UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-Q


(X)     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
        SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended          APRILJULY 5, 1998
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                                                OR

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

For the transition period from                 to
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Commission file number                         1-183
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                           HERSHEY FOODS CORPORATION
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             (Exact name of registrant as specified in its charter)

              DELAWARE                                      23-0691590
  ---------------------------------                    ------------------------------------------------------                    ------------------------
   (State or other jurisdiction of                       (I.R.S. Employer
   incorporation or organization)                     Identification Number)

              100 CRYSTAL A DRIVE
             HERSHEY, PENNSYLVANIA                              17033
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   (Address of principal executive offices)                  (Zip Code)


Registrant's telephone number, including area code:         (717) 534-6799
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(Former name, former address and former fiscal year, if changed since last 
  report)

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

                                      YES    X       NO

      ---         ---

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

Common Stock, $1 par value - 112,689,152112,661,777 shares, as of May 4,August 3, 1998. Class B
Common Stock, $1 par value - 30,453,908 shares, as of May 4,August 3, 1998.

Exhibit Index - Page 1617


 Page 2


HERSHEY FOODS CORPORATION CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) FOR THE THREE MONTHS ENDED APRIL-------------------------- JULY 5, MARCH 30,JUNE 29, 1998 1997 ----------- ------------------- NET SALES $ 1,098,076880,399 $ 1,002,469905,729 ----------- ----------- COSTS AND EXPENSES: Cost of sales 652,340 589,281522,715 530,318 Selling, marketing and administrative 299,370 284,005258,309 276,260 ----------- ----------- Total costs and expenses 951,710 873,286780,024 806,578 ----------- ----------- INCOME BEFORE INTEREST AND INCOME TAXES 146,366 129,18399,375 99,151 Interest expense, net 22,706 15,68220,744 15,851 ----------- ----------- INCOME BEFORE INCOME TAXES 123,660 113,50178,631 83,300 Provision for income taxes 48,227 44,60730,666 32,736 ----------- ----------- NET INCOME $ 75,43347,965 $ 68,89450,564 =========== ======================= NET INCOME PER SHARE - BASIC $ .53.33 $ .45.33 =========== =========== NET INCOME PER SHARE - DILUTED $ .52.33 $ .45.33 =========== =========== AVERAGE SHARES OUTSTANDING - BASIC 143,376 153,166143,510 153,114 =========== =========== AVERAGE SHARES OUTSTANDING - DILUTED 145,461 154,715145,752 155,064 =========== =========== CASH DIVIDENDS PAID PER SHARE: Common Stock $ .22 $ .20 =========== =========== Class B Common Stock $ .20 $ .18 =========== ===========
The accompanying notes are an integral part of these statements. Page 3
HERSHEY FOODS CORPORATION CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) FOR THE SIX MONTHS ENDED ------------------------ JULY 5, JUNE 29, 1998 1997 ----------- ---------- NET SALES $ 1,978,475 $ 1,908,198 ----------- ----------- COSTS AND EXPENSES: Cost of sales 1,175,055 1,119,600 Selling, marketing and administrative 557,679 560,264 ----------- ----------- Total costs and expenses 1,732,734 1,679,864 ----------- ----------- INCOME BEFORE INTEREST AND INCOME TAXES 245,741 228,334 Interest expense, net 43,450 31,533 ----------- ----------- INCOME BEFORE INCOME TAXES 202,291 196,801 Provision for income taxes 78,893 77,343 ----------- ----------- NET INCOME $ 123,398 $ 119,458 =========== =========== NET INCOME PER SHARE - BASIC $ .86 $ .78 =========== =========== NET INCOME PER SHARE - DILUTED $ .85 $ .77 =========== =========== AVERAGE SHARES OUTSTANDING - BASIC 143,441 153,139 =========== =========== AVERAGE SHARES OUTSTANDING - DILUTED 145,612 154,892 =========== =========== CASH DIVIDENDS PAID PER SHARE: Common Stock $ .44 $ .40 =========== =========== Class B Common Stock $ .40 $ .36 =========== ===========
The accompanying notes are an integral part of these statements.
