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HSY > SEC Filings for HSY > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for HERSHEY CO


7-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition
SUMMARY OF OPERATING RESULTS
              Analysis of Selected Items from Our Income Statement
                             For the Three Months Ended                            For the Nine Months Ended
                                                         Percent
                                                         Change                                            Percent Change
                  September 30,                         Increase     September 30,                            Increase
                       2012         October 2, 2011    (Decrease)         2012         October 2, 2011       (Decrease)
In millions except per share
amounts
Net Sales         $   1,746.7      $       1,624.3          7.5  %   $   4,893.2      $       4,513.6           8.4 %
Cost of Sales         1,003.9                944.1          6.3          2,788.5              2,612.9           6.7
Gross Profit            742.8                680.2          9.2          2,104.7              1,900.7          10.7
Gross Margin             42.5 %               41.9 %                        43.0 %               42.1 %
SM&A Expense            421.0                356.9         18.0          1,218.0              1,080.6          12.7
SM&A Expense as a
percent of sales         24.1 %               22.0 %                        24.9 %               23.9 %
Business
Realignment and
Impairment
Charges
(Credits), net           20.1                  2.2        817.0             28.2                 (5.9 )       575.9
EBIT                    301.7                321.1         (6.0 )          858.5                826.0           3.9
EBIT Margin              17.3 %               19.8 %                        17.5 %               18.3 %
Interest Expense,
net                      24.5                 23.0          6.5             72.9                 70.9           2.9
Provision for
Income Taxes            100.5                101.4         (0.9 )          274.6                268.3           2.3
Effective Income
Tax Rate                 36.2 %               34.0 %                        34.9 %               35.5 %
Net Income        $     176.7      $         196.7        (10.2 )    $     511.0      $         486.8           5.0
Net Income Per
Share-Diluted     $      0.77      $          0.86        (10.5 )    $      2.23      $          2.12           5.2

Results of Operations - Third Quarter 2012 vs. Third Quarter 2011 U.S. Price Increases
In March 2011, we announced a weighted-average increase in wholesale prices of approximately 9.7% across the majority of our U.S., Puerto Rico and export portfolio, effective immediately. The price increase applied to our instant consumable, multi-pack, packaged candy and grocery lines. Direct buying customers were able to purchase transitional amounts of product into May and seasonal net price realization was not expected until Easter 2012. Usually there is a time lag between the effective date of list price increases and the impact of the price increases on net sales. The impact of price increases is often delayed because we honor previous commitments to planned consumer and customer promotions and merchandising events that occur subsequent to the effective date of the price increases. In addition, promotional allowances may be increased subsequent to the effective date, delaying or partially offsetting the impact of price increases on net sales. Net Sales
Net sales increased 7.5% in the third quarter of 2012 over the comparable period of 2011 due to net price realization of 3.9% and sales volume increases of 2.1%. Sales volume increases were primarily associated with incremental sales of new products, primarily in the United States. Unfavorable foreign currency exchange rates reduced net sales by 0.8%. Net sales attributable to Brookside contributed 2.3% to the increase.


