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 July 3, 2005
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
THE HERSHEY COMPANY100 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 — 183,933,867 shares, as of July 22, 2005. Class B Common Stock, $1 par value — 60,818,478 shares, as of July 22, 2005.
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. EMPLOYEE STOCK OPTIONS AND OTHER STOCK-BASED EMPLOYEE COMPENSATION PLANS
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3. INTEREST EXPENSE
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4. EARNINGS PER SHARE
5. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
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6. COMPREHENSIVE INCOME
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7. INVENTORIES
8. SHORT-TERM DEBT
9. LONG-TERM DEBT
10. FINANCIAL INSTRUMENTS
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11. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
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12. SHARE REPURCHASES
13. PENDING ACCOUNTING PRONOUNCEMENTS
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14. SUBSEQUENT EVENTS
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Net sales for the second quarter of 2005 increased $94.8 million, or 11%, from 2004. The Mauna Loa and Grupo Lorena acquisitions contributed incremental sales of $26.6 million, or approximately 3% of the increase from 2004. Approximately half of the organic sales growth of 8% resulted from unit volume growth, primarily reflecting the introduction of new products and limited edition items, and improved performance by the Company’s international businesses, particularly in Canada, Mexico and Brazil. The remainder of the sales increase resulted primarily from improved price realization as a result of selling price increases and a more efficient rate of promotional spending, as well as the impact of favorable foreign currency exchange rates for the Company’s international businesses.
Cost of sales for the quarter increased $61.5 million, or 12%, from 2004 to 2005. The cost increase was primarily caused by the higher sales volume, higher raw material costs, principally associated with increased prices for cocoa and dairy products, and increased labor, overhead and shipping costs. Gross margin decreased from 40.3% in 2004 to 39.8% in 2005. The margin decrease primarily reflected a less favorable product mix, primarily associated with the lower margin Mauna Loa and Grupo Lorena businesses, sales of certain new products which currently have lower margins, and the impact of lower sales of loose bar products, offset by higher sales of take-home packaged candy items. Sales of higher-margin loose bar products were reduced somewhat by the buy-in during the first quarter prior to the effective date of selling price increases. Higher raw material, labor and overhead costs also contributed to the lower gross margin. The margin decline was offset somewhat by improved price realization, primarily from selling price increases, as well as reduced promotional spending as a percentage of sales.
Selling, marketing and administrative expenses for the second quarter of 2005 increased 5.3% from the comparable period in 2004, primarily reflecting increased performance-based employee compensation costs, incremental expenses related to the business acquisitions and higher consumer promotion expense. These increased expenses were slightly offset by decreased advertising expense. Selling, marketing and administrative expenses as a percentage of sales, declined from 23.4% in 2004 to 22.3% in 2005.
Net interest expense in the second quarter of 2005 was $5.1 million higher than the comparable period of 2004, primarily reflecting higher short-term interest expense and decreased capitalized interest. The increase in short-term interest expense was primarily associated with commercial paper borrowings for repurchases of Common Stock and the 2004 business acquisitions.
The effective income tax rate for the second quarter of 2005 was 36.2% reflecting the best estimate of the expected effective income tax rate for the full year. The effective income tax rates for the second quarters of 2005 and 2004 are not comparable because the Company’s provision for income taxes was benefited by a $61.1 million adjustment to income tax contingency reserves recorded in 2004. The non-cash reduction of income tax expense in the second quarter of 2004 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 the deductibility and timing of certain expenses, interest on potential assessments and acquisition and divestiture matters. The effective income tax rate for the second quarter of 2004, excluding the impact of the adjustment, was 36.4%.
Net income for the second quarter decreased $49.9 million, or 34%, from 2004 to 2005, and net income per share-diluted decreased $.17, or 29%. Net income for the second quarter of 2004 was favorably impacted by the $61.1 million or $.23 per share-diluted adjustment to the Federal and state income tax contingency reserves.
Net sales for the first six months of 2005 increased $208.1 million, or 11%, from 2004. The Mauna Loa and Grupo Lorena acquisitions contributed incremental sales of $55.6 million, or approximately 3% of the increase from 2004. Approximately two-thirds of the organic sales growth of 8% resulted from unit volume growth, primarily reflecting the introduction of new products and limited edition items, and improved performance by the Company’s international businesses, particularly in Canada and Mexico. The remainder of the sales increase resulted from a more efficient rate of promotional spending, selling price increases and lower returns, discounts and allowances as a percentage of sales.
