$818.4 million. Over the three year period, cash used by financing activities totaled $1.2 billion. Financing activities included cash used for the repurchase of common stock of $1.7 billion and cash dividends of $611.7 million. These cash outflows were partially offset by cash provided from net short-term and long-term borrowings of $761.5 million and cash provided from the exercise of stock options of $216.4 million. Cash equivalents decreased by $230.6 million over the three-year period.

additions, and funding contributions to the Company’s pension plans, future business acquisitions and working capital requirements. The Company expects to execute $500 million of term financing during 2006 under the January 2006 Registration Statement.

In November 2004, the Company entered into a Five Year Credit Agreement (the “Credit Agreement”) with the banks, financial institutions and other institutional lenders listed on the respective signature pages thereof (“Lenders”), Citibank, N.A., as administrative agent for the Lenders (as defined therein), Bank of America, N.A., as syndication agent, UBS Loan Finance LLC, as documentation agent, and Citigroup Global Markets, Inc. and Banc of America Securities LLC, as joint lead arrangers and joint book managers. The Credit Agreement establishes an unsecured revolving credit facility under which the Company may borrow up to $900 million with the option to increase borrowings by an additional $600 million with the concurrence of the Lenders. Funds borrowed may be used for general corporate purposes, including commercial paper backstop and business acquisitions. Advances other than competitive bid advances may be repaid without penalty at any time prior to the last day of the Credit Agreement. Competitive bid advances must be paid at maturity, and may not be prepaid. The Credit Agreement contains a financial covenant whereby the ratio of (a) pre-tax income from operations from the most recent four fiscal quarters to (b) consolidated interest expense for the most recent four fiscal quarters may not be less than 2.0 to 1 at the end of each fiscal quarter. The Credit Agreement contains customary representations and warranties and events of default. Payment of outstanding advances may be accelerated, at the option of the Lenders, should the Company default in its obligations under the Credit Agreement.

In September 2005, the Company entered into a new short-term credit agreement to establish an unsecured revolving credit facility to borrow up to $300 million. The agreement expired on December 30, 2005. Funds were used for general corporate purposes. The new short-term credit facility was entered into because the Company expected borrowings to exceed $900 million for up to three months beginning in early October 2005 due to the retirement of $200 million of 10-year notes in October 2005, refinancing of certain consolidated lease arrangements, recent contributions to the Company’s pension plans, stock repurchases and seasonal working capital needs.

The Company also maintains lines of credit with domestic and international commercial banks, under which it could borrow in various currencies up to approximately $71.1 million and $60.3 million as of December 31, 2005 and 2004, respectively. The higher lines of credit as of December 31, 2005, were primarily associated with the Company’s businesses in Mexico and Brazil.

Cash Flow Activities

Over the past three years, cash from operating activities provided approximately $1.8 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. The change in cash provided from other assets and liabilities between the years was primarily related to hedging transactions and the timing of payments for accrued liabilities, including income taxes. In 2004, the adjustment of deferred income taxes primarily reflected the deferred tax benefit resulting from the $61.1 million adjustment to income tax contingency reserves recorded in the second quarter of 2004 and an increase resulting from the Mauna Loa acquisition.

Investing activities included capital additions, capitalized software additions, and several 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 2005, the Company acquired the assets of Joseph Schmidt Confections, Inc. and completed the acquisition of Scharffen Berger Chocolate Maker, Inc. The combined purchase price for Scharffen Berger and Joseph Schmidt was $47.1 million, with the final amount subject to upward adjustment not to exceed $61.1 million to be determined based upon actual sales growth through 2007.

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In December 2004, the Company acquired Mauna Loa, a leading processor and marketer of macadamia snacks, for $127.8 million and in October 2004, the Company’s Mexican subsidiary, Hershey Mexico, acquired Grupo Lorena, one of Mexico’s top sugar confectionery companies, for $39.0 million.

In July 2004, the Company purchased 11,281,589 shares of its Common Stock from the Milton Hershey School Trust in a privately negotiated transaction. The Company paid $44.32 per share, or approximately $500.0 million, for the shares and fees of $1.4 million associated with the transaction.

In October 2005, the Company completed the sale of its Mr. Freeze freeze pops business in Canada for $2.7 million.

In September 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.

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 fund seasonal working capital requirements and finance share repurchase programs, including the purchase of Common Stock from the Milton Hershey School Trust. During the past three years, a total of 30,954,443 shares of Common Stock have been repurchased for $1.7 billion of which 22,991,517 shares were purchased for $1.2 billion under share repurchase programs and 7,962,926 shares were purchased for $.5 billion in the open market to replace Treasury Stock issued primarily for stock options exercises. The Company intends to repurchase shares to replace shares issued for stock options exercises. The value of shares purchased in a given period will vary based upon stock options exercises over time and market conditions. Cash payments for share repurchases were partially offset by cash receipts of $216.4 million from stock options exercises.

Net cash provided from operating activities was $461.8 million for 2005, a decrease of $326.0 million compared with 2004. The primary contributors to the decrease were an increase in contributions to the Company’s pension plans of $269.5 million from 2004 to 2005 and an increase in cash used by accounts receivable reflecting higher sales of new products and seasonal items in December 2005, which qualified for extended payment terms. The increase in cash provided from deferred income taxes principally reflected the tax impact of higher pension plan contributions in 2005 versus 2004.

Cash provided from changes in other assets and liabilities was $32.0 million in 2005 compared with cash provided of $108.4 million in 2004. The change in cash flows primarily reflected an increase in cash used as a result of changes in accrued liabilities for selling and marketing programs and long-term liabilities for incentive compensation in 2005 compared with 2004.

Net cash provided from operating activities was $787.8 million for 2004, an increase of $203.3 million compared with the prior year. The primary contributors to the increase were higher net income and increases in cash provided from other assets and liabilities and accounts receivable. These increases were partially offset by a decrease in cash flows related to deferred income taxes, principally reflecting the deferred tax benefit resulting from the income tax contingency reserve adjustment of $73.7 million in the second quarter of 2004, and cash used as a result of higher inventories as of December 31, 2004, to support higher sales anticipated in early 2005 prior to the effective date of selling price increases.

Cash provided from changes in other assets and liabilities was $108.4 million in 2004 compared with cash provided of $31.2 million in 2003. The change in cash flows reflected increased cash provided from commodity transactions, primarily reflecting higher commodity futures market prices in 2004, and cash provided from higher liabilities primarily associated with incentive plans in 2004. An increase in cash provided by accounts receivable in 2004 compared with cash used by accounts receivable in 2003 was primarily attributable to improved cash collections.

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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				2006				2007				2008				2009				2010				Thereafter				Total
Unconditional Purchase Obligations				$	977,500			$	343,800			$	101,200			$	54,800			$	—			$	—			$	1,477,300
Non-cancelable Operating Leases					13,119				11,819				10,433				7,078				5,461				10,938				58,848
Long-term Debt					56				190,000				147				136				142				752,330				942,811
Total Obligations				$	990,675			$	545,619			$	111,780			$	62,014			$	5,603			$	763,268			$	2,478,959

 

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, 2005. 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, 2005 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, 2005, such obligations were fully satisfied by taking delivery of and making payment for the specific commodities.

In January 2003, the 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 special-purpose trusts (“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, 2005 and 2004 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 $.03 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

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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 million in 2003, offset by a decrease in rental expense for these facilities included in cost of sales.

During 1999 and 2000, the Company entered into off-balance sheet arrangements for the leasing of certain warehouse and distribution facilities in Hershey, Pennsylvania, Atlanta, Georgia and Redlands, California. These off-balance sheet arrangements enabled the Company to lease these facilities under more favorable terms than other leasing alternatives. The lease arrangements were with SPTs. 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 made substantive residual equity capital investments in excess of 3% which were 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. As of December 31, 2005, only the lease for the Redlands, California warehouse and distribution facility remained in effect. The properties in Pennsylvania and Georgia were purchased and the leases terminated in July and October 2005, respectively.

The following is a summary of each of the lease transactions:

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 was 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 October 2005, at the end of the initial lease term, the Company exercised its option to purchase the facility and refinanced the related obligation of $17.5 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 was six years, including the one-year construction period, with up to four renewal periods of five years each with the consent of the lessor. In July 2005, at the end of the initial lease term, the Company exercised its option to purchase the facility and refinanced the related obligation of $59.3 million.

Aside from the residual guarantee and instrument guarantee associated with the individual leasing arrangement for the Redlands, California facility, as discussed below, the Company has provided no other guarantees or capitalization of the SPT associated with the Redlands facility. The Company has not collateralized the obligation in connection with the lease. 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 lease 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 arrangement. The Company’s transactions with the SPT are limited to the lease agreement. The Company does not anticipate entering into any other arrangements involving SPEs.

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The lease includes a substantial residual guarantee by the Company for a significant amount of the financing and an option to purchase the facility at original cost. Pursuant to instrument guarantees, in the event of a default under the lease agreement, the Company guaranteed to the note holders and certificate holders payment in an amount equal to all sums then due under the lease.

There are no penalties or other disincentives under the lease agreement if the Company decides not to renew the lease. The terms for each renewal period under the lease arrangement are identical to the initial terms and do not represent bargain lease terms.

If the Company were to exercise its option to purchase the facility at original cost at the end of the initial lease term, the Company could purchase the facility for a total of approximately $40.1 million in 2007. If the Company chooses not to renew the lease or purchase the assets at the end of the lease term, the Company is obligated under the residual guarantee for approximately $35.7 million for the lease. Additionally, the Company is obligated to re-market the 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 term, the Company does not anticipate a material disruption to operations, since such a facility is not unique, facilities with similar racking and storage capabilities are available in the area where the facility is located, there are no significant leasehold improvements that would be impaired, there would be no adverse tax consequences, the financing of a replacement facility would not be material to the Company’s cash flows and costs related to relocation would not be significant to income.

The Company has a number of facilities which contain varying degrees of asbestos in certain locations. Current regulations do not require the Company to remove or remediate locations containing asbestos in existing facilities. However, current regulations do require that the Company handle or dispose of this type of asbestos in a special manner if such facilities undergo major renovations or are demolished. The Company does not have plans to renovate or demolish these facilities in the foreseeable future. Accordingly, the Company believes it does not have sufficient information to estimate the fair value of any asset retirement obligations related to these facilities because the settlement date or range of potential settlement dates cannot be specified and information is not available to apply an expected present value technique. The facilities are expected to be maintained by repairs and maintenance activities that would not involve the removal of asbestos.

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.

A settlement of Federal tax audits for the 1999 and 2000 tax years, as well as the resolution of a number of state tax audit issues were concluded during the second quarter of 2004. Based upon the results of the audits, the income tax contingency reserves were adjusted resulting in a reduction of income tax reserves by $73.7 million, reflecting a reduction of the provision for income taxes by $61.1 million and a reduction to goodwill of $12.6 million. The income tax contingency reserve adjustments related primarily to the deductibility of certain expenses, interest on potential assessments, and acquisition and divestiture matters. Assessments of additional tax require use of the Company’s cash. The Company is not aware of any significant income tax assessments.

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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, foreign 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.

The Company accounts for derivative instruments in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS No. 133, as amended”). SFAS No. 133, as amended, 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. 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 6 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, 2005. This information should be read in conjunction with Note 1, Note 6 and Note 8 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, 2005. 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)
				2006				2007				2008				2009				2010				Thereafter				Total				Fair Value
Long-term Debt				$	56			$	190,000			$	147			$	136			$	142			$	752,330			$	942,811			$	1,051,127
Interest Rate					2.0	%			6.3	%			2.0	%			2.0	%			2.0	%			6.6	%			6.5	%

 

Interest rates on variable rate obligations were calculated using the rates in effect as of December 31, 2005.

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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 December 2005, the Company entered into forward swap agreements to hedge interest rate exposure related to the anticipated $500 million of term financing to be executed during 2006. The weighted average fixed rate on the forward swap agreements is 5.1%. 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 March 2004, the Company terminated these agreements, resulting in cash receipts totaling $5.2 million, with a corresponding increase to the carrying value of the long-term debt. This increase is being amortized over the remaining term of the respective long-term debt as a reduction to interest expense. 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%. These interest rate swap agreements expired at the end of the respective lease terms during 2005.

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 forward swap agreements was a liability of $4.9 million as of December 31, 2005. The fair value of the variable to fixed interest rate swaps was a liability of $1.7 million as of December 31, 2004. 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 $.2 million as of December 31, 2005 and 2004, 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 or forecasted purchases of equipment, certain raw materials and finished goods denominated in foreign currencies and to hedge payment of forecasted intercompany transactions with its subsidiaries outside the United States. 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 identifiable, foreign currency commitments. 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, 2005, the Company had foreign exchange forward contracts and options maturing primarily in 2006 and 2007 to purchase $51.1 million in foreign currency, primarily Australian dollars, British sterling and euros. As of December 31, 2005, the Company did not have foreign exchange forward contracts or options to sell foreign currencies.

As of December 31, 2004, the Company had foreign exchange forward contracts and options maturing primarily in 2005 and 2006 to purchase $103.1 million in foreign currency, primarily Australian dollars, Canadian dollars and euros, and to sell $30.8 million in foreign currency, primarily Mexican pesos and 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 forward contracts and options is estimated

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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 $.4 million and $4.4 million as of December 31, 2005 and 2004, respectively. The potential net loss in fair value of foreign exchange forward contracts and options of ten percent resulting from a hypothetical near-term adverse change in market rates was $.1 million and $.4 million as of December 31, 2005 and 2004, 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.

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 and to provide visibility to future costs, 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. During 2005, cocoa prices traded in a relatively wide range between 64¢ and 79¢ per pound, based on the New York Board of Trade futures contract. The Company’s costs will not necessarily reflect market price fluctuations because of its forward purchasing practices, premiums and discounts reflective of varying delivery times, and supply and demand for specific varieties and grades of cocoa beans.

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. The Company accounts for commodities futures contracts in accordance with 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 amount of futures contracts held over or under the amount required to price 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

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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.

