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HSY > SEC Filings for HSY > Form 10-Q on 7-Aug-2013All Recent SEC Filings

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Form 10-Q for HERSHEY CO


7-Aug-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                  For the Six Months Ended
                                                 Percent                                    Percent
                                                 Change                                     Change
                    June 30,       July 1,      Increase      June 30,       July 1,       Increase
                      2013          2012       (Decrease)       2013          2012        (Decrease)
In millions except per share
amounts
Net Sales          $ 1,508.5     $ 1,414.4          6.7  %   $ 3,335.9     $ 3,146.5          6.0  %
Cost of Sales          789.9         795.9         (0.8 )      1,768.0       1,784.6         (0.9 )
Gross Profit           718.6         618.5         16.2        1,567.9       1,361.9         15.1
Gross Margin            47.6 %        43.7 %                      47.0 %        43.3 %
SM&A Expense           446.1         391.4         14.0          896.8         797.0         12.5
SM&A Expense as a
percent of sales        29.6 %        27.7 %                      26.9 %        25.3 %
Business
Realignment and
Impairment
Charges, net             3.6           4.9        (26.0 )         10.4           8.1         28.1
EBIT                   268.9         222.2         21.0          660.7         556.8         18.7
EBIT Margin             17.8 %        15.7 %                      19.8 %        17.7 %
Interest Expense,
net                     21.1          24.3        (13.4 )         44.7          48.4         (7.5 )
Provision for
Income Taxes            88.3          62.2         41.9          214.6         174.1         23.3
Effective Income
Tax Rate                35.6 %        31.4 %                      34.8 %        34.2 %
Net Income         $   159.5     $   135.7         17.6      $   401.4     $   334.3         20.1
Net Income Per
Share-Diluted      $    0.70     $    0.59         18.6      $    1.77     $    1.46         21.2

Results of Operations - Second Quarter 2013 vs. Second 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 6.7% in the second quarter of 2013 over the comparable period of 2012 due primarily to sales volume increases of 6.6%. Sales volume increases were primarily associated with incremental sales of new products and core brand sales increases in the United States and our key international markets, along with higher sales of Brookside products. Favorable foreign currency exchange rates increased net sales by 0.1%.


Key Marketplace Metrics
For the twelve-week period ending June 15, 2013, consumer takeaway increased 4.3% in 2013 compared with the same period of 2012. Market share in measured channels increased by 1.4 share points in the twelve-week period ending June 15, 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 0.8% in the second 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 7.7%. 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 8.6%. There were no business realignment and impairment charges included in cost of sales in the second quarter of 2013 compared with $13.4 million in the second quarter of 2012, resulting in a reduction in cost of sales of 1.7%. Gross margin increased by 3.9 percentage points in the second quarter of 2013 as a result of lower input costs, supply chain productivity improvements, a favorable sales mix and lower fixed costs as a percentage of sales, which together improved gross margin by 4.7 percentage points. These improvements were offset somewhat by supply chain cost inflation which reduced gross margin by approximately 1.5 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 1.0 percentage point. Selling, Marketing and Administrative
Selling, marketing and administrative expenses increased by 14.0% in the second 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 second quarter of 2013 compared with the second quarter of 2012. Advertising costs in the second quarter of 2013 increased by 22.4% from the same period in 2012.
Business Realignment and Impairment Charges Business realignment and impairment charges of $3.6 million primarily associated with the Next Century program were recorded in the second quarter of 2013. These charges were principally related to costs for the demolition of a former manufacturing facility.
Business realignment and impairment charges of $4.8 million were recorded in the second 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 second quarter of 2013 compared with the second 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 $3.6 million were recorded in the second quarter of 2013. Net pre-tax business realignment and impairment charges of $19.0 million were recorded in the second quarter of 2012.
EBIT margin increased from 15.7% for the second quarter of 2012 to 17.8% for the second 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 second quarter of 2013 than the comparable period of 2012. Lower interest expense was primarily associated with lower interest rates on long-term debt and the impact of the timing of repayments and issuances of long-term debt, partially offset by lower capitalized interest.


