HSY

Business Context and Reporting Period

Company: The Hershey Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 28, 2008
Context: Hershey reported strong third-quarter and nine-month results driven by favorable price realization and significantly lower business realignment charges compared to the prior year. The company is executing a global supply chain transformation program and managing elevated input costs through price increases.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 6.4% in Q3 and 4.2% for the nine months ended September 28, 2008. Growth was driven by price increases (approx. 10% weighted average increase in August 2008) and volume gains in international markets (India, Brazil, Philippines), partially offset by volume declines in U.S. snack and refreshment products.
• Profitability Surge: Net income nearly doubled in Q3 (up 98.4%) and increased 43.5% for the nine-month period. This was primarily due to a drastic reduction in "Business realignment and impairment charges," which fell from $112.0 million in Q3 2007 to $8.9 million in Q3 2008.
• Cost Pressures: Cost of sales increased due to higher input and energy costs. Gross margin remained flat in Q3 but declined slightly for the nine-month period (33.6% vs 33.7%) as price realization only partially offset rising commodity costs.
• Expense Increases: Selling, marketing, and administrative (SM&A) expenses rose 18.5% in Q3 and 19.0% for the nine months, driven by higher advertising, consumer promotion, and incentive compensation costs.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• 2008 Full Year: Hershey expects consolidated net sales growth of 3% to 4%. Earnings per share (diluted), excluding items affecting comparability, are expected to be in the range of $1.85 to $1.90. GAAP EPS is expected to be $1.43 to $1.51.
• Restructuring Costs: Total pre-tax business realignment and impairment charges for 2008 are expected to be $135 million to $145 million. This includes potential pension settlement charges ranging from $0 to $27 million in Q4 2008 and up to $50 million in 2009, dependent on employee withdrawal decisions.
• 2009 Outlook: Net sales growth is expected to be 2% to 3%. Input and energy costs are projected to increase by $200 million to $225 million compared to 2008. EPS growth is expected to be modest due to high commodity costs and pension expense volatility.

Risks and Contingencies

• Commodity Volatility: Significant exposure to raw material price fluctuations (cocoa, sugar, milk) and energy costs.
• Pension Settlements: Potential for additional non-cash pension settlement charges under SFAS No. 88 if employees withdraw funds, exacerbated by declines in financial markets.
• Legal/Regulatory: Ongoing litigation regarding a 2006 product recall in Canada and government investigations into pricing practices in the confectionery industry.
• Market Conditions: Volatility in global capital and credit markets could impact access to financing, though the company currently maintains full access to commercial paper markets.

Investor Verification Checklist

• Price Realization Lag: Verify the timing of the full impact of August 2008 price increases on net sales, as management notes a delay due to promotional commitments.
• Pension Settlement Exposure: Monitor Q4 2008 and 2009 reports for actual pension settlement charges, which could range from $0 to $75 million depending on employee actions.
• Supply Chain Execution: Track progress of the global supply chain transformation program, specifically the closure of six manufacturing facilities and the associated cost savings.
• Input Cost Inflation: Assess the ability to pass through the projected $200M-$225M cost increase in 2009 without significant volume erosion.
• Canada Recall Litigation: Review updates on the recovery of damages from the supplier responsible for the 2006 product recall.