HERSHEY FOODS CORPORATION CONSOLIDATED BALANCE SHEETS APRILJULY 5, 1998 AND DECEMBER 31, 1997 (IN THOUSANDS OF DOLLARS) ASSETS 1998 1997 ----------- ------------------- CURRENT ASSETS: Cash and cash equivalents $ 59,61733,631 $ 54,237 Accounts receivable - trade 279,296230,442 360,831 Inventories 532,141623,578 505,525 Deferred income taxes 85,25586,168 84,024 Prepaid expenses and other 42,84251,818 30,197 ----------- ----------- Total current assets 999,1511,025,637 1,034,814 ----------- ----------- PROPERTY, PLANT AND EQUIPMENT, AT COST 2,620,8322,649,001 2,587,230 Less - accumulated depreciation and amortization (971,914)(1,002,376) (938,993) ----------- ----------- Net property, plant and equipment 1,648,9181,646,625 1,648,237 ----------- ----------- INTANGIBLES RESULTING FROM BUSINESS ACQUISITIONS 547,240541,197 551,849 OTHER ASSETS 61,15773,535 56,336 ----------- ----------- Total assets $ 3,256,4663,286,994 $ 3,291,236 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 131,379100,746 $ 146,932 Accrued liabilities 301,908292,510 371,545 Accrued income taxes 52,08741,007 19,692 Short-term debt 214,910286,799 232,451 Current portion of long-term debt 90100 25,095 ----------- ----------- Total current liabilities 700,374721,162 795,715 LONG-TERM DEBT 1,029,1291,029,121 1,029,136 OTHER LONG-TERM LIABILITIES 352,411353,871 346,500 DEFERRED INCOME TAXES 269,491271,281 267,079 ----------- ----------- Total liabilities 2,351,4052,375,435 2,438,430 ----------- ----------- STOCKHOLDERS' EQUITY: Preferred Stock, shares issued: none in 1998 and 1997 --- --- Common Stock, shares issued: 149,496,964 in 1998 and 149,484,964 in 1997 149,497 149,485 Class B Common Stock, shares issued: 30,453,908 in 1998 and 30,465,908 in 1997 30,453 30,465 Additional paid-in capital 27,04628,421 33,852 Unearned ESOP compensation (27,943)(27,144) (28,741) Retained earnings 2,022,4222,039,507 1,977,849 Treasury-Common Stock shares at cost: 36,757,82636,766,362 in 1998 and 37,018,566 in 1997 (1,253,596)(1,259,141) (1,267,861) Accumulated other comprehensive income (42,818)(50,034) (42,243) ----------- ----------- Total stockholders' equity 905,061911,559 852,806 ----------- ----------- Total liabilities and stockholders' equity $ 3,256,4663,286,994 $ 3,291,236 =========== ===========
The accompanying notes are an integral part of these balance sheets. Page 4
HERSHEY FOODS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS OF DOLLARS) FOR THE THREESIX MONTHS ENDED APRIL------------------------ JULY 5, MARCH 30,JUNE 29, 1998 1997 ----------- ------------------ CASH FLOWS PROVIDED FROM (USED BY) OPERATING ACTIVITIES Net Income $ 75,433123,398 $ 68,894119,458 Adjustments to Reconcile Net Income to Net Cash Provided from Operations: Depreciation and amortization 37,945 40,12477,162 76,397 Deferred income taxes 1,181 21,5582,058 7,349 Changes in assets and liabilities, net of effects from business acquisitions and divestitures: Accounts receivable - trade 81,535 48,955130,389 78,322 Inventories (26,616) (72,460)(118,053) (194,901) Accounts payable (15,553) (12,208)(46,186) 11,307 Other assets and liabilities (33,410) 39,594(59,224) 27,294 Other, net --- 5942,145 --------- --------- Net Cash Flows Provided from Operating Activities 120,515 135,051109,544 127,371 --------- --------- CASH FLOWS PROVIDED FROM (USED BY) INVESTING ACTIVITIES Capital additions (41,756) (38,017)(77,822) (85,365) Capitalized software additions (7,773)(20,164) --- Other, net 9,196 (13,181)8,933 10,749 --------- --------- Net Cash Flows (Used by) Investing Activities (40,333) (51,198)(89,053) (74,616) --------- --------- CASH FLOWS PROVIDED FROM (USED BY) FINANCING ACTIVITIES Net increase (decrease) in short-term debt (17,541) (173,311)54,348 (154,396) Long-term borrowings --- 150,000 Repayment of long-term debt (25,048) (46)(25,096) (93) Cash dividends paid (30,860) (29,952)(61,740) (59,897) Exercise of stock options 10,522 4,10413,849 8,879 Incentive plan transactions (11,875) (11,923)(22,458) (24,577) Repurchase of Common Stock --- (6,863)(7,654) --------- --------- Net Cash Flows (Used by) Financing Activities (74,802) (67,991)(41,097) (87,738) --------- --------- Increase(Decrease) in Cash and Cash Equivalents 5,380 15,862(20,606) (34,983) Cash and Cash Equivalents, beginning of period 54,237 61,422 --------- --------- Cash and Cash Equivalents, end of period $ 59,61733,631 $ 77,28426,439 ========= ========= Interest Paid $ 36,10543,787 $ 12,03829,109 ========= ========= Income Taxes Paid $ 2,83740,685 $ 12,59284,050 ========= =========
