HSY

Business Context and Reporting Period

Company: Hershey Foods Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 29, 2003
Business Overview: The Corporation manufactures and sells confectionery products. The reporting period covers the second quarter and first six months of 2003. Management notes that operating results are subject to seasonal effects and are not necessarily indicative of full-year results.

Key Financial Metrics

All figures in thousands of dollars, except per share data.

Debt & Liquidity: Total debt (short-term and long-term) was approximately $861.2 million as of June 29, 2003. The current ratio was 2.1:1. Cash and cash equivalents decreased significantly by $279.0 million during the six-month period, primarily due to share repurchases and capital expenditures.

Material Changes vs. Prior Period

• Revenue: Q2 2003 sales increased 3.1% year-over-year, driven by a January 2003 price increase, new product introductions, and lower returns. YTD sales decreased slightly (less than 1%) due to a customer "buy-in" prior to the price increase and the divestiture of Heide brands in 2002.
• Profitability: Net income increased 13% in Q2 and 12.5% YTD. Gross margins expanded in both periods due to price increases and lower raw material costs (dairy, peanuts), partially offset by higher promotional allowances.
• Expenses: Selling, marketing, and administrative expenses increased 3% in Q2 but decreased 2% YTD. A $5.0 million increase in the bad debt reserve was recorded in Q1 2003 related to the bankruptcy of Fleming Companies, Inc.
• Realignment Charges: Q2 2003 included a $3.9 million pre-tax charge for business realignment (asset impairments and inventory write-offs). This compares to $1.976 million in Q2 2002. YTD 2003 charges were $3.9 million versus $10.7 million in 2002 (which included significant pension settlement costs).

Guidance, Outlook, and Risks

• 2003 Realignment Initiatives: In July 2003, the company announced initiatives to streamline the supply chain, divest non-strategic brands, and rationalize production lines. These are expected to result in a total net charge of approximately $17.0 million for 2003 ($0.08 diluted EPS). The initiatives are expected to be cash flow positive in 2003 and generate approximately $5.0 million in annual savings starting in 2004.
• Share Repurchases: The company repurchased 3.9 million shares for $252.2 million under a $500 million program authorized in December 2002. Approximately $247.8 million remains available.
• Accounting Changes: Implementation of FASB Interpretation No. 46 in Q3 2003 will require the consolidation of three special purpose trusts. This is expected to result in a one-time charge of approximately $7.4 million ($0.06 diluted EPS) and an increase in annual depreciation expense of $5.2 million.
• Risks: Key risks include changes in raw material costs, consumer response to price increases, competitor actions, and the adequacy of the bad debt reserve regarding the Fleming Companies bankruptcy.

Investor Verification Checklist

• Cash Position: Verify the significant drawdown in cash equivalents ($297.7M to $18.7M) and the reliance on short-term debt ($42.5M) to fund operations and buybacks.
• Realignment Costs: Confirm the timing and magnitude of the remaining $13.1 million of expected 2003 realignment charges to be recognized in Q3 and Q4.
• Accounting Impact: Review the upcoming Q3 2003 impact of FASB Interpretation No. 46, specifically the $7.4 million cumulative effect charge and increased depreciation.
• Bad Debt Reserve: Monitor the exposure related to the Fleming Companies, Inc. bankruptcy and the $5.0 million reserve established in Q1.
• Seasonality: Acknowledge that Q2 results are not indicative of full-year performance due to the seasonal nature of the confectionery business.