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 2, 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 by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [ X ]
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 — 180,640,403 shares, as of October 21, 2005. Class B Common Stock, $1 par value — 60,818,478 shares, as of October 21, 2005.
-1-
-2-
The accompanying notes are an integral part of these consolidated financial statements.
-3-
-4-
-5-
-6-
1. BASIS OF PRESENTATION
2. EMPLOYEE STOCK OPTIONS AND OTHER STOCK-BASED EMPLOYEE COMPENSATION PLANS
-7-
3. ACQUISITIONS
4. BUSINESS REALIGNMENT INITIATIVES
-8-
5. INTEREST EXPENSE
Interest expense, net consisted of the following:
6. EARNINGS PER SHARE
-9-
7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
8. COMPREHENSIVE INCOME
A summary of the components of comprehensive income is as follows:
-10-
-11-
9. INVENTORIES
10. SHORT-TERM DEBT
11. LONG-TERM DEBT
-12-
12. FINANCIAL INSTRUMENTS
13. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
Components of net periodic benefits cost consisted of the following:
-13-
14. SHARE REPURCHASES
-14-
15. PENDING ACCOUNTING PRONOUNCEMENTS
-15-
Net sales for the third quarter of 2005 increased $113.7 million, or 9.1%, from 2004. Business acquisitions contributed approximately 2.6% of the increase from 2004. Approximately two-thirds of the additional sales increase of 6.5% resulted from unit volume growth, primarily reflecting new product introductions, strong seasonal sales, 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 because of selling price increases as well as the impact of favorable foreign currency exchange rates for the Company’s international businesses.
Cost of sales for the quarter increased $93.1 million, or 12.3%, from 2004 to 2005. Business realignment charges increased cost of sales for the quarter by $16.6 million. The remainder of the cost increase was primarily caused by the higher sales volume, business acquisitions, higher raw material costs, and increased labor, overhead and shipping costs. Gross margin decreased from 39.7% in 2004 to 37.9% in 2005. The margin decrease primarily reflected the impact of the business realignment charges and a less favorable product mix, primarily associated with the lower-margin Mauna Loa and Grupo Lorena businesses, sales of certain new products that currently have lower margins and higher sales of lower-margin seasonal products. 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.
Selling, marketing and administrative expenses for the third quarter of 2005 increased 1.6% from the comparable period in 2004, primarily reflecting incremental expenses related to the business acquisitions and higher consumer promotion expense. These increased expenses were offset somewhat by decreased advertising expense. Selling, marketing and administrative expenses as a percentage of sales, declined from 17.3% in 2004 to 16.1% in 2005.
Business realignment charges of $84.8 million pre-tax were associated primarily with the voluntary workforce reduction programs.
Net interest expense in the third quarter of 2005 was $5.4 million higher than the comparable period of 2004, primarily reflecting higher short-term interest expense. The increase in short-term interest expense was primarily associated with commercial paper borrowings to fund seasonal working capital requirements, stock repurchases and contributions to the Company’s pension plans.
The effective income tax rate for the third quarter of 2005 was 37.1%, compared with 36.8% for the third quarter of 2004. The impact of the tax effect on the business realignment charges increased the effective income tax rate for 2005 by .7 percentage points.
Net income for the third quarter decreased $46.8 million, or 28.1%, from 2004 to 2005, and net income per share-diluted decreased $.18, or 27.3%. Net income for the quarter was unfavorably impacted by the total business realignment charges of $101.4 million before tax, $65.8 million after tax or $.27 per share-diluted.
Net sales for the first nine months of 2005 increased $321.8 million, or 10.2%, from 2004. Business acquisitions contributed approximately 2.9% of the increase from 2004. Approximately two-thirds of the additional sales increase of 7.3% 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 the Canadian, Mexican and export businesses in China and the Philippines. The remainder of the sales increase resulted from selling price increases, a lower rate of promotional spending and the impact of favorable foreign currency exchange rates for the Company’s international businesses.