The accompanying notes are an integral part of these statements. Page 5
HERSHEY FOODS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ACCUMULATED CLASS B ADDITIONAL UNEARNED TREASURY OTHER TOTAL PREFERRED COMMON COMMON PAID-IN ESOP RETAINED COMMON COMPREHENSIVEOMPREHENSIVE STOCKHOLDERS' STOCK STOCK STOCK CAPITAL COMPENSATION EARNINGS STOCK INCOME EQUITY --------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------------------------- IN THOUSANDS OF DOLLARS BALANCE AS OF BALANCE AS OF DECEMBER 31, 1997 $---$ --- $149,485 $30,465 $33,852 $(28,741) $1,977,849 $(1,267,861) $(42,243) $852,806 -------- Comprehensive income Net income 75,433 75,433 Other comprehensive income: Foreign currency translation adjustments (575) (575) -------- Comprehensive income 74,858 -------- Dividends: Common Stock, $.22 per share (24,769) (24,769) Class B Common Stock, $.20 per share (6,091) (6,091) Conversion of Class B Common Stock into Common Stock 12 (12) --- Incentive plan transactions (1,033) (1,033) Exercise of stock options (5,902) 14,265 8,363 Employee stock ownership trust transactions 129 798 927 --------- -------- -------- ------ ------- ----------- ---------- ------- ------- BALANCE AS OF APRIL 5, 1998 --- 149,497 30,453 27,046 (27,943) 2,022,422 (1,253,596) (42,818) 905,061 Comprehensive income Net income 47,965 47,965 Other comprehensive income: Foreign currency translation adjustments (7,216) (7,216) -------- Comprehensive income 40,749 -------- Dividends: Common Stock, $.22 per share (24,789) (24,789) Class B Common Stock, $.20 per share (6,091) (6,091) Exercise of stock options 1,250 (5,545) (4,295) Employee stock ownership trust transactions 125 799 924 ----- -------- ------- ------- -------- ---------- ----------- -------- -------- BALANCE AS OF APRILJULY 5, 1998 $---$ --- $149,497 $30,453 $27,046 $(27,943) $2,022,422 $(1,253,596) $(42,818) $905,061 ====$28,421 $(27,144) $2,039,507 $(1,259,141) $(50,034) $911,559 ===== ======== ======= ======= ======== ========== =========== ======== ========
The accompanying notes are an integral part of these statements. Page 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the accounts of the Corporation and its subsidiaries after elimination of intercompany accounts and transactions. These statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months and year-to-date ended AprilJuly 5, 1998, are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. For more information, refer to the consolidated financial statements and footnotes included in the Corporation's 1997 Annual Report on Form 10-K. 2. COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS No. 130). Under FAS No. 130, standards are established for reporting and display of comprehensive income and its components in financial statements. Comprehensive income is reported in the Consolidated Statements of Stockholder's Equity. Other Comprehensive income represents foreign currency translation adjustments. 3. INTEREST EXPENSE Interest expense, net consisted of the following:
FOR THE THREE MONTHS ENDED -------------------------- APRIL 5, 1998 MARCH 30, 1997 ------------- -------------- (IN THOUSANDS OF DOLLARS) Interest expense $ 24,239 $ 16,918 Interest income (933) (1,068) Capitalized interest (600) (168) -------- -------- Interest expense, net $ 22,706 $ 15,682 ======== ========
FOR THE SIX MONTHS ENDED ------------------------ JULY 5, 1998 JUNE 29, 1997 ------------ ------------- (IN THOUSANDS OF DOLLARS) Interest expense $ 46,332 $ 33,619 Interest income (1,738) (1,644) Capitalized interest (1,144) (442) --------- --------- Interest expense, net $ 43,450 $ 31,533 ========= ========= Page 7 4. NET INCOME PER SHARE A total of 36,757,82636,766,362 shares were held as Treasury Stock as of AprilJuly 5, 1998. In February 1997, the Financial Accounting Standards Board issued Statement ofaccordance with Financial Accounting Standards No. 128 "Earnings perPer Share" (FAS No. 128). Under FAS No. 128,, Basic and Diluted Earnings per Share are computed based on the weighted average number of shares of the Common Stock and the Class B Stock outstanding as follows:
