HERSHEY CO — Interim / Quarterly Report 2001

May 10, 2001

10-Q 1 firstqtr2001_10-q.htm APRIL 1, 2001 FORM 10-Q First Quarter 2001 Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 1, 2001

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __to_

Commission file number: 1-183

HERSHEY FOODS CORPORATION 100 Crystal A Drive Hershey, PA 17033 Registrant's telephone number: 717-534-6799

State of Incorporation Delaware IRS Employer Identification No. 23-0691590

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [ X ] No [ ]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common Stock, $1 par value - 106,203,533 shares, as of April 30, 2001. Class B Common Stock, $1 par value - 30,441,858 shares, as of April 30, 2001.

Exhibit Index - Page 16

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PART I - FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements (Unaudited)

HERSHEY FOODS CORPORATION CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share amounts) For the Three Months Ended -------------------------- April 1, April 2, 2001 2000 -------- -------- Net Sales $ 1,080,281 $ 993,115 ------------ ------------ Costs and Expenses: Cost of sales 637,506 605,097 Selling, marketing and administrative 298,619 253,800 ------------ ------------ Total costs and expenses 936,125 858,897 ------------ ------------ Income before Interest and Income Taxes 144,156 134,218 Interest expense, net 17,297 17,530 ------------ ------------ Income before Income Taxes 126,859 116,688 Provision for income taxes 47,953 45,508 ------------ ------------ Net Income $ 78,906 $ 71,180 ============ ============ Net Income Per Share-Basic $ .58 $ .51 ============ ============ Net Income Per Share-Diluted $ .57 $ .51 ============ ============ Average Shares Outstanding-Basic 136,750 138,455 ============ ============ Average Shares Outstanding-Diluted 138,227 139,216 ============ ============ Cash Dividends Paid per Share: Common Stock $ .2800 $ .2600 ============ ============ Class B Common Stock $ .2525 $ .2350 ============ ============ The accompanying notes are an integral part of these statements.

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HERSHEY FOODS CORPORATION CONSOLIDATED BALANCE SHEETS APRIL 1, 2001 AND DECEMBER 31, 2000 (in thousands of dollars) ASSETS 2001 2000 --------- -------- Current Assets: Cash and cash equivalents $ 26,254 $ 31,969 Accounts receivable - trade 308,519 379,680 Inventories 624,805 605,173 Deferred income taxes 76,463 76,136 Prepaid expenses and other 84,261 202,390 ------------- -------------- Total current assets 1,120,302 1,295,348 ------------- -------------- Property, Plant and Equipment, at cost 2,787,063 2,764,845 Less-accumulated depreciation and amortization (1,213,050) (1,179,457) ------------- -------------- Net property, plant and equipment 1,574,013 1,585,388 ------------- -------------- Intangibles Resulting from Business Acquisitions, net 466,758 474,448 Other Assets 140,330 92,580 ------------- -------------- Total assets $ 3,301,403 $ 3,447,764 ============= ============== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 147,936 $ 149,232 Accrued liabilities 330,487 358,067 Accrued income taxes 44,620 1,479 Short-term debt 49,599 257,594 Current portion of long-term debt 634 529 ------------- -------------- Total current liabilities 573,276 766,901 Long-term Debt 877,510 877,654 Other Long-term Liabilities 322,570 327,674 Deferred Income Taxes 297,224 300,499 ------------- -------------- Total liabilities 2,070,580 2,272,728 ------------- -------------- Stockholders' Equity: Preferred Stock, shares issued: none in 2001 and 2000 --- --- Common Stock, shares issued: 149,509,014 in 2001 and 2000 149,508 149,508 Class B Common Stock, shares issued: 30,441,858 in 2001 and 2000 30,442 30,442 Additional paid-in capital 8,215 13,124 Unearned ESOP compensation (18,362) (19,161) Retained earnings 2,744,455 2,702,927 Treasury-Common Stock shares at cost: 43,223,356 in 2001 and 43,669,284 in 2000 (1,620,366) (1,645,088) Accumulated other comprehensive loss (63,069) (56,716) ------------- -------------- Total stockholders' equity 1,230,823 1,175,036 ------------- -------------- Total liabilities and stockholders' equity $ 3,301,403 $ 3,447,764 ============= ============== The accompanying notes are an integral part of these balance sheets.

