UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number 1-183
Registrant, State of Incorporation, Address and Telephone Number
HERSHEY FOODS CORPORATION
(a Delaware corporation)
100 Crystal A Drive
Hershey, Pennsylvania 17033
(717) 534-6799
I.R.S. Employer Identification Number 23-0691590
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class: | Name of each exchange on which registered: | |
| Common Stock, one dollar par value | New York Stock Exchange |
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes |X| No |_|
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
Common Stock, one dollar par value — $6,103,616,434 as of June 27, 2003.
Class B Common Stock, one dollar par value — $8,105,404 as of June 27, 2003. While the Class B Common Stock is not listed for public trading on any exchange or market system, shares of that class are convertible into shares of Common Stock at any time on a share-for-share basis. The market value indicated is calculated based on the closing price of the Common Stock on the New York Stock Exchange on June 27, 2003.
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date.
Common Stock, one dollar par value — 99,184,581 shares, as of March 1, 2004.
Class B Common Stock, one dollar par value — 30,422,096 shares, as of March 1, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
The Company’s Annual Report to Stockholders for the year ended December 31, 2003, included as Appendix A to the Company’s Proxy Statement for the Company’s 2004 Annual Meeting of Stockholders (the “Proxy Statement”) and attached hereto and filed as Exhibit 13, is incorporated by reference herein into portions of Part I and Part II. Portions of the Proxy Statement are incorporated by reference herein into Part III.
PART I
Item 1. BUSINESS
Hershey Foods Corporation, its wholly-owned subsidiaries and entities in which it has a controlling financial interest (the “Company”) are engaged in the manufacture, distribution and sale of confectionery and grocery products. The Company was organized under the laws of the State of Delaware on October 24, 1927, as a successor to a business founded in 1894 by Milton S. Hershey.
In July 2003, the Company announced a number of initiatives continuing its value-enhancing strategy. These initiatives included realigning the sales organization and streamlining the supply chain by divesting or eliminating certain non-strategic brands and products and by product line rationalization. In September 2003, the Company completed the sale of a group of the Company’s gum brands to Farley’s & Sathers Candy Company, Inc. for $20.0 million in cash as part of its business realignment initiatives. Included in the transaction were the FRUIT STRIPE, RAIN-BLO and SUPER BUBBLE trademarked gum brands.
The Company’s principal product groups include: confectionery products sold in the form of bar goods, bagged items and boxed items; and grocery products in the form of baking ingredients, chocolate drink mixes, peanut butter, dessert toppings and beverages. The Company believes it is a leader in many of these product groups in the United States, Canada and Mexico. Operating profit margins vary considerably among individual products and brands. Generally, such margins on confectionery products are greater than those on grocery products.
The Company manufactures confectionery products in a variety of packaged forms and markets them under more than 50 brands. The different packaged forms include various arrangements of the same bar products, such as boxes, trays and bags, as well as a variety of different sizes and weights of the same bar products, such as snack size, standard, king size, large and giant bars. Among the principal confectionery products in the United States are: HERSHEY’S COOKIES ‘N’ CREME candy bars, HERSHEY’S HUGS chocolates, HERSHEY’S KISSES chocolates, HERSHEY’S KISSES chocolates with almonds, HERSHEY’S chocolate bars, HERSHEY’S chocolate bars with almonds, HERSHEY’S MINIATURES chocolate bars, HERSHEY’S NUGGETS chocolates, HERSHEY’S S’MORES candy bars, HERSHEY’S sugar free candies, COOL BLAST mints, FAST BREAK candy bars, ICE BREAKERS mints and chewing gum, JOLLY RANCHER candy, KIT KAT and KIT KAT BIG KAT wafer bars, KRACKEL chocolate bars, MR. GOODBAR chocolate bars, REESE’S NUTRAGEOUS candy bars, REESE’S peanut butter cups, REESE’S PIECES candies, REESE’S sugar free peanut butter cups miniatures, REESESTICKS wafer bars, SPECIAL DARK chocolate bars, SWOOPS chocolate slices and SYMPHONY chocolate bars. Other confectionery products include: HERSHEY’S BITES candies, ALMOND JOY candy bars, BREATH SAVERS mints, BUBBLE YUM bubble gum, CARAMELLO candy bars, KOOLERZ chewing gum, GOOD & PLENTY candy, HEATH toffee bars, MILK DUDS candy, MOUNDS candy bars, PAYDAY candy bars, POT OF GOLD boxed chocolates, ROLO caramels in milk chocolate, SKOR toffee bars, TWIZZLERS candy, WHATCHAMACALLIT candy bars, WHOPPERS malted milk balls, YORK peppermint pattie candy, 5TH AVENUE candy bars and ZERO candy bars.
The Company also manufactures and/or markets grocery products in the baking, beverage, peanut butter and toppings categories. Principal products in the United States include HERSHEY’S, REESE’S and HEATH baking pieces, HERSHEY’S chocolate milk mix, HERSHEY’S cocoa, HERSHEY’S CHOCOLATE SHOPPE ice cream toppings, HERSHEY’S HOT COCOA COLLECTION hot cocoa mix, HERSHEY’S syrup and REESE’S peanut butter. HERSHEY’S chocolate and strawberry flavored milks are produced and sold under license by various dairies throughout the United States, using milk mixes manufactured by the Company. Baking and various other products are produced and sold under the HERSHEY’S and REESE’S brand names by third parties that have been granted licenses by the Company to use these trademarks.
Principal products in Canada include CHIPITS chocolate chips, GLOSETTE chocolate-covered raisins, peanuts and almonds, OH HENRY! candy bars, POT OF GOLD boxed chocolates, REESE PEANUT BUTTER CUPS candy and TWIZZLERS candy. The Company also manufactures, imports, markets, sells and distributes chocolate products in Mexico under the HERSHEY’S brand name.
The Company has license agreements with several companies to manufacture and/or sell products worldwide. Among the more significant are agreements with affiliated companies of Cadbury Schweppes p.l.c. to manufacture and/or market and distribute YORK, PETER PAUL ALMOND JOY and PETER PAUL MOUNDS confectionery products worldwide as well as CADBURY and CARAMELLO confectionery products in the United States. The Company’s rights under these agreements are extendible on a long-term basis at the Company’s option. The license for CADBURY and CARAMELLO products is subject to a minimum sales requirement that the Company exceeded in 2003. The Company also has an agreement with Societe des Produits Nestle SA, which licenses the Company to manufacture and distribute KIT KAT and ROLO confectionery products in the United States. The Company’s rights under this agreement are extendible on a long-term basis at the Company’s option, subject to certain conditions, including minimum unit volume sales. In 2003, the minimum unit volume requirements were exceeded. The Company has an agreement with an affiliate of Huhtamäki Oy (“Huhtamaki”) pursuant to which it licenses the use of certain trademarks, including GOOD & PLENTY,HEATH, JOLLY RANCHER, MILK DUDS, PAYDAY and
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WHOPPERS for confectionery products worldwide. The Company’s rights under this agreement are extendible on a long-term basis at the Company’s option.
The Company’s products are sold primarily to grocery wholesalers, chain grocery stores, candy distributors, mass merchandisers, chain drug stores, vending companies, wholesale clubs, convenience stores, concessionaires and food distributors by full-time sales representatives, food brokers and part-time retail sales merchandisers throughout the United States, Canada and Mexico. The Company believes its products are sold in over 2 million retail outlets in North America. In 2003, sales to McLane Company, Inc., formerly a subsidiary of Wal-Mart Stores, Inc., amounted to approximately 22 percent of the Company's total sales.
The Company manufactures, imports, markets, sells and distributes chocolate products in Brazil under the HERSHEY’S brand name. Additional products in Brazil include IO-IO hazelnut crème items and chocolate and confectionery products sold under the VISCONTI brand name. In China, Japan, Korea and the Philippines, the Company imports and/or markets selected confectionery and grocery products. The Company also markets confectionery and grocery products in over 60 countries worldwide.
The Company’s marketing strategy is based upon the consistently superior quality of its products, mass distribution and the best possible consumer value in terms of price and weight. In addition, the Company devotes considerable resources to the identification, development, testing, manufacturing and marketing of new products. The Company utilizes a variety of promotional programs for customers as well as advertising and promotional programs for consumers. The Company employs promotional programs at various times during the year to stimulate sales of certain products. Confectionery and grocery seasonal and holiday-related sales have typically been highest during the third and fourth quarters of the year.
The Company recognizes that the mass distribution of its confectionery and grocery products is an important element in maintaining sales growth and providing service to its customers. The Company attempts to meet the changing demands of its customers by planning optimum stock levels and reasonable delivery times consistent with achievement of efficiencies in distribution. To achieve these objectives, the Company has developed a distribution network from its manufacturing plants, distribution centers and field warehouses strategically located throughout the United States, Canada and Mexico. The Company uses a combination of public and contract carriers to deliver its products from the distribution points to its customers. In conjunction with sales and marketing efforts, the distribution system has been instrumental in the effective promotion of new, as well as established, products on both national and regional scales.
From time to time, the Company has changed the prices and weights of its products to accommodate changes in manufacturing costs, the competitive environment and profit objectives, while at the same time maintaining consumer value. The Company implemented an increase in the wholesale price of its domestic standard size, king size, variety pack, 6-pack and 10-pack lines effective January 1, 2003. The standard size increase was approximately 11 percent. The effect of all the increases translated into an approximate 3 percent increase over the entire domestic product line. The last standard candy bar price increase was implemented by the Company in December 1995.
The most significant raw material used in the production of the Company’s chocolate products is cocoa beans. This commodity is imported principally from Far Eastern, West African and South American equatorial regions. West Africa accounts for approximately 70 percent of the world’s crop. Cocoa beans are not uniform, and the various grades and varieties reflect the diverse agricultural practices and natural conditions found in the many growing areas. The Company buys a mix of cocoa beans and cocoa products to meet its manufacturing requirements.
The table below sets forth annual average cocoa prices as well as the highest and lowest monthly averages for each of the calendar years indicated. The prices are the monthly average of the quotations at noon of the three active futures trading contracts closest to maturity on the New York Board of Trade. Because of the Company’s forward purchasing practices discussed below, and premium prices paid for certain varieties of cocoa beans, these average futures contract prices are not necessarily indicative of the Company’s average cost of cocoa beans or cocoa products.
Cocoa Futures Contract
Prices
(cents per pound)
| 1999 | 2000 | 2001 | 2002 | 2003 | ||||||||||||
| Annual Average............... | 48.8 | 37.9 | 47.1 | 76.9 | 77.8 | |||||||||||
| High................................ | 62.7 | 40.1 | 57.9 | 96.7 | 99.8 | |||||||||||
| Low................................. | 39.6 | 34.4 | 41.5 | 60.3 | 65.6 |
Source: International Cocoa Organization Quarterly Bulletin of Cocoa Statistics
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After rising sharply in 2002, cocoa market prices reached an eighteen-year high in February 2003, before gradually declining, but remaining at levels somewhat higher than prices prior to 2002. Continued civil unrest in the world’s largest cocoa-producing country, the Ivory Coast, has resulted in volatile market conditions, but has not materially affected the harvesting and marketing of the cocoa crop. The Company’s costs during 2004 and beyond will not necessarily reflect market price fluctuations because of its forward purchasing practices, premiums and discounts reflective of relative values, varying delivery times, and supply and demand for specific varieties and grades of cocoa beans. The Company’s costs for cocoa will increase substantially in 2004; however, the Company expects to achieve its goals for growth and profitability over the foreseeable future by a combination of improved sales mix, supply chain cost reductions and strict control of other costs to offset cost increases and respond to changes in the competitive environment.
The Farm Security and Rural Investment Act of 2002, which is a six-year farm bill, impacts the prices of sugar, corn, peanuts and milk because it sets price support levels for these commodities.
The price of sugar, the Company’s second most important commodity for its domestic chocolate and confectionery products, is subject to price supports under the above referenced farm legislation. Due to import quotas and duties imposed to support the price of sugar established by that legislation, sugar prices paid by United States users are currently substantially higher than prices on the world sugar market. The average wholesale list price of refined sugar, F.O.B. Northeast, has remained in a range of 25¢ to 32¢ per pound for the past ten years. United States peanut prices traded around 40¢ per pound during 2003 and are expected to remain near that level in 2004. Almond prices began strengthening during the second quarter of 2003 and continued to increase during the second half of the year due to strong global demand and a weakening U.S. dollar. Prices began the year at $1.50 per pound, were at $2.00 per pound as of December 31, 2003, and are expected to remain firm during 2004. Milk prices remained low in 2003 as a result of higher than normal inventories of butter and skim milk powder. Prices began to increase late in the fourth quarter as milk and butter production fell below year earlier levels, and butter inventories declined. Milk prices in 2004 are expected to increase moderately from 2003 levels. The Company believes that the supply of raw materials is adequate to meet its manufacturing requirements.
The Company attempts to minimize the effect of future price fluctuations related to the purchase of its major raw materials primarily through forward purchasing to cover future manufacturing requirements, generally for periods from 3 to 24 months. With regard to cocoa, sugar, corn sweeteners, natural gas, fuel oil and certain dairy products, price risks are also managed by entering into futures contracts. At the present time, active futures contracts are not available for use in pricing the Company’s other major raw material requirements. Futures contracts are used in combination with forward purchasing of cocoa, sugar, corn sweetener, natural gas and certain dairy product requirements principally to take advantage of market fluctuations that provide more favorable pricing opportunities and flexibility in sourcing these raw materials and energy requirements. Fuel oil futures contracts are used to minimize price fluctuations associated with the Company’s transportation costs. The Company’s commodity procurement practices are intended to reduce the risk of future price increases, but also may potentially limit the ability to benefit from possible price decreases.
The primary effect on liquidity from using futures contracts is associated with margin requirements for futures contracts related to cocoa, sugar, corn sweeteners, natural gas, fuel oil and certain dairy products. Cash outflows and inflows result from original margins that are “good faith deposits” established by futures exchanges to ensure that market participants will meet their contractual financial obligations. Additionally, variation margin payments and receipts are required when the value of open positions is adjusted to reflect daily price movements. The magnitude of such cash inflows and outflows is dependent upon price coverage levels and the volatility of the markets. Cash flows related to margin requirements historically have not been material to the Company’s total working capital requirements.
The Company manages the purchase of forward and futures contracts by developing and monitoring procurement strategies for each of its major commodities. These procurement strategies, including the use of futures contracts to hedge the pricing of cocoa, sugar, corn sweeteners, natural gas, transportation costs and certain dairy products, are directly linked to the overall planning and management of the Company’s business, since the cost of raw materials, energy and transportation accounts for a significant portion of cost of sales. Procurement strategies with regard to cocoa, sugar and other major raw material requirements, energy requirements and transportation costs are developed by the analysis of fundamentals, including weather and crop analysis, imbalances between supply and demand, currency exchange rates, political unrest in producing countries and speculative influences and by discussions with market analysts, brokers and dealers. Procurement strategies are determined, implemented and monitored on a regular basis by senior management. Procurement activities for all major commodities are also reported to the Company’s Board of Directors (the “Board”) on a regular basis.
Competition
Many of the Company’s brands enjoy wide consumer acceptance and are among the leading brands sold in the marketplace. However, these brands are sold in highly competitive markets and compete with many other multinational, national, regional and local firms, some of which have resources in excess of those available to the Company.
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Trademarks
The Company owns various registered and unregistered trademarks and service marks and has rights under licenses to use various trademarks that are of material importance to the Company’s business.
Backlog of Orders
The Company manufactures primarily for stock and fills customer orders from finished goods inventories. While at any given time there may be some backlog of orders, such backlog is not material in respect to total annual sales, nor are the changes from time to time significant.
Research and Development
The Company engages in a variety of research activities. These principally involve development of new products, improvement in the quality of existing products, improvement and modernization of production processes and the development and implementation of new technologies to enhance the quality and value of both current and proposed product lines. Information concerning the Company’s research and development expense is contained in Note 1 of the Company’s Annual Report to Stockholders, attached hereto and filed as Exhibit 13 and incorporated herein by reference.
Regulation
The Company’s domestic plants are subject to inspection by the Food and Drug Administration and various other governmental agencies, and its products must comply with regulations under the Federal Food, Drug and Cosmetic Act and with various comparable state statutes regulating the manufacturing and marketing of food products.
Environmental Considerations
In the past the Company has made investments based on compliance with environmental laws and regulations. Such expenditures have not been material with respect to the Company’s capital expenditures, earnings or competitive position.
Employees
As of December 31, 2003, the Company had approximately 13,100 full-time and 1,700 part-time employees, of whom approximately 5,200 were covered by collective bargaining agreements. The Company considers its employee relations to be good.
Financial Information by Geographic Area
Information concerning the Company’s geographic segments is contained in Note 19 of the Company’s Annual Report to Stockholders, attached hereto and filed as Exhibit 13 and incorporated herein by reference.
Available Information
The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to all of the foregoing reports are available, free of charge, in the Investor Relations section of the Company’s website, www.hersheys.com, as soon as reasonably practicable after the reports are electronically filed with or furnished to the United States Securities and Exchange Commission.
The Board has adopted a Code of Ethical Business Conduct (“CEBC”) applicable to the Company’s directors, officers and employees, including without limitation the Company’s Chief Executive Officer and “senior financial officers” (including the Chief Financial Officer, Chief Accounting Officer, Corporate Controller and persons performing similar functions). The CEBC is posted on the Company’s website at www.hersheys.com in the Investor Relations section. Any amendment of the CEBC or waiver thereof applicable to any director or executive officer of the Company, including the Chief Executive Officer or any senior financial officer, will be disclosed on the Company’s website within five days of the date of such amendment or waiver. In the case of a waiver, the nature of the waiver, the name of the person to whom the waiver was granted and the date of the waiver will also be disclosed.
The Board has also adopted and posted in the Investor Relations section of its website the Company’s Corporate Governance Principles and Charters for each of the Board’s standing committees.
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The Company will provide without charge to each beneficial owner of its Common Stock and Class B Stock, upon such stockholder’s request, a copy of the CEBC, the Company’s Corporate Governance Principles or the Charter of any standing committee of the Board. Requests for copies should be addressed to Hershey Foods Corporation, Attn: Investor Relations Department, 100 Crystal A Drive, Hershey, Pennsylvania 17033-0810.
Safe Harbor Statement
The nature of the Company’s operations and the environment in which it operates subject it to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company notes the following factors that, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as “intend,” “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential,” among others. Factors which could cause results to differ include, but are not limited to: changes in the confectionery and grocery business environment, including actions of competitors and changes in consumer preferences; customer and consumer response to selling price increases; changes in governmental laws and regulations, including taxes; market demand for new and existing products; changes in raw material and other costs; pension cost factors, such as actuarial assumptions, market performance and employee retirement decisions; adequacy of the Company’s bad debt reserve; the Company’s ability to implement improvements to and reduce costs associated with the Company’s supply chain; and the Company’s ability to successfully implement its rationalization and realignment initiatives.
Item 2. PROPERTIES
The following is a list of the Company’s principal manufacturing properties. The Company owns each of these properties.
|
Hershey,Pennsylvania - confectionery and grocery products (3 principal plants) Lancaster, Pennsylvania - confectionery products Oakdale, California - confectionery and grocery products Robinson, Illinois - confectionery and grocery products Stuarts Draft, Virginia - confectionery and grocery products |
| Smiths Falls, Ontario - confectionery and grocery products |
In addition to the locations indicated above, the Company owns or leases several other properties used for manufacturing confectionery and grocery products and for sales, distribution and administrative functions.
The Company’s plants are efficient and well maintained. These plants generally have adequate capacity and can accommodate seasonal demands, changing product mixes and certain additional growth. The largest plants are located in Hershey, Pennsylvania. Many additions and improvements have been made to these facilities over the years and the plants’ manufacturing equipment includes equipment of the latest type and technology.
Item 3. LEGAL PROCEEDINGS
The Company has no material pending legal proceedings, other than ordinary routine litigation incidental to its business.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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PART II
Item 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY
Information concerning the principal United States trading market for, market prices of and dividends on the Company’s Common Stock and Class B Common Stock, and the approximate number of stockholders, may be found in the section entitled “Market Prices and Dividends” on page A-22 and A-23 of the Company’s Annual Report to Stockholders, incorporated herein by reference from Exhibit 13 hereto.
See Item 12 on page 10 for information about the Company's equity compensatin plans.
Item 6. SELECTED FINANCIAL DATA
The following information, for the five years ended December 31, 2003, found in the section entitled “Six-Year Consolidated Financial Summary” on page A-62 of the Company’s Annual Report to Stockholders, is incorporated herein by reference from Exhibit 13 hereto: Net Sales; Income before Cumulative Effect of Accounting Change (and related per share amounts); Net Income; Earnings Per Share - Basic and - Diluted; Dividends Paid on Common Stock (and related Per Share amounts); Dividends Paid on Class B Common Stock (and related Per Share amounts); Long-term Portion of Debt; and Total Assets.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The section entitled “Management’s Discussion and Analysis,” found on pages A-1 through A-24 of the Company’s Annual Report to Stockholders, is incorporated herein by reference from Exhibit 13 hereto.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item with respect to market risk is set forth in the section entitled “Accounting Policies and Market Risks Associated with Derivative Instruments,” found on pages A-13 through A-17 of the Company's Annual Report to Stockholders, and is incorporated by reference from Exhibit 13 hereto.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited consolidated financial statements of the Company and its subsidiaries are found at the indicated pages in the Company’s Annual Report to Stockholders, which financial statements, along with the Independent Auditors’ Reports thereon, are incorporated herein by reference from Exhibit 13 hereto:
1. Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001. (Page A-25) |
2. Consolidated Balance Sheets as of December 31, 2003 and 2002. (Page A-26) |
3. Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001. (Page A-27) |
4. Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2003, 2002 and 2001. (Page A-28) |
5. Notes to Consolidated Financial Statements (Pages A-29 through A-58), including “Quarterly Data (Unaudited).” (Page A-58) |
6. Independent Auditors’ Report. (Page A-60) |
7. Report of Predecessor Auditor (Arthur Andersen LLP). (Page A-61) |
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Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2003. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under 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 the Company’s 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.
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PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages, positions held with the Company, periods of service as a director, principal occupations, business experience and other directorships of nominees for director of the Company are set forth in the Proxy Statement in the section entitled “Election of Directors,” which information is incorporated herein by reference.
Executive Officers of the Company as of March 1, 2004
| Name | Age | Positions Held During the Last Five Years | ||||
R. H. Lenny (1) |
52 |
Chairman of the Board, President and Chief Executive Officer (2002); President and Chief Executive Officer (2001) |
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M. K. Arline |
51 |
Senior Vice President, Human Resources and Corporate Affairs (2002); Senior Vice President, Human Resources (2002); Vice President, Human Resources (2001); Vice President, Quality and Regulatory Compliance (1999); Director, Quality and Regulatory Compliance (1997) |
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J. P. Bilbrey(2) |
47 |
Senior Vice President, President Hershey International (2003) |
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F. Cerminara |
55 |
Senior Vice President, Chief Financial Officer (2001); Vice President, Chief Financial Officer and Treasurer (2000); Vice President, Procurement (1994) |
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T.K. Hernquist(3) |
45 |
Senior Vice President, Chief Marketing Officer (2003) |
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B. H. Snyder |
56 |
Senior Vice President, General Counsel and Secretary (2003); General Counsel, Secretary, and Senior Vice President, International (2002); Senior Vice President - Public Affairs, General Counsel and Secretary (2002); Vice President and Assistant General Counsel (2000); Assistant General Counsel (1993) |
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D. J. West(4) |
40 |
Senior Vice President, Sales (2002); Senior Vice President, Business Planning and Development (2002); Vice President, Business Planning and Development (2001) |
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R. Brace |
60 |
Vice President, Operations and Technology (2002); Vice President, Conversion and Procurement (2000); Senior Vice President, Operations (1999) |
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G. F. Davis (5) |
55 |
Vice President, Chief Information Officer (2000) |
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D. N. Eshleman |
49 |
Vice President, Strategy and Innovation (2002); Vice President Marketing, Brand Integration (2002); Vice President Marketing, New Products (2000); Vice President Marketing, Grocery Products (1999) |
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D. W. Tacka |
50 |
Vice President and Chief Accounting Officer (2004); Vice President, Corporate Controller and Chief Accounting Officer (2000); Corporate Controller and Chief Accounting Officer (1995) |
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There are no family relationships among any of the above-named officers of the Company.
(1) Mr. Lenny was elected President and Chief Executive Officer effective March 12, 2001. Prior to joining the Company he was Group Vice President, Kraft Foods, Inc. and President, Nabisco Biscuit and Snacks (2001); President, Nabisco Biscuit Company (1998).
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(2) Mr. Bilbrey was elected Senior Vice President, President Hershey International effective November 5, 2003. Prior to joining the Company he was Executive Vice President, Sales – Mission Foods (2003); President and Chief Executive Officer – Danone Waters of North America, Inc., a division of Groupe Danone, Paris (2001); Executive Vice President, Retail Sales, North America – Danone Waters of North America, Inc., a division of Groupe Danone, Paris (2000); Owner and Operator, Commercial Cattle Operations – Bilbrey Farms and Ranch (1999); Director, Corporate Sales, Taiwan - Procter & Gamble Company (1998).
(3) Mr. Hernquist was elected Senior Vice President, Chief Marketing Officer effective April 28, 2003. Prior to joining the Company he was Senior Vice President, Marketing, – Jim Beam Brands, Fortune Brands (2002); President and Chief Executive Officer – Sierra On-line, Vivendi Universal (2001); Senior Vice President, Marketing – Nabisco Biscuit Company (2000).
(4) Mr. West was elected Vice President, Business Planning and Development effective May 30, 2001. Prior to joining the Company he was Senior Vice President Finance, Kraft Foods – Nabisco Biscuit, Confectionery and Snacks (2001); Senior Vice President and Chief Financial Officer, Nabisco Biscuit Company (1999); Vice President, Strategic Planning, Nabisco Holdings Corporation (1998).
(5) Mr. Davis was elected Vice President, Chief Information Officer effective December 14, 2000. Prior to joining the Company Mr. Davis was Vice President – Global Infrastructure Services, Computer Sciences Corporation (2000); Director – Global Infrastructure Services, Computer Sciences Corporation (1999); Executive Director – Global Infrastructure and Financial Systems, Pratt and Whitney (1998).
Executive Officers are generally elected each year at the organization meeting of the Board in April.
Information regarding the identification of the Audit Committee as a separately-designated standing committee of the Board is set forth in the Proxy Statement in the section entitled “Board Committees,” and information regarding the status of one or more members of the Audit Committee being an “audit committee financial expert” is set forth in the Proxy Statement in the section entitled “Audit Committee Report,” which information is incorporated herein by reference.
Reporting of any inadvertent late filings under Section 16(a) of the Securities Exchange Act of 1934, as amended, is set forth in the section of the Proxy Statement entitled “Section 16(a) Beneficial Ownership Reporting Compliance.” This information is incorporated herein by reference.
Information regarding the Company’s Code of Ethical Business Conduct applicable to the Company’s directors, officers and employees is set forth in Part I of this Annual Report on Form 10-K, under the heading “Available Information.”
Item 11. EXECUTIVE COMPENSATION
Information concerning compensation of each of the named executive officers, including the Chief Executive Officer, of the Company during 2003, and compensation of directors, is set forth in the sections entitled, respectively, “2003 Executive Compensation” and “Directors’ Compensation” in the Proxy Statement, which information is incorporated herein by reference.
9
Item 12. STOCKHOLDER MATTERS
| (a) | Information concerning ownership of the Company’s voting securities by certain beneficial owners, individual nominees for director, the Chief Executive Officer, the four most highly compensated executive officers other than the Chief Executive Officer and executive officers as a group, is set forth in the section entitled “Voting Securities” in the Proxy Statement, which information is incorporated herein by reference. |
| (b) | The following table provides information about the Company’s common stock that may be issued under equity compensation plans as of December 31, 2003: |
| EQUITY COMPENSATION PLAN INFORMATION | ||||||||||||
| (a) | (b) | (c) | ||||||||||
| Number of securities | ||||||||||||
| Number of securities to be | remaining available for future | |||||||||||
| issued upon exercise of | Weighted-average | issuance under equity | ||||||||||
| outstanding options, | exercise price of outstanding | compensation plans (excluding | ||||||||||
| Plan Category | warrants, and rights | options, warrants, and rights | securities reflected in column (a) | |||||||||
Equity
compensation
plans approved
by security
holders (1) |
6,704,693 | $57.48 | 6,057,689 | |||||||||
Equity
compensation
plans not
approved by
security holders (2)
|
366,466 | $57.18 | 1,186,823 | |||||||||
Total |
7,071,159 | $57.46 | 7,244,512 | |||||||||
| (1) | Column (a) includes stock options granted under the stockholder-approved Key Employee Incentive Plan (“KEIP”). The securities available for future issuance in column (c) are not allocated to any specific type of award under the KEIP, but are available generally for future awards of stock options, performance stock units (“PSUs”), restricted stock units (“RSUs”) and dividend equivalent units on RSUs granted under the KEIP. |
| (2) | Column (a) includes 135,766 stock options granted under the Hershey Foods Corporation Broad Based Stock Option Plan, also referred to as HSY Growth. HSY Growth provided all eligible employees with a one-time grant of 100 non-qualified stock options that were granted outside of the KEIP under a separate registration statement. Under HSY Growth over 1,235,700 stock options were granted on January 7, 1997 with an exercise price of $44.50, which equates to 100% of the fair market value of the Company’s Common Stock on the date of grant. The stock options vested at the end of five years and had a maximum term of ten years from the date of grant. Column (c) includes 1,093,634 HSY Growth stock options remaining available for future issuance. |
| Column (a) also includes 230,700 stock options granted to R.H. Lenny outside of the KEIP under a separate registration statement. All of the options available for issuance under the registration statement have been granted. The stock options were granted on March 12, 2001 with an exercise price of $64.65, which equates to 100% of the fair market value of the Company’s Common Stock on the date of grant (determined as the closing price on the business day immediately preceding the date the stock options were granted). The stock options are subject to a four-year step vesting requirement of 25% per year and have a ten-year term. |
| Column (c) also includes 93,189 shares remaining available for future issuance under the Directors’ Compensation Plan. The Directors’ Compensation Plan is designed to attract and retain qualified non-employee directors and to align the interests of non-employee directors with those of the stockholders by paying a portion of their compensation in units representing shares of Common Stock. Directors who are employees of the Company receive no remuneration for their services as directors. RSUs are granted quarterly to each director on the first day of January, April, July and October on the basis of the number of shares of Common Stock, valued at the average closing price on the New York Stock Exchange of the Common Stock on the last three trading days preceding the grant, equal to $10,000. While the value of the annual RSU grant is targeted at $40,000, the actual value of the grant may be higher or lower depending upon the performance of the Common Stock following the grant dates. Beginning January 1, 2004, the target for the annual RSU |
10
| grant was increased to $60,000, with the quarterly grant equal to a value of $15,000. A director’s RSUs will vest and be distributed upon his or her retirement from the Board. Directors may elect to receive all or a portion of their retainer in cash or Common Stock, although committee chair fees are paid only in cash. A director may defer receipt of the retainer and committee chair fees until his or her retirement from the Board. |
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning “Certain Relationships and Related Transactions” is set forth in the section entitled “Certain Transactions and Relationships” in the Proxy Statement, which information is incorporated herein by reference.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning “Principal Accountant Fees and Services,” including the Pre-Approval Policy Regarding Independent Auditor Services, is set forth in the section entitled “Independent Auditor Fees” in the Proxy Statement, which information is incorporated herein by reference.
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Item 15(a)(1): Financial Statements
The audited consolidated financial statements of the Company and its subsidiaries and the Reports of Independent Auditors thereon, as required to be filed with this report, are incorporated by reference into Item 8 of this report from specific pages of the Company’s Annual Report to Stockholders attached hereto and filed as Exhibit 13.
Item 15(a)(2): Financial Statement Schedule
The following consolidated financial statement schedule of the Company and its subsidiaries for the years ended December 31, 2003, 2002 and 2001 is filed herewith on the indicated page in response to Item 15(d):
Schedule II -- Valuation and Qualifying Accounts (Page 18)
Other schedules have been omitted as not applicable or required, or because information required is shown in the consolidated financial statements or notes thereto.
Financial statements of the parent company only are omitted because the Company is primarily an operating company and there are no significant restricted net assets of consolidated and unconsolidated subsidiaries.
