UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
quarterly period ended April 1,
2007
OR
o
|
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
THE
HERSHEY COMPANY
100
Crystal A Drive
Hershey,
PA 17033
Registrant's
telephone number: 717-534-4200
State
of Incorporation
|
|
IRS
Employer Identification No.
|
Delaware
|
|
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 o
Indicate
by check mark whether the registrant is an accelerated filer (as defined
in Rule
12b-2 of the Exchange Act). Yes x No o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No x
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 – 167,755,884 shares, as of April 20, 2007. Class
B Common Stock,
$1
par
value - 60,815,010 shares, as of April 20, 2007.
THE
HERSHEY COMPANY
INDEX
Part
I. Financial Information
|
Page
Number
|
|
|
Item
1. Consolidated Financial Statements
(Unaudited)
|
|
|
|
Consolidated
Statements of Income
|
|
Three
months ended April 1, 2007 and April 2, 2006
|
3
|
|
|
Consolidated
Balance Sheets
|
|
April
1, 2007 and December 31, 2006
|
4
|
|
|
Consolidated
Statements of Cash Flows
|
|
Three
months ended April 1, 2007 and April 2, 2006
|
5
|
|
|
Notes
to Consolidated Financial Statements
|
6
|
|
|
|
|
Item
2. Management’s Discussion and Analysis of
|
|
Results
of Operations and Financial Condition
|
16
|
|
|
|
|
Item
3. Quantitative and Qualitative Disclosures
|
|
About
Market Risk
|
21
|
|
|
|
|
Item
4. Controls and Procedures
|
21
|
|
|
|
|
|
|
Part
II. Other Information
|
|
|
|
Item
2. Unregistered Sales of Equity Securities and
Use
|
|
Of
Proceeds
|
22
|
|
|
Item
6. Exhibits
|
22
|
PART
I - FINANCIAL INFORMATION
Item
1. Consolidated Financial Statements
(Unaudited)
THE
HERSHEY COMPANY
CONSOLIDATED
STATEMENTS OF INCOME
(in
thousands except per share amounts)
|
|
For
the Three Months Ended
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
|
|
|
|
|
|
|
Net
Sales
|
|
$ |
1,153,109
|
|
|
$ |
1,139,507
|
|
|
|
|
|
|
|
|
|
|
Costs
and Expenses:
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
739,078
|
|
|
|
707,365
|
|
Selling,
marketing and administrative
|
|
|
216,433
|
|
|
|
216,794
|
|
Business
realignment charge, net
|
|
|
27,545
|
|
|
|
3,331
|
|
|
|
|
|
|
|
|
|
|
Total
costs and expenses
|
|
|
983,056
|
|
|
|
927,490
|
|
|
|
|
|
|
|
|
|
|
Income
before Interest and Income Taxes
|
|
|
170,053
|
|
|
|
212,017
|
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
28,255
|
|
|
|
25,203
|
|
|
|
|
|
|
|
|
|
|
Income
before Income Taxes
|
|
|
141,798
|
|
|
|
186,814
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
48,325
|
|
|
|
64,343
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$ |
93,473
|
|
|
$ |
122,471
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
Per Share - Basic - Class B Common Stock
|
|
$ |
.37
|
|
|
$ |
.47
|
|
|
|
|
|
|
|
|
|
|
Earnings
Per Share - Diluted - Class B Common Stock
|
|
$ |
.37
|
|
|
$ |
.47
|
|
|
|
|
|
|
|
|
|
|
Earnings
Per Share - Basic - Common Stock
|
|
$ |
.42
|
|
|
$ |
.52
|
|
|
|
|
|
|
|
|
|
|
Earnings
Per Share - Diluted - Common Stock
|
|
$ |
.40
|
|
|
$ |
.50
|
|
|
|
|
|
|
|
|
|
|
Average
Shares Outstanding - Basic - Common Stock
|
|
|
169,836
|
|
|
|
178,892
|
|
|
|
|
|
|
|
|
|
|
Average
Shares Outstanding - Basic - Class B Common Stock
|
|
|
60,816
|
|
|
|
60,818
|
|
|
|
|
|
|
|
|
|
|
Average
Shares Outstanding - Diluted
|
|
|
233,708
|
|
|
|
243,147
|
|
|
|
|
|
|
|
|
|
|
Cash
Dividends Paid per Share:
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
$ |
.2700
|
|
|
$ |
.2450
|
|
Class
B Common Stock
|
|
$ |
.2425
|
|
|
$ |
.2200
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
THE
HERSHEY COMPANY
CONSOLIDATED
BALANCE SHEETS
(in
thousands of dollars)
ASSETS
|
|
April
1,
2007
|
|
|
December
31, 2006
|
|
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
60,483
|
|
|
$ |
97,141
|
|
Accounts
receivable - trade
|
|
|
405,908
|
|
|
|
522,673
|
|
Inventories
|
|
|
664,703
|
|
|
|
648,820
|
|
Deferred
income taxes
|
|
|
59,649
|
|
|
|
61,360
|
|
Prepaid
expenses and other
|
|
|
89,502
|
|
|
|
87,818
|
|
Total
current assets
|
|
|
1,280,245
|
|
|
|
1,417,812
|
|
Property,
Plant and Equipment, at cost
|
|
|
3,616,003
|
|
|
|
3,597,756
|
|
Less-accumulated
depreciation and amortization
|
|
|
(2,004,680 |
) |
|
|
(1,946,456 |
) |
Net
property, plant and equipment
|
|
|
1,611,323
|
|
|
|
1,651,300
|
|
Goodwill
|
|
|
502,815
|
|
|
|
501,955
|
|
Other
Intangibles
|
|
|
139,284
|
|
|
|
140,314
|
|
Other
Assets
|
|
|
470,866
|
|
|
|
446,184
|
|
Total
assets
|
|
$ |
4,004,533
|
|
|
$ |
4,157,565
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
198,147
|
|
|
$ |
155,517
|
|
Accrued
liabilities
|
|
|
405,327
|
|
|
|
454,023
|
|
Accrued
income taxes
|
|
|
39,005
|
|
|
|
—
|
|
Short-term
debt
|
|
|
722,670
|
|
|
|
655,233
|
|
Current
portion of long-term debt
|
|
|
(73 |
) |
|
|
188,765
|
|
Total
current liabilities
|
|
|
1,365,076
|
|
|
|
1,453,538
|
|
Long-term
Debt
|
|
|
1,248,137
|
|
|
|
1,248,128
|
|
Other
Long-term Liabilities
|
|
|
539,876
|
|
|
|
486,473
|
|
Deferred
Income Taxes
|
|
|
230,743
|
|
|
|
286,003
|
|
Total
liabilities
|
|
|
3,383,832
|
|
|
|
3,474,142
|
|
Stockholders'
Equity:
|
|
|
|
|
|
|
|
|
Preferred
Stock, shares issued:
|
|
|
|
|
|
|
|
|
none
in 2007 and 2006
|
|
|
—
|
|
|
|
—
|
|
Common
Stock, shares issued: 299,086,734 in 2007 and
299,085,666
in 2006
|
|
|
299,086
|
|
|
|
299,085
|
|
Class
B Common Stock, shares issued: 60,815,010 in 2007 and
60,816,078
in 2006
|
|
|
60,815
|
|
|
|
60,816
|
|
Additional
paid-in capital
|
|
|
311,876
|
|
|
|
298,243
|
|
Retained
earnings
|
|
|
3,998,188
|
|
|
|
3,965,415
|
|
Treasury-Common
Stock shares at cost:
|
|
|
|
|
|
|
|
|
131,449,993
in 2007 and 129,638,183 in 2006
|
|
|
(3,920,264 |
) |
|
|
(3,801,947 |
) |
Accumulated
other comprehensive loss
|
|
|
(129,000 |
) |
|
|
(138,189 |
) |
Total
stockholders' equity
|
|
|
620,701
|
|
|
|
683,423
|
|
Total
liabilities and stockholders' equity
|
|
$ |
4,004,533
|
|
|
$ |
4,157,565
|
|
The
accompanying notes are an integral part of these consolidated balance
sheets.
