HSY

Business Context and Reporting Period

Company: The Hershey Company
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: The largest producer of quality chocolate in North America and a global leader in chocolate and sugar confectionery. The company operates as a single reportable segment, aggregating operations in the Americas (U.S., Canada, Mexico, Brazil) and other international locations. Principal products include chocolate and confectionery, food and beverage enhancers, and gum and mint refreshment products.

Key Financial Metrics

Note: The significant decline in Stockholders' Equity was primarily driven by a reduction in pension plan assets due to market volatility and cumulative translation adjustments.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 3.8% driven by favorable price realization (wholesale price increases of ~10-13% in 2008) and international sales growth, partially offset by reduced U.S. sales volume.
• Profitability: Net income increased significantly year-over-year primarily due to a substantial reduction in business realignment and impairment charges ($94.8 million in 2008 vs. $276.9 million in 2007).
• Cost Pressures: Cost of sales rose 1.8% due to higher input costs (cocoa, sugar, dairy) and energy costs. Cocoa futures prices increased 38% in 2008 compared to 2007.
• Impairments: Recorded $45.7 million in trademark impairment charges (primarily Mauna Loa brand) and $4.9 million in Brazilian business realignment charges in 2008.
• Balance Sheet: Total assets decreased due to depreciation, asset retirements, and a significant drop in the fair value of pension plan assets. Cash and cash equivalents declined from $129.2 million to $37.1 million.

Guidance, Outlook, and Risks

2009 Outlook

• Net Sales: Expected to grow 2-3%, driven by pricing actions and core brand growth, offset by expected unit volume declines in the U.S. due to price elasticity.
• Costs: Commodity cost basket expected to increase by approximately $175 million. Pension expense expected to increase by ~$70 million due to the decline in plan asset values.
• Earnings: Diluted EPS (excluding items affecting comparability) expected to increase, but growth will be below the long-term objective of 6-8% due to cost increases and macroeconomic conditions.
• Realignment Charges: Total pre-tax charges for the global supply chain transformation program expected to be $45-70 million in 2009.

Key Risks and Contingencies

• Raw Material Volatility: Significant exposure to cocoa, sugar, and dairy price fluctuations. The company uses hedging but cannot fully eliminate risk.
• Antitrust Investigations: Subject to investigations by the Canadian Competition Bureau and U.S. Department of Justice regarding pricing practices, along with approximately 92 civil antitrust suits in the U.S.
• Pension Funding: Pension benefit obligations exceeded plan assets by $40.8 million as of year-end. Future funding requirements may increase.
• Customer Concentration: Sales to McLane Company, Inc. accounted for approximately 26% of total net sales in 2008.

Investor Verification Checklist

• Price Realization vs. Volume: Verify the extent to which 2008 price increases offset volume declines and whether this trend is sustainable in 2009.
• Pension Asset Valuation: Confirm the impact of the 2008 market decline on future pension expense and funding obligations.
• Commodity Hedging Effectiveness: Assess the company's ability to pass through rising input costs (cocoa, sugar) to consumers without further volume erosion.
• Antitrust Exposure: Monitor the status of ongoing antitrust investigations and potential financial impact of settlements or fines.
• Supply Chain Transformation: Track the realization of cost savings from the global supply chain transformation program against the projected $575-600 million total cost.