Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition
Results of Operations - Third Quarter 2000 vs. Third Quarter 1999
Consolidated net sales for the third quarter increased from $1,066.7 million in 1999 to $1,196.8 million in 2000, an increase of 12% from the prior year. The higher sales primarily reflected an increase in sales of core confectionery and grocery products in the United States, incremental sales from the introduction of new confectionery products, increased international exports, and lower returns, discounts, and allowances. In 2000, certain international distributor allowances were netted against sales instead of being reported in selling, marketing and administrative expenses as in 1999.
The consolidated gross margin increased from 40.6% in 1999 to 41.8% in 2000. Gross margin in 1999 would have been .3 percentage points lower if certain international distributor allowances were reclassified and reported as discussed above for 2000. The increase in gross margin reflected decreased costs for certain major raw materials, primarily cocoa, as well as lower returns, discounts, and allowances. The impact of these items was partially offset by higher freight, distribution and warehousing costs.
Selling, marketing and administrative expenses increased by 13% in 2000, primarily reflecting increased marketing expenditures for core confectionery brands and international exports, higher provisions for incentive compensation reflecting improved operating performance, and increased administrative expenses due to higher staffing levels to support sales and customer service activity in North America and the international export business.
Net interest expense in the third quarter of 2000 was $.6 million above the comparable period of 1999, primarily as a result of higher short-term interest expense reflecting increased average short-term borrowings and borrowing rates.
The third quarter effective income tax rate decreased from 39.0% in 1999 to 38.8% in 2000.
Results of Operations - First Nine Months 2000 vs. First Nine Months 1999
Consolidated net sales for the first nine months of 2000 increased from $2,865.1 million in 1999 to $3,026.1 million in 2000, an increase of $161.0 million or 6% from the prior year. The higher sales primarily reflected an increase in sales of core confectionery and grocery products in North America, incremental sales from the introduction of new confectionery products, increased international exports, and lower returns, discounts, and allowances. In 2000, certain international distributor allowances were netted against sales instead of being reported in selling, marketing and administrative expenses as in 1999. The first nine months of 1999 included $29.3 million in net sales related to the Corporation's pasta business, which was divested in January 1999.
The consolidated gross margin was 40.4% in 2000 and 1999. Gross margin in 1999 benefited .5 percentage points from the inclusion in cost of sales of a one-time $12.5 million gain from revisions to the Corporation's retiree medical plan, and results of the pasta business. In addition, gross margin in 1999 would have been .3 percentage points lower if certain international distributor allowances were reclassified and reported as discussed above for 2000. Excluding results of the pasta business and the one-time gain in 1999, the increase in gross margin reflected decreased costs for certain major raw materials, primarily cocoa, as well as lower returns, discounts, and allowances. The impact of these items was offset partially by higher freight, distribution and warehousing costs primarily related to increased fuel costs and expanded warehousing capacity and increased costs related to the disposal of obsolete packaging and aged finished goods inventory.
Selling, marketing and administrative expenses increased by 4% in 2000, primarily reflecting: increased marketing expenditures for core confectionery brands, international exports, and the introduction of new products; increased administrative expenses due to higher staffing levels to support sales and customer service activity in North American and international businesses; higher software amortization costs; and higher provisions for incentive compensation reflecting improved operating performance in 2000. The impact of these items was offset partially by the divestiture of the pasta business and the inclusion in administrative expense in 2000 of a one-time gain of $7.3 million arising from the exchange of certain corporate aircraft.
Net interest expense was $.6 million above the comparable period of 1999, primarily as a result of higher short-term interest expense related to increased average short-term borrowings and borrowing rates, and lower capitalized interest. The impact of these items was offset partially by lower fixed interest expense as a result of the interest rate swap and forward agreements entered into in October 1999 and higher interest income.
Excluding the provision for income taxes associated with the gain on the sale of the Corporation's pasta business, the effective income tax rate decreased from 39.0% in 1999 to 38.9% in 2000.
Net income for the first nine months of 2000 of $218.6 million was 40% below the prior year and net income per share - diluted of $1.58 per share was $0.97 below the prior year. Prior year net income included an after-tax gain of $165.0 million, or $1.16 per share - diluted, on the sale of the Corporation's pasta business.