THE
HERSHEY COMPANY
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands of dollars)
|
For
the Three Months Ended
|
|
|
April
1,
2007
|
|
April
2,
2006
|
|
Cash
Flows Provided from (Used
by) Operating
Activities
|
|
|
|
|
Net
Income
|
$ |
93,473
|
|
$ |
122,471
|
|
Adjustments
to Reconcile Net Income
to Net Cash
|
|
|
|
|
|
|
Provided
from Operations:
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
60,107
|
|
|
48,135
|
|
Stock-based
compensation expense, net
of tax of $2,393 and
$4,644, respectively
|
|
4,482
|
|
|
8,857
|
|
Excess
tax benefits from exercise
of stock options
|
|
(6,446 |
) |
|
(1,631 |
) |
Deferred
income taxes
|
|
21,455
|
|
|
6,973
|
|
Business
realignment initiatives,
net of tax of $15,077 and
$518, respectively
|
|
25,313
|
|
|
1,214
|
|
Contributions
to pension plans
|
|
(5,124 |
) |
|
(8,003 |
) |
Changes
in assets and liabilities:
|
|
|
|
|
|
|
Accounts
receivable - trade
|
|
116,765
|
|
|
135,332
|
|
Inventories
|
|
(17,083 |
) |
|
(110,596 |
) |
Accounts
payable
|
|
42,630
|
|
|
10,095
|
|
Other
assets and liabilities
|
|
(32,052 |
) |
|
(46,857 |
) |
Net
Cash Flows Provided from
Operating Activities
|
|
303,520
|
|
|
165,990
|
|
|
|
|
|
|
|
|
Cash
Flows Provided from (Used
by) Investing
Activities
|
|
|
|
|
|
|
Capital
additions
|
|
(39,877 |
) |
|
(36,191 |
) |
Capitalized
software additions
|
|
(1,877 |
) |
|
(2,067 |
) |
Net
Cash Flows (Used by) Investing
Activities
|
|
(41,754 |
) |
|
(38,258 |
) |
|
|
|
|
|
|
|
Cash
Flows Provided from (Used
by) Financing
Activities
|
|
|
|
|
|
|
Net
increase in short-term
debt
|
|
67,437
|
|
|
79,610
|
|
Repayment
of long-term debt
|
|
(188,742 |
) |
|
(58 |
) |
Cash
dividends paid
|
|
(60,700 |
) |
|
(56,936 |
) |
Exercise
of stock options
|
|
27,132
|
|
|
8,754
|
|
Excess
tax benefits from exercise
of stock options
|
|
6,446
|
|
|
1,631
|
|
Repurchase
of Common Stock
|
|
(149,997 |
) |
|
(183,976 |
) |
Net
Cash Flows (Used by) Financing
Activities
|
|
(298,424 |
) |
|
(150,975 |
) |
|
|
|
|
|
|
|
Decrease
in Cash and Cash Equivalents
|
|
(36,658 |
) |
|
(23,243 |
) |
Cash
and Cash Equivalents, beginning
of period
|
|
97,141
|
|
|
67,183
|
|
|
|
|
|
|
|
|
Cash
and Cash Equivalents, end
of period
|
$ |
60,483
|
|
$ |
43,940
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Paid
|
$ |
52,542
|
|
$ |
38,954
|
|
|
|
|
|
|
|
|
Income
Taxes Paid
|
$ |
9,848
|
|
$ |
33,785
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
THE
HERSHEY COMPANY
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS
OF PRESENTATION
Our
unaudited consolidated financial statements provided in this report include
the
accounts of the Company and our majority-owned subsidiaries and entities
in
which we have a controlling financial interest after the elimination of
intercompany accounts and transactions. We have a controlling financial interest
if we own a majority of the outstanding voting common stock or have significant
control over an entity through contractual or economic interests in which
we are
the primary beneficiary. We prepared these statements in accordance
with the instructions to Form 10-Q. These statements do not
include all of the information and footnotes required by U.S. generally accepted
accounting principles for complete financial statements.
We
included all adjustments (consisting only of normal recurring accruals) which
we
believe were considered necessary for a fair presentation. We reclassified
certain prior year amounts to conform to the 2007
presentation. Operating results for the three months ended April 1,
2007 may not be indicative of the results that may be expected for the year
ending December 31, 2007, because of the seasonal effects of our
business.
Items
Affecting Comparability
Securities
and Exchange Commission Staff Accounting Bulletin No. 108, Considering the
Effects of Prior Misstatements When Quantifying Misstatements in Current
Year
Financial Statements (“SAB No. 108”), required companies to change the
accounting principle used for evaluating the effect of possible prior year
misstatements when quantifying misstatements in current year financial
statements. As a result, we changed one of the five criteria of our revenue
recognition policy, resulting in a delay in the recognition of revenue on
goods
in-transit until they are received by our customers. As permitted by SAB
No.
108, we adjusted our financial statements for the three months ended April
2,
2006 to provide comparability. These adjustments were not material to our
results of operations for that period. For more information, refer to the
consolidated financial statements and notes included in our 2006 Annual Report
on Form 10-K.
2. STOCK
COMPENSATION PLANS
We
had
two share-based employee compensation plans and a Directors’ Compensation Plan
as of April 1, 2007. The following table summarizes our compensation
costs:
|
|
For
the Three Months Ended
|
|
|
April
1,
2007
|
|
April
2,
2006
|
|
|
(in
millions of dollars)
|
Total
compensation amount charged against income for stock compensation
plans,
including stock options, performance stock units and restricted
stock
units
|
|
$ 6.9
|
|
$ 14.0
|
Total
income tax benefit recognized in Consolidated Statements of Income
for
share-based compensation
|
|
$ 2.4
|
|
$ 4.8
|
The
decrease in share-based compensation expense from 2006 to 2007 was primarily
associated with the timing of stock option grants in 2007. The 2007
stock option grants were delayed pending approval by our stockholders of
The
Hershey Company Equity and Incentive Compensation Plan at the Annual Meeting
in
April 2007.
We
estimated the fair value of each stock option grant on the date of the grant
using a Black-Scholes option-pricing model and the weighted-average assumptions
set forth in the following table:
|
|
For
the Three Months Ended
|
|
|
April
1,
2007
|
|
April
2,
2006
|
Dividend
yields
|
|
1.9%
|
|
1.6%
|
Expected
volatility
|
|
20.1%
|
|
23.7%
|
Risk-free
interest rates
|
|
4.7%
|
|
4.6%
|
Expected
lives in years
|
|
6.6
|
|
6.6
|
Stock
Options
A
summary
of the status of our stock options as of April 1, 2007, and the change during
2007 is presented below:
|
For
the Three Months Ended April 1, 2007
|
Stock
Options
|
Shares
|
Weighted-
Average
Exercise
Price
|
Weighted-Average
Remaining
Contractual
Term
|
Outstanding
at beginning of the period
|
13,855,113
|
$40.29
|
6.3
years
|
Granted
|
27,300
|
$51.35
|
|
Exercised
|
(936,799)
|
$29.02
|
|
Forfeited
|
(59,037)
|
$53.74
|
|
Outstanding
as of April 1, 2007
|
12,886,577
|
$41.07
|
6.2
years
|
Options
exercisable as of April 1, 2007
|
8,953,778
|
$36.86
|
5.5
years
|
|
|
For
the Three Months Ended
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
Weighted
fair value of options granted (per share)
|
|
$ |
12.43
|
|
|
$ |
15.05
|
|
Intrinsic
value of options exercised (in millions of dollars)
|
|
$ |
20.5
|
|
|
$ |
6.2
|
|
·
|
As
of April 1, 2007, the aggregate intrinsic value of options outstanding
was
$188.0 million and the aggregate intrinsic value of options
exercisable was $166.3 million.
|
|
|
·
|
As
of April 1, 2007, there was $37.5 million of total unrecognized
compensation cost related to non-vested stock option compensation
arrangements granted under our stock option plans. That cost
is expected
to be recognized over a weighted-average period of 2.2
years.