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Cost of sales for the first six months increased $131.0 million, or 11%, from 2004 to 2005. The cost increase was primarily caused by the higher sales volume and higher raw material costs, principally associated with increased prices for cocoa, dairy and almonds in addition to higher labor, overhead and shipping costs. Gross margin decreased slightly from 39.2% in 2004 to 39.0% in 2005. The margin decline resulted primarily from a less favorable product mix, primarily associated with the lower margin Mauna Loa and Grupo Lorena businesses, sales of certain new products which currently have lower margins, and higher raw material, labor and overhead costs, substantially offset by improved price realization, primarily from selling price increases, reduced promotional spending as a percentage of sales and a lower rate of returns, discounts and allowances. Improved profitability for the Company’s international businesses also helped to offset the margin decline.
Selling, marketing and administrative expenses for the first six months increased 8% from the comparable period in 2004, primarily reflecting increased performance-based employee compensation costs, incremental expenses related to the business acquisitions and higher consumer promotions and marketing research expenses. Selling, marketing and administrative expenses as a percentage of sales declined from 21.7% in 2004 to 21.1% in 2005.
Net interest expense in the first six months was $9.7 million higher than the comparable period of 2004, primarily reflecting higher short-term interest expense and decreased capitalized interest. The increase in short-term interest expense was primarily associated with commercial paper borrowings for repurchases of Common Stock and the 2004 business acquisitions.
The effective income tax rate for the first six months of 2005 was 36.4%, compared with 16.3% in 2004. The lower effective income tax rate for the first six months of 2004 resulted from a $61.1 million reduction to the provision for income taxes related to the adjustment to income tax contingency reserves recorded in the second quarter of 2004. The effective income tax rate for the first six months of 2004, excluding the impact of the income tax contingency reserve adjustment, was 36.4%.
Net income for the six months decreased $38.8 million, or 15%, from 2004 to 2005, and net income per share-diluted decreased $.11, or 11%. Net income for the first six months of 2004 was favorably impacted by the $61.1 million adjustment to the Federal and state tax contingency reserves. The income tax adjustment was offset by increased income from operations and the impact of lower weighted-average shares outstanding resulting from share repurchases.
The trends of key marketplace metrics, such as retail takeaway and market share, continue to show positive results. During the first six months of 2005, the Company achieved gains in retail takeaway and market share and strengthened its confectionery category leadership position. In channels of distribution accounting for approximately 80% of the Company’s retail business, consumer takeaway increased by 6% for the most recent eight-week period, and increased 4% for the year-to-date. These channels of distribution include food, drug, mass merchandisers, including Wal-Mart Stores, Inc. and convenience stores. Market share in measured channels for the most recent eight-week period increased 0.7 share points and, for the year-to-date, increased 0.8 share points. Measured channels include sales in the food, drug, convenience store and mass merchandiser classes of trade, excluding sales to Wal-Mart Stores, Inc.
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. Commercial paper may also be issued from time to time to finance ongoing business transactions such as the refinancing of obligations associated with certain lease arrangements, the repayment of long-term debt and for other general corporate purposes. During the first six months of 2005, the Company’s cash and cash equivalents decreased by $30.1 million. Cash provided from operations, short-term borrowings, cash received from stock options exercises and cash on hand at the beginning of the period was sufficient to fund incentive plan transactions reflecting the repurchase of Common Stock issued for stock options exercises and benefits plans of $223.5 million, dividend payments of $105.4 million, the repurchase of the Company’s Common Stock for $44.2 million under the 2002 stock repurchase program, and capital expenditures and capitalized software expenditures of $100.6 million. Cash used by changes in other assets and liabilities was $155.1 million for the first six months of 2005 compared with $98.6 million for the same period of 2004. The increase in the use of cash from the prior year primarily reflected contributions to the Company’s pension plans in 2005 of $96.4 million compared with $1.4 million in the first six months of 2004, partially offset by a reduction in the use of cash from commodity transactions.
Income taxes paid of $120.6 million during the first six months of 2005 decreased from $151.2 million for the comparable period of 2004. The payment of estimated income taxes in 2005 was reduced significantly as a result of deductions for pension plan contributions.
