Business Context and Reporting Period
Company: Hershey Foods Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: October 3, 1999 (Third Quarter and First Nine Months)
Context: The reporting period was significantly impacted by the start-up of a new integrated information system in July 1999, which caused order fulfillment, warehousing, and shipping difficulties. Additionally, the company divested its pasta business in January 1999.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended Oct 3, 1999 | 3 Months Ended Oct 4, 1998 | 9 Months Ended Oct 3, 1999 | 9 Months Ended Oct 4, 1998 |
|---|---|---|---|---|
| Net Sales | $1,066,695 | $1,217,237 | $2,865,086 | $3,195,712 |
| Net Income | $87,578 | $107,533 | $362,303 | $230,931 |
| Diluted EPS | $0.62 | $0.74 | $2.55 | $1.59 |
| Gross Margin % | 40.6% | 42.0% | 40.4% | 41.1% |
| Cash & Equivalents | $42,896 | $39,024 | $42,896 | $40,163 |
| Total Debt (Short + Long) | $1,226,654 | $1,225,101 | $1,226,654 | $1,225,101 |
| Operating Cash Flow (9mo) | $56,710 | $167,760 | $56,710 | $167,760 |
Note: Total Debt calculated as Short-term debt ($345,821) + Current portion of long-term debt ($2,485) + Long-term debt ($878,347).
Material Changes vs. Prior Period
- Sales Decline: Net sales decreased 12% in the third quarter and 10% year-to-date. This was driven by the divestiture of the pasta business and reduced shipments due to new system implementation issues.
- Profitability: While reported Net Income for the nine months increased 57% to $362.3 million, this was primarily due to a one-time gain of $243.8 million ($165.0 million after-tax) from the sale of the pasta business. Excluding this gain, net income was 15% lower than the prior year.
- Margin Compression: Gross margins declined due to reduced manufacturing efficiency, higher freight/distribution costs from system issues, and lower sales volume absorption of fixed costs.
- Working Capital: Inventories increased by $120.6 million and accounts receivable by $57.1 million, largely attributed to system-related delays in shipments and collections.
- Share Repurchases: The company repurchased $310.3 million of common stock during the first nine months of 1999.
Outlook, Risks, and Management Commentary
- System Implementation: Management expects customer service levels to improve by the end of 1999 as process changes are implemented. However, increased costs for freight, warehousing, and working capital are expected to continue until the new distribution center opens in 2000.
- Market Share: The company anticipates regaining market share lost during the Back-to-School/Halloween period due to distribution difficulties.
- Capital Expenditures: Anticipated annual capital expenditures are in the range of $150 million to $170 million for modernization and capacity expansion.
- Legal & Tax Risks:
- IRS Dispute: A Notice of Proposed Deficiency regarding Corporate Owned Life Insurance (COLI) interest deductions for 1989-1996 is under protest.
- State Tax: A Pennsylvania Supreme Court ruling may invalidate the manufacturing exemption for state franchise tax, potentially increasing liability.
- Year 2000: Remediation programs are essentially complete, with contingency plans in place for suppliers and customers.
Investor Verification Checklist
- System Recovery: Verify if order fulfillment and customer service metrics have returned to historical levels as promised for late 1999.
- Core Earnings: Analyze operating performance excluding the $165 million after-tax gain from the pasta divestiture to assess true operational trends.
- Inventory Levels: Monitor inventory turnover to ensure the $120 million buildup is not indicative of obsolescence or permanent demand loss.
- Cost Control: Track freight and distribution expenses to confirm they decrease as the new distribution center becomes operational in 2000.
- Legal Exposure: Assess the potential financial impact of the Pennsylvania franchise tax ruling and the IRS COLI dispute.