Business Context and Reporting Period
Company: The Hershey Company
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Overview: The largest North American manufacturer of quality chocolate and sugar confectionery products. The company operates as a single reportable segment, aggregating operations in the Americas (U.S., Canada, Mexico, Brazil) and other international locations. The 2007 fiscal year was characterized by sharp increases in commodity costs, particularly dairy, and significant business realignment charges.
Key Financial Metrics
| Metric | 2007 | 2006 | Change |
|---|---|---|---|
| Net Sales | $4,946.7 million | $4,944.2 million | +0.1% |
| Gross Profit | $1,631.6 million | $1,867.5 million | -12.6% |
| Gross Margin | 33.0% | 37.8% | -480 bps |
| Net Income (GAAP) | $214.2 million | $559.1 million | -61.7% |
| Diluted EPS (Common Stock) | $0.93 | $2.34 | -60.3% |
| EBIT | $458.8 million | $992.6 million | -53.8% |
| Operating Cash Flow | $778.8 million | $723.2 million | +7.7% |
| Total Debt (Short + Long Term) | $2,136.4 million | $2,092.1 million | +2.1% |
| Stockholders' Equity | $592.9 million | $683.4 million | -13.2% |
Material Changes vs. Prior Period
- Revenue Stagnation: Net sales remained essentially flat year-over-year. International growth and the acquisition of Godrej Hershey Foods and Beverages Company ($46.5 million in sales) were offset by lower U.S. sales volume due to increased competition and reduced retail velocity.
- Margin Compression: Gross margin declined significantly (from 37.8% to 33.0%) primarily due to a $100 million increase in input costs (notably dairy products) and higher promotional spending. Price increases implemented in April 2007 only partially offset these costs.
- Business Realignment Charges: The company recorded $276.9 million in pre-tax business realignment and impairment charges in 2007, compared to $14.6 million in 2006. This included a $12.3 million goodwill impairment for the Brazil subsidiary and significant costs related to a global supply chain transformation program.
- Profitability Decline: Net income dropped by over 60% due to the combination of lower gross margins, higher selling/marketing expenses, and the aforementioned realignment charges.
Guidance, Outlook, and Risks
2008 Outlook
- Sales Growth: Consolidated net sales expected to grow 3% to 4%.
- Cost Environment: Input costs expected to increase by approximately $100 million compared to 2007, reducing gross margin by 200 basis points.
- EPS Guidance:
- GAAP EPS: Expected range of $1.43 to $1.53.
- Non-GAAP EPS: Expected range of $1.85 to $1.90 (excluding items affecting comparability).
- Realignment Costs: Total pre-tax charges for 2008 expected to be $140 million to $160 million, reducing diluted EPS by $0.37 to $0.42.
Key Risks and Contingencies
- Commodity Volatility: Significant exposure to cocoa, dairy, sugar, and energy prices. Dairy prices rose sharply in 2007; cocoa prices traded between 74¢ and 95¢ per pound.
- Supply Chain Transformation: A three-year program estimated to cost $525 million to $575 million. Risks include execution delays and cost overruns.
- Legal Proceedings: Subject to antitrust investigations by the U.S. Department of Justice, Canadian Competition Bureau, and European Commission regarding pricing practices. Also facing approximately 50 civil antitrust suits in the U.S.
- Customer Concentration: McLane Company, Inc. accounted for approximately 26% of total net sales in 2007.
Investor Verification Checklist
- Realignment Execution: Verify the progress and cost containment of the global supply chain transformation program and the restructuring of the Brazil business.
- Commodity Hedging: Assess the effectiveness of forward purchasing and futures contracts in mitigating the projected $100 million input cost increase for 2008.
- U.S. Market Share: Monitor consumer takeaway and market share metrics in the U.S. to confirm stabilization against competitive pressures.
- Legal Exposure: Track developments in the antitrust investigations and civil litigation to evaluate potential fines or damages.
- International Growth: Review performance of the Godrej Hershey joint venture in India and expansion efforts in China.