Back to GetFilings.com

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X]        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended   April 4, 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 CORPORATION
100 Crystal A Drive
Hershey, 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).

Yes  [ X ]      No  [   ]

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 — 99,263,018 shares, as of April 23, 2004. Class B Common Stock, $1 par value — 30,422,096 shares, as of April 23, 2004.

Exhibit Index – Page 16

-1-

PART I — FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements (Unaudited)

HERSHEY FOODS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share amounts)

The accompanying notes are an integral part of these statements.

-2-

HERSHEY FOODS CORPORATION
CONSOLIDATED BALANCE SHEETS
APRIL 4, 2004 AND DECEMBER 31, 2003
(in thousands of dollars)

The accompanying notes are an integral part of these balance sheets.

-3-

HERSHEY FOODS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)

The accompanying notes are an integral part of these statements.

-4-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.           BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the accounts of Hershey Foods Corporation, its wholly-owned subsidiaries and entities in which it has a controlling financial interest (the “Company”) after elimination of intercompany accounts and transactions. These statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended April 4, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004, because of the seasonal effects of the Company’s business. For more information, refer to the consolidated financial statements and notes included in the Company’s 2003 Annual Report on Form 10-K.

2.            EMPLOYEE STOCK OPTIONS AND OTHER STOCK-BASED EMPLOYEE COMPENSATION PLANS

As of April 4, 2004, the Company had two stock-based employee compensation plans. The Company applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for those plans. No stock-based employee compensation expense is reflected in net income for employee stock options since all stock options are granted at an exercise price equal to the market value of the underlying common stock on the date of grant. Compensation expense for performance stock units is recognized ratably over a period of up to seventy-two months based on the quarter-end market values of the stock. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

The fair value of each option grant is estimated on the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in the first three months of 2004 and 2003, respectively: dividend yields of 2.0% and 2.0%; expected volatility of 26% and 28%; risk-free interest rates of 3.7% and 3.6%; and expected lives of 6.5 years and 6.4 years.

-5-

3.            BUSINESS REALIGNMENT INITIATIVES

In July 2003, the Company announced a number of initiatives continuing its value-enhancing strategy. These initiatives included realigning the sales organization and streamlining the supply chain by divesting or eliminating certain non-strategic brands and products, and by production line rationalization.

As of December 31, 2003, the liability balance, primarily relating to charges for employee termination, sales office closing and relocation costs, was $8.8 million. Cash payments during the first quarter of 2004 reduced the liability balance to $6.0 million as of April 4, 2004. For more information on the business realignment initiatives recorded in 2003, refer to the consolidated financial statements and notes included in the Company’s 2003 Annual Report on Form 10-K.

4.            INTEREST EXPENSE

Interest expense, net consisted of the following:

5.           NET INCOME PER SHARE

In accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share, Basic and Diluted Earnings per Share are computed based on the weighted-average number of shares of the Common Stock and the Class B Stock outstanding as follows:

Employee stock options for 29,600 shares and 3,076,594 shares were anti-dilutive and were excluded from the earnings per share calculation for the three months ended April 4, 2004 and March 30, 2003, respectively.

-6-

6.           DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The Company accounts for derivative instruments in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. All derivative instruments currently utilized by the Company, including foreign exchange forward contracts and options, interest rate swap agreements and commodities futures contracts, are designated as cash flow hedges.

Net after-tax losses on cash flow hedging derivatives reflected in comprehensive income were $3.4 million and $9.3 million for the three months ended April 4, 2004 and March 30, 2003, respectively. Net gains and losses on cash flow hedging derivatives were primarily associated with commodities futures contracts. Reclassification adjustments from accumulated other comprehensive income (loss) to income, for gains or losses on cash flow hedging derivatives, were reflected in cost of sales. Reclassification of gains of $6.1 million and $12.8 million for the three months ended April 4, 2004 and March 30, 2003, respectively, were associated with commodities futures contracts. Gains on commodities futures contracts recognized in cost of sales as a result of hedge ineffectiveness were approximately $.8 million before tax for the three months ended April 4, 2004. No gains or losses as a result of hedge ineffectiveness were recorded during the three months ended March 30, 2003. No gains or losses on cash flow hedging derivatives were reclassified from accumulated other comprehensive income (loss) into income as a result of the discontinuance of a hedge because it became probable that a hedged forecasted transaction would not occur. There were no components of gains or losses on cash flow hedging derivatives that were recognized in income because such components were excluded from the assessment of hedge effectiveness.

