Business Context and Reporting Period
Company: The Hershey Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 2, 2006
Context: The Company reported results for the second quarter and first six months of 2006. Operations are seasonal, with results for the first six months not necessarily indicative of full-year performance. The Company continues to execute business realignment initiatives announced in 2005, including workforce reductions and facility rationalization.
Key Financial Metrics
| Metric | Three Months Ended July 2, 2006 | Six Months Ended July 2, 2006 |
|---|---|---|
| Net Sales | $1,052,067,000 | $2,184,795,000 |
| Net Income | $98,440,000 | $219,408,000 |
| Diluted EPS | $0.41 | $0.91 |
| Gross Margin | 38.8% | 38.4% |
| Operating Cash Flow (6mo) | $167,351,000 | |
| Cash and Equivalents (End of Period) | $23,485,000 | |
| Total Debt (Short + Long Term) | $2,076,403,000 | |
| Current Ratio | 0.8:1 |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 6.4% in Q2 and 3.3% year-to-date (YTD) compared to 2005. Growth was driven by volume increases from new products (Kissables, Ice Breakers, dark chocolate), improved price realization, and favorable foreign currency exchange rates. International volume declines in Canada and Brazil partially offset these gains.
- Profitability: Net income rose 5.6% in Q2 and 6.4% YTD. Diluted EPS increased 10.8% in Q2 and 9.6% YTD, aided by share repurchases reducing the weighted-average share count.
- Margins: Gross margin declined from 39.8% to 38.8% in Q2 and from 39.0% to 38.4% YTD. The decline was primarily due to higher raw material/input costs, logistics costs, and increased costs for obsolete/unsaleable products, partially offset by price increases and productivity gains.
- Expenses: Selling, marketing, and administrative (SM&A) expenses decreased 2.3% in Q2 and 4.7% YTD, reflecting cost controls, business realignment initiatives, and a strategic shift to reduce advertising in favor of trade/consumer promotions.
- Interest Expense: Net interest expense increased significantly ($6.9M in Q2, $12.7M YTD) due to higher short-term borrowings (commercial paper) used to fund share repurchases and working capital, alongside higher interest rates.
Guidance, Outlook, and Risks
- Full Year 2006 Outlook:
- Sales: Expected to grow somewhat above the long-term target of 3%-4%, driven by market share gains, new product platforms, and a "trading up" strategy.
- EBIT Margin: Excluding business realignment impacts, the Company expects an improvement of 70 to 90 basis points.
- Diluted EPS: Expected to increase slightly above the long-term goal of 9%-11%, excluding realignment impacts.
- Portfolio Rationalization: The Company is exiting or rationalizing certain lines (Ice Breakers Liquid Ice, SmartZone, Swoops) and exploring the sale of the Pot of Gold brand and related facility.
- Capital Allocation: The Company expects to issue $500 million in long-term debt in 2006. Share repurchases continue under a $500 million program authorized in December 2005, with $244.2 million remaining available as of July 2, 2006.
- Risks and Contingencies:
- Business Realignment: Net costs for 2005 initiatives reduced net income by $3.0 million YTD. Total expected net cost is approximately $130 million pre-tax.
- Input Costs: Continued pressure from raw material and logistics costs.
- Accounting Changes: The Company has not yet determined the impact of adopting FASB Interpretation No. 48 (Accounting for Uncertainty in Income Taxes), effective January 1, 2007.
Investor Verification Checklist
- Inventory Levels: Verify the sustainability of the $247.6 million increase in inventories YTD, driven by seasonal builds and higher raw material costs.
- Liquidity Position: Assess the impact of the current ratio dropping to 0.8:1 and the reliance on short-term commercial paper ($1.13 billion) to fund operations and buybacks.
- Product Obsolescence: Monitor the magnitude of costs associated with obsolete and unsaleable products, which materially impacted gross margins.
- Share Repurchase Execution: Confirm the pace of the remaining $244.2 million repurchase authorization and its impact on future EPS.
- Realignment Completion: Track the finalization of the 2005 business realignment initiatives and the associated remaining liability of $25.5 million.