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Hershey Foods 10-Q 2009 UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
For the
quarterly period ended April 5, 2009
OR
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
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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files). Yes o No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
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 – 166,316,744 shares, as of April 24, 2009. Class
B Common Stock,
$1 par
value – 60,709,908 shares, as of April 24, 2009.
THE
HERSHEY COMPANY
INDEX
-2-
PART
I - FINANCIAL INFORMATION
Item
1. Consolidated Financial Statements (Unaudited)
THE
HERSHEY COMPANY
CONSOLIDATED
STATEMENTS OF INCOME
(in
thousands except per share amounts)
The
accompanying notes are an integral part of these consolidated financial
statements.
-3-
THE
HERSHEY COMPANY
CONSOLIDATED
BALANCE SHEETS
(in
thousands of dollars)
The
accompanying notes are an integral part of these consolidated balance
sheets.
-4-
THE
HERSHEY COMPANY
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands of dollars)
The
accompanying notes are an integral part of these consolidated financial
statements.
-5-
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
and the noncontrolling shareholders do not have substantive participating
rights, or we 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 ("GAAP") 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 2009 presentation. Operating results
for the three months ended April 5, 2009 may not be indicative of the results
that may be expected for the year ending December 31, 2009, because of the
seasonal effects of our business. For more information, refer to the
consolidated financial statements and notes included in our 2008 Annual Report
on Form 10-K.
2.
BUSINESS ACQUISITIONS AND DIVESTITURES
In
January 2008 our Brazilian subsidiary, Hershey do Brasil, entered into a
cooperative agreement with Pandurata Alimentos LTDA (“Bauducco”), a leading
manufacturer of baked goods in Brazil whose primary brand is Bauducco. The
arrangement with Bauducco will leverage Bauducco’s strong sales and distribution
capabilities for our products throughout Brazil. Under this agreement we will
manufacture and market, and they will sell and distribute our products. In the
first quarter of 2008, we received approximately $2.0 million in cash and
recorded an other intangible asset of $13.7 million associated with the
cooperative agreement with Bauducco in exchange for our conveying to Bauducco a
49% interest in Hershey do Brasil. We will maintain a 51% controlling interest
in Hershey do Brasil.
In March
2009, the Company completed the acquisition of the Van Houten Singapore consumer
business. The acquisition from Barry Callebaut, AG provides the
Company with an exclusive license of the Van Houten brand name and related
trademarks in Asia and the Middle East for the retail and duty free distribution
channels. The purchase price for the acquisition of Van Houten
Singapore and the licensing agreement was approximately $15.2
million.
Results
subsequent to the acquisition dates were included in the consolidated financial
statements. Had the results of the acquisitions been included in the
consolidated financial statements for each of the periods presented, the effect
would not have been material.
3.
NONCONTROLLING INTERESTS IN SUBSIDIARIES
As of
January 1, 2009, the Company adopted Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in
Consolidated Financial Statements — an amendment of ARB No. 51 (“SFAS No.
160”). SFAS No. 160 establishes new accounting and reporting
standards for the noncontrolling interest in a subsidiary (formerly known as
minority interest) and for the deconsolidation of a subsidiary and requires the
noncontrolling interest to be reported as a component of equity. In
addition, changes in a parent’s ownership interest while the parent retains its
controlling interest will be accounted for as equity transactions, and any
retained noncontrolling equity investment upon the deconsolidation of a
subsidiary will be initially measured at fair value.
In May
2007, we entered into an agreement with Godrej Beverages and Foods, Ltd., one of
India’s largest consumer goods, confectionery and food companies, to manufacture
and distribute confectionery products, snacks and beverages across
India. Under the agreement, we own a 51% controlling interest in
Godrej Hershey Ltd. In January 2009, the Company contributed cash of
approximately $8.7 million to Godrej Hershey Ltd. and owners of the
noncontrolling interests in Godrej Hershey Ltd. contributed approximately $7.3
million. The ownership interest percentages in Godrej Hershey Ltd.
did not change significantly as a result of these contributions. The
noncontrolling interests in Godrej Hershey Ltd. are included in the equity
section of the Consolidated Balance Sheets.
We also
own a 51% controlling interest in Hershey do Brasil under the cooperative
agreement with Bauducco. The noncontrolling interest in Hershey do
Brasil is included in the equity section of the Consolidated Balance
Sheets.
The
increase in noncontrolling interests in subsidiaries from $31.7 million as of
December 31, 2008 to $37.5 million as of April 5, 2009 reflected the $7.3
million contribution from the noncontrolling interests in Godrej Hershey
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Ltd.,
partially offset by the adjustment to exclude the losses of noncontrolling
interests and the impact of currency translation adjustments. The
adjustment to exclude the losses of noncontrolling interests in subsidiaries
increased income by $1.2 million for the three months ended April 5, 2009 and by
$2.3 million for the three months ended March 30, 2008 and was
included in selling, marketing and administrative expenses.