|
Performance
Stock Units and Restricted Stock Units
A
summary
of the status of our performance stock units and restricted stock units as
of
April 1, 2007, and the change during 2007 is presented below:
Performance
Stock Units and Restricted Stock Units
|
|
For
the Three Months Ended
April
1, 2007
|
|
|
Weighted-average
grant date fair value for equity awards or
market
value for liability awards
|
|
Outstanding
at beginning of year
|
|
|
1,075,748
|
|
|
|
$44.89
|
|
Granted
|
|
|
215,405
|
|
|
|
$50.63
|
|
Performance
assumption change
|
|
|
(16,776 |
) |
|
|
$55.05
|
|
Vested
|
|
|
(402,576 |
) |
|
|
$50.56
|
|
Forfeited
|
|
|
(150 |
) |
|
|
$49.80
|
|
Outstanding
as of April 1, 2007
|
|
|
871,651
|
|
|
|
$44.74
|
|
As
of
April 1, 2007, there was $18.5 million of unrecognized compensation cost
relating to non-vested performance stock units and restricted stock
units. We expect to recognize that cost over a weighted-average
period of 2.5 years.
|
|
For
the Three Months Ended
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
Intrinsic
value of share - based liabilities paid, combined with the fair
value of
shares vested (in millions of dollars)
|
|
$ |
20.4
|
|
|
$ |
3.0
|
|
The
higher amount in 2007 was primarily associated with the additional three-year
vesting term for the 2003 performance stock unit grants which reduced the
number
of shares that vested in 2006 compared with 2007. An additional
three-year vesting term was imposed for the 2003 grants with accelerated
vesting
for retirement, disability or death. The compensation cost based on
grant date fair value for the 2003 grants is being recognized over a period
from
three to six years.
Deferred
performance stock units, deferred restricted stock units, deferred directors’
fees and accumulated dividend amounts totaled 703,297 units as of April,
1,
2007.
No
stock
appreciation rights were outstanding as of April 1, 2007.
For
more
information on our stock compensation plans, refer to the consolidated financial
statements and notes included in our 2006 Annual Report on Form
10-K.
3.
INTEREST EXPENSE
Net
interest expense consisted of the following:
|
|
For
the Three Months Ended
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
|
|
(in
thousands of dollars)
|
|
Interest
expense
|
|
$ |
29,051
|
|
|
$ |
25,701
|
|
Interest
income
|
|
|
(761 |
) |
|
|
(491 |
) |
Capitalized
interest
|
|
|
(35 |
) |
|
|
(7 |
) |
Interest
expense, net
|
|
$ |
28,255
|
|
|
$ |
25,203
|
|
For
the
first three months of 2007, net interest expense was higher than the comparable
period of 2006, primarily due to higher interest expense associated with
the
issuance of $500.0 million of long-term debt in August 2006. Higher
interest rates in 2007 as compared to 2006 also contributed to the increase
in
net interest expense.
4. BUSINESS
REALIGNMENT INITIATIVES
In
February 2007, we announced a comprehensive, three-year supply chain
transformation program (the “2007 business realignment
initiatives”). When completed, this program will greatly enhance our
manufacturing, sourcing and customer service capabilities, and will also
generate significant resources to invest in our growth
initiatives. These initiatives include accelerated marketplace
momentum within our core U.S. business, creation of innovative new product
platforms to meet customer needs and disciplined global
expansion. Under the program, which will be implemented in stages
over the next three years, we will significantly increase manufacturing capacity
utilization by reducing the number of production lines by more than one-third,
outsource production of low value-added items and construct a flexible,
cost-effective production facility in Monterrey, Mexico to meet current and
emerging marketplace needs. The program will result in a total net
reduction of approximately 1,500 positions across our supply chain over the
next
three years.
We
expect
the total pre-tax cost of the program to be from $525 million to $575 million
over the next three years. The total includes approximately $50
million in project implementation costs. The costs will be incurred
primarily in 2007 and 2008, with approximately $270 million to $300 million
expected in 2007.
In
July
2005, we announced initiatives intended to advance our value-enhancing strategy
(the “2005 business realignment initiatives”). Charges for the 2005
business realignment initiatives were recorded during 2005 and 2006 and the
2005
business realignment initiatives were completed by December 31,
2006.
Charges
(credits) associated with business realignment initiatives recorded during
the
three months ended April 1, 2007 and April 2, 2006 were as follows:
|
|
For
the Three Months Ended
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
|
|
(in
thousands of dollars)
|
|
Cost
of sales
|
|
|
|
|
|
|
2007
business realignment initiatives
|
|
$ |
9,859
|
|
|
$ |
–
|
|
2005
business realignment initiatives
|
|
|
–
|
|
|
|
(1,599 |
) |
Total
cost of sales
|
|
|
9,859
|
|
|
|
(1,599 |
) |
|
|
|
|
|
|
|
|
|
Selling,
marketing and administrative
|
|
|
|
|
|
|
|
|
2007
business realignment initiatives
|
|
|
2,986
|
|
|
|
–
|
|
2005
business realignment initiatives
|
|
|
–
|
|
|
|
–
|
|
Total
selling, marketing and administrative
|
|
|
2,986
|
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
Business
realignment charge, net
|
|
|
|
|
|
|
|
|
2007
business realignment initiatives:
|
|
|
|
|
|
|
|
|
Fixed
asset impairments and plant closure expenses
|
|
|
26,220
|
|
|
|
–
|
|
Employee
separation costs
|
|
|
1,325
|
|
|
|
–
|
|
2005
business realignment initiatives
|
|
|
–
|
|
|
|
3,331
|
|
Total
Business realignment charge, net
|
|
|
27,545
|
|
|
|
3,331
|
|
|
|
|
|
|
|
|
|
|
Total
net charges associated with business realignment
initiatives
|
|
$ |
40,390
|
|
|
$ |
1,732
|
|
The
charge of $9.9 million recorded in cost of sales during the first quarter
of
2007 related to the accelerated depreciation of fixed assets over a reduced
estimated remaining useful life. The $3.0 million recorded in
selling, marketing and administrative expenses related primarily to project
implementation costs. In determining the costs related to fixed asset
impairments, fair value was estimated based on the expected sales
proceeds. Certain real estate with a net realizable value of
approximately $5.0 million was being held for sale as of April 1,
2007. The net business realignment and asset impairments charge
included $1.3 million for involuntary terminations.
The
credit of $1.6 million recorded in cost of sales during the first quarter
of
2006 related to higher than expected proceeds from the sale of equipment
from
the Las Piedras, Puerto Rico plant. The $3.3 million net
business realignment charge recorded for the 2005 business realignment
initiatives included $1.4 million related to a U.S. Voluntary Workforce
Reduction Program, $1.3 million for facility rationalization relating to
the
closure of the Las Piedras plant and $.6 million related to streamlining
our
international operations.
The
April
1, 2007 liability balance relating to the 2007 business realignment initiatives
was $1.3 million for employee separation costs. The April 1, 2007
liability balance relating to the 2005 business realignment initiatives was
$12.1 million.
5. EARNINGS
PER SHARE
In
accordance with Statement of Financial Accounting Standards No. 128,
Earnings Per Share, we compute Basic and Diluted Earnings Per Share
based on the weighted-average number of shares of the Common Stock and the
Class
B Common Stock outstanding as follows:
|
|
For
the Three Months Ended
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
|
|
(in
thousands except per share amounts)
|
|
|
|
|
|
Net
income
|
|
$ |
93,473
|
|
|
$ |
122,471
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares - Basic
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
169,836
|
|
|
|
178,892
|
|
Class
B Common Stock
|
|
|
60,816
|
|
|
|
60,818
|
|
Total
weighted-average shares - Basic
|
|
|
230,652
|
|
|
|
239,710
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
Employee
stock options
|
|
|
2,403
|
|
|
|
2,848
|
|
Performance
and restricted stock units
|
|
|
653
|
|
|
|
589
|
|
Weighted-average
shares - Diluted
|
|
|
233,708
|
|
|
|
243,147
|
|
Earnings
Per Share - Basic
|
|
|
|
|
|
|
|
|
Class
B Common Stock
|
|
$ |
.37
|
|
|
$ |
.47
|
|
Common
Stock
|
|
$ |
.42
|
|
|
$ |
.52
|
|
Earnings
Per Share - Diluted
|
|
|
|
|
|
|
|
|
Class
B Common Stock
|
|
$ |
.37
|
|
|
$ |
.47
|
|
Common
Stock
|
|
$ |
.40
|
|
|
$ |
.50
|
|
The
Class
B Common Stock is convertible into Common Stock on a share for share basis
at
any time. In accordance with proposed Financial Accounting Standards Board
(“FASB”) Staff Position No. FAS 128-a, Computational Guidance for Computing
Diluted EPS under the Two-Class Method, the calculation of earnings per
share-diluted for the Class B Common Stock was performed using the two-class
method and the calculation of earnings per share-diluted for the Common Stock
was performed using the if-converted method.