As of April 4, 2004, the amount of net after-tax gains on cash flow hedging derivatives, including foreign exchange forward contracts and options, interest rate swap agreements and commodities futures contracts, expected to be reclassified into earnings in the next twelve months was approximately $21.0 million which were principally associated with commodities futures contracts. For more information, refer to the consolidated financial statements and notes included in the Company’s 2003 Annual Report on Form 10-K.

7.           COMPREHENSIVE INCOME

Comprehensive income consisted of the following:

-7-

The components of accumulated other comprehensive loss as shown on the Consolidated Balance Sheets are as follows:

8.            INVENTORIES

The majority of inventories are valued under the last-in, first-out (LIFO) method. The remaining inventories are stated at the lower of first-in, first-out (FIFO) cost or market. Inventories were as follows:

The increase in inventories as of April 4, 2004, reflected seasonal timing to support manufacturing requirements and higher costs in 2004.

9.     LONG-TERM DEBT

In August 1997, the Company filed a Form S-3 Registration Statement under which it could offer, on a delayed or continuous basis, up to $500 million of additional debt securities and issued $250 million of 7.2% Debentures due 2027. As of April 4, 2004, $250 million of debt securities remained available for issuance under the August 1997 Registration Statement.

10.     FINANCIAL INSTRUMENTS

The carrying amounts of financial instruments including cash and cash equivalents, accounts receivable, accounts payable and short-term debt approximated fair value as of April 4, 2004 and December 31, 2003, because of the relatively short maturity of these instruments. The carrying value of long-term debt, including the current portion, was $971.9 million as of April 4, 2004, compared with a fair value of $1,114.3 million, based on quoted market prices for the same or similar debt issues.

As of April 4, 2004, the Company had foreign exchange forward contracts and options maturing in 2004 and 2005 to purchase $69.0 million in foreign currency, primarily Canadian dollars and Japanese yen, and to sell $28.2 million in foreign currency, primarily Mexican pesos and Japanese yen, at contracted forward rates.

-8-

The fair value of foreign exchange forward contracts is estimated by obtaining quotes for future contracts with similar terms, adjusted where necessary for maturity differences. As of April 4, 2004, the fair value of foreign exchange forward contracts and options was a liability of $.8 million. As of December 31, 2003, the fair value of foreign exchange forward contracts and options was an asset of $1.6 million. The Company does not hold or issue financial instruments for trading purposes.

In order to minimize its financing costs and to manage interest rate exposure, the Company, from time to time, enters into interest rate swap agreements.  In October 2003, the Company entered into interest rate swap agreements to effectively convert interest payments on long-term debt from fixed to variable rates.  Interest payments on $200.0 million of 6.7% Notes due in October 2005 and $150.0 million of 6.95% Notes due in March 2007 were converted from the respective fixed rates to variable rates based on LIBOR.  In March 2004, the Company terminated these agreements, resulting in cash receipts totaling $5.2 million, with a corresponding increase to the carrying value of the long-term debt.  This increase will be amortized over the remaining term of the respective long-term debt as a reduction to interest expense.

In February 2001, the Company entered into interest rate swap agreements that effectively converted variable interest rate payments related to certain lease arrangements from a variable to a fixed rate of 6.1%. Any interest rate differential on interest rate swap agreements is recognized as an adjustment to interest expense over the term of each agreement. The fair value of interest rate swap agreements was a liability of $6.1 million and $5.2 million as of April 4, 2004 and December 31, 2003, respectively. The Company’s risk related to interest rate swap agreements is limited to the cost of replacing such agreements at prevailing market rates.