Cost of sales for the first nine months increased $224.1 million, or 11.7%, from 2004 to 2005. Business realignment charges increased cost of sales by $16.6 million. The remainder of the cost increase was primarily caused by the higher sales volume, business acquisitions, and higher raw material costs, in addition to higher labor, overhead and shipping costs. Gross margin decreased from 39.4% in 2004 to 38.6% 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 and sales of certain new products which currently have lower margins, higher raw material, labor and overhead costs, and the impact of business realignment charges, partially offset by improved price realization, primarily from selling price increases. Improved profitability for the Company’s international businesses also helped to offset the margin decline.
-16-
Selling, marketing and administrative expenses for the first nine months increased $35.9 million, or 5.7%, 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 expenses. These increases were offset somewhat by lower advertising expense. Selling, marketing and administrative expenses as a percentage of sales declined from 19.9% in 2004 to 19.1% in 2005.
Net interest expense in the first nine months was $15.1 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 to fund seasonal working capital requirements, stock repurchases and contributions to the Company’s pension plans.
The effective income tax rate for the first nine months of 2005 was 36.7%, compared with 25.8% in 2004. The lower effective income tax rate for the first nine 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 impact of the income tax contingency reserve adjustment reduced the effective income tax rate for 2004 by 10.8 percentage points.
Net income for the nine months decreased $85.5 million, or 20.3%, from 2004 to 2005, and net income per share-diluted decreased $.28, or 17.3%. Net income for the first nine months of 2005 was unfavorably impacted by total business realignment charges of $101.4 million before tax, $65.8 million after tax or $.27 per share-diluted. Net income for the first nine months of 2004 was favorably impacted by $61.1 million, or $.23 per share-diluted, as a result of the adjustment to the Federal and state income tax contingency reserves.
The trends of key marketplace metrics, such as retail takeaway and market share, continue to show positive results. During the third quarter and first nine months of 2005, the Company achieved gains in retail takeaway and market share and strengthened its position in the total snack market. In channels of distribution including sales in the food, drug, convenience store and mass merchandiser classes of trade, excluding sales to Wal-Mart Stores, Inc., retail takeaway during the third quarter increased by 4% resulting in a market share gain of .3 points and for the year-to-date retail takeaway increased 4.9% with a market share gain of .3 points.
The Company expects broadly higher input costs in the future during a period of economic uncertainty. Higher input costs are anticipated for certain raw materials, packaging and energy requirements. The Company is developing plans to address these cost pressures in order to sustain the future profitability of the business.
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 nine months of 2005, the Company’s cash and cash equivalents decreased by $16.9 million. Cash provided from operations, short-term and long-term borrowings, cash received from stock option 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 option exercises and benefits plans of $284.5 million, dividend payments of $163.7 million, the repurchase of the Company’s Common Stock for $141.9 million under the 2002 and 2005 stock repurchase programs, capital expenditures and capitalized software expenditures of $148.8 million and business acquisitions of $47.1 million. Cash used by changes in other assets and liabilities was $268.4 million for the first nine months of 2005 compared with cash provided of $53.6 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 $275.5 million compared with $2.5 million in the first nine months of 2004, a decrease in selling and marketing accruals, and adjustments related to the recording of the business realignment charges, partially offset by a reduction in the use of cash from commodity transactions.
Income taxes paid of $128.0 million during the first nine months of 2005 decreased from $181.7 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 October 2, 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
-17-
67.6% as of October 2, 2005 and 54.7% as of December 31, 2004. The higher capitalization ratio in 2005 primarily reflected the impact of additional short-term and long-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.
In September 2005, the Company entered into a new short-term credit agreement to establish an unsecured revolving credit facility to borrow up to $300 million. The agreement will expire on December 30, 2005. Funds may be used for general corporate purposes. The new short-term credit facility was entered into because the Company expects borrowings to exceed $900 million for up to three months beginning in early October 2005 due to the pending retirement of $200 million of 10-year notes in October 2005, recent contributions to the Company’s pension plans, stock repurchases and seasonal working capital needs.