For the years ended December 31,				2005								2004
In millions of dollars				Fair Value				Market Risk (Hypothetical 10% Change)				Fair Value				Market Risk (Hypothetical 10% Change)
Highest long position				$	16.3			$	1.6			$	128.2			$	12.8
Lowest long position					(204.5	)			20.5				(30.1	)			3.0
Average position (long)					(126.3	)			12.6				62.7				6.3

 

The decrease in fair values from 2004 to 2005 primarily reflected a decrease in net commodity positions. 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 U.S. generally accepted accounting principles 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’s primary concentration of credit risk is associated with McLane Company, Inc., one of the largest wholesale distributors in the United States to convenience stores, drug stores, wholesale clubs and mass merchandisers, which accounted for approximately 20.3% of the Company’s total accounts receivable as of December 31, 2005. As of December 31, 2005, no other customer accounted for more than 10% of the Company’s total accounts receivable and the Company believes that it has little concentration of credit risk associated with the remainder 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

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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, 2005, the Company recorded expense averaging approximately $1.2 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. This provision was reversed in the fourth quarter of 2004 upon the agreement with Fleming Reclamation Creditor’s Trust which resolved most significant matters related to the bankruptcy. Write-offs of uncollectible accounts, net of recoveries, averaged approximately $2.9 million over the same period. The provision for uncollectible accounts is recognized as selling, marketing and administrative expense in the Consolidated Statements of Income. Over the past three years, the allowance for doubtful accounts has ranged from 1% 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 $2.5 million to an increase in expense of approximately $1.5 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 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. 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 $584.8 million, $557.5 million and $551.2 million in 2005, 2004 and 2003, 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 $16.6 million to an increase in costs of approximately $6.4 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 6%. 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. 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, 2005, 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, 2005, 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.

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Pension and Other Post-Retirement Benefit Plans

The Company sponsors a number of defined benefit pension plans. The principal plans are The Hershey Company Retirement Plan and The Hershey Company 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.

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

The net periodic pension benefits cost for the Company’s pension plans was $29.9 million, $34.4 million and $51.5 million, respectively, in 2005, 2004 and 2003. For 2006, net periodic pension benefits cost is expected to be slightly higher than 2005 primarily due to the lower 2005 discount rate, partially offset by the impact of cash contributions to the pension plans in 2005. The recognized net actuarial losses will be higher in 2006 due to the lower discount rate. 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 2006 is $12.3 million based on the December 31, 2005 unrecognized net actuarial loss presented in Note 13, Pension and Other Post-Retirement Benefit Plans, of $314.1 million and an amortization period of primarily between thirteen 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 2005 recognized net actuarial loss component of net periodic pension benefits cost was $10.6 million. Projections beyond 2006 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 5.7%, 6.0% and 6.3% for 2005, 2004 and 2003, 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

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percentage point decrease in the discount rate assumption would have increased 2005 net periodic pension benefits cost by $11.1 million and a one percentage point increase in the discount rate assumption would have decreased 2005 net periodic pension benefits cost by $10.4 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. The duration of such securities is reasonably comparable to the duration of the pension plan liabilities.

The Company reduced its average discount rate assumption to 5.4% for valuing obligations as of December 31, 2005, from 5.7% as of December 31, 2004, due to the declining interest rate environment. A one percentage point decrease in the discount rate assumption would have increased the December 31, 2005 pension benefits obligations by $140.7 million and a one percentage point increase in the discount rate assumption would have decreased the December 31, 2005 pension benefits obligations by $121.5 million.

Asset return assumptions of 8.5% were used in the calculation of net periodic pension benefits cost for 2005, 2004 and 2003, 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. To determine the expected return on plan assets, the Company considers the current and expected asset allocations, as well as historical and expected returns on the categories of plan assets. The historical geometric average return over the 18 years prior to December 31, 2005 was approximately 9.6%. The actual return on assets was 7.8% during 2005, with gains during 2004 and 2003 of approximately 10.7% and 21.1%, 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 2005 net periodic pension benefits cost by $10.7 million and a one percentage point increase in the asset return assumption would have decreased 2005 net periodic pension benefits cost by $10.6 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 and certain other investments, 0%–10%. As of December 31, 2005, 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 2005 and 2004, minimum funding requirements for the plans were not material. However, the Company made contributions of $277.5 million in 2005 and $8.0 million in 2004 to improve the funded status. These contributions were fully tax deductible. A one percentage point change in the funding discount rate or asset return assumptions would not have changed the 2005 minimum funding requirements for the domestic plans. For 2006, there will be no minimum funding requirements for the domestic plans and minimum funding requirements for the non-domestic plans will not be material.

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 $24.6 million, $24.3 million and $23.9 million in 2005, 2004 and 2003, respectively. For the calculation of net periodic other post-retirement benefits costs, discount rate assumptions of 5.7%, 6.0% and 6.3% were used for 2005, 2004 and 2003, 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 2005 net periodic other post-retirement benefits costs by $1.2 million and a one percentage point increase in the discount rate assumption would have decreased 2005 net periodic other post-retirement benefits costs by $1.3 million.

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The Company used discount rate assumptions of 5.4% and 5.7% to value the other post-retirement benefits obligations as of December 31, 2005 and 2004, respectively. A one percentage point decrease in the discount rate assumption would have increased the December 31, 2005 other post-retirement benefits obligations by $40.4 million and a one percentage point increase in the discount rate assumption would have decreased the December 31, 2005 other post-retirement benefits obligations by $34.5 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 “2003 Medicare Act”). The 2003 Medicare Act introduced 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. Certain prescription drug benefits offered under the Company’s post-retirement health care plans qualify for the subsidy under Medicare Part D. The Federal subsidy to be provided by the 2003 Medicare Act reduced net periodic benefits costs beginning in 2004 by approximately $3.0 million and lowered the accumulated post-retirement benefits obligation by approximately $25.2 million.

Other critical accounting policies employed by the Company include the following:

Goodwill and Other Intangible Assets

The Company accounts for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. Other intangible assets consist primarily of trademarks, customer-related intangible assets and patents obtained through business acquisitions. The useful lives of trademarks were determined to be indefinite and, therefore, these assets are not being amortized. Customer-related intangible assets are being amortized over their estimated useful lives of approximately ten years. Patents are being amortized over their remaining legal lives of approximately fifteen 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 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 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 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 annual impairment tests were performed for goodwill and other intangible assets in the fourth quarters of 2003, 2004 and 2005. No impairment of assets was determined as a result of these tests.

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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 regard to accounting policies associated with derivative instruments is contained in Note 6, Derivative Instruments and Hedging Activities.

The net after-tax impact of cash flow hedging derivatives on comprehensive income (loss) reflected a $6.5 million loss in 2005, a $16.3 million gain in 2004 and a $20.2 million loss in 2003. 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 $18.1 million, $26.1 million, and $51.9 million for 2005, 2004 and 2003, respectively, were associated with commodities futures contracts. A before-tax loss of $2.0 million resulting from hedge ineffectiveness on commodities futures contracts was recognized in cost of sales for the year ended December 31, 2005. Gains on commodities futures contracts recognized in cost of sales as a result of hedge ineffectiveness were approximately $.4 million and $.4 million before tax for the years ended December 31, 2004 and 2003, 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 $3.6 million after tax as of December 31, 2005, which were principally associated with commodities futures contracts.

RETURN MEASURES

Operating Return on Average Stockholders’ Equity

The Company’s operating return on average stockholders’ equity, on a GAAP basis, was 45.7% in 2005. The Company’s adjusted operating return on average stockholders’ equity was 52.6% in 2005. For the purpose of calculating the adjusted operating return on average stockholders’ equity, earnings is defined as net income adjusted to reflect the impact of the elimination of the amortization of indefinite-lived intangibles for all years and excluding the impact of the adjustment to income tax contingency reserves on the provision for income taxes in 2004, the after-tax effect of the business realignment initiatives in 2005, 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 and the sale of corporate aircraft in 2000. Over the most recent six-year period, the adjusted return has ranged from 28.8% in 2000 to 52.6% in 2005.

Operating Return on Average Invested Capital

The Company’s operating return on average invested capital, on a GAAP basis, was 23.7% in 2005. The Company’s adjusted operating return on average invested capital was 27.0% in 2005. 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 the adjusted operating return on average invested capital, earnings is defined as net income adjusted to reflect the impact of the elimination of the amortization of indefinite-lived intangibles for all years and excluding the impact of the adjustment to income tax contingency reserves on the provision for income taxes in

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2004, the after-tax effect of the business realignment initiatives in 2005, 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 after-tax effect of interest on long-term debt. Over the most recent six-year period, the adjusted return has ranged from 16.0% in 2000 to 27.0% in 2005.

OUTLOOK

The outlook section contains a number of forward-looking statements, all of which are based on current expectations. Actual results may differ materially. Refer to Risk Factors on page 7 for information concerning the key risks to achieving future performance goals.

During the three years ended December 31, 2005, the Company significantly improved operating results as it implemented its strategies. Over the long-term these strategies seek to deliver average net sales growth of 3%–4% per year, 7%–9% annual growth in earnings before interest expense and income taxes (“EBIT”), improvement in EBIT margin of 90 basis points per year, and 9%–11% earnings per share-diluted (“EPS”) growth per year.

The Company expects sales growth in 2006 from benefit-driven innovation, such as the introduction of limited edition items and new products, continued expansion within the total U.S. snack market and a disciplined approach to achieving profitable growth in key global markets. The Company will continue to introduce new items and limited edition line extensions. During 2006 these will include a full year of sales for the following items that were introduced in 2005: Hershey’s Kisses brand filled with peanut butter, Ice Breakers sour mints, Hershey’s Kissables brand chocolate candies and Hershey’s caramel bar. The Company expects year-over-year net sales growth to build throughout 2006 due to the timing of new product shipments, price increases, and shifts in seasonal business early in 2005. Overall growth for the full year 2006 is expected to be somewhat above the Company’s 3%–4% long-term goal.

Geographically, net sales growth is expected to be concentrated primarily in the Americas and selected regions in Asia. The Company intends to focus on growth from its large-scale brands, expand its sales to global customers and develop region-specific business systems.

The Company expects higher input costs in 2006, particularly for commodities, transportation and employee benefits. The amount of these cost increases will be subject to changes in market conditions for costs which the Company has not fully hedged. The Company utilizes forward purchasing and commodity futures contracts and maintains a commodity procurement function to assess market fundamentals and develop procurement strategies. The Company expects to offset these cost increases through improved price realization, enhanced trade promotion efficiency, procurement strategies, continued improvements in supply chain efficiency and tight control of selling, marketing and administrative costs.

EBIT is expected to grow slightly above the long-term goal of 7%–9% in 2006, excluding items affecting comparability, as a result of net sales growth and gross margin expansion, combined with savings realized from the Company’s business realignment initiatives, along with careful control of selling, marketing and administrative costs.

EBIT margin is expected to improve by approximately 90 basis points in 2006, excluding items affecting comparability. 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 2006, EBIT margin expansion is expected from improved price realization resulting from a combination of selling price increases and product weight changes and from increased sales to more profitable channels, such as convenience stores, mass merchandisers, drug stores and specialty stores. In addition, enhanced effectiveness in trade promotion spending focused on fewer brands with greater reach and reduced selling, marketing and administrative expenses as a percentage of sales are expected to contribute to margin expansion in 2006. Gross margin is expected to increase modestly in 2006 from improved price realization and supply chain efficiencies

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as the Company continues to leverage its existing manufacturing capacity and distribution infrastructure. A reduction in selling, marketing and administrative expense as a percentage of sales is anticipated from leveraging the Company’s sales force capabilities without increasing costs and from combining various administrative functions in the Company’s North American operations. These initiatives are expected to more than offset the impact of higher input costs, primarily for raw materials, transportation and employee benefits.

Net income and EPS in 2005 were unfavorably impacted by the 2005 business realignment initiatives recorded in the third and fourth quarters. Excluding the impact of the 2005 business realignment initiatives, net income and EPS are expected to increase slightly above the range of the Company’s long-term goals for the full year 2006.

The Company expects strong cash flows from operating activities in 2006. 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. The plans were sufficiently funded at the end of 2005. The Company does not anticipate significant pension plan contributions in 2006. The Company plans to repurchase approximately $575 million of its common stock in 2006 to be funded by cash provided from operations and additional borrowings.

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 28 through 31.

Item 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

		PAGE
Responsibility for Financial Statements		39
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements		40
Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003		41
Consolidated Balance Sheets as of December 31, 2005 and 2004		42
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003		43
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2005, 2004 and 2003		44
Notes to Consolidated Financial Statements		45

 

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RESPONSIBILITY FOR FINANCIAL STATEMENTS

The Hershey Company 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 U.S. generally accepted accounting principles 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 2005, 2004 and 2003 financial statements have been audited by KPMG LLP, an independent registered public accounting firm. KPMG LLP’s report on the Company’s 2005 and 2004 financial statements is included on page 40.

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.

Richard H. Lenny		David J. West
Chairman of the Board, President		Senior Vice President
and Chief Executive Officer		Chief Financial Officer

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
The Hershey Company:

We have audited the accompanying consolidated balance sheets of The Hershey Company and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of income, cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Hershey Company and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 1, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, in the year ended December 31, 2005. Also, on June 30, 2003, the Company adopted Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, as discussed in Note 2.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

                               
 

New York, New York
February 27, 2006

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THE HERSHEY COMPANY
 
CONSOLIDATED STATEMENTS OF INCOME

For the years ended December 31,		2005			2004			2003
In thousands of dollars except per share amounts
Net Sales		$	4,835,974		$	4,429,248		$	4,172,551
Costs and Expenses:
Cost of sales			2,965,540			2,680,437			2,544,726
Selling, marketing and administrative			912,986			867,104			841,105
Business realignment and asset impairments, net			96,537			—			23,357
Gain on sale of business			—			—			(8,330	)
Total costs and expenses			3,975,063			3,547,541			3,400,858
Income before Interest and Income Taxes			860,911			881,707			771,693
Interest expense, net			87,985			66,533			63,529
Income before Income Taxes			772,926			815,174			708,164
Provision for income taxes			279,682			237,273			258,849
Income before Cumulative Effect of Accounting Change			493,244			577,901			449,315
Cumulative effect of accounting change, net of $4,933 tax benefit			—			—			7,368
Net Income		$	493,244		$	577,901		$	441,947
Earnings Per Share—Basic—Common Stock
Income before Cumulative Effect of Accounting Change		$	2.07		$	2.33		$	1.75
Cumulative Effect of Accounting Change, net of $.02 Tax Benefit			—			—			.03
Net Income		$	2.07		$	2.33		$	1.72
Earnings Per Share—Basic—Class B Common Stock
Income before Cumulative Effect of Accounting Change		$	1.87		$	2.12		$	1.58
Cumulative Effect of Accounting Change, net of $.02 Tax Benefit			—			—			.03
Net Income		$	1.87		$	2.12		$	1.55
Earnings Per Share—Diluted
Income before Cumulative Effect of Accounting Change		$	1.99		$	2.25		$	1.70
Cumulative Effect of Accounting Change, net of $.02 Tax Benefit			—			—			.03
Net Income		$	1.99		$	2.25		$	1.67
Cash Dividends Paid Per Share:
Common Stock		$	.9300		$	.8350		$	.7226
Class B Common Stock			.8400			.7576			.6526

 

The notes to consolidated financial statements are an integral part of these statements.

