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 October 3, 2004
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 — 185,241,222 shares, as of October 22, 2004. Class B Common Stock, $1 par value — 60,842,192 shares, as of October 22, 2004.
Exhibit Index – Page 22
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The accompanying notes are an integral part of these consolidated financial statements.
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1. BASIS OF PRESENTATION
2. STOCK SPLIT AND NET INCOME PER SHARE — BASIC
3. EMPLOYEE STOCK OPTIONS AND OTHER STOCK-BASED EMPLOYEE COMPENSATION PLANS
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4. BUSINESS REALIGNMENT INITIATIVES
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5. INTEREST EXPENSE
6. NET INCOME PER SHARE
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7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
8. COMPREHENSIVE INCOME
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9. INVENTORIES
10. SHORT-TERM DEBT
11. LONG-TERM DEBT
12. FINANCIAL INSTRUMENTS
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13. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
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14. SHARE REPURCHASES
15. INCOME TAXES
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16. PENDING ACCOUNTING PRONOUNCEMENTS
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Net sales for the third quarter increased $63.5 million, or 5%, from 2003. Approximately two-thirds of the sales increase resulted from sales volume growth, especially within the United States, primarily reflecting the introduction of new products and limited edition items. The remainder of the sales increase resulted from net price realization reflecting higher selling prices and more efficient promotional spending compared with the third quarter of 2003. Net sales in the Company’s Canadian business also increased, driven by the favorable impact of foreign currency exchange rates. Sales in the third quarter of 2004 were unfavorably affected by the divestiture of certain gum brands in September 2003, lower sales of remaining gum brands, and higher returns, discounts and allowances, relating primarily to the sales volume growth.
Cost of sales for the quarter increased $32.2 million, or 4%, from 2003 to 2004. The cost increase was primarily caused by the higher sales volume and higher raw material costs, principally associated with increased prices for cocoa and dairy products. The cost of sales increase was offset somewhat by reduced costs resulting from improved supply chain efficiencies primarily associated with lower costs for aged and obsolete inventories. Gross margin increased from 39.2% in 2003 to 39.7% in 2004. The margin expansion reflected improved price realization from price increases and weight reductions, as well as supply chain efficiencies. These margin improvements were partially offset by increases in raw material costs.
Selling, marketing and administrative expenses for the third quarter of 2004 increased 2% from the comparable period in 2003, primarily reflecting increased employee compensation costs, partially offset by lower advertising expense. Selling, marketing and administrative expenses declined from 17.8% of sales in 2003 to 17.3% in 2004.
Net interest expense in the third quarter of 2004 was $1.0 million higher than the comparable period of 2003, primarily reflecting higher short-term interest expense resulting from an increase in short-term borrowings to finance the purchase of 11,281,589 shares of Common Stock from Hershey Trust Company for approximately $500 million.
The effective income tax rate for the third quarter of 2004 was 36.8% compared with 36.4% for the third quarter of 2003, reflecting the best estimates of the expected effective income tax rates for the full-years. The increase in the effective income tax rate in 2004 reflected an expected change in the mix of the Company’s income among various tax jurisdictions, particularly Puerto Rico. The third quarter 2003 rate reflected the effective tax rates on business rationalization and realignment initiatives and the gain on sale of business for the third quarter of 2003.
An after-tax charge of $7.4 million, or $.03 per share-diluted, was recorded in the third quarter of 2003 to reflect the cumulative effect of a change in accounting for the Company’s leases of certain warehouse and distribution facilities.
Net income for the third quarter increased $22.6 million, or 16%, from 2003 to 2004, and net income per share-diluted increased $.11, or 20%. Income before the cumulative effect of the accounting change was $166.2 million for the third quarter of 2004 compared with $151.0 million for the third quarter of 2003, a 10% increase. Income per share-diluted before the cumulative effect of the accounting change was $.66 for the third quarter of 2004, 16% higher than in 2003. 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 sales for the first nine months of 2004 increased $168.0 million, or 6% from the comparable period of 2003. Sales were positively impacted by favorable sales volume, especially within the United States, primarily reflecting strong sales of higher margin instant consumable items driven by the introduction of innovative new products and line extensions. The impact of higher selling prices compared with the first nine months of 2003 also contributed to the sales growth. Net sales of the Company’s Canadian and Brazilian businesses also increased as a result of the impact of favorable foreign currency exchange rates, particularly in Canada, and increased sales volume. Sales were unfavorably affected by the divestiture of certain gum brands in September 2003, lower sales of remaining gum brands, and higher promotion allowances and returns, discounts and allowances, relating primarily to the sales volume growth. The results of the Company’s Asian operations, particularly in China and Taiwan, continued to be below expectations through the first nine months of 2004, but were offset somewhat by sales increases in the Philippines and Japan, compared with the first nine months of 2003.