Income Taxes and Effective Tax Rate
Our effective income tax rate was 35.6% for the second quarter of 2013 compared with 31.4% for the second quarter of 2012. The lower effective income tax rate in the second quarter of 2012 primarily resulted from favorable adjustments of approximately $11.5 million during the quarter associated with the conclusion of income tax audits for 2007 and 2008.
Net Income and Net Income Per Share
Earnings per share-diluted in the second quarter of 2013 increased $0.11, or 18.6%, compared with the second quarter of 2012. Net income was reduced by $2.2 million, or $0.01 per share-diluted, in the second quarter of 2013, and was reduced by $12.1 million, or $0.05 per share-diluted, in the second quarter of 2012 as a result of business realignment and impairment charges. There was no impact on net income in the second quarter of 2013 from integration costs for business acquisitions. Net income was reduced by $0.9 million, or $0.01 per share-diluted, in the second quarter of 2012 due to integration costs associated with the Brookside acquisition. Net income was reduced by $1.7 million, or $0.01 per share-diluted, in the second quarter of 2013, and was reduced by $2.8 million, or $0.01 per share-diluted, in the second 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 $0.06 per share, or 9.1%, in 2013 compared with 2012.
Results of Operations - First Six Months 2013 vs. First Six Months 2012 Net Sales
Net sales increased 6.0% for the first six months of 2013 over the comparable period of 2012 due to sales volume increases. Sales volume increases reflected incremental sales of new products and core brand sales increases in the U.S., and our key international markets. Higher sales of Brookside products contributed 1.7% to the sales volume increase primarily as a result of expanded distribution in the United States. Net price realization increased net sales by 0.1%, but was offset by the impact of unfavorable foreign currency exchange rates which decreased net sales by the same percentage. Key Marketplace Metrics
For the year-to-date period ended June 15, 2013, consumer takeaway increased 6.8% compared with the same period of 2012. Market share in measured channels increased 1.4 share points in the first six months of 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 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 0.9% in the first six months of 2013 primarily due to lower input costs, supply chain productivity and a favorable sales mix which decreased cost of sales by about 7.1%. The impact of sales volume increases and supply chain cost inflation increased cost of sales by approximately 8.0%. Business realignment and impairment charges of $0.1 million were included in cost of sales in the first six months of 2013 compared with $32.9 million recorded during the first six months of 2012, resulting in a decrease to cost of sales of approximately 1.8%.
Gross margin increased by 3.7 percentage points for the first six months of 2013 primarily as a result of reduced input costs, supply chain productivity improvements, a favorable sales mix and lower fixed costs as a percent of sales, which together improved gross margin by 4.2 percentage points. These improvements were partially offset by supply chain cost inflation of approximately 1.7 percentage points. The impact of lower business realignment and impairment charges recorded in the first six months of 2013 compared with the same period of 2012 increased gross margin by 1.0 percentage points. Selling, Marketing and Administrative
Selling, marketing and administrative expenses increased by 12.5% in the first six months of 2013 primarily due to increased advertising, consumer promotions and marketing research expenses, higher employee-related expenses, increased incentive compensation costs and legal fees. These increases were partially offset by lower business