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THE HERSHEY COMPANY
 
CONSOLIDATED BALANCE SHEETS

December 31,				2005				2004
In thousands of dollars
ASSETS
Current Assets:
Cash and cash equivalents				$	67,183			$	54,837
Accounts receivable—trade					559,289				408,930
Inventories					610,284				557,180
Deferred income taxes					78,196				61,756
Prepaid expenses and other					93,988				114,991
Total current assets					1,408,940				1,197,694
Property, Plant and Equipment, Net					1,659,138				1,682,698
Goodwill					487,338				463,947
Other Intangibles					142,626				125,233
Other Assets					597,194				343,212
Total assets				$	4,295,236			$	3,812,784
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable				$	167,812			$	148,686
Accrued liabilities					507,843				469,185
Accrued income taxes					23,453				42,280
Short-term debt					819,059				343,277
Current portion of long-term debt					56				279,043
Total current liabilities					1,518,223				1,282,471
Long-term Debt					942,755				690,602
Other Long-term Liabilities					412,929				383,379
Deferred Income Taxes					400,253				319,230
Total liabilities					3,274,160				2,675,682
Stockholders’ Equity:
Preferred Stock, shares issued: none in 2005 and 2004					—				—
Common Stock, shares issued: 299,083,266 in 2005 and 299,060,235 in 2004					299,083				299,060
Class B Common Stock, shares issued: 60,818,478 in 2005 and 60,841,509 in 2004					60,818				60,841
Additional paid-in capital					252,374				171,413
Unearned ESOP compensation					(3,193	)			(6,387	)
Retained earnings					3,646,179				3,374,170
Treasury—Common Stock shares, at cost: 119,377,690 in 2005 and 113,313,827 in 2004					(3,224,863	)			(2,762,304	)
Accumulated other comprehensive (loss) income					(9,322	)			309
Total stockholders’ equity					1,021,076				1,137,102
Total liabilities and stockholders’ equity				$	4,295,236			$	3,812,784

 

The notes to consolidated financial statements are an integral part of these balance sheets.

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THE HERSHEY COMPANY
 
CONSOLIDATED STATEMENTS OF CASH FLOWS

For the years ended December 31,				2005				2004				2003
In thousands of dollars
Cash Flows Provided from (Used by)
Operating Activities
Net income				$	493,244			$	577,901			$	441,947
Adjustments to reconcile net income to net cash provided from operations:
Depreciation and amortization					218,032				189,665				180,567
Stock-based compensation expense, net of tax of $19,716, $16,399 and $11,677, respectively					34,449				28,406				20,226
Deferred income taxes					71,038				(74,570	)			33,500
Gain on sale of business, net of tax of $2,624					—				—				(5,706	)
Business realignment initiatives, net of tax of $44,975 and $9,988, respectively					74,021				—				15,488
Cumulative effect of accounting change, net of tax of $4,933					—				—				7,368
Contributions to pension plans					(277,492	)			(8,020	)			(120,252	)
Changes in assets and liabilities, net of effects from business acquisitions and divestitures:
Accounts receivable—trade					(149,032	)			17,319				(36,636	)
Inventories					(51,204	)			(40,043	)			9,095
Accounts payable					16,715				(11,266	)			7,715
Other assets and liabilities					31,991				108,362				31,157
Net Cash Provided from Operating Activities					461,762				787,754				584,469
Cash Flows Provided from (Used by)
Investing Activities
Capital additions					(181,069	)			(181,728	)			(218,650	)
Capitalized software additions					(13,236	)			(14,158	)			(18,404	)
Business acquisitions					(47,074	)			(166,859	)			—
Proceeds from divestitures					2,713				—				20,049
Net Cash (Used by) Investing Activities					(238,666	)			(362,745	)			(217,005	)
Cash Flows Provided from (Used by)
Financing Activities
Net change in short-term borrowings					475,582				331,245				897
Long-term borrowings					248,318				—				3,194
Repayment of long-term debt					(278,236	)			(883	)			(18,633	)
Cash dividends paid					(221,235	)			(205,747	)			(184,686	)
Exercise of stock options					81,632				79,634				55,120
Excess tax benefits from exercise of stock options					20,186				9,696				8,474
Repurchase of Common Stock					(536,997	)			(698,910	)			(414,780	)
Net Cash (Used by) Financing Activities					(210,750	)			(484,965	)			(550,414	)
Increase (decrease) in Cash and Cash Equivalents					12,346				(59,956	)			(182,950	)
Cash and Cash Equivalents as of January 1					54,837				114,793				297,743
Cash and Cash Equivalents as of December 31				$	67,183			$	54,837			$	114,793
Interest Paid				$	88,077			$	66,151			$	65,347
Income Taxes Paid					206,704				289,607				207,672

 

The notes to consolidated financial statements are an integral part of these statements.

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THE HERSHEY COMPANY
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, 2003				$	—			$	149,528			$	30,422			$	105,717			$	(12,774	)		$	2,924,706			$	(1,808,227	)		$	21,071			$	1,410,443
Net income																									441,947												441,947
Other comprehensive (loss)																																	(32,156	)			(32,156	)
Comprehensive income																																					409,791
Dividends:
Common Stock, $.7226 per share																									(144,985	)											(144,985	)
Class B Common Stock, $.6526 per share																									(39,701	)											(39,701	)
Incentive plan transactions																	455												4,522								4,977
Stock-based compensation																	22,741																				22,741
Exercise of stock options																	1,519												67,788								69,307
Employee stock ownership trust/benefits transactions																	1,467				3,194								3,256								7,917
Repurchase of Common Stock																													(414,780	)							(414,780	)
Balance as of December 31, 2003					—				149,528				30,422				131,899				(9,580	)			3,181,967				(2,147,441	)			(11,085	)			1,325,710
Net income																									577,901												577,901
Other comprehensive income																																	11,394				11,394
Comprehensive income																																					589,295
Dividends:
Common Stock, $.835 per share																									(159,658	)											(159,658	)
Class B Common Stock, $.7576 per share																									(46,089	)											(46,089	)
Two-for-one stock split									149,529				30,422												(179,951	)											—
Conversion of Class B Common Stock into Common Stock									3				(3	)																							—
Incentive plan transactions																	36												1,609								1,645
Stock-based compensation																	14,934																				14,934
Exercise of stock options																	23,248												81,482								104,730
Employee stock ownership trust/benefits transactions																	1,296				3,193								956								5,445
Repurchase of Common Stock																													(698,910	)							(698,910	)
Balance as of December 31, 2004					—				299,060				60,841				171,413				(6,387	)			3,374,170				(2,762,304	)			309				1,137,102
Net income																									493,244												493,244
Other comprehensive (loss)																																	(9,631	)			(9,631	)
Comprehensive income																																					483,613
Dividends:
Common Stock, $.93 per share																									(170,147	)											(170,147	)
Class B Common Stock, $.84 per share																									(51,088	)											(51,088	)
Conversion of Class B Common Stock into Common Stock									23				(23	)																							—
Incentive plan transactions																	236												1,161								1,397
Stock-based compensation																	31,117																				31,117
Exercise of stock options																	49,406												73,258								122,664
Employee stock ownership trust/benefits transactions																	202				3,194								19								3,415
Repurchase of Common Stock																													(536,997	)							(536,997	)
Balance as of December 31, 2005				$	—			$	299,083			$	60,818			$	252,374			$	(3,193	)		$	3,646,179			$	(3,224,863	)		$	(9,322	)		$	1,021,076

 

The notes to consolidated financial statements are an integral part of these statements.

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THE HERSHEY COMPANY
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 2005 presentation. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment (“SFAS No. 123R”). SFAS No. 123R addresses the accounting for transactions in which an enterprise exchanges its valuable equity instruments for employee services. It also addresses transactions in which an enterprise incurs liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of those equity instruments in exchange for employee services. For public entities, the cost of employee services received in exchange for equity instruments, including employee stock options, would be measured based on the grant-date fair value of those instruments. That cost would be recognized as compensation expense over the requisite service period (often the vesting period). Generally, no compensation cost would be recognized for equity instruments that do not vest. The Company adopted SFAS No. 123R in the fourth quarter of 2005 and applied the modified retrospective application method to all prior years for which Statement of Financial Accounting Standards No. 123 was effective. Accordingly, consolidated financial statements for all prior periods were adjusted to give effect to the fair-value-based method of accounting for awards granted, modified or settled in cash subsequent to December 31, 1994. The impact of SFAS No. 123R decreased net income by $21.7 million, $13.0 million and $15.6 million, or $.09, $.05 and $.06 per share-diluted, in 2005, 2004 and 2003, respectively. The impact in 2005 included $2.4 million after tax, or $.01 per share-diluted, in business realignment charges.

Adjustments requiring increases (decreases) to assets, liabilities and stockholders’ equity resulting from the adoption of SFAS No. 123R were as follows:

December 31,				2004				2003				2002
In thousands of dollars
Current deferred income taxes				$	15,253			$	4,611			$	6,405
Total assets				$	15,253			$	4,611			$	6,405
Accrued liabilities				$	(2,911	)		$	(2,654	)		$	(1,634	)
Other long-term liabilities					(19,977	)			(10,917	)			(10,228	)
Deferred income taxes					(9,659	)			(27,662	)			(20,473	)
Total liabilities					(32,547	)			(41,233	)			(32,335	)
Additional paid-in capital					142,799				127,865				105,124
Retained earnings					(94,999	)			(82,021	)			(66,384	)
Total stockholders’ equity					47,800				45,844				38,740
Total liabilities and stockholders’ equity				$	15,253			$	4,611			$	6,405

 

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 $22.5 million and $2.1 million for the years ended December 31, 2005 and 2003, respectively.

The Company’s effective income tax rate was 36.2% in 2005, 29.1% in 2004 and 36.6% in 2003. The effective income tax rate for 2005 benefited by 0.2 percentage points from the impact of tax rates associated with business realignment charges. The effective income tax rate for 2004 is not comparable with the effective income tax rates for 2005 and 2003 because the Company’s provision

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for income taxes was benefited by a $61.1 million adjustment recorded in 2004 to income tax contingency reserves. The non-cash reduction of income tax expense resulted from the settlement of Federal tax audits for the 1999 and 2000 tax years, as well as the resolution of a number of state tax audit issues. Based upon the results of the audits, the income tax contingency reserves were adjusted, resulting in a reduction of income tax reserves by $73.7 million reflecting a reduction of the provision for income taxes by $61.1 million and a reduction to goodwill of $12.6 million. The income tax contingency reserve adjustments related primarily to the deductibility of certain expenses, interest on potential assessments, and acquisition and divestiture matters.

In January 2003, the 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. The Company has a controlling financial interest if it owns a majority of the outstanding voting common stock or has significant control over an entity through contractual or economic interests in which the Company is the primary beneficiary.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 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. Trade promotions and sales incentives primarily include reduced price features, merchandising displays, sales growth incentives, new item allowances and cooperative advertising.

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

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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.

The Company accounts for commodities futures contracts in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS No. 133, as amended”). SFAS No. 133, as amended, 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. Additional information with regard to accounting policies associated with derivative instruments is contained in Note 6, 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.

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Asset Retirement Obligations

The Company accounts for asset retirement obligations in accordance with Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, and FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations—an interpretation of FASB Statement No. 143. Asset retirement obligations generally apply to legal obligations associated with the retirement of a tangible long-lived asset that result from the acquisition, construction or development and the normal operation of a long-lived asset.

The Company assesses asset retirement obligations on a periodic basis. The fair value of a liability for an asset retirement obligation is recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. Associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset.

Goodwill and Other Intangible Assets

The Company accounts for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. Other intangible assets primarily consist of trademarks, customer-related intangible assets and patents obtained through business acquisitions. The useful lives of trademarks were determined to be indefinite and, therefore, these assets are not being amortized. Customer-related intangible assets are being amortized over their estimated useful lives of approximately ten years. Patents are being amortized over their remaining legal lives of approximately fifteen 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 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 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 7, 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

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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 6, 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 or forecasted purchases of equipment, certain raw materials and finished goods denominated in foreign currencies, and to hedge payment of forecasted 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 identifiable foreign currency commitments and forecasted transactions. 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 and options, is contained in Note 6, Derivative Instruments and Hedging Activities.

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 $22.6 million, $23.2 million and $24.5 million in 2005, 2004 and 2003, 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 $125.0 million, $137.9 million and $145.4 million in 2005, 2004 and 2003, respectively. No prepaid advertising expense was recorded as of December 31, 2005. Prepaid advertising as of December 31, 2004, was $1.5 million.

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

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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, 2005 and 2004 was $34.4 million and $36.1 million, respectively. Software costs are amortized using the straight-line method over the expected life of the software. Accumulated amortization of capitalized software was $130.8 million and $116.5 million as of December 31, 2005 and 2004, 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.

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 $.03 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.

3.    ACQUISITIONS AND DIVESTITURES

In August 2005, the Company acquired the assets of Joseph Schmidt Confections, Inc., a premium chocolate maker located in San Francisco, California. Joseph Schmidt is known for its artistic and innovative truffles, colorful chocolate mosaics, specialty cookies, and handcrafted chocolates. These products are sold in select department stores and other specialty outlets nationwide as well as in Joseph Schmidt stores located in San Jose and San Francisco, California.

Also, in August 2005, the Company completed the acquisition of Scharffen Berger Chocolate Maker, Inc. Based in San Francisco, California, Scharffen Berger is known for its high-cacao content, signature dark chocolate bars and baking products sold online and in a broad range of outlets, including specialty retailers, natural food stores and gourmet centers across the country. Scharffen Berger also owns and operates three specialty stores located in New York City, Berkeley, and San Francisco. The combined purchase price for Scharffen Berger and Joseph Schmidt was $47.1 million, with the final amount subject to upward adjustment not to exceed $61.1 million to be determined based upon actual sales growth through 2007. Together, these companies have combined annual sales of approximately $25 million.

In December 2004, the Company acquired Mauna Loa Macadamia Nut Corporation (“Mauna Loa”) for $127.8 million. Mauna Loa is the leading processor and marketer of macadamia snacks with annual sales of approximately $80 million.

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In October 2004, the Company’s Mexican subsidiary, Hershey Mexico, acquired Grupo Lorena, one of Mexico’s top sugar confectionery companies, for $39.0 million. This business has annual sales of over $30 million. Included in the acquisition was the Pelón Pelo Rico brand.