The ratio of current assets to current liabilities was 0.9:1 as of July 3, 2005 and December 31, 2004. 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
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62% as of July 3, 2005 and 55% as of December 31, 2004. The higher capitalization ratio in 2005 primarily reflected the impact of additional short-term borrowings.
In November 2004, the Company entered into a five-year credit agreement with banks, financial institutions and other institutional lenders. The credit agreement established an unsecured revolving credit facility under which the Company may borrow up to $900 million with the option to increase borrowings by an additional $600 million with the concurrence of the lenders. Funds borrowed may be used for general corporate purposes, including commercial paper backstop and business acquisitions.
In July 2005, the Company announced that in connection with its program to advance its value-enhancing strategy it will record a pre-tax charge of approximately $140 million to $150 million, or $.41 to $.44 per share-diluted. Of the total pre-tax charge, approximately $80 million will be incurred in connection with a voluntary workforce reduction program, approximately $41 million will be incurred in connection with facility rationalization, including the closure of the Las Piedras (Puerto Rico) plant, and approximately $24 million will be incurred in connection with streamlining and restructuring the Company’s international operations, including the Canadian voluntary workforce reduction program. The Company projects that approximately $85 million to $95 million of the total pre-tax charge will involve future cash expenditures. It is expected that approximately 80 percent of the total charge will be recorded during the remainder of 2005 (primarily in the third quarter), and the final 20 percent will be recorded in the first half of 2006.
The Company projects that the program will be fully completed by December 31, 2006. The program is expected to generate ongoing annual savings of approximately $45 million to $50 million when fully implemented. The savings will be reinvested in activities which will further the growth of the business in the total domestic snack market, including both confectionery and snack products, and in selected global markets, improve cash flows and enhance shareholder returns.
Also in July, the Company announced that it had entered into an agreement to acquire Scharffen Berger Chocolate Maker, Inc., one of the fastest-growing premium dark chocolate companies in the United States. Based in Berkeley, California, Scharffen Berger is known for its high-cacao content, signature dark chocolate bars and baking products sold online and in a broad range of outlets, including specialty retailers, natural food stores and gourmet centers across the country. Scharffen Berger also owns and operates three specialty stores located in New York City, Berkeley, and San Francisco. The acquisition is expected to be completed during the third quarter of 2005 and is subject to the customary closing conditions.
In August 2005, the Company’s Board of Directors approved the issuance of $250 million of Notes due 2015 under the Form S-3 Registration Statement which was declared effective in August 1997. Also in August 2005, the Company’s Board of Directors approved the filing of another Form S-3 Registration Statement under which it could offer, on a delayed or continuous basis, up to $750 million of additional debt securities. Proceeds from debt issuance and any offering of the $750 million of debt securities available under the shelf registration may be used for general corporate requirements which include reducing existing commercial paper borrowings, financing capital additions, and funding future business acquisitions and working capital requirements.
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: the Company’s ability to implement and generate expected ongoing annual savings from the program to advance its value enhancing strategy; changes in the Company’s 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; and the Company’s ability to implement improvements to and reduce costs associated with the Company’s supply chain.
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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 $.6 million as of December 31, 2004 and $.2 million as of July 3, 2005. 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 $6.3 million as of December 31, 2004, to $3.9 million as of July 3, 2005. 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 has been no change during the most recent fiscal quarter in the Company’s internal control over financial reporting identified in connection with the evaluation that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Items 1, 3, 4 and 5 have been omitted as not applicable.
There were no purchases of equity securities during the three-month period ended July 3, 2005. The approximate dollar value of shares that may yet be purchased under the share repurchase program authorized by the Company’s Board of Directors in December 2002 was $10.8 million as of July 3, 2005. In addition, in April 2005, the Company’s Board of Directors approved a share repurchase program authorizing the repurchase of up to $250 million of the Company’s Common Stock in the open market, or through privately negotiated transactions. Acquired shares of the Common Stock will be held as Treasury Stock.
The following items are attached and incorporated herein by reference:
The following item is furnished with this report:
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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.
THE HERSHEY COMPANY(Registrant)
Date: August 9, 2005
By: /s/David J. West David J. West Senior Vice President, Chief Financial Officer
By: /s/David W. Tacka David W. Tacka Vice President, Chief Accounting Officer
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EXHIBIT INDEX
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