HSY

Business Context and Reporting Period

This is a Quarterly Report on Form 10-Q for The Hershey Company, covering the three-month period ended March 30, 2008. The company is a large accelerated filer incorporated in Delaware. The report details financial performance, liquidity, and significant operational changes, including ongoing supply chain transformations and international business realignments.

Key Financial Metrics

Note: Debt figures for Q1 2007 are derived from the balance sheet comparison where Short-term debt was $850.3M and Long-term debt was $1,279.9M at Dec 31, 2007. Q1 2008 Short-term debt is $473.3M and Long-term debt is $1,528.7M.

Material Changes vs. Prior Period

• Revenue: Net sales increased slightly by 0.6% ($7.2 million) due to favorable price realization and the Godrej Hershey Ltd. acquisition, offset by volume decreases in the U.S.
• Profitability: Net income declined 32.3% to $63.2 million. Gross margin contracted from 35.9% to 32.4% primarily due to higher input costs and business realignment charges.
• Expenses: Cost of sales rose 6.1%, driven by a $25.2 million charge for business realignment initiatives (accelerated depreciation and start-up costs) and higher raw material costs. Selling, marketing, and administrative (SM&A) expenses increased 15.5% due to international expansion and stock option timing.
• Realignment Charges: Net business realignment and impairment charges dropped significantly to $4.1 million in Q1 2008 compared to $27.5 million in Q1 2007, largely due to gains on the sale of fixed assets ($13.9 million) offsetting impairments.
• Liquidity: Cash and cash equivalents increased by $23.7 million, aided by strong collections from accounts receivable and proceeds from the sale of property, plant, and equipment ($44.3 million).

Guidance, Outlook, and Risks

• 2008 Outlook:
  • Sales Growth: Expected consolidated net sales growth of 3% to 4%.
  • Cost Pressures: Anticipated input cost increases of approximately $100 million, expected to reduce gross margin by 200 basis points.
  • Realignment Costs: Total pre-tax business realignment and impairment charges for 2008 are projected between $140 million and $160 million.
  • Earnings Guidance:
    • GAAP EPS: Expected range of $1.43 to $1.53.
    • Non-GAAP EPS: Expected range of $1.85 to $1.90 (excluding realignment charges).
• Management Commentary: Management notes that price increases and productivity improvements will only partially offset input cost increases and investment spending, resulting in lower EBIT and EPS excluding non-comparable items.
• Risks and Contingencies:
  • Supply Chain Transformation: Risks associated with executing the global supply chain transformation within anticipated timeframes and cost estimates.
  • Legal/Regulatory: Ongoing litigation regarding a 2006 product recall in Canada and government investigations into pricing practices in the confectionery industry.
  • Commodity Prices: Continued volatility in raw material costs (cocoa, sugar, milk) and energy prices.

Investor Verification Checklist

• Realignment Charge Composition: Verify the breakdown of the $140-$160 million projected 2008 realignment charges, specifically the portion allocated to Cost of Sales ($85 million) versus SM&A ($20 million).
• Input Cost Hedging: Review the effectiveness of commodity hedging strategies given the $100 million projected cost increase and the $38.5 million market risk exposure to commodity price movements.
• Debt Structure: Confirm the impact of the new $250 million 5.0% Notes issued in March 2008 on future interest expense and liquidity ratios.
• International Performance: Assess the contribution of the Godrej Hershey Ltd. acquisition ($20.3 million sales increase) and the Bauducco cooperative agreement in Brazil to offset U.S. volume declines.
• Share Repurchases: Note that $100 million remains available under the current share repurchase program, though no open market repurchases were made in Q1 2008.