Key Marketplace Metrics
For the twelve-week period ending October 6, 2012, consumer takeaway increased 5.9% in 2012 compared with the same period of 2011. Market share in measured channels increased by 1.1 share points in the twelve-week period ending October 6, 2012 compared with the same period of 2011. Consumer takeaway and the change in market share are provided for channels of distribution accounting for approximately 90% of our U.S. confectionery retail business. These channels of distribution primarily include food, drug, mass merchandisers, including Wal-Mart Stores, Inc., and convenience stores. Cost of Sales and Gross Margin
Cost of sales increased by approximately 6.3% in the third quarter of 2012 due to higher input and supply chain costs, along with the impact of sales volume increases, which together increased total cost of sales by approximately 5.9%. An increase to cost of sales of 2.7% resulted from the Brookside acquisition. Supply chain productivity improvements reduced cost of sales by approximately 1.9%. Business realignment and impairment charges of $5.2 million were included in cost of sales in the third quarter of 2012 compared with $9.5 million in the third quarter of 2011, resulting in a reduction in cost of sales of 0.5%. Gross margin increased by 0.6 percentage points in the third quarter of 2012 primarily as a result of price realization and supply chain productivity improvements, which together improved gross margin by 3.0 percentage points. These improvements were substantially offset by higher input, supply chain and product obsolescence costs of approximately 2.4 percentage points. Selling, Marketing and Administrative
Selling, marketing and administrative expenses increased by 18.0% in the third quarter of 2012 primarily due to higher marketing and employee-related expenses, increased incentive compensation costs and expenses associated with business acquisitions. Selling, marketing and administrative costs in the third quarter of 2011 were reduced by a $17.0 million gain on the sale of certain trademark licensing rights. Advertising costs in the third quarter of 2012 increased by 12.1% from the same period in 2011.
Business realignment charges of $0.6 million were included in selling, marketing and administrative expenses in the third quarter of 2012. Business realignment charges of $1.9 million were included in selling, marketing and administrative expenses in the third quarter of 2011.
Business Realignment and Impairment Charges Business realignment and impairment charges of $20.1 million associated with the Next Century program were recorded in the third quarter of 2012. The 2012 charges were associated with a non-cash pension settlement loss of $13.1 million and charges associated with the closure of a manufacturing facility. Business realignment and impairment charges of $2.2 million were recorded in the third quarter of 2011 associated with the Next Century program. The 2011 charges were primarily associated with asset retirement costs and employee separation expenses.
Income Before Interest and Income Taxes and EBIT Margin EBIT decreased in the third quarter of 2012 compared with the third quarter of 2011 as a result of higher selling, marketing and administrative expenses and business realignment charges which more than offset an increase in gross profit. Net pre-tax business realignment and impairment charges of $25.8 million were recorded in the third quarter of 2012. Net pre-tax business realignment and impairment charges of $13.5 million were recorded in the third quarter of 2011. EBIT margin decreased from 19.8% for the third quarter of 2011 to 17.3% for the third quarter of 2012 due to higher selling, marketing and administrative expenses and higher business realignment charges as a percent of sales, offset partially by the increase in gross margin. Interest Expense, Net
Net interest expense was higher in the third quarter of 2012 than the comparable period of 2011 primarily reflecting the impact of higher short-term borrowings.


Income Taxes and Effective Tax Rate
Our effective income tax rate was 36.2% for the third quarter of 2012 compared with 34.0% for the third quarter of 2011. The increase was associated with the changes to Pennsylvania state tax legislation enacted in the third quarter of 2012, the impact of other discrete tax items recognized in third quarter of 2012 compared with 2011, and the impact of the mix of income among various tax jurisdictions.
Net Income and Net Income Per Share
Earnings per share-diluted in the third quarter of 2012 decreased $0.09 as compared with the third quarter of 2011. Net income was reduced by $16.5 million, or $0.07 per share-diluted, in the third quarter of 2012 as a result of business realignment and impairment charges. Closing and integration costs for the Brookside acquisition reduced net income by $3.5 million, or $0.02 per share-diluted, in the third quarter of 2012. Net income was reduced by $2.7 million, or $0.01 per share-diluted related to higher non-service related pension expenses in the third quarter of 2012 compared with 2011. Excluding the impact of business realignment and impairment charges, business acquisition costs and non-service related pension expenses, earnings per share-diluted increased $0.03 per share, or 3.6%, in 2012 compared with 2011. Results of Operations - First Nine Months 2012 vs. First Nine Months 2011 Net Sales
Net sales increased 8.4% for the first nine months of 2012 over the comparable period of 2011 due primarily to net price realization of 6.8% as well as sales volume increases of 0.6%. The increase was partially offset by the impact of unfavorable foreign currency exchange rates which reduced net sales by 0.8%. Net sales attributable to Brookside contributed 1.8% to the increase in net sales. Key Marketplace Metrics
For the year-to-date period ended October 6, 2012, consumer takeaway increased 5.2% compared with the same period of 2011. Market share in measured channels increased 0.4 share points in the year-to-date period ended October 6, 2012 compared with the same period of 2011. Consumer takeaway and the change in market share are provided for measured channels of distribution accounting for approximately 90% of our U.S. confectionery retail business. These channels of distribution primarily include food, drug, mass merchandisers, including Wal-Mart Stores, Inc., and convenience stores. Cost of Sales and Gross Margin
Cost of sales increased by approximately 6.7% in the first nine months of 2012 primarily due to higher input and supply chain costs, along with the impact of an unfavorable sales mix, which together increased total cost of sales by about 5.6%. An increase in cost of sales of 2.0% resulted from the Brookside acquisition. Supply chain productivity improvements reduced cost of sales by approximately 2.1%. Business realignment and impairment charges of $38.0 million were included in cost of sales in the first nine months of 2012 compared with $23.3 million included in the comparable period of 2011, resulting in an increase to cost of sales of 0.6%.
Gross margin increased by 0.9 percentage points for the first nine months of 2012 primarily as a result of price realization and supply chain productivity improvements, which together improved gross margin by 4.5 percentage points. These improvements were partially offset by higher input, supply chain and product obsolescence costs of approximately 3.2 percentage points. The impact of higher business realignment and impairment charges recorded in the first nine months of 2012 compared with the same period of 2011 reduced gross margin by 0.3 percentage points.