Item 15(a)(3): Exhibits
The following items are attached or incorporated by reference in response to Item 15(c):
(3) Articles of Incorporation and By-laws
| The Company’s Restated Certificate of Incorporation, as amended, is incorporated by reference from Exhibit 3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended April 3, 1988. The By-laws, as amended and restated as of December 1, 1998, are incorporated by reference from Exhibit 3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998. |
11
(4) Instruments defining the rights of security holders, including indentures
| a. | Stockholder Protection Rights Agreement between Hershey Foods Corporation and Mellon Investor Services LLC, as Rights Agent, dated December 14, 2000, is incorporated by reference from Exhibit 4.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000. |
| b. | The Company has issued certain long-term debt instruments, no one class of which creates indebtedness exceeding 10% of the total assets of the Company and its subsidiaries on a consolidated basis. These classes consist of the following: |
| 1) | 6.7% Notes due 2005 |
| 2) | 6.95% Notes due 2007 |
| 3) | 6.95% Notes due 2012 |
| 4) | 8.8% Debentures due 2021 |
| 5) | 7.2% Debentures due 2027 |
| 6) | Obligations Associated with Consolidation of Lease Arrangements |
| 7) | Other Obligations |
| The Company will furnish copies of the above debt instruments to the Commission upon request. |
(10) Material contracts
| a. | Kit Kat and Rolo License Agreement (the “License Agreement”) between Hershey Foods Corporation and Rowntree Mackintosh Confectionery Limited is incorporated by reference from Exhibit 10(a) to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1980. The License Agreement was amended in 1988 and the Amendment Agreement is incorporated by reference from Exhibit 19 to the Company’s Quarterly Report on Form 10-Q for the quarter ended July 3, 1988. The License Agreement was assigned by Rowntree Mackintosh Confectionery Limited to Societe des Produits Nestle SA as of January 1, 1990. The Assignment Agreement is incorporated by reference from Exhibit 19 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1990. |
| b. | Peter Paul/York Domestic Trademark & Technology License Agreement between Hershey Foods Corporation and Cadbury Schweppes Inc. (now Cadbury Beverages Delaware, Inc.) dated August 25, 1988, is incorporated by reference from Exhibit 2(a) to the Company’s Current Report on Form 8-K dated September 8, 1988. This agreement was assigned by the Company to its wholly owned subsidiary, Hershey Chocolate & Confectionery Corporation. |
| c. | Cadbury Trademark & Technology License Agreement between Hershey Foods Corporation and Cadbury Limited dated August 25, 1988, is incorporated by reference from Exhibit 2(a) to the Company’s Current Report on Form 8-K dated September 8, 1988. |
| d. | The Amended and Restated 364-Day Credit Agreement among Hershey Foods Corporation, the banks, financial institutions and other institutional lenders listed on the signature pages thereof, and Citibank, N.A. as administrative agent, Bank of America, N.A. as syndication agent, and Salomon Smith Barney Inc. and Banc America Securities LLC, as joint lead arrangers and joint book managers, incorporated by reference from Exhibit 10.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, was amended and renewed as of November 25, 2003, pursuant to the agreement attached hereto and filed as Exhibit 10.1. |
| e. | The Amended and Restated Five-Year Credit Agreement among Hershey Foods Corporation, the banks, financial institutions and other institutional lenders listed on the signature pages thereof, and Citibank, N.A. as administrative agent, Bank of America, N.A. as syndication agent, and Salomon Smith Barney Inc. and Banc America Securities LLC, as joint lead arrangers and joint book managers, is incorporated by reference from Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. |
12
| f. | Trademark and Technology License Agreement between Huhtamaki and Hershey Foods Corporation dated December 30, 1996, is incorporated by reference from Exhibit 10 to the Company’s Current Report on Form 8-K dated February 26, 1997. This agreement was assigned by the Company to its wholly owned subsidiary, Hershey Chocolate & Confectionery Corporation. The agreement was amended and restated in 1999 and the Amended and |
| Restated Trademark and Technology License Agreement is incorporated by reference from Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999. |
Executive Compensation Plans and Management Contracts
| g. | Hershey Foods Corporation’s Amended and Restated Key Employee Incentive Plan is incorporated by reference from Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 29, 2002. |
| h. | Hershey Foods Corporation’s Amended and Restated Deferred Compensation Plan is incorporated by reference from Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 29, 2002. |
| i. | Hershey Foods Corporation’s Amended and Restated Supplemental Executive Retirement Plan is attached hereto and filed as Exhibit 10.2. |
| j. | Hershey Foods Corporation’s Amended and Restated Directors’ Compensation Plan is incorporated by reference from Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. |
| k. | Hershey Foods Corporation’s Executive Benefits Protection Plan (Group 3A), as amended, covering certain of its executive officers, is incorporated by reference from Exhibit 10 to the Company’s quarterly report on Form 10-Q for the quarter ended June 29, 2003. |
| l. | The Separation Agreement and General Release entered into effective December 6, 2002 between Hershey Foods Corporation and Wynn A. Willard is incorporated by reference from Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. |
| m. | The Executive Employment Agreement between Hershey Foods Corporation and Richard H. Lenny, dated March 12, 2001, is incorporated by reference from Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended April 1, 2001. |
Broad Based Equity Compensation Plans
| n. | Hershey Foods Corporation’s Broad Based Stock Option Plan, as amended, is incorporated by reference from Exhibit 10.4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. |
(12) Computation of ratio of earnings to fixed charges statement
| A computation of ratio of earnings to fixed charges for the fiscal years ended December 31, 2003, 2002, 2001, 2000 and 1999 is attached hereto and filed as Exhibit 12. |
(13) Annual report to security holders
| The Company’s Annual Report to Stockholders, included as Appendix A to the Proxy Statement, is attached hereto and filed as Exhibit 13. |
(21) Subsidiaries of the Registrant
| A list setting forth subsidiaries of the Company is attached hereto and filed as Exhibit 21. |
(23) Independent Auditors’ Consent
| The consent dated March 12, 2004 to the incorporation of reports of the Company’s Independent Auditors is attached hereto and filed as Exhibit 23. |
13
(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 Frank Cerminara, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
The following item is furnished with this report:
(32) Certification of Richard H. Lenny, Chief Executive Officer, and Frank Cerminara, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Item 15(b): Reports on Form 8-K
| A Current Report on Form 8-K was furnished to the SEC on February 18, 2004, in connection with the Company's announcement that Richard H. Lenny, Chairman, President and CEO, in a presentation made at the 2004 Consumer Analyst Group of New York ("CAGNY") Conference, reaffirmed that the Corporation expects its 2004 full-year net sales to meet its stated objective of 3-4% growth and its full-year earnings per share-diluted to meet its stated objective of 9-11% growth. |
| A Current Report on Form 8-K was furnished to the SEC on February 9, 2004, in connection with the Company's announcement, along with Dr. Barry Sears, of the planned introduction in the third quarter of 2004 of the first nutrition bars with Dr. Barry Sears' Zone Diet seal of approval. |
| A Current Report on Form 8-K was furnished to the SEC on January 28, 2004, in connection with the Company’s announcement of sales and earnings for the fourth quarter and full year ended December 31, 2003. |
| A Current Report on Form 8-K was furnished to the SEC on October 16, 2003, in connection with the Company’s announcement of sales and earnings for the third quarter of 2003. |
| A Current Report on Form 8-K was furnished to the SEC on October 7, 2003, in connection with the Company’s announcement that Robert F. Cavanaugh had been elected to the Company’s Board of Directors, effective October 7, 2003. |
14
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, this 12th day of March, 2004.
| HERSHEY FOODS CORPORATION | |
| (Registrant) |
| By: | /s/ F. CERMINARA |
|
|
|
| F. Cerminara | |
| Senior Vice President, Chief Financial Officer |
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
| Signature | Title | Date | ||||
/s/ R. H. LENNY (R. H. Lenny) |
Chief Executive Officer and Director |
March 12, 2004 |
||||
/s/ F. CERMINARA (F. Cerminara) |
Chief Financial Officer |
March 12, 2004 |
||||
/s/ D. W. TACKA (D. W. Tacka) |
Chief Accounting Officer |
March 12, 2004 |
||||
/s/J. A. BOSCIA (J. A. Boscia) |
Director |
March 12, 2004 |
||||
/s/ R. H. CAMPBELL (R. H. Campbell) |
Director |
March 12, 2004 |
||||
/s/ R. F. CAVANAUGH (R. F. Cavanaugh) |
Director |
March 12, 2004 |
||||
/s/ G. P. COUGHLAN (G. P. Coughlan) |
Director |
March 12, 2004 |
||||
/s/ H. EDELMAN (H. Edelman) |
Director |
March 12, 2004 |
||||
/s/ B. G. HILL (B. G. Hill) |
Director |
March 12, 2004 |
||||
15
| Signature | Title | Date | ||||
/s/ J. C. JAMISON (J. C. Jamison) |
Director |
March 12, 2004 |
||||
/s/ M. J. MCDONALD (M. J. McDonald) |
Director |
March 12, 2004 |
||||
/s/ M.J. TOULANTIS (M.J. Toulantis) |
Director |
March 12, 2004 |
||||
16
INDEPENDENT AUDITORS’ REPORT
The Board of Directors
and Stockholders
Hershey Foods Corporation:
Under date of January 28, 2004, we reported on the consolidated balance sheets of Hershey Foods Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, cash flows and stockholders’ equity for the years then ended, which are included in Hershey Foods Corporation’s Proxy Statement for its 2004 Annual Meeting of Stockholders incorporated by reference in this Form 10-K. In connection with our audit of the aforementioned consolidated financial statements, we also audited the schedule listed on page 18 in Item 15(a)(2). This financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this financial statement schedule based on our audit.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/KPMG LLP
New York, New York
January 28, 2004
REPORT OF PREDECESSOR AUDITOR (ARTHUR ANDERSEN LLP)
The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. This report applies to supplemental Schedule II – Valuation and Qualifying Accounts for the year ended December 31, 2001.
To Hershey Foods Corporation:
We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements included in Hershey Foods Corporation’s Proxy Statement for its 2002 Annual Meeting of Stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 22, 2002. Our audit was made for the purpose of forming an opinion on those financial statements taken as a whole. The schedule listed on page 15 in Item 14(a)(2) is the responsibility of the Company’s management and is presented for purposes of complying with the Securities and Exchange Commission’s rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ARTHUR ANDERSEN LLP
New York, New York
January 22, 2002
17
Schedule II
HERSHEY FOODS CORPORATION AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 2003, 2002 and 2001
(in thousands of dollars)
| |
Additions |
|
|
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Description | Balance at Beginning of Period |
Charged to Costs and Expenses |
Charged to Other Accounts (a) |
Deductions from Reserves |
Balance at End of Period |
|||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2003: Reserves deducted in the consolidated balance sheet from the assets to which they apply: |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Accounts Receivable - Trade | $ | 16,524 | $ | 13,119 | $ | 3,599 | $ | (12,143) | $ | 21,099 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2002: Reserves deducted in the consolidated balance sheet from the assets to which they apply: |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Accounts Receivable - Trade | $ | 15,958 | $ | 6,414 | $ | 3,023 | $ | (8,871) | $ | 16,524 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2001: Reserves deducted in the consolidated balance sheet from the assets to which they apply: |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Accounts Receivable - Trade | $ | 16,004 | $ | 8,450 | $ | 3,299 | $ | (11,795) | $ | 15,958 | ||||||||||||||||||||||||||||||||||||||||||||||||||
(a) Includes recoveries of amounts previously written off.
18
Appendix A
Annual Report to Stockholders
HERSHEY FOODS CORPORATION
MANAGEMENT’S DISCUSSION AND
ANALYSIS
Hershey Foods Corporation, its wholly-owned subsidiaries and entities in which it has a controlling financial interest (the “Company”) are engaged in the manufacture, distribution and sale of confectionery and grocery products. The Company was organized under the laws of the State of Delaware on October 24, 1927, as a successor to a business founded in 1894 by Milton S. Hershey.
OVERVIEW
The Company concluded a strong year in 2003. Operating results were consistent with management’s strategies, which provide for profitable growth in sales by focusing on key brands, such as Hershey’s, Reese’s and Hershey’s Kisses, among others; gross margin expansion through enhanced price realization, improved sales mix and supply chain efficiencies; and increases in earnings per share through increased operating profits and share repurchases. These strategies have been successful in improving profitability and have enabled expanded marketing support. Marketing support, which includes promotional allowances that reduce net sales, combined with advertising and consumer promotions expense, increased approximately 200 basis points, as a percentage of gross sales before allowances during the three-year period ended December 31, 2003. The increase was focused on promotional allowances to the Company’s customers, which market research has shown are effective in supporting profitable growth. The Company’s advertising strategy has been focused on key brands and new products which, along with more efficient agency contracts, has resulted in reduced spending. Results show that these marketing strategies have been successful in achieving performance goals and gaining market share.
Strategies providing for profitable sales growth, gross margin expansion and earnings growth, along with a disciplined approach toward capital investment, have resulted in increased economic returns for the Company. These strategies are expected to provide for the sustainable achievement of the Company’s long-term performance goals.
Net sales increased approximately 1% in 2003, compared with 2002 net sales which were down slightly from 2001. The increase in 2003 reflected the selling price increase announced in December 2002, effective in January 2003, and the introduction of new products. Net sales in 2003 and 2002 were reduced considerably as a result of business divestitures and product line rationalization as part of the Company’s business realignment initiatives. Growth in sales during the three-year period resulted from accelerating the introduction of innovative new products and limited edition items and by leveraging the Company’s selling capabilities. The Company gained market share during the period in key growth channels, reflecting its value-enhancing strategies, including the introduction of new products.
Gross margin increased to 39.0% in 2003 compared with 37.8% in 2002 and 35.5% in 2001. The selling price increase, an improved sales mix and reduced supply chain costs, primarily reflecting lower costs for raw materials and packaging, over the three-year period were the primary contributors to the enhanced margins. Margin expansion during the period was consistent with the Company’s strategy of shifting its portfolio of products to more profitable customer and consumer segments.
Net income was $457.6 million in 2003 compared with $403.6 million in 2002. Net income per share-diluted of $3.46 for 2003 was up 18% from $2.93 per share for 2002 as a result of increased income from operations and the impact of lower weighted-average shares outstanding resulting from share repurchases during the year. Income before the cumulative effect of accounting change was $465.0 million for 2003, a 15% increase over 2002. Income per share-diluted before the cumulative effect of accounting change was $3.52 for 2003, 20% higher than in 2002. Income before the cumulative effect of accounting change for 2003 included total net business realignment charges of $15.5 million after tax and a gain on the sale of certain gum brands of $5.7 million after tax.
A-1
Net income in 2002 was $403.6 million which included total net business realignment charges of $21.5 million after tax and after-tax expenses of $10.9 million related to the exploration of the sale of the Company. Net income in 2001 of $207.2 million included total net business realignment charges of $171.9 million after tax and an after-tax gain on the sale of the Luden’s throat drops business of $1.1 million.
The table below presents various items affecting the comparability of income over the three-year period ended December 31, 2003. These items include charges related to business rationalization and realignment initiatives, the gain on the sale of businesses and charges to explore the sale of the Company. The Company believes the presentation of income excluding such items provides additional information to investors to facilitate the comparison of past and present operations which are indicative of its ongoing operations. The Company excludes such items in evaluating key measures of performance internally and in assessing the impact of known trends and uncertainties on its business. The Company believes that this presentation provides a more balanced view of the underlying dynamics of the business. Financial results including the impact of business realignment and rationalization charges, gains on the sale of businesses and expenses related to the possible sale of the Company, and excluding the impact of the elimination of amortization of goodwill and other intangible assets over the three-year period may be insufficient in facilitating a complete understanding of the business as a whole and ascertaining the likelihood that past performance is indicative of future performance.
The 2003 and 2001 business realignment initiatives are described below and in Note 4 to the Consolidated Financial Statements.
| For
the years ended December 31,
|
|
2003
|
|
2002
|
|
2001
|
|
||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars except per share amounts |
Per
share- diluted |
Per
share- diluted |
Per
share- diluted |
||||||||||||||||||||||||
| Income
before cumulative effect of accounting change |
$ | 464,952 | $ | 3.52 | $ | 403,578 | $ | 2.93 | $ | 207,156 | $ | 1.50 | |||||||||||||||
| Items
affecting comparability after tax: |
|||||||||||||||||||||||||||
| Business
realignment and asset impairments included in cost of sales |
1,287 | — | 4,068 | .03 | 31,765 | .23 | |||||||||||||||||||||
| Costs
to explore the sale of the Company included in selling, marketing and
administrative expense |
— | — | 10,907 | .08 | — | — | |||||||||||||||||||||
| Business
realignment and asset impairments, net |
14,201 | .11 | 17,441 | .13 | 140,085 | 1.02 | |||||||||||||||||||||
| Gain
on sale of business |
(5,706 | ) | (.04 | ) | — | — | (1,103 | ) | (.01 | ) | |||||||||||||||||
| Elimination
of amortization of goodwill and other intangible assets |
— | — | — | — | 13,579 | .10 | |||||||||||||||||||||
| Income
excluding items affecting comparability |
$ | 474,734 | $ | 3.59 | $ | 435,994 | $ | 3.17 | $ | 391,482 | $ | 2.84 | |||||||||||||||
Income per share-diluted excluding items affecting comparability increased 13% and 12% in 2003 and 2002, respectively, reflecting the impact of the Company’s value-enhancing strategies and share repurchases during the period. This performance also drove increases in operating return on average invested capital during the period, as discussed under the heading Return Measures on page A-23.
Primary challenges in 2004 and beyond include profitable sales growth within the core confectionery category and the broader snack market and continued evolution of the product portfolio to meet emerging consumer trends, while balancing product line rationalization. Focus will continue to be placed on higher margin and faster growth channels. In addition, determining the appropriate balance of growth and profit in the Company’s seasonal and packaged candy businesses is a key imperative. The development and growth of the Company’s businesses outside North America are also important priorities for the future. Successfully meeting these challenges is critical to the Company’s achievement of its growth objectives.
A-2
The Company expects to achieve its long-term goals of three to four percent revenue growth, enhanced margins and returns, and nine to eleven percent growth in earnings per share in 2004 and beyond, despite the substantial increase in the Company’s raw material costs in 2004.
The Company’s net cash from operations was strong during the three-year period ended December 31, 2003, and was sufficient to finance capital additions, payment of dividends and repurchases of Common Stock. The Company also made significant contributions to its pension plans and reduced its short-term borrowings during the period.
RESULTS OF OPERATIONS
Net Sales
Net sales increased $52.2 million, or 1.3%, from 2002 to 2003, resulting primarily from the selling price increase, volume growth in sales of key confectionery brands reflecting the introduction of new products and limited edition items in the United States, and increased selling prices and sales volume, as well as the impact of favorable currency exchange rates for the Company’s Canadian business. These sales increases were substantially offset by higher promotional allowances, the continued rationalization of certain under-performing products and brands, including the divestiture of the Heide brands in June 2002, the discontinuance of the Company’s aseptically packaged drink products in the United States in March 2002 and the divestiture of certain gum brands in September 2003, and by a prior year buy-in associated with the January 2003 price increase. Net sales were also reduced by declines in export sales to Latin America and Asia, due primarily to changes in distributor relationships in certain markets and the discontinuance of certain products.
Net sales decreased $16.9 million from 2001 to 2002, primarily as a result of increased promotion costs and returns, discounts and allowances, the divestiture of the Heide brands in 2002 and the timing of sales related to the gum and mint business acquired from Nabisco Inc. (“Nabisco”) which resulted in incremental sales in 2001 compared with 2002. A challenging retail environment, characterized by the bankruptcies and store closings of certain customers, also contributed to the lower sales. Sales were also lower in several international markets, particularly Canada and Brazil. These sales decreases were partially offset by volume increases of key confectionery brands, including new products and line extensions, and selected confectionery selling price increases, as well as incremental sales from the Visagis acquisition, the Brazilian chocolate and confectionery business acquired in July 2001.
In December 2002, the Company announced an increase of 11% in the price of standard-size candy bars effective January 1, 2003, representing an average increase of approximately 3% over the entire domestic product line. A buy-in prior to the January 1, 2003 price increase resulted in an approximate 1% to 2% increase in fourth quarter, 2002 sales.
Cost of Sales
Cost of sales decreased $16.3 million from 2002 to 2003. The cost decline was primarily caused by the divestitures and rationalization of certain products and lower supply chain costs, principally associated with reduced costs for raw materials, packaging, shipping and distribution. Lower raw material costs primarily for peanuts and dairy products were partially offset by higher costs for cocoa. These cost reductions were offset somewhat by sales volume increases for key confectionery brands. Cost of sales included costs associated with business realignment initiatives of $2.1 million and $6.4 million in 2003 and 2002, respectively. Business realignment costs in 2003 related to the write-off of certain inventories associated with discontinued products and, in 2002, reflected the relocation of manufacturing equipment due to the rationalization and consolidation of production lines.
Gross margin increased from 37.8% in 2002 to 39.0% in 2003. The margin expansion reflected the impact of the price increase, an improved sales mix and the aforementioned decrease in supply chain costs. These margin improvements were partially offset by increases in promotional allowances.
A-3
Cost of sales decreased $107.5 million, or 4%, from 2001 to 2002. Cost of sales in 2002 included $6.4 million of costs primarily related to the relocation of equipment associated with the Company’s business realignment initiatives. Cost of sales in 2001 included $50.1 million associated with business realignment initiatives recorded in the fourth quarter of that year. The decrease in cost of sales from 2001 to 2002 primarily reflected lower costs associated with business realignment initiatives, lower costs for certain major raw materials, primarily cocoa, milk and packaging materials, and reduced supply chain costs, particularly related to shipping and distribution.
Gross margin increased from 35.5% in 2001 to 37.8% in 2002. Gross margin in 2001 was negatively impacted 1.2 percentage points from the inclusion in cost of sales of a charge of $50.1 million associated with business realignment initiatives recorded during the fourth quarter of that year. Gross margin in 2002 was reduced by .2 percentage points from business realignment charges of $6.4 million recorded in cost of sales during the year. The increase in gross margin from 2001 to 2002 primarily reflected decreased costs for certain major raw materials, higher profitability resulting from the mix of confectionery items sold in 2002 compared with sales in 2001 and the impact of supply chain efficiencies in addition to reduced costs associated with business realignment initiatives. These increases in gross margin were partially offset by higher promotion costs and returns, discounts and allowances, which were higher as a percent of sales compared to the prior year. Gross margin was also unfavorably impacted in 2002 by poor profitability in the Company’s Canadian and Brazilian businesses.
Selling, Marketing and Administrative
Selling, marketing and administrative expenses for 2003 decreased by 2% from 2002, primarily attributable to a charge of $17.2 million in 2002 related to the exploration of the sale of the Company. Advertising and consumer promotion expenses were also lower in 2003 as a result of decisions to increase promotional allowances, as discussed above, and more efficient agency contracts. These cost reductions were offset somewhat by increased compensation and employee benefits costs, packaging development and marketing research expenses. Additionally, the bad debt reserve was increased by $5.0 million in the first quarter of 2003 as an estimate of probable exposure to the bankruptcy of one of the Company’s customers, Fleming Companies, Inc., announced on April 1, 2003.
Selling, marketing and administrative expenses for 2002 decreased by $13.6 million, or 2% from 2001, primarily as a result of savings from the business realignment initiatives and the elimination of goodwill amortization in 2002, offset by $17.2 million of expenses incurred to explore the possible sale of the Company, as discussed below. The decrease in 2002 primarily reflected lower advertising, depreciation and administrative expenses, partially offset by higher expenses associated with increased consumer marketing programs and selling activities.
On July 25, 2002, the Company confirmed that the Hershey Trust Company, as Trustee for the Benefit of Milton Hershey School (the “Milton Hershey School Trust”) which at that time controlled 77.6% of the combined voting power of the Company’s Common Stock and Class B Common Stock, had informed the Company that it had decided to diversify its holdings and in this regard wanted Hershey Foods Corporation to explore a sale of the entire Company. On September 17, 2002, the Milton Hershey School Trust informed the Company that it had elected not to sell its controlling interest and requested that the process to explore a sale be terminated.
Business Realignment Initiatives
In July 2003, the Company announced a number of initiatives continuing its value-enhancing strategy. These initiatives included realigning the sales organization and streamlining the supply chain by divesting or eliminating certain non-strategic brands and products, and by production line rationalization.
During 2003, these actions resulted in a net charge of approximately $17.2 million, or $.07 per share-diluted. The $17.2 million net charge consisted of the write-off of certain inventories of $2.1 million included in cost of sales, a net business realignment and asset impairments charge of $23.4 million and an $8.3 million net gain resulting from the divestiture of certain brands.
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The net business realignment and asset impairments charge of $23.4 million consisted of early retirement and involuntary termination costs of $10.0 million, sales office closing and relocation costs of $7.3 million, fixed asset impairment charges of $5.7 million, equipment removal costs of $.7 million and a net gain of $.3 million relating to the elimination of non-strategic brands and products. In determining the fixed asset impairment losses, fair value was estimated based on the expected sales proceeds. Cash payments during the third and fourth quarters of 2003 reduced the liability balance, primarily relating to the aforementioned charges for employee termination, sales office closing and relocation costs, to $8.8 million as of December 31, 2003.
In late October 2001, the Company’s Board of Directors approved a plan to improve the efficiency and profitability of the Company’s operations. The plan included asset management improvements, product line rationalization, supply chain efficiency improvements and a voluntary work force reduction program (collectively, “the 2001 business realignment initiatives”). Total costs for the 2001 business realignment initiatives recorded in 2002 and 2001 were $312.4 million.
During 2002, charges to cost of sales and business realignment and asset impairments were recorded totaling $34.0 million before tax. The total included a charge to cost of sales of $6.4 million associated with the relocation of manufacturing equipment and a net business realignment and asset impairments charge of $27.6 million. Components of the net $27.6 million pre-tax charge included a $28.8 million charge for pension settlement losses resulting from a voluntary work force reduction program (“VWRP”), a $3.0 million charge for pension curtailment losses and special termination benefits resulting from manufacturing plant closures, a $.1 million charge relating to involuntary termination benefits and a $.1 million charge relating to the realignment of the domestic sales organization, partially offset by a $4.4 million favorable adjustment reflecting higher than estimated proceeds from the sale of certain assets.
During the fourth quarter of 2001, charges to cost of sales and business realignment and asset impairments were recorded totaling $278.4 million before tax. The total included a charge to cost of sales of $50.1 million associated with raw material inventory reductions and a business realignment and asset impairments charge of $228.3 million. Components of the $228.3 million pre-tax charge included $175.2 million for business realignment charges and $53.1 million for asset impairment charges. The $175.2 million for business realignment charges included $139.8 million for enhanced pension and other post-retirement benefits associated with the VWRP and $35.4 million for other costs associated with the 2001 business realignment initiatives. The $53.1 million for asset impairment charges included $45.3 million for fixed asset impairments and $7.8 million for goodwill impairment. The major components of the 2001 business realignment initiatives were completed as of December 31, 2002. Remaining transactions primarily pertain to the sale of certain real estate associated with the closure of facilities, as discussed below.
Product line rationalization plans included the sale or exit of certain businesses, the discontinuance of certain non-chocolate confectionery products and the realignment of the Company’s sales organizations. Costs associated with the realignment of the sales organizations related primarily to sales office closings and terminating the use of certain sales brokers. During 2002, sales offices were closed as planned and the use of certain sales brokers was discontinued which resulted in an additional charge of $.1 million. During the second quarter of 2002, the sale of a group of the Company’s non-chocolate confectionery candy brands to Farley’s & Sathers Candy Company, Inc. (“Farley’s & Sathers”) was completed. Included in the transaction were the Heide, Jujyfruits, Wunderbeans and Amazin’ Fruit trademarked confectionery brands, as well as the rights to sell Chuckles branded products, under license. Proceeds of $12.0 million associated with the sale of certain confectionery brands to Farley’s & Sathers exceeded the 2001 estimates which resulted in a $4.4 million favorable adjustment. Also during the second quarter of 2002, the Company discontinued and subsequently licensed the sale of its aseptically packaged drink products in the United States. Net sales for these brands were $11.6 million and $34.2 million in 2002 and 2001, respectively. The sale of certain confectionery brands to Farley’s & Sathers resulted in the closure of a manufacturing facility in New Brunswick, New Jersey which was being held for sale as of December 31, 2002. The manufacturing facility was sold in May 2003. An additional charge of
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$.7 million relating to pension curtailment losses and special termination benefits associated with the closure of the facility was recorded in 2002.
To improve supply chain efficiency and profitability, three manufacturing facilities, a distribution center and certain other facilities were planned to be closed. These included manufacturing facilities in Denver, Colorado; Pennsburg, Pennsylvania; and Palmyra, Pennsylvania and a distribution center and certain minor facilities located in Oakdale, California. During the first quarter of 2002, the manufacturing facility in Palmyra, Pennsylvania was closed and additional costs of $.1 million were recorded, as incurred, relating to retention payments. During the second quarter, operations utilizing the distribution center in Oakdale, California ceased. The manufacturing facilities in Denver, Colorado and Pennsburg, Pennsylvania were closed in the fourth quarter of 2002. An additional charge of $2.3 million relating to pension curtailment losses and special termination benefits associated with the facility closures was recorded in 2002. The Denver, Colorado facility was being held for sale and the Pennsburg, Pennsylvania facility was idle and being held for possible future use as of December 31, 2003.
In October 2001, the Company offered the VWRP to certain eligible employees in the United States, Canada and Puerto Rico in order to reduce staffing levels and improve profitability. The VWRP consisted of an early retirement program which provided enhanced pension, post-retirement and certain supplemental benefits and an enhanced mutual separation program which provided increased severance and temporary medical benefits. A reduction of approximately 500 employees occurred during 2002 as a result of the VWRP. Additional pension settlement costs of $28.8 million were recorded in 2002, principally associated with lump sum payments of pension benefits.
The following table summarizes the charges for certain business realignment initiatives recorded in the fourth quarter of 2001 and the related activities completed during 2002:
| Accrued Liabilities | Balance 12/31/01 |
2002 Utilization |
New charges during 2002 |
Balance 12/31/02 |
||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
|
|
||||||||||||||
| In
thousands of dollars |
||||||||||||||||||
Asset
management improvements |
$ | 2,700 | $ | (2,700 | ) | $ | — | $ | — | |||||||||
Product
line rationalization |
15,529 | (15,644 | ) | 115 | — | |||||||||||||
Supply
chain efficiency improvements |
8,300 | (8,400 | ) | 100 | — | |||||||||||||
Voluntary
work force reduction program |
8,860 | (8,860 | ) | — | — | |||||||||||||
Total |
$ | 35,389 | $ | (35,604 | ) | $ | 215 | $ | — | |||||||||
New charges during 2002 related to the elimination of the Company’s broker sales force and termination benefits associated with the closing of a manufacturing facility. Utilization recorded against the liability in 2002 reflected cash payments totaling $25.7 million and non-cash write-offs of $9.9 million associated primarily with exiting certain businesses. The cash payments related primarily to severance payments associated with the enhanced mutual separation program and plant closures, outsourcing the manufacture of certain ingredients, VWRP administrative expenses, the realignment of the Company’s sales organizations and other expenses associated with exiting certain businesses and maintaining properties prior to sale.
Gain on Sale of Business
As part of the Company’s business realignment initiatives, the sale of a group of gum brands to Farley’s & Sathers was completed in September 2003. The gum brands included Fruit Stripe chewing gum, Rain-Blo gum balls and Super Bubble bubble gum. In the third quarter of 2003, the Company received cash proceeds from the sale of $20.0 million and recorded a gain of $8.3 million before tax, or $5.7 million after tax, as a result of the transaction.
In September 2001, the Company completed the sale of the Luden’s throat drops business to Pharmacia Consumer Healthcare, a unit of Pharmacia Company. Included in the sale were the trademarks and manufacturing equipment for the throat drops business. In the third quarter
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of 2001, the Company received cash proceeds of $59.9 million and recorded a gain of $19.2 million before tax, $1.1 million after tax, as a result of the transaction. A higher gain for tax purposes reflected the low tax basis of the intangible assets included in the sale, resulting in taxes on the gain of $18.1 million. Net sales for the Luden’s throat drops business were $8.9 million and $20.7 million in 2001 and 2000, respectively.
Interest Expense, Net
Net interest expense for 2003 was $2.8 million higher than in 2002 primarily reflecting lower interest income and higher fixed interest expense, principally due to interest expense associated with the consolidation of three former off-balance sheet arrangements for the leasing of certain warehouse and distribution facilities, as discussed below. Net interest expense for 2002 was $8.4 million below the prior year, primarily as a result of a decrease in short-term interest expense due to reduced average short-term borrowings.
Income Taxes
The Company’s effective income tax rate was 36.6% in 2003, 36.7% in 2002 and 39.7% in 2001. The lower effective income tax rate in 2003 reflected the impact of the effective tax rates on business rationalization and realignment initiatives and the gain on sale of business in 2003. The decrease in the effective income tax rate from 2001 to 2002 primarily reflected the income tax provision associated with the gain on the sale of the Luden’s throat drops business in 2001 and the impact of the elimination of the amortization of intangibles in 2002.
Cumulative Effect of Accounting Change
An after-tax charge of $7.4 million, or $.06 per share-diluted, was recorded in 2003 to reflect the cumulative effect of a change in accounting for the Company’s leases of certain warehouse and distribution facilities as discussed further under the heading Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments.
Net Income
Net income was $457.6 million in 2003 compared with $403.6 million in 2002. Net income per share-diluted of $3.46 for 2003, was up 18% from $2.93 per share for 2002 as a result of increased income from operations and the impact of lower weighted-average shares outstanding resulting from share repurchases during the year. Income before the cumulative effect of accounting change was $465.0 million for 2003, a 15% increase over 2002. Income per share-diluted before the cumulative effect of accounting change was $3.52 for 2003, 20% higher than in 2002. Income before the cumulative effect of accounting change for 2003 included total net business realignment charges of $15.5 million after tax and a gain on the sale of certain gum brands of $5.7 million after tax.
Net income in 2002 was $403.6 million including total net business realignment charges of $21.5 million after tax and after-tax expenses of $10.9 million related to the exploration of the sale of the Company. Net income in 2001 of $207.2 million included total net business realignment charges of $171.9 million after tax and an after-tax gain on the sale of the Luden’s throat drops business of $1.1 million.
FINANCIAL CONDITION
The Company’s financial condition remained strong during 2003. The capitalization ratio (total short-term and long-term debt as a percent of stockholders’ equity, short-term and long-term debt) increased to 43% as of December 31, 2003, from 39% as of December 31, 2002, primarily as a result of higher long-term debt due to the consolidation of special-purpose trusts (“SPTs”) associated with the leasing of certain warehouse and distribution facilities and decreased stockholders’ equity as a result of share repurchases in 2003. The ratio of current assets to current liabilities decreased to 1.9:1 as of December 31, 2003, from 2.3:1 as of December 31, 2002 primarily reflecting a decrease in cash and cash equivalents and an increase in accrued liabilities.
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In September 2003, the Company completed the sale of certain gum brands to Farley’s & Sathers for $20.0 million in cash as part of its business realignment initiatives. The gum brands included Fruit Stripe chewing gum, Rain-Blo gum balls and Super Bubble bubble gum.
In June 2002, the Company completed the sale of certain confectionery brands to Farley’s & Sathers for $12.0 million in cash as part of its 2001 business realignment initiatives. Included in the transaction were the Heide, Jujyfruits, Wunderbeans and Amazin’ Fruit trademarked confectionery brands, as well as the rights to sell Chuckles branded products, under license.
In September 2001, the Company completed the sale of the Luden’s throat drops business to Pharmacia Consumer Healthcare, a unit of Pharmacia Company. Included in the sale were the trademarks and manufacturing equipment for the throat drops business. In the third quarter of 2001, the Company received cash proceeds of $59.9 million and recorded a gain of $19.2 million before tax, $1.1 million or $.01 per share-diluted after tax, as a result of the transaction.
In July 2001, the Company’s Brazilian subsidiary, Hershey do Brasil, acquired the chocolate and confectionery business of Visagis for $17.1 million. This business had sales of approximately $20 million in 2000. Included in the acquisition were the IO-IO brand of hazelnut crème items and the chocolate and confectionery products sold under the Visconti brand. Also included in the purchase were a manufacturing plant and confectionery equipment in Sao Roque, Brazil. Had the results of the acquisition been included in the consolidated results for the full year of 2001, the effect would not have been material.
Assets
Total assets increased $102.0 million, or 3%, as of December 31, 2003, primarily as a result of higher accounts receivable, other current and non-current assets and property, plant and equipment, offset substantially by lower cash and cash equivalents.
Current assets decreased by $132.0 million principally reflecting decreased cash and cash equivalents resulting primarily from increased funding for share repurchases, capital additions and pension plan contributions during the year. This decrease was partially offset by higher accounts receivable due to increased sales in December 2003 compared with the prior year.
The increase in property, plant and equipment was primarily due to the consolidation of SPTs associated with the leasing of certain warehouse and distribution facilities of $107.7 million and capital expenditures, net of depreciation expense, during the year. The increase in other current and non-current assets reflected the funding of pension plans in 2003.
P ALIGN="LEFT">LiabilitiesTotal liabilities increased by $193.8 million, as of December 31, 2003, primarily reflecting an increase in accrued liabilities and long-term debt. Higher accrued liabilities were principally related to increased promotional allowances and employee benefits. The increase in long-term debt was primarily related to long-term debt of $115.5 million resulting from the consolidation of SPTs associated with the leasing of certain warehouse and distribution facilities.
Capital Structure
The Company has two classes of stock outstanding, Common Stock and Class B Common Stock (“Class B Stock”). Holders of the Common Stock and the Class B Stock generally vote together without regard to class on matters submitted to stockholders, including the election of directors, with the Common Stock having one vote per share and the Class B Stock having ten votes per share. However, the Common Stock, voting separately as a class, is entitled to elect one-sixth of the Board of Directors. With respect to dividend rights, the Common Stock is entitled to cash dividends 10% higher than those declared and paid on the Class B Stock.
In December 2000, the Company’s Board of Directors unanimously adopted a Stockholder Protection Rights Agreement (“Rights Agreement”). The Company’s largest stockholder, the Milton Hershey
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School Trust, supported the Rights Agreement. This action was not in response to any specific effort to acquire control of the Company. Under the Rights Agreement, the Company’s Board of Directors declared a dividend of one right (“Right”) for each outstanding share of Common Stock and Class B Stock payable to stockholders of record at the close of business on December 26, 2000. The Rights will at no time have voting power or receive dividends. The issuance of the Rights has no dilutive effect, will not affect reported earnings per share, is not taxable and will not change the manner in which the Company’s Common Stock is traded. The Rights Agreement is discussed further in Note 16 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company’s major source of financing has been cash generated from operations. The Company’s income and, consequently, cash provided from operations during the year are affected by seasonal sales patterns, the timing of new product introductions, business acquisitions and divestitures, and price changes. Sales have typically been highest during the third and fourth quarters of the year, representing seasonal and holiday-related sales patterns. Generally, seasonal working capital needs peak during the summer months and have been met by issuing commercial paper.
Over the past three years, cash provided from operating activities and cash and cash equivalents on hand at the beginning of 2003 exceeded cash requirements for capital expenditures and capitalized software additions, dividend payments, share repurchases, incentive plan transactions and repayment of debt by $12.1 million. Cash provided from operating activities during the period included contributions to pension plans of $600.7 million. Total debt decreased during the period by $154.8 million, reflecting reduced short-term borrowings and the repayment of long-term debt, partially offset by an increase in long-term debt resulting from the consolidation of SPTs associated with certain lease agreements in 2003. Cash and cash equivalents increased by $82.8 million during the period.
The Company anticipates that capital expenditures and capitalized software additions will be in the range of $175 million to $200 million per annum during the next several years primarily for continued efficiency improvements in existing facilities and capacity expansion to support sales growth and new products, along with continued improvement and enhancements of computer software. As of December 31, 2003, the Company’s principal capital commitments included manufacturing capacity expansion to support sales growth and new products, construction of a mid-western distribution facility, modernization and efficiency improvements and selected enhancements of computer software.
