UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______to_______
Commission file number 1-183
HERSHEY FOODS CORPORATION100 Crystal A DriveHershey, PA 17033
Registrant’s telephone number: 717-534-6799
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, $1 par value — 99,695,245 shares, as of October 24, 2003. Class B Common Stock, $1 par value — 30,422,096 shares, as of October 24, 2003.
Exhibit Index – Page 18
-1-
The accompanying notes are an integral part of these statements.
- 2 -
- 3 -
- 4 -
-5-
1. BASIS OF PRESENTATION
2. EMPLOYEE STOCK OPTIONS AND OTHER STOCK-BASED EMPLOYEE COMPENSATION PLANS
3. BUSINESS REALIGNMENT INITIATIVES
-6-
4. INTEREST EXPENSE
Interest expense, net consisted of the following:
-7-
5. CUMULATIVE EFFECT OF ACCOUNTING CHANGE
6. NET INCOME PER SHARE
7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
-8-
8. COMPREHENSIVE INCOME
-9-
9. INVENTORIES
10. LONG-TERM DEBT
11. FINANCIAL INSTRUMENTS
12. SHARE REPURCHASES
-10-
13. NEW ACCOUNTING PRONOUNCEMENTS
-11-
Consolidated net sales for the third quarter increased 3.4% from $1,152.3 million in 2002 to $1,191.0 million in 2003. The improvement over the prior year primarily reflected increased sales of key confectionery brands related to the impact of a selling price increase effective in January 2003 and sales volume increases primarily resulting from the introduction of new products and limited edition items. Lower returns, discounts and allowances, as well as improved sales for the Corporation’s Canadian business also contributed to the sales increase. These favorable results were partially offset by increased promotional allowances, primarily to support merchandising programs and new product introductions, and the rationalization of certain under-performing brands and products. A decline in export sales to several Asian markets also negatively impacted sales for the quarter.
Third quarter cost of sales increased $7.0 million, or 1%, from 2002 to 2003. Costs to write-off inventory related to under-performing brands and products along with higher manufacturing costs were substantially offset by supply chain improvements. Cost of sales for the third quarter included costs associated with business realignment initiatives of $1.1 million and $.6 million in 2003 and 2002, respectively. Business realignment costs in 2003 related to the write-off of certain inventories and, in 2002, reflected costs for the relocation of manufacturing equipment. Gross margin increased from 37.8% in 2002 to 39.2% in 2003. The margin expansion reflected the impact of the selling price increase and decreases in supply chain costs. These margin improvements were partially offset by the aforementioned increases in promotional allowances and write-offs related to aged inventory of certain under-performing brands and products.
Selling, marketing and administrative expenses decreased 3% in 2003 compared with the third quarter of 2002. The change in these expenses was primarily attributable to a prior year charge of $17.3 million related to the exploration of the sale of the Corporation. Increased consumer promotion and packaging development expenses along with higher employee benefits costs were offset slightly by reduced administrative expenses in the third quarter of 2003.
During the third quarter of 2003, the Corporation recorded $8.6 million of pre-tax charges related to business rationalization and realignment initiatives primarily associated with the realignment of the sales organization. The net $8.5 million pre-tax charge for business realignment initiatives recorded in the third quarter of 2002 related to pension settlement costs associated with a voluntary work force reduction program (VWRP). The Corporation also recorded a pre-tax gain on the sale of certain gum brands of $8.3 million during the third quarter of 2003.
Net interest expense for the third quarter of 2003 was $3.1 million higher than the third quarter of 2002, primarily reflecting lower interest income and higher fixed interest expense, partly due to interest expense associated with the consolidation of three off-balance sheet arrangements for the leasing of certain warehouse and distribution facilities.
The effective income tax rate for the third quarter of 2003 was 36.4% compared with 36.7% for the third quarter of 2002, reflecting the best estimates of the expected effective income tax rates for the full-years, including the expected effective tax rates on business rationalization and realignment initiatives and the gain on sale of business.
An after-tax charge of $7.4 million, or $.06 per share-diluted, was recorded in the third quarter of 2003 to reflect the cumulative effect of a change in accounting for the Corporation’s leases of certain warehouse and distribution facilities.