For
the
three-month period ended April 1, 2007, we excluded from the earnings per
share
calculation a total of 3,846,294 employee stock options because they were
antidilutive. We excluded 3,597,505 employee stock options for the
period ended April 2, 2006.
6. DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES
We
account for derivative instruments in accordance with Statement of Financial
Accounting Standards No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended (“SFAS No. 133, as
amended”). SFAS No. 133, as amended, requires us to recognize all
derivative instruments at fair value. We classify the derivatives as assets
or
liabilities on the balance sheet. As of April 1, 2007 and April 2, 2006,
all of
our derivative instruments were classified as cash flow hedges.
Summary
of Activity
Our
cash
flow hedging derivative activity during the three months ended April 1, 2007
and
April 2, 2006 was as follows:
|
|
For
the three months ended
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
|
|
(in
millions of dollars)
|
|
|
|
|
|
|
|
|
Net
after-tax gains on cash flow hedging derivatives
|
|
$ |
5.9
|
|
|
$ |
6.5
|
|
Reclassification
adjustment of (gains) losses from accumulated other
comprehensive
income to income, net of tax
|
|
|
(.1 |
) |
|
|
.6
|
|
Hedge
ineffectiveness gains (losses) recognized in cost of sales,
before
tax
|
|
|
–
|
|
|
|
–
|
|
·
|
Net
gains and losses on cash flow hedging derivatives were primarily
associated with commodities futures
contracts.
|
·
|
Reclassification
adjustments from accumulated other comprehensive income (loss)
to income
related to gains or losses on commodities futures contracts and
were
reflected in cost of sales. Reclassification adjustments for
gains on interest rate swaps were reflected as an adjustment
to interest
expense.
|
·
|
We
recognized no components of gains or losses on cash flow hedging
derivatives in income due to excluding such components from the
hedge
effectiveness assessment.
|
The
amount of net gains on cash flow hedging derivatives, including foreign exchange
forward contracts, interest rate swap agreements and commodities futures
contracts, expected to be reclassified into earnings in the next twelve months
was approximately $1.2 million after tax as of April 1, 2007. This amount
was
primarily associated with foreign exchange forward contracts.
In
February 2006, we terminated a forward swap agreement hedging the anticipated
execution of $250 million of term financing because the transaction was no
longer expected to occur by the originally specified time period or within
an
additional two-month period of time thereafter. A gain of
$1.0 million was recorded in the first quarter of 2006 as a result of the
discontinuance of this cash flow hedge. No other gains or losses on
cash flow hedging derivatives were reclassified from accumulated other
comprehensive income (loss) into income as a result of the discontinuance
of a
hedge because it became probable that a hedged forecasted transaction would
not
occur.
For
more
information, refer to the consolidated financial statements and notes included
in our 2006 Annual Report on Form 10-K.
7. COMPREHENSIVE
INCOME
A
summary
of the components of comprehensive income (loss) is as
follows:
|
|
For
the Three Months Ended April 1, 2007
|
|
|
|
Pre-Tax
Amount
|
|
|
Tax
(Expense)
Benefit
|
|
|
After-Tax
Amount
|
|
|
|
(in
thousands of dollars)
|
|
Net
income
|
|
|
|
|
|
|
|
$ |
93,473
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
$ |
2,604
|
|
|
$ |
—
|
|
|
|
2,604
|
|
Pension
and post-retirement benefit plans
|
|
|
1,412
|
|
|
|
(636 |
) |
|
|
776
|
|
Cash
flow hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
on cash flow hedging derivatives
|
|
|
9,296
|
|
|
|
(3,368 |
) |
|
|
5,928
|
|
Reclassification
adjustments
|
|
|
(193 |
) |
|
|
74
|
|
|
|
(119 |
) |
Total
other comprehensive income
|
|
$ |
13,119
|
|
|
$ |
(3,930 |
) |
|
|
9,189
|
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
$ |
102,662
|
|
|
|
For
the Three Months Ended April 2, 2006
|
|
|
|
Pre-Tax
Amount
|
|
|
Tax
(Expense)
Benefit
|
|
|
After-Tax
Amount
|
|
|
|
(in
thousands of dollars)
|
|
Net
income
|
|
|
|
|
|
|
|
$ |
122,471
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
$ |
(484 |
) |
|
$ |
—
|
|
|
|
(484 |
) |
Minimum
pension liability adjustments
|
|
|
118
|
|
|
|
(42 |
) |
|
|
76
|
|
Cash
flow hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
on cash flow hedging derivatives
|
|
|
10,289
|
|
|
|
(3,745 |
) |
|
|
6,544
|
|
Reclassification
adjustments
|
|
|
915
|
|
|
|
(332 |
) |
|
|
583
|
|
Total
other comprehensive income
|
|
$ |
10,838
|
|
|
$ |
(4,119 |
) |
|
|
6,719
|
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
$ |
129,190
|
|
The
components of accumulated other comprehensive income (loss) as shown on the
Consolidated Balance Sheets are as follows:
|
|
April
1,
2007
|
|
|
December
31,
2006
|
|
|
|
(in
thousands of dollars)
|
|
Foreign
currency translation adjustments
|
|
$ |
2,569
|
|
|
$ |
(35 |
) |
Pension
and post-retirement benefit plans, net of tax
|
|
|
(137,196 |
) |
|
|
(137,972 |
) |
Cash
flow hedges, net of tax
|
|
|
5,627
|
|
|
|
(182 |
) |
Total
accumulated other comprehensive loss
|
|
$ |
(129,000 |
) |
|
$ |
(138,189 |
) |
8. INVENTORIES
We
value
the majority of our inventories under the last-in, first-out (“LIFO”) method and
the remaining inventories at the lower of first-in, first-out (“FIFO”) cost or
market. Inventories were as follows:
|
|
April
1,
2007
|
|
|
December
31,
2006
|
|
|
|
(in
thousands of dollars)
|
|
Raw
materials
|
|
$ |
235,898
|
|
|
$ |
214,335
|
|
Goods
in process
|
|
|
107,056
|
|
|
|
94,740
|
|
Finished
goods
|
|
|
401,895
|
|
|
|
418,250
|
|
Inventories
at FIFO
|
|
|
744,849
|
|
|
|
727,325
|
|
Adjustment
to LIFO
|
|
|
(80,146 |
) |
|
|
(78,505 |
) |
Total
inventories
|
|
$ |
664,703
|
|
|
$ |
648,820
|
|
The
increase in raw material inventories as of April 1, 2007 resulted from the
timing of deliveries to support manufacturing requirements, reflecting the
seasonality of our business, and higher costs in 2007. Lower finished
goods inventories as of April 1, 2007 primarily reflected the impact of various
improvements to our sales and operations planning process to reduce working
capital utilization.
9. SHORT-TERM
DEBT
As
a
source of short-term financing, we utilize commercial paper or bank loans
with
an original maturity of three months or less. In December 2006, we entered
into
a new five-year unsecured revolving credit agreement. The credit limit is
$1.1
billion with an option to borrow an additional $400 million with the concurrence
of the lenders. These funds may be used for general corporate
purposes. This unsecured revolving credit agreement contains certain
financial covenants and customary representations and warranties, and events
of
default. As of April 1, 2007 we complied with all covenants pertaining to
our
credit agreement. There were no significant compensating balance agreements
that
legally restricted these funds. For more information, refer to the consolidated
financial statements and notes included in our 2006 Annual Report on Form
10-K.
10. LONG-TERM
DEBT
In
May
2006, we filed a new shelf registration statement on Form S-3 that registered
an
indeterminate amount of debt securities. This registration statement was
effective immediately upon filing under new Securities and Exchange Commission
regulations governing “well-known seasoned issuers” (the "WKSI Registration
Statement"). In August 2006, we issued $500 million of Notes under the WKSI
Registration Statement. Proceeds from the debt issuances and any
other offerings under the WKSI Registration Statement may be used for general
corporate requirements. These may include reducing existing borrowings,
financing capital additions, funding contributions to our pension plans,
future
business acquisitions and working capital requirements.