As of December 31, 2003, the fair value of the Company’s pension plan assets exceeded benefits obligations. Contributions totaling $120.3 million and $308.1 million were made to the pension plans during 2003 and 2002, respectively, primarily to improve the funded status as a result of negative returns on pension plan assets during 2002. In order to improve the funded status of the Company’s domestic pension plans, a contribution of $75.0 million was made in February 2001. An additional contribution of $95.0 million was made in December 2001 to fund payments related to the early retirement program implemented in the fourth quarter of that year.
Under share repurchase programs which began in 1993, a total of 24,525,182 shares of Common Stock have been repurchased for approximately $1.2 billion, including purchases from the Milton Hershey School Trust of 4,000,000 shares for $103.1 million in 1993 and 1,579,779 shares for $100.0 million in 1999. Of the shares repurchased, 528,000 shares were retired and 9,010,078 shares were reissued to satisfy stock options obligations, Supplemental Retirement Contributions and employee stock ownership trust (“ESOP”) obligations. Of the shares reissued, 7,433,499 shares were repurchased in the open market to replace the reissued shares. Additionally, the Company has purchased a total of 28,000,536 shares of its Common Stock to be held as Treasury Stock from the Milton Hershey School Trust for $1.0 billion in privately negotiated transactions. In December 2002, the Company’s Board of Directors approved a share repurchase program authorizing the repurchase of up to $500 million of the Company’s Common Stock. Under this program, a total of 4,924,200 shares of Common Stock was purchased through December 31, 2003, for $329.4 million. As of December 31, 2003, a total of
A-9
50,421,139 shares were held as Treasury Stock and $170.6 million remained available for repurchases of Common Stock under the repurchase program.
As of December 31, 2003, $250 million of debt securities remained available for issuance under an August 1997 Form S-3 Registration Statement. Proceeds from any offering of the $250 million of debt securities available under the shelf registration may be used for general corporate requirements, which include reducing existing commercial paper borrowings, financing capital additions and share repurchases, and funding future business acquisitions and working capital requirements.
As of December 31, 2003, the Company maintained short-term and long-term committed credit facilities with a syndicate of banks in the amount of $400 million that could be borrowed directly or used to support the issuance of commercial paper. The Company may increase the credit facilities to $1.0 billion with the concurrence of the banks. In November 2003, the short-term credit facility agreement was renewed with a credit limit of $200 million expiring in November 2004. The long-term committed credit facility agreement with a $200 million credit limit will expire in November 2006. The credit facilities may be used to fund general corporate requirements, to support commercial paper borrowings and, in certain instances, to finance future business acquisitions. The Company also had lines of credit with domestic and international commercial banks of $43.6 million and $21.0 million as of December 31, 2003 and 2002, respectively. The higher lines of credit as of December 31, 2003, were associated with an anticipated increase in borrowing requirements for the Company’s Canadian business.
Cash Flow Activities
Over the past three years, cash from operating activities provided approximately $1.9 billion. Over this period, cash used by or provided from accounts receivable and inventories has tended to fluctuate as a result of sales during December and inventory management practices. Higher cash provided from inventories in 2001 was principally associated with a reduction in raw material inventories in December 2001 as part of the Company’s business realignment initiatives. The change in cash required for or provided from other assets and liabilities between the years was primarily related to hedging transactions, the timing of payments for accrued liabilities, including income taxes, and variations in the funded status of pension plans.
Investing activities included capital additions, capitalized software additions, business acquisitions and divestitures. Capital additions during the past three years included the purchase of manufacturing equipment, and expansion and modernization of existing facilities. Capitalized software additions over the past three years were associated primarily with the ongoing enhancement of information systems.
In August 2003, the Company completed the sale of a group of gum brands to Farley’s & Sathers for $20.0 million in cash as part of its business realignment initiatives and in June 2002, the Company completed the sale of certain confectionery brands to Farley’s & Sathers for $12.0 million in cash as part of its 2001 business realignment initiatives.
In July 2001, the Company’s Brazilian subsidiary, Hershey do Brasil, acquired the chocolate and confectionery business of Visagis for $17.1 million. In September 2001, the Luden’s throat drops business was sold for $59.9 million in cash.
Financing activities included debt borrowings and repayments, payments of dividends, the exercise of stock options, incentive plan transactions and the repurchase of Common Stock. During the past three years, short-term borrowings in the form of commercial paper or bank borrowings were used to purchase Nabisco’s mint and gum business, fund seasonal working capital requirements and finance share repurchase programs. During the past three years, a total of 6,901,145 shares of Common Stock have been repurchased for $453.9 million. Cash used for incentive plan transactions of $308.2 million during the past three years was partially offset by cash received from the exercise of stock options of $171.8 million. Cash used by incentive plan transactions reflected purchases of the Company’s Common Stock in the open market to replace treasury stock issued for stock options exercises.
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Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments
The following table summarizes the Company’s contractual cash obligations by year:
| Payments
Due by Year
|
|
||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In
thousands of dollars) |
|||||||||||||||||||||||||||||||
| Contractual Obligations |
2004 | 2005 | 2006 | 2007 | 2008 | Thereafter | Total | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||||||||||||
|
Unconditional
Purchase Obligations |
$ | 758,600 | $ | 427,100 | $ | 80,900 | $ | 12,600 | $ | 7,500 | $ | 3,800 | $ | 1,290,500 | |||||||||||||||||
|
Non-cancelable Operating Leases |
14,599 | 14,392 | 13,783 | 12,187 | 10,145 | 13,738 | 78,844 | ||||||||||||||||||||||||
|
Long-term
Debt |
477 | 279,061 | 142 | 189,960 | 147 | 499,189 | 968,976 | ||||||||||||||||||||||||
|
Total
Obligations |
$ | 773,676 | $ | 720,553 | $ | 94,825 | $ | 214,747 | $ | 17,792 | $ | 516,727 | $ | 2,338,320 | |||||||||||||||||
In entering into contractual obligations, the Company has assumed the risk which might arise from the possible inability of counterparties to meet the terms of their contracts. The Company’s risk is limited to replacing the contracts at prevailing market rates. The Company does not expect any significant losses as a result of counterparty defaults.
The Company has entered into certain obligations for the purchase of raw materials. Purchase obligations primarily reflect forward contracts for the purchase of raw materials from third-party brokers and dealers to minimize the effect of future price fluctuations. Total obligations for each year are comprised of fixed price contracts for the purchase of commodities and unpriced contracts that have been valued using market prices as of December 31, 2003. The cost of commodities associated with the unpriced contracts is variable as market prices change over future periods. However, the variability of such costs is mitigated to the extent of the Company’s futures price cover for those periods. Accordingly, increases or decreases in market prices will be offset by gains or losses on commodity futures contracts to the extent that the unpriced contracts are hedged as of December 31, 2003 and in future periods. Taking delivery of the specific commodities for use in the manufacture of finished goods satisfies these obligations. For each of the three years in the period ended December 31, 2003, such obligations were fully satisfied by taking delivery of and making payment for the specific commodities.
In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (“Interpretation No. 46”). Interpretation No. 46 addresses consolidation by business enterprises of special-purpose entities (“SPEs”), such as SPTs, to which the usual condition for consolidation described in Accounting Research Bulletin No. 51, Consolidated Financial Statements, does not apply because the SPEs have no voting interests or otherwise are not subject to control through ownership of voting interests.
The Company adopted Interpretation No. 46 as of June 30, 2003, resulting in the consolidation of three off-balance sheet arrangements with SPTs. As of December 31, 2003, the Company had no off-balance sheet arrangements. The consolidation of the SPTs resulted in an adjustment to record the cumulative effect of the accounting change of approximately $7.4 million, or $.06 per share-diluted, in the third quarter of 2003, reflecting the after-tax effect of accumulated depreciation for these facilities from lease inception through June 29, 2003. Additionally, the consolidation of these entities resulted in a net increase to property, plant and equipment of approximately $107.7 million, with a corresponding increase to long-term debt of $115.5 million and to other long-term liabilities of $4.4 million, reflecting the third party equity interest associated with the lease arrangements. Prior to June 30, 2003, expenses associated with the lease arrangements were classified as rent expense and included in cost of sales in the Consolidated Statement of Income. Subsequent to the consolidation of these entities, expenses were classified as interest expense associated with the corresponding long-term debt. The consolidation of these entities resulted in an increase to interest expense of $2.8
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million in 2003, offset by a decrease in rental expense for these facilities included in cost of sales. An increase in depreciation expense of $2.6 million in 2003 also resulted from the consolidation of these entities, which will amount to higher depreciation expense of approximately $5.2 million on an annual basis.
During 1999 and 2000, the Company entered into off-balance sheet arrangements for the leasing of certain warehouse and distribution facilities. These off-balance sheet arrangements enabled the Company to lease these facilities under more favorable terms than other leasing alternatives. The lease arrangements are with SPTs whereby the Company leases warehouse and distribution facilities in Redlands, California; Atlanta, Georgia; and Hershey, Pennsylvania, as discussed below. The SPTs were formed to facilitate the acquisition and subsequent leasing of the facilities to the Company. The SPTs financed the acquisition of the facilities by issuing notes and equity certificates to independent third-party financial institutions. The independent third-party financial institutions that hold the equity certificates are the owners of the SPTs. The owners of the SPTs have made substantive residual equity capital investments in excess of 3% which will be at risk during the entire term of each lease. Accordingly, the Company did not consolidate the SPTs prior to June 30, 2003 because all of the conditions for consolidation had not been met.
In December 2000, the Company entered into a lease agreement with the owner of the warehouse and distribution facility in Redlands, California. The lease term was approximately ten years, with occupancy to begin upon completion of the facility. The lease agreement contained an option for the Company to purchase the facility. In January 2002, the Company assigned its right to purchase the facility to an SPT that in turn purchased the completed facility and leased it to the Company under a new lease agreement. The lease term is five years, with up to four renewal periods of five years each with the consent of the lessor. The cost incurred by the SPT to acquire the facility, including land, was $40.1 million.
In October 2000, the Company entered into a lease agreement with an SPT for the leasing of a warehouse and distribution facility near Atlanta, Georgia. The lease term is five years, with up to four renewal periods of five years each with the consent of the lessor. The cost incurred by the SPT to acquire the facility, including land, was $18.2 million.
In July 1999, the Company entered into a lease agreement with an SPT for the construction and leasing of a warehouse and distribution facility located on land owned by the Company near Hershey, Pennsylvania. Under the agreement, the lessor paid construction costs totaling $61.7 million. The lease term is six years, including the one-year construction period, with up to four renewal periods of five years each with the consent of the lessor.
Aside from the residual guarantees and instrument guarantees associated with the individual leasing arrangements, as discussed below, the Company has provided no other guarantees or capitalization of these entities. The Company has not collateralized the obligations in connection with these leases. The Company has no obligations with respect to refinancing of the lessor’s debt, would incur no significant penalties which would result in the reasonable assurance of continuation of the leases and has no significant guarantees other than the residual and instrument guarantees discussed below. There are no other material commitments or contingent liabilities associated with the leasing arrangements. The Company’s transactions with the SPTs are limited to the lease agreements. The Company does not anticipate entering into any other arrangements involving SPEs.
The leases include substantial residual guarantees by the Company for a significant amount of the financing and options to purchase the facilities at original cost. Pursuant to instrument guarantees, in the event of a default under the lease agreements, the Company guaranteed to the note holders and certificate holders payment in an amount equal to all sums then due under the leases.
There are no penalties or other disincentives under the lease agreements if the Company decides not to renew any of the three leases. The terms for each renewal period under each of the three lease arrangements are identical to the initial terms and do not represent bargain lease terms.
A-12
If the Company were to exercise its options to purchase the three facilities at original cost at the end of the respective initial lease terms, the Company could purchase the facilities for a total of approximately $120.0 million, $79.9 million for the Pennsylvania and Georgia facilities in 2005 and $40.1 million for the California facility in 2007. If the Company chooses not to renew the leases or purchase the assets at the end of the lease terms, the Company is obligated under the residual guarantees for approximately $103.2 million in total for the three leases. Additionally, the Company is obligated to re-market each property on the lessor’s behalf and, upon sale, distribute a portion of the proceeds to the note holders and certificate holders up to an amount equal to the remaining debt and equity certificates and to pay closing costs. If the Company chooses not to renew or purchase the assets at the end of the lease terms, the Company does not anticipate a material disruption to operations, since such facilities are not unique, facilities with similar racking and storage capabilities are available in each of the areas where the facilities are located, there are no significant leasehold improvements that would be impaired, there would be no adverse tax consequences, the financing of replacement facilities would not be material to the Company’s cash flows and costs related to relocation would not be significant to income.
The facility located near Hershey, Pennsylvania was constructed on land owned by the Company. The Company entered into a ground lease with the lessor, an SPT. The initial term of the ground lease extends to the date that is the later of (i) the date the facility lease is no longer in effect, or (ii) the date when the Company satisfies the residual guarantee associated with the lease. An additional term for the ground lease begins upon the end of the initial ground lease term and ends upon the later of the date all sums required to be paid under the lease agreement are paid in full and the 75th anniversary of the ground lease commencement date. If the Company chooses not to renew the building lease or purchase the building, it must re-market the building on the lessor’s behalf subject to the ground lease, which will continue in force until the earlier of the date all sums required to be paid under the lease agreement are paid in full and the 75th anniversary of the ground lease inception date. The lease of the warehouse and distribution facility does not include any provisions which would require the Company to sell the land to the SPT.
The Company’s provision for income taxes, accrued income taxes and deferred income taxes are based upon income, statutory tax rates, the legal structure of the Company and interpretation of tax laws. As a matter of course, the Company is regularly audited by federal, state and foreign tax authorities. From time to time, these audits result in assessments of additional tax. The Company maintains reserves for such assessments. The reserves are determined based upon the Company’s judgment of assessment risk and are adjusted, from time to time, based upon changing facts and circumstances, such as receiving audit assessments or clearing of an item for which a reserve has been established.
Assessments of additional tax require use of the Company’s cash. The Company is not aware of any significant income tax assessments.
ACCOUNTING POLICIES AND MARKET RISKS ASSOCIATED WITH DERIVATIVE INSTRUMENTS
The Company utilizes certain derivative instruments, from time to time, including interest rate swaps, foreign currency forward exchange contracts and options and commodities futures contracts, to manage interest rate, currency exchange rate and commodity market price risk exposures. Interest rate swaps and foreign currency contracts and options are entered into for periods consistent with related underlying exposures and do not constitute positions independent of those exposures. Commodities futures contracts are entered into for varying periods and are intended to be and are effective as hedges of market price risks associated with anticipated raw material purchases, energy requirements and transportation costs. The Company does not hold or issue derivative instruments for trading purposes and is not a party to any instruments with leverage or prepayment features. In entering into these contracts, the Company has assumed the risk that might arise from the possible inability of counterparties to meet the terms of their contracts. The Company does not expect any significant losses as a result of counterparty defaults.
A-13
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. Subsequently, the FASB issued Statement No. 137, Accounting for Derivative Instruments and Hedging Activities–Deferral of the Effective Date of FASB Statement No. 133, an amendment of FASB Statement No. 133, Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FASB Statement No. 133 and Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (collectively referred to as “SFAS No. 133, as amended”). SFAS No. 133, as amended, establishes accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133, as amended, requires that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative’s gains and losses to offset related results on the hedged item in the income statement, to the extent effective, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.
SFAS No. 133, as amended, provides that the effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedging instrument be reported as a component of other comprehensive income and be reclassified into earnings in the same period or periods during which the transaction affects earnings. The remaining gain or loss on the derivative instrument, if any, must be recognized currently in earnings. For a derivative designated as hedging the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (referred to as a fair value hedge), the gain or loss must be recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value. All derivative instruments currently utilized by the Company, including variable to fixed interest rate swaps, foreign exchange contracts and options and commodities futures contracts, are designated and accounted for as cash flow hedges, except for fixed to variable interest rate swaps which are designated and accounted for as fair value hedges of the underlying long-term debt. The Company adopted SFAS No. 133, as amended, as of January 1, 2001. Additional information with regard to accounting policies associated with derivative instruments is contained in Note 7 to the Consolidated Financial Statements, Derivative Instruments and Hedging Activities.
The information below summarizes the Company’s market risks associated with long-term debt and derivative instruments outstanding as of December 31, 2003. This information should be read in conjunction with Note 1, Note 7 and Note 9 to the Consolidated Financial Statements.
Long-Term Debt
The table below presents the principal cash flows and related interest rates by maturity date for long-term debt, including the current portion, as of December 31, 2003. The fair value of long-term debt was determined based upon quoted market prices for the same or similar debt issues.
| Maturity
Date
|
||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In
thousands of dollars except for rates) |
||||||||||||||||||||||||||||||||||
| 2004
|
2005
|
2006
|
2007
|
2008
|
Thereafter
|
Total
|
Fair Value |
|||||||||||||||||||||||||||
Long-term
Debt |
$ | 477 | $279,061 |
$142 |
$189,960 |
$147 |
$499,189 |
$968,976 |
$1,100,926 |
|||||||||||||||||||||||||
Interest
Rate |
5.8 | % | 5.9 |
% | 2.0 |
% | 6.3 |
% | 2.0 |
% | 7.4 |
% | 6.8 |
% | ||||||||||||||||||||
The fair value of long-term debt increased $95.0 million from the prior year primarily as a result of the increase in long-term debt related to the consolidation of SPTs associated with certain lease agreements, partially offset by the impact of higher interest rates for the same or similar debt instruments as of December 31, 2003. Interest rates on variable rate obligations were calculated using the rate in effect as of December 31, 2003. Interest rates on certain long-term debt have been converted from fixed to variable rates or from variable to fixed rates as discussed under the heading Interest Rate Swaps below.
A-14
Interest Rate Swaps
In order to minimize its financing costs and to manage interest rate exposure, the Company, from time to time, enters into interest rate swap agreements. In October 2003, the Company entered into interest rate swap agreements to effectively convert interest payments on long-term debt from fixed to variable rates. Interest payments on $200.0 million of 6.7% Notes due in October 2005 and $150.0 million of 6.95% Notes due in March 2007 were converted from the respective fixed rates to variable rates based on the London Interbank Offered Rate, LIBOR. In February 2001, the Company entered into interest rate swap agreements that effectively converted variable-interest-rate payments on certain leases from a variable to a fixed rate of 6.1%.
The fair value of interest rate swaps is defined as 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. The fair value of the swap agreements is calculated quarterly based upon the quoted market price for the same or similar financial instruments. The fair value of the fixed to variable interest rate swap agreements was an asset of $2.2 million as of December 31, 2003 and the fair value of the variable to fixed interest rate swaps was a liability of $5.2 million and $7.1 million as of December 31, 2003 and 2002, respectively. The potential net loss in fair value of interest rate swaps of ten percent resulting from a hypothetical near-term adverse change in market rates was $.5 million and $.7 million as of December 31, 2003 and 2002, respectively. The Company’s risk related to the interest rate swap agreements is limited to the cost of replacing the agreements at prevailing market rates.
Foreign Exchange Forward Contracts and Options
The Company enters into foreign exchange forward contracts and options to hedge transactions primarily related to firm commitments to purchase equipment, certain raw materials and finished goods denominated in foreign currencies and to hedge payment of intercompany transactions with its non-domestic subsidiaries. These contracts reduce currency risk from exchange rate movements. Foreign currency price risks are hedged generally for periods from 3 to 24 months.
Foreign exchange forward contracts and options are intended to be and are effective as hedges of firm, identifiable, foreign currency commitments. As of January 1, 2001, the Company accounted for foreign exchange forward contracts under SFAS No. 133, as amended. Foreign exchange forward contracts are designated as cash flow hedging derivatives and the fair value of such contracts is recorded on the Consolidated Balance Sheets as either an asset or liability. Gains and losses on these contracts are recorded as a component of other comprehensive income and are reclassified into earnings in the same period during which the hedged transaction affects earnings.
As of December 31, 2003, the Company had foreign exchange forward contracts and options maturing primarily in 2004 and 2005 to purchase $57.7 million in foreign currency, primarily Canadian dollars, and to sell $18.0 million in foreign currency, primarily Japanese yen, at contracted forward rates.
As of December 31, 2002, the Company had foreign exchange forward contracts maturing primarily in 2003 and 2004 to purchase $45.1 million in foreign currency, primarily British sterling and euros, and to sell $17.2 million in foreign currency, primarily Japanese yen, at contracted forward rates.
The fair value of foreign exchange contracts and options is defined as the amount of the difference between contracted and current market foreign currency exchange rates as of the end of the period. On a quarterly basis, the fair value of foreign exchange contracts and options is estimated by obtaining market quotes for future contracts with similar terms, adjusted where necessary for maturity differences. The fair value of foreign exchange forward contracts and options was an asset of $1.6 million and $3.1 million as of December 31, 2003 and 2002, respectively. The potential net loss in fair value of foreign exchange contracts and options of ten percent resulting from a hypothetical near-term adverse change in market rates was $.2 million and $.3 million as of December 31, 2003 and 2002, respectively. The Company’s risk related to the foreign exchange contracts and options is limited to the cost of replacing the contracts at prevailing market rates.
A-15
Commodity Price Risk Management
The Company’s most significant raw material requirements include cocoa, sugar, milk, peanuts and almonds. The Company attempts to minimize the effect of future price fluctuations related to the purchase of these raw materials primarily through forward purchasing to cover future manufacturing requirements, generally for periods from 3 to 24 months. With regard to cocoa, sugar, corn sweeteners, natural gas, fuel oil and certain dairy products, price risks are also managed by entering into futures contracts. At the present time, active futures contracts are not available for use in pricing the Company’s other major raw material requirements. Futures contracts are used in combination with forward purchasing of cocoa, sugar, corn sweetener, natural gas and certain dairy product requirements principally to take advantage of market fluctuations that provide more favorable pricing opportunities and flexibility in sourcing these raw material and energy requirements. Fuel oil futures contracts are used to minimize price fluctuations associated with the Company’s transportation costs. The Company’s commodity procurement practices are intended to reduce the risk of future price increases, but also may potentially limit the ability to benefit from possible price decreases.
The cost of cocoa beans and the prices for the related commodity futures contracts historically have been subject to wide fluctuations attributable to a variety of factors, including the effect of weather on crop yield, other imbalances between supply and demand, currency exchange rates, political unrest in producing countries and speculative influences. After rising sharply in 2002, cocoa market prices reached an eighteen-year high in February 2003, before gradually declining, but remaining at levels somewhat higher than prices prior to 2002. Continued civil unrest in the world’s largest cocoa-producing country, the Ivory Coast, has resulted in volatile market conditions, but has not materially affected the harvesting and marketing of the cocoa crop. The Company’s costs during 2004 and beyond will not necessarily reflect market price fluctuations because of its forward purchasing practices, premiums and discounts reflective of relative values, varying delivery times, and supply and demand for specific varieties and grades of cocoa beans. The Company’s costs for cocoa will increase substantially in 2004; however, the Company expects to achieve its long-term goals for growth and profitability by a combination of improved sales mix, supply chain cost reductions and strict control of other costs to offset cost increases and respond to changes in the competitive environment.
Commodities Futures Contracts
In connection with the purchasing of cocoa, sugar, corn sweeteners, natural gas, fuel oil and certain dairy products for anticipated manufacturing requirements and to hedge transportation costs, the Company enters into commodities futures contracts as deemed appropriate to reduce the effect of price fluctuations. Exchange traded futures contracts are used to fix the price of physical forward purchase contracts. Cash transfers reflecting changes in the value of futures contracts (unrealized gains and losses) are made on a daily basis. As of January 1, 2001, the Company accounted for commodities futures contracts under SFAS No. 133, as amended, and accordingly, cash transfers are reported as a component of other comprehensive income. Such cash transfers will be offset by higher or lower cash requirements for payment of invoice prices of raw materials, energy requirements and transportation costs in the future. Futures being held in excess of the amount required to fix the price of unpriced physical forward contracts are effective as hedges of anticipated purchases.
The following sensitivity analysis reflects the market risk of the Company to a hypothetical adverse market price movement of ten percent, based on the Company’s net commodity positions at four dates spaced equally throughout the year. The Company’s net commodity positions consist of the excess of futures contracts held over unpriced physical forward contracts for the same commodities, relating to cocoa, sugar, corn sweeteners, natural gas, fuel oil and certain dairy products. Inventories, priced forward contracts and estimated anticipated purchases not yet contracted for were not included in the sensitivity analysis calculations. A loss is defined, for purposes of determining market risk, as the potential decrease in fair value or the opportunity cost resulting from the hypothetical adverse price movement. The fair values of net commodity positions were based upon quoted market prices or estimated future prices including estimated carrying costs corresponding with the future delivery period.
A-16
| For
the years ended December 31,
|
|
|
|
2003
|
|
2002
|
|
||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In
millions of dollars |
Fair Value |
Market
Risk (Hypothetical 10% Change) |
Fair Value |
Market
Risk (Hypothetical 10% Change) |
|||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
| Highest
long position |
$ | 115.0 | $ | 11.5 | $ | 72.3 | $7.2 | ||||||||||||
| Lowest
long position |
(14.3 | ) | 1.4 | (30.1 | ) | 3.0 | |||||||||||||
| Average
position (long) |
54.9 | 5.5 | 23.8 | 2.4 | |||||||||||||||
The increase in fair values from 2002 to 2003 primarily reflected an increase in commodity prices during 2003. The negative positions primarily resulted as unpriced physical forward contract futures requirements exceeded the amount of commodities futures being held at certain points in time during the years.
Sensitivity analysis disclosures represent forward-looking statements, which are subject to certain risks and uncertainties that could cause actual results to differ materially from those presently anticipated or projected. The important factors that could affect the sensitivity analysis disclosures include significant increases or decreases in market prices reflecting fluctuations attributable to the effect of weather on crop yield, other imbalances between supply and demand, currency exchange rates, political unrest in producing countries and speculative influences in addition to changes in the Company’s hedging strategies.
USE OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the period. Significant accounting policies employed by the Company, including the use of estimates, are presented in the Notes to Consolidated Financial Statements.
Critical accounting estimates involved in applying the Company’s accounting policies are those that require management to make assumptions about matters that are highly uncertain at the time the accounting estimate was made and those for which different estimates reasonably could have been used for the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, and would have a material impact on the presentation of the Company’s financial condition, changes in financial condition or results of operations. The Company’s most critical accounting estimates, discussed below, pertain to accounting policies for accounts receivable—trade, accrued liabilities and pension and other post-retirement benefit plans.
Accounts Receivable—Trade
In the normal course of business, the Company extends credit to customers that satisfy pre-defined credit criteria. The Company believes that it has little concentration of credit risk due to the diversity of its customer base. Accounts Receivable—Trade, as shown on the Consolidated Balance Sheets, were net of allowances and anticipated discounts. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable at the date of the financial statements, assessments of collectibility based on historical trends and an evaluation of the impact of current and projected economic conditions. The Company monitors the collectibility of its accounts receivable on an ongoing basis by analyzing the aging of its accounts receivable, assessing the credit worthiness of its customers and evaluating the impact of reasonably likely changes in economic conditions that may impact credit risks. Estimates with regard to the collectibility of accounts receivable are reasonably likely to change in the future.
Over the three-year period ended December 31, 2003, the Company recorded expense averaging approximately $3.9 million per year for potential uncollectible accounts, including a $5.0 million provision in 2003 related to the estimate of probable exposure to the bankruptcy of one of the Company’s customers, Fleming Companies, Inc. Write-offs of uncollectible accounts, net of recoveries, averaged approximately $2.2 million over the same period. The provision for uncollectible accounts is recognized as selling, marketing and administrative expense in the Consolidated Statements of
A-17
Income. Over the past three years, the allowance for doubtful accounts has ranged from 2% to 3% of gross accounts receivable. If reasonably possible near-term changes in the most material assumptions were made with regard to the collectibility of accounts receivable, the amounts by which the annual provision would have changed would have resulted in a reduction in expense of approximately $2.3 million to an increase in expense of approximately $1.3 million. Changes in estimates for future uncollectible accounts receivable would not have a material impact on the Company’s liquidity or capital resources.
Accrued Liabilities
Accrued liabilities requiring the most difficult or subjective judgments include liabilities associated with marketing promotion programs and potentially unsaleable products. The Company utilizes numerous trade promotion and consumer coupon programs. The costs of such programs are recognized as a reduction to net sales with the recording of a corresponding accrued liability based on estimates at the time of product shipment or coupon release. The accrued liability for marketing promotions is determined through analysis of programs offered, historical trends, expectations regarding customer and consumer participation, sales and payment trends, and experience with payment patterns associated with similar programs that had been previously offered. The estimated costs of these programs are reasonably likely to change in the future as a result of changes in trends with regard to customer and consumer participation, particularly for new programs and for programs related to the introduction of new products. Promotional costs were $551.2 million, $461.6 million and $423.0 million in 2003, 2002 and 2001, respectively. Reasonably possible near-term changes in the most material assumptions regarding the cost of promotional programs would have resulted in changes ranging from a reduction in such costs of approximately $11.1 million to an increase in costs of approximately $10.5 million, with an increase or decrease to net sales and income before income taxes within that range. Over the last three years, actual promotion costs have not deviated from the estimated amounts by more than 4%. Changes in estimates related to the cost of promotion programs would not have a material impact on the Company’s liquidity or capital resources.
At the time of sale, the Company estimates a cost for the possibility that products will become aged or unsaleable in the future. The estimated cost is included as a reduction to net sales. A related accrued liability is determined using statistical analysis that incorporates historical sales trends, seasonal timing and sales patterns, and product movement at retail. Changes in estimates for costs associated with unsaleable products may change as a result of inventory levels in the distribution channel, current economic trends, changes in consumer demand, the introduction of new products and changes in trends of seasonal sales in response to promotion programs. Over the three-year period ended December 31, 2003, costs associated with aged or unsaleable products have amounted to approximately 2% of gross sales. Reasonably possible near-term changes in the most material assumptions regarding the estimates of such costs would have increased or decreased net sales and income before income taxes in a range from $.5 million to $1.0 million. In each of the years in the three-year period ended December 31, 2003, actual costs have not deviated from the Company’s estimates by more than 1%. Reasonably possible near-term changes in the estimates of costs associated with unsaleable products would not have a material impact on the Company’s liquidity or capital resources.
Pension and Other Post-Retirement Benefit Plans
The Company sponsors a number of defined benefit pension plans. The principal plans are the Hershey Foods Corporation Retirement Plan and the Hershey Foods Corporation Retirement Plan for Hourly Employees which are cash balance plans that provide pension benefits for most domestic employees. The Company is monitoring legislative and regulatory developments regarding cash balance plans, as well as recent court cases, for any impact on its plans. The Company also sponsors two primary post-retirement benefit plans. The health care plan is contributory, with participants’ contributions adjusted annually, and the life insurance plan is non-contributory.
A-18
The Company’s policy is to fund domestic pension liabilities in accordance with the minimum and maximum limits imposed by the Employee Retirement Income Security Act of 1974 and federal income tax laws, respectively. Non-domestic pension liabilities are funded in accordance with applicable local laws and regulations. Plan assets are invested in a broadly diversified portfolio consisting primarily of domestic and international common stocks and fixed income securities. Short-term and long-term liabilities associated with benefit plans are primarily determined based on actuarial calculations. These calculations are made considering payroll and employee data, including age and years of service, along with actuarial assumptions at the date of the financial statements. The Company takes into consideration long-term projections with regard to economic conditions, including interest rates, return on assets and the rate of increase in compensation levels. With regard to liabilities associated with other post-retirement benefit plans that provide health care and life insurance, the Company takes into consideration the long-term annual rate of increase in the per capita cost of the covered benefits. In compliance with the provisions of Statement of Financial Accounting Standards No. 87, Employers’ Accounting for Pensions, and Statement of Financial Accounting Standards No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions, the discount rate assumption is reviewed and may be revised annually. The expected long-term rate of return on assets assumption (“asset return assumption”) for funded plans is by its nature of a longer duration and would be revised only when long-term asset return projections demonstrate that need.
Pension Plans
Net periodic pension benefits costs for the Company sponsored plans were $51.0 million, $29.8 million and $20.4 million, respectively, in 2003, 2002 and 2001. For 2004, net periodic pension benefits cost is expected to be lower than 2003 primarily due to the higher December 31, 2003 fair value of plan assets resulting from the actual 2003 return on plan assets and 2003 employer contributions, and lower recognized net actuarial losses. The recognized net actuarial losses will be lower in 2004 due to an actual 2003 return on plan assets in excess of the 8.5% expected long-term rate of return on plan assets. Actuarial gains and losses may arise when actual experience differs from assumed experience or when the actuarial assumptions used to value the plan’s obligations are revised from time to time. The Company’s policy is to amortize only unrecognized net actuarial gains/losses in excess of 10% of the respective plan’s projected benefit obligation, or fair market value of assets, if greater. The estimated recognized net actuarial loss component of net periodic pension benefits cost for 2004 is $9.7 million based on the December 31, 2003 unrecognized net actuarial loss presented in Note 14, Pension and Other Post-Retirement Benefit Plans, of $236.1 million and an amortization period of primarily between fourteen and fifteen years, the average remaining service period of active employees expected to receive benefits under the plans (“average remaining service period”). Changes to the assumed rates of participant termination, disability and retirement would impact the average remaining service period. An increase in these rates would decrease the average remaining service period and a decrease in these rates would have the opposite effect. However, changes to these assumed rates are not anticipated at this time. The 2003 recognized net actuarial loss component of net periodic pension benefits cost was $16.4 million. Projections beyond 2004 are dependent on a variety of factors such as changes to the discount rate and the actual return on pension plan assets.
The Company used an average discount rate assumption of 6.3%, 6.9% and 7.5% for 2003, 2002 and 2001, respectively, in the calculation of net periodic pension benefits cost for its plans. The use of a different discount rate assumption can significantly impact net periodic pension benefits cost. A one percentage point decrease in the discount rate assumption would have increased 2003 net periodic pension benefits cost by $10.1 million and a one percentage point increase in the discount rate assumption would have decreased 2003 net periodic pension benefits cost by $9.0 million. The Company’s discount rate represents the estimated rate at which pension benefits could be effectively settled. In order to estimate this rate, the Company considers the yields of high quality securities, which are generally considered to be those receiving a rating no lower than the second highest given by a recognized rating agency.
A-19
The Company reduced its average discount rate assumption to 6.0% for valuing obligations as of December 31, 2003, from 6.3% as of December 31, 2002, due to the declining interest rate environment. A one percentage point decrease in the discount rate assumption would have increased the December 31, 2003 pension benefits obligations by $110.1 million and a one percentage point increase in the discount rate assumption would have decreased the December 31, 2003 pension benefits obligations by $93.4 million.
Asset return assumptions of 8.5%, 9.5% and 9.5% were used in the calculation of net periodic pension benefits cost for 2003, 2002 and 2001, respectively, and the expected return on plan assets component of net periodic pension benefits cost was based on the fair market value of pension plan assets. The Company reduced its average asset return assumption for 2003 to 8.5% based on an assessment of expected average asset returns for each asset class over the next 10 years utilizing outside investment manager projections. The geometric average asset return assumptions for the asset classes were as follows: equity securities, 9.5%, and debt securities, 5.5%. The historical geometric average return over the 16 years prior to December 31, 2003 was approximately 9.6%. The actual return on assets was 21.1% during 2003, with losses during 2002 and 2001 of approximately (13.1)% and (5.8)%, respectively. The use of a different asset return assumption can significantly impact net periodic pension benefits cost. A one percentage point decrease in the asset return assumption would have increased 2003 net periodic pension benefits cost by $7.1 million and a one percentage point increase in the asset return assumption would have decreased 2003 net periodic pension benefits cost by $7.0 million.
The Company’s pension asset investment policies specify ranges of pension asset allocation percentages for each asset class. The ranges for the domestic pension plans were as follows: equity securities, 40%–85%; debt securities, 15%–60%; and cash, 0%–10%. As of December 31, 2003, the actual allocations were within the ranges. The level of volatility in pension plan asset returns is expected to be in line with the overall volatility of the markets and weightings within the asset classes disclosed.