Results subsequent to the dates of acquisition were included in the consolidated financial statements. Had the results of the acquisitions been included in the consolidated financial statements for each of the periods presented, the effect would not have been material.

In October 2005, the Company completed the sale of its Mr. Freeze freeze pops business in Canada for $2.7 million. There was no significant gain or loss on the transaction.

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.

4.    BUSINESS REALIGNMENT INITIATIVES

In July 2005, the Company announced initiatives intended to advance its value-enhancing strategy. The Company also announced that it would record a total pre-tax charge of approximately $140 million to $150 million, or $.41 to $.44 per share-diluted in connection with the initiatives. Of the total pre-tax charge, approximately $80 million will be incurred in connection with a U.S. Voluntary Workforce Reduction Program (“VWRP”), approximately $41 million will be incurred in connection with facility rationalization and approximately $24 million will be incurred in connection with streamlining and restructuring the Company’s international operations, including a Canadian VWRP.

During the second half of 2005, the Company recorded charges totaling $119.0 million associated with the initiatives. The charges of $119.0 million consisted of a $96.5 million business realignment charge and $22.5 million recorded in cost of sales (together, the “2005 business realignment initiatives”). The business realignment charge included $69.5 million related to the U.S. VWRP, $12.8 million for facility rationalization relating to the closure of the Las Piedras, Puerto Rico plant and $14.2 million related to streamlining the Company’s international operations, primarily associated with costs for the Canadian VWRP. The business realignment charge included $8.3 million for involuntary termination benefits primarily for Las Piedras plant employees. The $22.5 million recorded in cost of sales resulted from accelerated depreciation related to the closure of the Las Piedras manufacturing facility. The Company believes that the 2005 business realignment initiatives will be fully completed by December 31, 2006.

Changes in liabilities recorded for the business realignment initiatives were as follows:

Accrued Liabilities				Balance 10/02/05				Fourth Quarter Utilization				New charges during Fourth Quarter				Balance 12/31/05
In thousands of dollars
VWRP				$	33,726			$	(5,650	)		$	3,807			$	31,883
Facility rationalization					4,725				(6,615	)			1,890				—
Streamline international operations					5,390				(890	)			1,388				5,888
Total				$	43,841			$	(13,155	)		$	7,085			$	37,771

 

During 2003, the Company executed 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. These actions resulted in a net charge of approximately $17.2 million, or $.04 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

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$23.4 million and an $8.3 million net gain resulting from the divestiture of certain brands (together, the “2003 business realignment initiatives”).

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 2004 reduced the liability balance to $3.9 million as of December 31, 2004. Cash payments during 2005 reduced the liability balance to $1.3 million.

Arising out of the 2003 business realignment initiatives, eight former employees of the Company filed a complaint in federal court in Colorado alleging the Company discriminated against them on the basis of age. The trial of these claims is scheduled to begin in the Fall of 2006. The Company intends to vigorously defend against these claims and, based on the developments of the case to date, the Company does not consider the likelihood of a material unfavorable outcome to the Company to be probable.

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, 2005. 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, 2005 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, 2005, such obligations were fully satisfied by taking delivery of and making payment for the specific commodities.

As of December 31, 2005, 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 $977.5 million in 2006, $343.8 million in 2007, $101.2 million in 2008 and $54.8 million in 2009.

The Company has certain obligations associated with an arrangement with an SPT for the leasing of a warehouse and distribution facility discussed in Note 2, Cumulative Effect of Accounting Change.

The Company has a number of facilities which contain varying degrees of asbestos in certain locations. Current regulations do not require the Company to remove or remediate locations containing asbestos in existing facilities. However, current regulations do require that the Company handle or dispose of this type of asbestos in a special manner if such facilities undergo major renovations or are demolished. The Company does not have plans to renovate or demolish these facilities in the foreseeable future. Accordingly, the Company believes it does not have sufficient information to estimate the fair value of any asset retirement obligations related to these facilities because the settlement date or range of potential settlement dates cannot be specified and information is not available to apply an expected present value technique. The facilities are expected to be maintained by repairs and maintenance activities that would not involve the removal of asbestos.

Future minimum rental payments under non-cancelable operating leases with a remaining term in excess of one year as of December 31, 2005, totaled $58.8 million (2006—$13.1 million; 2007— $11.8 million; 2008—$10.4 million; 2009—$7.1 million; 2010—$5.5 million; 2011 and beyond—$10.9 million).

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6.    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.

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 options, 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, 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 for hedging purposes only 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 December 2005, the Company entered into forward swap agreements to hedge interest rate exposure related to the anticipated $500 million of term financing to be executed during 2006. The average fixed rate on the forward swap agreements is 5.1%. 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 March 2004, the Company terminated these agreements, resulting in cash receipts totaling $5.2 million, with a corresponding increase to the carrying value of the long-term debt. This increase is being amortized over the remaining term of the respective long-term debt as a reduction to interest expense.

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 were variable based on LIBOR. The interest rate swap agreements effectively converted the variable-interest-rate payments on the leases from LIBOR to a fixed rate of 6.1%. These interest rate swap agreements expired at the end of the respective lease terms during 2005.

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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 $59.3 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 qualified as cash flow hedges and the notional amounts, interest rates and terms of the swap agreements were consistent with the underlying lease agreements they were intended to hedge and, therefore, there was no hedge ineffectiveness. Gains and losses on the interest rate swap agreements were included in other comprehensive income and were recognized in cost of sales in the same period as the hedged interest payments affected earnings. The fair value of forward swap agreements was a liability of $4.9 million as of December 31, 2005. The fair value of variable to fixed interest rate swap agreements was a liability of $1.7 million as of December 31, 2004. Liabilities associated with swap agreements as of December 31, 2005 and 2004 are included on the Consolidated Balance Sheets as accrued liabilities and other long-term liabilities, respectively, with the offset reflected in accumulated other comprehensive income (loss), net of income taxes.

Cash flows from interest rate swap agreements were 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 was 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 or forecasted purchases of equipment, certain raw materials and finished goods denominated in foreign currencies, and to hedge payment of forecasted intercompany transactions with its subsidiaries outside the United States. 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 identifiable foreign currency commitments or forecasted transactions denominated in foreign currencies. 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.

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 $.4 million and $4.4 million as of December 31, 2005 and 2004, 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.

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Cash flows from other foreign exchange forward contracts and options 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.

The net after-tax impact of cash flow hedging derivatives on comprehensive income (loss) reflected a $6.5 million loss in 2005, a $16.3 million gain in 2004 and a $20.2 million loss in 2003. 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 $18.1 million, $26.1 million, and $51.9 million for 2005, 2004 and 2003, respectively, were associated with commodities futures contracts. A before-tax loss of $2.0 million resulting from hedge ineffectiveness on commodities futures contracts was recognized in cost of sales for the year ended December 31, 2005. Gains on commodities futures contracts recognized in cost of

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sales as a result of hedge ineffectiveness were approximately $.4 million and $.4 million before tax for the years ended December 31, 2004 and 2003, 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, 2005, the amount of net after-tax losses 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 $3.6 million, which was primarily associated with commodities futures contracts.

7.

COMPREHENSIVE INCOME

A summary of the components of comprehensive income is as follows:

For the year ended December 31, 2005				Pre-Tax Amount				Tax (Expense) Benefit				After-Tax Amount
In thousands of dollars
Net income												$	493,244
Other comprehensive income (loss):
Foreign currency translation adjustments				$	17,151			$	—				17,151
Minimum pension liability adjustments, net of tax					(3,617	)			1,386				(2,231	)
Cash flow hedges:
Gains (losses) on cash flow hedging derivatives					(10,255	)			3,791				(6,464	)
Reclassification adjustments					(28,435	)			10,348				(18,087	)
Total other comprehensive loss				$	(25,156	)		$	15,525				(9,631	)
Comprehensive income												$	483,613

 

For the year ended December 31, 2004				Pre-Tax Amount				Tax (Expense) Benefit				After-Tax Amount
In thousands of dollars
Net income												$	577,901
Other comprehensive income (loss):
Foreign currency translation adjustments				$	21,229			$	—				21,229
Minimum pension liability adjustments, net of tax					81				(32	)			49
Cash flow hedges:
Gains (losses) on cash flow hedging derivatives					25,571				(9,314	)			16,257
Reclassification adjustments					(41,222	)			15,081				(26,141	)
Total other comprehensive income				$	5,659			$	5,735				11,394
Comprehensive income												$	589,295

 

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For the year ended December 31, 2003				Pre-Tax Amount				Tax (Expense) Benefit				After-Tax Amount
In thousands of dollars
Net income												$	441,947
Other comprehensive income (loss):
Foreign currency translation adjustments				$	40,938			$	—				40,938
Minimum pension liability adjustments, net of tax					(1,565	)			623				(942	)
Cash flow hedges:
Gains (losses) on cash flow hedging derivatives					(31,971	)			11,732				(20,239	)
Reclassification adjustments					(82,012	)			30,099				(51,913	)
Total other comprehensive loss				$	(74,610	)		$	42,454				(32,156	)
Comprehensive income												$	409,791

 

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:

December 31,				2005				2004
In thousands of dollars
Foreign currency translation adjustments				$	243			$	(16,908	)
Minimum pension liability adjustments					(3,360	)			(1,129	)
Cash flow hedges					(6,205	)			18,346
Total accumulated other comprehensive (loss) income				$	(9,322	)		$	309

 

8.

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, 2005 and 2004, because of the relatively short maturity of these instruments. The carrying value of long-term debt, including the current portion, was $942.8 million as of December 31, 2005, compared with a fair value of $1,051.1 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 $969.6 million as of December 31, 2004, compared with a fair value of $1,094.3 million.

As of December 31, 2005, the Company had foreign exchange forward contracts and options maturing in 2006 and 2007 to purchase $51.1 million in foreign currency, primarily Australian dollars, British sterling and euros. As of December 31, 2005, the Company did not have any foreign exchange forward contracts or options to sell foreign currencies.

As of December 31, 2004, the Company had foreign exchange forward contracts and options maturing in 2005 and 2006 to purchase $103.1 million in foreign currency, primarily Australian dollars, Canadian dollars and euros, and to sell $30.8 million in foreign currency, primarily Mexican pesos and 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 $.4 million and $4.4 million as of December 31, 2005 and 2004, 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 as discussed in Note 6, Derivative Instruments and Hedging Activities.

In December 2005, the Company entered into forward swap agreements to hedge interest rate exposure related to the anticipated $500 million of term financing to be executed during 2006. The

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weighted average fixed rate on the forward swap agreements is 5.1%. The fair value of the forward swap agreements was a liability of $4.9 million as of December 31, 2005.

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%. These interest rate swap agreements expired at the end of the respective lease terms during 2005. The fair value of variable to fixed interest rate swaps was a liability of $1.7 million as of December 31, 2004.

9.    INTEREST EXPENSE

Interest expense, net consisted of the following:

For the years ended December 31,				2005				2004				2003
In thousands of dollars
Long-term debt and lease obligations				$	66,324			$	66,005			$	66,283
Short-term debt					23,164				4,511				935
Capitalized interest					(3	)			(2,597	)			(1,953	)
Interest expense, gross					89,485				67,919				65,265
Interest income					(1,500	)			(1,386	)			(1,736	)
Interest expense, net				$	87,985			$	66,533			$	63,529

 

10.

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. In November 2004, the Company entered into a Five Year Credit Agreement (the “Credit Agreement”) with the banks, financial institutions and other institutional lenders listed on the respective signature pages thereof (“Lenders”), Citibank, N.A., as administrative agent for the Lenders (as defined therein), Bank of America, N.A., as syndication agent, UBS Loan Finance LLC, as documentation agent, and Citigroup Global Markets, Inc. and Banc of America Securities LLC, as joint lead arrangers and joint book managers. The Credit Agreement establishes an unsecured revolving credit facility under which the Company may borrow up to $900 million with the option to increase borrowings by an additional $600 million with the concurrence of the Lenders. Funds borrowed may be used for general corporate purposes, including commercial paper backstop and business acquisitions. Advances other than competitive bid advances may be repaid without penalty at any time prior to the last day of the Agreement. Competitive bid advances must be paid at maturity, and may not be prepaid. The Credit Agreement contains a financial covenant whereby the ratio of (a) pre-tax income from operations from the most recent four fiscal quarters to (b) consolidated interest expense for the most recent four fiscal quarters may not be less than 2.0 to 1 at the end of each fiscal quarter. The Credit Agreement contains customary representations and warranties and events of default. Payment of outstanding advances may be accelerated, at the option of the Lenders, should the Company default in its obligations under the Credit Agreement.

In September 2005, the Company entered into a new short-term credit agreement to establish an unsecured revolving credit facility to borrow up to $300 million. The agreement expired on December 30, 2005. Funds were used for general corporate purposes. The new short-term credit facility was entered into because the Company expected borrowings to exceed $900 million for up to three months beginning in early October 2005 due to the retirement of $200 million of 10-year notes in October 2005, refinancing of certain consolidated lease arrangements, recent contributions to the Company’s pension plans, stock repurchases and seasonal working capital needs.

The Company also maintains lines of credit with domestic and international commercial banks, under which it could borrow in various currencies up to approximately $71.1 million and $60.3 million as of December 31, 2005 and 2004, respectively, at the lending banks’ prime commercial interest rates

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or lower. The Company had short-term foreign bank loans against its lines of credit of $18.0 million and $19.2 million as of December 31, 2005 and 2004, respectively.

The maximum amount of the Company’s short-term borrowings during 2005 was $950.8 million reflecting commercial paper borrowings primarily for the funding of seasonal working capital requirements, the refinancing of certain lease arrangements, pension plan contributions, share repurchases and business acquisitions. The weighted-average interest rates on short-term borrowings outstanding as of December 31, 2005 and 2004 were 4.3% and 2.3%, respectively.

The credit facility and lines of credit were supported by commitment fee arrangements. The average fee during 2005 was approximately 0.1% per annum of the commitment. The Company is in compliance with all covenants included in the Credit Agreement. 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 $42.4 million and $32.2 million as of December 31, 2005 and 2004, respectively.

11.    LONG-TERM DEBT

Long-term debt consisted of the following:

December 31,		2005			2004
In thousands of dollars
6.7% Notes due 2005		$	—		$	201,187
6.95% Notes due 2007			151,176			152,184
6.95% Notes due 2012			150,000			150,000
4.85% Notes due 2015			250,000			—
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			38,680			115,544
Other obligations, net of unamortized debt discount			2,955			730
Total long-term debt			942,811			969,645
Less—current portion			56			279,043
Long-term portion		$	942,755		$	690,602

 

Maturities of obligations associated with consolidation of lease arrangements are $38.7 million in 2007. Aggregate annual maturities during the next five years are: 2006, $.1 million; 2007, $190.0 million; 2008, $.1 million; 2009, $.1 million; and 2010, $.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.