11. 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, 2007 and December 31, 2006, because of the relatively
short
maturity of these instruments.
The
carrying value of long-term debt, including the current portion, was
$1,248.1 million as of April 1, 2007, compared with a fair value of
$1,321.5 million, an increase of $73.4 million over the carrying
value, based on quoted market prices for the same or similar debt
issues.
Foreign
Exchange Forward Contracts
The
following table summarizes our foreign exchange activity:
|
April
1, 2007
|
|
Contract
Amount
|
Primary
Currencies
|
|
(in
millions of dollars)
|
|
|
|
Foreign
exchange forward contracts to
puchase
foreign currencies
|
$ 31.9
|
Australian dollars
Canadian
dollars
Euros
|
Foreign
exchange forward contracts to
sell
foreign currencies
|
$ 14.7
|
Mexican
pesos
Brazilian
reais
|
Our
foreign exchange forward contracts mature in 2007 and 2008.
We
define
the fair value of foreign exchange forward contracts as the amount of the
difference between contracted and current market foreign currency exchange
rates
at the end of the period. On a quarterly basis, we estimate the fair value
of
foreign exchange forward contracts by obtaining market quotes for future
contracts with similar terms, adjusted where necessary for maturity differences.
We do not hold or issue financial instruments for trading purposes.
The
total
fair value of our foreign exchange forward contracts included in prepaid
expenses and other current assets and in other non-current assets, as
appropriate, on the Consolidated Balance Sheets were as
follows:
|
|
April
1,
2007
|
|
December
31,
2006
|
|
|
(in
millions of dollars)
|
|
|
|
|
|
Fair
value of foreign exchange forward contracts - asset
|
|
$ 2.1
|
|
$ 1.5
|
12. INCOME
TAXES
In
June
2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN No.
48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with Statement
of Financial Accounting Standards No. 109, Accounting for Income Taxes.
FIN No. 48 describes a recognition threshold and measurement attribute
for
the financial statement recognition and measurement of a tax position taken
or
expected to be taken in a tax return and also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.
We
adopted the provisions of FIN No. 48 as of January 1, 2007. The
adoption of FIN No. 48 did not result in a significant change to the liability
for unrecognized tax benefits. Upon adoption, we had unrecognized tax
benefits of $63.3 million of which $45.5 million would impact the effective
income tax rate if recognized. The entire amount of unrecognized tax
benefits was classified as other long-term liabilities on the balance sheet
since we do not expect to make any payments to taxing authorities related
to
such tax positions in the next twelve months. We report accrued
interest and penalties related to unrecognized tax benefits in income tax
expense. Upon adoption, we had accruals of $13.8 million for the
payment of interest and penalties.
We
file
income tax returns in the U.S. federal jurisdiction and various state and
foreign jurisdictions. A number of years may elapse before an
uncertain tax position, for which we have unrecognized tax benefits, is audited
and finally resolved. While it is often difficult to predict the final outcome
or the timing of resolution of any particular uncertain tax position, we
believe
that our unrecognized tax benefits reflect the most likely
outcome. We adjust these unrecognized tax benefits, as well as the
related interest, in light of changing facts and circumstances. Settlement
of
any particular position would usually require the use of
cash. Favorable resolution would be recognized as a reduction to our
effective income tax rate in the period of resolution.
The
number of years with open tax audits varies depending on the tax
jurisdiction. Our major taxing jurisdictions include the United
States (federal and state) and Canada. We are no longer subject to
U.S. federal examinations by the Internal Revenue Service for years before
2004. Various state tax examinations by taxing authorities could be
conducted for years beginning in 2000, and some examinations are currently
in
progress. The Canada Revenue Agency (“CRA”) is conducting an audit of
our income tax returns in Canada for 1999 through 2002 that is expected to
be
completed by the end
of
2007. As of April 1, 2007, the CRA has proposed certain adjustments
to our transfer pricing tax position for years beginning in 1999. We
are currently evaluating those proposed adjustments to determine if we agree
and
are determining the possibility of offsetting U.S. tax relief through the
use of
Competent Authority. We do not anticipate that any Canada/U.S. tax
adjustments will have a significant impact on our financial position or results
of operations.
13. PENSION
AND OTHER POST-RETIREMENT BENEFIT PLANS
Components
of net periodic benefits (income) cost consisted of the following:
|
|
Pension
Benefits
|
|
|
Other
Benefits
|
|
|
|
For
the Three Months Ended
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
|
|
(in
thousands of dollars)
|
|
Service
cost
|
|
$ |
11,157
|
|
|
$ |
14,509
|
|
|
$ |
1,172
|
|
|
$ |
1,442
|
|
Interest
cost
|
|
|
14,668
|
|
|
|
14,125
|
|
|
|
4,747
|
|
|
|
4,611
|
|
Expected
return on plan assets
|
|
|
(28,588 |
) |
|
|
(25,568 |
) |
|
|
—
|
|
|
|
—
|
|
Amortization
of prior service cost
|
|
|
379
|
|
|
|
1,146
|
|
|
|
(39 |
) |
|
|
213
|
|
Amortization
of unrecognized transition balance
|
|
|
—
|
|
|
|
4
|
|
|
|
—
|
|
|
|
—
|
|
Recognized
net actuarial loss
|
|
|
756
|
|
|
|
3,269
|
|
|
|
542
|
|
|
|
768
|
|
Administrative
expenses
|
|
|
173
|
|
|
|
302
|
|
|
|
—
|
|
|
|
—
|
|
Net
periodic benefits (income) cost
|
|
$ |
(1,455 |
) |
|
$ |
7,787
|
|
|
$ |
6,422
|
|
|
$ |
7,034
|
|
We
made
contributions of $5.1 million and $4.5 million to the pension plans and
other benefits plans, respectively, during the first quarter of
2007. In the first quarter of 2006, we made contributions of
$8.0 million and $6.4 million to our pension and other benefits plans,
respectively. The contributions in 2007 and 2006 also included
benefit payments from our non-qualified pension plans and post-retirement
benefit plans.
In
the
first quarter of 2007, there was net periodic pension benefits income of
$1.5
million, compared to net periodic benefits cost of $7.8 million in the first
quarter of 2006. The net periodic pension benefits income resulted
from the changes to the U.S. pension plans announced in October 2006, the
higher
actual return on pension assets during 2006 and a higher discount
rate.
For
2007,
there are no minimum funding requirements for the domestic plans and minimum
funding requirements for the non-domestic plans are not material. We
do not anticipate any significant contributions during the remainder of
2007.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
158, Employers’ Accounting for Defined Benefit Pension and Other
Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and
132(R) (“SFAS No. 158”). We adopted the recognition and related
disclosure provisions of SFAS No. 158 as of December 31,
2006. SFAS No. 158 does not change the measurement or recognition of
these plans. For more information, refer to the consolidated
financial statements and notes included in our 2006 Annual Report on Form
10-K.
14. SHARE
REPURCHASES
Repurchases
and Issuances of Common Stock
A
summary
of cumulative share repurchases and issuances is as follows:
|
|
For
the three months ended
April
1, 2007
|
|
|
|
Shares
|
|
|
Dollars
|
|
|
|
(in
thousands)
|
|
Shares
repurchased in the open market under pre-approved
share
repurchase programs
|
|
|
1,862
|
|
|
$ |
99,998
|
|
Shares
repurchased to replace Treasury Stock issued for stock
options
and
employee benefits
|
|
|
931
|
|
|
|
49,999
|
|
Total
share repurchases
|
|
|
2,793
|
|
|
|
149,997
|
|
Shares
issued for stock options and employee benefits
|
|
|
(981 |
) |
|
|
(31,680 |
) |
Net
change
|
|
|
1,812
|
|
|
$ |
118,317
|
|
·
|
We
intend to continue to repurchase shares of Common Stock in order
to
replace Treasury Stock shares issued for exercised stock options.
The
value of shares purchased in a given period will vary based on
stock
options exercised over time and market conditions.
|
|
|
·
|
In
December 2006, our Board of Directors approved an additional
$250 million
share repurchase program. As of April 1, 2007, $150.0 million
remained
available for repurchases of Common Stock under this
program.
|
15.
PENDING ACCOUNTING PRONOUNCEMENTS
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No.
