Business Context and Reporting Period
Company: Hershey Foods Corporation
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and six months ended July 4, 2004
Business Overview: The Company manufactures and sells confectionery products. The reporting period includes the impact of a two-for-one stock split effected in June 2004 and significant adjustments to income tax reserves following the settlement of federal and state tax audits.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended July 4, 2004 |
Three Months Ended June 29, 2003 |
Six Months Ended July 4, 2004 |
Six Months Ended June 29, 2003 |
|---|---|---|---|---|
| Net Sales | $893,688 | $849,115 | $1,906,777 | $1,802,277 |
| Net Income | $147,217 | $71,484 | $254,364 | $169,042 |
| Diluted EPS | $0.56 | $0.27 | $0.97 | $0.64 |
| Gross Margin % | 40.3% | 39.3% | 39.2% | 38.3% |
| Operating Cash Flow (6mo) | $145,550 (2004) vs $125,563 (2003) | |||
| Cash & Equivalents | $19,475 (July 4, 2004) vs $114,793 (Dec 31, 2003) | |||
| Total Debt (Short + Long Term) | $1,069,171 (July 4, 2004) |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 5% in Q2 and 6% in the first six months of 2004 compared to 2003. Growth was driven by volume increases in the U.S. (new products), higher selling prices, and favorable foreign currency exchange rates in Canada and Brazil.
- Profitability Surge: Net income increased 106% in Q2 and 50% in the first six months. This dramatic increase was primarily due to a $61.1 million reduction in income tax expense resulting from the settlement of federal and state tax audits for the 1999 and 2000 tax years.
- Cost Pressures: Cost of sales increased due to higher raw material costs, specifically cocoa prices, and increased sales volume. These were partially offset by manufacturing efficiencies.
- Divestitures: Sales were negatively impacted by the September 2003 divestiture of certain gum brands.
- Asian Operations: Results in Asia, particularly China, remained below expectations, prompting management changes and a reexamination of the business model.
Guidance, Outlook, and Risks
- Tax Rate Normalization: Management notes that the effective tax rate for 2004 (16.3% for six months) is not comparable to prior years due to the one-time tax reserve adjustment. The normalized effective tax rate excluding this adjustment was 36.4%.
- Capital Allocation: The Company continues a share repurchase program. As of July 4, 2004, $75 million remained available under the $500 million authorization. Subsequent to the period end, the Company purchased approximately $500 million of shares from the Hershey Trust Company.
- Liquidity: Cash and cash equivalents decreased by $95.3 million in the first six months, driven by capital expenditures ($114.9 million), dividends ($99.9 million), and share repurchases ($95.6 million). The Company maintains a 364-Day Credit Agreement for up to $500 million and existing facilities of $400 million.
- Risks: Key risks include volatility in raw material costs (cocoa), changes in consumer preferences, competitive actions, and the impact of pending accounting standards regarding stock-based compensation (FASB exposure draft) which could reduce EPS by $0.06 to $0.08 per share upon adoption.
Investor Verification Checklist
- Tax Reserve Adjustment: Verify the sustainability of earnings by excluding the $61.1 million one-time tax benefit to assess core operational performance.
- Raw Material Costs: Monitor cocoa price trends and their impact on future gross margins, as rising costs are a stated headwind.
- Asian Market Performance: Track the results of the restructured business model in China and other Asian markets, which have underperformed expectations.
- Share Repurchases: Confirm the impact of the $500 million post-period purchase from the Hershey Trust on outstanding share count and future EPS.
- Stock-Based Compensation: Assess the potential impact of the new FASB standard on future earnings, estimated at a $0.06–$0.08 per share reduction.