Liquidity and Capital Resources
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 months, generally have been met by issuing commercial paper. During the first nine months of 2000, the Corporation's cash and cash equivalents decreased by $73.8 million. Cash and cash equivalents on hand at the beginning of the period, cash provided from operations and short-term borrowings were sufficient to repurchase $99.9 million of the Corporation's Common Stock, pay cash dividends of $107.5 million, and finance capital expenditures and capitalized software additions of $104.8 million.
The ratio of current assets to current liabilities was 1.6:1 as of October 1, 2000, and 1.8:1 as of December 31, 1999. The Corporation's capitalization ratio (total short-term and long-term debt as a percentage of stockholders' equity, short-term and long-term debt) was 55% as of October 1, 2000, and 50% as of December 31, 1999.
As of October 1, 2000, the Corporation maintained a committed credit facility agreement with a syndicate of banks in the amount of $500.0 million which could be borrowed directly or used to support the issuance of commercial paper. The Corporation has the option to increase the credit facility by $1.0 billion with the concurrence of the banks. The Corporation also had lines of credit with domestic and international commercial banks in the amount of $24.4 million and $25.0 million, respectively, as of October 1, 2000 and December 31, 1999.
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 October 1, 2000, $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 October 1, 2000, the Corporation's principal capital commitments included manufacturing capacity expansion, modernization and efficiency improvements. The Corporation anticipates that capital expenditures will be in the range of $150 million to $170 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. Such expenditures will be financed with cash provided from operations and short-term borrowings.
In July 1999, the Corporation entered into an operating lease agreement for the purpose of financing construction of a warehouse and distribution facility located on land owned by the Corporation near Hershey, Pennsylvania. Under the agreement, the lessor paid for construction costs totaling $61.7 million. The lease term is six years, including the construction period. The lease provides for a substantial residual guarantee and includes an option to purchase the facility at original cost.
In January 1999, the Corporation received a Notice of Proposed Deficiency (Notice) from the Internal Revenue Service (IRS) related to years 1989 through 1996. The Notice pertained to the Corporate Owned Life Insurance (COLI) program which was implemented by the Corporation in 1989. The IRS disallowed the interest expense deductions associated with the underlying life insurance policies. The total deficiency of $61.2 million, including interest, was paid to the IRS in September 2000 to eliminate further accruing of interest. The Corporation believes that it has fully complied with the tax law as it relates to its COLI program and will continue to vigorously defend its position on this matter.
Subsequent Event
In November 2000, the Corporation entered into an agreement with Nabisco, Inc. to acquire Nabisco's intense and breath freshener mints and gum businesses, which had 1999 sales of approximately $270 million.
Under the agreement, the Corporation will pay $135 million to acquire the businesses, includingIce Breakers andBreath SaversCool Blasts intense mints,Breath Savers mints, andIce Breakers,Care*free, Stick*free ,Bubble Yum andFruit Stripe gums. Also included in the purchase is Nabisco's gum-manufacturing plant in Las Piedras, Puerto Rico.
The purchase of these businesses by the Corporation is conditional upon consummation of the acquisition of Nabisco Holdings Corp. by Philip Morris Companies Inc. (which is subject to Federal Trade Commission (FTC) approval) and FTC approval of the sale of these businesses to the Corporation, as well as other customary closing conditions. The parties expect to complete the transaction by the end of the year.
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. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential" among others. Factors which could cause results to differ include, but are not limited to: changes in the confectionery and grocery business environment, including actions of competitors and changes in consumer preferences; changes in governmental laws and regulations, including income and sales taxes; market demand for new and existing products; changes in raw material costs; and the Corporation's ability to implement improvements and to reduce costs associated with the Corporation's customer service, warehousing and order fulfillment processes and systems.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The potential loss in fair value of foreign exchange forward contracts and interest rate swaps and forward agreements resulting from a hypothetical near-term adverse change in market rates of ten percent was not material as of October 1, 2000. The market risk resulting from a hypothetical adverse market price movement of ten percent associated with the estimated average fair value of net commodity positions decreased from $11.1 million as of December 31, 1999, to $3.6 million as of October 1, 2000. Market risk represents 10% of the estimated average fair value of net commodity positions at four dates prior to the end of each period. |
