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HSY > SEC Filings for HSY > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for HERSHEY CO


8-May-2013

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
                                                                          Percent
                                                                           Change
                                                                          Increase
                                   March 31, 2013     April 1, 2012      (Decrease)
In millions except per share amounts
Net Sales                         $      1,827.4     $      1,732.1           5.5  %
Cost of Sales                              978.1              988.7          (1.1 )
Gross Profit                               849.3              743.4          14.3
Gross Margin                                46.5 %             42.9 %
SM&A Expense                               450.7              405.6          11.1
SM&A Expense as a percent of
sales                                       24.7 %             23.4 %
Business Realignment and
Impairment Charges, net                      6.8                3.3         107.4
EBIT                                       391.8              334.5          17.1
EBIT Margin                                 21.4 %             19.3 %
Interest Expense, net                       23.6               24.0          (1.6 )
Provision for Income Taxes                 126.3              111.8          12.9
Effective Income Tax Rate                   34.3 %             36.0 %
Net Income                        $        241.9     $        198.7          21.8
Net Income Per Share-Diluted      $         1.06     $         0.87          21.8

Results of Operations - First Quarter 2013 vs. First Quarter 2012 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 5.5% in the first quarter of 2013 over the comparable period of 2012 due primarily to sales volume increases of 5.3% and net price realization of 0.5%. Sales volume increases were primarily associated with higher sales of Brookside products reflecting expanded distribution in the United States, along with incremental sales from new products, also primarily in the United States. Unfavorable foreign currency exchange rates reduced net sales by 0.3%.


Key Marketplace Metrics
For the twelve-week period ending March 23, 2013, consumer takeaway increased 9.4% in 2013 compared with the same period of 2012. Excluding the impact of Easter seasonal sales, consumer takeaway increased 8.6%. Market share in measured channels increased by 1.4 share points in the twelve-week period ending March 23, 2013 compared with the same period of 2012. 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 decreased by approximately 1.1% in the first quarter of 2013 due to lower input costs, supply chain productivity and a favorable sales mix, which together decreased total cost of sales by approximately 6.5%. These decreases were substantially offset by higher costs associated with sales volume increases and supply chain cost inflation, resulting in a total increase to cost of sales of 7.2%. Business realignment and impairment charges of $0.1 million were included in cost of sales in the first quarter of 2013 compared with $19.5 million in the first quarter of 2012, resulting in a reduction in cost of sales of 2.0%.
Gross margin increased by 3.6 percentage points in the first quarter of 2013 primarily as a result of lower input costs, supply chain productivity improvements and price realization, which together improved gross margin by 4.0 percentage points. These improvements were somewhat offset by supply chain cost inflation which reduced gross margin by approximately 1.4 percentage points. The impact of lower business realignment and impairment charges recorded in the first quarter of 2013 compared with the same period of 2012 increased gross margin by 1.1 percentage points.
Selling, Marketing and Administrative
Selling, marketing and administrative expenses increased by 11.1% in the first quarter of 2013 primarily due to higher marketing and employee-related expenses, increased legal fees and incentive compensation costs. These increases were partially offset by lower costs associated with the integration of business acquisitions in the first quarter of 2013 compared with the first quarter of 2012. Advertising costs in the first quarter of 2013 increased by 21.7% from the same period in 2012.
Business Realignment and Impairment Charges Business realignment and impairment charges of $6.8 million associated with the Next Century program were recorded in the first quarter of 2013. These charges were primarily associated with costs for the demolition of a former manufacturing facility.
Business realignment and impairment charges of $3.3 million were recorded in the first quarter of 2012 associated with the Next Century program. The 2012 charges were primarily associated with the relocation and start-up of production lines. Income Before Interest and Income Taxes and EBIT Margin EBIT increased in the first quarter of 2013 compared with the first quarter of 2012 as a result of an increase in gross profit and lower business realignment charges, partially offset by higher selling, marketing and administrative expenses. Net pre-tax business realignment and impairment charges of $7.0 million were recorded in the first quarter of 2013. Net pre-tax business realignment and impairment charges of $23.6 million were recorded in the first quarter of 2012.
EBIT margin increased from 19.3% for the first quarter of 2012 to 21.4% for the first quarter of 2013 due to the increase in gross margin and lower business realignment charges as a percent of sales, partially offset by higher selling, marketing and administrative expenses as a percent of sales. Interest Expense, Net
Net interest expense was lower in the first quarter of 2013 than the comparable period of 2012 as lower interest expense associated with long-term borrowings was substantially offset by lower capitalized interest.