4.
STOCK COMPENSATION PLANS
The
Hershey Company Equity and Incentive Compensation Plan (“EICP”) is the plan
under which grants using shares for compensation and incentive purposes are
made. The following table summarizes our stock compensation
costs:
The
increase in share-based compensation for the first quarter of 2009 resulted from
higher performance expectations for our PSU awards.
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:
Stock
Options
A summary
of the status of our stock options as of April 5, 2009, and the change during
2009 is presented below:
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Performance
Stock Units and Restricted Stock Units
A summary
of the status of our performance stock units and restricted stock units as of
April 5, 2009, and the change during 2009 is presented below:
As of
April 5, 2009, there was $30.6 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 2.7 years.
Deferred
performance stock units, deferred restricted stock units, and directors’ fees
and accumulated dividend amounts representing deferred stock units totaled
486,198 units as of April 5, 2009. Each unit is equivalent to one
share of the Company’s Common Stock.
No stock
appreciation rights were outstanding as of April 5, 2009.
For more
information on our stock compensation plans, refer to the consolidated financial
statements and notes included in our 2008 Annual Report on Form 10-K and our
proxy statement for the 2009 annual meeting of stockholders.
5.
INTEREST EXPENSE
Net
interest expense consisted of the following:
6.
BUSINESS REALIGNMENT INITIATIVES
In
February 2007, we announced a comprehensive, three-year supply chain
transformation program (the “global supply chain transformation program”) and,
in December 2007, we initiated a business realignment program associated with
our business in Brazil (together, “the 2007 business realignment
initiatives”). In December 2008, we approved a
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modest
expansion in the scope of the global supply chain transformation program to
include the closure of two subscale manufacturing facilities of Artisan
Confections Company, a wholly-owned subsidiary, and consolidation of the
associated production into existing U.S. facilities, along with rationalization
of other select portfolio items. The affected facilities are located
in Berkeley and San Francisco, California. The additional business
realignment charges related to the expansion in scope will be recorded in 2009
and include severance for approximately 150 impacted employees.
The
original estimated pre-tax cost of the program announced in February 2007 was
from $525 million to $575 million over three years. The total
included from $475 million to $525 million in business realignment costs and
approximately $50 million in project implementation costs. The
increase in scope approved in December 2008 increased the total expected cost by
about $25 million. In addition, the current trends of employee lump
sum withdrawals from the defined benefit pension plans are expected to result in
non-cash pension settlement charges of $40 million to $65 million in 2009 and
2010. Therefore, we now expect total pre-tax charges and
non-recurring project implementation costs of $615 million to $665 million for
the GSCT. Total costs of $19.0 million were recorded during the first
three months of 2009, costs of $130.0 million were recorded in 2008 and costs of
$400.0 million were recorded in 2007 for this program.
In an
effort to improve the performance of our business in Brazil, in January 2008
Hershey do Brasil entered into a cooperative agreement with
Bauducco. Business realignment and impairment charges of $4.9 million
were recorded in 2008 and charges of $12.6 million were recorded in
2007.
Charges
(credits) associated with business realignment initiatives recorded during the
three-month periods ended April 5, 2009 and March 30, 2008 were as
follows:
The
charge of $4.1 million recorded in cost of sales during the first quarter of
2009 related primarily to the accelerated depreciation of fixed assets over a
reduced estimated remaining useful life and start-up costs associated with the
global supply chain transformation program. The $2.1 million recorded
in selling, marketing and administrative expenses related primarily to project
administration for the global supply chain transformation program. In
determining the costs related to fixed asset impairments, fair value was
estimated based on the expected sales proceeds. The $10.5 million of
fixed asset impairments and plant closure expenses for 2009 related primarily to
the preparation of plants for sale and line removal costs. Certain real estate
with a carrying value of $20.3 million was being held for sale as of
April 5, 2009. The global supply chain transformation
program employee separation costs were related to involuntary terminations at
the manufacturing facilities of Artisan Confections Company which are being
closed. As of April 5, 2009, manufacturing facilities located in
Dartmouth, Nova Scotia; Oakdale, California and; Montreal, Quebec have been
closed and sold. The facilities located in Naugatuck, Connecticut; Reading,
Pennsylvania; and Smiths Falls, Ontario have been closed and are being held for
sale.