For 2003 and 2002, the Company had no minimum funding requirements for the domestic plans and minimum funding requirements for the non-domestic plans were not material. However, the Company made contributions of $120.3 million in 2003 and $308.1 million in 2002 to improve the funded status. These contributions were fully tax deductible. A one percentage point change in the discount rate or asset return assumptions would not have changed the 2003 minimum funding requirements for the domestic plans. For 2004, there will be no minimum funding requirements for the domestic plans and minimum funding requirements for the non-domestic plans will not be material. However, the Company may choose to make contributions in 2004 to improve the funded status.
Post-Retirement Benefit Plans
Other post-retirement benefits costs relate primarily to health care and life insurance benefits. Net periodic other post-retirement benefits costs for the Company sponsored plans were $23.9 million, $23.7 million and $21.8 million in 2003, 2002 and 2001, respectively. For the calculation of net periodic other post-retirement benefits costs, discount rate assumptions of 6.3%, 7.0% and 7.5% were used for 2003, 2002 and 2001, respectively. The use of a different discount rate assumption can significantly impact net periodic other post-retirement benefits costs. A one percentage point decrease in the discount rate assumption would have increased 2003 net periodic other post-retirement benefits costs by $2.6 million and a one percentage point increase in the discount rate assumption would have decreased 2003 net periodic other post-retirement benefits costs by $2.4 million.
The Company used discount rate assumptions of 6.0% and 6.3% to value the other post-retirement benefits obligations as of December 31, 2003 and 2002, respectively. A one percentage point decrease in the discount rate assumption would have increased the December 31, 2003 other post-retirement benefits obligations by $38.2 million and a one percentage point increase in the discount rate assumption would have decreased the December 31, 2003 other post-retirement benefits obligations by $31.9 million.
On December 8, 2003, the President of the United States signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). The Act introduced a prescription
A-20
drug benefit under Medicare (“Medicare Part D”) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The accumulated benefits obligation or net periodic post-retirement benefits costs in the consolidated financial statements or accompanying notes do not reflect the effects of the Act on the Company’s post-retirement benefit plans.
Other critical accounting policies employed by the Company include the following:
Goodwill and Other Intangible Assets
The Company adopted Statement of Financial Accounting Standards No. 141, Business Combinations, as of July 1, 2001, and Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, as of January 1, 2002. Through December 31, 2001, goodwill resulting from business acquisitions was amortized over 40 years. The reassessment of the useful lives of intangible assets acquired on or before June 30, 2001 was completed during the first quarter of 2002. Amortization of goodwill resulting from business acquisitions of $388.7 million was discontinued as of January 1, 2002. Other intangible assets totaling $40.4 million as of January 1, 2002 primarily consisted of trademarks and patents obtained through business acquisitions. The useful lives of trademarks were determined to be indefinite and, therefore, amortization of these assets was discontinued as of January 1, 2002. Patents valued at a total of $9.0 million are being amortized over their remaining legal lives of approximately seventeen years.
The impairment evaluation for goodwill is conducted annually using a two-step process. In the first step, the fair value of each reporting unit is compared with the carrying amount of the reporting unit, including goodwill. The estimated fair value of the reporting unit is generally determined on the basis of discounted future cash flows. If the estimated fair value of the reporting unit is less than the carrying amount of the reporting unit, then a second step must be completed in order to determine the amount of the goodwill impairment that should be recorded. In the second step, the implied fair value of the reporting unit’s goodwill is determined by allocating the reporting unit’s fair value to all of its assets and liabilities other than goodwill (including any unrecognized intangible assets) in a manner similar to a purchase price allocation. The resulting implied fair value of the goodwill that results from the application of this second step is then compared to the carrying amount of the goodwill and an impairment charge is recorded for the difference.
The evaluation of the carrying amount of intangible assets with indefinite lives is made annually by comparing the carrying amount of these assets to their estimated fair value. If the estimated fair value is less than the carrying amount of the intangible assets with indefinite lives, then an impairment charge is recorded to reduce the asset to its estimated fair value. The estimated fair value is generally determined on the basis of discounted future cash flows.
The assumptions used in the estimate of fair value are generally consistent with the past performance of each reporting unit and intangible assets and are also consistent with the projections and assumptions that are used in current operating plans. Such assumptions are subject to change as a result of changing economic and competitive conditions.
Goodwill was assigned to reporting units and transitional impairment tests were performed for goodwill and other intangible assets during the first quarter of 2002 and the annual impairment tests were performed in the fourth quarters of 2002 and 2003. No impairment of assets was determined as a result of these tests.
Commodities Futures Contracts
In connection with the purchasing of cocoa, sugar, corn sweeteners, natural gas, fuel oil and certain dairy products for anticipated manufacturing requirements and to hedge transportation costs, the Company enters into commodities futures contracts as deemed appropriate to reduce the effect of price fluctuations. Commodities futures contracts utilized by the Company are designated and accounted for as cash flow hedges under SFAS No. 133, as amended. Additional information with
A-21
regard to accounting policies associated with derivative instruments is contained in Note 7, Derivative Instruments and Hedging Activities.
The net after-tax impact of cash flow hedging derivatives on comprehensive income (loss) reflected a $20.2 million loss in 2003, a $106.7 million gain in 2002 and a $7.8 million loss in 2001. 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, for gains or losses on cash flow hedging derivatives, were reflected in cost of sales. Reclassification of gains of $51.9 million and $17.9 million for 2003 and 2002, respectively, and a loss of $19.3 million for 2001 were associated with commodities futures contracts. Gains on commodities futures contracts recognized in cost of sales as a result of hedge ineffectiveness were approximately $.4 million, $1.5 million and $1.7 million before tax for the years ended December 31, 2003, 2002 and 2001, respectively. No 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. There were no components of gains or losses on cash flow hedging derivatives that were recognized in income because such components were excluded from the assessment of hedge effectiveness. The amount of net gains on cash flow hedging derivatives, including foreign exchange forward contracts and options, interest rate swap agreements and commodities futures contracts, expected to be reclassified into earnings in the next twelve months was approximately $28.3 million after tax as of December 31, 2003, which were principally associated with commodities futures contracts.
MARKET PRICES AND DIVIDENDS
Cash dividends paid on the Company’s Common Stock and Class B Stock were $184.7 million in 2003 and $167.8 million in 2002. The annual dividend rate on the Common Stock in 2003 was $1.58 per share, an increase of 21% over the 2002 rate of $1.31 per share. The 2003 dividend increase represented the 29th consecutive year of Common Stock dividend increases.
On February 17, 2004, the Company’s Board of Directors declared a quarterly dividend of $.395 per share of Common Stock payable on March 15, 2004, to stockholders of record as of February 25, 2004. It is the Company’s 297th consecutive Common Stock dividend. A quarterly dividend of $.3575 per share of Class B Stock also was declared.
The Company’s Common Stock is listed and traded principally on the New York Stock Exchange (“NYSE”) under the ticker symbol “HSY.” Approximately 105.9 million shares of the Company’s Common Stock were traded during 2003. The Class B Stock is not publicly traded.
The closing price of the Common Stock on December 31, 2003, was $76.99. There were 39,002 stockholders of record of the Common Stock and the Class B Stock as of December 31, 2003.
The following table shows the dividends paid per share of Common Stock and Class B Stock and the price range of the Common Stock for each quarter of the past two years:
| Dividends
Paid Per Share |
Common
Stock Price Range* |
||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
||||||||||||||||||||
| Common Stock |
Class
B Stock |
High | Low | ||||||||||||||||||
|
|
|
|
|
||||||||||||||||||
| 2003 |
|||||||||||||||||||||
| 1st
Quarter |
$ | .3275 | $ | .2950 | $ | 68.99 | $ | 60.69 | |||||||||||||
| 2nd
Quarter |
.3275 | .2950 | 72.82 | 62.45 | |||||||||||||||||
| 3rd
Quarter |
.3950 | .3575 | 74.20 | 68.93 | |||||||||||||||||
| 4th
Quarter |
.3950 | .3575 | 78.65 | 72.68 | |||||||||||||||||
| Total |
$ | 1.4450 | $ | 1.3050 | |||||||||||||||||
A-22
| Dividends
Paid Per Share |
Common
Stock Price Range* |
||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Common Stock |
Class
B Stock |
High
|
Low
|
||||||||||||||||||
|
2002 |
|||||||||||||||||||||
|
1st
Quarter |
$ | .3025 | $ | .2725 | $ | 72.49 | $ | 65.92 | |||||||||||||
|
2nd
Quarter |
.3025 | .2725 | 72.14 | 62.13 | |||||||||||||||||
|
3rd
Quarter |
.3275 | .2950 | 79.49 | 56.45 | |||||||||||||||||
|
4th
Quarter |
.3275 | .2950 | 67.99 | 61.22 | |||||||||||||||||
|
Total |
$ | 1.2600 | $ | 1.1350 | |||||||||||||||||
__________
| * | NYSE-Composite Quotations for Common Stock by calendar quarter. |
RETURN MEASURES
Operating Return on Average Stockholders’ Equity
The Company’s operating return on average stockholders’ equity was 35.8% in 2003. Over the most recent six-year period, the return has ranged from 28.9% in 1999 to 37.6% in 1998. For the purpose of calculating operating return on average stockholders’ equity, earnings is defined as net income adjusted to reflect the impact of the elimination of the amortization of intangibles for all years and excluding the after-tax effect of the business realignment initiatives in 2003, 2002 and 2001, the after-tax effect of incremental expenses to explore the possible sale of the Company in 2002 and the after-tax gains on the sale of a group of the Company’s gum brands in 2003, the sale of the Luden’s throat drops business in 2001, the sale of corporate aircraft in 2000 and the sale of the pasta business in 1999.
Operating Return on Average Invested Capital
The Company’s operating return on average invested capital was 19.9% in 2003. Over the most recent six-year period, the return has ranged from 15.4% in 1999 to 19.9% in 2003. Average invested capital consists of the annual average of beginning and ending balances of long-term debt, deferred income taxes and stockholders’ equity. For the purpose of calculating operating return on average invested capital, earnings is defined as net income adjusted to reflect the impact of the elimination of the amortization of intangibles for all years and excluding the after-tax effect of the business realignment initiatives in 2003, 2002 and 2001, the after-tax effect of incremental expenses to explore the possible sale of the Company in 2002, the after-tax gains on the sale of a group of the Company’s gum brands in 2003, the sale of the Luden’s throat drops business in 2001, the sale of corporate aircraft in 2000, and the sale of the pasta business in 1999, and the after-tax effect of interest on long-term debt.
OUTLOOK
The outlook section contains a number of forward-looking statements, all of which are based on current expectations. Actual results may differ materially. Key risks to achieving future performance include: the continued ability to accelerate the introduction of new products, while balancing the rationalization of under-performing items; discipline in managing the Company’s seasonal business for profitability; targeted cost improvement and the control of administrative costs, such as employee benefits; intensified competitive activity in certain markets; changes in the retail environment; the ability to improve profitability of international businesses which are subject to certain volatility with regard to the economic and foreign currency exchange environment in certain countries; and the risk of increases in raw material and other costs.
During the three years ended December 31, 2003, the Company significantly improved operating results as it implemented its strategies. Over the foreseeable future these strategies seek to deliver average net sales growth of 3%-4% per year, gross margin improvement of 70-90 basis points per year, 7%-9% annual growth in earnings before interest expense and income taxes (“EBIT”) and 9%-11% earnings per share-diluted (“EPS”) growth per year.
A-23
Net sales in 2004 are expected to increase as the Company’s market leadership continues to expand. The Company will continue to introduce new items and limited edition line extensions. During 2004 these will include: a full year of sales for Hershey’s Swoops and Hershey’s S’mores introduced in December 2003; Reese’s white chocolate peanut butter cups, previously sold as a limited edition item, and Ice Breakers Liquid Ice mints, Hershey’s Kisses milk chocolates filled with caramel, York sugar-free peppermint patties, and limited edition items, such as Hershey’s Cookies ‘N’ Mint and Cookies ‘N’ Chocolate bars and Almond Joy piña colada candy bar. The 2003 entry into sugar-free items and the recently announced introduction of the Hershey’s 1 G Sugar Carb bar line represent adjacent platforms from which the Company expects future growth.
Net sales growth is expected to be primarily in North America. Growth outside of North America will be focused on limited geographic areas, but attractive market opportunities.
Gross margin is expected to improve in 2004, but at the lower end of the Company’s long-term improvement target. Margin improvement is affected by various factors, including selling prices, promotional allowances, raw material costs, supply chain efficiencies and the mix of products sold in any period. During 2004, improved price realization resulting from a combination of limited selling price increases, product weight changes and an enhanced sales mix will more than offset higher supply chain costs. The higher costs will result primarily from an increase in the cost of raw materials, partially offset by cost savings from supply chain efficiency improvements.
EBIT growth and EPS growth are expected to be within the long-term target range in 2004.
The Company expects strong cash flows from operating activities in 2004. Net cash provided from operating activities is expected to exceed cash requirements for capital additions, capitalized software additions and anticipated dividend payments. The Company will continue to monitor the funded status of pension plans based on market performance and make future contributions as appropriate, recognizing that the plans are well funded at the end of 2003.
Safe Harbor Statement
The nature of the Company’s operations and the environment in which it operates subject it to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company notes the following factors that, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as “intend,” “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential,” among others. Factors which could cause results to differ include, but are not limited to: changes in the confectionery and grocery business environment, including actions of competitors and changes in consumer preferences; customer and consumer response to selling price increases; changes in governmental laws and regulations, including taxes; market demand for new and existing products; changes in raw material and other costs; pension cost factors, such as actuarial assumptions, market performance and employee retirement decisions; adequacy of the Company’s bad debt reserve; the Company’s ability to implement improvements to and reduce costs associated with the Company’s supply chain and the Company’s ability to successfully implement its rationalization and realignment initiatives.
Certifications
Certifications of the Chief Executive Officer and Chief Financial Officer of the Company under Section 302 of the Sarbanes-Oxley Act of 2002 are filed as Exhibits 31.1 and 31.2 to the Company’s Annual Report on Form 10-K for 2003.
A-24
HERSHEY FOODS CORPORATION
CONSOLIDATED STATEMENTS OF
INCOME
| For the years ended December 31, |
|
2003 |
|
2002 |
|
2001 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars except per share
amounts |
||||||||||||||
Net
Sales |
$ | 4,172,551 | $ | 4,120,317 | $ | 4,137,217 | ||||||||
Costs and
Expenses: |
||||||||||||||
Cost of
sales |
2,544,726 | 2,561,052 | 2,668,530 | |||||||||||
Selling,
marketing and administrative |
816,442 | 833,426 | 846,976 | |||||||||||
Business
realignment and asset impairments, net |
23,357 | 27,552 | 228,314 | |||||||||||
Gain on sale
of business |
(8,330 | ) | — | (19,237 | ) | |||||||||
Total costs
and expenses |
3,376,195 | 3,422,030 | 3,724,583 | |||||||||||
Income
before Interest and Income Taxes |
796,356 | 698,287 | 412,634 | |||||||||||
Interest
expense, net |
63,529 | 60,722 | 69,093 | |||||||||||
Income
before Income Taxes |
732,827 | 637,565 | 343,541 | |||||||||||
Provision for
income taxes |
267,875 | 233,987 | 136,385 | |||||||||||
Income
before Cumulative Effect of Accounting Change |
464,952 | 403,578 | 207,156 | |||||||||||
Cumulative
effect of accounting change, net of $4,933 tax benefit |
7,368 | — | — | |||||||||||
Net
Income |
$ | 457,584 | $ | 403,578 | $ | 207,156 | ||||||||
Earnings
Per Share—Basic |
||||||||||||||
Income
before Cumulative Effect of Accounting Change |
$ | 3.54 | $ | 2.96 | $ | 1.52 | ||||||||
Cumulative
Effect of Accounting Change, net of $.04 Tax Benefit |
.06 | — | — | |||||||||||
Net
Income |
$ | 3.48 | $ | 2.96 | $ | 1.52 | ||||||||
Earnings
Per Share—Diluted |
||||||||||||||
Income
before Cumulative Effect of Accounting Change |
$ | 3.52 | $ | 2.93 | $ | 1.50 | ||||||||
Cumulative
Effect of Accounting Change, net of $.04 Tax Benefit |
.06 | — | — | |||||||||||
Net
Income |
$ | 3.46 | $ | 2.93 | $ | 1.50 | ||||||||
Cash
Dividends Paid Per Share: |
||||||||||||||
Common
Stock |
$ | 1.445 | $ | 1.260 | $ | 1.165 | ||||||||
Class B
Common Stock |
1.305 | 1.135 | 1.050 | |||||||||||
The notes to consolidated financial statements are an integral part of these statements.
A-25
HERSHEY FOODS CORPORATION
CONSOLIDATED BALANCE
SHEETS
| December 31, |
|
2003 |
|
2002 |
||||||
|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars |
||||||||||
ASSETS |
||||||||||
Current
Assets: |
||||||||||
Cash and cash
equivalents |
$ | 114,793 | $ | 297,743 | ||||||
Accounts
receivable—trade |
407,612 | 370,976 | ||||||||
Inventories |
492,859 | 503,291 | ||||||||
Deferred
income taxes |
13,285 | — | ||||||||
Prepaid
expenses and other |
103,020 | 91,608 | ||||||||
Total current
assets |
1,131,569 | 1,263,618 | ||||||||
Property,
Plant and Equipment, Net |
1,661,939 | 1,486,055 | ||||||||
Goodwill |
388,960 | 378,453 | ||||||||
Other
Intangibles |
38,511 | 39,898 | ||||||||
Other
Assets |
361,561 | 312,527 | ||||||||
Total
assets |
$ | 3,582,540 | $ | 3,480,551 | ||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||||
Current
Liabilities: |
||||||||||
Accounts
payable |
$ | 132,222 | $ | 124,507 | ||||||
Accrued
liabilities |
416,181 | 356,716 | ||||||||
Accrued
income taxes |
24,898 | 12,731 | ||||||||
Deferred
income taxes |
— | 24,768 | ||||||||
Short-term
debt |
12,032 | 11,135 | ||||||||
Current
portion of long-term debt |
477 | 16,989 | ||||||||
Total current
liabilities |
585,810 | 546,846 | ||||||||
Long-term
Debt |
968,499 | 851,800 | ||||||||
Other
Long-term Liabilities |
370,776 | 362,162 | ||||||||
Deferred
Income Taxes |
377,589 | 348,040 | ||||||||
Total
liabilities |
2,302,674 | 2,108,848 | ||||||||
Stockholders’ Equity: |
||||||||||
Preferred
Stock, shares issued: none in 2003 and 2002 |
— | — | ||||||||
Common Stock,
shares issued: 149,528,776 in 2003 and 149,528,564 in 2002 |
149,528 | 149,528 | ||||||||
Class B
Common Stock, shares issued: 30,422,096 in 2003 and 30,422,308 in 2002 |
30,422 | 30,422 | ||||||||
Additional
paid-in capital |
4,034 | 593 | ||||||||
Unearned ESOP
compensation |
(9,580 | ) | (12,774 | ) | ||||||
Retained
earnings |
3,263,988 | 2,991,090 | ||||||||
Treasury—Common Stock shares, at cost: 50,421,139 in 2003 and 45,730,735 in 2002 |
(2,147,441 | ) | (1,808,227 | ) | ||||||
Accumulated
other comprehensive (loss) income |
(11,085 | ) | 21,071 | |||||||
Total
stockholders’ equity |
1,279,866 | 1,371,703 | ||||||||
Total
liabilities and stockholders’ equity |
$ | 3,582,540 | $ | 3,480,551 | ||||||
The notes to consolidated financial statements are an integral part of these balance sheets.
A-26
HERSHEY FOODS CORPORATION
CONSOLIDATED STATEMENTS OF CASH
FLOWS
| For the years ended December 31, |
|
2003 |
|
2002 |
|
2001 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars |
||||||||||||||
Cash Flows
Provided from (Used by) Operating Activities |
||||||||||||||
Net
income |
$ | 457,584 | $ | 403,578 | $ | 207,156 | ||||||||
Adjustments
to reconcile net income to net cash provided from operations: |
||||||||||||||
Depreciation
and amortization |
180,567 | 177,908 | 190,494 | |||||||||||
Deferred
income taxes |
38,895 | 137,817 | (49,342 | ) | ||||||||||
Gain on sale
of business, net of tax of $2,624 and $18,134, respectively |
(5,706 | ) | — | (1,103 | ) | |||||||||
Business
realignment initiatives, net of tax of $9,988, $12,470 and $106,564, respectively |
15,488 | 21,509 | 171,852 | |||||||||||
Asset
impairment write-downs |
— | — | 53,100 | |||||||||||
Cumulative
effect of accounting change, net of tax of $4,933 |
7,368 | — | — | |||||||||||
Changes in
assets and liabilities, net of effects from business acquisitions and divestitures: |
||||||||||||||
Accounts
receivable—trade |
(36,636 | ) | (9,250 | ) | 17,954 | |||||||||
Inventories |
9,095 | 8,843 | 94,405 | |||||||||||
Accounts
payable |
7,715 | (8,542 | ) | (16,183 | ) | |||||||||
Other assets
and liabilities |
(81,427 | ) | (106,520 | ) | 38,072 | |||||||||
Net Cash
Provided from Operating Activities |
592,943 | 625,343 | 706,405 | |||||||||||
Cash Flows
Provided from (Used by) Investing Activities |
||||||||||||||
Capital
additions |
(218,650 | ) | (132,736 | ) | (160,105 | ) | ||||||||
Capitalized
software additions |
(18,404 | ) | (11,836 | ) | (9,845 | ) | ||||||||
Business
acquisition |
— | — | (17,079 | ) | ||||||||||
Proceeds from
divestitures |
20,049 | 12,000 | 59,900 | |||||||||||
Other,
net |
— | — | 3,142 | |||||||||||
Net Cash
(Used by) Investing Activities |
(217,005 | ) | (132,572 | ) | (123,987 | ) | ||||||||
Cash Flows
Provided from (Used by) Financing Activities |
||||||||||||||
Net change in
short-term borrowings |
897 | 4,130 | (250,589 | ) | ||||||||||
Long-term
borrowings |
3,194 | 304 | 379 | |||||||||||
Repayment of
long-term debt |
(18,633 | ) | (9,578 | ) | (826 | ) | ||||||||
Cash
dividends paid |
(184,686 | ) | (167,821 | ) | (154,750 | ) | ||||||||
Exercise of
stock options |
55,120 | 86,491 | 30,210 | |||||||||||
Incentive
plan transactions |
(85,347 | ) | (158,507 | ) | (64,342 | ) | ||||||||
Repurchase of
Common Stock |
(329,433 | ) | (84,194 | ) | (40,322 | ) | ||||||||
Net Cash
(Used by) Financing Activities |
(558,888 | ) | (329,175 | ) | (480,240 | ) | ||||||||
(Decrease)
Increase in Cash and Cash Equivalents |
(182,950 | ) | 163,596 | 102,178 | ||||||||||
Cash and Cash
Equivalents as of January 1 |
297,743 | 134,147 | 31,969 | |||||||||||
Cash and Cash
Equivalents as of December 31 |
$ | 114,793 | $ | 297,743 | $ | 134,147 | ||||||||
Interest
Paid |
$ | 65,347 | $ | 64,343 | $ | 72,043 | ||||||||
Income Taxes
Paid |
207,672 | 57,495 | 171,362 | |||||||||||
The notes to consolidated financial statements are an integral part of these statements.
A-27
HERSHEY FOODS CORPORATION
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS’ EQUITY
| Preferred Stock |
Common Stock |
Class
B Common Stock |
Additional Paid-in Capital |
Unearned ESOP Compensation |
Retained Earnings |
Treasury Common Stock |
Accumulated Other Comprehensive Income (Loss) |
Total Stockholders’ Equity |
||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||||||||||
| In
thousands of dollars |
||||||||||||||||||||||||||||||||||||
Balance
as of January 1, 2001 |
$ | — | $ | 149,508 | $ | 30,442 | $ | 13,124 | $ | (19,161 | ) | $ | 2,702,927 | $ | (1,645,088 | ) | $ | (56,716 | ) | $ | 1,175,036 | |||||||||||||||
Net
income |
207,156 | 207,156 | ||||||||||||||||||||||||||||||||||
Other
comprehensive (loss) |
(29,416 | ) | (29,416 | ) | ||||||||||||||||||||||||||||||||
Comprehensive
income |
177,740 | |||||||||||||||||||||||||||||||||||
Dividends: |
||||||||||||||||||||||||||||||||||||
Common
Stock, $1.165 per share |
(122,790 | ) | (122,790 | ) | ||||||||||||||||||||||||||||||||
Class
B Common Stock, $1.05 per share |
(31,960 | ) | (31,960 | ) | ||||||||||||||||||||||||||||||||
Conversion
of Class B Common Stock into Common Stock |
8 | (8 | ) | — | ||||||||||||||||||||||||||||||||
Incentive
plan transactions |
1,062 | 1,062 | ||||||||||||||||||||||||||||||||||
Exercise
of stock options |
(11,863 | ) | (3,833 | ) | (15,696 | ) | ||||||||||||||||||||||||||||||
Employee
stock ownership trust/benefits transactions |
940 | 3,194 | 4,134 | |||||||||||||||||||||||||||||||||
Repurchase
of Common Stock |
(40,322 | ) | (40,322 | ) | ||||||||||||||||||||||||||||||||
Balance
as of December 31, 2001 |
— | 149,516 | 30,434 | 3,263 | (15,967 | ) | 2,755,333 | (1,689,243 | ) | (86,132 | ) | 1,147,204 | ||||||||||||||||||||||||
Net
income |
403,578 | 403,578 | ||||||||||||||||||||||||||||||||||
Other
comprehensive income |
107,203 | 107,203 | ||||||||||||||||||||||||||||||||||
Comprehensive
income |
510,781 | |||||||||||||||||||||||||||||||||||
Dividends: |
||||||||||||||||||||||||||||||||||||
Common
Stock, $1.26 per share |
(133,285 | ) | (133,285 | ) | ||||||||||||||||||||||||||||||||
Class
B Common Stock, $1.135 per share |
(34,536 | ) | (34,536 | ) | ||||||||||||||||||||||||||||||||
Conversion
of Class B Common Stock into Common Stock |
12 | (12 | ) | — | ||||||||||||||||||||||||||||||||
Incentive
plan transactions |
(298 | ) | (298 | ) | ||||||||||||||||||||||||||||||||
Exercise
of stock options |
(3,517 | ) | (34,790 | ) | (38,307 | ) | ||||||||||||||||||||||||||||||
Employee
stock ownership trust/benefits transactions |
1,145 | 3,193 | 4,338 | |||||||||||||||||||||||||||||||||
Repurchase
of Common Stock |
(84,194 | ) | (84,194 | ) | ||||||||||||||||||||||||||||||||
Balance
as of December 31, 2002 |
— | 149,528 | 30,422 | 593 | (12,774 | ) | 2,991,090 | (1,808,227 | ) | 21,071 | 1,371,703 | |||||||||||||||||||||||||
Net
income |
457,584 | 457,584 | ||||||||||||||||||||||||||||||||||
Other
comprehensive (loss) |
(32,156 | ) | (32,156 | ) | ||||||||||||||||||||||||||||||||
Comprehensive
income |
425,428 | |||||||||||||||||||||||||||||||||||
Dividends: |
||||||||||||||||||||||||||||||||||||
Common
Stock, $1.445 per share |
(144,985 | ) | (144,985 | ) | ||||||||||||||||||||||||||||||||
Class
B Common Stock, $1.305 per share |
(39,701 | ) | (39,701 | ) | ||||||||||||||||||||||||||||||||
Conversion
of Class B Common Stock into Common Stock |
— | — | — | |||||||||||||||||||||||||||||||||
Incentive
plan transactions |
455 | 455 | ||||||||||||||||||||||||||||||||||
Exercise
of stock options |
1,519 | (9,781 | ) | (8,262 | ) | |||||||||||||||||||||||||||||||
Employee
stock ownership trust/benefits transactions |
1,467 | 3,194 | 4,661 | |||||||||||||||||||||||||||||||||
Repurchase
of Common Stock |
(329,433 | ) | (329,433 | ) | ||||||||||||||||||||||||||||||||
Balance
as of December 31, 2003 |
$ | — | $ | 149,528 | $ | 30,422 | $ | 4,034 | $ | (9,580 | ) | $ | 3,263,988 | $ | (2,147,441 | ) | $ | (11,085 | ) | $ | 1,279,866 | |||||||||||||||
The notes to consolidated financial statements are an integral part of these statements.
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HERSHEY FOODS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies employed by the Company are discussed below and in other notes to the consolidated financial statements.
Items Affecting Comparability
Certain reclassifications have been made to prior year amounts to conform to the 2003 presentation. During 2000 and 2001, the Financial Accounting Standards Board’s Emerging Issues Task Force (“EITF”) addressed various issues related to the income statement classification of certain promotional payments, including consideration from a vendor to a reseller or another party that purchases the vendor’s products. EITF No. 01-9, Accounting for Consideration Given by a Vendor to a Customer or Reseller of the Vendor’s Products, was issued in November 2001 and codified earlier pronouncements. In accordance with EITF No. 01-9, certain consumer and trade promotion expenses, such as consumer coupon redemption expense, off-invoice allowances and various marketing performance funds previously reported in selling, marketing and administrative expense were reclassified as a reduction of net sales. Reclassifications for 2001 totaled $423.0 million. In addition, certain freight billings totaling $3.0 million for 2001, previously reported in cost of sales, were reclassified as an increase to net sales.
The consolidated financial statements include the impact of the Company’s business realignment initiatives as described in Note 4. Cost of sales included pre-tax charges resulting from the business realignment initiatives of $2.1 million, $6.4 million and $50.1 million for the years ended December 31, 2003, 2002 and 2001, respectively. Additionally, selling, marketing and administrative expenses for the year ended December 31, 2002, included expenses of $17.2 million associated with the exploration of the potential sale of the Company.
In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (“Interpretation No. 46”). Interpretation No. 46 addresses consolidation by business enterprises of special-purpose entities (“SPEs”) to which the usual condition for consolidation described in Accounting Research Bulletin No. 51, Consolidated Financial Statements, does not apply because the SPEs have no voting interests or otherwise are not subject to control through ownership of voting interests. The Company adopted Interpretation No. 46 as of June 30, 2003. Additional information regarding the adoption of Interpretation No. 46 is contained in Note 2, Cumulative Effect of Accounting Change.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and entities in which it has a controlling financial interest after the elimination of intercompany accounts and transactions.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Critical accounting estimates involved in applying the Company’s accounting policies are those that require management to make assumptions about matters that are highly uncertain at the time the accounting estimate was made and those for which different estimates reasonably could have been used for the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, and would have a material impact on the presentation of the Company’s financial condition, changes in financial
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condition or results of operations. The Company’s most critical accounting estimates pertain to accounting policies for accounts receivable—trade, accrued liabilities and pension and other post-retirement benefit plans.
Revenue Recognition
The Company records sales when all of the following criteria have been met: a valid customer order with a fixed price has been received; a delivery appointment with the customer has been made; the product has been shipped in accordance with the delivery appointment within the required lead time; there is no further significant obligation to assist in the resale of the product; and collectibility is reasonably assured. Net sales include revenue from the sale of finished goods and royalty income, net of allowances for trade promotions, consumer coupon programs and other sales incentives, and allowances and discounts associated with aged or potentially unsaleable products.
Cost of Sales
Cost of sales represents costs directly related to the manufacture and distribution of the Company’s products. Primary costs include raw materials, packaging, direct labor, overhead, shipping and handling, warehousing and the depreciation of manufacturing, warehousing and distribution facilities. Manufacturing overhead and related expenses include salaries, wages, employee benefits, utilities, maintenance and property taxes.
Selling, Marketing and Administrative
Selling, marketing and administrative expenses represent costs incurred in generating revenues and in managing the business of the Company. Such costs include advertising and other marketing expenses, salaries, employee benefits, incentive compensation, research and development, travel, office expenses, amortization of capitalized software and depreciation of administrative facilities.
Cash Equivalents
Cash equivalents consist of highly liquid debt instruments, time deposits and money market funds with original maturities of three months or less. The fair value of cash and cash equivalents approximates the carrying amount.
Commodities Futures Contracts
In connection with the purchasing of cocoa, sugar, corn sweeteners, natural gas, fuel oil and certain dairy products for anticipated manufacturing requirements and to hedge transportation costs, the Company enters into commodities futures contracts as deemed appropriate to reduce the effect of price fluctuations.
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. Subsequently, the FASB issued Statement No. 137, Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB Statement No. 133, an amendment of FASB Statement No. 133, Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FASB Statement No. 133, and Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (collectively referred to as “SFAS No. 133, as amended”). SFAS No. 133, as amended, establishes accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133, as amended, requires that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative’s gains and losses to offset related results on the hedged item in the income statement, to the extent effective, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.
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The Company adopted SFAS No. 133, as amended, as of January 1, 2001. SFAS No. 133, as amended, provides that the effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedging instrument be reported as a component of other comprehensive income and be reclassified into earnings in the same period or periods during which the transaction affects earnings. The remaining gain or loss on the derivative instrument, if any, must be recognized currently in earnings. For a derivative designated as hedging the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (referred to as a fair value hedge), the gain or loss must be recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value. All derivative instruments currently utilized by the Company, including commodities futures contracts, are designated and accounted for as cash flow hedges, except for fixed to variable interest rate swaps which are designated and accounted for as fair value hedges of the underlying long-term debt. Additional information with regard to accounting policies associated with derivative instruments is contained in Note 7, Derivative Instruments and Hedging Activities.
Property, Plant and Equipment
Property, plant and equipment are stated at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets, as follows: 3 to 15 years for machinery and equipment; and 25 to 40 years for buildings and related improvements. Maintenance and repair expenditures are charged to expense as incurred. Applicable interest charges incurred during the construction of new facilities and production lines are capitalized as one of the elements of cost and are amortized over the assets’ estimated useful lives.
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of long-lived assets to future undiscounted net cash flows expected to be generated, in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.
Goodwill and Other Intangible Assets
The Company adopted Statement of Financial Accounting Standards No. 141, Business Combinations, as of July 1, 2001, and Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, as of January 1, 2002. Through December 31, 2001, goodwill resulting from business acquisitions was amortized over 40 years. The reassessment of the useful lives of intangible assets acquired on or before June 30, 2001 was completed during the first quarter of 2002. Amortization of goodwill resulting from business acquisitions of $388.7 million was discontinued as of January 1, 2002. Other intangible assets totaling $40.4 million as of January 1, 2002 primarily consisted of trademarks and patents obtained through business acquisitions. The useful lives of trademarks were determined to be indefinite and, therefore, amortization of these assets was discontinued as of January 1, 2002. Patents valued at a total of $9.0 million are being amortized over their remaining legal lives of approximately seventeen years.
The impairment evaluation for goodwill is conducted annually, or more frequently if events or changes in circumstances indicate that an asset might be impaired. The evaluation is performed by using a two-step process. In the first step, the fair value of each reporting unit is compared with the carrying amount of the reporting unit, including goodwill. The estimated fair value of the reporting unit is generally determined on the basis of discounted future cash flows. If the estimated fair value of the reporting unit is less than the carrying amount of the reporting unit, then a second step must be completed in order to determine the amount of the goodwill impairment that should be recorded. In the second step, the implied fair value of the reporting unit’s goodwill is determined by allocating
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the reporting unit’s fair value to all of its assets and liabilities other than goodwill (including any unrecognized intangible assets) in a manner similar to a purchase price allocation. The resulting implied fair value of the goodwill that results from the application of this second step is then compared to the carrying amount of the goodwill and an impairment charge is recorded for the difference.
The impairment evaluation of the carrying amount of intangible assets with indefinite lives is conducted annually, or more frequently if events or changes in circumstances indicate that an asset might be impaired. The evaluation is performed by comparing the carrying amount of these assets to their estimated fair value. If the estimated fair value is less than the carrying amount of the intangible assets with indefinite lives, then an impairment charge is recorded to reduce the asset to its estimated fair value. The estimated fair value is generally determined on the basis of discounted future cash flows.
The assumptions used in the estimate of fair value are generally consistent with the past performance of each reporting unit and intangible assets and are also consistent with the projections and assumptions that are used in current operating plans. Such assumptions are subject to change as a result of changing economic and competitive conditions.
