Business Context and Reporting Period
This Form 10-Q covers Hershey Foods Corporation for the quarterly period ended September 28, 1997, and the nine months ended on that date. The company is a Delaware corporation headquartered in Hershey, Pennsylvania, primarily engaged in the confectionery business. The reporting period includes the impact of the Leaf North America acquisition completed in December 1996 and the divestiture of Gubor and Sperlari businesses.
Key Financial Metrics
Income Statement Highlights (Nine Months Ended Sept 28, 1997)
- Net Sales: $3,059.8 million (vs. $2,800.2 million in 1996).
- Net Income: $220.1 million (vs. $194.5 million in 1996).
- Diluted EPS: $1.46 (vs. $1.26 in 1996).
- Gross Margin: 41.4% (vs. 41.7% in 1996).
- Operating Income: $414.7 million (vs. $361.4 million in 1996).
- Interest Expense (Net): $52.1 million (vs. $36.6 million in 1996).
Balance Sheet and Liquidity (As of Sept 28, 1997)
- Cash and Cash Equivalents: $71.0 million.
- Total Assets: $3,496.9 million.
- Total Liabilities: $2,721.6 million.
- Stockholders' Equity: $775.3 million.
- Short-term Debt: $522.0 million.
- Long-term Debt: $1,029.1 million.
- Current Ratio: 1.1:1.
- Capitalization Ratio: 67% (Debt as a percent of total capital).
Cash Flow (Nine Months Ended Sept 28, 1997)
- Operating Cash Flow: $138.8 million (down from $189.7 million in 1996 due to increased receivables and inventory).
- Investing Cash Flow: $(121.0) million (primarily capital additions of $133.8 million).
- Financing Cash Flow: $(8.2) million (net of $507.7 million in stock repurchases and $550.0 million in long-term borrowings).
Material Changes vs. Prior Period
- Sales Growth: Net sales increased 9% year-over-year for the nine-month period, driven by the Leaf acquisition, new product introductions, and higher core confectionery sales. This was partially offset by divestitures and declines in pasta/grocery products.
- Margin Compression: Gross margin decreased slightly to 41.4% due to the lower margin profile of the Leaf business and higher costs for new/seasonal products, though lower milk and flour costs provided some offset.
- Increased Leverage: Net interest expense rose significantly ($15.5 million increase for the nine months) due to borrowings for the Leaf acquisition and a major share repurchase program.
- Share Repurchases: The company repurchased $507.7 million of its Common Stock, including 9.9 million shares from the Milton Hershey School Trust in August 1997, reducing average shares outstanding.
- Working Capital: Accounts receivable and inventories increased significantly, reflecting higher sales volume and seasonal build-up, which reduced operating cash flow.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Capital Expenditures: Management anticipates capital expenditures in the range of $175 million to $225 million annually for the next several years to support modernization and capacity expansion.
- Debt Capacity: $250 million of debt securities remain available under an August 1997 shelf registration for general corporate requirements, including refinancing commercial paper and funding acquisitions.
- Financing Strategy: The company relies on cash from operations and commercial paper for seasonal needs. It maintains a $600 million committed credit facility with options to increase by $1.0 billion.
Risks and Contingencies
- Market Conditions: Results are subject to changes in consumer preferences, competitor actions, and raw material pricing (notably flour, which remains above historical levels).
- Regulatory and Tax: Changes in governmental laws, including income taxes, could impact future results.
- Accounting Standards: Adoption of FAS 128 (Earnings Per Share) is expected to be effective after December 15, 1997, but is not expected to have a material effect.
Investor Verification Checklist
- Verify the sustainability of sales growth post-Leaf acquisition integration.
- Monitor raw material costs, specifically flour and milk, and their impact on gross margins.
- Assess the impact of the increased debt load (capitalization ratio rose to 67%) on interest coverage and liquidity.
- Review the effectiveness of the $507.7 million share repurchase program in driving EPS growth.
- Track the utilization of the remaining $250 million debt shelf and the $600 million credit facility.