The
charge of $25.2 million recorded in cost of sales during the first three months
of 2008 for the global supply chain transformation program related to the
accelerated depreciation of fixed assets over a reduced estimated
remaining
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useful
life. The $1.4 million recorded in selling, marketing and
administrative expenses related primarily to project implementation costs for
the global supply chain transformation program. The $13.9 million of gains on
sale of fixed assets resulted from the receipt of proceeds in excess of the
carrying value primarily from the sale of a warehousing and distribution
facility. The $9.8 million of fixed asset impairments and plant closure expenses
for 2008 related primarily to the preparation of plants for sale and line
removal costs. In determining the costs related to fixed asset impairments, fair
value was estimated based on the expected sales proceeds. The global supply
chain transformation program employee separation costs were related to
involuntary terminations at the North American manufacturing facilities which
were being closed.
The 2008
charges for the Brazilian business realignment were related to costs for
involuntary terminations and costs associated with office consolidation related
to the cooperative agreement with Bauducco.
The April
5, 2009 liability balance relating to the 2007 business realignment initiatives
was $21.1 million for employee separation costs to be paid primarily in 2009.
Charges for employee separation costs of $2.5 million were recorded during the
first three months of 2009. During the first three months of 2009, we made
payments against the liabilities recorded for the 2007 business realignment
initiatives of $12.3 million principally related to employee separation
costs. The liability balance as of April 5, 2009 was reduced by $.1
million as a result of foreign currency translation adjustments.
7. 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:
The Class
B Common Stock is convertible into Common Stock on a share for share basis at
any time. In accordance with proposed 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 5, 2009, 17.1 million stock options were not
included in the diluted earnings per share calculation because the effect would
have been antidilutive. In the first quarter of 2008, 12.8 million stock
options were not included in the diluted earnings per share calculation because
the effect would have been antidilutive.
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8. DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES
We
account for derivative instruments in accordance with FASB Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended ("SFAS No. 133"). SFAS No.
133 requires us to recognize all derivative instruments at fair
value. We classify derivatives as assets or liabilities on the balance sheet.
Accounting for the change in fair value of the derivative depends
on:
There are
three types of hedging relationships:
As of
April 5, 2009 and December 31, 2008, we classified all of our derivative
instruments as cash flow hedges.
The
amount of net losses 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 $5.7 million after tax as of April 5,
2009. This amount was primarily associated with commodities futures
contracts.
For more
information, refer to the consolidated financial statements and notes included
in our 2008 Annual Report on Form 10-K.
Objectives,
Strategies and Accounting Policies Associated with Derivative
Instruments
We use
certain derivative instruments, from time to time, to manage interest rate,
foreign currency exchange rate and commodity market price risk exposures. We
enter into interest rate swap agreements and foreign currency forward contracts
and options for periods consistent with their related underlying exposures. We
enter into commodities futures and options contracts for varying periods. Our
commodities futures and options contracts are effective as hedges of market
price risks associated with anticipated raw material purchases, energy
requirements and transportation costs.
We do not
hold or issue derivative instruments for trading purposes and are not a party to
any instruments with leverage or prepayment features. In entering into these
contracts, we have assumed the risk that might arise from the possible inability
of counterparties to meet the terms of their contracts. We mitigate
this risk by performing financial assessments prior to contract execution,
conducting periodic evaluations of counterparty performance and maintaining a
diverse portfolio of qualified counterparties. We do not expect any
significant losses from counterparty defaults.
Interest
Rate Swaps
In order
to minimize financing costs and to manage interest rate exposure, from time to
time, we enter into interest rate swap agreements. We include gains and losses
on interest rate swap agreements in other comprehensive income. We recognize
gains and losses on interest rate swap agreements as an adjustment to interest
expense in the same period as the hedged interest payments affect
earnings. We classify cash flows from interest rate swap agreements
as net cash provided from operating activities on the Consolidated Statements of
Cash Flows. Our risk related to interest rate swap agreements is
limited to the cost of replacing the agreements at prevailing market
rates.
Foreign
Exchange Forward Contracts
We enter
into foreign exchange forward contracts to hedge transactions primarily related
to commitments and forecasted purchases of equipment, raw materials and finished
goods denominated in foreign currencies. We may also hedge payment of forecasted
intercompany transactions with our subsidiaries outside the United States. These
contracts reduce currency risk from exchange rate movements. We generally hedge
foreign currency price risks for periods from 3 to 24 months.
Foreign
exchange forward contracts are effective as hedges of identifiable, foreign
currency commitments. Since there is a direct relationship between the foreign
currency derivatives and the foreign currency denomination of the transactions,
the derivatives are highly effective in hedging cash flows related to
transactions denominated in the corresponding foreign currencies. We designate
our foreign exchange forward contracts as cash flow hedging
derivatives.
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These
contracts meet the criteria for cash flow hedge accounting treatment.
Accordingly, we include related gains and losses in other comprehensive income.