Comprehensive Income
Comprehensive income (loss) is reported on the Consolidated Statements of Stockholders’ Equity and accumulated other comprehensive income (loss) is reported on the Consolidated Balance Sheets. Additional information regarding comprehensive income is contained in Note 8, Comprehensive Income.
Results of operations for foreign entities are translated using the average exchange rates during the period. For foreign entities, assets and liabilities are translated to U.S. dollars using the exchange rates in effect at the balance sheet date. Resulting translation adjustments are recorded as a component of other comprehensive income (loss), “Foreign Currency Translation Adjustments.”
A minimum pension liability adjustment is required when the actuarial present value of accumulated pension plan benefits exceeds plan assets and accrued pension liabilities, less allowable intangible assets. Minimum pension liability adjustments, net of income taxes, are recorded as a component of other comprehensive income (loss), “Minimum Pension Liability Adjustments.”
Gains and losses on cash flow hedging derivatives, to the extent effective, are included in other comprehensive income (loss). Reclassification adjustments reflecting such gains and losses are ratably recorded in income in the same period as the hedged items affect earnings. Additional information with regard to accounting policies associated with derivative instruments is contained in Note 7, Derivative Instruments and Hedging Activities.
Foreign Exchange Forward Contracts and Options
The Company enters into foreign exchange forward contracts and options to hedge transactions primarily related to firm commitments to purchase equipment, certain raw materials and finished goods denominated in foreign currencies, and to hedge payment of intercompany transactions with its subsidiaries outside the United States. These contracts reduce currency risk from exchange rate movements.
Foreign exchange forward contracts and options are intended to be and are effective as hedges of firm, identifiable, foreign currency commitments. Foreign exchange forward contracts and options are designated as cash flow hedging derivatives and the fair value of such contracts is recorded on the Consolidated Balance Sheets as either an asset or liability. Gains and losses on these contracts are recorded as a component of other comprehensive income and are reclassified into earnings in the same period during which the hedged transaction affects earnings. Additional information with regard to accounting policies for derivative instruments, including foreign exchange forward contracts, is contained in Note 7, Derivative Instruments and Hedging Activities.
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License Agreements
The Company has entered into license agreements under which it has access to certain trademarks and proprietary technology, and manufactures and/or markets and distributes certain products. The rights under these agreements are extendible on a long-term basis at the Company’s option subject to certain conditions, including minimum sales levels, which the Company has met. License fees and royalties, payable under the terms of the agreements, are expensed as incurred and included in selling, marketing and administrative expenses.
Research and Development
The Company expenses research and development costs as incurred. Research and development expense was $24.5 million, $23.4 million and $26.5 million in 2003, 2002 and 2001, respectively, and is included in selling, marketing and administrative expenses.
Advertising
The Company expenses advertising costs as incurred. Advertising expense included in selling, marketing and administrative expenses was $145.4 million, $162.9 million and $187.2 million in 2003, 2002 and 2001, respectively. Prepaid advertising as of December 31, 2003 and 2002, was $4.2 million and $1.3 million, respectively.
Computer Software
The Company capitalizes costs associated with software developed or obtained for internal use when both the preliminary project stage is completed and it is probable that computer software being developed will be completed and placed in service. Capitalized costs include only (i) external direct costs of materials and services consumed in developing or obtaining internal-use software, (ii) payroll and other related costs for employees who are directly associated with and who devote time to the internal-use software project and (iii) interest costs incurred, when material, while developing internal-use software. Capitalization of such costs ceases no later than the point at which the project is substantially complete and ready for its intended purpose.
The unamortized amount of capitalized software as of December 31, 2003 and 2002, was $39.3 million and $41.3 million, respectively. Software costs are amortized using the straight-line method over the shorter of five years or the expected life of the software. Accumulated amortization of capitalized software was $99.1 million and $78.4 million as of December 31, 2003 and 2002, respectively.
The Company reviews the carrying value of software and development costs for impairment in accordance with its policy pertaining to the impairment of long-lived assets. Generally, measurement of impairment occurs when internal use computer software is not expected to provide substantive service potential, a significant change occurs in the extent or manner in which the software is used or is expected to be used, a significant change is made or will be made to the software program, or costs of developing or modifying internal-use computer software significantly exceed the amount originally expected to develop or modify the software.
Employee Stock Options
The Company currently sponsors two stock-based employee compensation plans, which are described more fully in Note 17, Stock Compensation Plans. The Company applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for those plans. No employee compensation expense for stock options is reflected in net income as all stock options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share in each period if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
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| For the years ended December 31, |
|
2003 |
|
2002 |
|
2001 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars except per share
amounts |
||||||||||||||
Net income,
as reported |
$ | 457,584 | $ | 403,578 | $ | 207,156 | ||||||||
Deduct: Total
stock-based employee compensation expense determined under fair value method, net of related tax effects |
(15,637 | ) | (12,421 | ) | (7,398 | ) | ||||||||
Pro forma net
income |
$ | 441,947 | $ | 391,157 | $ | 199,758 | ||||||||
Earnings per
share: |
||||||||||||||
Basic—as
reported |
$ | 3.48 | $ | 2.96 | $ | 1.52 | ||||||||
Basic—pro forma |
$ | 3.37 | $ | 2.86 | $ | 1.47 | ||||||||
Diluted—as reported |
$ | 3.46 | $ | 2.93 | $ | 1.50 | ||||||||
Diluted—pro forma |
$ | 3.34 | $ | 2.84 | $ | 1.45 | ||||||||
The fair value of each option grant is estimated on the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2003, 2002 and 2001, respectively: dividend yields of 2.0%, 1.9% and 2.2%; expected volatility of 28%, 28% and 28%; risk-free interest rates of 3.6%, 4.7% and 5.0%; and expected lives of 6.4 years, 6.4 years and 6.4 years.
2. CUMULATIVE EFFECT OF ACCOUNTING CHANGE
The Company adopted Interpretation No. 46 as of June 30, 2003, resulting in the consolidation of three off-balance sheet arrangements with special-purpose trusts (“SPTs”) for the leasing of certain warehouse and distribution facilities. The consolidation of these entities resulted in an adjustment to record the cumulative effect of the accounting change of approximately $7.4 million, or $.06 per share-diluted, in the third quarter of 2003 reflecting the after-tax effect of accumulated depreciation for these facilities from lease inception through June 29, 2003. Additionally, the consolidation of these entities resulted in a net increase to property, plant and equipment of approximately $107.7 million, with a corresponding increase to long-term debt of $115.5 million and to other long-term liabilities of $4.4 million, reflecting the third party equity interest associated with the lease arrangements. Prior to June 30, 2003, expenses associated with the lease arrangements were classified as rent expense and included in cost of sales in the Consolidated Statements of Income. Subsequent to the consolidation of these entities, expenses were classified as interest expense associated with the corresponding long-term debt. An increase in depreciation expense of $2.6 million in 2003 also resulted from the consolidation of these entities.
3. ACQUISITIONS AND DIVESTITURES
In September 2003, the Company completed the sale of certain gum brands to Farley’s & Sathers Candy Company, Inc. (“Farley’s & Sathers”) for $20.0 million in cash as part of its business realignment initiatives. In the third quarter of 2003, the Company recorded a gain on the sale of $8.3 million before tax, $5.7 million after tax. The gum brands included Fruit Stripe chewing gum, Rain-blo gum balls and Super Bubble bubble gum.
In June 2002, the Company completed the sale of certain confectionery brands to Farley’s & Sathers for $12.0 million in cash as part of its 2001 business realignment initiatives. In the second quarter of 2002, the Company recorded a gain of $4.4 million before tax, $2.8 million after tax, as a result of the transaction. The gain was included as an adjustment to the Company’s business realignment and asset impairments charge. Included in the transaction were the Heide, Jujyfruits, Wunderbeans and Amazin’ Fruit trademarked confectionery brands, as well as the rights to sell Chuckles branded products, under license.
In September 2001, the Company completed the sale of the Luden’s throat drops business to Pharmacia Consumer Healthcare, a unit of Pharmacia Company. Included in the sale were the trademarks and manufacturing equipment for the throat drops business. In the third quarter of 2001, the Company received cash proceeds of $59.9 million and recorded a gain of $19.2 million before tax,
A-34
$1.1 million after tax, as a result of the transaction. A higher gain for tax purposes reflected the low tax basis of the intangible assets included in the sale, resulting in taxes on the gain of $18.1 million. Net sales for the Luden’s throat drops business were $8.9 million in 2001.
In July 2001, the Company’s Brazilian subsidiary, Hershey do Brasil, acquired the chocolate and confectionery business of Visagis for $17.1 million. Included in the acquisition were the IO-IO brand of hazelnut crème items and the chocolate and confectionery products sold under the Visconti brand. Also included in the purchase were a manufacturing plant and confectionery equipment in Sao Roque, Brazil. In accordance with the purchase method of accounting, the purchase price of the acquisition was allocated to the underlying assets and liabilities at the date of acquisition based on their estimated respective fair values. Results subsequent to the date of acquisition were included in the consolidated financial statements. Had the results of the acquisition been included in the consolidated results for the periods prior to the acquisition dates, the effect would not have been material.
4. BUSINESS REALIGNMENT INITIATIVES
In July 2003, the Company announced a number of initiatives continuing its value-enhancing strategy. These initiatives included realigning the sales organization and streamlining the supply chain by divesting or eliminating certain non-strategic brands and products, and by production line rationalization.
During 2003, these actions resulted in a net charge of approximately $17.2 million, or $.07 per share-diluted. The $17.2 million net charge consisted of the write-off of certain inventories of $2.1 million included in cost of sales, a net business realignment and asset impairments charge of $23.4 million and an $8.3 million net gain resulting from the divestiture of certain brands.
The net business realignment and asset impairments charge of $23.4 million consisted of early retirement and involuntary termination costs of $10.0 million, sales office closing and relocation costs of $7.3 million, fixed asset impairment charges of $5.7 million, equipment removal costs of $.7 million and a net gain of $.3 million relating to the elimination of non-strategic brands and products. In determining the fixed asset impairment losses, fair value was estimated based on the expected sales proceeds. Cash payments during the third and fourth quarters of 2003 reduced the liability balance, primarily relating to the aforementioned charges for employee termination, sales office closing and relocation costs, to $8.8 million as of December 31, 2003.
In late October 2001, the Company’s Board of Directors approved a plan to improve the efficiency and profitability of the Company’s operations. The plan included asset management improvements, product line rationalization, supply chain efficiency improvements and a voluntary work force reduction program (collectively, “the 2001 business realignment initiatives”). Total costs for the 2001 business realignment initiatives recorded in 2002 and 2001 were $312.4 million.
During 2002, charges to cost of sales and business realignment and asset impairments were recorded totaling $34.0 million before tax. The total included a charge to cost of sales of $6.4 million associated with the relocation of manufacturing equipment and a net business realignment and asset impairments charge of $27.6 million. Components of the net $27.6 million pre-tax charge included a $28.8 million charge for pension settlement losses resulting from a voluntary work force reduction program (“VWRP”), a $3.0 million charge for pension curtailment losses and special termination benefits resulting from manufacturing plant closures, a $.1 million charge relating to involuntary termination benefits and a $.1 million charge relating to the realignment of the domestic sales organization, partially offset by a $4.4 million favorable adjustment reflecting higher than estimated proceeds from the sale of certain assets.
During the fourth quarter of 2001, charges to cost of sales and business realignment and asset impairments were recorded totaling $278.4 million before tax. The total included a charge to cost of sales of $50.1 million associated with raw material inventory reductions and a business realignment and asset impairments charge of $228.3 million. Components of the $228.3 million pre-tax charge included $175.2 million for business realignment charges and $53.1 million for asset impairment
A-35
charges. The $175.2 million for business realignment charges included $139.8 million for enhanced pension and other post-retirement benefits associated with the VWRP and $35.4 million for other costs associated with the 2001 business realignment initiatives. The $53.1 million for asset impairment charges included $45.3 million for fixed asset impairments and $7.8 million for goodwill impairment. The major components of the 2001 business realignment initiatives were completed as of December 31, 2002. Remaining transactions primarily pertain to the sale of certain real estate associated with the closure of facilities, as discussed below.
Product line rationalization plans included the sale or exit of certain businesses, the discontinuance of certain non-chocolate confectionery products and the realignment of the Company’s sales organizations. Costs associated with the realignment of the sales organizations related primarily to sales office closings and terminating the use of certain sales brokers. During 2002, sales offices were closed as planned and the use of certain sales brokers was discontinued which resulted in an additional charge of $.1 million. During the second quarter of 2002, the sale of a group of the Company’s non-chocolate confectionery candy brands to Farley’s & Sathers was completed. Included in the transaction were the Heide, Jujyfruits, Wunderbeans and Amazin’ Fruit trademarked confectionery brands, as well as the rights to sell Chuckles branded products, under license. Proceeds of $12.0 million associated with the sale of certain confectionery brands to Farley’s & Sathers exceeded the 2001 estimates which resulted in a $4.4 million favorable adjustment. The sale of certain confectionery brands to Farley’s & Sathers resulted in the closure of a manufacturing facility in New Brunswick, New Jersey which was being held for sale as of December 31, 2002. The manufacturing facility was sold in May 2003. Also during the second quarter of 2002, the Company discontinued and subsequently licensed the sale of its aseptically packaged drink products in the United States. Net sales for these brands were $11.6 million and $34.2 million in 2002 and 2001, respectively. An additional charge of $.7 million relating to pension curtailment losses and special termination benefits associated with the closure of the facility was recorded in 2002.
To improve supply chain efficiency and profitability, three manufacturing facilities, a distribution center and certain other facilities were planned to be closed. These included manufacturing facilities in Denver, Colorado; Pennsburg, Pennsylvania; and Palmyra, Pennsylvania and a distribution center and certain minor facilities located in Oakdale, California. During the first quarter of 2002, the manufacturing facility in Palmyra, Pennsylvania was closed and additional costs of $.1 million were recorded, as incurred, relating to retention payments. During the second quarter, operations utilizing the distribution center in Oakdale, California ceased. The manufacturing facilities in Denver, Colorado and Pennsburg, Pennsylvania were closed in the fourth quarter of 2002. An additional charge of $2.3 million relating to pension curtailment losses and special termination benefits associated with the facility closures was recorded in 2002. The Denver, Colorado facility was being held for sale and the Pennsburg, Pennsylvania facility was idle and being held for possible future use as of December 31, 2003.
In October 2001, the Company offered the VWRP to certain eligible employees in the United States, Canada and Puerto Rico in order to reduce staffing levels and improve profitability. The VWRP consisted of an early retirement program which provided enhanced pension, post-retirement and certain supplemental benefits and an enhanced mutual separation program which provided increased severance and temporary medical benefits. A reduction of approximately 500 employees occurred during 2002 as a result of the VWRP. Additional pension settlement costs of $28.8 million were recorded in 2002, principally associated with lump sum payments of pension benefits.
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The following table summarizes the charges for certain business realignment initiatives recorded in the fourth quarter of 2001 and the related activities completed during 2002:
| Accrued
Liabilities
|
Balance 12/31/01 |
2002 Utilization |
New
charges during 2002 |
Balance 12/31/02 |
||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars |
||||||||||||||||||||
Asset
management improvements |
$ | 2,700 | $ | (2,700 | ) | $ | — | $ |
— |
|||||||||||
Product
line rationalization |
15,529 | (15,644 | ) | 115 | — |
|||||||||||||||
Supply
chain efficiency improvements |
8,300 | (8,400 | ) | 100 | — |
|||||||||||||||
Voluntary
work force reduction program |
8,860 | (8,860 | ) | — | — |
|||||||||||||||
Total |
$ | 35,389 | $ | (35,604 | ) | $ | 215 | $ |
— |
|||||||||||
New charges during 2002 related to the elimination of the Company’s broker sales force and termination benefits associated with the closing of a manufacturing facility. Utilization recorded against the liability in 2002 reflected cash payments totaling $25.7 million and non-cash write-offs of $9.9 million associated primarily with exiting certain businesses. The cash payments related primarily to severance payments associated with the enhanced mutual separation program and plant closures, outsourcing the manufacture of certain ingredients, VWRP administrative expenses, the realignment of the Company’s sales organizations and other expenses associated with exiting certain businesses and maintaining properties prior to sale.
5. COMMITMENTS
The Company has entered into certain obligations for the purchase of raw materials. Purchase obligations primarily reflect forward contracts for the purchase of raw materials from third-party brokers and dealers to minimize the effect of future price fluctuations. Total obligations for each year are comprised of fixed price contracts for the purchase of commodities and unpriced contracts that have been valued using market prices as of December 31, 2003. The cost of commodities associated with the unpriced contracts is variable as market prices change over future periods. However, the variability of such costs is mitigated to the extent of the Company’s futures price cover for those periods. Accordingly, increases or decreases in market prices will be offset by gains or losses on commodity futures contracts to the extent that the unpriced contracts are hedged as of December 31, 2003 and in future periods. Taking delivery of the specific commodities for use in the manufacture of finished goods satisfies these obligations. For each of the three years in the period ended December 31, 2003, such obligations were fully satisfied by taking delivery of and making payment for the specific commodities.
As of December 31, 2003, the Company had entered into purchase agreements with various suppliers. Subject to the Company’s quality standards being met, the purchase obligations covered by these agreements aggregated approximately $758.6 million in 2004, $427.1 million in 2005, $80.9 million in 2006, $12.6 million in 2007, $7.5 million in 2008 and $3.8 million in 2009 and beyond.
As previously discussed in Note 2, Cumulative Effect of Accounting Change, the Company adopted Interpretation No. 46 as of June 30, 2003, resulting in the consolidation of the three off-balance sheet arrangements with SPTs. The consolidation of these entities resulted in an adjustment to record the cumulative effect of the accounting change of approximately $7.4 million, or $.06 per share-diluted, in the third quarter of 2003, reflecting the after-tax effect of accumulated depreciation for these facilities from lease inception through June 29, 2003. Additionally, the consolidation of these entities resulted in a net increase to property, plant and equipment of approximately $107.7 million, with a corresponding increase to long-term debt of $115.5 million and to other long-term liabilities of $4.4 million, reflecting the third party equity interest associated with the lease arrangements. Prior to June 30, 2003, expenses associated with the lease arrangements were classified as rent expense and included in cost of sales in the Consolidated Statements of Income. Subsequent to the consolidation of these entities, expenses were classified as interest expense associated with the corresponding long-term debt. An increase in depreciation expense of $2.6 million in 2003 also resulted from the consolidation of these entities.
A-37
During 1999 and 2000 the Company entered into off-balance sheet arrangements for the leasing of certain warehouse and distribution facilities. These off-balance sheet arrangements enabled the Company to lease these facilities under more favorable terms than other leasing alternatives. The lease arrangements are with SPTs whereby the Company leases warehouse and distribution facilities in Redlands, California; Atlanta, Georgia; and Hershey, Pennsylvania, as discussed below. The SPTs were formed to facilitate the acquisition and subsequent leasing of the facilities to the Company. The SPTs financed the acquisition of the facilities by issuing notes and equity certificates to independent third-party financial institutions. The independent third-party financial institutions that hold the equity certificates are the owners of the SPTs. The owners of the SPTs have made substantive residual equity capital investments in excess of 3% which will be at risk during the entire term of each lease. Accordingly, the Company did not consolidate the SPTs prior to June 30, 2003 because all of the conditions for consolidation had not been met.
In December 2000, the Company entered into a lease agreement with the owner of the warehouse and distribution facility in Redlands, California. The lease term was approximately ten years, with occupancy to begin upon completion of the facility. The lease agreement contained an option for the Company to purchase the facility. In January 2002, the Company assigned its right to purchase the facility to an SPT that in turn purchased the completed facility and leased it to the Company under a new lease agreement. The lease term is five years, with up to four renewal periods of five years each with the consent of the lessor. The cost incurred by the SPT to acquire the facility, including land, was $40.1 million.
In October 2000, the Company entered into a lease agreement with an SPT for the leasing of a warehouse and distribution facility near Atlanta, Georgia. The lease term is five years, with up to four renewal periods of five years each with the consent of the lessor. The cost incurred by the SPT to acquire the facility, including land, was $18.2 million.
In July 1999, the Company entered into a lease agreement with an SPT for the construction and leasing of a warehouse and distribution facility located on land owned by the Company near Hershey, Pennsylvania. Under the agreement, the lessor paid construction costs totaling $61.7 million. The lease term is six years, including the one-year construction period, with up to four renewal periods of five years each with the consent of the lessor.
Aside from the residual guarantees and instrument guarantees associated with the individual leasing arrangements, as discussed below, the Company has provided no other guarantees or capitalization of these entities. The Company has not collateralized the obligations in connection with these leases. The Company has no obligations with respect to refinancing of the lessor’s debt, would incur no significant penalties which would result in the reasonable assurance of continuation of the leases and has no significant guarantees other than the residual and instrument guarantees discussed below. There are no other material commitments or contingent liabilities associated with the leasing arrangements. The Company’s transactions with the SPTs are limited to the lease agreements. The Company does not anticipate entering into any other arrangements involving SPEs.
The leases include substantial residual guarantees by the Company for a significant amount of the financing and options to purchase the facilities at original cost. Pursuant to instrument guarantees, in the event of a default under the lease agreements, the Company guaranteed to the note holders and certificate holders payment in an amount equal to all sums then due under the leases.
There are no penalties or other disincentives under the lease agreements if the Company decides not to renew any of the three leases. The terms for each renewal period under each of the three lease arrangements are identical to the initial terms and do not represent bargain lease terms.
If the Company were to exercise its options to purchase the three facilities at original cost at the end of the respective initial lease terms, the Company could purchase the facilities for a total of approximately $120.0 million, $79.9 million for the Pennsylvania and Georgia facilities in 2005 and $40.1 million for the California facility in 2007. If the Company chooses not to renew the leases or purchase the assets at the end of the lease terms, the Company is obligated under the residual
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guarantees for approximately $103.2 million in total for the three leases. Additionally, the Company is obligated to re-market each property on the lessor’s behalf and, upon sale, distribute a portion of the proceeds to the note holders and certificate holders up to an amount equal to the remaining debt and equity certificates and to pay closing costs. If the Company chooses not to renew or purchase the assets at the end of the lease terms, the Company does not anticipate a material disruption to operations, since such facilities are not unique, facilities with similar racking and storage capabilities are available in each of the areas where the facilities are located, there are no significant leasehold improvements that would be impaired, there would be no adverse tax consequences, the financing of replacement facilities would not be material to the Company’s cash flows and costs related to relocation would not be significant to income.
The facility located near Hershey, Pennsylvania was constructed on land owned by the Company. The Company entered into a ground lease with the lessor, an SPT. The initial term of the ground lease extends to the date that is the later of (i) the date the facility lease is no longer in effect, or (ii) the date when the Company satisfies the residual guarantee associated with the lease. An additional term for the ground lease begins upon the end of the initial ground lease term and ends upon the later of the date all sums required to be paid under the lease agreement are paid in full and the 75th anniversary of the ground lease commencement date. If the Company chooses not to renew the building lease or purchase the building, it must re-market the building on the lessor’s behalf subject to the ground lease, which will continue in force until the earlier of the date all sums required to be paid under the lease agreement are paid in full and the 75th anniversary of the ground lease inception date. The lease of the warehouse and distribution facility does not include any provisions which would require the Company to sell the land to the SPT.
Rent expense was $32.6 million, $34.6 million and $37.3 million for 2003, 2002 and 2001, respectively. Rent expense pertains to all operating leases, which were principally related to certain administrative buildings, warehouse and distribution facilities and transportation equipment.
Future minimum rental payments under non-cancelable operating leases with a remaining term in excess of one year as of December 31, 2003, totaled $78.8 million (2004—$14.6 million; 2005—$14.4 million; 2006—$13.8 million; 2007—$12.2 million; 2008—$10.1 million; 2009 and beyond—$13.7 million).
6. GOODWILL AND OTHER INTANGIBLE ASSETS
A reconciliation of reported net income to net income adjusted to reflect the impact of the discontinuance of the amortization of goodwill and other intangible assets for the year ended December 31, 2001 is as follows:
| For the years ended December 31, |
|
2003 |
|
2002 |
|
2001 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars except per share
amounts |
||||||||||||||
Reported
net income: |
$ | 457,584 | $ | 403,578 | $ | 207,156 | ||||||||
Add back:
Goodwill amortization |
11,959 | |||||||||||||
Add back:
Trademark amortization |
1,620 | |||||||||||||
Adjusted net
income |
$ | 457,584 | $ | 403,578 | $ | 220,735 | ||||||||
Basic
earnings per share: |
||||||||||||||
Reported net
income |
$ | 3.48 | $ | 2.96 | $ | 1.52 | ||||||||
Goodwill
amortization |
.09 | |||||||||||||
Trademark
amortization |
.01 | |||||||||||||
Adjusted net
income |
$ | 3.48 | $ | 2.96 | $ | 1.62 | ||||||||
Diluted
earnings per share: |
||||||||||||||
Reported net
income |
$ | 3.46 | $ | 2.93 | $ | 1.50 | ||||||||
Goodwill
amortization |
.09 | |||||||||||||
Trademark
amortization |
.01 | |||||||||||||
Adjusted net
income |
$ | 3.46 | $ | 2.93 | $ | 1.60 | ||||||||
A-39
Accumulated amortization of intangible assets resulting from business acquisitions was $134.3 million and $129.2 million as of December 31, 2003 and 2002, respectively.
7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company adopted SFAS No. 133, as amended, as of January 1, 2001. SFAS No. 133, as amended, requires the Company to recognize all derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for the change in fair value of the derivative depends on whether the instrument qualifies for and has been designated as a hedging relationship and on the type of hedging relationship. There are three types of hedging relationships: a cash flow hedge, a fair value hedge and a hedge of foreign currency exposure of a net investment in a foreign operation. The designation is based upon the exposure being hedged. All derivative instruments currently utilized by the Company are designated and accounted for as cash flow hedges, except for fixed to variable interest rate swaps which are designated and accounted for as fair value hedges of the underlying long-term debt.
Objectives, Strategies and Accounting Policies Associated with Derivative Instruments
The Company utilizes certain derivative instruments, from time to time, including interest rate swaps, foreign currency forward exchange contracts and commodities futures contracts, to manage variability in cash flows associated with interest rate, currency exchange rate and commodity market price risk exposures. The interest rate swaps and foreign currency contracts are entered into for periods consistent with related underlying exposures and do not constitute positions independent of those exposures. Commodities futures contracts are entered into for varying periods and are intended to be and are effective as hedges of market price risks associated with anticipated raw material purchases, energy requirements and transportation costs. If it is probable that hedged forecasted transactions will not occur either by the end of the originally specified time period or within an additional two-month period of time, derivative gains and losses reported in accumulated other comprehensive income (loss) on the Consolidated Balance Sheets are immediately reclassified into earnings. Gains and losses on terminated derivatives designated as hedges are accounted for as part of the originally hedged transaction. Gains and losses on derivatives designated as hedges of items that mature or are sold or terminated, are recognized in income in the same period as the originally hedged transaction was anticipated to affect earnings. The Company utilizes derivative instruments as cash flow or fair value hedges and does not hold or issue derivative instruments for trading purposes. In entering into these contracts, the Company has assumed the risk that might arise from the possible inability of counterparties to meet the terms of their contracts. The Company does not expect any significant losses as a result of counterparty defaults.
Interest Rate Swaps
In order to minimize its financing costs and to manage interest rate exposure, the Company, from time to time, enters into interest rate swap agreements. In October 2003, the Company entered into interest rate swap agreements to effectively convert interest payments on long-term debt from fixed to variable rates. Interest payments on $200.0 million of 6.7% Notes due in October 2005 and $150.0 million of 6.95% Notes due in March 2007 were converted from the respective fixed rates to variable rates based on the London Interbank Offered Rate (“LIBOR”). The interest rate swap agreements qualify as fair value hedges and the notional amounts, interest rates and terms of the swap agreements are consistent with the underlying long-term debt they are intended to hedge. Therefore, there is no hedge ineffectiveness. Under SFAS No. 133, as amended, gains and losses on the fixed to variable interest rate swaps are recorded currently in earnings and the fair value is recorded as an asset or liability on the Consolidated Balance Sheets. The corresponding gain or loss on the underlying long-term debt is also recorded currently in earnings and an adjustment to the carrying value of the underlying long-term debt is recorded in the Consolidated Balance Sheets. The fair value of the fixed to variable interest rate swaps, an asset of $2.2 million, was included in other
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assets on the Consolidated Balance Sheets as of December 31, 2003. The corresponding increase to long-term debt was $2.2 million as of December 31, 2003.
In February 2001, the Company entered into interest rate swap agreements that effectively converted variable-interest-rate payments on certain leases from a variable to a fixed rate. Payments on leases associated with the financing of construction of a warehouse and distribution facility near Hershey, Pennsylvania for $61.7 million and the financing of the purchase of a warehouse and distribution facility near Atlanta, Georgia for $18.2 million are variable based on LIBOR. Such variable payments are forecasted transactions as defined by SFAS No. 133, as amended. The interest rate swap agreements effectively converted the variable-interest-rate payments on the leases from LIBOR to a fixed rate of 6.1%. Future changes in LIBOR are offset by changes in the value of the interest rate swap agreements, resulting in interest expense at the fixed rate of 6.1%.
As previously discussed in Note 2, Cumulative Effect of Accounting Change, the Company adopted Interpretation No. 46 as of June 30, 2003, resulting in the consolidation of the Company’s three off-balance sheet arrangements with SPTs for the leasing of certain warehouse and distribution facilities. The consolidation of those entities resulted in the recording of long-term debt of $59.4 million and $17.5 million associated with the warehouse and distribution facilities near Hershey and Atlanta, respectively, corresponding to the aforementioned interest rate swap agreements. As of June 30, 2003, the Company designated a new hedging relationship contemporaneous with the discontinuance of the pre-existing hedging relationship due to the consolidation of the two corresponding SPTs. Prospectively, beginning on June 30, 2003, the interest rate differential on the interest rate swap agreements was classified as an adjustment to interest expense.
The variable to fixed interest rate swap agreements qualify as cash flow hedges and the notional amounts, interest rates and terms of the swap agreements are consistent with the underlying lease agreements they are intended to hedge and, therefore, there is no hedge ineffectiveness. Gains and losses on the interest rate swap agreements are included in other comprehensive income and are recognized in cost of sales in the same period as the hedged interest payments affect earnings. The fair value of variable to fixed interest rate swap agreements was a liability of $5.2 million and $7.1 million as a December 31, 2003 and 2002, respectively, and was included on the Consolidated Balance Sheets as other long-term liabilities, with the offset reflected in accumulated other comprehensive income (loss), net of income taxes.
Cash flows from interest rate swap agreements are classified as net cash provided from operating activities on the Consolidated Statements of Cash Flows. The Company’s risk related to the interest rate swap agreements is limited to the cost of replacing the agreements at prevailing market rates.
Foreign Exchange Forward Contracts and Options
The Company enters into foreign exchange forward contracts to hedge transactions primarily related to firm commitments to purchase equipment, certain raw materials and finished goods denominated in foreign currencies, and to hedge payment of intercompany transactions with its non-domestic subsidiaries. These contracts reduce currency risk from exchange rate movements. Foreign currency price risks are hedged generally for periods from 3 to 24 months.
Foreign exchange forward contracts and options are intended to be and are effective as hedges of firm, identifiable, foreign currency commitments. Since there is a direct relationship between the foreign currency derivatives and the foreign currency denomination of the transactions, foreign currency derivatives are highly effective in hedging cash flows related to transactions denominated in the corresponding foreign currencies. These contracts meet the criteria for cash flow hedge accounting treatment and, accordingly, gains and losses are included in other comprehensive income and are recognized 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 the Company has assumed the risk that might arise from the possible inability of counterparties to meet the terms of their contracts. The Company does not expect any significant losses as a result of counterparty defaults.
A-41
The fair value of foreign exchange forward contracts and options was estimated by obtaining quotes for future contracts with similar terms, adjusted where necessary for maturity differences. The fair value of foreign exchange forward contracts and options was an asset of $1.6 million and $3.1 million as of December 31, 2003 and 2002, respectively, included on the Consolidated Balance Sheets as other current assets with the offset reflected in accumulated other comprehensive income (loss), net of income taxes. Cash flows from foreign exchange forward contracts and options designated as hedges of foreign currency price risks associated with the purchase of equipment are classified as net cash flows (used by) provided from investing activities on the Consolidated Statements of Cash Flows. Cash flows from other foreign exchange forward contracts are classified as net cash provided from operating activities.
Commodities Futures Contracts
In connection with the purchasing of cocoa, sugar, corn sweeteners, natural gas, fuel oil and certain dairy products for anticipated manufacturing requirements and to hedge transportation costs, the Company enters into commodities futures contracts as deemed appropriate to reduce the effect of price fluctuations. Commodity price risks are hedged generally for periods from 3 to 24 months. Commodities futures contracts meet the hedge criteria and are accounted for as cash flow hedges. Accordingly, gains and losses are included in other comprehensive income and are recognized ratably in cost of sales in the same period that the hedged raw material manufacturing requirements are recorded in cost of sales.
In order to qualify as a hedge of commodity price risk, it must be demonstrated that the changes in fair value of the commodities futures contracts are highly effective in hedging price risks associated with commodity purchases for manufacturing requirements and with transportation costs. The assessment of hedge effectiveness for commodities futures is performed on a quarterly basis by calculating the change in switch values relative to open commodities futures contracts being held and the number of futures contracts needed to price raw material purchases for anticipated manufacturing requirements and to hedge transportation costs. Tracking changes in basis differentials as discussed below also monitors effectiveness. The prices of commodities futures contracts reflect delivery to the same locations where the Company takes delivery of the physical commodities and, therefore, there is no ineffectiveness resulting from differences in location between the derivative and the hedged item. Commodities futures contracts have been deemed to be highly effective in hedging price risks associated with corresponding raw material purchases for manufacturing requirements and transportation costs.
Because of the rollover strategy used for commodities futures contracts, which is required by futures market conditions, some ineffectiveness may result in hedging forecasted manufacturing requirements as futures contracts are switched from nearby contract positions to contract positions which are required to fix the price of raw material purchases for manufacturing requirements. Hedge ineffectiveness may also result from variability in basis differentials associated with the purchase of raw materials for manufacturing requirements. Hedge ineffectiveness is measured on a quarterly basis and the ineffective portion of gains or losses on commodities futures is recorded currently in cost of sales in accordance with SFAS No. 133, as amended.
Exchange traded futures contracts are used to fix the price of physical forward purchase contracts. Cash transfers reflecting changes in the value of futures contracts (unrealized gains and losses) are made on a daily basis and are included in accumulated other comprehensive income (loss), net of income taxes, on the Consolidated Balance Sheets. Such cash transfers will be offset by higher or lower cash requirements for payment of invoice prices of raw materials, energy requirements and transportation costs in the future. Cash flows from commodities futures contracts are classified as net cash provided from operating activities on the Consolidated Statements of Cash Flows. Futures contracts being held in excess of the amount required to fix the price of unpriced physical forward contracts are effective as hedges of anticipated manufacturing requirements for each commodity. Physical commodity forward purchase contracts meet the SFAS No. 133, as amended, definition of “normal purchases and sales” and, therefore, are not considered derivative instruments.
A-42
The net after-tax impact of cash flow hedging derivatives on comprehensive income (loss) reflected a $20.2 million loss in 2003, a $106.7 million gain in 2002 and a $7.8 million loss in 2001. 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, for gains or losses on cash flow hedging derivatives, were reflected in cost of sales. Reclassification of gains of $51.9 million and $17.9 million for 2003 and 2002, respectively, and losses of $19.3 million for 2001 were associated with commodities futures contracts. Gains on commodities futures contracts recognized in cost of sales as a result of hedge ineffectiveness were approximately $.4 million, $1.5 million and $1.7 million before tax for the years ended December 31, 2003, 2002 and 2001, respectively. No 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. There were no components of gains or losses on cash flow hedging derivatives that were recognized in income because such components were excluded from the assessment of hedge effectiveness. As of December 31, 2003, the amount of net after-tax gains on cash flow hedging derivatives, including foreign exchange forward contracts and options, interest rate swap agreements and commodities futures contracts, expected to be reclassified into earnings in the next twelve months was approximately $28.3 million, which was primarily associated with commodities futures contracts.