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12.    INCOME TAXES

The provision for income taxes was as follows:

For the years ended December 31,				2005				2004				2003
In thousands of dollars
Current:
Federal				$	184,271			$	267,645			$	204,602
State					12,326				39,835				21,318
Foreign					12,047				4,363				(571	)
Current provision for income taxes					208,644				311,843				225,349
Deferred:
Federal					53,265				(52,987	)			18,159
State					18,799				(26,731	)			5,520
Foreign					(1,026	)			5,148				9,821
Deferred income tax provision (benefit)					71,038				(74,570	)			33,500
Total provision for income taxes				$	279,682			$	237,273			$	258,849

 

A settlement of Federal tax audits for the 1999 and 2000 tax years, as well as the resolution of a number of state tax audit issues were concluded during the second quarter of 2004. Based upon the results of the audits, the income tax contingency reserves were adjusted resulting in a reduction of income tax reserves by $73.7 million, reflecting a reduction of the provision for income taxes by $61.1 million and a reduction to goodwill of $12.6 million. The income tax contingency reserve adjustments related primarily to the deductibility of certain expenses, interest on potential assessments, and acquisition and divestiture matters.

The income tax benefits associated with the exercise of non-qualified stock options reduced accrued income taxes on the Consolidated Balance Sheets as of December 31, 2005 and 2004 by $42.1 million and $24.7 million, respectively. Such income tax benefits were credited to additional paid-in capital.

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,				2005				2004
In thousands of dollars
Deferred tax assets:
Post-retirement benefit obligations				$	111,864			$	103,959
Accrued expenses and other reserves					133,689				102,585
Stock-based compensation					38,795				34,016
Accrued trade promotion reserves					5,413				27,220
Other					15,763				25,118
Total deferred tax assets					305,524				292,898
Deferred tax liabilities:
Property, plant and equipment, net					275,030				289,410
Pension					224,161				128,605
Acquired intangibles					43,479				11,963
Inventories					33,435				34,314
Other					51,476				86,080
Total deferred tax liabilities					627,581				550,372
Net deferred tax liabilities				$	322,057			$	257,474
Included in:
Current deferred tax assets, net				$	(78,196	)		$	(61,756	)
Non-current deferred tax liabilities, net					400,253				319,230
Net deferred tax liabilities				$	322,057			$	257,474

 

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The Company believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. Additional information on income tax benefits and expenses related to components of accumulated other comprehensive income (loss) is provided in Note 7, 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,				2005				2004				2003
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				2.6
Qualified production income deduction					(.9	)			—				—
Settlement of prior years’ tax audits					—				(7.3	)			—
Puerto Rico operations					(.6	)			(.4	)			(.8	)
Other, net					.1				(.8	)			(.2	)
Effective income tax rate					36.2	%			29.1	%			36.6	%

 

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 IRC Section 936 company was sold by the Company in December 2005.

The effective income tax rate for 2005 benefited by 0.2 percentage points from the impact of tax rates associated with the business realignment charges.

13.

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 (“ERISA”) 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.

On December 8, 2003, the President of the United States signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “2003 Medicare Act”). The 2003 Medicare Act introduced 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. Certain prescription drug benefits offered under the Company’s post-retirement health care plans qualify for the subsidy under Medicare Part D.

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A summary of the changes in benefit obligations and plan assets as of December 31, 2005 and 2004 is presented below:

				Pension Benefits								Other Benefits
December 31,				2005				2004				2005				2004
In thousands of dollars
Change in benefits obligation
Benefits obligation at beginning of year				$	972,073			$	893,159			$	328,799			$	328,263
Service cost					49,065				43,296				5,149				4,898
Interest cost					55,181				52,551				18,115				18,335
Amendments					2,275				3,541				960				1,479
Actuarial loss (gain)					79,903				34,826				15,221				(2,748	)
Special termination benefits					22,790				—				1,910				—
Curtailment (gain) loss					(6,319	)			—				8,092				—
Other					3,598				6,093				780				775
Benefits paid					(62,352	)			(61,393	)			(23,148	)			(22,203	)
Benefits obligation at end of year					1,116,214				972,073				355,878				328,799
Change in plan assets
Fair value of plan assets at beginning of year					974,045				927,658				—				—
Actual return on plan assets					81,494				95,158				—				—
Employer contribution					277,492				8,020				23,148				22,203
Other					2,548				4,602				—				—
Benefits paid					(62,352	)			(61,393	)			(23,148	)			(22,203	)
Fair value of plan assets at end of year					1,273,227				974,045				—				—
Funded status					157,013				1,972				(355,878	)			(328,799	)
Unrecognized transition asset					48				444				—				—
Unrecognized prior service cost					37,582				40,379				(2,653	)			(5,155	)
Unrecognized net actuarial loss					314,071				243,859				84,704				71,716
Intangible asset					(1,447	)			—				—				—
Accumulated other comprehensive loss					(5,395	)			(1,878	)			—				—
Prepaid (Accrued) benefits cost				$	501,872			$	284,776			$	(273,827	)		$	(262,238	)

 

The impact of the 2003 Medicare Act, included in actuarial loss (gain), reduced the accumulated post-retirement benefits obligation by approximately $25.2 million as of December 31, 2004, which was substantially offset by the impact of the lower discount rate assumption.

Weighted-average assumptions used to determine benefit obligation as of December 31:

				Pension Benefits								Other Benefits
				2005				2004				2005				2004
Discount rate					5.4	%			5.7	%			5.4	%			5.7	%
Rate of increase in compensation levels					4.8	%			4.9	%			N/A				N/A

 

For measurement purposes as of December 31, 2005, a 10.5% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2006, grading down to 5.25% by 2010. For measurement purposes as of December 31, 2004, a 12.0% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2005, grading down to 5.25% by 2010.

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Amounts recognized in the Consolidated Balance Sheets consisted of the following:

				Pension Benefits								Other Benefits
December 31,				2005				2004				2005				2004
In thousands of dollars
Prepaid expenses and other				$	14,867			$	22,854			$	—			$	—
Other assets					552,402				299,466				—				—
Accrued liabilities					(8,872	)			(48	)			(26,992	)			(30,302	)
Other long-term liabilities					(51,130	)			(35,618	)			(246,835	)			(231,936	)
Accumulated other comprehensive loss					(5,395	)			(1,878	)			—				—
Net amount recognized				$	501,872			$	284,776			$	(273,827	)		$	(262,238	)

 

The accumulated benefit obligation for all defined benefit pension plans was $1,054,742 and $883,694 as of December 31, 2005 and 2004, respectively.

Information for pension plans with an accumulated benefit obligation in excess of plan assets was as follows:

December 31,				2005				2004
In thousands of dollars
Projected benefit obligation				$	187,911			$	48,178
Accumulated benefit obligation					149,840				41,366
Fair value of plan assets					91,140				167

 

Included in the projected benefit obligation and accumulated benefit obligation and fair value of plan assets amounts were $109.7 million, $80.5 million, and $77.1 million, respectively, primarily for the pension plans associated with the Company’s business in Canada, whose accumulated benefits exceeded the amount of their assets as of December 31, 2005. As of December 31, 2004, pension assets for Canadian pension plans exceeded the amount of their accumulated benefits obligations.

Contributions totaling $277.5 million and $8.0 million were made to the Company’s pension plans during 2005 and 2004, respectively, primarily to improve the funded status of the plans. For 2006, there will be no minimum funding requirements for the domestic plans and minimum funding requirements for the non-domestic plans will not be material.

The higher unrecognized net actuarial loss for pension benefits as of December 31, 2005, was due primarily to the reduced discount rate assumption. The asset return assumption of 8.5% for 2005 and 2004 was based on the current and expected asset allocations, as well as historical and expected returns on the categories of plan assets. The historical geometric average return over the 18 years prior to December 31, 2005, 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. Minimum liability adjustments of $3.6 million and $.1 million, net of deferred tax benefits, were recorded in 2005 and 2004, respectively, as a component of other comprehensive income (loss) and reported in accumulated other comprehensive income (loss) as a component of stockholders’ equity.

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A summary of the components of net periodic benefits cost for the years ended December 31, 2005, 2004 and 2003 is presented below:

				Pension Benefits												Other Benefits
For the years ended December 31,				2005				2004				2003				2005				2004				2003
In thousands of dollars
Components of net periodic benefits cost
Service cost				$	49,065			$	43,296			$	39,096			$	5,149			$	4,898			$	3,712
Interest cost					55,181				52,551				50,951				18,115				18,335				18,653
Expected return on plan assets					(90,482	)			(76,438	)			(59,557	)			—				—				—
Amortization of prior service cost					4,380				4,245				4,486				(1,279	)			(1,507	)			(1,654	)
Amortization of unrecognized transition balance					392				139				(331	)			—				—				—
Recognized net actuarial loss					10,611				9,812				16,377				2,639				2,554				3,171
Administrative expenses					782				773				517				—				—				—
Net periodic benefits cost					29,929				34,378				51,539				24,624				24,280				23,882
Special termination benefits					22,792				—				3,383				1,910				—				539
Curtailment loss					785				—				28				7,874				—				—
Settlement loss					—				—				7				—				—				—
Total amount reflected in earnings				$	53,506			$	34,378			$	54,957			$	34,408			$	24,280			$	24,421

 

The Federal subsidy to be provided by the 2003 Medicare Act reduced net periodic benefits costs in 2004 by approximately $3.0 million, which was substantially offset by the impact of the lower discount rate. The Special Termination benefits charge and Curtailment Loss recorded during 2005, were associated with the Voluntary Workforce Reduction Programs which are described in more detail in Note 4, Business Realignment Initiatives.

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,				2005				2004				2003				2005				2004				2003
In thousands of dollars except percents
Discount rate					5.7	%			6.0	%			6.3	%			5.7	%			6.0	%			6.3	%
Expected long-term return on plan assets					8.5	%			8.5	%			8.5	%			N/A				N/A				N/A
Rate of compensation increase					4.8	%			4.9	%			4.9	%			N/A				N/A				N/A
Additional information:
Decrease (increase) in minimum liability included in other comprehensive (loss) income				$	(3,617	)		$	81			$	(1,565	)			N/A				N/A				N/A

 

The Company’s pension plan asset target allocation for 2006 and the actual allocation as of December 31, 2005 and 2004 are as follows:

								Percentage of Plan Assets as of December 31,
Asset Category				Target Allocation 2006				2005				2004
Equity securities					40–85	%			74	%			75	%
Debt securities					15–60				24				24
Other					0–10				2				1
Total									100	%			100	%

 

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The assets of domestic plans are invested in compliance with 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 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 following table summarizes the Company’s future benefits payments by year:

				Payments Due by Year
				In thousands of dollars
				2006				2007				2008				2009				2010				2011–2015
Pension benefits				$	68,221			$82,495				$64,813				$62,160				$57,512				$432,734
Other benefits					31,002			32,048				30,078				30,923				31,500				158,411

 

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.

In 2005, the Special Termination Benefits and Curtailment Loss were related to the early retirement program which was a component of the 2005 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 $23.6 million and $9.8 million, respectively.

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.

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				$	1,272			$	(1,009	)
Effect on post-retirement benefit obligation					12,726				(10,664	)

 

14.

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 2005 and 2004, 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 318,351 shares of Common Stock each year. As of December 31, 2005, the ESOP held 2,558,256 allocated shares and 318,344 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 $10.03 per share less dividends received by the ESOP on unallocated shares. Compensation expense (income) related to the ESOP for 2005, 2004 and 2003 was $.4 million, $(.1) million and $1.6 million, respectively. Dividends paid on unallocated ESOP shares for 2005, 2004 and 2003 were $.5 million, $.7 million and $.8 million, respectively. Dividends paid on all ESOP shares are recorded as a reduction to retained earnings. The unearned ESOP compensation balance in

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stockholders’ equity represented deferred compensation expense to be recognized by the Company in 2006 as remaining shares are allocated to participants.

15.

CAPITAL STOCK AND NET INCOME PER SHARE

As of December 31, 2005, the Company had 1,055,000,000 authorized shares of capital stock. Of this total, 900,000,000 shares were designated as Common Stock, 150,000,000 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, 2005, a combined total of 359,901,744 shares of both classes of common stock had been issued of which 240,524,054 shares were outstanding. No shares of the Preferred Stock were issued or outstanding during the three-year period ended December 31, 2005.

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 2005 and 2004, a total of 23,031 shares and 2,683 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 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 Stock held at that time). Each 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)

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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.

In July 2004, the Company purchased 11,281,589 shares of its Common Stock from the Milton Hershey School Trust in a privately negotiated transaction. The Company paid $44.32 per share, or approximately $500.0 million, for the shares and fees of $1.4 million associated with the transaction financed principally by additional commercial paper borrowings.

Hershey Trust Company, as Trustee for the benefit of Milton Hershey School, as institutional fiduciary for estates and trusts unrelated to Milton Hershey School, and as direct owner of investment shares, held a total of 14,019,366 shares of the Common Stock, and as Trustee for the benefit of Milton Hershey School, held 60,612,012 shares of the Class B Stock as of December 31, 2005, and was entitled to cast approximately 78.7% 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,				2005				2004				2003
Shares issued					359,901,744				359,901,744				359,901,744
Treasury shares at beginning of year					(113,313,827	)			(100,842,278	)			(91,461,470	)
Stock repurchases:
Repurchase programs and privately negotiated transactions					(4,153,228	)			(13,914,089	)			(9,848,400	)
Stock options and benefits					(4,859,403	)			(1,898,411	)			(2,410,224	)
Stock issuances:
Stock options and benefits					2,948,768				3,340,951				2,877,816
Treasury shares at end of year					(119,377,690	)			(113,313,827	)			(100,842,278	)
Net shares outstanding at end of year					240,524,054				246,587,917				259,059,466

 

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,				2005				2004				2003
In thousands except per share amounts
Net income				$	493,244			$	577,901			$	441,947
Weighted-average shares—Basic
Common Stock					183,747				193,037				201,768
Class B Stock					60,821				60,844				60,844
Total weighted-average shares—Basic					244,568				253,881				262,612
Effect of dilutive securities:
Employee stock options					3,336				2,809				1,826
Performance and restricted stock units					388				244				94
Weighted-average shares—Diluted					248,292				256,934				264,532
Earnings Per Share—Basic
Common Stock				$	2.07			$	2.33			$	1.72
Class B Stock				$	1.87			$	2.12			$	1.55
Earnings Per Share—Diluted				$	1.99			$	2.25			$	1.67

 

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For the years ended December 31, 2005, 2004 and 2003, 2.0 million, .1 million and 6.2 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.