157 establishes a framework for measuring fair value in GAAP, and expands
disclosures about fair value measurements. SFAS No. 157 applies under
other accounting pronouncements that require or permit fair value
measurements. SFAS No. 157 is effective for our Company beginning
January 1, 2008. We have not yet determined the impact of
the adoption of this new accounting standard.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
No.
159, The Fair Value Option for Financial Assets and Financial Liabilities
(“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value and establishes
presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar
types
of assets and liabilities. SFAS No. 159 is effective for our Company beginning
January 1, 2008. We have not yet determined the impact, if any, from the
adoption of SFAS No. 159.
16. SUBSEQUENT
EVENTS
The
following events were announced in April 2007:
Our
Company and Godrej Beverages and Foods, Ltd., one of India's largest consumer
goods, confectionery and food companies, announced that we have entered into
an
agreement to form a joint venture to manufacture and distribute confectionery
products, snacks and beverages across India. Upon completion of this agreement,
which is subject to normal closing requirements, we will own a 51 percent
stake
in this joint venture. This alliance will provide our Company with broad
distribution access in India. The combination will leverage Godrej's
manufacturing and distribution network in India that includes over 1.6 million
outlets. In the future, the alliance will also provide the capability to
manufacture certain Hershey branded products in India.
We
announced an increase of approximately 4% to 5% in the wholesale prices of
our
domestic confectionery line, effective immediately. The increase
applies to our standard bar, king-size bar, 6-pack and vending lines. These
products represent approximately one-third of our portfolio. This action
was
implemented to help offset increases in input costs, including raw and packaging
materials, fuel, utilities and transportation. We expect minimal financial
impact from the pricing changes for the full year 2007.
Our
Company and Barry Callebaut AG, the world’s largest manufacturer of high-quality
cocoa, industrial chocolate and confectionery products, announced the intent
to
enter into a strategic supply and innovation partnership agreement. The alliance
will enable us to work together to accelerate long-term growth in the global
chocolate market. Under the agreement, Barry Callebaut will construct and
operate a facility to provide chocolate for our new plant in Monterrey, Mexico,
and will also lease a portion of our Robinson, Ill., plant and operate
chocolate-making equipment at that facility. The partnership includes a
long-term global agreement under which Barry Callebaut will supply Hershey
with
a minimum of 80,000 tonnes per year of chocolate and chocolate products.
We
expect final agreements to be signed by the end of May 2007.
Item
2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Results
of Operations - First Quarter 2007 vs. First Quarter
2006
SUMMARY
OF OPERATING RESULTS
Analysis
of Selected Items from Our Income Statement
|
|
For
the three months ended
|
|
|
|
|
|
April
1,
2007
|
|
|
April
2,
2006
|
|
|
Percent
Change
Increase
(Decrease)
|
|
|
(in
thousands except per
share
amounts)
|
|
|
|
Net
Sales
|
|
$ |
1,153.1
|
|
|
$ |
1,139.5
|
|
|
|
1.2%
|
Cost
of Sales
|
|
|
739.1
|
|
|
|
707.4
|
|
|
|
4.5%
|
Gross
Profit
|
|
|
414.0
|
|
|
|
432.1
|
|
|
|
(4.2)%
|
Gross
Margin
|
|
|
35.9 |
% |
|
|
37.9 |
% |
|
|
|
Selling,
Marketing and Administrative (“SM&A”)
Expense
|
|
|
216.4
|
|
|
|
216.8
|
|
|
|
(0.2)%
|
SM&A
Expense as a percent of sales
|
|
|
18.8 |
% |
|
|
19.0 |
% |
|
|
|
Business
Realignment Charge, net
|
|
|
27.5
|
|
|
|
3.3
|
|
|
N/A
|
Income
before Interest and Income
|
|
|
|
|
|
|
|
|
|
|
|
Taxes
(“EBIT”)
|
|
|
170.1
|
|
|
|
212.0
|
|
|
|
(19.8)%
|
EBIT
Margin
|
|
|
14.7 |
% |
|
|
18.6 |
% |
|
|
|
Interest
Expense, net
|
|
|
28.3
|
|
|
|
25.2
|
|
|
|
12.1%
|
Provision
for Income Taxes
|
|
|
48.3
|
|
|
|
64.3
|
|
|
|
(24.9)%
|
Effective
Income Tax Rate
|
|
|
34.1 |
% |
|
|
34.4 |
% |
|
|
|
Net
Income
|
|
$ |
93.5
|
|
|
$ |
122.5
|
|
|
|
(23.7)%
|
Net
Income Per Share-Diluted
|
|
$ |
0.40
|
|
|
$ |
0.50
|
|
|
|
(20.0)%
|
Net
Sales
The
increase in net sales was attributable to sales volume increases from the
introduction of new products, primarily in the United States, and higher
sales
for our businesses in Canada and Mexico. Strong sales of seasonal
products and our dark and premium chocolate items also contributed to the
sales
increase. These increases were substantially offset by decreased
price realization from higher rates of promotional spending and higher returns,
discounts and allowances for products at retail. Softness in sales of
single serve items and the shift from limited edition items to new product
growth platforms in 2007, compared with the first quarter of 2006, also had
a
negative impact on sales performance in the quarter.
Key
Marketplace Metrics
Consumer
takeaway increased 1.5% during the first quarter of 2007, in line with
shipments. Consumer takeaway is provided for channels of distribution
accounting for approximately 80% of our U.S. confectionery retail business.
These channels of distribution include food, drug, mass merchandisers, including
Wal-Mart Stores, Inc., and convenience stores.
Market
Share in measured channels declined by 1.2 share points during the first
quarter
of 2007. The change in market share is provided for measured channels which
include sales in the food, drug, convenience store and mass merchandiser
classes
of trade, excluding sales of Wal-Mart Stores, Inc.
Cost
of Sales and Gross Margin
Business
realignment charges of $9.9 million were included in cost of sales in the
first
quarter 2007, compared with a credit of $1.6 million in the prior
year. The remainder of the cost of sales increase was primarily
associated with sales volume increases and higher raw material and other
input
costs.
Half
of
the gross margin decline was attributable to the impact of business realignment
initiatives recorded in 2007 compared with 2006. The rest of the
decline reflected higher costs for raw materials, fuel, and packaging, along
with lower net price realization. Favorable product mix and supply
chain productivity partially offset the impact of cost increases.
Selling,
Marketing and Administrative
Selling,
marketing and administrative expenses decreased primarily as a result of
expense
control and lower administrative costs associated with incentive compensation,
primarily stock options. These decreases were offset by expenses
of $3.0 million for project implementation related to our business realignment
initiatives and higher advertising expenses.
Business
Realignment Initiatives
Business
realignment charges of $27.5 million were recorded in the first quarter of
2007
associated with our supply chain transformation program. The charges
were primarily associated with fixed asset impairments and expenses for the
closure of certain manufacturing facilities, along with employee separation
costs.
During
the first quarter of 2006, we recorded charges related to previous business
realignment initiatives that began in 2005. The $3.3 million business
realignment charge included $1.4 million related to a U.S. voluntary workforce
reduction program, $1.3 million for facility rationalization relating to
the
closure of the Las Piedras plant and $.6 million related to streamlining
our
international operations.
Income
Before Interest and Income Taxes and EBIT Margin
EBIT
decreased in the first quarter 2007 compared with the first quarter 2006
principally as a result of higher net business realignment charges associated
with our business realignment initiatives. Net pre-tax business realignment
charges of $40.4 million were recorded in the first quarter 2007 compared
with
$1.7 million recorded in the first quarter 2006, an increase of $38.7 million.
The remainder of the decrease in EBIT was attributable to lower gross profit
resulting primarily from higher input costs which were only slightly offset
by
lower selling, marketing and administrative expenses.
EBIT
margin decreased from 18.6% for the first quarter of 2006 to 14.7% for the
first
quarter of 2007. The impact of net business realignment charges
reduced EBIT margin by 3.4 percentage points. The remainder of the
decrease resulted from the lower gross margin offset partially by lower SM&A
expense as a percentage of sales.
Interest
Expense, Net
Net
interest expense was higher in the first quarter 2007 than the comparable
period
of 2006, primarily reflecting higher interest expense associated with the
issuance of $500.0 million of long-term debt in August 2006. Higher interest
rates in the first quarter 2007 as compared to the first quarter 2006 also
contributed to the increase in interest expense.