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HERSHEY FOODS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) For the Three Months Ended -------------------------- April 1, April 2, 2001 2000 -------- -------- Cash Flow Provided from (Used by) Operating Activities Net Income $ 78,906 $ 71,180 Adjustments to Reconcile Net Income to Net Cash Provided from Operations: Depreciation and amortization 46,875 43,203 Deferred income taxes (4,141) (11,259) Changes in assets and liabilities: Accounts receivable - trade 71,161 39,285 Inventories (45,432) (16,572) Accounts payable (1,296) (47,976) Other assets and liabilities 104,808 14,975 ------------ ------------ Net Cash Flows Provided from Operating Activities 250,881 92,836 ------------ ------------ Cash Flows Provided from (Used by) Investing Activities Capital additions (32,032) (30,045) Capitalized software additions (1,125) (1,652) Other, net 11,079 (5,398) ------------ ------------ Net Cash Flows (Used by) Investing Activities (22,078) (37,095) ------------ ------------ Cash Flows Provided from (Used by) Financing Activities Net (decrease) in short-term debt (207,995) (34,635) Long-term borrowings --- 102 Repayment of long-term debt (76) (192) Cash dividends paid (37,378) (35,182) Exercise of stock options 15,134 658 Incentive plan transactions (4,203) (2,670) Repurchase of Common Stock --- (55,342) ------------ ------------ Net Cash Flows (Used by) Financing Activities (234,518) (127,261) ------------ ------------ (Decrease) in Cash and Cash Equivalents (5,715) (71,520) Cash and Cash Equivalents, beginning of period 31,969 118,078 ------------ ------------ Cash and Cash Equivalents, end of period $ 26,254 $ 46,558 ============ ============ ======================================================================================== Interest Paid $ 30,109 $ 29,613 ============ ============ Income Taxes Paid $ 1,852 $ 58,484 ============ ============ The accompanying notes are an integral part of these statements

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the accounts of Hershey Foods Corporation and its subsidiaries (the “Corporation”) after elimination of intercompany accounts and transactions. These statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Certain reclassifications have been made to prior year amounts to conform to the 2001 presentation. Operating results for the three months ended April 1, 2001, are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. For more information, refer to the consolidated financial statements and footnotes included in the Corporation’s 2000 Annual Report on Form 10-K.
2. INTEREST EXPENSE Interest expense, net consisted of the following:

For the Three Months Ended -------------------------- April 1, 2001 April 2, 2000 ------------- ------------- (in thousands of dollars) Interest expense $ 18,541 $ 18,946 $ Interest income (972) (1,416) Capitalized interest (272) --- ---------- ---------- Interest expense, net $ 17,297 $ 17,530 $ ========== ==========

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April 1, 2001 December 31, 2000 (in thousands of dollars) Raw materials $ 272,700 $ 263,658 Goods in process 47,028 47,866 Finished goods 334,312 338,749 ------------ ------------ Inventories at FIFO 654,040 650,273 Adjustment to LIFO (29,235) (45,100) ------------ ------------ Total inventories $ 624,805 $ 605,173 ============ ============

1. LONG-TERM DEBT In August 1997, the Corporation filed a Form S-3 Registration Statement under which it could offer, on a delayed or continuous basis, up to $500 million of additional debt securities. As of April 1, 2001, $250 million of debt securities remained available for issuance under the August 1997 Registration Statement.
2. FINANCIAL INSTRUMENTS The carrying amounts of financial instruments including cash and cash equivalents, accounts receivable, accounts payable and short-term debt approximated fair value as of April 1, 2001 and December 31, 2000, because of the relatively short maturity of these instruments. The carrying value of long-term debt, including the current portion, was $878.1 million as of April 1, 2001, compared to a fair value of $938.4 million, based on quoted market prices for the same or similar debt issues. As of April 1, 2001, the Corporation had foreign exchange forward contracts maturing in 2001 and 2002 to purchase $30.8 million in foreign currency, primarily British sterling and euros, and to sell $7.5 million in foreign currency, primarily Japanese yen, at contracted forward rates. The fair value of foreign exchange forward contracts is estimated by obtaining quotes for future contracts with similar terms, adjusted where necessary for maturity differences. As of April 1, 2001, the fair value of foreign exchange forward contracts approximated the contract value. The Corporation does not hold or issue financial instruments for trading purposes. In order to minimize its financing costs and to manage interest rate exposure, the Corporation, from time to time, enters into interest rate swap agreements. In February 2001, the Corporation entered into interest rate swap agreements that effectively convert interest-rate-contingent rental payments on certain operating leases from a variable to a fixed rate of 6.1%. Any interest rate differential on interest rate swap agreements is recognized as an adjustment to interest expense over the term of each agreement. As of April 1, 2001, the fair value of interest rate swap agreements approximated the contract value. The Corporation’s risk related to interest rate swap agreements is limited to the cost of replacing such agreements at prevailing market rates.