Selling, Marketing and Administrative
Selling, marketing and administrative expenses increased by 12.7% in the first nine months of 2012 primarily due to increased advertising and marketing research expenses, higher employee-related expenses, increased incentive compensation costs and expenses associated with business acquisitions. In addition, selling, marketing and administrative expenses in the first nine months of 2011 were reduced by a $17.0 million gain on the sale of certain trademark licensing rights. The increases in the first nine months of 2012 were partially offset by lower costs associated with legal fees and contingencies compared with the first nine months of 2011. Advertising costs in the first nine months of 2012 increased by 12.1% from the same period in 2011.
Business realignment charges of $2.1 million were included in selling, marketing and administrative expenses in the first nine months of 2012. Business realignment charges of $4.0 million were included in selling, marketing and administrative expenses in the first nine months of 2011. Business Realignment and Impairment Charges (Credits) Business realignment and impairment charges of $28.2 million associated with the Next Century program were recorded in the first nine months of 2012. The 2012 charges were primarily associated with the relocation and start up of production lines and the closure of a manufacturing facility, in addition to the pension settlement loss recorded in the third quarter of 2012.
Net pre-tax business realignment and impairment credits of $5.9 million were recorded in the first nine months of 2011 associated with the Next Century program. The 2011 credits were primarily associated with a reduction of employee separation expense of $9.7 million, partially offset by asset retirement costs. Income Before Interest and Income Taxes and EBIT Margin EBIT increased in the first nine months of 2012 compared with the first nine months of 2011 as a result of higher gross profit, partially offset by higher selling, marketing and administrative expenses. Net pre-tax business realignment and impairment charges of $68.4 million were recorded in the first nine months of 2012. Net pre-tax business realignment and impairment charges of $21.4 million were recorded in the first nine months of 2011.
EBIT margin decreased from 18.3% for the first nine months of 2011 to 17.5% for the first nine months of 2012 as higher selling, marketing and administrative expenses and business realignment and impairment charges as a percent of sales more than offset the increase in gross margin. Interest Expense, Net
Net interest expense was slightly higher in the first nine months of 2012 than the comparable period of 2011, primarily reflecting increased interest expense associated with higher short-term borrowings. Income Taxes and Effective Tax Rate
Our effective income tax rate was 34.9% for the first nine months of 2012 compared with 35.5% for the first nine months of 2011. Excluding the impact of tax rates associated with business realignment and impairment charges, we expect our income tax rate for the full year 2012 to be slightly less than 35.0%. Net Income and Net Income Per Share
Earnings per share-diluted for the first nine months of 2012 were $2.23 compared with $2.12 for the first nine months of 2011. Net income was reduced by $43.5 million, or $0.19 per share-diluted, in the first nine months of 2012 as a result of business realignment and impairment charges. Net income was reduced by $8.3 million, or $0.04 per share-diluted, in the first nine months of 2012 as a result of closing and integration costs for the Brookside acquisition. Net income was reduced by $8.0 million, or $0.04 per share-diluted, related to higher non-service related pension expenses in the first nine months of 2012 compared with 2011. Excluding the impact of business realignment and impairment charges, business acquisition costs and non-service related pension expenses, earnings per share-diluted increased $0.37 per share, or 17.4%, in 2012 compared with 2011.