Cost of sales for the first nine months increased $78.8 million, or 4%, from the comparable period of 2003. The cost increase was primarily caused by higher sales volume and higher raw material costs, principally associated with increased cocoa prices. The cost of sales increase was partially offset by efficiency improvements in manufacturing and logistics operations and by reduced costs associated with aged and obsolete inventory in 2004. Gross margin increased from 38.6% in 2003 to 39.4% in
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2004. The margin expansion reflected improved price realization as well as lower supply chain costs. These margin improvements were partially offset by increases in raw material costs.
Selling, marketing and administrative expenses for the first nine months of 2004 increased by 5% over the comparable period of 2003, primarily attributable to higher employee compensation costs as well as increased consumer promotion expenses. Selling, marketing and administrative expenses, as a percentage of sales, decreased from 20.1% for the first nine months of 2003 to 19.9% for the comparable period of 2004.
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.
Net interest expense in the first nine months increased $1.2 million, primarily reflecting higher short-term and fixed interest expense, partially offset by higher capitalized interest.
The effective income tax rates for the first nine months of 2004 and 2003 are not comparable because the Company’s provision for income taxes was benefited by the $61.1 million adjustment to income tax contingency reserves recorded in the second quarter of 2004. The non-cash reduction of income tax expense resulted from the settlement of Federal tax audits for the 1999 and 2000 tax years, as well as the resolution of a number of state tax audit issues. Based upon the results of the audits, the income tax contingency reserves were adjusted, resulting in a reduction of $61.1 million in income tax expense. The income tax contingency reserve adjustments related primarily to acquisition and divestiture matters, as well as deductibility and timing of certain expenses and also included interest on potential assessments.
The effective income tax rate for the first nine months of 2004, excluding the impact of the adjustment, was 36.6%, compared with an effective income tax rate of 36.5% for the comparable period of 2003. The effective income tax rates for the first nine months of 2004 and 2003 reflect the best estimates of the expected effective income tax rates for the full years.
An after-tax charge of $7.4 million, or $.03 per share diluted, was recorded in the first nine months of 2003 to reflect the cumulative effect of a change in accounting for the Company’s leases of certain warehouse and distribution facilities.
Net income was $420.6 million in the first nine months of 2004 compared with $312.6 million in the comparable period of 2003. Earnings per share-diluted for the first nine months of 2004 was $1.62, a 37% increase from $1.18 per share for the same period last year. Income before the cumulative effect of the accounting change was $420.6 million for the first nine months of 2004. Income per share-diluted before the cumulative effect of the accounting change was $1.62 for the first nine months of 2004, 34% higher than in 2003. Income before the cumulative effect of accounting change for 2004 was favorably impacted by the $61.1 million adjustment to Federal and state income tax contingency reserves, as discussed above. 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.