3. PENDING ACCOUNTING PRONOUNCEMENTS In May 2000, the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board reached a consensus on EITF Issue No. 00-14, “ Accounting for Coupons, Rebates and Discounts,” requiring the reporting of certain sales incentives such as consumer coupon redemption costs and off-invoice allowances as a reduction of net sales. In November 2000, the EITF delayed implementation of this change until the quarter ended June 30, 2001. A further delay until the quarter ended March 31, 2002 was announced in April 2001. Consumer coupon redemption expense and off-invoice allowances currently being reported in selling, marketing, and administrative expense will be recorded as a reduction of net sales on the effective date of the consensus. -9- Consumer coupon redemption costs are expensed and recognized at the offer date and measured based on expected utilization. Off-invoice allowances are expensed and recognized as incurred. During the first quarter, these costs and allowances amounted to $8.2 million and $30.3 million in 2001 and 2000, respectively, and are included in selling, marketing and administrative expenses in the Consolidated Statements of Income. In April 2001, a final consensus was reached on Issue No. 00-25 “ Vendor Income Statement Characterization of Consideration from a Vendor to a Retailer” , which is effective for the quarter ended March 31, 2002. The Corporation’s marketing performance funds and cooperative advertising programs are covered by this issue and the total potential impact of such reclassifications has not yet been determined. Similar to the consumer coupon redemption costs and off-invoice allowances in EITF Issue 00-14, marketing performance funds and cooperative advertising currently being reported in selling, marketing and administrative expense may be recorded as a reduction of net sales on the effective date of the consensus. The EITF is also addressing several related topics that impact the classification and recognition of certain sales incentives including:

4. Issue No. 00-21 “ Accounting for Revenue Arrangements with Multiple Deliverables” ; and

5. Issue No. 00-22 “ Accounting for 'Points' and Certain Other Time-Based or Volume-Based Sales Incentive Offers, and Offers for Free Products or Services to Be Delivered in the Future.”

6. SHARE REPURCHASES In October 1999, the Corporation’s Board of Directors approved a share repurchase program authorizing the repurchase of up to $200 million of the Corporation’s Common Stock. Under this program, a total of 1,711,986 shares of Common Stock was purchased during 2000. As of April 1, 2001, a total of 43,223,356 shares were held as Treasury Stock and $124.5 million remained available for repurchases of Common Stock under the repurchase program.

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Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition

Results of Operations - First Quarter 2001 vs. First Quarter 2000

Consolidated net sales for the first quarter increased from $993.1 million in 2000 to $1,080.3 million in 2001, an increase of 9% from the prior year. The higher sales primarily reflected incremental sales from the newly acquired mint and gum businesses and from the introduction of new confectionery products.

The consolidated gross margin increased from 39.1% in 2000 to 41.0% in 2001. The increase in gross margin primarily reflected decreased costs for freight, distribution and warehousing, and certain major raw materials, primarily cocoa. Selling, marketing and administrative expenses increased by 18% in 2001, primarily reflecting marketing and selling expenditures for the mint and gum businesses, and increased marketing and selling expenditures for core confectionery brands. Selling, marketing and administrative costs in 2000 included a one-time gain of $7.3 million arising from the sale of certain corporate aircraft.

Net interest expense in the first quarter of 2001 was $.2 million less than the comparable period of 2000.

Net income for the first quarter was $78.9 million compared to $71.2 million in 2000, and net income per share - diluted was $.57 per share compared to $.51 per share in the prior year. Prior year net income included an after-tax gain of $4.5 million, or $0.03 per share - diluted, on the sale of certain corporate aircraft.

Liquidity and Capital Resources

Historically, the Corporation's major source of financing has been cash generated from operations. Domestic seasonal working capital needs, which typically peak during the summer months, generally have been met by issuing commercial paper. During the first quarter of 2001, the Corporation’s cash and cash equivalents decreased by $5.7 million. Cash provided from operations was sufficient to reduce short-term debt by $208.0 million, fund a $75.0 million contribution to the Corporation’s domestic pension plans, and pay cash dividends of $37.4 million. Changes in cash flows provided from (used by) inventories and other assets and liabilities exclude the impact of adjustments required by the adoption of SFAS No. 133. Cash provided from other assets and liabilities of $104.8 million, primarily reflected commodities transactions.

The ratio of current assets to current liabilities was 2.0:1 as of April 1, 2001, and 1.7:1 as of December 31, 2000. The Corporation’s capitalization ratio (total short-term and long-term debt as a percent of stockholders’ equity, short-term and long-term debt) was 43% as of April 1, 2001, and 49% as of December 31, 2000.

In February 2001, the Corporation made a $75.0 million contribution to its domestic pension plans to improve the funded status and reduce future expenses.

Safe Harbor Statement

The nature of the Corporation's operations and the environment in which it operates subject it to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Corporation notes the following factors which, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential,” among others. Factors which could cause results to differ include, but are not limited to: changes in the confectionery and grocery business environment, including actions of competitors and changes in consumer preferences; changes in governmental laws and regulations, including taxes; market demand for new and existing products; changes in raw material costs; and the Corporation’s ability to implement improvements and to reduce costs associated with the Corporation’s distribution operations.