16.

STOCK COMPENSATION PLANS

As of December 31, 2005, the Company had two share-based employee compensation plans, which are described below, and a Director’s compensation plan. The compensation cost that was charged against income for those plans was $58.1 million, $44.8 million and $31.9 million for 2005, 2004 and 2003, respectively. The total income tax benefit recognized in the Consolidated Statements of Income for share-based compensation arrangements was $21.3 million, $16.4 million, and $11.7 million for 2005, 2004 and 2003, respectively. The 2005 compensation cost and income tax benefit amounts include $3.9 million and $1.6 million, respectively, for the impact of accelerated vesting of stock options relating to employees exiting the Company in 2005 under the terms of the VWRP which is more fully described in Note 4, Business Realignment Initiatives. The accelerated vesting affected less than 100 employees.

The long-term portion of the Key Employee Incentive Plan (“Incentive Plan”) provides for grants to executives and key employees of stock-based compensation awards of one or more of the following: non-qualified stock options (“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, 2005, 38.0 million shares were authorized and approved by the Company’s stockholders for grants under the long-term portion of the Incentive Plan.

In July 2004, the Company announced a worldwide stock option grant under the Broad Based Stock Option Plan, which provided over 13,000 eligible employees with a grant of 100 non-qualified stock options. The stock options were granted at a price of $46.44 per share, have a term of ten years and will vest on July 19, 2009.

In 1996, the Company’s Board of Directors approved a worldwide, stock option grant, called HSY Growth, under the Broad Based Stock Option Plan. HSY Growth provided all eligible employees with a one-time grant of 200 non-qualified stock options. Under HSY Growth, over 2.4 million options were granted on January 7, 1997. Options granted under HSY Growth have a term of ten years and vested on January 7, 2002.

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 2005, 2004 and 2003, respectively: dividend yields of 1.7%, 2.0% and 2.0%; expected volatility of 25%, 26% and 28%; risk-free interest rates of 3.9%, 3.7% and 3.6%; and expected lives of 6.5 years, 6.5 years and 6.4 years. The calculation of dividend yields was based on the sum of dividends declared for the most recent four quarterly periods, divided by the estimated average price of the Company’s Common Stock for the comparable periods. The calculation of expected volatility was based on the historical volatility of the Company’s Common Stock over the expected term of each grant, except for the period during 2002 when unusual volatility resulted from the exploration of the possible sale of the Company. The risk-free interest rate for periods within the contractual life of the option was based on the U.S. Treasury yield curve in effect at the time of grant. The expected lives were based primarily on historical data representing the period of time that options granted were outstanding.

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 trading day immediately preceeding 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 grants were

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changed to provide for pro-rated vesting over four years for options granted subsequent to December 31, 1999. Compensation cost charged against income for stock options was $38.2 million, $23.8 million and $25.0 million for 2005, 2004 and 2003, respectively. The 2005 compensation cost included $3.9 million for the impact of the modification of stock option grants resulting in accelerated vesting of stock options relating to employees exiting the Company in 2005 under the terms of the VWRP. An additional $4.6 million was also recorded to reflect expense recognition for 2005 stock option grants over the substantive service period rather than the vesting period which had been used for prior grants. The substantive service period is the period from the grant date to the date on which an employee becomes retirement-eligible.

A summary of the status of the Company’s stock options as of December 31, 2005, 2004 and 2003, and changes during the years ending on those dates is presented below:

				2005								2004								2003
Stock Options				Shares				Weighted- Average Exercise Price				Shares				Weighted- Average Exercise Price				Shares				Weighted- Average Exercise Price
Outstanding at beginning of year					14,909,536			$	32.82				14,142,318			$	28.73				13,929,124			$	26.49
Granted					2,051,255			$	61.49				4,013,900			$	41.25				2,945,850			$	32.60
Exercised					(2,898,419	)		$	28.14				(3,241,948	)		$	24.58				(2,580,706	)		$	21.00
Forfeited					(337,259	)		$	43.54				(4,734	)		$	33.81				(151,950	)		$	29.34
Outstanding at end of year					13,725,113			$	37.83				14,909,536			$	32.82				14,142,318			$	28.73
Options exercisable at year-end					7,001,941			$	30.86				7,272,885			$	28.03				7,474,162			$	26.34
Weighted-average fair value of options granted during the year (per share)				$	16.90							$	10.67							$	8.87

 

The total intrinsic value of options exercised during 2005, 2004 and 2003 was $91.8 million, $62.7 million and $32.5 million, respectively. The aggregate intrinsic value of options outstanding and of options exercisable as of December 31, 2005, was $251.5 million and $171.4 million, respectively.

As of December 31, 2005, there was $50.1 million of total unrecognized compensation cost related to non-vested stock option compensation arrangements granted under the Incentive Plan. That cost is expected to be recognized over a weighted-average period of 2.7 years.

The following table summarizes information about stock options outstanding as of December 31, 2005:

				Options Outstanding												Options Exercisable
Range of Exercise Prices				Number Outstanding as of 12/31/05				Weighted- Average Remaining Contractual Life in Years				Weighted- Average Exercise Price				Number Exercisable as of 12/31/05				Weighted- Average Exercise Price
$16.53–32.25					5,050,696				4.8				$28.19				3,950,997				$27.07
$32.31–37.76					4,980,787				6.8				$35.55				2,830,673				$34.64
$37.84–64.65					3,693,630				8.9				$54.09				220,271				$50.36
$16.53–64.65					13,725,113				6.6				$37.83				7,001,941				$30.86

 

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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 2005 grants of performance stock units can range from 0% to 250% of the targeted amounts. Restricted stock units were awarded in 2005, 2004 and 2003 under the long-term portion of the Incentive Plan to certain executive officers and other key employees. Restricted stock units 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 $19.9 million, $21.0 million and $6.9 million for 2005, 2004 and 2003, 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 based on grant date fair value. 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. Upon adoption of SFAS No. 123R in the fourth quarter of 2005, the Company elected to begin recognizing expense for employee restricted stock units granted after 2004 based on the straight-line method for the entire award. The straight-line method for each separately vesting portion of the award had been used for prior grants. The impact of the change was not material. The compensation cost associated with non-employee director restricted stock units is recognized at the grant date.

Performance stock units and restricted stock units granted for potential future distribution were as follows:

For the years ended December 31,				2005				2004				2003
Units granted					241,887				332,162				228,224
Weighted-average fair value at date of grant					$57.21				$40.53				$33.17

 

A summary of the status of the Company’s performance stock units and restricted stock units as of December 31, 2005, and the change during 2005 is presented below:

Performance Stock Units and Restricted Stock Units				2005				Weighted-average grant date fair value for equity awards or market value for liability awards
Outstanding at beginning of year					1,046,499				$47.57
Granted					241,887				$57.21
Performance assumption change					176,725				$44.42
Vested					(222,759	)			$55.74
Forfeited					(50,985	)			$51.28
Outstanding at end of year					1,191,367				$47.01

 

As of December 31, 2005, there was $21.2 million of unrecognized compensation cost relating to non-vested performance stock units and restricted stock units. That cost is expected to be recognized over a weighted-average period of 1.9 years. The total intrinsic value of share-based liabilities paid combined with the fair value of shares vested during 2005, 2004 and 2003 was $12.4 million, $3.9 million and $6.9 million, respectively.

Deferred performance stock units, deferred restricted stock units, deferred directors’ fees and accumulated dividend amounts totaled 692,023 units as of December 31, 2005.

No stock appreciation rights were outstanding as of December 31, 2005.

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17.

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’s primary concentration of credit risk is associated with McLane Company, Inc., one of the largest wholesale distributors in the United States to convenience stores, drug stores, wholesale clubs and mass merchandisers, which accounted for approximately 20.3% of the Company’s total accounts receivable as of December 31, 2005. As of December 31, 2005, no other customer accounted for more than 10% of the Company’s total accounts receivable and the Company believes that it has little concentration of credit risk associated with the remainder of its customer base. Receivables, as shown on the Consolidated Balance Sheets, were net of allowances and anticipated discounts of $19.4 million and $17.6 million as of December 31, 2005 and 2004, respectively.

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 $380.9 million and $369.9 million as of December 31, 2005 and 2004, respectively, and inventories were stated at amounts that did not exceed realizable values. Total inventories were as follows:

December 31,				2005				2004
In thousands of dollars
Raw materials				$	202,826			$	166,813
Goods in process					92,923				70,440
Finished goods					385,798				384,094
Inventories at FIFO					681,547				621,347
Adjustment to LIFO					(71,263	)			(64,167	)
Total inventories				$	610,284			$	557,180

 

Property Plant and Equipment

Property, plant and equipment balances included construction in progress of $73.1 million and $74.8 million as of December 31, 2005 and 2004, respectively. Major classes of property, plant and equipment were as follows:

December 31,				2005				2004
In thousands of dollars
Land				$	81,672			$	84,563
Buildings					699,899				688,642
Machinery and equipment					2,676,845				2,595,997
Property, plant and equipment, gross					3,458,416				3,369,202
Accumulated depreciation					(1,799,278	)			(1,686,504	)
Property, plant and equipment, net				$	1,659,138			$	1,682,698

 

Accelerated depreciation of property, plant and equipment of $21.8 million was recorded as a result of asset impairments associated with the Company’s business realignment initiatives relating to facility rationalization recorded in the second half of 2005. Certain real estate with a net realizable value of $5.6 million and $7.0 million was being held for sale as of December 31, 2005 and 2004, respectively. These assets were associated with the closure of facilities as part of the Company’s business realignment initiatives.

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Goodwill and Other Intangible Assets

Goodwill and other intangible assets were as follows:

December 31,				2005				2004
In thousands of dollars
Unamortized intangible assets:
Goodwill				$	487,338			$	463,947
Trademarks				$	111,928			$	100,335
Amortized intangible assets, gross:
Customer-related					27,395				18,567
Patents					8,317				8,317
Total other intangible assets, gross					147,640				127,219
Accumulated amortization					(5,014	)			(1,986	)
Other intangibles				$	142,626			$	125,233

 

Goodwill increased $34.4 million as a result of the acquisition of the Scharffen Berger and Joseph Schmidt businesses and $3.8 million as a result of currency translation adjustments, partially offset by reductions reflecting adjustments to the preliminary acquisition accounting for the Mauna Loa and Grupo Lorena acquisitions. The increases in trademarks and customer-related intangible assets were also due to adjustments to preliminary acquisition accounting for the 2004 business acquisitions and the Scharffen Berger and Joseph Schmidt acquisitions in 2005. The useful lives of trademarks were determined to be indefinite and, therefore, these assets are not being amortized. Customer-related intangible assets are being amortized over their estimated useful lives of approximately ten years. Patents are being amortized over their remaining legal lives of approximately fifteen years. Total amortization expense for other intangible assets was $3.0 million, $.6 million and $.5 million in 2005, 2004 and 2003, respectively. The estimated aggregate amortization expense will be approximately $3.3 million on an annual basis over the next five years based upon the preliminary purchase price allocations as of December 31, 2005.

Accrued Liabilities

Accrued liabilities were as follows:

December 31,				2005				2004
In thousands of dollars
Payroll, compensation and benefits				$	172,529			$	145,123
Advertising and promotion					200,842				218,376
Other					134,472				105,686
Total accrued liabilities				$	507,843			$	469,185

 

Other Long-term Liabilities

Other long-term liabilities were as follows:

December 31,				2005				2004
In thousands of dollars
Accrued post-retirement benefits				$	246,896			$	231,967
Other					166,033				151,412
Total other long-term liabilities				$	412,929			$	383,379

 

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18.

SEGMENT INFORMATION

The Company operates as a single reportable segment, encompassing the manufacture, distribution and sale of confectionery, snack, refreshment and grocery products. The Company’s five operating segments are comprised of geographic areas including the United States, Canada, Mexico, Brazil and the combination of the Company’s other international operations. For purposes of segment reporting, the Company’s operations in the Americas, the United States, Canada, Mexico and Brazil, 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 Company’s operations in the Americas 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 operations in the Americas 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 and snack products.

The Company’s principal operations and markets are located in the United States. The Company also manufactures, markets, sells and distributes confectionery and grocery products in Canada, Mexico and Brazil, imports and/or markets selected confectionery products in the Philippines, Japan and South Korea and markets confectionery products in over 60 countries worldwide. The percentage of total consolidated net sales for businesses outside of the United States was 10.9%, 9.8% and 9.9% for 2005, 2004 and 2003, respectively. The percentage of total consolidated assets outside of the United States as of December 31, 2005 and 2004, was 12.4% and 12.1%, respectively.

Sales to McLane Company, Inc., one of the largest wholesale distributors in the United States to convenience stores, drug stores, wholesale clubs and mass merchandisers, exceeded 10% of total net sales and approximated $1.1 billion, $1.1 billion and $930.1 million in 2005, 2004, and 2003, respectively.

19.