Income Taxes and Effective Tax Rate
Our effective income tax rate was 34.3% for the first quarter of 2013 compared with 36.0% for the first quarter of 2012. The decrease was associated with the 2013 tax law reinstatement of expiring tax benefits, non-recurring discrete items and a favorable shift of income to jurisdictions having lower tax rates. Net Income and Net Income Per Share
Earnings per share-diluted in the first quarter of 2013 increased $0.19, or 21.8%, compared with the first quarter of 2012. Net income was reduced by $4.3 million, or $0.02 per share-diluted, in the first quarter of 2013, and was reduced by $14.9 million, or $0.07 per share-diluted, in the first quarter of 2012 as a result of business realignment and impairment charges. Net income was reduced by $0.5 million, in the first quarter of 2013 and was reduced by $3.8 million, or $0.01 per share-diluted, in the first quarter of 2012 due to integration costs for business acquisitions. Net income was reduced by $1.8 million, or $0.01 per share-diluted, in the first quarter of 2013, and was reduced by $2.6 million, or $0.01 per share-diluted, in the first quarter of 2012 by non-service related pension expenses. Excluding the impact of business realignment and impairment charges, business acquisition costs and non-service related pension expenses, earnings per share-diluted increased $0.13 per share, or 13.5%, in 2013 compared with 2012.
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 three months of 2013, cash and cash equivalents increased by $1.8 million to $730.1 million.
Net cash provided from operating activities was $293.2 million in 2013 and $275.8 million in 2012. The increase was primarily the result of the change in cash provided from (used by) working capital and higher net income in 2013. These increases were substantially offset by a decrease in cash provided by other assets and liabilities, an increase in cash used by excess tax benefits from stock-based compensation, and reduced cash provided from non-cash business realignment charges and depreciation and amortization. Cash provided from changes in other assets and liabilities was $96.0 million for the first three months of 2013 compared with $149.2 million for the same period of 2012. The decrease in the amount of cash provided from other assets and liabilities from 2012 to 2013 primarily reflected the effect of hedging transactions of $68.7 million. Cash used by working capital was $63.9 million in 2013 compared with $129.7 million in 2012. The decrease in cash used by working capital was principally associated with changes in cash used by trade accounts receivable and inventories in 2013 compared with 2012.
During the first three months of 2012, the Company acquired Brookside for approximately $172.9 million. Also during the first three months of 2012, the $9.0 million loan to affiliate was associated with financing the expansion of capacity under our manufacturing agreement in China with Lotte Confectionery Company LTD.
Interest paid was $29.2 million during the first three months of 2013 versus $31.4 million for the comparable period of 2012. The decrease in interest paid in 2013 was due to the lower outstanding debt balance in 2013. Income taxes paid were $0.1 million during the first three months of 2013 versus $7.6 million for the comparable period of 2012. The decrease in taxes paid in 2013 was primarily related to the receipt of a tax refund resulting from a loss on the sale of a former manufacturing facility in Canada.
The ratio of current assets to current liabilities was 1.5:1.0 as of March 31, 2013 and 1.4:1.0 as of December 31, 2012. The capitalization ratio (total short-term and long-term debt as a percent of stockholders' equity, short-term and long-term debt) decreased to 63% as of March 31, 2013 from 65% as of December 31, 2012.
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 March 31, 2013, we had no commercial paper borrowings.