8. COMPREHENSIVE INCOME
A summary of the components of comprehensive income is as follows:
| For the years ended December 31, |
|
2003 |
|
2002 |
|
2001 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars |
||||||||||||||
Net
income |
$ | 457,584 | $ | 403,578 | $ | 207,156 | ||||||||
Other
comprehensive income (loss): |
||||||||||||||
Foreign
currency translation adjustments |
40,938 | (16,530 | ) | (6,745 | ) | |||||||||
Minimum
pension liability adjustments, net of tax |
(942 | ) | 34,899 | (34,219 | ) | |||||||||
(Losses)
gains on cash flow hedging derivatives, net of tax |
(20,239 | ) | 106,748 | (7,764 | ) | |||||||||
Add:
Reclassification adjustments, net of tax |
(51,913 | ) | (17,914 | ) | 19,312 | |||||||||
Other
comprehensive income (loss) |
(32,156 | ) | 107,203 | (29,416 | ) | |||||||||
Comprehensive
income |
$ | 425,428 | $ | 510,781 | $ | 177,740 | ||||||||
A-43
Comprehensive income is included on the Consolidated Statements of
Stockholders’ Equity. The components of accumulated other comprehensive income (loss) as shown on the Consolidated Balance Sheets are as
follows:
|
|
|
|
|
Foreign Currency Translation Adjustments |
|
Minimum Pension Liability Adjustments |
|
Gains (Losses) on Cash Flow Hedging Derivatives |
Accumulated Other Comprehensive Income (Loss) |
|
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars |
||||||||||||||||||
Balance
as of January 1, 2001 |
$ | (55,800 | ) | $ | (916 | ) | $ | — | $(56,716 |
) | ||||||||
Transition
adjustment (loss), net of a tax benefit of $41,756 |
— | — | (70,191 | ) | (70,191 |
) |
||||||||||||
Current
period credit (charge), gross |
(6,745 | ) | (57,127 | ) | 99,565 | 35,693 |
||||||||||||
Income
tax benefit (expense) |
— | 22,908 | (37,138 | ) | (14,230 |
) |
||||||||||||
Reclassification adjustment charge, gross |
— | — | 30,800 | 30,800 |
||||||||||||||
Income
tax (expense) |
— | — | (11,488 | ) | (11,488 |
) |
||||||||||||
Balance
as of December 31, 2001 |
(62,545 | ) | (35,135 | ) | 11,548 | (86,132 |
) |
|||||||||||
Current
period (charge) credit, gross |
(16,530 | ) | 58,261 | 168,463 | 210,194 |
|||||||||||||
Income
tax (expense) |
— | (23,362 | ) | (61,715 | ) | (85,077 |
) |
|||||||||||
Reclassification adjustment (credit), gross |
— | — | (28,300 | ) | (28,300 |
) |
||||||||||||
Income
tax benefit |
— | — | 10,386 | 10,386 |
||||||||||||||
Balance
as of December 31, 2002 |
(79,075 | ) | (236 | ) | 100,382 | 21,071 |
||||||||||||
Current
period credit (charge), gross |
40,938 | (1,565 | ) | (31,971 | ) | 7,402 |
||||||||||||
Income
tax benefit |
— | 623 | 11,732 | 12,355 |
||||||||||||||
Reclassification adjustment (credit), gross |
— | — | (82,012 | ) | (82,012 |
) |
||||||||||||
Income
tax benefit |
— | — | 30,099 | 30,099 |
||||||||||||||
Balance
as of December 31, 2003 |
$ | (38,137 | ) | $ | (1,178 | ) | $ | 28,230 | $(11,085 |
) |
||||||||
9. 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 December 31, 2003 and 2002, because of the relatively short maturity of these instruments. The carrying value of long-term debt, including the current portion, was $969.0 million as of December 31, 2003, compared to a fair value of $1,100.9 million based on quoted market prices for the same or similar debt issues. The carrying value of long-term debt, including the current portion, was $868.8 million as of December 31, 2002, compared to a fair value of $1,005.9 million.
As of December 31, 2003, the Company had foreign exchange forward contracts and options maturing in 2004 and 2005 to purchase $57.7 million in foreign currency, primarily Canadian dollars, and to sell $18.0 million in foreign currency, primarily Japanese yen, at contracted forward rates.
As of December 31, 2002, the Company had foreign exchange forward contracts maturing in 2003 and 2004 to purchase $45.1 million in foreign currency, primarily British sterling and euros, and to sell $17.2 million in foreign currency, primarily Japanese yen, at contracted forward rates.
The fair value of foreign exchange forward contracts and options is estimated by obtaining quotes for future contracts with similar terms, adjusted where necessary for maturity differences. The fair value of foreign exchange forward contracts and options included in prepaid expenses and other current assets was $1.6 million and $3.1 million as of December 31, 2003 and 2002, respectively. The Company does not hold or issue financial instruments for trading purposes.
In order to minimize its financing costs and to manage interest rate exposure, the Company, from time to time, enters into interest rate swap agreements. In October 2003, the Company entered into interest rate swap agreements to effectively convert interest payments on long-term debt from fixed to variable rates. Interest payments on $200.0 million of 6.7% Notes due in October 2005 and $150.0 million of 6.95% Notes due in March 2007 were converted from the respective fixed rates to
A-44
variable rates based on LIBOR. In February 2001, the Company entered into interest rate swap agreements that effectively converted variable-interest-rate payments on certain leases from a variable to a fixed rate of 6.1%. The fair value of fixed to variable interest rate swap agreements was an asset of $2.2 million as of December 31, 2003 and the fair value of variable to fixed interest rate swaps was a liability of $5.2 million and $7.1 million as of December 31, 2003 and 2002, respectively.
10. INTEREST EXPENSE
Interest expense, net consisted of the following:
| For the years ended December 31, |
|
2003 |
|
2002 |
|
2001 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars |
||||||||||||||
Long-term
debt and lease obligations |
$ | 66,283 | $ | 65,183 | $ | 65,500 | ||||||||
Short-term
debt |
935 | 359 | 7,468 | |||||||||||
Capitalized
interest |
(1,953 | ) | (1,144 | ) | (1,498 | ) | ||||||||
Interest
expense, gross |
65,265 | 64,398 | 71,470 | |||||||||||
Interest
income |
(1,736 | ) | (3,676 | ) | (2,377 | ) | ||||||||
Interest
expense, net |
$ | 63,529 | $ | 60,722 | $ | 69,093 | ||||||||
11. SHORT-TERM DEBT
Generally, the Company’s short-term borrowings are in the form of commercial paper or bank loans with an original maturity of three months or less. As of December 31, 2003, the Company maintained short-term and long-term committed credit facilities with a syndicate of banks in the amount of $400 million that could be borrowed directly or used to support the issuance of commercial paper. The Company may increase the credit facilities to $1.0 billion with the concurrence of the banks. In November 2003, the short-term credit facility agreement was renewed with a credit limit of $200 million expiring in November 2004. The long-term committed credit facility agreement with a credit limit of $200 million will expire in November 2006. The credit facilities may be used to fund general corporate requirements, to support commercial paper borrowings and, in certain instances, to finance future business acquisitions.
The Company also maintains lines of credit with domestic and international commercial banks, under which it could borrow in various currencies up to approximately $43.6 million and $21.0 million as of December 31, 2003 and 2002, respectively, at the lending banks’ prime commercial interest rates or lower. The higher lines of credit as of December 31, 2003, were associated with an anticipated increase in borrowing requirements for the Company’s Canadian business.
The Company had short-term foreign bank loans against its credit facilities and lines of credit of $12.0 million and $11.1 million as of December 31, 2003 and 2002, respectively. The maximum amount of the Company’s short-term borrowings during 2003 was $231.0 million reflecting commercial paper borrowings primarily for the funding of seasonal working capital requirements. The weighted-average interest rate on short-term borrowings outstanding as of December 31, 2003 and 2002 was 0.3% for both years.
The credit facilities and lines of credit were supported by commitment fee arrangements. The average fee during 2003 was approximately 0.1% per annum of the commitment. The Company’s credit facility agreements contain a financial covenant which requires that a specified income to interest ratio be maintained. These agreements are also subject to other representations and covenants that do not materially restrict the Company’s activities. The Company is in compliance with all covenants included in the credit facility agreements. There were no significant compensating balance agreements that legally restricted these funds.
As a result of maintaining a consolidated cash management system, the Company maintains overdraft positions in certain accounts at several banks. The Company has the contractual right of offset for the accounts with overdrafts. Such overdrafts, which were reflected as a reduction to cash and cash equivalents, were $27.1 million and $24.8 million as of December 31, 2003 and 2002, respectively.
A-45
12. LONG-TERM DEBT
Long-term debt consisted of the following:
| December 31, |
|
2003 |
|
2002 |
||||||
|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars |
||||||||||
6.7% Notes
due 2005 |
$ | 201,058 | $ | 200,000 | ||||||
6.95% Notes
due 2007 |
151,136 | 150,000 | ||||||||
6.95% Notes
due 2012 |
150,000 | 150,000 | ||||||||
8.8%
Debentures due 2021 |
100,000 | 100,000 | ||||||||
7.2%
Debentures due 2027 |
250,000 | 250,000 | ||||||||
Obligations
associated with consolidation of lease arrangements |
115,544 | — | ||||||||
Other
obligations, net of unamortized debt discount |
1,238 | 18,789 | ||||||||
Total
long-term debt |
968,976 | 868,789 | ||||||||
Less—current portion |
477 | 16,989 | ||||||||
Long-term
portion |
$ | 968,499 | $ | 851,800 | ||||||
The increase in the carrying amounts of 6.7% Notes due 2005 and 6.95% Notes due 2007, compared with 2002, reflects the impact of fair value hedge accounting for the related interest rate swap agreements entered into in October 2003, as discussed in Note 9, Financial Instruments. Maturities of obligations associated with consolidation of lease arrangements are $76.8 million in 2005 and $38.7 million in 2007. Aggregate annual maturities during the next five years are: 2004, $.5 million; 2005, $279.1 million; 2006, $.1 million; 2007, $190.0 million; and 2008, $.1 million. The Company’s debt is principally unsecured and of equal priority. None of the debt is convertible into stock of the Company. The Company is in compliance with all covenants included in the related debt agreements.
13. INCOME TAXES
Income before income taxes was as follows:
| For
the years ended December 31,
|
|
|
|
2003
|
|
2002
|
|
2001
|
||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars |
||||||||||||||
Domestic |
$ | 707,973 | $ | 625,385 | $ | 320,065 | ||||||||
Foreign |
24,854 | 12,180 | 23,476 | |||||||||||
Income
before income taxes |
$ | 732,827 | $ | 637,565 | $ | 343,541 | ||||||||
The provision for income taxes was as follows: |
||||||||||||||
| For
the years ended December 31,
|
|
|
|
2003
|
2002
|
2001
|
||||||||
| In
thousands of dollars |
||||||||||||||
Current: |
||||||||||||||
Federal |
$ | 207,373 | $ | 84,312 | $ | 160,182 | ||||||||
State |
22,178 | 11,801 | 22,155 | |||||||||||
Foreign |
(571 | ) | 57 | 3,390 | ||||||||||
Current
provision for income taxes |
228,980 | 96,170 | 185,727 | |||||||||||
Deferred: |
||||||||||||||
Federal |
22,416 | 119,752 | (41,293 | ) | ||||||||||
State |
6,658 | 14,115 | (7,120 | ) | ||||||||||
Foreign |
9,821 | 3,950 | (929 | ) | ||||||||||
Deferred
income tax provision (benefit) |
38,895 | 137,817 | (49,342 | ) | ||||||||||
Total
provision for income taxes |
$ | 267,875 | $ | 233,987 | $ | 136,385 | ||||||||
A-46
Deferred taxes reflect temporary differences between the tax basis and financial statement carrying value of assets and liabilities. The tax effects of the significant temporary differences that comprised the deferred tax assets and liabilities were as follows:
| December 31, |
|
2003 |
|
2002 |
||||||
|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars |
||||||||||
Deferred tax
assets: |
||||||||||
Post-retirement benefit obligations |
$ | 104,175 | $ | 102,487 | ||||||
Accrued
expenses and other reserves |
98,012 | 91,586 | ||||||||
Accrued trade
promotion reserves |
16,679 | 11,377 | ||||||||
Other |
25,330 | 26,935 | ||||||||
Total
deferred tax assets |
244,196 | 232,385 | ||||||||
Deferred tax
liabilities: |
||||||||||
Property,
plant and equipment, net |
272,173 | 220,694 | ||||||||
Cash flow
hedging derivatives |
17,042 | 59,518 | ||||||||
Pension |
137,658 | 119,742 | ||||||||
Inventories |
44,020 | 37,208 | ||||||||
Other |
137,607 | 168,031 | ||||||||
Total
deferred tax liabilities |
608,500 | 605,193 | ||||||||
Net deferred
tax liabilities |
$ | 364,304 | $ | 372,808 | ||||||
Included
in: |
||||||||||
Current
deferred tax liabilities (assets), net |
$ | (13,285 | ) | $ | 24,768 | |||||
Non-current
deferred tax liabilities, net |
377,589 | 348,040 | ||||||||
Net deferred
tax liabilities |
$ | 364,304 | $ | 372,808 | ||||||
Additional information on income tax benefits and expenses related to the components of accumulated other comprehensive income (loss) is provided in Note 8, Comprehensive Income.
The following table reconciles the Federal statutory income tax rate with the Company’s effective income tax rate:
| For the years ended December 31, |
|
2003 |
|
2002 |
|
2001 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Federal
statutory income tax rate |
35.0 | % | 35.0 | % | 35.0 | % | ||||||||
Increase
(reduction) resulting from: |
||||||||||||||
State income
taxes, net of Federal income tax benefits |
2.6 | 2.6 | 3.4 | |||||||||||
Gain on sale
of Luden’s throat drops business |
— | — | 1.6 | |||||||||||
Non-deductible acquisition costs |
— | — | .7 | |||||||||||
Puerto Rico
operations |
(.8 | ) | (1.0 | ) | (1.2 | ) | ||||||||
Other,
net |
(.2 | ) | .1 | .2 | ||||||||||
Effective
income tax rate |
36.6 | % | 36.7 | % | 39.7 | % | ||||||||
Included with the purchase of the Nabisco gum and mint business in December 2000, was a U.S. Internal Revenue Code (“IRC”) Section 936 company with a subsidiary operating in Las Piedras, Puerto Rico. The operating income of this subsidiary is subject to a lower income tax rate in both the United States and Puerto Rico. The U.S. IRC Section 936 incentive is scheduled to expire on December 31, 2005.
The gain on the sale of the Luden’s throat drops business in 2001 primarily reflected the lower tax basis of the intangible assets included in the sale, resulting in a higher effective income tax rate.
A-47
14. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
The Company’s policy is to fund domestic pension liabilities in accordance with the minimum and maximum limits imposed by the Employee Retirement Income Security Act of 1974 and Federal income tax laws, respectively. Non-domestic pension liabilities are funded in accordance with applicable local laws and regulations. Plan assets are invested in a broadly diversified portfolio consisting primarily of domestic and international common stocks and fixed income securities. The Company uses a December 31 measurement date for the majority of its plans. Other benefits include health care and life insurance provided by the Company under two post-retirement benefit plans.
A summary of the changes in benefit obligations and plan assets as of December 31, 2003 and 2002 is presented below:
| Pension
Benefits
|
Other
Benefits
|
||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December
31,
|
|
|
|
2003
|
|
2002
|
|
2003
|
|
2002
|
|||||||||
| In
thousands of dollars |
|||||||||||||||||||
Change
in benefits obligation |
|||||||||||||||||||
Benefits
obligation at beginning of year |
$ | 816,164 | $ | 837,540 | $ | 328,884 | $ | 301,406 | |||||||||||
Service
cost |
39,096 | 31,890 | 3,712 | 3,157 | |||||||||||||||
Interest
cost |
50,951 | 50,372 | 18,653 | 19,674 | |||||||||||||||
Amendments |
5,095 | 2,528 | — | — | |||||||||||||||
Actuarial
loss (gain) |
38,643 | 75,207 | (3,935 | ) | 21,551 | ||||||||||||||
Special
termination benefits |
3,408 | 809 | 539 | — | |||||||||||||||
Settlements |
(109 | ) | (141,546 | ) | — | — | |||||||||||||
Curtailment
(gain) loss |
— | (1,060 | ) | — | 62 | ||||||||||||||
Other |
10,053 | 1,665 | 1,172 | 33 | |||||||||||||||
Benefits
paid |
(70,142 | ) | (41,241 | ) | (20,762 | ) | (16,999 | ) | |||||||||||
Benefits
obligation at end of year |
893,159 | 816,164 | 328,263 | 328,884 | |||||||||||||||
Change
in plan assets |
|||||||||||||||||||
Fair
value of plan assets at beginning of year |
716,888 | 687,151 | — | — | |||||||||||||||
Actual
return on plan assets |
152,793 | (95,385 | ) | — | — | ||||||||||||||
Employer
contribution |
120,252 | 308,080 | 20,762 | 16,999 | |||||||||||||||
Settlements
paid |
(109 | ) | (141,546 | ) | — | — | |||||||||||||
Other |
7,976 | (171 | ) | — | — | ||||||||||||||
Benefits
paid |
(70,142 | ) | (41,241 | ) | (20,762 | ) | (16,999 | ) | |||||||||||
Fair
value of plan assets at end of year |
927,658 | 716,888 | — | — | |||||||||||||||
Funded
status |
34,499 | (99,276 | ) | (328,263 | ) | (328,884 | ) | ||||||||||||
Unrecognized
transition asset |
583 | 270 | — | — | |||||||||||||||
Unrecognized
prior service cost |
40,853 | 39,533 | (8,246 | ) | (10,180 | ) | |||||||||||||
Unrecognized
net actuarial loss |
236,140 | 305,520 | 76,904 | 84,231 | |||||||||||||||
Intangible
asset |
— | (738 | ) | — | — | ||||||||||||||
Accumulated
other comprehensive loss |
(1,959 | ) | (394 | ) | — | — | |||||||||||||
Prepaid
(Accrued) benefits cost |
$ | 310,116 | $ | 244,915 | $ | (259,605 | ) | $ | (254,833 | ) | |||||||||
Weighted-average assumptions used to determine benefit obligation as of December 31:
|
|
|
|
|
2003
|
|
2002
|
|
2003
|
|
2002
|
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Discount
rate |
6.0 | % | 6.3 | % | 6.0 | % | 6.3 | % | ||||||||||
Rate
of increase in compensation levels |
4.9 | 4.9 | N/A | N/A | ||||||||||||||
For measurement purposes, an 8% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2003 and future years.
A-48
Amounts recognized in the Consolidated Balance Sheets consisted of the following:
| Pension
Benefits |
Other
Benefits
|
||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December
31, |
|
|
|
2003
|
|
2002
|
|
2003
|
|
2002
|
|||||||||
| In
thousands of dollars |
|||||||||||||||||||
Prepaid
expenses and other |
$ | 33,240 | $ | 19,346 | $ | — | $ | — | |||||||||||
Other
assets |
311,692 | 262,207 | — | — | |||||||||||||||
Accrued
liabilities |
(3,802 | ) | (8,075 | ) | (27,401 | ) | (20,742 | ) | |||||||||||
Other
long-term liabilities |
(29,055 | ) | (27,431 | ) | (232,204 | ) | (234,091 | ) | |||||||||||
Intangible
assets |
— | (738 | ) | N/A | N/A | ||||||||||||||
Accumulated
other comprehensive loss |
(1,959 | ) | (394 | ) | N/A | N/A | |||||||||||||
Net
amount recognized |
$ | 310,116 | $ | 244,915 | $ | (259,605 | ) | $ | (254,833 | ) | |||||||||
The accumulated benefit obligation for all defined pension plans was $815,022 and $746,949 as of December 31, 2003 and 2002, respectively. Information for pension plans with an accumulated benefit obligation in excess of plan assets was as follows: |
|||||||||||||||||||
| December 31, |
|
|
|
2003
|
2002
|
||||||||||||||
| In
thousands of dollars |
|||||||||||||||||||
Projected
benefit obligation |
$ | 38,978 | $ | 87,650 | |||||||||||||||
Accumulated
benefit obligation |
34,889 | 73,244 | |||||||||||||||||
Fair
value of plan assets |
— | 35,011 | |||||||||||||||||
Contributions totaling $120.3 million were made to the Company’s pension plans during 2003 primarily to improve the funded status of the plans. In 2002, the Company contributed $308.1 million to its pension plans to improve the funded status as a result of the poor market performance of pension plan assets during the year. For 2004, there will be no minimum funding requirements for the domestic plans and minimum funding requirements for the non-domestic plans will not be material. However, the Company may choose to make contributions in 2004 to improve the funded status.
The lower unrecognized net actuarial loss for pension benefits as of December 31, 2003, was due primarily to the 2003 actual return on plan assets being greater than the expected long-term rate of return. The unrecognized net actuarial loss for pension benefits as of December 31, 2002, was due primarily to the actual return on plan assets being less than the expected rate of return and the reduced discount rate assumption. The Company reduced the asset return assumption for 2003 to 8.5% based on an assessment of expected average asset returns for each asset class over the next 10 years utilizing outside investment manager projections. The historical geometric average return over the 16 years prior to December 31, 2003, was approximately 9.6%.
A minimum pension liability adjustment is required when the actuarial present value of accumulated plan benefits exceeds plan assets and accrued pension liabilities. In 2003 a minimum liability adjustment of $1.6 million, net of a deferred tax benefit of $.6 million, was recorded as a component of other comprehensive income (loss) and reported in accumulated other comprehensive income (loss) as a component of stockholders’ equity. In 2002, the reversal of a minimum liability adjustment of $58.3 million, net of deferred tax expense of $23.4 million, was recorded as a component of other comprehensive income (loss) and reported in accumulated other comprehensive income (loss) as a component of stockholders’ equity.
A-49
A summary of the components of net periodic benefits cost for the years ended December 31, 2003, 2002 and 2001 is presented below:
| Pension
Benefits
|
Other
Benefits
|
||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For
the years ended December 31,
|
|
|
|
2003
|
|
2002
|
|
2001
|
|
2003
|
|
2002
|
|
2001
|
|||||||||||||
| In
thousands of dollars |
|||||||||||||||||||||||||||
Components
of net periodic benefits cost |
|||||||||||||||||||||||||||
Service
cost |
$ | 39,096 | $ | 31,890 | $ | 30,093 | $ | 3,712 | $ | 3,157 | $ | 3,434 | |||||||||||||||
Interest
cost |
50,951 | 50,372 | 48,239 | 18,653 | 19,674 | 17,829 | |||||||||||||||||||||
Expected
return on plan assets |
(59,557 | ) | (60,443 | ) | (61,791 | ) | — | — | — | ||||||||||||||||||
Amortization
of prior service cost |
4,486 | 3,906 | 3,891 | (1,654 | ) | (1,858 | ) | (2,168 | ) | ||||||||||||||||||
Amortization
of unrecognized transition balance |
(331 | ) | (326 | ) | (27 | ) | — | — | — | ||||||||||||||||||
Recognized
net actuarial loss |
16,377 | 4,371 | — | 3,171 | 2,774 | 2,761 | |||||||||||||||||||||
Other |
— | — | — | — | — | (80 | ) | ||||||||||||||||||||
Company
sponsored plans |
51,022 | 29,770 | 20,405 | 23,882 | 23,747 | 21,776 | |||||||||||||||||||||
Multi-employer
plans |
— | 483 | 615 | — | — | — | |||||||||||||||||||||
Administrative
expenses |
517 | 423 | 297 | — | — | — | |||||||||||||||||||||
Net
periodic benefits cost |
51,539 | 30,676 | 21,317 | 23,882 | 23,747 | 21,776 | |||||||||||||||||||||
Special
termination benefits |
3,383 | 809 | 106,273 | 539 | — | 15,451 | |||||||||||||||||||||
Curtailment
loss |
28 | 2,116 | 2,802 | — | — | 15,366 | |||||||||||||||||||||
Settlement
loss |
7 | 30,118 | — | — | — | — | |||||||||||||||||||||
Total
amount reflected in earnings |
$ | 54,957 | $ | 63,719 | $ | 130,392 | $ | 24,421 | $ | 23,747 | $ | 52,593 | |||||||||||||||
A summary of the weighted-average assumptions used to determine net periodic benefits cost is as follows:
| Pension
Benefits
|
Other
Benefits
|
||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For
the years ended December 31,
|
|
|
|
2003
|
|
2002
|
|
2001
|
|
2003
|
|
2002
|
|
2001
|
|||||||||||||
Discount
rate |
6.3 | % | 6.9 | % | 7.5 | % | 6.3 | % | 7.0 | % | 7.5 | % | |||||||||||||||
Expected
long-term return on plan assets |
8.5 | 9.5 | 9.5 | N/A | N/A | N/A | |||||||||||||||||||||
Rate
of compensation increase |
4.9 | 4.9 | 4.9 | N/A | N/A | N/A | |||||||||||||||||||||
Additional
information: |
|||||||||||||||||||||||||||
(Increase)
decrease in minimum liability included in other comprehensive income |
$(1,565) |
$58,261 |
$(57,127) |
N/A | N/A | N/A | |||||||||||||||||||||
The Company’s pension plan asset target allocation for 2004, the actual allocation as of December 31, 2003 and 2002, and the expected long-term rate of return by asset category for 2003 are as follows:
Target Allocation |
Percentage of Plan Assets as of December 31, |
Weighted-Average Expected Long-term Rate of Return |
||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Asset Category |
|
2004 |
|
2003 |
|
2002 |
|
2003 |
||||||||||
Equity
securities |
40-85 | % | 61 | % | 68 | % | 9.5 | % | ||||||||||
Debt
securities |
15-60 | 37 | 15 | 5.5 | ||||||||||||||
Other |
0-10 | 2 | 17 | — | ||||||||||||||
Total |
100 | % | 100 | % | 8.5 | % | ||||||||||||
The assets of domestic plans are invested in compliance with the Employee Retirement Income Security Act of 1974 (“ERISA”) and the rules and regulations promulgated thereunder. The investment goals are to provide a total return that, over the long-term, increases the ratio of Plan
A-50
assets to liabilities subject to a level of risk and to diversify investments within asset classes. Investments or investment strategies not allowed by ERISA are prohibited. Direct purchases of the Company’s securities and the use of derivatives for the purpose of speculation are also not permitted. The assets of non-domestic plans are invested in compliance with applicable local laws and regulations.
The Company has two post-retirement benefit plans. The health care plan is contributory, with participants’ contributions adjusted annually, and the life insurance plan is non-contributory.
On December 8, 2003, the President of the United States signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). The Act introduces a prescription drug benefit under Medicare (“Medicare Part D”) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The accumulated benefits obligation or net periodic post-retirement benefits cost in the consolidated financial statements or accompanying notes do not reflect the effects of the Act on the Company’s post-retirement benefit plans.
In 2003, the Special Termination Benefits were related to the early retirement program which was a component of the 2003 business realignment initiatives, described more fully in Note 4, Business Realignment Initiatives. The early retirement program provided enhanced pension and retiree medical benefits with pre-tax costs of $3.4 million and $.5 million, respectively.
In conjunction with the business realignment initiatives announced in October 2001, the Company offered an early retirement program to approximately 10% of its work force in the fourth quarter of 2001. The early retirement program gave eligible salaried employees an opportunity to retire with enhanced benefits related to the Company’s pension and other post-retirement benefit plans. In general, eligible employees were born before January 1, 1954, and were hired before January 1, 1999. Pension benefits were enhanced by adding five additional years of age and service to eligible employees’ retirement accounts, along with certain supplemental benefits. Retiree medical benefits were enhanced by adding five additional years to age and service formulas used to determine retiree contributions.
In 2002, pension settlement and curtailment losses and special termination benefits totaled $33.0 million. This amount related primarily to the non-cash costs for pension settlements associated with departing employees electing a lump sum payment of their pension benefit under the early retirement program and for pension curtailments and special termination benefits associated with the closure of three manufacturing facilities as part of the business realignment initiatives.
The total pre-tax charge for the VWRP recorded in the fourth quarter of 2001 was $148.7 million and was accrued based on actual employee acceptances. Improved pension benefits under the early retirement program of $109.1 million will be funded through payments from one of the Company’s defined benefit pension plans. Enhanced retiree medical benefits of $30.8 million will be funded from operating cash flows. Additional costs for outplacement services and enhanced severance benefits under a voluntary mutual separation program of $8.8 million were funded from operating cash flows.
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage point change in assumed health care cost trend rates would have the following effects:
| |
1 Percentage Point Increase |
|
1 Percentage Point (Decrease) |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
| In thousands of dollars |
||||||||||
Effect on total
service and interest cost components |
$ | 857 | $ | (635 | ) | |||||
Effect on
post-retirement benefit obligation |
11,903 | (10,452 | ) | |||||||
A-51
15. EMPLOYEE STOCK OWNERSHIP TRUST
The Company’s employee stock ownership trust (“ESOP”) serves as the primary vehicle for contributions to its existing Employee Savings Stock Investment and Ownership Plan for participating domestic salaried and hourly employees. In December 1991, the ESOP was funded by a 15-year, 7.75% loan of $47.9 million from the Company. During 2003 and 2002, the ESOP received a combination of dividends on unallocated shares and contributions from the Company equal to the amount required to meet its principal and interest payments under the loan. Simultaneously, the ESOP allocated to participants 159,176 shares of Common Stock each year. As of December 31, 2003, the ESOP held 1,120,076 allocated shares and 477,520 unallocated shares. All ESOP shares are considered outstanding for income per share computations.
The Company recognized net compensation expense equal to the shares allocated multiplied by the original cost of $20.06 per share less dividends received by the ESOP on unallocated shares. Compensation expense related to the ESOP for 2003, 2002 and 2001 was $1.6 million, $.9 million and $1.6 million, respectively. Dividends paid on unallocated ESOP shares for 2003, 2002 and 2001 were $.8 million, $.9 million and $1.0 million, respectively. Dividends paid on all ESOP shares are recorded as a reduction to retained earnings. The unearned ESOP compensation balance in stockholders’ equity represented deferred compensation expense to be recognized by the Company in future years as additional shares are allocated to participants.
16. CAPITAL STOCK AND NET INCOME PER SHARE
As of December 31, 2003, the Company had 530,000,000 authorized shares of capital stock. Of this total, 450,000,000 shares were designated as Common Stock, 75,000,000 shares as Class B Common Stock (“Class B Stock”) and 5,000,000 shares as Preferred Stock, each class having a par value of one dollar per share. As of December 31, 2003, a combined total of 179,950,872 shares of both classes of common stock had been issued of which 129,529,733 shares were outstanding. No shares of the Preferred Stock were issued or outstanding during the three-year period ended December 31, 2003.
Holders of the Common Stock and the Class B Stock generally vote together without regard to class on matters submitted to stockholders, including the election of directors, with the Common Stock having one vote per share and the Class B Stock having ten votes per share. However, the Common Stock, voting separately as a class, is entitled to elect one-sixth of the Board of Directors. With respect to dividend rights, the Common Stock is entitled to cash dividends 10% higher than those declared and paid on the Class B Stock.
Class B Stock can be converted into Common Stock on a share-for-share basis at any time. During 2003, 2002 and 2001, a total of 212 shares, 11,500 shares and 8,050 shares, respectively, of Class B Stock were converted into Common Stock.
In December 2000, the Company’s Board of Directors unanimously adopted a Stockholder Protection Rights Agreement (“Rights Agreement”) and declared a dividend of one right (“Right”) for each outstanding share of Common Stock and Class B Stock payable to stockholders of record at the close of business on December 26, 2000. The Rights will at no time have voting power or receive dividends. The issuance of the Rights has no dilutive effect, will not affect reported earnings per share, is not taxable and will not change the manner in which the Company’s Common Stock is traded.
The Rights become exercisable only upon (i) resolution of the Board of Directors after any person has commenced a tender offer that would result in such person becoming the beneficial owner of 15% or more of the Common Stock, (ii) the Company’s announcement that a person or group has acquired 15% or more of the outstanding shares of Common Stock, or (iii) a person or group becoming the beneficial owner of more than 35% of the voting power of all of the outstanding Common Stock and Class B Stock. When exercisable, each Right entitles its registered holder to purchase from the Company, at a pre-determined exercise price, one one-thousandth of a share of Series A Participating Preferred Stock, par value $1.00 per share (which would be convertible by holders of Class B Stock into Series B Participating Preferred Stock on the basis of one one-thousandth of a share of Series B Participating Preferred Stock for every share of Class B Common Stock held at that time). Each
A-52
one one-thousandth of a share of Series A Participating Preferred Stock would have economic and voting terms similar to those of one share of Common Stock. Similarly, each one one-thousandth of a share of Series B Participating Preferred Stock would have economic and voting terms similar to those of one share of Class B Stock.
Upon the earlier of (a) a public announcement by the Company that a person or group has acquired 15% or more of the outstanding shares of Common Stock or (b) such person or group acquiring more than 35% of the voting power of the Common Stock and Class B Stock, each Right (except those owned by the acquiring person or group) will automatically become a right to buy, at the pre-determined exercise price, that number of one one-thousandth of a share of Series A Participating Preferred Stock having a market value of twice the exercise price. In addition, if the Company is acquired in a merger or other business combination, each Right will entitle a holder to purchase from the acquiring company, for the pre-determined exercise price, preferred stock of the acquiring company having an aggregate market value equal to twice the exercise price.
Further, at any time after a person or group acquires 15% or more (but less than 50%) of the Company’s Common Stock or more than 35% of the voting power of all outstanding Common Stock and Class B Stock, the Company’s Board of Directors may, at its option, exchange all (but not less than all) of the outstanding Preferred Stock (other than Rights held by the acquiring person or group) for shares of Common Stock or Class B Stock, as applicable, at an exchange ratio of one share of Common Stock or Class B Stock for each one one-thousandth of a share of Preferred Stock.
The Company, solely at its option, may amend the Rights or redeem the Rights for $.01 per Right at any time before the acquisition by a person or group of beneficial ownership of 15% or more of its Common Stock or more than 35% of the voting power of all of the outstanding Common Stock and Class B Stock. Unless redeemed earlier or extended by the Company, the Rights will expire on December 14, 2010.
Hershey Trust Company, as Trustee for the benefit of Milton Hershey School (“Milton Hershey School Trust”), as institutional fiduciary for estates and trusts unrelated to Milton Hershey School, and as direct owner of investment shares, held a total of 12,720,806 shares of the Common Stock, and as Trustee for the benefit of Milton Hershey School, held 30,306,006 shares of the Class B Stock as of December 31, 2003, and was entitled to cast approximately 78.3% of the total votes of both classes of the Company’s common stock. The Milton Hershey School Trust must approve the issuance of shares of Common Stock or any other action that would result in the Milton Hershey School Trust not continuing to have voting control of the Company.
Changes in outstanding Common Stock for the past three years were:
| For
the years ended December 31,
|
|
|
|
2003
|
|
2002
|
|
2001
|
||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Shares
issued |
179,950,872 | 179,950,872 | 179,950,872 | |||||||||||
Treasury
shares at beginning of year |
(45,730,735 | ) | (44,311,870 | ) | (43,669,284 | ) | ||||||||
Stock
repurchases: |
||||||||||||||
Repurchase
programs |
(4,924,200 | ) | (1,300,345 | ) | (676,600 | ) | ||||||||
Stock
options and benefits |
(1,205,112 | ) | (2,422,385 | ) | (1,037,455 | ) | ||||||||
Stock
issuances: |
||||||||||||||
Stock
options and benefits |
1,438,908 | 2,303,865 | 1,071,469 | |||||||||||
Treasury
shares at end of year |
(50,421,139 | ) | (45,730,735 | ) | (44,311,870 | ) | ||||||||
Net
shares outstanding at end of year |
129,529,733 | 134,220,137 | 135,639,002 | |||||||||||
A-53
Basic and Diluted Earnings Per Share were computed based on the weighted-average number of shares of the Common Stock and the Class B Stock outstanding as follows:
| For
the years ended December 31,
|
|
|
|
2003
|
|
2002
|
|
2001
|
||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands except per share amounts |
||||||||||||||
Net
income |
$ | 457,584 | $ | 403,578 | $ | 207,156 | ||||||||
Weighted-average shares—Basic |
131,306 | 136,538 | 136,245 | |||||||||||
Effect
of dilutive securities: |
||||||||||||||
Employee
stock options |
913 | 1,067 | 1,379 | |||||||||||
Performance
and restricted stock units |
47 | 109 | 72 | |||||||||||
Weighted-average shares—Diluted |
132,266 | 137,714 | 137,696 | |||||||||||
Earnings
Per Share—Basic |
$ | 3.48 | $ | 2.96 | $ | 1.52 | ||||||||
Earnings
Per Share—Diluted |
$ | 3.46 | $ | 2.93 | $ | 1.50 | ||||||||
For the years ended December 31, 2003, 2002 and 2001, 3.1 million, 1.9 million and 2.0 million stock options, respectively, were not included in the diluted earnings per share calculation because the exercise price was higher than the average market price of the Common Stock for the year and, therefore, the effect would have been antidilutive.