11.     PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS

Components of net periodic benefits cost consisted of the following:

Employer contributions of $0.9 million and $6.1 million were made during the first quarter of 2004 to the Company’s pension plans and other benefits plans, respectively. In the first quarter of 2003, the Company contributed $3.0 million and $4.6 million to the Company’s pension and other benefits plans, respectively. The contributions in 2004 and 2003 also included benefit payments from the non-qualified pension plans and the post-retirement benefit plans. For 2004, there are no minimum funding requirements for the domestic plans and minimum funding requirements for the non-domestic plans are not material. However, the Company may choose to make contributions in 2004 to improve the funded status. For more information on the Company’s pension and other post-retirement benefit plans, refer to the consolidated financial statements and notes included in the Company’s 2003 Annual Report on Form 10-K.

12.     SHARE REPURCHASES

In December 2002, the Company’s Board of Directors approved a share repurchase program authorizing the repurchase of up to $500 million of the Company’s Common Stock. Under this program, a total of 5,185,200 shares of Common Stock was purchased through April 4, 2004 for $349.6 million. As of April 4, 2004, a total of 50,288,658 shares were held as Treasury Stock and $150.4 million remained available for repurchases of Common Stock under the repurchase program.

-9-

13.     PENDING ACCOUNTING PRONOUNCEMENTS

In March 2004, the Financial Accounting Standards Board (“FASB”) issued an exposure draft of Proposed Statement of Financial Accounting Standards, Share-Based Payment, an amendment of FASB Statements No. 123 and 95. This proposed Statement addresses the accounting for transactions in which an enterprise exchanges its valuable equity instruments for employee services. It also addresses transactions in which an enterprise incurs liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of those equity instruments in exchange for employee services. For public entities, the cost of employee services received in exchange for equity instruments, including employee stock options, would be measured based on the grant-date fair value of those instruments. That cost would be recognized as compensation expense over the requisite service period (often the vesting period). Generally, no compensation cost would be recognized for equity instruments that do not vest.

If the proposed statement were adopted by the Company as currently written, it would require that compensation expense be recorded for employee stock options vesting or granted subsequent to December 31, 2004. The impact on earnings per share-diluted of expensing stock options will be dependent upon the final pronouncement issued by the FASB and the method to be used for valuation of stock options determined by the Company. The impact could range from approximately $.12 to $.16 per share-diluted, assuming option grants continue at the same level as in 2003. For more information on the Company’s stock-based employee compensation plans, refer to the consolidated financial statements and notes included in the Company’s 2003 Annual Report on Form 10-K.

Also in March 2004, the FASB issued Proposed FASB Staff Position No. FAS 106-b ("FSP"), Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The FSP provides guidance on the accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act"), for employers that sponsor post-retirement health care plans that provide prescription drug benefits. The FSP also requires those employers to provide certain disclosures regarding the effect of the federal subsidy provided by the Act. The accumulated post-retirement benefits obligation or net periodic post-retirement benefits cost in the consolidated financial statements or accompanying notes do not reflect the effects of the Act on the Company's post-retirement benefit plans. The Company is in the process of determining the impact of the Act on the accumulated post-retirement benefits obligation and net periodic post-retirement benefits cost to be recorded when the FSP is finalized and effective, which currently is scheduled for the third quarter of 2004.

14.     SUBSEQUENT EVENT

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 will receive one additional share for each share in their possession on that date. This does not change the proportionate interest a stockholder maintains in the Company. The additional shares will be distributed on June 15, 2004.

On a pro forma basis, if the stock split had been completed as of April 4, 2004 and March 30, 2003, net income per share and weighted-average shares outstanding would have been as follows:

-10-

Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition

Results of Operations - First Quarter 2004 vs. First Quarter 2003

Net sales for the first quarter increased $59.9 million, or 6%, from 2003.  Net sales were favorably impacted by increased 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 quarter of 2003 also contributed to the sales increase.  Net sales in the Company’s Canadian, Mexican and Brazilian businesses also increased as a result of volume growth and the impact of favorable foreign currency exchange rates, particularly in Canada.  Although there were four additional shipping days in the first quarter of 2004 compared with the same period of the prior year, net sales in 2004 were not materially impacted. The Company’s sales are programmed around specific customer events and brand and product initiatives which were the primary contributors to the sales volume increase in 2004. Sales were unfavorably affected by the divestiture of certain gum brands in September 2003, and higher promotion allowances and returns, discounts and allowances, relating primarily to the volume growth.  The results of the Company’s Asian operations, particularly in China, continued to be below expectations through the first quarter of 2004.  Consequently, management changes were made and the Company is reexamining its business model for this part of the world.

