Business Context and Reporting Period
Company: Hershey Foods Corporation (Hershey Co.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2004
Business Overview: The Company is a leading manufacturer and distributor of confectionery, snack, refreshment, and grocery products in the United States, Canada, and Mexico. Principal brands include Hershey's, Reese's, Kit Kat, Almond Joy, and York. The Company operates as a single reportable segment.
Key Financial Metrics (2004)
| Metric | 2004 Value | 2003 Value |
|---|---|---|
| Net Sales | $4,429.2 million | $4,172.6 million |
| Net Income | $590.9 million | $457.6 million |
| Diluted EPS | $2.30 | $1.73 |
| Gross Margin | 39.5% | 39.0% |
| Operating Cash Flow | $797.5 million | $592.9 million |
| Total Assets | $3,797.5 million | $3,582.5 million |
| Total Debt (Short + Long Term) | $1,312.9 million | $980.5 million |
| Stockholders' Equity | $1,089.3 million | $1,279.9 million |
Material Changes vs. Prior Period
- Sales Growth: Net sales increased 6% ($256.7 million) driven by higher unit volume (new products and limited editions), price increases, and favorable foreign exchange rates. Sales to McLane Company, Inc. represented approximately 25% of total net sales.
- Profitability: Net income increased 29% ($133.3 million). This was significantly aided by a non-recurring $61.1 million reduction in income tax expense due to the settlement of federal and state tax audits.
- Acquisitions: Acquired Mauna Loa Macadamia Nut Corporation ($127.8 million) in December 2004 and Grupo Lorena ($39.0 million) in October 2004.
- Share Repurchases: Purchased 11.3 million shares of Common Stock from the Milton Hershey School Trust for approximately $500 million in July 2004.
- Debt Structure: Short-term debt increased significantly ($331.2 million) to fund share repurchases and acquisitions. The capitalization ratio (debt to equity + debt) increased to 55% from 43%.
- Dividends: Declared a 30th consecutive year of dividend increases. The annual dividend rate on Common Stock was $0.88 per share (11% increase over 2003).
Guidance, Outlook, and Risks
- 2005 Outlook:
- Sales: Expected to grow 6%–7%, driven by the ongoing business and the first-year impact of Mauna Loa and Grupo Lorena.
- Gross Margin: Expected to improve 30–40 basis points, offsetting higher input costs (cocoa, dairy, transportation) with price increases and supply chain efficiencies.
- EPS: Expected to grow 9%–11% (excluding items affecting comparability).
- Tax Rate: Expected to return to a normal rate of approximately 36.6% in 2005, compared to the 29.3% effective rate in 2004.
- Key Risks:
- Commodity Prices: Significant exposure to cocoa, sugar, milk, and peanut prices. Cocoa costs are expected to increase in 2005.
- Price Realization: Success depends on consumer acceptance of announced price increases (average 3% increase on domestic line effective early 2005).
- Competition: Intensified global competition and retailer consolidation.
- Regulatory/Social: Potential restrictions on product sales due to childhood obesity concerns.
- Unusual Items: The 2004 results included a $61.1 million tax benefit from audit settlements and a $5.0 million reversal of bad debt reserves related to the Fleming Companies, Inc. bankruptcy.
Investor Verification Checklist
- Tax Rate Normalization: Verify the impact of the 2004 non-recurring tax benefit on 2005 earnings projections, as the effective tax rate is expected to rise to ~36.6%.
- Commodity Hedging: Review the effectiveness of forward purchasing and futures contracts in mitigating rising cocoa and dairy costs in 2005.
- Price Elasticity: Monitor consumer response to the ~3% average price increase implemented in early 2005 to ensure volume does not decline significantly.
- Debt Maturity: Confirm the repayment of $201.2 million in 6.7% Notes due in 2005 using operating cash flow and short-term borrowings.
- Acquisition Integration: Assess the integration progress and margin impact of the Mauna Loa and Grupo Lorena acquisitions.