HSY

Business Context and Reporting Period

Company: The Hershey Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: April 5, 2009
Context: The Hershey Company is a large accelerated filer engaged in the manufacture and sale of confectionery products. The quarter reflects seasonal effects and the ongoing impact of a global supply chain transformation program initiated in 2007.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 6.5% year-over-year, driven by favorable price realization from price increases implemented in 2008 and growth in international businesses. This was partially offset by foreign currency headwinds and volume declines due to pricing elasticity.
• Margin Expansion: Gross margin improved to 35.6% from 32.4%. Approximately two-thirds of this improvement was due to significantly lower business realignment charges in cost of sales ($4.1 million in 2009 vs. $25.2 million in 2008). The remainder was driven by net price realization and international margins, offset by higher raw material and energy costs.
• Expense Increases: Selling, marketing, and administrative (SM&A) expenses rose 9.8% to $274.5 million, primarily due to higher pension expenses (driven by the 2008 market decline reducing plan asset values), increased incentive compensation, and higher advertising spend.
• Realignment Charges: Net business realignment and impairment charges increased to $12.8 million in Q1 2009 from $4.1 million in Q1 2008. These charges relate to plant closures, employee separations, and fixed asset impairments associated with the global supply chain transformation.
• Tax Rate: The effective income tax rate increased to 41.2% from 35.5%, largely due to specific tax events during the quarter.

Guidance, Outlook, and Risks

• 2009 Sales Outlook: Management expects net sales growth of 2% to 3% for the full year, driven by price realization and core brand growth, offset by volume declines and unfavorable foreign currency impacts.
• Cost Pressures: The commodity cost basket is expected to increase significantly in 2009. Pension expense is projected to rise by approximately $70 million due to the decline in pension asset values in 2008.
• Earnings Outlook: The company expects an increase in diluted earnings per share for 2009, excluding business realignment charges. However, growth is expected to be below the long-term objective of 6% to 8% due to commodity costs, pension expenses, and increased core brand investment (advertising expected to rise 20-25%).
• Realignment Forecast: Total pre-tax business realignment and impairment charges for the global supply chain transformation program in 2009 are expected to range from $85 million to $120 million ($0.24 to $0.33 per share).
• Key Risks: Risks include product safety/recalls, raw material and energy cost volatility, insufficient price increases to offset costs, declining market demand, and potential regulatory investigations into industry pricing practices.

Investor Verification Checklist

• Pension Asset Volatility: Verify the impact of the 2008 financial market decline on 2009 pension expense and future funding requirements.
• Commodity Hedging: Review the effectiveness of commodity futures and options in mitigating rising raw material costs (cocoa, sugar, dairy).
• Volume vs. Price: Monitor consumer takeaway metrics to ensure price increases do not lead to unsustainable volume declines.
• Realignment Execution: Track the progress of the global supply chain transformation program against the revised cost estimates ($615M-$665M total).
• Foreign Currency: Assess the impact of currency fluctuations on international sales and earnings, particularly in Brazil and other key markets.