Subsequently, we recognize the gains and losses in cost of sales or selling,
marketing and administrative expense in the same period that the hedged items
affect earnings. In entering into these contracts, we have assumed the risk that
might arise from the possible inability of counterparties to meet the terms of
their contracts. We do not expect any significant losses from counterparty
defaults.
We
classify the fair value of foreign exchange forward contracts as prepaid
expenses and other current assets, other non-current assets, accrued liabilities
or other long-term liabilities on the Consolidated Balance Sheets. We report the
offset to the contracts in accumulated other comprehensive loss, net of income
taxes. We record gains and losses on these contracts as a component of other
comprehensive income and reclassify them into earnings in the same period during
which the hedged transaction affects earnings. For hedges associated with the
purchase of equipment, we designate the related cash flows as net cash flows
(used by) provided from investing activities on the Consolidated Statements of
Cash Flows. We classify cash flows from other foreign exchange forward contracts
as net cash provided from operating activities.
As of
April 5, 2009, the fair value of foreign exchange forward contracts with gains
totaled $10.3 million and the fair value of foreign exchange forward contracts
with losses totaled $1.1 million. Over the last three years the
volume of activity for foreign exchange forward contracts to purchase foreign
currencies ranged from a contract amount of $.8 million to $56.1
million. Over the same period, the volume of activity for foreign
exchange forward contracts to sell foreign currencies ranged from a contract
amount of $7.0 million to $165.1 million.
Commodities
Futures and Options Contracts
We enter
into commodities futures and options contracts to reduce the effect of raw
material price fluctuations and to hedge transportation costs. We generally
hedge commodity price risks for 3 to 24 month periods. The commodities futures
and options contracts are highly effective in hedging price risks for our raw
material requirements and transportation costs. Because our commodities futures
and options contracts meet hedge criteria, we account for them as cash flow
hedges. Accordingly, we include gains and losses on hedging in other
comprehensive income. We recognize gains and losses ratably in cost of sales in
the same period that we record the hedged raw material requirements in cost of
sales.
We use
exchange traded futures contracts to fix the price of unpriced physical forward
purchase contracts. Physical forward purchase contracts meet the SFAS
No. 133 definition of “normal purchases and sales” and, therefore, are not
accounted for as derivative instruments. On a daily basis, we receive or make
cash transfers reflecting changes in the value of futures contracts (unrealized
gains and losses). As mentioned above, such gains and losses are included as a
component of other comprehensive income. The cash transfers offset higher or
lower cash requirements for payment of future invoice prices for raw materials,
energy requirements and transportation costs. Futures held in excess of the
amount required to fix the price of unpriced physical forward contracts are
effective as hedges of anticipated purchases.
Over the
last three years our total annual volume of futures and options traded in
conjunction with commodities hedging strategies ranged from 55,000 to 70,000
contracts. We use futures and options contracts in combination with
forward purchasing of cocoa products, sugar, corn sweeteners, natural gas, fuel
oil and certain dairy products primarily to provide favorable pricing
opportunities and flexibility in sourcing our raw material and energy
requirements. Our commodity procurement practices are intended to
reduce the risk of future price increases and provide visibility to future
costs, but also may potentially limit our ability to benefit from possible price
decreases.
Hedge
Effectiveness—Commodities
We
perform an assessment of hedge effectiveness for commodities futures and options
contracts on a quarterly basis. Because of the rollover strategy used for
commodities futures contracts, as required by futures market conditions, some
ineffectiveness may result in hedging forecasted manufacturing requirements.
This occurs as we switch futures contracts from nearby contract positions to
contract positions that are required to fix the price of anticipated
manufacturing requirements. Hedge ineffectiveness may also result from
variability in basis differentials associated with the purchase of raw materials
for manufacturing requirements. In accordance with SFAS No. 133, we record
the ineffective portion of gains or losses on commodities futures and options
contracts currently in cost of sales.
The
prices of commodities futures contracts reflect delivery to the same locations
where we take delivery of the physical commodities. Therefore, there is no
ineffectiveness resulting from differences in location between the derivative
and the hedged item.
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The fair
value of derivative instruments in the Consolidated Balance Sheet as of April 5,
2009 was as follows:
The fair
value of the interest rate swap agreements represents the difference in the
present values of cash flows calculated at the contracted interest rates and at
current market interest rates at the end of the period. We calculate
the fair value of interest rate swap agreements quarterly based on the quoted
market price for the same or similar financial instruments.
We define
the fair value of foreign exchange forward contracts and options as the amount
of the difference between the contracted and current market foreign currency
exchange rates at the end of the period. We estimate the fair value
of foreign exchange forward contracts and options on a quarterly basis by
obtaining market quotes of spot and forward rates for contracts with similar
terms, adjusted where necessary for maturity differences.