INCOME SHARES PER-SHARE FOR THE THREE MONTHS ENDED APRILJULY 5, 1998 (NUMERATOR) (DENOMINATOR) AMOUNT - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- In thousands of dollars except shares and per share amounts NET INCOME PER SHARE - BASIC - ---------------------------- Net income $ 75,433 143,375,704 $.5347,965 143,509,698 $.33 ==== EFFECT OF DILUTIVE SECURITIES - ----------------------------- Stock options - 2,021,5432,162,813 Performance stock units - 57,58372,928 Restricted stock units - 5,923 ---------- -------------6,747 -------- ------------ NET INCOME PER SHARE - DILUTED - ------------------------------ Net income and assumed conversions $ 75,433 145,460,753 $.52 ========== =============47,965 145,752,186 $.33 ======== ============ ==== INCOME SHARES PER-SHARE FOR THE THREE MONTHS ENDED MARCH 30,JUNE 29, 1997 (NUMERATOR) (DENOMINATOR) AMOUNT - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- In thousands of dollars except shares and per share amounts NET INCOME PER SHARE - BASIC - ---------------------------- Net income $ 68,894 153,165,527 $.4550,564 153,113,903 $.33 ==== EFFECT OF DILUTIVE SECURITIES - ----------------------------- Stock options - 1,471,2221,851,438 Performance stock units - 75,13694,392 Restricted stock units - 2,935 ---------- -------------3,786 --------- ------------ NET INCOME PER SHARE - DILUTED - ------------------------------ Net income and assumed conversions $ 68,894 154,714,820 $.45 ========== =============50,564 155,063,519 $.33 ========= ============ ====
Page 8
INCOME SHARES PER-SHARE FOR THE SIX MONTHS ENDED JULY 5, 1998 (NUMERATOR) (DENOMINATOR) AMOUNT - --------------------------------------------------------------------------------------------- In thousands of dollars except shares and per share amounts NET INCOME PER SHARE - BASIC - ---------------------------- Net income $ 123,398 143,441,165 $.86 ==== EFFECT OF DILUTIVE SECURITIES - ----------------------------- Stock options - 2,092,179 Performance stock units - 72,366 Restricted stock units - 6,694 ----------- ----------- NET INCOME PER SHARE - DILUTED - ------------------------------ Net income and assumed conversions $ 123,398 145,612,404 $.85 ========== ============ ==== INCOME SHARES PER-SHARE FOR THE SIX MONTHS ENDED JUNE 29, 1997 (NUMERATOR) (DENOMINATOR) AMOUNT - --------------------------------------------------------------------------------------------- In thousands of dollars except shares and per share amounts NET INCOME PER SHARE - BASIC - ---------------------------- Net income $ 119,458 153,139,428 $.78 ==== EFFECT OF DILUTIVE SECURITIES - ----------------------------- Stock options - 1,656,928 Performance stock units - 92,685 Restricted stock units - 3,435 ---------- ------------ NET INCOME PER SHARE - DILUTED - ------------------------------ Net income and assumed conversions $ 119,458 154,892,476 $.77 ========== ============ ====
5. INVENTORIES The majority of inventories are valued under the last-in, first-out (LIFO) method. The remaining inventories are stated at the lower of first-in, first-out (FIFO) cost or market. Inventories were as follows: APRILJULY 5, 1998 DECEMBER 31, 1997 ------------------------- ----------------- (IN THOUSANDS OF DOLLARS) Raw materials $ 265,809251,340 $ 223,702 Goods in process 39,47445,727 36,015 Finished goods 341,906439,133 334,639 ------------------- --------- Inventories at FIFO 647,189736,200 594,356 Adjustment to LIFO (115,048)(112,622) (88,831) --------- ------------------- ---------- Total inventories $ 532,141623,578 $ 505,525 ========= =================== ========== 6. LONG-TERM DEBT In March 1997, the Corporation issued $150 million of 6.95% Notes due 2007 (6.95% Notes) under the November 1993 Form S-3 Registration Statement. Proceeds from the debt issuance were used to repay a portion of the commercial paper borrowings associated with the acquisition of the Leaf North America confectionery operations (Leaf) in December 1996. In August 1997, the Corporation filed another Form S-3 Registration Statement under which it could offer, on a delayed or continuous basis, up to $500 million of additional debt securities. Also in August 1997, the Corporation issued $150 million of 6.95% Notes due 2012 (Notes) and $250 million of 7.2% Debentures due 2027 (Debentures) under the November 1993 and August 1997 Registration Statements. Proceeds from the debt issuance were used to repay short-term borrowings associated with the purchase of Common Stock from the Hershey Trust Company, as Trustee for the benefit of Milton Hershey School (Milton Hershey School Trust). As of AprilJuly 5, 1998, $250 million of debt securities remained available for issuance under the August 1997 Registration Statement. As of AprilJuly 5, 1998 and December 31, 1997, $150.0 million of commercial paper borrowings were reclassified as long-term debt in accordance with the Corporation's intent and ability to refinance such obligations on a long-term basis. 