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Item 3. Quantitative and Qualitative Disclosure About Market Risk

The potential loss in fair value of foreign exchange forward contracts and interest rate swap agreements resulting from a hypothetical near-term adverse change in market rates of ten percent was not material as of April 1, 2001. The market risk resulting from a hypothetical adverse market price movement of ten percent associated with the estimated average fair value of net commodity positions decreased from $3.0 million as of December 31, 2000, to $1.5 million as of April 1, 2001. Market risk represents 10% of the estimated average fair value of net commodity positions at four dates prior to the end of each period.

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PART II - OTHER INFORMATION

Items 2, 3 and 5 have been omitted as not applicable.

Item 1 - Legal Proceedings

In January 1999, the Corporation received a Notice of Proposed Deficiency (Notice) from the Internal Revenue Service (IRS) related to the years 1989 through 1996. The Notice pertained to the Corporate Owned Life Insurance (COLI) program which was implemented by the Corporation in 1989. The IRS disallowed the interest expense deductions associated with the underlying life insurance policies. The total deficiency of $61.2 million, including interest, was paid to the IRS in September 2000 to eliminate further accruing of interest. The Corporation may be subject to additional assessments for federal taxes and interest for years 1997 and 1998 and for state taxes and interest for 1989 through 1998. The Corporation believes that it has fully complied with tax law as it relates to its COLI program, has filed for the refund of amounts paid and will continue to seek favorable resolution of this matter. The Corporation has no other material pending legal proceedings, other than ordinary routine litigation incidental to its business.

Item 4 - Submission of Matters to a Vote of Security Holders

Hershey Foods Corporation's Annual Meeting of Stockholders was held on April 24, 2001. The following directors were elected by the holders of Common Stock and Class B Common Stock, voting together without regard to class:

Name Votes For Votes Withheld ---- --------- -------------- C. McCollister Evarts, M.D. 395,776,041 4,494,642 J. Robert Hillier 396,268,752 4,001,931 Bonnie G. Hill 396,379,847 3,890,836 John C. Jamison 396,255,655 4,015,028 Richard H. Lenny 396,424,465 3,846,218 John M. Pietruski 393,713,382 6,557,301 Kenneth L. Wolfe 386,000,560 14,270,123 The following directors were elected by the holders of the Common Stock voting as a class: Name Votes For Votes Withheld ---- --------- -------------- Robert H. Campbell 92,739,620 3,986,283 Mackey J. McDonald 92,735,178 3,990,725

Holders of the Common Stock and the Class B Common Stock voting together approved the appointment of Arthur Andersen LLP as independent auditors for 2001. Stockholders cast 395,577,794 votes FOR the appointment, 4,159,758 votes AGAINST the appointment and ABSTAINED from casting 533,131 votes on the appointment of accountants.

Holders of the Common Stock and the Class B Common Stock voting together rejected the proposal requesting that a review and report of the Corporation’s sales of genetically engineered (GE) food products be undertaken and compiled by the Board of Directors, with the goal of establishing an action plan and timeline to eliminate GE ingredients from the Corporation’s products within 24 months. Stockholders cast 373,701,967 AGAINST the proposal, 8,503,083 votes FOR the proposal and ABSTAINED from casting 4,081,857 votes on the proposal.

No other matters were submitted for stockholder action.

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Item 6 - Exhibits and Reports on Form 8-K

a) Exhibits

The following items are attached and incorporated herein by reference:

Exhibit 10.1 - Key Employee Incentive Plan, as amended by the Corporation’s Board of Directors on February 6, 2001.

Exhibit 10.2 - Executive Employment Agreement between Hershey Foods Corporation and Richard H. Lenny, dated March 12, 2001.

Exhibit 12 - Statement showing computation of ratio of earnings to fixed charges for the quarters ended April 1, 2001 and April 2, 2000.

b) Reports on Form 8-K

A report on Form 8-K was filed March 12, 2001 announcing that Richard H. Lenny had been elected President and Chief Executive Officer, and that Kenneth L. Wolfe would continue in his capacity as Chairman of the Board of Directors for a period of up to one year.

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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HERSHEY FOODS CORPORATION (Registrant) Date May 10, 2001 /s/ Frank Cerminara ------------ ---------------------- Frank Cerminara Vice President, Chief Financial Officer and Treasurer Date May 10, 2001 /s/ David W. Tacka ------------ ----------------------- David W. Tacka Vice President, Corporate Controller and Chief Accounting Officer

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EXHIBIT INDEX

Exhibit 10.1 Key Employee Incentive Plan

Exhibit 10.2 Executive Employment Agreement

Exhibit 12 Computation of Ratio of Earnings to Fixed Charges

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