In August 2005, the Company issued $250 million of 4.85% Notes due 2015 under the Form S-3 Registration Statement which was declared effective in August 1997. In September 2005, the Company filed 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 the 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 contributions to the Company’s pension plans, future business acquisitions and working capital requirements.
In August 2005, the Company announced that it had acquired the assets of Joseph Schmidt Confections, Inc., a premium chocolate maker. Joseph Schmidt is known for its artistic and innovative truffles, colorful chocolate mosaics, specialty cookies, and handcrafted chocolates. These products are sold in select department stores and other specialty outlets nationwide as well as in Joseph Schmidt stores located in San Jose and San Francisco, California.
Also, in August 2005, the Company completed the previously announced acquisition of Scharffen Berger Chocolate Maker, Inc. Based in San Francisco, 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 combined purchase price for Scharffen Berger and Joseph Schmidt as of October 2, 2005 was $47.1 million, with the final amount subject to upward adjustment not to exceed $61.1 million to be determined based upon actual sales growth through 2007. Together, these companies have combined annual sales of approximately $25 million.
During the third quarter of 2005, the Company recorded charges totaling $101.4 million associated with its previously announced business realignment program intended to advance its value enhancing strategy. The charges of $101.4 million consisted of an $84.8 million business realignment charge and $16.6 million recorded in cost of sales. The business realignment charge included $62.6 million related to the U.S. voluntary workforce reduction program (VWRP), $10.0 million for facility rationalization relating to the closure of the Las Piedras, Puerto Rico plant and $12.2 million related to streamlining the Company’s international operations, primarily associated with costs for the Canadian VWRP. The third quarter charge for facility rationalization included a $4.7 million liability for involuntary termination benefits for Las Piedras plant employees and an additional charge for involuntary termination benefits of $1.9 million is expected to be recorded in the fourth quarter. The $16.6 million recorded in cost of sales resulted from accelerated depreciation related to the closure of the Las Piedras manufacturing facility.
The components of the $84.8 million business realignment charge were liabilities of $43.8 million primarily for voluntary and involuntary termination benefits, $33.7 million of pension and other special termination benefits and curtailment charges which are detailed in Note 13, Pension and Other Post-Retirement Benefit Plans, $4.9 million primarily for incentive compensation and $2.4 million for the write-off of certain trademarks. Cash payments related to these liabilities were not significant.
In connection with the program to advance its value-enhancing strategy, the Company estimates that it will record a total pre-tax charge of approximately $140 million to $150 million, or $.41 to $.44 per share-diluted. Approximately 90% of the charge will be recorded in 2005, with the remainder recorded in the first half of 2006. Of the total pre-tax charge, approximately $80 million will be incurred in connection with the U.S. VWRP, approximately $41 million will be incurred in connection with facility rationalization and approximately $24 million will be incurred in connection with streamlining and restructuring the
-18-
Company’s international operations, including the Canadian VWRP. The Company projects that approximately $90 million to $100 million of the total pre-tax charge will involve future cash expenditures.
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 to $50 million when fully implemented. The savings will be reinvested in activities which will further the growth of the business, improve cash flows and enhance shareholder returns.
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; changes in the value of the Company’s Common Stock; and the Company’s ability to implement improvements to and reduce costs associated with the Company’s supply chain.
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 $.1 million as of October 2, 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 increased from $6.3 million as of December 31, 2004, to $9.8 million as of October 2, 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.
-19-
(1) The 2002 share repurchase program which authorized the repurchase of $500 million of the Company’s Common Stock was completed in the third quarter of 2005. In April 2005, the Company’s Board of Directors approved a new 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.
The following exhibits are attached or incorporated herein by reference:
-20-
*Pursuant to Securities and Exchange Commission Release No. 33-8212, this certification will be treated as “accompanying” this Quarterly Report on Form 10-Q and not “filed” as part of such report for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of Section 18 of the Exchange Act, and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.
-21-
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: November 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
-22-