Liquidity and Capital Resources
Historically, our major source of financing has been cash generated from operations. Domestic seasonal working capital needs, which typically peak during the summer months, generally have been met by utilizing cash on hand and issuing commercial paper. Commercial paper also may be issued, from time to time, to finance ongoing business transactions such as the repayment of long-term debt, business acquisitions and for other general corporate purposes. During the first nine months of 2012, cash and cash equivalents decreased by $227.5 million to $466.2 million.
Cash provided from operations, cash on hand at the beginning of the period, short-term borrowings and other cash inflows, primarily associated with the exercise of stock options, during the first nine months of 2012 were sufficient to fund the repurchase of Common Stock of $497.6 million, business acquisitions of $172.9 million, capital additions and capitalized software expenditures of $214.0 million and dividend payments of $249.8 million.
Net cash provided from operating activities was $605.9 million in 2012 and $257.2 million in 2011. The increase was primarily the result of the change in cash provided from (used by) other assets and liabilities, the impact of business realignment and impairment charges, and higher net income in 2012. Cash provided from changes in other assets and liabilities was $169.3 million for the first nine months of 2012 compared with cash used of $85.3 million for the same period of 2011. The increase in the amount of cash provided from other assets and liabilities from 2011 to 2012 primarily reflected the effect of hedging transactions of $250.0 million. Cash used by working capital was $284.5 million in 2012 compared with $304.3 million in 2011. The decrease in cash used by working capital was principally related to changes in raw material and finished goods inventories in 2012 compared with 2011. This was offset somewhat by an increase in accounts receivable resulting from higher sales in 2012 compared with 2011, along with a decrease in accounts payable in 2012 compared with 2011, primarily associated with capital and manufacturing expenditures. During the first nine months of 2012, the Company acquired Brookside for approximately $172.9 million. Also during the first nine months of 2012, the Company loaned $16.0 million to an affiliate to finance the expansion of its manufacturing capacity.
In May 2007, we entered into an agreement with Godrej Beverages and Foods, Ltd., a consumer goods, confectionery and food company, to manufacture and distribute confectionery products, snacks and beverages across India. Under the agreement, we owned a 51% controlling interest in Godrej Hershey Ltd. In September 2012, we acquired the remaining 49% interest in Godrej Hershey Ltd. for approximately $15.9 million reflected in net payments to noncontrolling interests. Since the Company had a controlling interest in Godrej Hershey Ltd., the transaction was recorded in additional paid-in capital and the noncontrolling interest in Godrej Hershey Ltd. was eliminated as of September 30, 2012. Payments to noncontrolling interests associated with Godrej Hershey Ltd. were partially offset by equity contributions of $2.9 million by the noncontrolling interests in Hershey do Brasil.
During the third quarter 2011, the Company recorded an $11.1 million gain, net of tax, on the sale of trademark licensing rights. We received net proceeds of $20.0 million from this sale. Additionally, we entered into a sale and leasing agreement for the 19 East Chocolate Avenue manufacturing facility. Based on the leasing agreement, we are deemed to be the "owner" of the property for accounting purposes. We received net proceeds of $47.6 million and recorded a lease financing obligation of $50.0 million under the leasing agreement. Interest paid was $82.1 million during the first nine months of 2012 versus $84.1 million for the comparable period of 2011. The decrease in interest paid in 2012 was due to timing of long-term interest payments. Income taxes paid were $233.7 million during the first nine months of 2012 versus $224.0 million for the comparable period of 2011. The increase in taxes paid in 2012 was primarily related to the impact of higher annualized taxable income in 2012 compared with 2011.
The ratio of current assets to current liabilities was 1.4:1.0 as of September 30, 2012 and 1.7:1.0 as of December 31, 2011. The capitalization ratio (total short-term and long-term debt as a percent of stockholders' equity, short-term and long-term debt) decreased to 67% as of September 30, 2012 from 68% as of December 31, 2011.
Generally, our short-term borrowings are in the form of commercial paper or bank loans with an original maturity of three months or less. As of September 30, 2012, we had commercial paper borrowings of $50.0 million.