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 2012 Annual Report on Form 10-K for information concerning the key risks to achieving future performance goals. Our results for the first three months of 2013 were strong and we expect to continue our marketplace momentum. The overall macroeconomic environment appears to be improving, but it is difficult to predict consumer sentiment and purchasing patterns. 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 continue to expect 2013 net sales growth of 5% to 7%, including the impact of foreign currency exchange rates. Net sales will be driven primarily by core brand volume growth, the U.S. launch of the Brookside product line in the food, drug and mass channels, as well as the introduction of new products such as Kit Kat minis, Twizzlers Bites and Jolly Rancher Bites. In key international markets such as China, we will extend our portfolio of products with the introduction of Hershey's Kisses Deluxe and build our sales of Hershey's chocolate products in instant consumable and take home pack types, which were introduced in the fourth quarter of 2012. In Brazil, manufacturing capacity was increased to support geographic expansion of Hershey's Mais, a chocolate-covered wafer product. We have good visibility into our cost structure and we expect gross margin to increase in 2013, driven by productivity, cost savings initiatives and lower costs for certain major raw materials. Therefore, we now expect 2013 gross margin on a reported basis to increase 260 to 280 basis points and we now expect expansion of adjusted gross margin to be 190 to 210 basis points.
Considering this financial flexibility, we expect to accelerate our investments in 2013 for advertising, go-to-market capabilities and expansion of our Insights Driven Performance initiatives. Advertising is expected to increase approximately 20% versus last year. Advertising spending on core U.S. brands is expected to increase by approximately the same percentage as in 2012. Incremental advertising in 2013 will support the expanded distribution of Brookside products and innovation in both the U.S. and international markets, including increased advertising for the Hershey's brand in China. We expect to continue investments in 2013 to build on the go-to-market capabilities established over the last few years, as well as the consumer insights work underway in key international markets for our five global brands, Hershey's, Reese's, Hershey's Kisses, Jolly Rancher and Ice Breakers, that we believe can gain strong consumer acceptance around the world. Additionally, we will continue to invest in international selling and marketing functions and support new product introductions with increased levels of consumer promotion and sampling to drive trial and repeat purchases. As a result, we anticipate that earnings per share-diluted in accordance with GAAP will increase 22% to 24% in 2013 compared with 2012. Growth in adjusted earnings per share-diluted is now expected to be about 12%, as reflected in the reconciliation of reported to adjusted earnings per share-diluted projections provided below.
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 2012, the Company recorded pre-tax acquisition closing and integration costs of $13.4 million, or $0.04 per share-diluted, related to the Brookside acquisition. In 2012, the Company recorded charges of $76.3 million, or $0.22 per share-diluted, attributable to the Next Century program and $7.5 million, or $0.03 per share-diluted, of non-cash impairment charges associated with the discontinuation of the Tri-US, Inc. nutritional beverages business. Non-service related pension expense of $20.6 million, or $0.06 per share-diluted, was recorded in 2012.
In 2013, the Company expects to record charges of about $10 million to $15 million, or $0.03 to $0.05 per share-diluted, attributable to the Next Century program. Non-service related pension expenses are expected to be $13.2 million, or $0.04 per share-diluted, in 2013.


Below is a reconciliation of 2012 and projected 2013 earnings per share-diluted in accordance with GAAP to non-GAAP 2012 adjusted earnings per share-diluted and projected adjusted earnings per share-diluted for 2013:

                                                                2013
                                                   2012      (Projected)
Reported EPS-Diluted                              $ 2.89    $3.52 - $3.58
Acquisition closing and integration charges         0.04          -
Total Business Realignment and Impairment Charges   0.25     0.03 - 0.05
Non-service related pension expenses                0.06        0.04
Adjusted EPS-Diluted                              $ 3.24    $3.61 - $3.65

Safe Harbor Statement
We are subject to changing economic, competitive, regulatory and technological risks and uncertainties because of the nature of our operations. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, we note the following factors that, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions that we have discussed directly or implied in this report. Many of the forward-looking statements contained in this report may be identified by the use of words such as "intend," "believe," "expect," "anticipate," "should," "planned," "projected," "estimated," and "potential," among others.
The factors that could cause our actual results to differ materially from the results projected in our forward-looking statements include, but are not limited to the following:
Issues or concerns related to the quality and safety of our products, ingredients or packaging could cause a product recall and/or result in harm to the Company's reputation, negatively impacting our operating results;

Increases in raw material and energy costs, along with the availability of adequate supplies of raw materials could affect future financial results;

Price increases may not be sufficient to offset cost increases and maintain profitability, or may result in sales volume declines associated with pricing elasticity;

Market demand for new and existing products could decline;

Increased marketplace competition could hurt our business;

Disruption to our supply chain could impair our ability to produce or deliver our finished products, resulting in a negative impact on our operating results;

Our financial results may be adversely impacted by the failure to successfully execute or integrate acquisitions, divestitures and joint ventures;

Changes in governmental laws and regulations could increase our costs and liabilities or impact demand for our products;

Political, economic, and/or financial market conditions could negatively impact our financial results;

International operations could fluctuate unexpectedly and adversely impact our business;

Disruptions, failures or security breaches of our information technology infrastructure could have a negative impact on our operations;


Future developments related to the investigation by government regulators of alleged pricing practices by members of the confectionery industry and civil antitrust lawsuits in the United States could negatively impact our reputation and our operating results;

Pension costs or funding requirements could increase at a higher than anticipated rate; and

Such other matters as discussed in our Annual Report on Form 10-K for 2012.


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