 11% in the second quarter and 11% year-to-date compared to 2004. Growth was driven by organic volume (new products, international expansion) and price realization, with acquisitions (Mauna Loa, Grupo Lorena) contributing approximately 3% of the increase.
- Profitability Decline: Net income decreased 34% in the quarter and 15% year-to-date. This decline is largely attributable to a one-time $61.1 million benefit from income tax contingency reserve adjustments recorded in the second quarter of 2004, which is not present in 2005.
- Margin Compression: Gross margin decreased slightly (40.3% to 39.8% in Q2) due to higher raw material costs (cocoa, dairy), unfavorable product mix from lower-margin acquisitions, and increased labor/overhead costs.
- Expense Management: Selling, marketing, and administrative expenses increased 5.3% in Q2 but declined as a percentage of sales (23.4% to 22.3%) due to efficient promotional spending.
- Liquidity Position: Cash and cash equivalents decreased by $30.1 million year-to-date. Short-term debt increased significantly to fund share repurchases and working capital needs, raising the capitalization ratio from 55% to 62%.
Outlook, Risks, and Unusual Items
- Restructuring Charge: In July 2005, the Company announced a pre-tax charge of $140 million to $150 million ($0.41 to $0.44 diluted EPS) related to a value-enhancing strategy. This includes $80 million for workforce reduction, $41 million for facility rationalization (including closing the Las Piedras, Puerto Rico plant), and $24 million for international streamlining. Approximately 80% of the charge is expected in the remainder of 2005.
- Acquisition: The Company agreed to acquire Scharffen Berger Chocolate Maker, Inc., expected to close in Q3 2005.
- Share Repurchases: The Company repurchased $223.5 million of stock for incentive plans and $44.2 million under the 2002 program. A new $250 million repurchase authorization was approved in April 2005.
- Accounting Changes: The Company expects to adopt SFAS No. 123R (Share-Based Payment) effective January 1, 2006, which will require expensing stock options. The estimated impact is $0.06 to $0.08 per share annually.
- Risks: Key risks include raw material cost volatility (cocoa, dairy), currency exchange fluctuations, and the ability to realize projected savings from the restructuring program.
Investor Verification Checklist
- Tax Impact: Verify the non-recurring nature of the 2004 tax benefit ($61.1M) to accurately assess normalized earnings trends.
- Restructuring Costs: Monitor the timing and cash impact of the announced $140M-$150M restructuring charge in Q3 and Q4 2005.
- Raw Material Costs: Assess the sustainability of gross margins given the elevated costs of cocoa and dairy products.
- Debt Levels: Review the increase in short-term debt ($682M) and the Company's strategy to refinance commercial paper with long-term notes.
- Acquisition Integration: Evaluate the financial impact and integration progress of the Scharffen Berger acquisition upon closing.