Business Context and Reporting Period
Company: Hershey Foods Corporation
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended July 4, 1999
Industry: Confectionery and Grocery Products
The company reported results for the second quarter and first half of fiscal 1999. Operations were significantly impacted by the divestiture of its pasta business in January 1999 and the implementation of a new enterprise-wide information system in July 1999.
Key Financial Metrics
| Metric (in thousands) | Q2 1999 | Q2 1998 | 6 Months 1999 | 6 Months 1998 |
|---|---|---|---|---|
| Net Sales | $853,239 | $880,399 | $1,798,391 | $1,978,475 |
| Net Income | $50,055 | $47,965 | $274,725 | $123,398 |
| Diluted EPS | $0.35 | $0.33 | $1.93 | $0.85 |
| Gross Margin % | 39.9% | 40.6% | 40.2% | 40.6% |
| Operating Cash Flow (6mo) | $(11,396) vs $109,544 | |||
| Total Debt (Short + Long Term) | $1,152,702 (as of July 4, 1999) | |||
| Cash & Equivalents | $31,749 (as of July 4, 1999) |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 3% in Q2 and 9% year-to-date (YTD) compared to 1998. The decline is primarily attributed to the divestiture of the pasta business and lower sales of core confectionery products in Q1.
- Profitability Surge: YTD Net Income increased 123% to $274.7 million. This is driven by a one-time after-tax gain of $165.0 million ($1.16 per share) from the sale of the pasta business. Excluding this gain, YTD net income was $109.7 million, an 11% decrease from the prior year.
- Margin Compression: Gross margins declined slightly (Q2: 40.6% to 39.9%; YTD: 40.6% to 40.2%) due to product mix shifts toward less profitable items and higher freight/distribution costs, partially offset by lower raw material costs.
- Expense Reduction: Selling, marketing, and administrative expenses decreased 7% in Q2 and 9% YTD, largely due to the removal of pasta business costs.
- Share Repurchases: The company repurchased $252.0 million of common stock in the first six months of 1999, reducing the share count.
Outlook, Risks, and Unusual Items
- Unusual Item (Gain on Sale): The financial results for the first six months are heavily skewed by the $243.8 million pre-tax gain on the sale of the pasta business.
- System Implementation Risk: In early July 1999, the company implemented the final phase of an enterprise-wide information system. Management reported "start-up difficulties" with order taking and distribution processes. The financial impact of these issues is currently undetermined but could adversely affect future sales and earnings.
- Year 2000 Compliance: Remediation of IT and non-IT systems is approximately 90% complete. The company anticipates completion in Q3 1999. Contingency plans, including inventory build-ups, are in place to mitigate risks from supplier or partner failures.
- Legal Proceedings:
- 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 Capital Stock-Franchise Tax, potentially increasing state tax liability.
- Liquidity: The company maintains a $576.8 million committed credit facility. Capital expenditures are expected to range between $150 million and $170 million annually.
Investor Verification Checklist
- Adjusted Earnings: Verify the company's organic growth by excluding the $165 million after-tax gain from the pasta sale when analyzing YTD profitability.
- System Impact: Monitor subsequent filings for the resolution of "start-up difficulties" related to the new information system implemented in July 1999.
- Year 2000 Status: Confirm the completion of Y2K remediation and the absence of operational disruptions from suppliers or partners in Q3 and Q4 1999.
- Legal Exposure: Track the outcome of the IRS COLI dispute and the Pennsylvania tax court remand regarding franchise tax exemptions.
- Debt Reduction: Confirm the utilization of pasta sale proceeds to reduce short-term borrowings and the status of the remaining $90.5 million share repurchase authorization.