Historically, the Company’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 2004, the Company’s cash and cash equivalents decreased by $27.4 million. Cash and cash equivalents on hand at the beginning of the period, cash provided from operations and short-term borrowings were sufficient to fund capital expenditures and capitalized software expenditures of $155.7 million, dividend payments of $152.8 million and the repurchase of 13.9 million shares of the Company’s Common Stock for $617.0 million. On July 27, 2004, the Company purchased 11,281,589 shares of its Common Stock from Hershey Trust Company, as Trustee of the Milton Hershey School Trust, in a privately negotiated transaction. The Company paid $44.32 per share, or approximately $500 million, for the shares and fees of $1.4 million associated with the transaction. Cash provided from changes in other assets and liabilities was $53.6 million for the first nine months of 2004 compared with cash used by other assets and liabilities of $128.2 million for the same period of 2003. The variance from the prior year primarily reflects changes in pension assets and liabilities resulting from contributions to the Company’s pension plans in 2003, a reduction in the use of cash from commodity transactions and cash provided from increases in liabilities related to incentive plans in 2004, partially offset by an increase in cash used from changes in accrued income taxes in 2004 compared with 2003. Cash used by deferred income taxes primarily reflects the $73.7 million reduction to deferred tax liabilities resulting from the adjustment to reserves for Federal and state income tax contingencies recorded in the second quarter of 2004 which offsets the non-cash impact of the adjustments to the provision for income taxes and goodwill.
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Income taxes paid of $181.7 million during the first nine months of 2004 increased from $156.4 million for the comparable period of 2003. The payment of estimated income taxes in 2003 was reduced significantly as a result of deductions for pension plan contributions.
The ratio of current assets to current liabilities decreased to 1.2:1 as of October 3, 2004 from 1.9:1 as of December 31, 2003 primarily reflecting an increase in short-term borrowings. The Company’s capitalization ratio (total short-term and long-term debt as a percent of stockholders’ equity, short-term and long-term debt) was 62% as of October 3, 2004 and 43% as of December 31, 2003. The higher capitalization ratio in 2004 primarily reflected additional borrowings of $500 million to finance the purchase of Common Stock from the Hershey Trust Company and the related decrease in stockholders’ equity as a result of the additional treasury stock.
On July 28, 2004, the Company entered into a 364-Day Credit Agreement (the “Credit Agreement”) which established a credit facility with a syndicate of banks under which the Company may borrow up to $500 million with the option to increase borrowings by an additional $300 million with the concurrence of the lenders. In addition to the Credit Agreement, the Company also maintains short-term and long-term committed credit facilities (together the “Existing Facilities”) with a syndicate of banks in the amount of $400 million. The Company may increase borrowings under the Existing Facilities to $1.0 billion with the concurrence of the banks. Information about the Existing Facilities is contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
On April 21, 2004, the Company’s Board of Directors approved a two-for-one stock split to be effected in the form of a 100 percent stock dividend to stockholders of record May 25, 2004. The Company’s stockholders received one additional share for each share in their possession on that date. This did not change the proportionate interest a stockholder maintained in the Company. The additional shares were distributed on June 15, 2004. All shares and per share amounts have been adjusted for the two-for-one stock split.
The nature of the Company’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 Company 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 Company’s bad debt reserve; the Company’s ability to implement improvements to and reduce costs associated with the Company’s supply chain; and the Company’s ability to successfully implement its rationalization and realignment initiatives, as discussed in the Company’s 2003 Annual Report on Form 10-K.
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The potential net loss in fair value of foreign exchange forward contracts and options and interest rate swap agreements of ten percent resulting from a hypothetical near-term adverse change in market rates was $.7 million as of December 31, 2003 and $.4 million as of October 3, 2004. 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 decreased from $5.5 million as of December 31, 2003, to $2.7 million as of October 3, 2004. 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 Company’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 Company’s reports filed under the Exchange Act is accumulated and communicated to management, including the Company’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 Company conducted an evaluation of the effectiveness of the design and operation of the Company’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 Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective. There have been no changes in the Company’s internal control over financial reporting which could materially affect, or are reasonably likely to materially affect, internal control over financial reporting.
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The following items are attached and incorporated herein by reference:
(10) Material Contracts
(12) Statement showing computation of ratio of earnings to fixed charges for the nine months ended October 3, 2004 and September 28, 2003.
(31.1) Certification of Richard H. Lenny, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(31.2) Certification of Frank Cerminara, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
The following item is furnished with this report:
(32) Certification of Richard H. Lenny, Chief Executive Officer, and Frank Cerminara, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
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.
HERSHEY FOODS CORPORATION (Registrant)
Date: November 10, 2004
By: /s/Frank Cerminara Frank Cerminara Senior Vice President, Chief Financial Officer
By: /s/David W. Tacka David W. Tacka Vice President, Chief Accounting Officer
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