Business Context and Reporting Period
Company: The Hershey Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 29, 2008
Context: Hershey is a large accelerated filer engaged in the manufacture and sale of confectionery products. The reporting period covers the second quarter and first six months of fiscal year 2008. The company is currently executing a global supply chain transformation program and restructuring its Brazilian operations.
Key Financial Metrics
| Metric (in thousands) | Q2 2008 | Q2 2007 | YTD 2008 | YTD 2007 |
|---|---|---|---|---|
| Net Sales | $1,105,437 | $1,051,916 | $2,265,779 | $2,205,025 |
| Net Income | $41,467 | $3,554 | $104,712 | $97,027 |
| Diluted EPS (Common) | $0.18 | $0.01 | $0.46 | $0.42 |
| Gross Margin | 34.6% | 31.3% | 33.5% | 33.7% |
| EBIT Margin | 8.5% | 3.1% | 9.6% | 9.2% |
| Cash & Equivalents | $45,427 | $129,198 (Dec 2007) | $45,427 | $129,198 (Dec 2007) |
| Operating Cash Flow (YTD) | $320,072 | $293,505 | ||
| Total Debt (Short + Long Term) | ||||
| Debt Balance | $1,949,275 | $2,136,357 (Dec 2007) | $1,949,275 | $2,136,357 (Dec 2007) |
Note: Debt figures represent the sum of Short-term debt, Current portion of long-term debt, and Long-term debt as of June 29, 2008 ($419,372 + $16,874 + $1,514,029).
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 5.1% in Q2 and 2.8% YTD compared to 2007. Growth was driven by favorable price realization (offsetting higher input costs), the Godrej Hershey Ltd. acquisition in India, and favorable foreign currency exchange rates. These gains were partially offset by volume decreases in the U.S. due to seasonal shifts (early Easter) and reduced snack sales.
- Profitability Surge: Net income for Q2 2008 ($41.5M) was significantly higher than Q2 2007 ($3.6M). This improvement is primarily attributable to a substantial decrease in "Business realignment and impairment charges," which dropped from $79.7M in Q2 2007 to $21.8M in Q2 2008.
- Expense Increases: Selling, marketing, and administrative (SM&A) expenses rose 22.9% in Q2 and 19.2% YTD. Increases were driven by higher employee-related costs (retail coverage expansion), international expansion, and higher advertising/promotional spending for new products.
- Balance Sheet: Cash and cash equivalents decreased by $83.8M YTD, primarily due to the repayment of $430.9M in short-term debt, dividend payments of $131.5M, and capital additions of $146.5M. Inventory levels increased to $697.6M (from $600.2M at year-end 2007) due to higher raw material prices and seasonal build-up.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- 2008 Sales Guidance: Consolidated net sales are expected to grow 3% to 4% in 2008.
- 2008 EPS Guidance: Diluted EPS excluding items affecting comparability is expected to be in the range of $1.85 to $1.90. GAAP EPS is expected to be $1.43 to $1.51.
- Cost Outlook: The company expects input costs to increase by approximately $100M in 2008 versus 2007, reducing gross margin by 200 basis points. Total pre-tax business realignment charges for 2008 are expected to be $135M to $145M, reducing EPS by $0.39 to $0.42.
- Strategic Initiatives: Hershey announced a new consumer-driven business model targeting long-term sales growth of 3-5% and EPS growth of 6-8% (excluding comparability items). Key initiatives include the global supply chain transformation (now estimated at $550M-$575M total cost) and investments in emerging markets (China, India).
Risks and Contingencies
- Commodity Volatility: Significant increases in raw material prices (cocoa, sugar, dairy) and fuel costs pose a risk to margins.
- Legal and Regulatory: Ongoing litigation regarding a 2006 product recall in Canada (contaminated ingredient) and government investigations into industry pricing practices.
- Execution Risk: The ability to implement supply chain transformation within the anticipated timeframe and cost estimates.
- Market Demand: Changes in consumer preferences and competitive activity in the confectionery sector.
Investor Verification Checklist
- Realignment Charge Accuracy: Verify the remaining liability for the global supply chain transformation program ($46.6M employee separation liability as of June 29, 2008) and the total projected cost of $550M-$575M.
- Input Cost Hedging: Review the effectiveness of commodity hedging strategies given the $38.1M market risk exposure to a 10% adverse price movement in commodities.
- Volume Trends: Monitor U.S. consumer takeaway and market share metrics, which declined in Q2 due to seasonal timing but showed underlying growth when adjusted.
- Debt Maturity Profile: Assess the impact of the $250M 5.0% Notes issued in March 2008 and the reduction in short-term commercial paper borrowings.
- International Performance: Evaluate the integration and performance of the Godrej Hershey Ltd. acquisition in India and the cooperative agreement with Bauducco in Brazil.