7. FINANCIAL INSTRUMENTS The contractcarrying amounts of financial instruments including cash and cash equivalents, accounts receivable, accounts payable and short-term debt, including $150.0 million of commercial paper borrowings reclassified as long-term debt, approximated fair value as of AprilJuly 5, 1998 and December 31, 1997, because of the relatively short maturity of these instruments. The carrying value of long-term debt, including the current portion, was $879.2 million as of AprilJuly 5, 1998, compared to a fair value of $956.0$958.8 million, based on quoted market prices for the same or similar debt issues. Page 9 As of AprilJuly 5, 1998, the Corporation had foreign exchange forward contracts maturing in 1998 and 1999 to purchase $10.6$18.3 million in foreign currency, primarily British sterling and Swiss francs, and to sell $12.7$11.6 million in foreign currency, primarily Japanese yen and Canadian dollars, at contracted forward rates. To hedge foreign currency exposure related to anticipated transactions associated with the purchase of certain raw materials and finished goods, generally covering 3 to 24 months, the Corporation, from time to time, also purchases foreign exchange options.options which permit, but do not require, the Corporation to exchange foreign currencies at a future date with another party at a contracted exchange rate. As of July 5, 1998, the Corporation had purchased foreign exchange options of $4.1 million and written foreign exchange options of $3.9 million, related to German marks. No options were outstanding as of April 5, 1998.June 29, 1997. The fair value of foreign exchange forward contracts is estimated by obtaining quotes for future contracts with similar terms, adjusted where necessary for maturity differences. The fair value of foreign exchange options is estimated using active market quotations. As of AprilJuly 5, 1998, the fair value of foreign exchange forward and options contracts approximated the contract value. The Corporation does not hold or issue financial instruments for trading purposes. In order to minimize its financing costs and to manage interest rate exposure, the Corporation, from time to time, enters into interest rate swap agreements to effectively convert a portion of its floating rate debt to fixed rate debt. As of AprilJuly 5, 1998, the Corporation had agreements outstanding with an aggregate notional amount of $150.0 million, with maturities through 1999. As of AprilJuly 5, 1998, interest rates payable were at a weighted average fixed rate of 6.3%, and the interest rate receivable was floating based on the 30-day commercial paper composite rate which was 5.5% as of AprilJuly 5, 1998. Any interest rate differential on interest rate swaps is recognized as an adjustment to interest expense over the term of each agreement. The Corporation's risk related to swap agreements is limited to the cost of replacing such agreements at prevailing market rates. 8. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES (FAS No. 133). FAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. FAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. FAS No. 133 is effective for fiscal years beginning after June 15, 1999, but may be implemented as of the beginning of any fiscal quarter after issuance. Retroactive application is not permitted. FAS No. 133 must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired, or substantively modified after December 31, 1997. Changes in accounting methods will be required for derivative instruments utilized by the Corporation to hedge commodity price, foreign currency exchange rate and interest rate risks. Such derivatives include, but are not limited to, commodity futures and options contracts, foreign exchange forward and options contracts and interest rate swaps. The Corporation has not yet quantified the impacts of adopting FAS No. 133 on its financial statements and has not determined the timing of or method of adoption. However, the implementation of FAS No. 133 could increase volatility in earnings and other comprehensive income. Page 10 MANAGEMENT'S DISCUSSION AND ANALYSIS RESULTS OF OPERATIONS - FIRSTSECOND QUARTER 1998 VS. FIRSTSECOND QUARTER 1997 - ------------------------------------------------------------------- Consolidated