As of
April 5, 2009, prepaid expense and other current assets associated with
commodity contracts were related to cash transfers receivable on commodities
futures contracts reflecting the change in quoted market prices on the last
trading day for the period. We make or receive cash transfers to or
from commodity futures brokers on a daily basis reflecting changes in the value
of futures contracts on the IntercontinentalExchange or various other
exchanges. These changes in value represent unrealized gains and
losses.
The
effect of derivative instruments on the Consolidated Statements of Income for
the three months ended April 5, 2009 was as follows:
All gains
(losses) recognized in earnings were related to the ineffective portion of the
hedging relationship. We recognized no components of gains and losses
on cash flow hedging derivatives in income due to excluding such components from
the hedge effectiveness assessment.
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9. COMPREHENSIVE
INCOME
A summary
of the components of comprehensive income (loss) is as follows:
The
components of accumulated other comprehensive income (loss) as shown on the
Consolidated Balance Sheets are as follows:
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10. 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:
The
increase in raw material inventories as of April 5, 2009 resulted from the
timing of deliveries to support manufacturing requirements and higher prices in
2009. The decrease in finished goods inventories was primarily associated with
seasonal sales patterns.
11. 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. Our five-year unsecured revolving
credit agreement expires in December 2012. The credit limit is $1.1 billion with
an option to borrow an additional $400 million with the concurrence of the
lenders. The unsecured revolving credit agreement contains certain financial and
other covenants, customary representations, warranties and events of default. As
of April 5, 2009, we complied with all covenants pertaining to the 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 2008 Annual Report on Form
10-K.
12. LONG-TERM
DEBT
In May
2006, we filed a shelf registration statement on Form S-3 that registered an
indeterminate amount of debt securities. This registration statement was
effective immediately upon filing under Securities and Exchange Commission
regulations governing “well-known seasoned issuers” (the “WKSI Registration
Statement”). In March 2008, the Company issued $250 million of 5.0% Notes
due April 1, 2013 under the WKSI Registration Statement.
The net proceeds of this debt issuance were used to repay a portion of the
Company’s outstanding indebtedness under its short-term commercial paper
program.
13. 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 5, 2009 and December 31, 2008, because of the relatively short
maturity of these instruments.
The
carrying value of long-term debt, including the current portion, was
$1,522.4 million as of April 5, 2009, compared with a fair value of
$1,636.8 million, an increase of $114.4 million over the carrying value,
based on quoted market prices for the same or similar debt issues.
Interest
Rate Swaps
In order
to minimize financing costs and to manage interest rate exposure, the Company,
from time to time, enters into interest rate swap agreements. In
March 2009, the Company entered into forward starting interest rate swap
agreements to hedge interest rate exposure related to the anticipated $250
million of term financing expected to be executed during 2011 to repay $250
million of 5.3% Notes maturing in September 2011. The
weighted-average fixed rate on the forward starting swap agreements was
3.5%. The fair value of interest rate swap agreements was a net asset
of $0.1 million as of April 5, 2009. The Company’s risk related to
interest rate swap agreements is limited to the cost of replacing such
agreements at prevailing market rates. For more information see Note
8. Derivative Instruments and Hedging Activities.
-15-
Foreign
Exchange Forward Contracts
The
following table summarizes our foreign exchange activity:
Our foreign exchange forward contracts
mature in 2009. For more information, see Note 8. Derivative
Instruments and Hedging Activities.
14. FAIR
VALUE ACCOUNTING
As of
January 1, 2008, we adopted certain provisions of FASB Statement of Financial
Accounting Standards No. 157, Fair Value Measurements
(“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in GAAP, and expands disclosures about fair
value measurements. SFAS No. 157 applies when another standard
requires or permits assets or liabilities to be measured at fair
value. Accordingly, SFAS No. 157 does not require any new fair value
measurements. As of January 1, 2009, we adopted the remaining
provisions of SFAS No. 157 as it relates to nonfinancial assets and liabilities
that are not recognized or disclosed at fair value on a recurring
basis. The adoption of SFAS No. 157 did not materially impact our
consolidated financial statements.
We use
certain derivative instruments, from time to time, to manage interest rate,
foreign currency exchange rate and commodity market price risk exposures, all of
which are recorded at fair value based on quoted market prices or
rates.
A summary
of our cash flow hedging derivative assets and liabilities measured at fair
value on a recurring basis as of April 5, 2009, is as follows:
As of
April 5, 2009, cash flow hedging derivative Level 1 assets were related to cash
transfers receivable on commodities futures contracts reflecting the change in
quoted market prices on the last trading day for the period. As of
April 5, 2009, cash flow hedging derivative Level 2 assets and liabilities were
principally related to the fair value of foreign exchange forward
contracts. For more information, see Note 8. Derivative Instruments
and Hedging Activities.
