Business Context and Reporting Period
Company: Hershey Foods Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 1, 2001
Business Overview: The Corporation manufactures and sells confectionery products. The reporting period includes the impact of a newly acquired mint and gum business and the introduction of new confectionery products. The company operates globally, with significant exposure to raw material costs (cocoa, sugar) and foreign currency fluctuations.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended July 1, 2001 |
Three Months Ended July 2, 2000 |
Six Months Ended July 1, 2001 |
Six Months Ended July 2, 2000 |
|---|---|---|---|---|
| Net Sales | $898,859 | $836,204 | $1,979,140 | $1,829,319 |
| Gross Margin % | 42.5% | 40.0% | 41.7% | 39.5% |
| Net Income | $52,439 | $39,996 | $131,345 | $111,176 |
| Diluted EPS | $0.38 | $0.29 | $0.95 | $0.80 |
| Operating Cash Flow (6mo) | $188,241 | $71,180 | ||
| Total Debt (Short + Long) | $1,156,101 | $1,135,777 | ||
| Cash & Equivalents | $21,071 | $31,969 | ||
| Current Ratio | 1.6:1 | 1.7:1 | ||
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 7% in the quarter and 8% year-to-date. Growth was driven by the newly acquired mint and gum business, increased international exports, and new product introductions. This was partially offset by declines in base confectionery sales in the U.S. due to SKU rationalization and customer inventory reductions.
- Margin Expansion: Gross margin improved to 42.5% (Q2) and 41.7% (YTD) from 40.0% and 39.5% respectively. Improvements were due to lower freight, distribution, and raw material costs (specifically cocoa), as well as reduced costs for disposing of aged inventory.
- Expense Increases: Selling, marketing, and administrative expenses rose 13% in the quarter and 15% year-to-date, primarily due to the mint and gum acquisition, higher staffing levels, and marketing for new products.
- Profitability: Net income increased 31% in the quarter and 18% year-to-date. The prior year six-month period included a one-time gain of $7.3 million from the sale of corporate aircraft.
- Liquidity: Cash and cash equivalents decreased by $10.9 million during the first six months. The decrease was utilized for pension contributions ($75.0 million), capital additions ($81.7 million), dividends ($74.5 million), and share repurchases ($29.6 million).
Guidance, Outlook, Risks, and Unusual Items
- Accounting Changes: The company adopted SFAS No. 133 (Derivatives) on Jan 1, 2001, with no significant impact on results. Pending adoption of EITF 00-14 and 00-25 (effective Q1 2002) will reclassify certain marketing costs as a reduction of net sales, potentially affecting reported revenue by $350-$400 million annually, though net income will remain unchanged. SFAS No. 142 (Goodwill) will be effective Jan 1, 2002, ending the amortization of goodwill and indefinite-life intangibles.
- Legal Proceedings: The IRS issued Notices of Proposed Deficiency regarding the Corporate Owned Life Insurance (COLI) program for years 1989-1998. A deficiency of $61.2 million (1989-1996) was paid in 2000. Assessments for 1997-1998 totaled $7.4 million. The company is seeking a refund and believes it has complied with tax laws.
- Subsequent Event: In July 2001, Hershey do Brasil acquired the chocolate and confectionery business of Visagis (approx. $20 million in 2000 sales), including the IO-IO and Visconti brands.
- Risks: Key risks include changes in consumer preferences, competitor actions, raw material cost volatility, foreign currency exchange rates, and regulatory changes.
Investor Verification Checklist
- Revenue Quality: Verify the sustainability of sales growth from the mint and gum acquisition versus the decline in core U.S. confectionery sales.
- Margin Sustainability: Assess whether lower cocoa and freight costs are temporary or indicative of a longer-term trend.
- Accounting Impact: Monitor the impact of the upcoming EITF 00-14/00-25 adoption on reported Net Sales figures starting in 2002.
- Legal Exposure: Track the resolution of the IRS COLI program dispute and potential state tax assessments.
- Capital Allocation: Review the balance between capital expenditures, pension funding, and share repurchases given the reduction in cash reserves.