17. STOCK COMPENSATION PLANS
The long-term portion of the Key Employee Incentive Plan (“Incentive Plan”) provides for grants to senior executives and key employees of stock-based compensation awards of one or more of the following: non-qualified stock options (“fixed stock options”), performance stock units, stock appreciation rights and restricted stock units. The Incentive Plan also provides for the deferral of performance stock unit and restricted stock unit awards by participants. As of December 31, 2003, 19.0 million shares (inclusive of adjustments for stock splits) were authorized and approved by the Company’s stockholders for grants under the long-term portion of the Incentive Plan.
In 1996, the Company’s Board of Directors approved a worldwide, broad-based employee stock option program, called HSY Growth. HSY Growth provided all eligible employees with a one-time grant of 100 non-qualified stock options. Under HSY Growth, over 1.2 million options were granted on January 7, 1997.
Fixed Stock Options
The exercise price of each option equals the market price of the Company’s Common Stock on the date of grant (determined as the closing price of the Common Stock on the New York Stock Exchange on the business day immediately preceding the date the stock options were granted). Each option has a maximum term of ten years. Options granted under the Incentive Plan prior to December 31, 1999, vest at the end of the second year after grant. In 2000, the terms and conditions of the grant were changed to provide for pro-rated vesting over four years for options granted subsequent to December 31, 1999. Options granted under the HSY Growth program have a term of ten years and vested on January 7, 2002.
A-54
A summary of the status of the Company’s fixed stock options as of December 31, 2003, 2002 and 2001, and changes during the years ending on those dates is presented below:
| 2003 | 2002 | 2001 | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fixed Options | Shares | Weighted- Average Exercise Price |
Shares | Weighted- Average Exercise Price |
Shares | Weighted- Average Exercise Price |
|||||||||||||||||||||
| Outstanding
at beginning of year |
6,964,562 | $ | 52.97 | 8,006,561 | $ | 46.39 | 8,298,665 | $ | 43.10 | ||||||||||||||||||
| Granted |
1,472,925 | $ | 65.20 | 1,356,605 | $ | 69.33 | 781,900 | $ | 62.43 | ||||||||||||||||||
| Exercised |
(1,290,353 | ) | $ | 41.99 | (2,184,592 | ) | $ | 39.53 | (921,043 | ) | $ | 30.22 | |||||||||||||||
| Forfeited |
(75,975 | ) | $ | 58.67 | (214,012 | ) | $ | 50.30 | (152,961 | ) | $ | 46.84 | |||||||||||||||
| Outstanding
at end of year |
7,071,159 | $ | 57.46 | 6,964,562 | $ | 52.97 | 8,006,561 | $ | 46.39 | ||||||||||||||||||
| Options
exercisable at year-end |
3,737,081 | $ | 52.67 | 3,970,269 | $ | 48.37 | 4,544,590 | $ | 44.73 | ||||||||||||||||||
| Weighted-average
fair value of options granted during the year (per share) |
$ | 17.74 | $ | 20.96 | $ | 18.58 | |||||||||||||||||||||
The following table summarizes information about fixed stock options outstanding as of December 31, 2003:
| Options
Outstanding
|
Options
Exercisable
|
||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Range
of Exercise Prices |
|
|
|
Number Outstanding as of 12/31/03 |
|
Weighted- Average Remaining Contractual Life in Years |
|
Weighted- Average Exercise Price |
|
Number Exercisable as of 12/31/03 |
|
Weighted- Average Exercise Price |
|||||||
$24.50–49.81
|
2,320,567 | 4.9 |
$42.32 |
1,780,472 | $41.51 |
||||||||||||||
$58.50–64.50
|
2,826,068 | 6.7 |
$62.52 |
1,413,333 | $61.12 |
||||||||||||||
$64.61–78.51
|
1,924,524 | 8.0 |
$68.28 |
543,276 | $67.24 |
||||||||||||||
$24.50–78.51
|
7,071,159 | 6.4 |
$57.46 |
3,737,081 | $52.67 |
||||||||||||||
Performance Stock Units and Restricted Stock Units
Under the long-term portion of the Incentive Plan, each February the Company grants selected executives and other key employees performance stock units whose vesting is contingent upon the achievement of certain performance objectives. If at the end of the applicable three-year performance cycle targets for financial measures are met, the full number of shares is awarded to the participants. The performance scores for 2003 grants of performance stock units can range from 0% to 250% of the targeted amounts. Restricted stock units were awarded in 2003, 2002 and 2001 under the long-term portion of the Incentive Plan to certain executive officers and were also awarded quarterly to non-employee directors of the Company as part of the Directors’ Compensation Plan. The compensation amount charged against income for performance and restricted stock units was $7.2 million, $6.4 million and $6.6 million for 2003, 2002 and 2001, respectively. The compensation cost associated with the performance stock units is recognized ratably over the three-year term based on the year-end market value of the stock, except for the 2003 grants. An additional three-year vesting term was imposed for the 2003 grants with accelerated vesting for retirement, disability or death. The compensation cost for the 2003 grants is being recognized over a period from three to six years. The compensation cost associated with employee restricted stock units is recognized over a specified restriction period based on the year-end market value of the stock. The compensation cost associated with non-employee director restricted stock units is recognized at the grant date and adjusted based on the year-end market value of the stock. Performance stock units and restricted stock units granted for potential future distribution were as follows:
| For the years ended December 31, |
|
2003 |
|
2002 |
|
2001 |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Shares
granted |
114,112 | 60,615 | 111,007 | |||||||||||
Weighted-average fair value at date of grant |
$66.34 | $66.80 | $62.66 | |||||||||||
A-55
Deferred performance stock units, deferred restricted stock units, deferred directors’ fees and accumulated dividend amounts totaled 302,002 shares as of December 31, 2003.
No stock appreciation rights were outstanding as of December 31, 2003.
18. SUPPLEMENTAL BALANCE SHEET
INFORMATION
Accounts Receivable—Trade
In the normal course of business, the Company extends credit to customers that satisfy pre-defined credit criteria. The Company believes that it has little concentration of credit risk due to the diversity of its customer base. As of December 31, 2003, McLane Company, Inc., formerly a subsidiary of Wal-Mart Stores, Inc., accounted for approximately 13% of the Company’s total accounts receivable. As of December 31, 2003, no other customer accounted for more than 10% of the Company’s total accounts receivable. Receivables, as shown on the Consolidated Balance Sheets, were net of allowances and anticipated discounts of $21.1 million and $16.5 million as of December 31, 2003 and 2002, respectively. The higher amount as of December 31, 2003, was principally related to an increase of $5.0 million to cover estimated exposure to the bankruptcy of Fleming Companies, Inc. announced on April 1, 2003.
Inventories
The Company values the majority of its 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 include material, labor and overhead. LIFO cost of inventories valued using the LIFO method was $321.0 million and $334.4 million as of December 31, 2003 and 2002, respectively, and inventories were stated at amounts that did not exceed realizable values. Total inventories were as follows:
| December
31,
|
|
|
|
2003
|
|
2002
|
||||
|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars |
||||||||||
Raw
materials |
$ | 158,859 | $ | 154,893 | ||||||
Goods
in process |
53,744 | 53,814 | ||||||||
Finished
goods |
327,415 | 347,677 | ||||||||
Inventories
at FIFO |
540,018 | 556,384 | ||||||||
Adjustment
to LIFO |
(47,159 | ) | (53,093 | ) | ||||||
Total
inventories |
$ | 492,859 | $ | 503,291 | ||||||
Property, Plant and Equipment
Property, plant and equipment balances included construction in progress of $153.7 million and $121.4 million as of December 31, 2003 and 2002, respectively. Net write-downs of property, plant and equipment of $5.7 million were recorded as a result of asset impairments associated with the Company’s business realignment initiatives recorded in the fourth quarter of 2003. These initiatives included realigning the sales organizations and streamlining the supply chain by divesting or eliminating certain non-strategic brands and products and by product line rationalization. Major classes of property, plant and equipment were as follows:
| December
31,
|
|
|
|
2003
|
|
2002
|
||||
|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars |
||||||||||
Land |
$ | 78,744 | $ | 54,181 | ||||||
Buildings |
633,362 | 537,473 | ||||||||
Machinery
and equipment |
2,514,917 | 2,311,365 | ||||||||
Property,
plant and equipment, gross |
3,227,023 | 2,903,019 | ||||||||
Accumulated
depreciation |
(1,565,084 | ) | (1,416,964 | ) | ||||||
Property,
plant and equipment, net |
$ | 1,661,939 | $ | 1,486,055 | ||||||
A-56
As of December 31, 2003, certain real estate with a net realizable value of $1.5 million was being held for sale. These assets were associated with the closure of facilities as part of the Company’s business realignment initiatives. The consolidation of SPTs associated with the leasing of certain warehouse and distribution facilities in the third quarter of 2003 resulted in an increase to property, plant and equipment, net of approximately $107.7 million primarily pertaining to buildings and machinery and equipment.
Accrued Liabilities
Accrued liabilities were as follows:
| December
31,
|
|
|
|
2003
|
|
2002
|
||||
|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars |
||||||||||
Payroll,
compensation and benefits |
$ | 127,222 | $ | 119,478 | ||||||
Advertising
and promotion |
191,382 | 143,130 | ||||||||
Other |
97,577 | 94,108 | ||||||||
Total
accrued liabilities |
$ | 416,181 | $ | 356,716 | ||||||
Other Long-term Liabilities
Other long-term liabilities were as follows:
| December
31,
|
|
|
|
2003
|
|
2002
|
||||
|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars |
||||||||||
Accrued
post-retirement benefits |
$ | 232,398 | $ | 234,545 | ||||||
Other |
138,378 | 127,617 | ||||||||
Total
other long-term liabilities |
$ | 370,776 | $ | 362,162 | ||||||
19. SEGMENT INFORMATION
The Company operates as a single reportable segment, encompassing the manufacture, distribution and sale of confectionery and grocery products. The Company’s four operating segments are comprised of geographic areas including the United States, Canada and Mexico, and the combination of the Company’s other international operations. For purposes of segment reporting, the Company’s North American operations, the United States, Canada and Mexico, have been aggregated in accordance with the criteria of Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The North American operations were aggregated on the basis of their similar economic characteristics and the similarity of their products and services, production processes, types or classes of customers for their products and services, methods used to distribute products and the nature of the regulatory environments. The Company’s other international operations were aggregated with its North American operations to form one reportable segment, since the other international operations combined share most of the aggregation criteria and represent less than 10% of consolidated revenues, operating profits and assets. Consolidated net sales represented primarily sales of confectionery products.
The Company’s principal operations and markets are located in the United States. The Company manufactures, markets, sells and distributes confectionery and grocery products in Canada, Mexico and Brazil, imports and/or markets selected confectionery products in China, the Philippines, Japan and South Korea and markets confectionery products in over 60 countries worldwide. Net sales and long-lived assets of businesses outside of the United States were not significant.
Sales to McLane Company, Inc., formerly a subsidiary of Wal-Mart Stores, Inc., exceeded 10% of total net sales and approximated $930.1 million in 2003. Sales to Wal-Mart Stores, Inc. and subsidiaries exceeded 10% of total net sales in 2002 and 2001 and amounted to approximately $857.9 million and $777.7 million, respectively.
A-57
20. QUARTERLY DATA (Unaudited)
Summary quarterly results were as follows:
| Year
2003
|
|
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In
thousands of dollars except per share amounts |
||||||||||||||||||
Net
sales |
$ | 953,162 | $ | 849,115 | $ | 1,191,019 | $ | 1,179,255 | ||||||||||
Gross
profit |
356,283 | 333,745 | 466,834 | 470,963 | ||||||||||||||
Income
before cumulative effect of accounting change |
97,558 | 71,484 | 150,972 | 144,938 | ||||||||||||||
Per
share—Basic(a) |
.73 | .55 | 1.16 | 1.11 | ||||||||||||||
Per
share—Diluted |
.73 | .54 | 1.15 | 1.10 | ||||||||||||||
Net
income |
97,558 | 71,484 | 143,604 | 144,938 | ||||||||||||||
Per
share—Basic(a) |
.73 | .55 | 1.10 | 1.11 | ||||||||||||||
Per
share—Diluted |
.73 | .54 | 1.09 | 1.10 | ||||||||||||||
Year 2002 |
|
First |
|
Second |
|
Third |
|
Fourth |
||||||||||
| In thousands of dollars except per share amounts |
||||||||||||||||||
Net sales |
$ | 988,506 | $ | 823,462 | $ | 1,152,321 | $ | 1,156,028 | ||||||||||
Gross
profit |
364,482 | 313,471 | 435,124 | 446,188 | ||||||||||||||
Net income |
87,045 | 63,148 | 123,065 | 130,320 | ||||||||||||||
Per
share—Basic |
.64 | .46 | .90 | .96 | ||||||||||||||
Per
share—Diluted(a) |
.63 | .46 | .89 | .96 | ||||||||||||||
| (a) | Quarterly income per share amounts do not total to the annual amounts due to changes in weighted-average shares outstanding during the year. |
A-58
RESPONSIBILITY FOR FINANCIAL STATEMENTS
Hershey Foods Corporation is responsible for the financial statements and other financial information contained in this report. The Company believes that the financial statements have been prepared in conformity with accounting principles generally accepted in the United States appropriate under the circumstances to reflect in all material respects the substance of applicable events and transactions. In preparing the financial statements, it is necessary that management make informed estimates and judgments. The other financial information in this annual report is consistent with the financial statements.
The Company maintains a system of internal accounting controls designed to provide reasonable assurance that financial records are reliable for purposes of preparing financial statements and that assets are properly accounted for and safeguarded. The concept of reasonable assurance is based on the recognition that the cost of the system must be related to the benefits to be derived. The Company believes its system provides an appropriate balance in this regard. The Company maintains an Internal Audit Department which reviews the adequacy and tests the application of internal accounting controls.
The 2003 and 2002 financial statements have been audited by KPMG LLP, independent auditors, whose appointment was approved by the Company’s Board of Directors on May 10, 2002, following dismissal on April 30, 2002 of Arthur Andersen LLP, the Company’s former independent auditors. KPMG LLP’s report on the Company’s 2003 and 2002 financial statements is included on page A-60.
The Audit Committee of the Board of Directors of the Company, consisting solely of independent, non-management directors, meets regularly with the independent auditors, internal auditors and management to discuss, among other things, the audit scopes and results. KPMG LLP and the internal auditors both have full and free access to the Audit Committee, with and without the presence of management.
A-59
INDEPENDENT AUDITORS’ REPORT
The Board of Directors and Stockholders
Hershey Foods
Corporation:
We have audited the accompanying consolidated balance sheets of Hershey Foods Corporation and subsidiaries (the “Corporation”) as of December 31, 2003 and 2002, and the related consolidated statements of income, cash flows and stockholders’ equity for the years then ended. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated statements of income, cash flows and stockholders’ equity for the year ended December 31, 2001, before the revisions described in Notes 1 and 6 to the consolidated financial statements, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their report dated January 22, 2002.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Hershey Foods Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
As discussed above, the consolidated statements of income, cash flows and stockholders’ equity for the year ended December 31, 2001 were audited by other auditors who have ceased operations. As described in Notes 1 and 6, these financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which was adopted by the Corporation as of January 1, 2002. As described in Note 1, these financial statements have been revised to reflect reclassifications of certain consumer and trade promotional expenses as required by Emerging Issues Task Force No. 01-9, Accounting for Consideration Given by a Vendor to a Customer or Reseller of the Vendor’s Products. In our opinion, the disclosures and reclassifications for 2001 as described in Notes 1 and 6 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of Hershey Foods Corporation other than with respect to such disclosures and reclassifications and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole.
As discussed in Note 2, the Corporation adopted Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, on June 30, 2003.
New York, New
York
January 28, 2004
A-60
REPORT OF PREDECESSOR AUDITOR (ARTHUR ANDERSEN LLP)
The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. As discussed in Note 1, in 2003, the Company adopted the provisions of Emerging Issues Task Force Issue 01-9, Accounting for Consideration Given by a Vendor to a Customer, which requires reclassification of certain consumer and trade promotional expenses in the 2001 consolidated income statements. Also, in 2002, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). Included in Notes 1 and 6 are transitional disclosures for 2001 that are required by SFAS No. 142. The Arthur Andersen LLP report does not extend to these changes in the 2001 consolidated financial statements. The adjustments to the 2001 consolidated financial statements were reported on by KPMG LLP as stated in their report appearing herein.
To the Stockholders and Board of Directors
of Hershey Foods
Corporation:
We have audited the accompanying consolidated balance sheets of Hershey Foods Corporation (a Delaware Corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, cash flows and stockholders’ equity for each of the three years in the period ended December 31, 2001, appearing on pages A-16 through A-43. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Hershey Foods Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally
accepted in the United States.
New York, New York
January 22, 2002
A-61
HERSHEY FOODS CORPORATION
SIX-YEAR CONSOLIDATED FINANCIAL SUMMARY
All
dollar and share amounts in thousands except market price and per share statistics
| 5-Year Compound Growth Rate |
2003 | 2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Summary
of Operations |
|||||||||||||||||||||||||
Net Sales(a) |
1.0 | % | $ | 4,172,551 | 4,120,317 | 4,137,217 | 3,820,416 | 3,586,183 | 3,974,832 | ||||||||||||||||
Cost
of Sales |
(0.6 | )% | $ | 2,544,726 | 2,561,052 | 2,668,530 | 2,471,151 | 2,354,724 | 2,625,057 | ||||||||||||||||
Selling,
Marketing and Administrative(a) |
2.9 | % | $ | 816,442 | 833,426 | 846,976 | 726,615 | 673,099 | 707,112 | ||||||||||||||||
Business
Realignment and Asset Impairments Charge |
$ | 23,357 | 27,552 | 228,314 | — | — | — | ||||||||||||||||||
Gain
on Sale of Businesses(b) |
$ | 8,330 | — | 19,237 | — | 243,785 | — | ||||||||||||||||||
Interest
Expense, Net |
(5.8 | )% | $ | 63,529 | 60,722 | 69,093 | 76,011 | 74,271 | 85,657 | ||||||||||||||||
Provision
for Income Taxes |
4.4 | % | $ | 267,875 | 233,987 | 136,385 | 212,096 | 267,564 | 216,118 | ||||||||||||||||
Income
before Cumulative Effect of Accounting Change |
6.4 | % | $ | 464,952 | 403,578 | 207,156 | 334,543 | 460,310 | 340,888 | ||||||||||||||||
Cumulative
Effect of Accounting Change |
$ | 7,368 | — | — | — | — | — | ||||||||||||||||||
Net
Income |
6.1 | % | $ | 457,584 | 403,578 | 207,156 | 334,543 | 460,310 | 340,888 | ||||||||||||||||
Earnings
Per Share before Cumulative Effect of Accounting Change: |
|||||||||||||||||||||||||
—Basic |
8.3 | % | $ | 3.54 | 2.96 | 1.52 | 2.44 | 3.29 | 2.38 | ||||||||||||||||
—Diluted |
8.5 | % | $ | 3.52 | 2.93 | 1.50 | 2.42 | 3.26 | 2.34 | ||||||||||||||||
Weighted-Average
Shares Outstanding: |
|||||||||||||||||||||||||
—Basic |
131,306 | 136,538 | 136,245 | 137,326 | 140,031 | 143,446 | |||||||||||||||||||
—Diluted |
132,266 | 137,714 | 137,696 | 138,365 | 141,300 | 145,563 | |||||||||||||||||||
Dividends
Paid on Common Stock |
6.9 | % | $ | 144,985 | 133,285 | 122,790 | 115,209 | 109,175 | 103,616 | ||||||||||||||||
Per
Share |
9.5 | % | $ | 1.445 | 1.26 | 1.165 | 1.08 | 1.00 | .92 | ||||||||||||||||
Dividends
Paid on Class B Common Stock |
9.3 | % | $ | 39,701 | 34,536 | 31,960 | 29,682 | 27,553 | 25,428 | ||||||||||||||||
Per
Share |
9.3 | % | $ | 1.305 | 1.135 | 1.05 | .975 | .905 | .835 | ||||||||||||||||
Net
Income as a Percent of Net Sales(a) (c) |
11.4 | % | 10.6 | % | 9.5 | % | 9.0 | % | 8.6 | % | 9.0 | % | |||||||||||||
Depreciation |
2.8 | % | $ | 158,933 | 155,384 | 153,493 | 140,168 | 135,574 | 138,489 | ||||||||||||||||
Advertising(a) |
(4.4 | )% | $ | 145,387 | 162,874 | 187,244 | 156,319 | 158,965 | 182,383 | ||||||||||||||||
Promotions
Expense(a) |
13.9 | % | $ | 60,480 | 62,893 | 53,450 | 46,615 | 35,380 | 31,521 | ||||||||||||||||
Payroll |
.8 | % | $ | 585,419 | 594,372 | 614,197 | 557,342 | 534,854 | 563,045 | ||||||||||||||||
Year-end
Position and Statistics |
|||||||||||||||||||||||||
Capital
Additions |
6.3 | % | $ | 218,650 | 132,736 | 160,105 | 138,333 | 115,448 | 161,328 | ||||||||||||||||
Capitalized
Software Additions |
(15.6 | )% | $ | 18,404 | 11,836 | 9,845 | 4,686 | 25,394 | 42,859 | ||||||||||||||||
Total
Assets |
1.0 | % | $ | 3,582,540 | 3,480,551 | 3,247,430 | 3,447,764 | 3,346,652 | 3,404,098 | ||||||||||||||||
Long-term
Portion of Debt |
2.0 | % | $ | 968,499 | 851,800 | 876,972 | 877,654 | 878,213 | 879,103 | ||||||||||||||||
Stockholders’
Equity |
4.5 | % | $ | 1,297,866 | 1,371,703 | 1,147,204 | 1,175,036 | 1,098,627 | 1,042,301 | ||||||||||||||||
Operating
Return on Average Stockholders’ Equity(c) |
35.8 | % | 34.6 | % | 33.7 | % | 30.2 | % | 28.9 | % | 37.6 | % | |||||||||||||
Operating
Return on Average Invested Capital(c) |
19.9 | % | 19.7 | % | 18.7 | % | 16.5 | % | 15.4 | % | 18.1 | % | |||||||||||||
Full-time
Employees |
13,100 | 13,700 | 14,400 | 14,300 | 13,900 | 14,700 | |||||||||||||||||||
Stockholders’
Data |
|||||||||||||||||||||||||
Outstanding
Shares of Common Stock and Class B Common Stock at Year-end |
129,530 | 134,220 | 135,639 | 136,282 | 138,460 | 143,147 | |||||||||||||||||||
Market
Price of Common Stock at Year-end |
4.4 | % | $ | 76.99 | 67.44 | 67.70 | 64.38 | 47.44 | 62.19 | ||||||||||||||||
Range
During Year |
$ |
78.65-60.69 | 79.49-56.45 | 70.15-55.13 | 66.44-37.75 | 64.88-45.75 | 76.38-59.69 | ||||||||||||||||||
__________
| (a) | All years have been restated in accordance with final consensuses reached on various EITF issues regarding the reporting of certain sales incentives. |
| (b) | Includes the gain on the sale of gum brands in 2003, the gain on the sale of the Luden’s throat drops business in 2001 and the gain on the sale of the Company’s pasta business in 1999. |
| (c) | Net Income as a Percent of Sales, Operating Return on Average Stockholders’ Equity and Operating Return on Average Invested Capital have been calculated using Net Income, excluding the after-tax impacts of the elimination of amortization of intangibles for all years, the after-tax effect of the 2003, 2002 and 2001 Business Realignment and Asset Impairments Charges, the after-tax effect of incremental expenses to explore the possible sale of the Company in 2002, the 2003, 2001 and 1999 Gain on the Sale of Businesses and the 2000 gain on the sale of certain Corporate aircraft. Net Income as a Percent of Net Sales, as reported above was 11.0% in 2003, 9.8% in 2002, 5.0% in 2001, 8.8% in 2000, 12.8% in 1999 and 8.6% in 1998. |
A-62
EXECUTION COPY
AMENDED AND RESTATED 364-DAY CREDIT AGREEMENT
Dated as of November 25, 2003
HERSHEY FOODS CORPORATION, a Delaware corporation (the “Company”), the banks, financial institutions and other institutional lenders (collectively, the “Initial Lenders”) party hereto, CITIBANK, N.A., as administrative agent (together with any successor thereto appointed pursuant to Article VII of the Existing Credit Agreement referred to below, the “Agent”) for the Lenders (as defined in the Existing Credit Agreement referred to below), BANK OF AMERICA, N.A., as syndication agent, and CITIGROUP GLOBAL MARKETS INC. and BANC OF AMERICA SECURITIES LLC, as joint lead arrangers and joint book managers, hereby agree as follows:
PRELIMINARY STATEMENTS
(1) The Company is party to an Amended and Restated 364-Day Credit Agreement dated as of November 27, 2001, amended and restated as of November 26, 2002 (as amended, supplemented or otherwise modified from time to time to (but not including) the date of this Amendment and Restatement, the “Existing Credit Agreement”) with the banks, financial institutions and other institutional lenders party thereto and Citibank, N.A., as Agent for the Lenders and such other lenders. Capitalized terms not otherwise defined in this Amendment and Restatement shall have the same meanings as specified in the Existing Credit Agreement.
(2) The parties to this Amendment and Restatement desire to amend the Existing Credit Agreement as set forth herein and to restate the Existing Credit Agreement in its entirety to read as set forth in the Existing Credit Agreement with the following amendments.
(3) The Company has requested that the Lenders agree to extend credit to it from time to time in an aggregate principal amount of up to $200,000,000 for general corporate purposes of the Company and its Subsidiaries not otherwise prohibited under the terms of this Amendment and Restatement. The Lenders have indicated their willingness to agree to extend credit to the Company from time to time in such amount on the terms and conditions of this Amendment and Restatement.
SECTION 1. Amendments to the Existing Credit Agreement. The Existing Credit Agreement is, effective as of the date of this Amendment and Restatement and subject to the satisfaction of the conditions precedent set forth in Section 2, hereby amended as follows:
(a) Section 1.01 is hereby amended by deleting the definitions of “Lenders” and “Termination Date” set forth therein and replacing them, respectively, with the following new definitions thereof:
| “Lenders” means, collectively, each of the banks, financial institutions and other institutional lenders listed on Schedule I hereto, each Assuming Lender that shall become a party hereto pursuant to Section 2.05(c) and each Eligible Assignee that shall become a party hereto pursuant to Section 9.07. |
| “Termination Date” means the earlier of (a) November 23, 2004 or, if the Termination Date is extended pursuant to Section 2.18(a), the date to which the Termination Date is extended pursuant to Section 2.18(a), and (b) the date of termination in whole of the Commitments pursuant to Section 2.05(a), 2.05(b) or 6.01. |
(b) Section 4.01(e) is amended (i) by replacing the date “December 31, 2001” with the date “December 31, 2002” and (ii) by replacing the date “June 30, 2002” with the date “June 29, 2003". |
(c) Section 9.02 is amended in full to read as follows: |
(a) All notices and other communications provided for hereunder shall be in writing (including telecopier, telegraphic or telex communication) and mailed, telecopied, telegraphed, telexed or delivered, if to the Company or to any Designated Subsidiary, at the Company’s address at Corporate Headquarters, 100 Crystal A Drive, Hershey, Pennsylvania 17033-0810, Attention: Treasury Department, Fax No. (717) 534-6724; if to any Initial Lender, at its Domestic Lending Office specified opposite its name on Schedule I hereto; if to any other Lender, at its Domestic Lending Office specified in the Assumption Agreement or the Assignment and Acceptance, as the case may be, pursuant to which it became a Lender; and if to the Agent, at its address at Two Penn’s Way, New Castle, Delaware 19720, Attention: Bank Loan Syndications, Fax No. (302) 894-6120; or, as to any Borrower or the Agent, at such other address as shall be designated by such party in a written notice to the other parties and, as to each other party, at such other address as shall be designated by such party in a written notice to the Company and the Agent; provided that materials as may be agreed between the Borrowers and the Agent may be delivered to the Agent in accordance with clause (b) below. All such notices and communications shall, when mailed, telecopied, telegraphed or telexed, be effective when deposited in the mails, telecopied, delivered to the telegraph company or confirmed by telex answerback, respectively, except that notices and communications to the Agent pursuant to Article II, III or VIII shall not be effective until received by the Agent. Delivery by telecopier of an executed counterpart of any amendment or waiver of any provision of this Agreement or the Notes or of any Exhibit hereto to be executed and delivered hereunder shall be effective as delivery of a manually executed counterpart thereof. |
(b) So long as Citibank or any of its Affiliates is the Agent, such materials as may be agreed between the Borrowers and the Agent may be delivered to the Agent in an electronic medium in a format acceptable to the Agent and the Lenders by e-mail at oploanswebadmin@citigroup.com. The Borrowers agree that the Agent may make such materials (collectively, the “Communications”) available to the Lenders by posting such notices on Intralinks, “e-Disclosure”, the Agent’s internet delivery system that is part of Fixed Income Direct, Global Fixed Income’s primary web portal, or a substantially similar electronic system (the “Platform”). The Borrowers acknowledge that (i) the distribution of material through an electronic medium is not necessarily secure and that there are confidentiality and other risks associated with such distribution, (ii) the Platform is provided “as is” and “as available” and (iii) neither the Agent nor any of its Affiliates warrants the accuracy, adequacy or completeness of the Communications or the Platform and each expressly disclaims liability for errors or omissions in the Communications or the Platform. No warranty of any kind, express, implied or statutory, including, without limitation, any warranty of merchantability, fitness for a particular purpose, non-infringement of third party rights or freedom from viruses or other code defects, is made by the Agent or any of its Affiliates in connection with the Platform. |
(c) Each Lender agrees that notice to it (as provided in the next sentence) (a “Notice”) specifying that any Communications have been posted to the Platform shall constitute effective delivery of such information, documents or other materials to such Lender for purposes of this Agreement; provided that if requested by any Lender the Agent shall deliver a copy of the Communications to such Lender by email or telecopier. Each Lender agrees (i) to notify the Agent in writing of such Lender’s e-mail address to which a Notice may be sent by electronic transmission (including by electronic communication) on or before the date such Lender becomes a party to this Agreement (and from time to time thereafter to ensure that the Agent has on record an effective e-mail address for such Lender) and (ii) that any Notice may be sent to such e-mail address. |
(d) Section 9.09 is amended by adding to the end thereof a new sentence to read as follows: |
| Notwithstanding anything herein to the contrary, each Borrower, the Agent and each Lender (and each employee, representative or other agent of each of the foregoing parties) may disclose to any and all Persons, without limitation of any kind, the U.S. tax treatment and tax structure of the transactions contemplated hereby and all materials of any kind (including opinions or other tax analyses) that are provided to any of the foregoing parties relating to such U.S. tax treatment and tax structure. |
(e) Schedule I is deleted in its entirety and replaced with Schedule I to this Amendment and Restatement. |
SECTION 2. Conditions of Effectiveness of this Amendment and Restatement. This Amendment and Restatement shall become effective as of the date first above written (the “Restatement Effective Date”) when and only if:
(a) The Agent shall have received counterparts of this Amendment and Restatement executed by the Company and all of the Initial Lenders or, as to any of the Initial Lenders, advice satisfactory to the Agent that such Initial Lender has executed this Amendment and Restatement. |
(b) On the Restatement Effective Date, the following statements shall be true and the Agent shall have received for the account of each Lender a certificate signed by a duly authorized officer of the Company, dated the Restatement Effective Date, stating that: |
(i) The representations and warranties of the Company contained in Section 4.01 of the Existing Credit Agreement, as amended hereby, are correct on and as of the Restatement Effective Date, and |
(ii) No event has occurred and is continuing that constitutes a Default. |
(c) The Agent shall have received on or before the Restatement Effective Date the following, each dated such date and (unless otherwise specified below) in form and substance satisfactory to the Agent and in sufficient copies for each Initial Lender: |
(i) The Revolving Credit Notes of the Company to the order of the Lenders, respectively, to the extent requested by any Lender pursuant to Section 2.19 of the Existing Credit Agreement. |
(ii) Certified copies of the resolutions of the Board of Directors of the Company approving this Amendment and Restatement (including the Commitment Increase contemplated by Section 2.05(c) of the Existing Credit Agreement) and the Notes of the Company, and of all documents evidencing other necessary corporate action and governmental approvals, if any, with respect to this Amendment and Restatement and such Notes. |
(iii) A certificate of the Secretary or an Assistant Secretary of the Company certifying the names and true signatures of the officers of the Company authorized to sign this Amendment and Restatement and the Notes of the Company and the other documents to be delivered hereunder. |
(iv) A favorable opinion of Burton H. Snyder, General Counsel of the Company, substantially in the form of Exhibit H to the Existing Credit Agreement but with such modifications as are required to address the Existing Credit Agreement, as amended by this Amendment and Restatement in form and substance reasonably satisfactory to the Initial Lenders. |
(v) A favorable opinion of Shearman & Sterling LLP, counsel for the Agent, in form and substance satisfactory to the Agent. |
(vi) Such other approvals, opinions or documents as any Lender, through the Agent, may reasonably request prior to the Effective Date. |
SECTION 3. Reference to and Effect on the Existing Credit Agreement and the Notes. (a) On and after the effectiveness of this Amendment and Restatement, each reference in the Existing Credit Agreement to “this Agreement”, “hereunder”, “hereof” or words of like import referring to the Existing Credit Agreement, and each reference in the Notes to “the Credit Agreement”, “thereunder”, “thereof” or words of like import referring to the Existing Credit Agreement, shall mean and be a reference to the Existing Credit Agreement, as amended by this Amendment and Restatement.
(b) The Existing Credit Agreement and the Notes, as specifically amended by this Amendment and Restatement, are and shall continue to be in full force and effect and are hereby in all respects ratified and confirmed.
(c) Without limiting any of the other provisions of the Existing Credit Agreement, as amended by this Amendment and Restatement, any references in the Existing Credit Agreement to the phrases “on the date hereof”, “on the date of this Agreement” or words of similar import shall mean and be a reference to the Restatement Effective Date.
SECTION 4. Costs and Expenses. The Company agrees to pay on demand all reasonable out-of-pocket costs and expenses of the Agent in connection with the preparation, execution, delivery and administration, modification and amendment of this Amendment and Restatement, the Notes and the other documents to be delivered hereunder (including, without limitation, the reasonable and documented fees and expenses of counsel for the Agent with respect hereto and thereto) in accordance with the terms of Section 9.04 of the Existing Credit Agreement.
SECTION 5. Execution in Counterparts. This Amendment and Restatement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of a signature page to this Amendment and Restatement by telecopier shall be effective as delivery of a manually executed counterpart of this Amendment and Restatement.
SECTION 6. Governing Law. This Amendment and Restatement shall be governed by, and construed in accordance with, the laws of the State of New York.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment and Restatement to be executed by their respective officers thereunto duly authorized, as of the date first above written.