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15. PENSION
AND OTHER POST-RETIREMENT BENEFIT PLANS
Components
of net periodic benefits cost (income) consisted of the
following:
We made
contributions of $1.3 million and $6.6 million to the pension plans and
other benefits plans, respectively, during the first quarter of
2009. In the first quarter of 2008, we made contributions of
$3.3 million and $5.9 million to our pension and other benefits plans,
respectively. The contributions in 2009 and 2008 also included
benefit payments from our non-qualified pension plans and post-retirement
benefit plans.
In the
first quarter of 2009, there was net periodic pension benefits expense of
$12.4 million, compared with net periodic pension benefits income of
$3.9 million in the first quarter of 2008. The net periodic
pension benefits expense was primarily due to the significant decline in the
value of pension assets during 2008 reflecting the unprecedented volatility and
deterioration in financial market and economic conditions.
For 2009,
there are no minimum funding requirements in excess of available credits for the
domestic plans and minimum funding requirements for the non-domestic plans are
not material. The Company may choose to make contributions to pension plans
in excess of minimum funding requirements depending on pension asset performance
during 2009. Based on current pension asset performance, we do not expect
such contributions to exceed $100 million, including benefit payments from
our non-qualified plans.
For more
information, refer to the consolidated financial statements and notes included
in our 2008 Annual Report on Form 10-K.
16. SHARE
REPURCHASES
Repurchases
and Issuances of Common Stock
A summary
of cumulative share repurchases and issuances is as follows:
In
December 2006, our Board of Directors approved a $250 million share repurchase
program. As of April 5, 2009, $100.0 million remained available for repurchases
of Common Stock under this program.
-17-
Item
2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
SUMMARY
OF OPERATING RESULTS
Analysis
of Selected Items from Our Income Statement
Results of Operations -
First Quarter 2009 vs. First Quarter 2008
Price
Increases
In August
2008, we announced an increase in wholesale prices across the United States,
Puerto Rico and export chocolate and sugar confectionery lines. This
price increase was effective immediately, and represented a weighted average
eleven percent increase on our instant consumable, multi-pack and packaged candy
lines. These changes approximated a ten percent increase over the
entire domestic product line.
In
January 2008, we announced an increase in the wholesale prices of our domestic
confectionery line, effective immediately. This price increase applied to our
standard bar, king-size bar, 6-pack and vending lines and represented a weighted
average increase of approximately thirteen percent on these items. These price
changes approximated a three percent price increase over our entire domestic
product line.
In April
2007, we announced an increase of approximately four percent to five percent in
the wholesale prices of our domestic confectionery line, effective
immediately. The price increase applied to our standard bar,
king-size bar, 6-pack and vending lines. These products represent approximately
one-third of our U.S. confectionery portfolio.
We
implemented these pricing actions to help partially offset increases in input
costs, including raw materials, fuel, utilities and transportation.
Net
Sales
Net sales
for the first quarter of 2009 increased over the comparable period of 2008
principally due to favorable price realization from price increases and
increased sales for our international businesses. These increases
were offset somewhat by the impact of foreign currency exchange rates and sales
volume decreases reflecting the impact of pricing elasticity.
Key
Marketplace Metrics
Consumer
takeaway decreased 6.7% during the first quarter of 2009 compared with the same
period of 2008. However, the first quarter of 2008 benefited from an
early Easter season. Excluding the impact of Easter sales, consumer
takeaway increased 7.4% during the period. 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.
-18-
Market
share in measured channels increased by 0.5 share points during the first
quarter of 2009. Excluding the impact of Easter sales, market share
increased 0.9 share points. 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
The cost
of sales increase was primarily associated with significantly higher input
costs, principally ingredient and energy costs, offset somewhat by improved
supply chain productivity and the impact of the sales volume
decreases. The cost of sales increase was substantially offset by
lower business realignment charges included in cost of sales of $4.1 million in
the first quarter of 2009 compared with $25.2 million in the first quarter of
2008.
Approximately
two-thirds of the gross margin increase was attributable to the impact of
reduced costs for business realignment initiatives recorded in 2009 compared
with 2008. The remainder of the gross margin increase in the first
quarter of 2009 compared with the first quarter of 2008 resulted from improved
net price realization and improved margins for our international
businesses. These increases were substantially offset primarily by
higher input costs for raw materials and energy.
Selling,
Marketing and Administrative
Selling,
marketing and administrative expenses were higher due to increases in employee
benefits expense, primarily pension expense, and higher incentive compensation
and selling expenses. Increased advertising expenses, offset slightly by lower
consumer promotions expense, also contributed to the increase.