realignment and acquisition costs compared with the first six months of 2012. Advertising costs in the first six months of 2013 increased by 22.0% from the same period in 2012.
Business Realignment and Impairment Charges Business realignment and impairment charges of $10.4 million associated with the Next Century program were recorded in the first six months of 2013. These charges were primarily related to costs for the demolition of a former manufacturing facility.
Net pre-tax business realignment and impairment charges of $8.1 million were recorded in the first six months 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 six months of 2013 compared with the first six months of 2012 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 $10.6 million were recorded in the first six months of 2013. Net pre-tax business realignment and impairment charges of $42.6 million were recorded in the first six months of 2012.
EBIT margin increased from 17.7% for the first six months of 2012 to 19.8% for the first six months of 2013 due to higher gross margin and lower business realignment and impairment 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 six months of 2013 than the comparable period of 2012 primarily reflecting decreased interest expense associated with reduced short-term borrowings, lower interest rates on long-term debt and the timing of repayments and issuances of long-term debt, partially offset by a decrease in capitalized interest. Income Taxes and Effective Tax Rate
Our effective income tax rate was 34.8% for the first six months of 2013 compared with 34.2% for the first six months of 2012. The lower effective income tax rate in the first six months of 2012 primarily resulted from favorable adjustments associated with the conclusion of income tax audits for 2007 and 2008. We expect our income tax rate for the full year 2013 to be about 35.0%. Net Income and Net Income Per Share
Earnings per share-diluted for the first six months of 2013 were $1.77 compared with $1.46 for the first six months of 2012. Net income was reduced by $6.6 million, or $0.03 per share-diluted, in the first six months of 2013 as a result of business realignment and impairment charges. Net income was reduced by $27.0 million, or $0.12 per share-diluted, in the first six months of 2012 as a result of business realignment and impairment charges. Net income was reduced by $0.6 million in the first six months of 2013 from integration costs for business acquisitions. Net income was reduced by $4.7 million, or $0.2 per share-diluted, in the first six months of 2012 as a result of closing and integration costs for the Brookside acquisition. Net income was reduced by $3.5 million, or $0.01 per share-diluted, associated with non-service related pension expenses in the first six months of 2013 and was reduced by $5.3 million, or $0.02 per share-diluted, in the comparable period of 2012. Excluding the impact of business realignment and impairment charges, business acquisition costs and non-service related pension expenses, earnings per share-diluted increased $0.19 per share, or 11.7%, 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 six months of 2013, cash and cash equivalents decreased by $159.9 million to $568.4 million.
Net cash provided from operating activities was $349.4 million in 2013 and $314.2 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 an increase in cash used by other assets and liabilities, an increase in cash used by excess tax benefits from stock-based compensation and the impact of non-cash business realignment charges and deferred income taxes. Cash used by other assets and liabilities was $51.2 million for the first six months of 2013 compared with $13.8 million for the same period of 2012. The increase in the amount of cash used by other assets and liabilities from 2012 to 2013 primarily reflected the effect of hedging transactions and the timing of payments associated with selling and marketing programs of $108.7 million. These increases were offset by a decrease in cash used by business realignment and impairment charges and timing of payments associated with income taxes of $80.8 million. Cash used by working capital was $60.9 million in 2013 compared with $121.3 million in 2012. The decrease in cash used by working capital was principally associated with changes in cash provided from (used by) trade accounts receivable and inventories in 2013 compared with 2012.
During the first quarter of 2012, the Company acquired Brookside for approximately $172.9 million. Also during the first six months of 2013 and 2012, the Company loaned $16.0 million to an affiliate to finance the expansion of its manufacturing capacity.
In April 2013, we repaid $250.0 million of 5.0% Notes due in 2013. In May 2013, we issued $250 million of 2.625% Notes due in 2023.
Interest paid was $47.7 million during the first six months of 2013 versus $49.2 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 was $190.8 million during the first six months of 2013 versus $218.2 million for the comparable period of 2012. The decrease in taxes paid in 2013 was primarily related to the impact of higher annualized tax benefits associated with stock-based compensation in 2013 compared with 2012 and 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 1.8:1.0 as of June 30, 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 June 30, 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 June 30, 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 six months of 2013 were strong and we expect to continue our marketplace momentum driven by advertising and in-store merchandising and programming for core brands and new products in both U.S. and international markets. 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 now expect 2013 net sales growth of about 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 Hershey's Drops, 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 full-year cost structure and we expect gross margin to increase in 2013, driven by lower input costs, productivity, cost savings initiatives and greater fixed cost volume absorption. Therefore, we now expect 2013 gross margin on a reported basis to increase 300 to 310 basis points and we now expect expansion of adjusted gross margin to be 220 to 230 basis points, after excluding expected charges of approximately $6.0 million in 2013 and actual charges of $49.1 million in 2012 that were included in cost of sales and associated primarily with the Next Century program.


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. 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 in market research, category management and other 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. Therefore, for the full year, we expect selling, marketing and administrative expenses, excluding advertising, to increase at a rate greater than net sales growth, particularly in the third quarter. We anticipate that earnings per share-diluted in accordance with GAAP will increase 24% to 26% in 2013 compared with 2012. Growth in adjusted earnings per share-diluted is now expected to be about 14%, 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 now expected to be $11.3 million, or $0.03 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    $3.60 - $3.65
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        0.03
Adjusted EPS-Diluted                              $ 3.24    $3.68 - $3.71


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

. . .

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