Business Context and Reporting Period
This Form 10-Q covers The Hershey Company for the quarterly period ended July 1, 2007, and the six-month period ended July 1, 2007. The company is a large accelerated filer incorporated in Delaware. As of July 20, 2007, there were 167,243,374 shares of Common Stock and 60,815,010 shares of Class B Common Stock outstanding.
Key Financial Metrics
Income Statement (Six Months Ended July 1, 2007)
- Net Sales: $2,205.0 million (vs. $2,191.4 million in 2006)
- Cost of Sales: $1,461.6 million (vs. $1,351.4 million in 2006)
- Gross Profit: $743.5 million (vs. $840.0 million in 2006)
- Gross Margin: 33.7% (vs. 38.3% in 2006)
- Business Realignment Charge: $107.3 million (vs. $7.6 million in 2006)
- Income Before Interest and Taxes (EBIT): $202.9 million (vs. $394.1 million in 2006)
- Net Income: $97.0 million (vs. $220.4 million in 2006)
- Diluted EPS (Common Stock): $0.42 (vs. $0.91 in 2006)
Balance Sheet (July 1, 2007)
- Cash and Cash Equivalents: $38.8 million (vs. $97.1 million at Dec 31, 2006)
- Total Current Assets: $1,425.6 million
- Total Current Liabilities: $1,616.0 million
- Short-term Debt: $926.3 million
- Long-term Debt: $1,272.5 million
- Total Stockholders' Equity: $571.3 million
Cash Flow (Six Months Ended July 1, 2007)
- Operating Cash Flow: $293.5 million
- Investing Cash Flow: $(160.2) million (Includes $77.0 million for business acquisitions)
- Financing Cash Flow: $(191.7) million (Includes $197.0 million for share repurchases)
- Net Decrease in Cash: $58.3 million
Material Changes vs. Prior Period
Net sales remained essentially flat for the quarter and grew 0.6% for the six-month period, driven by volume increases from new products and international growth, offset by lower sales of existing U.S. products and decreased price realization due to higher promotional spending. Gross margin declined significantly (from 38.3% to 33.7% for the six months) primarily due to higher input costs (especially dairy) and a $107.3 million business realignment charge. EBIT dropped 48.5% year-over-year, and Net Income fell 56.0% to $97.0 million.
Short-term debt increased by $271.0 million to $926.3 million, largely to finance share repurchases and working capital needs. Cash and cash equivalents decreased by $58.3 million.
Guidance, Outlook, and Risks
Management Commentary and Outlook
Management revised full-year 2007 expectations due to slower U.S. retail sales trends and significant increases in dairy input costs.
- Sales Growth: Expected in the low single-digit range.
- Business Realignment: Total pre-tax charges expected to be $525 million to $575 million over three years, with $270 million to $300 million expected in 2007.
- Gross Margin: Expected to be down over 100 basis points for the full year, excluding realignment charges.
- EBIT Margin: Expected to decline approximately 200 basis points for the full year, excluding realignment charges.
- EPS (Diluted): Expected to decline in the mid-single digits range for the full year, excluding realignment charges. Reported/Expected EPS range is $1.41 to $1.50.
Risks and Contingencies
- Supply Chain Transformation: Risks related to executing the three-year plan and achieving estimated savings.
- Input Costs: Continued volatility in raw material costs, particularly dairy, which cannot be fully hedged.
- Product Recall Litigation: Ongoing litigation regarding a 2006 product recall in Canada; a receivable of $16.5 million is recorded for potential recovery.
- Market Demand: Changes in consumer preferences and competitive actions.
Unusual Items
The financial results were significantly impacted by the "2007 business realignment initiatives," a three-year supply chain transformation program. This resulted in charges of $107.3 million for the six months ended July 1, 2007, including employee separation costs, fixed asset impairments, and facility closures. Additionally, the company acquired a 51% interest in Godrej Hershey Foods and Beverages in India ($58.7 million) and a 44% interest in a joint venture with Lotte Confectionery in China ($18.3 million).
Investor Verification Checklist
- Verify the progress and cost containment of the $525-$575 million supply chain transformation program.
- Monitor the trajectory of dairy and other raw material input costs and their impact on gross margins.
- Assess the outcome of the litigation regarding the 2006 Canadian product recall and the recoverability of the $16.5 million receivable.
- Review the integration and performance of the new India and China joint ventures.
- Track the company's ability to execute price increases to offset input cost inflation without further eroding market share.