Expenses
of $2.1 million related to our business realignment initiatives were
included in selling, marketing and administrative expenses in the first quarter
of 2009 compared with $1.4 million in the first quarter of 2008.
Business
Realignment Initiatives
Business
realignment charges of $12.8 million were recorded in the first quarter of
2009. The charges were primarily related to plant closure expenses,
employee separation and severance expenses and fixed asset impairments. Business
realignment charges of $4.1 million were recorded in the first quarter of 2008
associated with the 2007 business realignment initiatives. The
charges were primarily associated with fixed asset impairments, plant closure
expenses, and employee separation and contract termination costs, partially
offset by gains on the sale of fixed assets.
Income
Before Interest and Income Taxes and EBIT Margin
EBIT
increased in the first quarter of 2009 compared with the first quarter of 2008
as a result of higher gross profit, partially offset by higher selling,
marketing and administrative expenses. Net pre-tax business realignment charges
of $19.0 million were recorded in the first quarter of 2009 compared with $30.7
million recorded in the first quarter of 2008, a decrease of $11.7
million.
EBIT
margin increased from 10.6% for the first quarter of 2008 to 12.4% for the first
quarter of 2009. The impact of net business realignment charges in 2009 reduced
EBIT margin by 1.5 percentage points and in the first quarter of 2008, reduced
EBIT margin by 2.6 percentage points. The remainder of the increase
was the result of the higher gross margin, partially offset by higher selling,
marketing and administrative expense as a percentage of sales.
Interest
Expense, Net
Net
interest expense was lower in the first quarter of 2009 than the comparable
period of 2008 primarily reflecting lower commercial paper borrowings and lower
interest rates, offset marginally by lower capitalized interest in 2009 as
compared with 2008.
Income
Taxes and Effective Tax Rate
Our
effective income tax rate was 41.2% for the first quarter of 2009. The impact of
tax rates associated with business realignment and impairment charges recorded
during the quarter reduced the effective income tax rate by 0.7 percentage
points. The higher effective rate in the first quarter of 2009
resulted primarily from the accounting associated with certain tax events during
the quarter. We expect our income tax rate for the full year 2009 to
be 36.2%, excluding the impact of tax benefits associated with business
realignment charges during the year.
-19-
Net
Income and Net Income Per Share
Net
income in the first quarter of 2009 was reduced by $10.1 million, or $0.05 per
share-diluted, and was reduced by $20.7 million, or $0.09 per share-diluted, in
the first quarter of 2008 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 of 2009 increased $0.01 as compared with the first quarter of
2008.
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
repayment of long-term debt, business acquisitions and for other general
corporate purposes. During the first three months of 2009, cash and cash
equivalents increased by $33.8 million.
Cash
provided from operations was sufficient to fund the repayment of short-term debt
of $125.3 million, dividend payments of $65.7 million, capital
additions and capitalized software expenditures of $37.5 million, a
business acquisition of $15.2 million and the repurchase of Common Stock
for $9.3 million.
Cash
provided by changes in other assets and liabilities was $9.5 million for
the first three months of 2009 compared with cash used of $92.7 million for
the same period of 2008. The change in the amount of cash provided from (used
by) other assets and liabilities from 2008 to 2009 primarily reflected the
effect of hedging transactions, the timing of payments associated with selling
and marketing programs, the impact of certain commodity transactions, as well as
the impact of business realignment initiatives.
In March
2009, the Company completed the acquisition of the Van Houten Singapore consumer
business. The acquisition from Barry Callebaut, AG provides the
Company with an exclusive license of the Van Houten brand name and related
trademarks in Asia and the Middle East for the retail and duty free distribution
channels. The purchase price for the acquisition of Van Houten
Singapore and the licensing agreement was approximately $15.2
million.
During
the first quarter of 2008, Hershey do Brasil entered into a cooperative
agreement with Bauducco. We received cash of $2.0 million from Bauducco and
recorded an intangible asset of $13.7 million related to the agreement. We will
maintain a 51% controlling interest in Hershey do Brasil.
Proceeds
from the sale of manufacturing and distribution facilities and related equipment
under the global supply chain transformation program were $0.1 million in the
first quarter of 2009 and $44.3 million in the first quarter of
2008.
A
receivable of approximately $14.3 million was included in prepaid expenses and
other current assets as of April 5, 2009 and $14.5 million as of December
31, 2008 related to the recovery of damages from a product recall and temporary
plant closure in Canada. The decrease primarily resulted from
currency exchange rate fluctuations. The product recall during the fourth
quarter of 2006 was caused by a contaminated ingredient purchased from an
outside supplier with whom we have filed a claim for damages and are currently
in litigation.