Income
Taxes and Effective Tax Rate
Our
effective income tax rate was 34.1% for the first quarter of 2007 and benefited
by .7 percentage points as a result of the effective tax rates associated
with
business realignment charges recorded during the quarter. We expect
our effective income tax rate for the full year 2007 to be 36.1%, excluding
the
impact of tax benefits associated with business realignment charges during
the
year.
Net
Income and Net Income Per Share
Net
Income in the first quarter 2007 was reduced by $25.3 million, or $0.11 per
share-diluted, and was reduced by $1.2 million, or $0.01 per share-diluted,
in the first quarter of 2006 as a result of net charges associated with our
business realignment initiatives. After considering the impact of business
realignment charges in each period, earnings per share-diluted in the first
quarter 2007 was even with the first quarter of 2006.
Liquidity
and Capital Resources
Historically,
our 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. Commercial paper may
also
be issued from time to time to finance ongoing business transactions such
as the
refinancing of obligations associated with certain lease arrangements, the
repayment of long-term debt and for other general corporate purposes. During
the
first quarter of 2007, cash and cash equivalents decreased by
$36.7 million.
Cash
provided from operations, short-term borrowings, cash provided from stock
options exercises and cash on hand at the beginning of the period was sufficient
to fund the repayment of long-term debt of $188.7 million, the repurchase
of
Common Stock for $150.0 million, dividend payments of $60.7 million and capital
additions and capitalized software expenditures of
$41.8 million.
Cash
used
by changes in other assets and liabilities was $32.1 million for the first
quarter of 2007 compared with cash used of $46.9 million for the same period
of
2006. The decrease in the amount of cash used by other assets and liabilities
from 2006 to 2007 primarily reflected the timing of payments for accrued
liabilities associated with selling and marketing programs and lower payments
relating to incentive compensation and business realignment
initiatives.
A
receivable of approximately $14.0 million was included in prepaid expenses
and
other current assets as of April 1, 2007 and December 31, 2006 related
to the
recovery of damages from a product recall and temporary plant closure in
Canada. The product recall during the fourth quarter of 2006 was
caused by a contaminated ingredient purchased from an outside
supplier.
Interest
paid was $52.5 million during the first quarter of 2007 versus $39.0 million
for
the comparable period of 2006. The increase in interest paid reflects
additional borrowings and the higher interest rate
environment. Income taxes paid were $9.8 million during the first
quarter of 2007 versus $33.8 million for the comparable period of
2006. The decrease in taxes paid in 2007 was primarily related to a
lower federal extension payment for 2006 income taxes.
The
ratio
of current assets to current liabilities decreased slightly to .9:1 as
of April
1, 2007 from 1.0:1 as of December 31, 2006. The capitalization ratio (total
short-term and long-term debt as a percent of stockholders' equity, short-term
and long-term debt) increased slightly to 76% as of April 1, 2007 from
75% as of
December 31, 2006.
Generally,
our short-term borrowings are in the form of commercial paper or bank loans
with
an original maturity of three months or less. In December 2006, we entered
into
a five-year credit agreement establishing an unsecured revolving credit
facility
to borrow up to $1.1 billion with the option to increase borrowings by an
additional $400 million with the consent of the lenders. We may use these
funds for general corporate purposes, including commercial paper backstop
and
business acquisitions.
Outlook
The
outlook section contains a number of forward-looking statements, all of
which
are based on current expectations. Actual results may differ
materially. Refer to the Safe Harbor Statement below as well as Risk
Factors and other information contained in our 2006 Annual Report on Form
10-K
for information concerning the key risks to achieving future performance
goals.
We
have
revised our operating performance expectations for the full year 2007 as
a
result of significant increases in dairy input costs. On April 20,
2007, the United States Department of Agriculture announced significant
changes
to the prices of dairy products effective immediately. These price changes,
along with unfavorable worldwide supply and demand conditions for dairy
products, will result in costs for our dairy raw materials for 2007, which
are
now anticipated to be considerably higher than our previous
expectations. The dairy markets are not as developed as many of the
other commodities markets and, therefore, it is not possible to hedge our
costs
by taking forward positions to extend coverage for longer periods of
time. Our latest expectations with regard to key operating
performance measures are presented below.
We
continue to expect sales growth in 2007 to be within our long-term goal
of 3% to
4%. Marketplace performance has been below this level to date, but we expect
it
to improve in the second half of the year behind continued increases in
consumer
and customer investment.
We
expect
that our 2007 business realignment initiatives designed to execute a
comprehensive, three-year supply chain transformation plan will result
in total
pre-tax charges and non-recurring project implementation costs of $525
million
to $575 million. Total charges include project management and
start-up costs of approximately $50 million. In 2007, we expect to
record charges of approximately $270 million to $300 million, or $.75 to
$.84
per share-diluted. As a result of the program, we estimate that our
gross margin should improve significantly, with on-going savings of
approximately $170 million to $190 million generated by 2010. A
portion of the savings will be invested in our strategic growth initiatives,
in
such areas as core brand growth, new product innovation, selling and
go-to-market capabilities and disciplined global expansion. The
amount and timing of this investment will be contingent upon market conditions
and the pace of our innovation and global expansion.
We
have
identified a number of initiatives which will help to offset a portion
of
anticipated increases in input costs and have implemented certain price
increases. However, the magnitude of the higher dairy input
costs and maintaining our planned increases in brand investment are
expected to result in reduced earnings compared with our previous
expectations.
Excluding
the impact of business realignment charges, we now expect our gross margin
to be
essentially flat for the full year 2007. We expect significantly
higher input costs in 2007 compared with 2006, particularly as a result
of the
recent increase in expected dairy input costs. Productivity
improvements, cost control initiatives and improving price realization
are
expected to partially offset these cost increases.
Excluding
the impact of business realignment charges, we now expect EBIT margin to
decline
somewhat for the full year 2007. This decline will result from the
decision to maintain our increased levels of brand investment, despite
the
recent increase in expected dairy input costs.
Excluding
the impact of business realignment charges, earnings per share-diluted
is now
expected to increase within a range of 4% to 6% for the full year
2007.
The
sudden and large increase in dairy costs will have a disproportionate impact
on
earnings in the second quarter of 2007. This results from our interim
accounting methodology in which expected annual costs for major raw materials
are recorded ratably on a year-to-date basis. Therefore, dairy costs recorded
in
the second quarter will reflect approximately half of the expected full
year
impact of the recent increases in dairy input costs. This factor,
combined with expected sales performance, is expected to result in earnings
per
share-diluted for the second quarter of 2007 of $.34 to $.35, excluding
the
impact of business realignment charges. We expect year-over-year
earnings performance to improve during the second half of 2007 as our increased
brand investment, including a double-digit increase in advertising, translates
into improved marketplace performance, our price increase is reflected
in the
market and our productivity initiatives accelerate.
In
this
section, we have provided diluted earnings per share measures excluding
certain
items. These non-GAAP financial measures are used in evaluating results
of
operations for internal purposes. These non-GAAP measures are not intended
to
replace the presentation of financial results in accordance with GAAP.
Rather,
we believe exclusion of such items provides additional information to investors
to facilitate the comparison of past and present operations. Below is
a reconciliation of GAAP and non-GAAP items to our earnings per share
outlook:
|
|
2006
|
|
2007
|
|
Reported
/ Expected Diluted EPS
|
|
$2.34
|
|
$1.62
- $1.76
|
|
Total
Realignment Charges
|
|
$0.03
|
|
$0.75
- $0.84
|
|
Diluted
EPS from Operations*
|
|
$2.37
|
|
|
|
Expected
4-6% Increase in diluted
|
|
|
|
|
|
EPS from Operations*
|
|
|
|
$2.46
- $2.51
|
|
|
|
|
|
|
|
*From
operations, excluding
business realignment and one-time costs.
|
|
Subsequent
Events
The
following events were announced in April 2007:
Our
Company and Godrej Beverages and Foods, Ltd., one of India's largest consumer
goods, confectionery and food companies, announced that we have entered
into an
agreement to form a joint venture to manufacture and distribute confectionery
products, snacks and beverages across India. Upon completion of this agreement,
which is subject to normal closing requirements, we will own a 51% stake
in this
joint venture. This alliance will provide our Company with broad distribution
access in India. The combination will leverage Godrej's manufacturing
and distribution network in India that includes over 1.6 million outlets.