Net income for the third quarter of $143.6 million increased $20.5 million, or 17%, from 2002 to 2003, and net income per share-diluted of $1.09 for the third quarter of 2003 increased $.20, or 22%, compared with the third quarter of 2002. Income before the cumulative effect of the accounting change was $151.0 million for the third quarter of 2003, a 23% increase over 2002. Income per share-diluted before the cumulative effect of the accounting change was $1.15 for the third quarter of 2003, 29% higher than in 2002. Income before the cumulative effect of the accounting change in 2003 included total net business realignment charges of $5.9 million after tax and an after-tax gain on the sale of certain gum brands of $5.7 million. Net income of $123.1 million for the third quarter of 2002 included total net business realignment charges of $5.8 million after tax and incremental expenses of $11.0 million after tax related to the exploration of the sale of the Corporation.
Consolidated net sales for the first nine months increased 1% from $2,964.3 million in 2002 to $2,993.3 million in 2003. The increase resulted primarily from incremental sales related to a January 2003 selling price increase, growth in sales of key confectionery brands reflecting the introduction of new products and limited edition items and increased sales for the Corporation’s Canadian business. These sales increases were substantially offset by sales volume decreases due to a prior
-12-
year buy-in associated with the January 2003 price increase, the continued rationalization of certain under-performing products and brands, including the divestiture of Heide brands in June 2002, and the discontinuance of the Corporation’s aseptically packaged drink products in the United States in March 2002. Incremental sales from the January 2003 selling price increase were partially offset by higher promotional allowances.
Cost of sales for the first nine months decreased $14.8 million, or 1%, from 2002 to 2003. The cost decline was primarily caused by lower sales volume, reduced supply chain costs, and lower costs for raw materials, primarily peanuts and dairy products, and for packaging. Cost of sales for the first nine months included costs associated with business realignment initiatives of $1.2 million and $1.4 million in 2003 and 2002, respectively. Business realignment costs in 2003 related to the write-off of certain inventories and, in 2002, reflected the relocation of manufacturing equipment. The consolidated gross margin increased from 37.5% in 2002 to 38.6% in 2003. The margin expansion reflected the impact of the price increase and the aforementioned decreases in raw material, packaging, and supply chain costs. These margin improvements were partially offset by increases in promotional allowances and manufacturing costs.
Selling, marketing and administrative expenses for the first nine months of 2003 decreased by 3% from the comparable period of 2002, primarily attributable to the one-time charge of $17.3 million in 2002 related to the exploration of the sale of the Corporation as well as reduced advertising and consumer promotion expenses. These cost reductions were offset somewhat by increased employee benefits costs, packaging development and marketing research expenses. Additionally, the bad debt reserve was increased by $5.0 million in the first quarter of 2003 as an estimate of probable exposure to the bankruptcy of Fleming Companies, Inc., announced on April 1, 2003. At the present time, the Corporation does not anticipate any material impact on sales for the remainder of the year as a result of the Fleming bankruptcy.
Net pre-tax business rationalization and realignment charges of $12.4 million recorded in the first nine months of 2003 were principally associated with costs pertaining to the realignment of the sales organization and impairment charges resulting from production line rationalization and the elimination of non-strategic brands and products. Pre-tax charges of $19.3 million recorded in the first nine months of 2002 were primarily associated with pension settlement costs related to the VWRP. A pre-tax gain on the sale of certain gum brands of $8.3 million was also recorded during the first nine months of 2003.
Net interest expense in the first nine months of 2003 was $2.0 million higher than the comparable period of 2002, primarily reflecting lower interest income and higher fixed interest expense, partly due to interest expense associated with the consolidation of three off-balance sheet arrangements for the leasing of certain warehouse and distribution facilities.
The effective income tax rate for the first nine months of 2003 was 36.5% compared with 36.7% for the comparable period of 2002, reflecting the best estimates of the expected effective income tax rates for the full years, including the expected effective tax rates on business rationalization and realignment initiatives and the gain on sale of business.
An after-tax charge of $7.4 million, or $.06 per share diluted, was recorded in the first nine months of 2003 to reflect the cumulative effect of a change in accounting for the Corporation’s leases of certain warehouse and distribution facilities.