Interest
paid was $45.8 million during the first three months of 2009 versus $45.3
million for the comparable period of 2008. Income taxes paid were
$16.7 million during the first three months of 2009 versus $5.8 million for the
comparable period of 2008. The increase in taxes paid in 2009 was
primarily related to a higher payment for 2008 income taxes.
The ratio
of current assets to current liabilities was 1.1:1.0 as of April 5, 2009 and
December 31, 2008. The capitalization ratio (total short-term and long-term
debt as a percent of stockholders' equity, short-term and long-term debt)
decreased to 83% as of April 5, 2009 from 85% as of December 31,
2008.
Generally,
our short-term borrowings are in the form of commercial paper or bank loans with
an original maturity of three months or less. Our five-year unsecured
revolving credit agreement expires in December 2012. The credit limit
is $1.1 billion with an option to borrow an additional $400 million with the
concurrence of the lenders.
In March
2008, the Company issued $250 million of 5.0% Notes due April 1, 2013 under the
WKSI Registration Statement. The net proceeds of this debt issuance were used to
repay a portion of the Company’s outstanding indebtedness under its short-term
commercial paper program. -20-
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 2008 Annual Report on Form 10-K
for information concerning the key risks to achieving future performance
goals.
For 2009,
we continue to expect net sales growth of two to three percent from our pricing
actions and core brand sales growth. We expect unit sales volume to
decline due to the elasticity effects of price increases implemented during 2008
which will result in higher everyday and promoted prices for
consumers. The impact of the declines in unit sales volume is
expected to be more than offset by price realization. We expect
growth in net sales substantially driven by net price realization, offset
somewhat by the impact of unfavorable foreign currency exchange
rates.
We
continue to expect our commodity cost basket to increase significantly in 2009
compared with 2008. The total increase could be lower than the
previous estimate of $175 million if current market prices, particularly for
dairy products, continue through the remainder of the year. The
decline in the financial markets in 2008 significantly reduced the fair value of
our pension plan assets which is expected to result in an increase in 2009
pension expense of approximately $70 million. Despite these increases
we plan to continue to invest in our core brands in the U.S. and key
international markets to build on our momentum. Specifically,
advertising expense is expected to increase by 20 to 25 percent in
2009. These cost increases will be more than offset by higher net
pricing, savings from the global supply chain transformation program and
on-going operating productivity improvement. We continue to expect an
increase in earnings per share-diluted in 2009, excluding business realignment
charges; however, due to the significant commodity and pension costs increases,
higher levels of core brand investment spending and current macroeconomic
conditions, we expect growth in earnings per share-diluted to be at a rate below
our long-term objective of six to eight percent.
For 2009,
we expect total pre-tax business realignment and impairment charges for our
global supply chain transformation program, including the increase in the scope
of the program and non-cash pension settlement charges, to be in the range of
$85 million to $120 million, or $0.24 to $0.33 per share-diluted.
Outlook for Global Supply
Chain Transformation Program
We now
expect total pre-tax charges and non-recurring project implementation costs for
the global supply chain transformation program of $615 million to $665 million,
including estimated pension settlement charges in 2009 and 2010. This
includes pension settlement charges recorded in 2007 and 2008 as required in
accordance with FASB Statement of Financial Accounting Standards No. 88, Employers’ Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits (as amended) (“SFAS No. 88”). Pension
settlement charges are non-cash charges for the Company. Such charges
accelerate the recognition of pension expense related to actuarial gains and
losses resulting from interest rate changes and differences in actual versus
assumed returns on pension assets. The Company normally amortizes
actuarial gains and losses over a period of about 13 years.
The
global supply chain transformation program charges recorded in 2007 and 2008
have included pension settlement charges of approximately $24.6 million as
employees leaving the Company under the program have been withdrawing lump sums
from the defined benefit pension plans. In addition to these charges,
incremental SFAS No. 88 pension settlement charges of $40 million to $65 million
were added to the GSCT program estimates based upon the current trends of
employee withdrawals, with $40 million to $50 million projected for
2009.
-21-
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.
The
factors that could cause our actual results to differ materially from the
results projected in our forward-looking statements include, but are not limited
to the following:
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
The
potential net loss in fair value of foreign exchange forward contracts and
interest rate swap agreements of ten percent resulting from a hypothetical
near-term adverse change in market rates was $.9 million as of March 30,
2009 and was $1.0 million as of December 31, 2008. 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 $44.1 million as of December 31, 2008, to $42.2 million
as of April 5, 2009. Market risk
represents ten percent 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.
-22-
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. -23-
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
Item
6 - Exhibits
The
following items are attached or incorporated herein by reference:
-24-
SIGNATURES
-25-
-26-
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