In the
future, the alliance will also provide the capability to manufacture certain
Hershey branded products in India.
We
announced an increase of approximately 4% to 5% in the wholesale prices
of our
domestic confectionery line, effective immediately. The increase
applies to our standard bar, king-size bar, 6-pack and vending lines. These
products represent approximately one-third of our portfolio. This action
was
implemented to help offset increases in input costs, including raw and
packaging
materials, fuel, utilities and transportation. We expect minimal financial
impact from the pricing changes for the full year 2007.
Our
Company and Barry Callebaut AG, the world’s largest manufacturer of high-quality
cocoa, industrial chocolate and confectionery products, announced the intent
to
enter into a strategic supply and innovation partnership agreement. The
alliance
will enable us to work together to accelerate long-term growth in the global
chocolate market. Under the agreement, Barry Callebaut will construct and
operate a facility to provide chocolate for our new plant in Monterrey,
Mexico,
and will also lease a portion of our Robinson, Ill., plant and operate
chocolate-making equipment at that facility. The partnership includes a
long-term global agreement under which Barry Callebaut will supply Hershey
with
a minimum of 80,000 tonnes per year of chocolate and chocolate products.
We
expect final agreements to be signed by the end of May 2007.
Safe
Harbor Statement
We
are
subject to changing economic, competitive, regulatory and technological
conditions, risks and uncertainties because of the nature of our operations.
In
connection with the “safe harbor” provisions of the Private Securities
Litigation Reform Act of 1995, we note the following factors that, among
others,
could cause future results to differ materially from the forward-looking
statements, expectations and assumptions that we have discussed directly
or
implied in this report. Many of the forward-looking statements
contained in this report may be identified by the use of words such as
“intend,”
“believe,” “expect,” “anticipate,” “should,” “planned,” “projected,”
“estimated,” and “potential,” among others.
Our
results could differ materially because of the following factors, which
include,
but are not limited to:
·
|
Our
ability to implement and generate expected ongoing annual
savings from the
initiatives to transform our supply chain and advance our
value-enhancing
strategy;
|
|
|
·
|
Changes
in raw material and other costs and selling price
increases;
|
|
|
·
|
Our
ability to execute our supply chain transformation within
the anticipated
timeframe in accordance with our cost estimates;
|
|
|
·
|
The
impact of future developments related to the product recall
and temporary
plant closure in Canada during the fourth quarter of 2006,
including our
ability to recover costs we incurred for the recall and plant
closure from
responsible third-parties;
|
|
|
·
|
Pension
cost factors, such as actuarial assumptions, market performance
and
employee retirement decisions;
|
|
|
·
|
Changes
in our stock price, and resulting impacts on our expenses
for incentive
compensation, stock options and certain employee
benefits;
|
|
|
·
|
Market
demand for our new and existing products;
|
|
|
·
|
Changes
in our business environment, including actions of competitors
and changes
in consumer preferences;
|
|
|
·
|
Changes
in governmental laws and regulations, including taxes;
|
|
|
·
|
Risks
and uncertainties related to our international operations;
and
|
|
|
·
|
Such
other matters as discussed in our Annual Report on Form 10-K
for
2006.
|
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
The
potential net loss in fair value of foreign exchange forward contracts
and
options of ten percent resulting from a hypothetical near-term adverse
change in
market rates was $.2 million as of April 1, 2007 and December 31,
2006. 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 increased from $3.7 million as of December 31,
2006,
to $10.0 million as of April 1, 2007. Market risk represents 10%
of the estimated average fair value of net commodity positions at four
dates
prior to the end of each period.
Item
4. Controls and Procedures
Disclosure
controls and procedures are controls and other procedures that are designed
to
ensure that information required to be disclosed in our reports filed or
submitted under the Securities Exchange Act of 1934 (the "Exchange Act")
is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and
forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information
required
to be disclosed in our reports filed under the Exchange Act is accumulated
and
communicated to management, including the Company's Chief Executive Officer
and
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.
As
of the
end of the period covered by this quarterly report, we conducted an evaluation
of the effectiveness of the design and operation of our disclosure controls
and
procedures, as required by Rule 13a-15 under the Exchange Act. This
evaluation was carried out under the supervision and with the participation
of
the Company's management, including our Chief Executive Officer and Chief
Financial Officer. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective. There has been no change
during the most recent fiscal quarter in our internal control over financial
reporting identified in connection with the evaluation that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART
II - OTHER INFORMATION
Items
1, 1A, 3, 4 and 5 have been omitted as not applicable.
Item
2 - Unregistered Sales of Equity Securities and Use of
Proceeds
Issuer
Purchases of Equity Securities
Period
|
(a)
Total Number
of
Shares
Purchased
|
(b)
Average
Price
Paid
per
Share
|
(c)
Total Number
of
Shares
Purchased
as Part
of
Publicly
Announced
Plans
or
Programs
|
(d)
Approximate
Dollar
Value of
Shares
that May
Yet
Be Purchased
Under
the Plans
or
Programs
|
|
|
|
|
(in
thousands of dollars)
|
January
1 through
January
28, 2007
|
—
|
$ —
|
—
|
$250,000
|
|
|
|
|
|
January 29
through
February
25, 2007
|
—
|
$ —
|
—
|
$250,000
|
|
|
|
|
|
February
26 through
April
1, 2007
|
2,793,400
|
$ 53.70
|
1,862,265
|
$150,000
|
|
|
|
|
|
Total
|
2,793,400
|
|
1,862,265
|
|
Item
6 - Exhibits
The
following items are attached or incorporated herein by reference:
Exhibit
Number
|
|
Description
|
|
|
|
10.1
|
|
First
Amendment to The Hershey Company Deferred Compensation Plan
dated March
20, 2007, is attached hereto and filed as Exhibit 10.1.
|
|
|
|
12.1
|
|
Statement
showing computation of ratio of earnings to fixed charges
for the three
months ended April 1, 2007 and April 2, 2006.
|
|
|
|
31.1
|
|
Certification
of Richard H. Lenny, Chief Executive Officer, pursuant to
Section 302 of
the Sarbanes-Oxley Act of 2002.
|
|
|
|
31.2
|
|
Certification
of David J. West, Chief Financial Officer, pursuant to Section
302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
|
32.1*
|
|
Certification
of Richard H. Lenny, Chief Executive Officer, and David J.
West, Chief
Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley
Act of
2002.
|
|
|
|
*Pursuant
to Securities and Exchange Commission Release No. 33-8212,
this
certification will be treated as “accompanying” this Quarterly Report on
Form 10-Q and not “filed” as part of such report for purposes of Section
18 of the Exchange Act or otherwise subject to the liability
of Section 18
of the Exchange Act, and this certification will not be deemed
to be
incorporated by reference into any filing under the Securities
Act of
1933, as amended, or the Exchange Act, except to the extent
that the
Company specifically incorporates it by
reference.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, this
report
has been signed below by the following persons on behalf of the
Company
and in the capacities and on the date indicated.
|
|
THE
HERSHEY COMPANY
|
|
(Registrant)
|
|
|
|
|
Date: May 9, 2007
|
/s/David J.
West
David
J. West
Chief
Financial Officer
|
|
|
Date: May 9, 2007
|
/s/David
W.
Tacka
David
W. Tacka
Chief
Accounting Officer
|
EXHIBIT
INDEX
|
|
|
Exhibit
10.1
|
First
Amendment to The Hershey Company Deferred Compensation
Plan
|
|
|
Exhibit
12.1
|
Computation
of Ratio of Earnings to Fixed Charges
|
|
|
Exhibit
31.1
|
Certification
of Richard H. Lenny, Chief Executive Officer, pursuant to Section
302 of
the Sarbanes-Oxley Act of 2002
|
|
|
Exhibit
31.2
|
Certification
of David J. West, Chief Financial Officer, pursuant to Section
302 of the
Sarbanes-Oxley Act of 2002
|
|
|
Exhibit
32.1
|
Certification
of Richard H. Lenny, Chief Executive Officer, and David J.
West, Chief
Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley
Act of
2002
|
|
|