Net income was $312.6 million in the first nine months of 2003 as compared with $273.3 million in the comparable period of 2002. Net income per share-diluted of $2.36 for the nine months ended September 28, 2003 was up 19% from $1.98 per share for the same period last year as a result of increased income from operations and the impact of lower weighted average shares outstanding resulting from share repurchases during the year. Income before the cumulative effect of the accounting change was $320.0 million for the first nine months of 2003, a 17% increase over 2002. Income per share-diluted before the cumulative effect of the accounting change was $2.41 for the first nine months of 2003, 22% higher than in 2002. Income before the cumulative effect of the accounting change for the first nine months of 2003 included net business realignment charges of $8.3 million after tax and a gain on the sale of certain gum brands of $5.7 million after tax. Income before the cumulative effect of the accounting change for the first nine months of 2002 included net business realignment charges of $13.1 million after tax and incremental expenses of $11.0 million after tax related to the exploration of the sale of the Corporation.
Historically, the Corporation’s major source of financing has been cash generated from operations. Domestic seasonal working capital needs, which typically peak during the summer months, generally have been met by issuing commercial paper. During the first nine months of 2003, the Corporation’s cash and cash equivalents decreased by $267.9 million. Cash provided from operations of $88.7 million for the first nine months of 2003 was net of contributions of $112.6 million to the Corporation's pension plans to improve the funded status. Cash and cash equivalents on hand at the beginning of the period, short-term borrowings, cash provided from operations, and proceeds from a business divestiture were sufficient to
-13-
repurchase 4.5 million shares of the Corporation’s Common Stock for $299.3 million, and to fund capital expenditures and capitalized software expenditures of $143.9 million and dividend payments of $134.5 million. Cash used by other assets and liabilities of $128.2 million was principally the result of commodities transactions and contributions to the Corporation’s pension plans, partially offset by an increase in accrued income taxes and accrued liabilities. Cash provided from other assets and liabilities in 2002 of $165.9 million primarily reflected commodities transactions and an increase in accrued income taxes, partially offset by contributions to the Corporation’s pension plans and decreases in accrued liabilities.
The ratio of current assets to current liabilities was 1.6:1 as of September 28, 2003, and 2.3:1 as of December 31, 2002. The Corporation’s capitalization ratio (total short-term and long-term debt as a percent of stockholders’ equity, short-term and long-term debt) was 50% as of September 28, 2003 and 39% as of December 31, 2002. The increase in the capitalization ratio principally reflected the increase in short-term borrowings during 2003.
As of June 30, 2003, the Corporation recorded a change in accounting method resulting in the consolidation of the Corporation’s three off-balance sheet arrangements for the leasing of certain warehouse and distribution facilities. The consolidation of these entities resulted in a net increase to property, plant and equipment of approximately $107.7 million, with a corresponding increase to long-term debt of $115.5 million and to other long-term liabilities of $4.4 million, reflecting the third party equity interest associated with the lease agreements. The consolidation of these entities resulted in an increase to interest expense of $1.4 million in the third quarter of 2003, offset by a decrease in rental expense for these facilities included in cost of sales. An increase in depreciation expense of $1.3 million in the third quarter also resulted from the consolidation of these entities, which will amount to higher depreciation expense of approximately $5.2 million on an annual basis.
In July 2003, the Corporation announced a number of initiatives continuing its value-enhancing strategy, including the introduction of new products and various initiatives to streamline the supply chain. New product introductions include Hershey’s S’mores candy bar incorporating graham crackers, marshmallow and Hershey’s milk chocolate, Swoopschocolate slices in four flavors, packaged in re-sealable on the go containers, andReese’s mini pieces in portable tubes, as well as additional Limited EditionReese’s products, all of which are expected to be introduced by the end of 2003.
Initiatives to realign the sales organization and streamline the supply chain, including divesting or eliminating certain non-strategic brands and products, and production line rationalization, are expected to be substantially completed by December 31, 2003. During 2003, the initiatives to streamline the supply chain are expected to result in a net charge of approximately $18.8 million, or $.08 per share-diluted, of which $.02 per share-diluted was recognized during the nine months ended September 28, 2003. The $18.8 million net charge is expected to consist of employee termination and early retirement costs of $18.5 million, asset impairment and other costs relating to production line rationalization and the discontinuance of certain brands and products of $8.6 million, and an $8.3 million net gain, resulting from the divestiture of certain brands. Changes in the total estimated net charge reflected increased costs associated with employee terminations, offset somewhat by a higher than expected net gain resulting from a decision not to divest certain assets.