HERSHEY FOODS CORORATION
| By: /s/ Frank Cerminara Title: Senior Vice President, Chief Financial Officer | ||
| By: /s/ Robert J. Mazzoni, Jr Title: Vice President and Treasurer | ||
| CITIBANK, N.A. as Administrative Agent | ||
| By: /s/ Carolyn Kee Title: Vice President | ||
| Lenders | ||
| CITIBANK, N.A. | ||
| By: /s/ Carolyn Kee Title: Vice President | ||
| BANK OF AMERICA, N.A. | ||
| By: /s/ William Sweeney Title: Managing Director | ||
| UBS LOAN FINANCE LLC | ||
| By: /s/ Patricia O'Kicki Title: Director | ||
| By: /s/ Joselin Fernandes Title: Associate Director | ||
| MELLON BANK, N.A. | ||
| By: /s/ Marla A. DeYulis Title: Assistant Vice President | ||
| NORTHERN TRUST COMPANY | ||
| By: /s/ Eric Dybing Title: Second Vice President | ||
| BANCO POPULAR DE PUERTO RICO | ||
| By: /s/ Hector J. Gonzalez Title: Vice President | ||
| CIBC INC. | ||
| By: /s/ Dominic Sorresso Title: Executive Director | ||
| PNC BANK, NATIONAL ASSOCIATION | ||
| By: /s/ Robert Giannone Title: Vice President | ||
| SUMITOMO MITSUI BANKING CORPORATON |
||
| By: /s/ Edward D. Henderson, Jr. Title: General Manager | ||
SCHEDULE I TO THE AMENDMENT AND RESTATEMENT
COMMITMENTS AND APPLICABLE LENDING OFFICES
| Name of Initial Lender | Commitment | Domestic Lending Office | Eurodollar Lending Office |
|---|
| BANCO POPULAR | $10,000,000 | 7 West 51st - 2nd Floor | 7 West 51st - 2nd Floor |
| DE PUERTO RICO, | New York, NY 10019 | New York, NY 10019 | |
| NEW YORK | Attn: Hector J. Gonzalez | Attn: Hector J. Gonzalez | |
| BRANCH | T: (212) 445-1988 | T: (212) 445-1988 | |
| F: (212) 245-4677 | F: (212) 245-4677 |
| BANK OF AMERICA, | $40,000,000 | 901 Main Street, 14th Floor | 901 Main Street, 14th Floor |
| N.A. | Dallas, TX 75202 | Dallas, TX 75202 | |
| Attn: Sam Brown | Attn: Sam Brown | ||
| T: (214) 209-9262 | T: (214) 209-9262 | ||
| F: (214) 290-9519 | F: (214) 290-9519 |
| CIBC Inc. | $10,000,000 | 425 Lexington Avenue | 425 Lexington Avenue |
| New York, NY 10017 | New York, NY 10017 | ||
| Attn: Dominic Sorresso | Attn: Dominic Sorresso | ||
| T: (212) 856-4133 | T: (212) 856-4133 | ||
| F: (212) 856-3991 | F: (212) 856-3991 |
| CITIBANK, N.A. | $40,000,000 | Two Penns Way | Two Penns Way |
| New Castle, DE 19720 | New Castle, DE 19720 | ||
| Attn: Bank Loan | Attn: Bank Loan | ||
| Syndications | Syndications | ||
| T: (302) 894-6029 | T: (302) 894-6029 | ||
| F: (212) 994-0961 | F: (212) 994-0961 |
| MELLON BANK, | $25,000,000 | 3 Mellon Bank Center, 12th | 3 Mellon Bank Center, |
| N.A. | Floor | 12th Floor | |
| Pittsburgh, PA 15259 | Pittsburgh, PA 15259 | ||
| Attn: Sannford M. Richards | Attn: Sannford M. Richards | ||
| T: (412) 234-8285 | T: (412) 234-8285 | ||
| F: (412) 209-6118 | F: (412) 209-6118 |
| NORTHERN TRUST | $20,000,000 | 50 S. LaSalle Street | 50 S. LaSalle Street |
| COMPANY | Chicago, IL 60675 | Chicago, IL 60675 | |
| Attn: Linda Honda | Attn: Linda Honda | ||
| T: (312) 444-4715 | T: (312) 444-4715 | ||
| F: (312) 630-1566 | F: (312) 630-1566 |
| PNC BANK, | $10,000,000 | 1600 Market Street | 1600 Market Street |
| NATIONAL | MS F2 F07021 5 | MS F2 F07021 5 | |
| ASSOCIATION | Philadelphia, PA 19103 | Philadelphia, PA 19103 | |
| Attn: Robert F. Giannone | Attn: Robert F. Giannone | ||
| T: (215) 585-7630 | T: (215) 585-7630 | ||
| F: (215) 585-6987 | F: (215) 585-6987 |
| SUMITOMO MITSUI | $10,000,000 | 277 Park Avenue | 277 Park Avenue |
| BANKING | New York, NY 10172 | New York, NY 10172 | |
| CORPORATION | Attn: Tracey Watson | Attn: Tracey Watson | |
| T: (212) 224-4393 | T: (212) 224-4393 | ||
| F: (212) 224-5197 | F: (212) 224-5197 |
| UBS LOAN FINANCE | $35,000,000 | 677 Washington Blvd. | 677 Washington Blvd. |
| LLC | Stamford, CT 06901 | Stamford, CT 06901 | |
| Attn: Denise Conzo | Attn: Denise Conzo | ||
| T: (203) 719-3853 | T: (203) 719-3853 | ||
| F: (203) 719-3888 | F: (203) 719-3888 |
| TOTAL OF | $200,000,000 | ||
| COMMITMENTS |
EXHIBIT 10.2
HERSHEY FOODS CORPORATION
AMENDED AND RESTATED
(2003)
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
1. Purpose of Plan. The purpose of the Amended and Restated (2003) Supplemental Executive Retirement Plan, effective as of October 6, 2003, (hereinafter called the “Plan”) is to obtain for Hershey Foods Corporation (hereinafter called the “Corporation”) all of the benefits which flow from maintaining a strong management team by providing to executive and certain selected upper level management employees the means to continue their attained standard of living during retirement and by offering benefits that will assist in attracting executive and upper level management employees of outstanding ability. The Plan constitutes an amendment, restatement and continuation of the prior plan which was most recently restated as of March 1, 2003. |
To the extent provided by law, the benefits provided hereunder with respect to any Participant who retired or whose employment with the Corporation terminated prior to October 6, 2003, will, except as otherwise specifically provided for herein, be governed in all respects by the terms of the plan document then in effect on the date of the Participant’s retirement or other termination of employment. |
2. Definitions. The following words and phrases as used in the Plan shall have the following meanings, unless a different meaning is plainly required by the context: |
a. “Cause” means, as determined by the Committee in its reasonable discretion, the willful engaging by an employee of the Corporation in illegal conduct or gross misconduct which is materially and demonstrably injurious to the Corporation, including, without limitation, illegal conduct or gross misconduct that causes, or has the potential to cause, material financial or reputational injury to the Corporation. |
For purposes of this definition, no act or failure to act, on the part of an employee of the Corporation, shall be considered “willful” unless it is done, or omitted to be done, by the employee in bad faith and without reasonable belief that the employee’s action or omission was in the best interest of the Corporation. Any act or failure to act, based upon prior approval given by the Board or upon the instruction or with the approval of the Chief Executive Officer or the employee’s superior or based upon the advice of counsel for the Corporation shall be conclusively presumed to be done, or omitted to be done, by the employee in good faith and in the best interest of the Corporation. |
b. “Committee” means the Compensation and Executive Organization Committee of the Board of Directors of the Corporation (the “Board”) or other such person, persons or committees as the Board may prescribe from time to time. |
Effective as of October 2, 2001, Committee shall also mean the Employee Benefits Committee of the Corporation, to which the Board has delegated certain duties with respect to the administration of the Corporation’s employee benefit plans, or any successor committee as designated by the Board. |
c. “Deferred Retirement Date” means the first day of the month following an employee’s termination of employment with the Corporation provided such termination occurs after his Normal Retirement Date. |
d. “Disability” or “Disabled”, for purposes of this Plan, shall have the same meaning as provided in Section 1.16 of the Retirement Plan, as such section may be amended from time to time. |
e. “Early Retirement Date” means the first day of any month following an employee’s termination of employment with the Corporation which is coincident with or following his fifty-fifth (55th) birthday and prior to his Normal Retirement Date. |
f. “Final Average Compensation” means the sum of (1) the highest annual average of a Vested Participant’s basic salary paid or accrued over any thirty-six (36) consecutive month period during his last ten (10) years of employment with the Corporation and (2) the highest annual average of his annual awards under the Annual Incentive Program (hereinafter called the “AIP”) of the Corporation’s Key Employee Incentive Plan (“KEIP”) paid or accrued over any five (5) consecutive calendar years during his last ten (10) years of employment with the Corporation. If a Vested Participant dies, retires, or suffers a Disability or if a Participant suffers a Disability during a calendar year and only a partial AIP award is made for that year, for purposes of the Plan, his AIP award for such year will be considered to equal the award actually made divided by the fraction of such year that he was employed by the Corporation prior to his death, retirement or Disability. If a Vested Participant otherwise terminates employment with the Corporation during a calendar year, his AIP award for that year for purposes of the Plan will be considered to be zero (0), regardless of whether any AIP award is actually made for that year. |
g. “GATT Interest Rate” means, for purposes of this Plan, for any specific month, the “applicable interest rate” as specified by the Commissioner of the Internal Revenue Service in Section 417(e)(3) of the Internal Revenue Code of 1986, as amended (the “Code”) (as such applicable interest rate is modified from time to time in revenue rulings, notices or other guidance, published in the Internal Revenue Service Bulletin), decreased by the percentage applicable to such month as set forth on Schedule I attached hereto. |
h. “Lump Sum Interest Rate” means, as of any specific date, the sum of one-twelfth (1/12th) of each GATT Interest Rate for the twelve (12) consecutive months beginning with the thirteenth (13th) month preceding the month during which such date occurs. |
i. “Normal Retirement Date” means, for the purposes of this Plan, the first day of the month nearest an employee’s sixty-fifth (65th) birthday, except that if his birthday is equally near the first of two (2) calendar months, the first day of the month prior to his sixty-fifth (65th) birthday shall be his Normal Retirement Date. |
2
j. “PBGC Interest Rate” means, for any specific month, the interest rate used by the Pension Benefit Guaranty Corporation for such month for purposes of valuing immediate annuities for terminating single employer plans with insufficient assets to pay guaranteed benefits. |
k. “Participant” means an employee of the Corporation who: (i) as of October 5, 2003, was a participant in the performance share unit portion of the KEIP or who, as of such date, was not then but had been a participant in the performance share unit portion of the KEIP for at least five (5) of his last ten (10) years of employment with the Corporation (hereinafter referred to collectively as a “Current Status Participant”); or (ii) is not a Current Status Participant and, after October 5, 2003, is selected for participation in the Plan by the Compensation and Executive Organization Committee of the Board or any successor committee as designated by the Board on the basis of eligibility criteria adopted from time to time by that committee and whose selection has not been revoked by that committee. |
l. “Retirement Plan” means the Corporation’s Retirement Plan, As Amended and Restated Effective as of January 1, 1997, as in effect from time to time and any successor plan thereto. |
m. “Vested Participant” means, as of any specific date, a Participant who, as of such date, satisfies each eligibility requirement set forth in the first sentence of Section 3 of the Plan. |
n. “Years of Service”, for purposes of this Plan, shall have the same meaning as provided in Section 1.59 of the Retirement Plan, as such section may be amended from time to time. |
3. Eligibility. An employee of the Corporation will be eligible to receive a benefit pursuant to Section 4 of the Plan if, at the time of his termination of employment with the Corporation, such employee (i) is at least fifty-five (55) years of age, (ii) has ten (10) Years of Service, and (iii) in the case of a Current Status Participant, has participated in the performance share unit portion of the KEIP for at least five (5) of his last ten (10) years of employment with the Corporation or, in the case of an employee selected for participation in the Plan pursuant to Section 2.k.(ii) above, has been a Participant in the Plan pursuant to Section 2.k.(ii) for at least five (5) out of his last ten (10) years of employment with the Corporation. No employee of the Corporation, regardless of whether he satisfies all the eligibility requirements to be a Vested Participant, shall be entitled to receive any benefits under the Plan if his employment with the Corporation is terminated for Cause. Notwithstanding the above, an employee whose employment with the Corporation is terminated prior to his Normal Retirement Date for reason of Disability will be treated as provided for in Section 4.c. |
3
4. Retirement Benefits. |
a. Normal Retirement Benefit. An employee who qualifies as a Vested Participant on the date of his termination of employment with the Corporation, and who retires (or whose employment is otherwise terminated, other than for Cause) on or after his Normal Retirement Date shall be entitled under the Plan to receive a normal retirement benefit which shall be an annual benefit, payable in monthly installments, equal to: |
(1) the product of three and two-thirds percent (3 2/3%) of his Final Average Compensation and his Years of Service not in excess of fifteen (15) Years of Service; |
reduced by: |
(2) one hundred percent (100%) of the Vested Participant’s retirement benefit under the Retirement Plan and any other tax-qualified defined benefit pension plan maintained by the Corporation or any affiliate thereof, payable as a life annuity commencing at his Normal Retirement Date or his Deferred Retirement Date if he retires after his Normal Retirement Date, regardless of whether such benefit payment is in that form or begins at that time; and |
(3) one hundred percent (100%) of the primary social security benefit to which the Vested Participant would be entitled on his Normal Retirement Date or his Deferred Retirement Date if he retires after his Normal Retirement Date regardless of whether he receives any portion of such primary Social Security benefit on such date. |
Payment of such benefit shall commence on his Normal Retirement Date if he retires (or otherwise has his employment terminated, other than for Cause) on such date and on his Deferred Retirement Date if he retires (or otherwise has his employment terminated, other than for Cause) after his Normal Retirement Date. |
b. Early Retirement Benefit. An employee who qualifies as a Vested Participant on the date of his termination of employment with the Corporation, and who retires (or whose employment is otherwise terminated, other than for Cause) on or after his Early Retirement Date and prior to his Normal Retirement Date shall be entitled under the Plan to receive an early retirement benefit which shall be an annual benefit payable in monthly installments, equal to: |
(1) the product of three and two-thirds percent (3 2/3%) of his Final Average Compensation and his Years of Service not in excess of fifteen (15) Years of Service reduced by the sum of (2), (3) and (4), where (2), (3) and (4) equal: |
(2) one hundred percent (100%) of his retirement benefit under the Retirement Plan and any other tax-qualified defined benefit pension plan maintained by the Corporation or any affiliate thereof, payable as a life annuity commencing at his Early Retirement Date or the first date thereafter on which such benefits would be payable if |
4
they are not payable on his Early Retirement Date regardless of whether such benefit payment is in that form or begins at that time; |
(3) one hundred percent (100%) of the primary Social Security benefit to which the Vested Participant would be entitled on his Early Retirement Date or the first date thereafter on which such benefits would be payable if they are not payable on his Early Retirement Date regardless of whether he receives any portion of such primary Social Security benefit on such date; and |
| (4) the product of (A) the difference between (1) and the sum of (2) and (3), (B) five-twelfths of a percent (5/12%), and (C) the number of complete calendar months by which the Vested Participant’s date of termination of employment precedes his sixtieth (60th) birthday. |
| Payment of such benefit shall commence on the first day of the month coincident with the Vested Participant’s retirement or other termination of employment, other than for Cause. |
| c. Disability Retirement Benefit. If an employee who is a Current Status Participant is an active participant in the performance share unit portion of the KEIP at a time when he suffers a Disability prior to his Normal Retirement Date and while employed by the Corporation, the period of his Disability will be recognized as Years of Service and as years of participation in the performance share unit portion of the KEIP under the Plan. If an employee who is selected for participation in the Plan pursuant to Section 2.k.(ii) (and whose selection has not been revoked as described in that Section) suffers a Disability prior to his Normal Retirement Date and while employed by the Corporation, the period of his Disability will be recognized as Years of Service and as years as a Participant in the Plan. If in either of the situations described in the two immediately preceding sentences such person’s Disability continues to his Normal Retirement Date, for purposes of the Plan, he will retire on that date and will be entitled to a normal retirement benefit calculated in accordance with Section 4.a. commencing on that date. In calculating the benefit under Section 4.a., the Participant’s Final Average Compensation shall be equal to his annual base compensation immediately prior to his Disability plus the average of his AIP earned during the three (3) years immediately prior to the commencement of his Disability. |
| d. Pre-Retirement Death Benefit. If a Participant dies before his employment by the Corporation terminates and qualifies as a Vested Participant on his date of death, his designated beneficiary(ies), or his estate if he has not designated any beneficiary or beneficiaries in accordance with procedures established by the Committee, shall receive within ten (10) days of the Vested Participant’s death a death benefit equal to the lump sum present value of one hundred percent (100%) of the retirement benefit that would have been payable to the Vested Participant under Sections 4.a. or 4.b. (including the spousal survivor benefit payable pursuant to Section 4.e. with respect to any Vested Participant survived by a spouse) if he had retired on the date of his death. The lump sum present value of the retirement benefit shall be calculated using: (i) the prevailing commissioner’s standard mortality table (described in Section 807(d)(5)(A) of the Internal Revenue Code of 1986, as amended from time to time) used to determine reserves |
5
for group annuity contracts issued on the date of the Vested Participant’s death (without regard to any other subparagraph for such Section 807(d)(5)) that is prescribed by the Commissioner of the Internal Revenue Service in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin; and (ii) an interest rate equal to the Lump Sum Interest Rate as of the date of the Vested Participant’s death. |
e. Post-Retirement Death Benefit. If a Vested Participant who is receiving monthly retirement benefits under this Plan following his termination of employment by the Corporation dies, his surviving spouse, if he is survived by a spouse, shall be entitled to receive a death benefit which shall be a monthly payment for the spouse’s life, beginning on the first day of the month following the Vested Participant’s death, equal to: |
(1) fifty percent (50%) of the monthly retirement benefit to which the Vested Participant was entitled under the Plan prior to his death; |
reduced by: |
(2) the monthly annuity value of any life insurance provided by the Corporation or any affiliate thereof for retired employees that is in excess of post-retirement group term life insurance regularly provided by the Corporation or any affiliate thereof. |
5. Administration of the Plan. The Committee is charged with the administration of the Plan. It shall have full power and authority to construe and interpret the Plan. Its decisions shall be final, conclusive and binding on all parties. Subject to Section 10 of this Plan, the Committee shall also have the power, in its sole discretion, at any time (i) to waive, in whole or in part, application of any of the eligibility requirements of Section 3 or of the benefit reduction factors in Sections 4.a. and 4.b. and (ii) to determine the timing and form of payment of any benefit under the Plan, in the case of any individual Participant, Vested Participant or other employee of the Corporation (including an employee who has participated in the performance share unit portion of the KEIP). |
6. Optional Forms of Payment. In lieu of the monthly retirement benefit (including the spousal survivor benefit payable pursuant to Section 4.e. hereof) payable pursuant to Section 4.a. or 4.b. hereof to a Vested Participant (and his surviving spouse) who retires (or whose employment is terminated other than for Cause) after August 2, 1994 (such benefit payable to a Vested Participant and/or his surviving spouse is herein referred to for purposes of this Section 6 as the “Applicable Retirement Benefit”), such Vested Participant may elect to receive the following form of benefit payment: |
A lump sum cash payment, payable to the Vested Participant within ten (10) days after the Vested Participant’s date of retirement (or the Vested Participant’s date of termination of employment other than for Cause), equal to the actuarial present value of the Applicable Retirement Benefit, calculated using: (i) the prevailing commissioner’s standard mortality table (described in Section 807(d)(5)(A) of the Internal Revenue Code of 1986, as amended from time to time) used to determine reserves for group annuity contracts issued on the date of the Vested |
6
Participant’s retirement (or the Vested Participant’s date of termination of employment other than for Cause) (without regard to any other subparagraph of such Section 807(d)(5)) that is prescribed by the Commissioner of the Internal Revenue Service in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin; and (ii) an interest rate equal to the Lump Sum Interest Rate as of the date of the Vested Participant’s retirement. |
Any such election must be made by those Participants designated by the Committee from time to time at least two (2) years and by all other Participants at least one (1) year prior to the date that the Applicable Retirement Benefit payments would otherwise become payable. |
7. Payment Upon Change in Control |
a. Any former employee or the surviving spouse of an employee or former employee who is receiving a benefit under Sections 4.a., 4.b., 4.d. or 4.e. hereof (or pursuant to the terms of any version of this Plan) at the time of a Change in Control (collectively or individually, “SERP Recipient”) shall receive, in lieu of the future monthly retirement benefit (including the spousal survivor benefit in the case of a benefit under Section 4.a. or 4.b.) to which he is entitled (such future benefit payable to the SERP Recipient is herein referred to for purposes of this Section 7.a. as the “Future Retirement Benefit”), a lump sum cash payment, payable to the SERP Recipient, as applicable, within ten (10) days after a Change in Control (or such later date that is forty-five (45) days after the notice required by the following provisions of this Section 7.a. is provided to the applicable SERP Recipient), equal to the actuarial present value of his Future Retirement Benefit, calculated using: (x) for each SERP Recipient who was (or whose benefit is applicable to a Vested Participant who was) a Vested Participant on January 1, 1998, (i) the 83 GAM mortality tables; and (ii) an interest rate equal to the PBGC Interest Rate as of the date of the Change in Control; and (y) for each SERP Recipient who first became (or whose benefit is the result of a Vested Participant who first became) a Vested Participant after January 1, 1998, (i) the prevailing commissioner’s standard mortality table (described in Section 807(d)(5)(A) of the Internal Revenue Code of 1986, as amended from time to time) used to determine reserves for group annuity contracts issued on the date of the Change in Control (without regard to any other subparagraph for such Section 807(d)(5)) that is prescribed by the Commissioner of the Internal Revenue Service in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin; and (ii) an interest rate equal to the Lump Sum Interest Rate as of the date of the Change in Control. Notwithstanding anything in this paragraph to the contrary, the lump sum cash value of the benefit described in this Section 7.a. for each SERP Recipient who was, or whose benefit is applicable to a Vested Participant who (A) was a Vested Participant as of January 1, 1998 and (B) whose employment with the Corporation terminated on or after January 1, 2002, shall be equal to the greater of the value of the lump sum cash payment calculated pursuant to the rates and factors set forth in subsections (x) or (y) of this paragraph. |
Notwithstanding the foregoing, the provisions of this Section 7.a. shall not apply with respect to a SERP Recipient unless such SERP Recipient consents to the application of this Section 7.a. within thirty (30) days after the date the SERP Recipient receives written notice of the terms of this Section 7.a., as provided for by the following sentences. The Corporation shall |
7
provide each SERP Recipient with a written notice of the terms of this Section 7.a. and the consent requirement contained herein not later than five (5) days after the earliest of (y) the date that the Corporation provides notice to its stockholders that a vote on a transaction which, if consummated, would constitute a Change in Control will be submitted to the Corporation’s stockholders for approval, or (z) the occurrence of a Change in Control. |
b. For purposes of Sections 7 and 10, a “Change in Control” means: |
(1) Individuals who, on June 8, 1999, constitute the Board (the “Incumbent Directors”) cease for any reason to constitute at least a majority of the Board, provided that any person becoming a director subsequent to June 8, 1999, whose election or nomination for election was approved by a vote of at least two-thirds (2/3) of the Incumbent Directors then on the Board (either by specific vote or by approval of the proxy statement of the Corporation in which such person is named as nominee for director, without written objection to such nomination) shall be an Incumbent Director; provided, however, that no individual initially elected or nominated as a director of the Corporation as a result of an actual or threatened election contest (as described in Rule 14a-11 under the Exchange Act) (“Election Contest”) or other actual or threatened solicitation of proxies or consents by or on behalf of any Person other than the Board (“Proxy Contest”), including by reason of any agreement intended to avoid or settle any Election Contest or Proxy Contest, shall be deemed an Incumbent Director; and provided further, however, that a director who has been approved by the Hershey Trust while it beneficially owns more than 50% of the combined voting power of the then outstanding voting securities of the Corporation entitled to vote generally in the election of directors (the “Outstanding Company Voting Power”) shall be deemed to be an Incumbent Director; |
| (2) The acquisition or holding by any Person of beneficial ownership (within the meaning of Section 13(d) under the Exchange Act and the rules and regulations promulgated thereunder) of shares of the Common Stock and/or the Class B Common Stock of the Corporation representing 25% or more of either (i) the total number of then outstanding shares of both Common Stock and Class B Common Stock of the Corporation (the “Outstanding Company Stock”) or (ii) the Outstanding Company Voting Power; provided that, at the time of such acquisition or holding of beneficial ownership of any such shares, the Hershey Trust does not beneficially own more than 50% of the Outstanding Company Voting Power; and provided, further, that any such acquisition or holding of beneficial ownership of shares of either Common Stock or Class B Common Stock of the Corporation by any of the following entities shall not by itself constitute such a Change in Control hereunder: (i) the Hershey Trust; (ii) any trust established by the Corporation or by any Subsidiary for the benefit of the Corporation and/or its employees or those of a Subsidiary; (iii) any employee benefit plan (or related trust) sponsored or maintained by the Corporation or any Subsidiary; (iv) the Corporation or any Subsidiary or (v) any underwriter temporarily holding securities pursuant to an offering of such securities; |
8
(3) The approval by the stockholders of the Corporation of any merger, reorganization, recapitalization, consolidation or other form of business combination (a “Business Combination”) if, following consummation of such Business Combination, the Hershey Trust does not beneficially own more than 50% of the total voting power of all outstanding voting securities eligible to elect directors of (x) the surviving entity or entities (the “Surviving Corporation”) or (y) if applicable, the ultimate parent corporation that directly or indirectly has beneficial ownership of more than 50% of the combined voting power of the then outstanding voting securities eligible to elect directors of the Surviving Corporation; or |
(4) The approval by the stockholders of the Corporation of (i) any sale or other disposition of all or substantially all of the assets of the Corporation, other than to a corporation (the “Acquiring Corporation”) if, following consummation of such sale or other disposition, the Hershey Trust beneficially owns more than 50% of the total voting power of all outstanding voting securities eligible to elect directors (x) of the Acquiring Corporation or (y) if applicable, the ultimate parent corporation that directly or indirectly has beneficial ownership of more than 50% of the combined voting power of the then outstanding voting securities eligible to elect directors of the Acquiring Corporation, or (ii) a liquidation or dissolution of the Corporation. |
c. For purposes of Sections 7 and 10, a “Potential Change in Control” means: |
(1) The Hershey Trust by action of any of the Board of Directors of Hershey Trust Company; the Board of Managers of Milton Hershey School; the Investment Committee of the Hershey Trust; and/or any of the officers of Hershey Trust Company or Milton Hershey School (acting with authority) undertakes consideration of any action the taking of which would lead to a Change in Control as defined herein, including, but not limited to consideration of (i) an offer made to the Hershey Trust to purchase any number of its shares in the Corporation such that if the Hershey Trust accepted such offer and sold such number of shares in the Corporation the Hershey Trust might no longer have more than 50% of the Outstanding Company Voting Power, (ii) an offering by the Hershey Trust of any number of its shares in the Corporation for sale such that if such sale were consummated the Hershey Trust might no longer have more than 50% of the Outstanding Company Voting Power or (iii) entering into any agreement or understanding with a person or entity that would lead to a Change in Control; or |
(2) the Board approves a transaction described in subsection (2), (3) or (4) of the definition of a Change in Control contained in Section 7.b. |
9
d. For purposes of this Section 7: (i) “Hershey Trust” means either or both of (a) the Hershey Trust Company, a Pennsylvania corporation, as Trustee for the Milton Hershey School, or any successor to the Hershey Trust Company as such trustee, and (b) the Milton Hershey School, a Pennsylvania not-for-profit corporation; (ii) “Exchange Act” shall mean the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder; (iii) “Person” shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d)(3) and 14(d) thereof; and (iv) “Subsidiary” shall mean any corporation controlled by the Corporation, directly or indirectly. |
8. Payment of Benefits. |
a. Nothing contained in the Plan and no action taken pursuant to the provisions of the Plan shall create or be construed to create a trust of any kind, or a fiduciary relationship between the Corporation and any Participant, Vested Participant, spouse of a Participant or Vested Participant, or any other person. No person other than the Corporation shall by virtue of the provisions of the Plan have any interest in such assets. To the extent that any person acquires a right to receive payments from the Corporation under the Plan, such right shall be no greater than the right of any unsecured general creditor of the Corporation. The right of any Vested Participant or any other person to the payment of benefits under the Plan shall not be assigned, transferred, pledged or encumbered; such payments and the right thereto are expressly declared to be non-assignable and nontransferable. No payments hereunder shall be subject to the claim of the creditors of any Vested Participant or of any other person entitled to payments hereunder. Any payments required to be made pursuant to the Plan to a person who is under a legal disability may be made by the Corporation to or for the benefit of such person in such of the following ways as the Committee shall determine: |
1. directly to such person. |
The Corporation shall not be required to see to the application by any third party of any payments made pursuant to the Plan. |
b. The Committee may, in its discretion, suspend or terminate the benefits provided by the Plan to any Vested Participant, the spouse of such Vested Participant or any other person succeeding to the interests under the Plan of such Vested Participant, who first receives benefit payments under the Plan after March 1, 2003 if such Vested Participant (i) was not a Vested Participant under the Plan on March 1, 2003; and (ii) engaged in any conduct or misconduct while employed by the Corporation that the Committee reasonably determines constitutes Cause under the Plan. Such suspension or termination of benefits shall apply prospectively from and after the date of the Committee’s determination that such conduct or misconduct constitutes Cause. |
10
9. Effective Date of Plan. This Amended and Restated (2003) Supplemental Executive Retirement Plan shall be effective October 6, 2003 and Vested Participants who become eligible to retire under the Plan on or after that date shall be entitled to the benefits provided hereunder. |
10. Amendment, Suspension or Termination of the Plan. The Board of Directors of the Corporation may, at any time, suspend or terminate the Plan. The Board, or its duly appointed delegee, if applicable, may also from time to time, amend the Plan in such respects as it may deem advisable in order that benefits provided hereunder may conform to any change in law or in other respects which the Board, or its delegee in accordance with the Board’s delegation of authority thereto, deems to be in the best interest of the Corporation. No such suspension, termination or amendment of the Plan shall adversely affect any right of any person who is a Vested Participant at the time of such suspension, termination or amendment or his beneficiary(ies), estate or surviving spouse, as applicable, to receive benefits under the Plan in accordance with its provisions in effect immediately prior to such suspension, termination or amendment without the consent of such Vested Participant, beneficiary(ies), estate or surviving spouse. Any benefits payable under the terms of the Plan at the time of any suspension, termination or amendment of the Plan shall remain in effect according to their original terms, or such alternate terms as may be in the best interests of both parties and agreed to by the Vested Participant or his beneficiaries, estate or surviving spouse, as applicable. Notwithstanding the foregoing, (a) the Plan may not be terminated or amended in any manner that is adverse to the interests of a Participant or the surviving spouse of a Participant without the consent of the Participant or surviving spouse, as applicable, either: (i) after a Potential Change in Control occurs and for one (1) year following the cessation of the Potential Change in Control, or (ii) for a two (2) year period beginning on the date of a Change in Control (the “Coverage Period”); and (b) no termination of this Plan or amendment hereof in a manner adverse to the interests of any Participant, or such Participant’s surviving spouse, (without the consent of the Participant or surviving spouse) shall be effective if such termination or amendment occurs (i) at the request of a third party who has taken steps reasonably calculated to effect a Change in Control, or (ii) in connection with or in anticipation of a Change in Control. After the Coverage Period, the Plan may not be amended or terminated in any manner that would adversely affect the entitlement of a Participant or his surviving spouse (without the consent of the Participant or surviving spouse) to benefits that have accrued hereunder. For purposes of the immediately preceding two sentences of this Section 10, whether an employee of the Corporation qualifies as a Participant shall be determined at the time (a) the Coverage Period commences and any time thereafter or (b) his employment is terminated or the Plan is amended (i) at the request of a third party who has taken steps reasonably calculated to effect a Change in Control, or (ii) in connection with or in anticipation of a Change in Control. |
11
IN WITNESS WHEREOF, Hershey Foods Corporation has caused this Hershey Foods Corporation Amended and Restated (2003) Supplemental Executive Retirement Plan to be executed the 2nd day of December, 2003.
HERSHEY FOODS CORPORATION
By:
/s/ Marcella K. Arline
Marcella K. Arline
Senior Vice President, Human Resources
and Corporate Affairs
12
SCHEDULE I
to
AMENDED AND RESTATED (2003)
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
| January 2001 | 1.310 | January 2003 | 0.385% | |||
| February 2001 | 1.272 | February 2003 | 0.347% | |||
| March 2001 | 1.233 | March 2003 | 0.308% | |||
| April 2001 | 1.195 | April 2003 | 0.270% | |||
| May 2001 | 1.156 | May 2003 | 0.231% | |||
| June 2001 | 1.118 | June 2003 | 0.193% | |||
| July 2001 | 1.079 | July 2003 | 0.154% | |||
| August 2001 | 1.041 | August 2003 | 0.116% | |||
| September 2001 | 1.002 | September 2003 | 0.077% | |||
| October 2001 | 0.964 | October 2003 | 0.039% | |||
| November 2001 | 9.925 | November 2003 and | ||||
| December 2001 | 0.887 | each succeeding month | 0.000% | |||
| January 2002 | 0.848% | |||||
| February 2002 | 0.809% | |||||
| March 2002 | 0.771% | |||||
| April 2002 | 0.732% | |||||
| May 2002 | 0.694% | |||||
| June 2002 | 0.655% | |||||
| July 2002 | 0.617% | |||||
| August 2002 | 0.578% | |||||
| September 2002 | 0.540% | |||||
| October 2002 | 0.501% | |||||
| November 2002 | 0.463% | |||||
| December 2002 | 0.424% |
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
The Board of Directors and Stockholders
Hershey Foods Corporation:
We consent to the incorporation by reference in the registration statements (File No. 333-25853, File No. 333-33507, File No. 33-45431, File No. 33-45556, File No. 333-52509 and File No. 333-107706) on Forms S-8 and S-3 of Hershey Foods Corporation of our reports dated January 28, 2004, with respect to the consolidated balance sheets of Hershey Foods Corporation and subsidiaries as of December 31, 2003 and 2002, the related consolidated statements of income, cash flows and stockholders' equity for the years then ended, and the related financial statement schedule, which reports appear in the December 31, 2003 Annual Report on Form 10-K of Hershey Foods Corporation.
Our report refers to our audit of the disclosures added and reclassifications that were applied to revise the 2001 consolidated financial statements, as more fully described in Notes 1 and 6 to the consolidated financial statements. However, we were not engaged to audit, review or apply any procedures to the 2001 consolidated financial statements other than with respect to such disclosures and reclassifications.
/s/KPMG LLP
New York, New York
March 12, 2004
Exhibit 32
CERTIFICATION
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officers of Hershey Foods Corporation (the “Company”) hereby certify that the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: March 12, 2004
/s/ RICHARD H. LENNY
Richard H. Lenny
Chief Executive Officer
Dated: March 12, 2004
/s/ FRANK CERMINARA
Frank Cerminara
Chief Financial Officer
A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.
Exhibit 31.1
CERTIFICATION
I, Richard H. Lenny, certify that:
| 1. | I have reviewed this Annual Report on Form 10-K of Hershey Foods Corporation; |
| 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| 4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (c) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors: |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
| March 12, 2004 | /s/ RICHARD H. LENNY Richard H. Lenny Chief Executive Officer |
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
The following is a listing of Subsidiaries of the Company, their jurisdictions of incorporation, and the name under which they do business. Each is wholly owned. Certain subsidiaries are not listed since, considered in the aggregate as a single subsidiary, they would not constitute a significant subsidiary as of December 31, 2003.
| Name of Subsidiary |
Jurisdiction of Incorporation |
||||
| Hershey Chocolate & Confectionery Corporation | Delaware | ||||
| Hershey Chocolate of Virginia, Inc. | Delaware | ||||
| Hershey Canada, Inc. | Canada | ||||
Exhibit 31.2
CERTIFICATION
I, Frank Cerminara, certify that:
| 1. | I have reviewed this Annual Report on Form 10-K of Hershey Foods Corporation; |
| 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| 4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (c) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors: |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
| March 12, 2004 | /s/ FRANK CERMINARA Frank Cerminara Chief Financial Officer |