Outlook
The outlook section contains a number of forward-looking statements, all of which are based on current expectations. Actual results may differ materially. Refer to the Safe Harbor Statement below as well as Risk Factors and other information contained in our 2011 Annual Report on Form 10-K for information concerning the key risks to achieving future performance goals. Our results for the first nine months of 2012 were strong and we expect to continue our marketplace momentum. The economic environment is expected to continue to be challenging during the remainder of 2012. We will continue to remain focused on building brands in both the U.S. and key international markets and will make incremental investments in our brands and business capabilities. We have planned merchandising and programming events during the remainder of the year and will work closely with retail customers and monitor our brand performance. We will continue with the distribution and rollout of Jolly Rancher Crunch 'N Chew candy, Rolo minis, Ice Breakers Duo mints and Hershey's Simple Pleasures candy.
Advertising expense increased 12.1% in the first nine months of 2012, compared with the first nine months of 2011. For the full year, we now expect advertising to increase 13% to 15% versus the prior year, supporting core brands in both the U.S. and key international markets, new product launches, and new advertising campaigns on the Jolly Rancher and Rolo brands.
Excluding the Brookside acquisition, we expect organic sales volume growth to continue to improve in the fourth quarter and be up for the full-year 2012. Including a 1.75 to 2.0 percentage point benefit from net sales for Brookside at current exchange rates, we now expect full-year net sales growth of about 8% to 9%, including the impact of foreign currency exchange rates.
In 2012, the Company expects reported earnings per share-diluted of $2.87 to $2.92. Reported earnings per share-diluted includes anticipated business realignment and impairment charges of $0.23 to $0.24 per share-diluted related to the Next Century program and non-service related pension expenses of $0.06 per share-diluted. Reported gross margin, reported EBIT margin and reported earnings per share-diluted will be impacted by these charges and expenses in addition to closing and integration costs related to the Brookside acquisition estimated at $0.04 to $0.05 per share-diluted. We now expect reported gross margin to increase from 120 to 140 basis points in 2012.
We do not expect a material change to our full-year inflation outlook. We continue to expect that input costs in 2012 will be higher than last year. As a result of our strong results for the first nine months and further visibility into our full-year cost structure, we now expect adjusted gross margin expansion of 120 to 140 basis points compared with last year, driven by net price realization, strong productivity and cost savings. Therefore, considering our results for the first nine months and planned investments in advertising, market research, category management and selling capabilities during the remainder of the year, particularly in our international markets, we now expect adjusted earnings per share-diluted for 2012 to be in the range of $3.22 to $3.25, a 14% to 15% increase over 2011. This is greater than our previous estimate of a 12% to 14% increase.
As we look to 2013, we assume the economic environment for retailers and consumers will continue to be challenging. However, we believe the investments we've made have resulted in a business model that is more efficient and effective, enabling us to deliver predictable, consistent and achievable marketplace and financial performance. Therefore, we expect 2013 net sales growth to be within our 5% to 7% long-term target, including the impact of foreign currency exchange rates, as we continue to focus on core brands and innovation in both the U.S. and key international markets. Additionally, we will leverage Hershey's scale at retail as we launch Brookside branded products in the broader U.S. food, drug and mass merchandiser channels. We remain focused on gross margin. We have solid productivity and cost savings initiatives in place and, while early in the planning cycle, we do not expect input cost inflation next year. Therefore, we expect to achieve gross margin expansion in 2013 and growth in adjusted earnings per share-diluted in the 8% to 10% range, consistent with our long-term target, as reflected in the reconciliation of reported to adjusted projections for 2013 on page 30.
NOTE: In the Outlook above, the Company has provided income measures excluding certain items, in addition to net income determined in accordance with GAAP. These non-GAAP financial measures are used in evaluating results of operations for internal purposes. These non-GAAP measures are not intended to replace the presentation of financial results in accordance with GAAP. Rather, the Company believes exclusion of such items provides additional information to investors to facilitate the comparison of past and present operations.


In 2011, the Company recorded GAAP charges of $49.2 million, or $0.13 per share-diluted, attributable to the Next Century program and the global supply chain transformation program. Additionally, in the third quarter of 2011, the Company recorded a pre-tax gain of $17.0 million, or $0.05 per share-diluted, from the sale of trademark licensing rights. Non-service related pension expense of $2.8 million, or $0.01 per share-diluted, was recorded in 2011. In 2012, the Company expects acquisition closing and integration costs related to the Brookside acquisition to be $0.04 to $0.05 per share-diluted. The Company also expects to record total GAAP charges of about $80 million to $85 million, or $0.23 to $0.24 per share-diluted, attributable to the Next Century program. Non-service related pension expenses are expected to be $0.06 per share-diluted in 2012.
In 2013, the Company expects to record acquisition closing and integration costs of $0.01 per share-diluted. The Company expects to record GAAP charges of about $10 million to $15 million, or $0.02 to $0.04 per share-diluted, attributable to the Next Century program. Non-service related pension expenses are expected to be $0.06 per share-diluted in 2013.
Below is a reconciliation of 2011 and projected 2012 and 2013 earnings per share-diluted in accordance with GAAP to non-GAAP 2011 adjusted earnings per share-diluted and projected adjusted earnings per share-diluted for 2012 and 2013:

                                                          2012             2013
                                          2011        (Projected)      (Projected)
Reported EPS-Diluted                     $2.74       $2.87 - $2.92    $3.37 - $3.49
Acquisition closing and integration
charges                                    -          0.04 - 0.05          0.01
Gain on sale of trademark licensing
rights                                   (0.05)            -                -
Total Business Realignment and
Impairment Charges                        0.13        0.23 - 0.24      0.02 - 0.04
Non-service related pension expenses      0.01            0.06             0.06
Adjusted EPS-Diluted                     $2.83       $3.22 - $3.25    $3.48 - $3.58


Outlook for Project Next Century . . .

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