net sales for the firstsecond quarter rosefell from $1,002.5$905.7 million in 1997 to $1,098.1$880.4 million in 1998, an increasea decrease of 10%3% from the prior year. The higherlower sales primarily reflected increasedlower sales related to the promotional tie-in with the movie GODZILLA as compared to last year's highly successful LOST WORLD promotion, continued softness in the Corporation's Asian and Russian markets and a higher level of core confectionery brands,unsalables. These decreases were offset somewhat by incremental sales from the introduction of new confectionery products, and increased sales of pasta and grocery products, offset somewhat by lower international sales in the Far East.products. The consolidated gross margin decreased from 41.2%41.4% in 1997 to 40.6% in 1998. The decrease reflected increased costs associated with seasonal items, higher costs for certain major raw materials, primarily cocoa and semolina, andthe cost of realigning our Russian business, lower profitability resulting from the mix of non-chocolate and chocolate confectionery items sold in the second quarter of 1998 compared to sales in the firstsecond quarter of 1997.1997, and increased production and distribution costs for certain products sold under special promotions and for seasonal items. These unfavorable varianceshigher costs were partially offset by lower costs for raw materials and packaging and improved manufacturing efficiencies and increased profitability from the acquired Leaf brands.efficiencies. Selling, marketing and administrative expenses increaseddecreased by 5%6%, primarily reflecting higherlower marketing expenses for existing products, offset somewhat by increased spending associated with the introduction of new products. Net interest expense in the firstsecond quarter of 1998 was $7.0$4.9 million above the comparable period of 1997 primarily as a result of increased borrowings associated with the purchase of Common Stock from the Milton Hershey School Trust. The second quarter effective income tax rate decreased from 39.3% in 1997 to 39.0% in 1998 primarily due to changes in the mix of the Corporation's income among various tax jurisdictions. RESULTS OF OPERATIONS - FIRST SIX MONTHS 1998 VS. FIRST SIX MONTHS 1997 - ----------------------------------------------------------------------- Consolidated net sales for the first quartersix months of 1998 increased by $70.3 million or 4% primarily as a result of incremental sales from the introduction of new confectionery products, increased sales of core confectionery items and higher sales of grocery and pasta products. These increases were offset somewhat by a decline in sales in the Corporation's Asian and Russian markets and a higher level of unsalables. The consolidated gross margin decreased from 41.3% in 1997 to 40.6% in 1998. The decrease was primarily due to lower profitability resulting from the mix of non-chocolate and chocolate confectionery items sold in 1998 compared to sales in 1997, the cost of realigning our Russian business, and higher costs for certain major raw materials, primarily milk and cocoa, labor and overhead. These cost increases were partially offset by improved manufacturing efficiencies associated primarily with production of the acquired Leaf brands. Selling, marketing and administrative expenses were slightly less than 1997, as higher marketing expenses associated with the introduction of new products were offset by lower spending for existing brands. Net interest expense was $11.9 million above prior year, primarily as a result of increased borrowings associated with the purchase of Common Stock from the Milton Hershey School Trust. The effective income tax rate decreased from 39.3% in 1997 to 39.0% in 1998 primarily due to changes in the mix of the Corporation's income among various tax jurisdictions. FINANCIAL CONDITION Historically, the Corporation's major source of financing has been cash generated from operations. Domestic seasonal working capital needs, which typically peak during the summer, generally have been met by issuing commercial paper. During the first threesix months of 1998, the Corporation's cash and cash equivalents increaseddecreased by $5.4$20.6 million. Cash and cash equivalents on hand at the beginning of the period, cash provided from operations wasand short-term borrowings were sufficient to finance capital and capitalized software additions of $41.8$98.0 million, pay cash dividends of $30.9$61.7 million and to repay $25.0$25.1 million of long-term debt and $17.5 million of short-term borrowings.debt. The ratio of current assets to current liabilities was 1.4:1 as of AprilJuly 5, 1998, and 1.3:1 as of December 31, 1997. The Corporation's capitalization ratio (total short-term and long-term debt as a percent of stockholders' equity, short-term and long-term debt) was 58%59% as of AprilJuly 5, 1998, and 60% as of December 31, 1997. As of AprilJuly 5, 1998, the Corporation maintained committed credit facility agreements with a syndicate of banks in the amount of $600 million which could be borrowed directly or used to support the issuance of commercial paper. The Corporation has options to increase the credit facility by $1.0 billion with the concurrence of the banks. As of AprilJuly 5, 1998, and March 30,June 29, 1997, the Corporation also had lines of credit with domestic and international commercial banks in the amount of approximately $25 million and $20 million, respectively. Page 11million. In March 1997, the Corporation issued $150 million of 6.95% Notes under a November 1993 Registration Statement. In August 1997, the Corporation issued $150 million of Notes and $250 million of Debentures under the November 1993 and August 1997 Registration Statements. As of AprilJuly 5, 1998, $250 million of debt securities remained available for issuance under the August 1997 Registration Statement. Proceeds from any offering of the $250 million of debt securities available under the shelf registration may be used for general corporate requirements, which include reducing existing commercial paper borrowings, financing capital additions, and funding future business acquisitions and working capital requirements. As of AprilJuly 5, 1998, the Corporation's principal capital commitments included manufacturing capacity expansion and modernization. The Corporation anticipates that capital expenditures will be in the range of $175 million to $200 million per annum during the next several years as a result of continued modernization of existing facilities and capacity expansion to support new products and line extensions. In late 1996, the Corporation approved a project to implement an enterprise-wide integrated information system to replace most of the transaction systems and applications currently supporting operations of the Corporation. Total commitments for this system are expected to be in the range of $75 million to $85 million. ThisThe system is Year 2000 compliantcompliant. The Corporation is evaluating its manufacturing processes and will replace a large portion of the Corporation'sremaining legacy information systems. Legacy systems not being replaced by the new integrated information systemto identify and remediate any Year 2000 compliance issues. In addition, major business partners and suppliers are being upgradedcontacted to gain assurances that they will be Year 2000 compliant and, as of April 5, 1998,compliant. Failure, either by the costs areCorporation, its major business partners or suppliers, to complete remediation in a timely manner could result in significant adverse financial consequences to the Corporation. At the present time, the total cost to remediate Year 2000 compliance issues is not expected to be material to the Corporation's business, operations or financial condition. Progress toward compliance with Year 2000 issues byIt is also expected that remediation to both the Corporation's manufacturing processes and information systems and those of major business partners is being reviewed for the most significant operations and business activities. The extent of Year 2000 compliance efforts by major partners andor suppliers and the possible effect on the Corporation's business of their failure to comply continues to be evaluated, but a final determination of the potential impact cannot be made at this time. The remediation of Year 2000 issues involving the Corporation's information systems is expected towill be completed in time to prevent any material adverse consequences to the Corporation's business, operations or financial condition. The potential loss in fair value of foreign exchange forward contracts and interest rate swaps resulting from a hypothetical near-term adverse change in market rates of ten percent was not material as of AprilJuly 5, 1998. The market risk resulting from a hypothetical adverse market price movement of ten percent associated with the estimated average