QUARTERLY DATA (Unaudited)

The Company adopted SFAS No. 123R in the fourth quarter of 2005 and applied the modified retrospective application method to all prior periods for which Financial Accounting Standards No. 123 was effective. Accordingly, quarterly results were adjusted for the impact of the adoption of SFAS No. 123R. Summary quarterly results prior to the adoption of SFAS No. 123R, the impact of the adoption of SFAS No. 123R and results subsequent to the adoption were as follows:

Year 2005
In thousands of dollars except per share amounts
Results prior to SFAS No. 123R adoption				First				Second				Third				Fourth
Net sales				$	1,126,414			$	988,447			$	1,368,240			$	1,352,873
Gross profit					431,283				393,748				518,754				528,008
Net income					118,221				97,361				119,475				172,847
Per share—Basic—Common					.49				.41				.50				.73
Per share—Basic—Class B					.45				.37				.45				.66
Per share—Diluted					.47				.39				.48				.70

 

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Impact of SFAS No. 123R				First				Second				Third				Fourth
Net sales					N/A				N/A				N/A				N/A
Gross profit					(453	)			(453	)			(453	)			N/A
Net income					(5,199	)			(4,138	)			(5,323	)			N/A
Per share—Basic—Common					(.02	)			(.02	)			(.02	)			N/A
Per share—Basic—Class B					(.02	)			(.02	)			(.02	)			N/A
Per share—Diluted					(.02	)			(.02	)			(.02	)			N/A
Results subsequent to SFAS No. 123R adoption				First				Second				Third				Fourth
Net sales				$	1,126,414			$	988,447			$	1,368,240			$	1,352,873
Gross profit					430,830				393,295				518,301				528,008
Net income					113,022				93,223				114,152				172,847
Per share—Basic—Common					.47				.39				.48				.73
Per share—Basic—Class B					.43				.35				.43				.66
Per share—Diluted(a)					.45				.37				.46				.70
Year 2004
In thousands of dollars except per share amounts
Results prior to SFAS No. 123R adoption				First				Second				Third				Fourth
Net sales				$	1,013,089			$	893,688			$	1,254,508			$	1,267,963
Gross profit					387,457				360,484				498,100				503,676
Net income					107,147				147,217				166,229				170,286
Per share—Basic—Common					.42				.58				.68				.71
Per share—Basic—Class B					.38				.53				.62				.64
Per share—Diluted					.41				.56				.66				.68
Impact of SFAS No. 123R				First				Second				Third				Fourth
Net sales					N/A				N/A				N/A				N/A
Gross profit					N/A				N/A				(453	)			(453	)
Net income					(3,060	)			(3,036	)			(3,712	)			(3,170	)
Per share—Basic—Common(a)					(.01	)			(.01	)			(.02	)			(.02	)
Per share—Basic—Class B					(.01	)			(.01	)			(.02	)			(.01	)
Per share—Diluted					(.01	)			(.01	)			(.02	)			(.01	)
Results subsequent to SFAS No. 123R adoption				First				Second				Third				Fourth
Net sales				$	1,013,089			$	893,688			$	1,254,508			$	1,267,963
Gross profit					387,457				360,484				497,647				503,223
Net income					104,087				144,181				162,517				167,116
Per share—Basic—Common					.41				.57				.66				.69
Per share—Basic—Class B					.37				.52				.60				.63
Per share—Diluted(a)					.40				.55				.64				.67

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(a)

Quarterly income per share amounts do not total to the annual amounts due to the impact of changes in weighted-average shares outstanding during the year.

Item 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

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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, 2005. 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 has been no change during the most recent fiscal quarter in the Company’s internal control over financial reporting identified in connection with the evaluation that has materially affected, or is likely to materially affect, the Company’s internal control over financial reporting.

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.

The Company’s Common Stock is listed on the New York Stock Exchange (“NYSE”) under the ticker symbol “HSY.” On April 29, 2005, the Company’s Chief Executive Officer, Richard H. Lenny, certified to the NYSE pursuant to Rule 303A.12(a) that, as of the date of that certification, he was not aware of any violation by the Company of the NYSE’s Corporate Governance listing standards.

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of The Hershey Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on this assessment, management believes that, as of December 31, 2005, the Company’s internal control over financial reporting was effective based on those criteria.

KPMG LLP, an independent registered public accounting firm, has issued an audit report on management’s assessment of the Company’s internal control over financial reporting. This report appears on page 76.

Richard H. Lenny		David J. West
Chairman of the Board, President		Senior Vice President
and Chief Executive Officer		Chief Financial Officer

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
The Hershey Company:

We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that The Hershey Company and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). These standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects based on criteria established in Internal Control-Integrated Framework issued by COSO. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2005 and 2004, and the related consolidated statements of income, cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2005, and our report dated February 27, 2006 expressed an unqualified opinion on those consolidated financial statements.

                               
 

New York, New York
February 27, 2006

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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 February 17, 2006

Name				Age				Positions Held During the Last Five Years
Richard H. Lenny(1)				54				Chairman of the Board, President and Chief Executive Officer (January 2002); President and Chief Executive Officer (March 2001)
Marcella K. Arline				53				Senior Vice President, Chief People Officer (June 2004); Senior Vice President, Human Resources and Corporate Affairs (December 2002); Senior Vice President, Human Resources (June 2002); Vice President, Human Resources (June 2001); Vice President, Quality and Regulatory Compliance (October 1999)
Christopher J. Baldwin(2)				43				Senior Vice President, President U.S. Commercial Group (November 2005); Senior Vice President, Global Chief Customer Officer (October 2004)
John P. Bilbrey(3)				49				Senior Vice President, President International Commercial Group (November 2005); Senior Vice President, President Hershey International (November 2003)
Raymond Brace				62				Senior Vice President, Global Operations (April 2005); Senior Vice President, Operations (June 2004); Vice President, Operations and Technology (January 2002); Vice President, Manufacturing and Engineering (June 2001); Vice President, Operations (January 1997)
Thomas K. Hernquist(4)				47				Senior Vice President, Global Chief Growth Officer (November 2005); Senior Vice President, President U.S. Confectionery (February 2005); Senior Vice President, Chief Marketing Officer (April 2003)
Burton H. Snyder				58				Senior Vice President, General Counsel and Secretary (November 2003); General Counsel, Secretary, and Senior Vice President, International (December 2002); Senior Vice President—Public Affairs, General Counsel and Secretary (January 2002); Vice President and Assistant General Counsel (January 2001)
David J. West(5)				42				Senior Vice President, Chief Financial Officer (January 2005); Senior Vice President, Chief Customer Officer (June 2004); Senior Vice President, Sales (December 2002); Senior Vice President, Business Planning and Development (June 2002); Vice President, Business Planning and Development (May 2001)
George F. Davis				57				Vice President, Chief Information Officer (December 2000)
David W. Tacka				52				Vice President, Chief Accounting Officer (February 2004); Vice President, Corporate Controller and Chief Accounting Officer (April 2000)

 

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There are no family relationships among any of the above-named officers of the Company.

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(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 (January 2001).

(2)

Mr. Baldwin was elected Senior Vice President, Global Chief Customer Officer effective October 25, 2004. Prior to joining the Company he was National Vice President, Field Sales and Logistics, Kraft Foods, Inc. (January 2004); National Vice President Sales and Logistics, Direct Store Delivery—Kraft Foods (January 2003); Vice President, Sales and Integrated Logistics, Nabisco Biscuit (January 2002); Vice President, Sales, Nabisco Biscuit and Snacks (January 2001).

(3)

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 (May 2003); President and Chief Executive Officer—Danone Waters of North America, Inc., a division of Groupe Danone, Paris (June 2001); President—Danone Waters of North America, Inc., a division of Groupe Danone, Paris (January 2001).

(4)

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 (January 2002); President and Chief Executive Officer—Sierra On-line, Vivendi Universal (April 2001).

(5)

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 (January 2001).

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 for 2005, and compensation of directors, is set forth in the sections entitled, respectively, “2005 Executive Compensation” and “Directors’ Compensation” in the Proxy Statement, which information is incorporated herein by reference.

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Item 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

(a)

Information concerning ownership of the Company’s voting securities by certain beneficial owners, individual nominees for director, the named executive officers, including the Chief Executive Officer of the Company for 2005 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, 2005:

EQUITY COMPENSATION PLAN INFORMATION

				(a)				(b)				(c)
Plan Category				Number of securities to be issued upon exercise of outstanding options, warrants and rights				Weighted-average exercise price of outstanding options, warrants and rights				Number of securities remaining available for future issuance under equity compensation plans excluding securities reflected in column (a)
Equity compensation plans approved by security holders (1)					12,010,063			$	37.46				6,793,875
Equity compensation plans not approved by security holders (2)					1,715,050			$	40.44				927,113
Total					13,725,113			$	37.83				7,720,988

 

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(1)

Column (a) includes stock options granted under the stockholder-approved Key Employee Incentive Plan (“Incentive Plan”). The securities available for future issuance in column (c) are not allocated to any specific type of award under the Incentive Plan, 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 Incentive Plan.

(2)

Column (a) includes 1,478,650 stock options granted under the The Hershey Company Broad Based Stock Option Plan. In July 2004, the Company announced a worldwide stock option grant under the Broad Based Stock Option Plan, which provided over 13,000 eligible employees with a grant of 100 non-qualified stock options. The stock options were granted at a price of $46.44 per share 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 New York Stock Exchange on the trading day immediately preceding the date the stock options were granted), have a term of ten years and will vest on July 19, 2009. In 1996, the Company’s Board of Directors approved a worldwide stock option grant, called HSY Growth, under the Broad Based Stock Option Plan. HSY Growth provided all eligible employees with a one-time grant of 200 non-qualified stock options that were granted outside of the Incentive Plan under a separate registration statement. Under HSY Growth over 2,471,400 stock options were granted on January 7, 1997 with an exercise price of $22.25, 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 New York Stock Exchange on the trading day immediately preceding the date the stock options were granted). 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 772,800 stock options under the Broad Based Stock Option Plan remaining available for future issuance.

Column (a) also includes 236,400 stock options granted to Mr. Lenny outside of the Incentive Plan 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 $32.33, 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 New York Stock Exchange on the trading day immediately preceding the date the stock options were granted). The stock options were subject to a four-year step vesting requirement of 25% per year and have a ten-year term.

Column (c) also includes 154,313 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 $20,000. While the value of the annual

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RSU grant is targeted at $80,000, 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, 2006, the target for the annual RSU grant was increased to $100,000, with the quarterly grant equal to a value of $25,000. 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.

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PART IV

Item 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

Item 15(a)(1):

Financial Statements

The audited consolidated financial statements of the Company and its subsidiaries and the Report of the Independent Registered Public Accounting Firm thereon, as required to be filed with this report, are set forth under Item 8 of this report.

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, 2005, 2004 and 2003 is filed herewith on the indicated page in response to Item 15(c):

Schedule II—Valuation and Qualifying Accounts (Page 87)

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, 2005. The By-laws, as amended and restated as of August 16, 2005, are incorporated by reference from Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 2, 2005.

(4)

Instruments defining the rights of security holders, including indentures

a.

Stockholder Protection Rights Agreement between the Company 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)

6.95% Notes due 2007

2)

6.95% Notes due 2012

3)

4.85% Notes due 2015

4)

8.8% Debentures due 2021

5)

7.2% Debentures due 2027

6)

Obligations Associated with Consolidation of Lease Arrangements

7)

Other Obligations

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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 the Company 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 the Company 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 the Company 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. This agreement was assigned by the Company to its wholly-owned subsidiary, Hershey Chocolate & Confectionery Corporation.

d.

Trademark and Technology License Agreement between Huhtamaki and the Company 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.

e.

Stock Purchase Agreement between Hershey Trust Company, as Trustee of the Milton Hershey School Trust, and the Company, dated July 27, 2004, is incorporated by reference from Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 3, 2004.

f.

Five Year Credit Agreement dated as of November 12, 2004 among the Company and the banks, financial institutions and other institutional lenders listed on the respective signature pages thereof (“Lenders”), Citibank, N.A., as administrative agent for the Lenders (as defined therein), Bank of America, N.A., as syndication agent, UBS Loan Finance LLC, as documentation agent, and Citigroup Global Markets, Inc. and Banc of America Securities LLC, as joint lead arrangers and joint book managers is incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed November 16, 2004.

g.

Credit Agreement dated as of September 23, 2005 among the Company and the banks, financial institutions and other institutional lenders listed on the respective signature pages thereof (“Lenders”), Citibank, N.A., as administrative agent for the Lenders (as defined therein), Bank of America, N.A., as Syndication Agent, UBS Loan Finance LLC, as Documentation Agent, and Citigroup Global Markets Inc. and Banc of America Securities LLC, as Joint Lead Arrangers and Joint Book Managers

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is incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed September 28, 2005.

h.

Agreement dated December 12, 2005 between the Company and Hershey Trust Company, as Trustee for the benefit of Milton Hershey School, is incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed December 12, 2005.

Executive Compensation Plans and Management Contracts

i.

The Company’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.

j.

Terms and Conditions of Nonqualified Stock Option Grants under the Key Employee Incentive Plan is incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed February 18, 2005.

k.

The Long-Term Incentive Program Participation Agreement is incorporated by reference from Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed February 18, 2005.

l.

The Company’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.

m.

The Company’s Amended and Restated Supplemental Executive Retirement Plan 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, 2003.

n.

First Amendment to the Hershey Foods Corporation Amended and Restated (2003) Supplemental Executive Retirement Plan is incorporated by reference from Exhibit 10.5 to the Company’s Current Report on Form 8-K, filed July 21, 2005.

o.

The Company’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 fiscal year ended December 31, 2002.

p.

The Company’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.

q.

The Executive Employment Agreement between the Company 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.

r.

The Retirement Agreement and General Release between the Company and Frank Cerminara, dated October 21, 2004, is incorporated by reference from Exhibit 10.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

s.

The Company’s 2005 Early Retirement Plan for E-Grade Employees is incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed July 21, 2005.

t.

The Company’s 2005 Early Retirement Plan for E-Grade Employees Separation Agreement and General Release is incorporated by reference from Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed July 21, 2005.

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u.

The Company’s 2005 Enhanced Mutual Separation Plan for E-Grade Employees is incorporated by reference from Exhibit 10.3 to the Company’s Current Report on Form 8-K, filed July 21, 2005.

v.

The Company’s 2005 Enhanced Mutual Separation Plan for E-Grade Employees Separation Agreement and General Release is incorporated by reference from Exhibit 10.4 to the Company’s Current Report on Form 8-K, filed July 21, 2005.

w.

A summary of certain compensation grants and awards made in February 2005 by the Compensation and Executive Organization Committee or the independent directors of the Company’s Board of Directors is incorporated herein by reference from Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

x.

A summary of changes to non-employee director compensation for 2006, previously disclosed in the Company’s Current Report on Form 8-K, filed December 7, 2005, is attached hereto and filed as Exhibit 10.1.

y.

A summary of certain compensation matters previously contained in the Company’s Current Report on Form 8-K filed February 22, 2006, is attached hereto and filed as Exhibit 10.2.

Broad Based Equity Compensation Plans

z.

The Company’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, 2005, 2004, 2003, 2002 and 2001 is attached hereto and filed as Exhibit 12.

(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 February 28, 2006 to the incorporation of reports of the Company’s Independent Auditors is attached hereto and filed as Exhibit 23.

(31.1)

Certification of Richard H. Lenny, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, is attached hereto and filed as Exhibit 31.1.

(31.2)

Certification of David J. West, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, is attached hereto and filed as Exhibit 31.2.

(32)*

Certification of Richard H. Lenny, Chief Executive Officer, and David J. West, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is attached hereto and furnished as Exhibit 32.

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*Pursuant to Securities and Exchange Commission Release No. 33-8212, this certification will be treated as “accompanying” this Annual Report on Form 10-K and not “filed” as part of such report for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of Section 18 of the Exchange Act, and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.

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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 28th day of February, 2006.