Cost of sales for the quarter increased $28.8 million, or 5%, from 2003 to 2004.  The cost increase was primarily caused by the higher sales volume and higher raw material costs, principally associated with increased cocoa prices.  The cost of sales increase was offset somewhat by reduced costs resulting from improved efficiencies in manufacturing and logistics operations.  Gross margin for the first quarter increased from 37.4% in 2003 to 38.2% in 2004.  The margin expansion reflected lower costs from manufacturing and logistics efficiencies as well as higher selling prices in the first quarter of 2004.  These margin improvements were partially offset by increases in raw material costs and promotional allowances. 

Selling, marketing and administrative expenses for the first three months of 2004 increased 9% from the comparable period in 2003, primarily reflecting increased consumer promotion and advertising expenses, as well as higher employee compensation and benefits. 

Net interest expense in the first quarter of 2004 was $.2 million higher than the comparable period of 2003, primarily reflecting lower interest income and higher fixed interest expense.

The Company’s effective income tax rate was 36.4% for the first quarter of 2004, compared with 36.7% for the first quarter of 2003.  The decrease was primarily attributable to expected changes in income among the tax jurisdictions in which the Company operates.

Net income for the first quarter increased $9.6 million, or 10%, from 2003 to 2004, and net income per share — diluted increased $.09, or 12%.

Liquidity and Capital Resources

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 quarter of 2004, the Company’s cash and cash equivalents increased by $120.6 million. Cash provided from operations was sufficient to fund capital expenditures and capitalized software additions totaling $65.5 million, dividend payments of $50.1 million, incentive plan transactions of $32.4 million and repurchases of the Company’s Common Stock of $20.2 million. Cash used by other assets and liabilities of $55.3 million in the first quarter of 2004 was primarily attributable to commodities transactions and lower liabilities associated with marketing programs, partially offset by an increase in accrued income taxes. Cash used by other assets and liabilities of $81.4 million in the first quarter of 2003 was principally the result of commodities transactions and lower liabilities associated with marketing programs and incentive compensation, partially offset by an increase in accrued income taxes.

The ratio of current assets to current liabilities was 2.0:1 as of April 4, 2004, and 1.9:1 as of December 31, 2003. 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 43% as of April 4, 2004 and December 31, 2003.

-11-

Stock Split

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 will receive one additional share for each share in their possession on that date. This does not change the proportionate interest a stockholder maintains in the Company. The additional shares will be distributed on June 15, 2004.

Safe Harbor Statement

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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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 April 4, 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 $1.9 million as of April 4, 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.

Item 4. Controls and Procedures

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.

-12-

PART II — OTHER INFORMATION

Items 1, 3 and 5 have been omitted as not applicable.

Item 2 — Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.

Issuer Purchases of Equity Securities

Item 4 — Submission of Matters to a Vote of Security Holders

Hershey Foods Corporation’s Annual Meeting of Stockholders was held on April 28, 2004. The following directors were elected by the holders of Common Stock and Class B Common Stock, voting together without regard to class:

The following directors were elected by the holders of the Common Stock voting as a class:

Holders of the Common Stock and the Class B Common Stock voting together approved the appointment of KPMG LLP as the independent auditors for 2004. Stockholders cast 390,732,104 votes FOR the appointment, 2,570,391 votes AGAINST the appointment and ABSTAINED from casting 758,717 votes on the appointment of independent auditors.

No other matters were submitted for stockholder action.

-13-

Item 6 — Exhibits and Reports on Form 8-K

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

-14-

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: May 12, 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

-15-

EXHIBIT INDEX

-16-