fair value of net commodity positions declined from $9.6 million as of December 31, 1997, to $7.3$7.5 million as of AprilJuly 5, 1998. Market risk represents 10% of the estimated average fair value of net commodity positions at four dates prior to the end of each period. The decrease in average market risk was primarily related to changes in the excess of futures contracts held over unpriced physical forward contracts in 1998 compared to 1997. Page 12 SAFE HARBOR STATEMENT The nature of the Corporation's operations and the environment in which it operates subject it to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Corporation notes the following factors which, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein. Forward looking statements contained in this document include, but are not limited to Year 2000 issues (particularly with regard to the Corporation's business partners and suppliers), the impact of the use of derivative instruments, the amount of future capital expenditures and the possible uses of proceeds from any future borrowings under the Corporation's currently effective credit facility or August 1997 Registration Statement. Factors which could cause results to differ include, but are not limited to: changes in the confectionery and pasta business environment, including actions of competitors and changes in consumer preferences; changes in governmental laws and regulations, including income taxes; market demand for new and existing products; and raw material pricing. Page 13 PART II Items 1 through 3 and 5 have been omitted as not applicable. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Hershey Foods Corporation's Annual Meeting of Stockholders was held on April 28, 1998. The following directors were elected by the holders of Common Stock and Class B Common Stock, voting together without regard to class: NAME VOTES FOR VOTES WITHHELD ---- --------- -------------- William H. Alexander 402,336,618 993,901 Robert H. Campbell 402,650,807 679,712 C. McCollister Evarts 402,288,572 1,041,947 Bonnie Guiton Hill 402,599,830 730,689 John C. Jamison 402,653,029 677,490 John M. Pietruski 402,625,959 704,560 Joseph P. Viviano 402,575,430 755,089 Kenneth L. Wolfe 402,617,029 713,490 The following directors were elected by the holders of the Common Stock voting as a class: NAME VOTES FOR VOTES WITHHELD ---- --------- -------------- Mackey J. McDonald 99,577,164 692,935 Vincent A. Sarni 99,553,669 716,430 Holders of the Common Stock and the Class B Common Stock voting together approved the appointment of Arthur Andersen LLP as the independent public accountants for 1998. Stockholders cast 402,729,249 votes FOR the appointment, 330,658 votes AGAINST the appointment and ABSTAINED from casting 270,612 votes on the appointment of accountants. No other matters were submitted for stockholder action. Page 14 ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K - ----------------------------------------- a) EXHIBITS -------- The following items are attached and incorporated herein by reference: Exhibit 3 - Restated By-laws of Hershey Foods Corporation as amended and restated on June 2, 1998. Exhibit 12 - Statement showing computation of ratio of earnings to fixed charges for the quarterssix months ended AprilJuly 5, 1998 and March 30,June 29, 1997. Exhibit 27 - Financial Data Schedule for the period ended AprilJuly 5, 1998 (required for electronic filing only). b) REPORTS ON FORM 8-K No reports-------------------- A report on Form 8-K werewas filed duringJuly 10, 1998 announcing that the three-month period ended April 5, 1998.Corporation's earnings for the second quarter of 1998 may be below market expectations. Page 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HERSHEY FOODS CORPORATION ------------------------- (Registrant) Date MAY 13,AUGUST 12, 1998 /S/ WILLIAM F. CHRIST ------------ -------------------------------------------- ------------------------------ William F. Christ Senior Vice President, Chief Financial Officer and Treasurer Date MAY 13,AUGUST 12, 1998 /S/ DAVID W. TACKA ------------ ------------------------------------------- ----------------------------- David W. Tacka Corporate Controller and Chief Accounting Officer Page 16 EXHIBIT INDEX Exhibit 3 - Amended and Restated By-laws of Hershey Foods Corporation Exhibit 12 - Computation of Ratio of Earnings to Fixed Charges Exhibit 27 - Financial Data Schedule for the period ended AprilJuly 5, 1998 (required for electronic filing only)