				THE HERSHEY COMPANY (Registrant)
				By: /s/ DAVID J. WEST David J. West 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/ RICHARD H. LENNY				Chief Executive Officer and Director				February 28, 2006
(Richard H. Lenny)
/s/ DAVID J. WEST				Chief Financial Officer				February 28, 2006
(David J. West)
/s/ DAVID W. TACKA				Chief Accounting Officer				February 28, 2006
(David W. Tacka)
/s/ JON A. BOSCIA				Director				February 28, 2006
(Jon A. Boscia)
/s/ ROBERT H. CAMPBELL				Director				February 28, 2006
(Robert H. Campbell)
/s/ ROBERT F. CAVANAUGH				Director				February 28, 2006
(Robert F. Cavanaugh)
/s/ GARY P. COUGHLAN				Director				February 28, 2006
(Gary P. Coughlan)
/s/ HARRIET EDELMAN				Director				February 28, 2006
(Harriet Edelman)
/s/ BONNIE G. HILL				Director				February 28, 2006
(Bonnie G. Hill)
/s/ ALFRED F. KELLY, JR.				Director				February 28, 2006
(Alfred F. Kelly, Jr.)
/s/ MACKEY J. MCDONALD				Director				February 28, 2006
(Mackey J. McDonald)
/s/ MARIE J. TOULANTIS				Director				February 28, 2006
(Marie J. Toulantis)

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
The Hershey Company:

Under date of February 27, 2006, we reported on the consolidated balance sheets of The Hershey Company and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2005, which are included in The Hershey Company’s Annual Report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule. 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.

As discussed in Note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, in the year ended December 31, 2005. Also, on June 30, 2003, the Company adopted Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, as discussed in Note 2.

/s/ KPMG LLP

New York, New York
February 27, 2006

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Schedule II

THE HERSHEY COMPANY AND SUBSIDIARIES
SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 2005, 2004 and 2003

								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
In thousands of dollars
Year Ended December 31, 2005: Reserves deducted in the consolidated balance sheet from the assets to which they apply
Accounts Receivable—Trade				$	17,581			$	13,342			$	676			$	(12,166	)		$	19,433
Year Ended December 31, 2004: Reserves deducted in the consolidated balance sheet from the assets to which they apply
Accounts Receivable—Trade				$	21,099			$	1,844			$	2,930			$	(8,292	)		$	17,581
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

 

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(a)

Includes recoveries of amounts previously written off and amounts related to acquired businesses.

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CERTIFICATION

I, Richard H. Lenny, certify that:

1.

I have reviewed this Annual Report on Form 10-K of The Hershey Company;

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)) and internal control over financial reporting (as defined in Exchange Act Rules 15(f) and 15d-15(f)) 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)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)

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

(d)

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 the 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.

Richard H. Lenny

Chief Executive Officer

February 28, 2006

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CERTIFICATION

I, David J. West, certify that:

1.

I have reviewed this Annual Report on Form 10-K of The Hershey Company;

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)) and internal control over financial reporting (as defined in Exchange Act Rules 15(f) and 15d-15(f)) 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)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)

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

(d)

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 the 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.

David J. West

Chief Financial Officer

February 28, 2006

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Exhibit 10.1

Compensation Summary

(As reported in The Hershey Company’s

Current Report on Form 8-K, filed

December 7, 2005)

On December 6, 2005, the Board of Directors of The Hershey Company approved an increase in non-employee director compensation effective January 1, 2006. The increase was approved following a review of competitive data that disclosed the need to adjust director compensation upward to be at the mid-point of compensation paid to directors at a peer group of food, beverage and consumer packaged goods companies the Board uses for benchmarking non-employee director compensation.

The charts below show non-employee director compensation in 2005 and as approved for 2006.

2005 Directors’ Compensation

Annual Retainer	$55,000
Annual Restricted Stock Unit Grant	$80,000
Annual Retainer for Committee Chairs	$  5,000

2006 Directors’ Compensation

Annual Retainer	$  65,000
Annual Restricted Stock Unit Grant	$100,000
Annual Retainer for Committee Chairs (except Audit Committee Chair)	$    5,000
Annual Retainer for Audit Committee Chair	$  10,000

Except as provided above, all other terms and conditions regarding director compensation remain as outlined in the Company’s Proxy Statement for the 2005 Annual Meeting of Stockholders, filed March 10, 2005. Information regarding director compensation will also be provided in the Company’s Proxy Statement for the 2006 Annual Meeting of Stockholders, which will be filed in March 2006.

Exhibit 10.2

Compensation Summary

(As reported in The Hershey Company’s

Current Report on Form 8-K, filed February 22, 2006)

Base Salaries. On February 15, 2006, the Compensation and Executive Organization Committee (“Committee”) of the Board of Directors of The Hershey Company (the “Company”) approved the base salaries of the executive officers who will be named in the Company’s 2006 Proxy Statement (“Named Executive Officers”) other than Richard H. Lenny, Chairman of the Board, President and Chief Executive Officer, and on February 16, 2006, the Committee recommended to the Company’s independent directors as a group the base salary for Mr. Lenny, as follows:

Name	Base Salary
Richard H. Lenny	$ 1,100,000
Marcella K. Arline	$    375,000
Michele G. Buck	$    400,000
Thomas K. Hernquist	$    420,000
Burton H. Snyder	$    435,000
David J. West	$    485,000

The independent directors as a group approved the recommended base salary for Mr. Lenny on February 16, 2006. Base salaries are effective as of January 1, 2006.

2006 Annual Incentive Program (AIP) Target Goals. On February 15, 2006, the Committee approved the target grants for a 2006 AIP award under the Company’s Key Employee Incentive Plan (“Incentive Plan”) for executive officers other than Mr. Lenny, and on February 16, 2006, the Committee recommended to the independent directors as a group a target grant for Mr. Lenny’s 2006 AIP award. For executive officers other than Mr. Lenny, the final award is the product of the executive officer’s base salary, the applicable target percentage and a performance score calculated as the sum of a corporate performance score and an individual score. The corporate performance objectives for the Named Executive Officers other than Mr. Lenny are based on the Company’s earnings per share-diluted, consolidated net sales and earnings before interest and taxes (“EBIT”) margin. The range of the target percentages of base salary used in the 2006 AIP target grants for the Named Executive Officers other than Mr. Lenny is 60% to 70%. For Mr. Lenny, the Committee recommended to the independent directors that his final award be calculated on the basis of a contingent target maximum grant. For 2006, the Committee recommended that the independent directors waive the maximum AIP award specified in Mr. Lenny’s March 12, 2001 Executive Employment Agreement and approve a contingent target maximum grant for Mr. Lenny equal to the maximum AIP award available to executive officers under the Incentive Plan with an award at this maximum

 

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being contingent upon his achievement of his 2006 corporate performance goal from among the corporate performance objectives for the other Named Executive Officers. The Committee, in its recommendation to the independent directors of a final 2006 AIP award for Mr. Lenny, whether at or below the maximum level, will consider such corporate and individual performance factors it deems relevant. The Committee has the right to adjust the Company’s performance results, if necessary, to take into account extraordinary or unusual items occurring during the performance year, subject, in the case of Mr. Lenny, to the approval of the independent directors as a group. The independent directors as a group approved the Committee’s recommended 2006 AIP target grant for Mr. Lenny on February 16, 2006.

Performance Stock Unit (PSU) Awards for the 2003-2005 Cycle. The Committee approved PSU awards under the Incentive Plan for the Named Executive Officers other than Mr. Lenny effective February 16, 2006, and recommended to the independent directors as a group a PSU award under the Incentive Plan for Mr. Lenny, as follows:

 

Name	Performance Stock Unit Award
Mr. Lenny	145,000 units
Ms. Arline	16,500 units
Mr. Hernquist	18,250 units
Mr. Snyder	22,250 units
Mr. West	18,000 units

The independent directors as a group approved the recommended PSU award for Mr. Lenny on February 16, 2006. Ms. Buck was not eligible for a PSU award for the 2003-2005 cycle.

PSUs awarded for the 2003-2005 performance cycle will not be paid out until their normal vesting date on December 31, 2008 or, if earlier, an accelerated vesting date based upon the executive’s retirement, disability or death. If an executive’s employment terminates prior to December 31, 2008 other than by retirement, disability or death, the PSU award will be forfeited. Once vested, the award will be paid in shares of Company Common Stock plus regular dividends from January 1, 2006 to the vesting date.

PSU Grant for the 2006-2008 Cycle. The Committee also approved, effective February 16, 2006, contingent target grants of PSUs under the Incentive Plan for executive officers other than Mr. Lenny, and on February 16, 2006, the Committee recommended to the independent directors as a group a contingent target grant of PSUs under the Incentive Plan for Mr. Lenny, for the 2006-2008 PSU performance cycle. PSU grants are based upon a percentage of the executive officer’s base salary and are earned based upon the Company’s performance relative to certain performance objectives over the three-year cycle. The performance objectives for the 2006-2008 performance cycle are as follows: the Company’s three-year compound annual growth in earnings per share-diluted measured against an internal target and measured against the three-year

 

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compound annual growth in earnings per share-diluted of a peer group of 15 food, beverage and consumer packaged goods companies and the cumulative three-year improvement in the Company’s economic return on invested capital measured against an internal target. The total performance score can range from a minimum of 0% to a maximum of 250% based upon each of the performance measurements having a 50% weighted value in the formula. Upon completion of the performance cycle, an award will be paid on the basis of the number of PSUs originally awarded to the executive, the Company’s performance against the performance objectives for the cycle and the value per unit, which is determined at the conclusion of the cycle based upon the average of the daily closing prices of the Common Stock on the New York Stock Exchange in December of the final year of the cycle. The Committee has the right to adjust the Company’s performance results, if necessary, to take into account extraordinary or unusual items occurring during the performance cycle, subject, in the case of Mr. Lenny, to the approval of the independent directors as a group. Awards will be paid only in shares of Common Stock. The independent directors as a group approved the Committee’s recommended contingent target PSU grant for Mr. Lenny on February 16, 2006.

 

Stock Option Grants. The Committee approved stock option grants under the Incentive Plan for the executive officers other than Mr. Lenny, and recommended to the independent directors as a group a stock option grant to Mr. Lenny, all such grants to be effective February 16, 2006. The independent directors as a group approved the grant of stock options to Mr. Lenny on February 16, 2006. All such grants were made subject to the Incentive Plan and the Terms and Conditions for stock option grants previously filed with the Securities and Exchange Commission.

Additional information regarding the compensation of the Company’s executive officers will be provided in the Company’s Proxy Statement for the 2006 Annual Meeting of Stockholders, which will be filed in March 2006.

EXHIBIT 12

THE HERSHEY COMPANY

COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES

For the Years Ended December 31, 2005, 2004, 2003, 2002, and 2001

(in thousands of dollars except for ratios)

(Unaudited)

Earnings:		2005			2004			2003			2002			2001
Income from continuing operations before income taxes*		$	772,926(a)		$	815,174		$	708,164(b)		$	617,943(c)		$	330,550(d)
Add (Deduct):
Interest on indebtedness			89,485			67,919			65,265			64,398			71,470
Portion of rents representative of the interest factor (e)			8,244			9,711			12,742			15,467			15,451
Amortization of debt expense			463			446			446			457			464
Amortization of capitalized interest			3,068			3,544			3,880			4,018			4,228
Earnings as adjusted		$	874,186		$	896,794		$	790,497		$	702,283		$	422,163
Fixed Charges:
Interest on indebtedness		$	89,485		$	67,919		$	65,265		$	64,398		$	71,470
Portion of rents representative of the interest factor (e)			8,244			9,711			12,742			15,467			15,451
Amortization of debt expense			463			446			446			457			464
Capitalized interest			3			2,597			1,953			1,144			1,498
Total fixed charges		$	98,195		$	80,673		$	80,406		$	81,466		$	88,883
Ratio of earnings to fixed charges			8.90			11.12			9.83			8.62			4.75

NOTES:

*	Amounts for all years have been adjusted to reflect the impact of Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, adopted by the Company in 2005.
(a)	Includes total charges for business realignment initiatives of $119.0 million before tax.
(b)	Includes total charges for business realignment initiatives of $25.5 million and a gain on sale of business of $8.3 million.
(c)	Includes total charges for business realignment initiatives of $34.0 million before tax and costs related to the potential sale of the Company of $17.2 million before tax.
(d)	Includes total charges for business realignment initiatives of $278.4 million before tax.
(e)	Portion of rents representative of the interest factor consists of all rental expense pertaining to off-balance sheet operating lease arrangements and one-third of rental expense for other operating leases.

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, 2005.

Name of Subsidiary	Jurisdiction of                          Incorporation
Hershey Chocolate & Confectionery Corporation	Delaware
Hershey Chocolate of Virginia, Inc.	Delaware
Hershey Canada, Inc.	Canada

EXHIBIT 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

The Hershey Company:

We consent to the incorporation by reference in the registration statements (File No. 333-128375, 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 The Hershey Company of our reports dated February 27, 2006, with respect to the consolidated balance sheets of The Hershey Company and subsidiaries as of December 31, 2005 and 2004, the related consolidated statements of income, cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2005, and the related financial statement schedule, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2005, and the effectiveness of internal control over financial reporting as of December 31, 2005, which reports appear in the December 31, 2005 Annual Report on Form 10-K of The Hershey Company.

Our report on the consolidated financial statements refers to the Company’s adoption of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, in the year ended December 31, 2005 and Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, on June 30, 2003.

/s/ KPMG LLP

New York, New York

February 28, 2006

Exhibit 31.1

CERTIFICATION

I, Richard H. Lenny, certify that:

1.	I have reviewed this Annual Report on Form 10-K of The Hershey Company;

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)) and internal control over financial reporting (as defined in Exchange Act Rules 15(f) and 15d-15(f)) 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)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)	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

(d)

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 the 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.

Date:  February 28, 2006          /s/ RICHARD H. LENNY      

 Richard H. Lenny

 Chief Executive Officer

---

Exhibit 31.2

CERTIFICATION

I, David J. West, certify that:

1.	I have reviewed this Annual Report on Form 10-K of The Hershey Company;

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)) and internal control over financial reporting (as defined in Exchange Act Rules 15(f) and 15d-15(f)) 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)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)	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

(d)

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 the 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.

Date:   February 28, 2006            /s/ DAVID J. WEST           

  David J. West

  Chief Financial Officer

Exhibit 32

CERTIFICATION

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officers of The Hershey Company (the “Company”) hereby certify that the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 (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.

Date: February 28, 2006           /s/ RICHARD H. LENNY     

 Richard H. Lenny

 Chief Executive Officer

Date: February 28, 2006         /s/ DAVID J. WEST     

           David J. West

                                                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.