Business Context and Reporting Period
Company: The Hershey Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: October 1, 2006
Business Overview: The Company manufactures and sells confectionery products, primarily chocolate, as well as non-chocolate confectionery, food, and beverage products. The reporting period covers the third quarter and the first nine months of fiscal year 2006.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Oct 1, 2006 | Three Months Ended Oct 2, 2005 | Nine Months Ended Oct 1, 2006 | Nine Months Ended Oct 2, 2005 |
|---|---|---|---|---|
| Net Sales | $1,413,361 | $1,368,240 | $3,598,156 | $3,483,101 |
| Net Income | $183,665 | $114,152 | $403,073 | $320,397 |
| Diluted EPS | $0.77 | $0.46 | $1.68 | $1.29 |
| Gross Margin % | 38.4% | 37.9% | 38.4% | 38.5% |
| Operating Cash Flow (9mo) | $226,353 (2006) vs. $(5,296) (2005) | |||
| Total Debt (Short + Long Term) | $2,284,196 (Oct 1, 2006) | |||
| Cash and Equivalents | $47,635 (Oct 1, 2006) |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 3.3% in both the third quarter and the first nine months of 2006 compared to 2005. Growth was driven by volume increases from new products (e.g., Hershey's Kissables, dark/premium chocolates) and price realization, partially offset by unfavorable foreign currency and international volume declines.
- Profitability: Net income increased significantly ($69.5 million in Q3; $82.7 million in 9 months). This was largely due to a reduction in "Business realignment charges" compared to the prior year. In Q3 2005, a one-time charge of $84.8 million was recorded, whereas Q3 2006 saw only $1.6 million in such charges.
- Cost Structure: Cost of sales increased due to higher input costs (energy, raw materials) and volume. However, Selling, Marketing, and Administrative (SM&A) expenses decreased 2.8% in Q3 and 4.1% in the first nine months, reflecting cost controls and the completion of workforce reduction programs.
- Capital Allocation: The Company repurchased $490.5 million of Common Stock in the first nine months of 2006. Dividends paid increased to $174.4 million for the nine-month period.
Guidance, Outlook, and Risks
- 2006 Outlook: The Company expects full-year sales growth of 3%-4%. Earnings per share (diluted) growth is expected to be somewhat below the long-term goal of 9%-11% due to increased investments in consumer programs and higher input costs. EBIT margin is expected to improve by 50 to 70 basis points.
- 2007 Outlook: Sales growth is expected to remain within the 3%-4% long-term target. EPS growth is expected to return to the 9%-11% long-term goal, driven by new product platforms and cost control initiatives.
- Marketplace Trends: Retail takeaway and market share were below expectations in Q3 2006, with market share declining 0.8 points in measured channels. The focus for Q4 is on restoring marketplace momentum.
- Risks and Contingencies:
- Input Costs: Rising costs for energy and raw materials (cocoa, sugar) continue to pressure margins.
- Pension Plans: The Company announced a redesign of U.S. pension plans effective Jan 1, 2007, to reduce future costs. Adoption of SFAS No. 158 is expected to reduce stockholders' equity by $150-$250 million in late 2006, though it will not impact operating results.
- Accounting Changes: Implementation of FIN No. 48 (Income Taxes) and SFAS No. 157 (Fair Value Measurements) is pending.
Investor Verification Checklist
- Realignment Charges: Verify the remaining liability for business realignment initiatives ($19.7 million accrued as of Oct 1, 2006) and the timeline for completion (expected by Dec 31, 2006).
- Market Share Trends: Monitor Q4 retail takeaway and market share data to confirm if the Company can reverse the Q3 decline in measured channels.
- Input Cost Hedging: Review the effectiveness of commodity hedging strategies given the volatility in raw material prices and the reported net losses on cash flow hedging derivatives in Q3 2006.
- Debt Levels: Assess the impact of increased short-term and long-term debt (capitalization ratio rose to 73%) on future interest expense and liquidity.
- Pension Reform Impact: Evaluate the long-term cost savings from the redesigned pension plan announced in October 2006 against the immediate equity reduction from SFAS No. 158 adoption.