During the third quarter of 2003, the Corporation recorded pre-tax charges related to the business rationalization and realignment initiatives of $1.4 million. The $1.4 million net charge consisted of the write-off of certain inventories of $1.1 million included in cost of sales, a net business realignment charge of $8.6 million consisting of employee early retirement and involuntary termination costs of $7.7 million and fixed asset impairment charges of $.9 million, and a net gain of $8.3 million relating to the sale of a group of gum brands to Farley’s and Sathers Candy Company, Inc. The gum brands included Fruit Stripe chewing gum,Rain-Blo gum balls and Super Bubble bubble gum. Proceeds from the sale of the gum brands totaled approximately $20.0 million. In determining the fixed asset impairment losses, fair value was estimated based on the expected sales proceeds.
During the nine months ended September 28, 2003, the Corporation recorded pre-tax charges related to the business rationalization and realignment initiatives of $5.3 million. The $5.3 million net charge consisted of the write-off of certain inventories of $1.2 million included in cost of sales, a net business realignment charge of $12.4 million and a net gain of $8.3 million relating to the sale of the group of gum brands to Farley’s and Sathers Candy Company, Inc. The net business realignment charge of $12.4 million consisted of early retirement and involuntary termination costs of $7.7 million, fixed asset impairment charges of $5.0 million and a net gain of $.3 million relating to production line rationalization and the elimination of non-strategic brands and products. In determining the fixed asset impairment losses, fair value was estimated based on the expected sales proceeds.
-14-
A $2.8 million liability for the components of the net business realignment charge relating to employee termination costs was recorded during the third quarter of 2003. Cash payments during the third quarter of 2003 reduced the liability balance to $1.3 million as of September 28, 2003.
In late October 2001, the Corporation’s Board of Directors approved a plan to improve the efficiency and profitability of the Corporation’s operations. The plan included asset management improvements, product line rationalization, supply chain efficiency improvements, and a voluntary work force reduction program (collectively, “the business realignment initiatives”). The major components were completed as of December 31, 2002. For more information on the business realignment initiatives recorded in the fourth quarter of 2001 and during 2002, refer to the consolidated financial statements and notes included in the Corporation’s 2002 Annual Report on Form 10-K.
The nature of the Corporation’s operations and the environment in which it operates subject it to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Corporation notes the following factors that, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as “intend,” “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential,” among others. Factors which could cause results to differ include, but are not limited to: changes in the confectionery and grocery business environment, including actions of competitors and changes in consumer preferences; customer and consumer response to selling price increases; changes in governmental laws and regulations, including taxes; market demand for new and existing products; changes in raw material and other costs; pension cost factors, such as actuarial assumptions, market performance and employee retirement decisions; adequacy of the Corporation’s bad debt reserve; the Corporation’s ability to implement improvements to and reduce costs associated with the Corporation’s supply chain; and the Corporation’s ability to successfully implement its 2003 rationalization and realignment initiatives.
The potential net loss in fair value of foreign exchange forward contracts and interest rate swap agreements resulting from a hypothetical near-term adverse change in market rates of ten percent was $1.0 million as of September 28, 2003 and December 31, 2002. The market risk resulting from a hypothetical adverse market price movement of ten percent associated with the estimated average fair value of net commodity positions increased from $2.4 million as of December 31, 2002, to $5.8 million as of September 28, 2003. Market risk represents 10% of the estimated average fair value of net commodity positions at four dates prior to the end of each period.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the Corporation’s reports filed under the Exchange Act is accumulated and communicated to management, including the Corporation’s Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure.
As of the end of the period covered by this quarterly report, the Corporation conducted an evaluation of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures, as required by Rule 13a-15 under the Exchange Act. This evaluation was carried out under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are effective. There have been no changes in the Corporation’s internal control over financial reporting which could materially affect, or are reasonably likely to materially affect, internal control over financial reporting.
-15-
a) Exhibits
The following items are attached and incorporated herein by reference:
The following item is furnished with this report:
b) Reports on Form 8-K
-16-
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
-17-
-18-