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HSY > SEC Filings for HSY > Form 10-Q on 1-Nov-2013All Recent SEC Filings

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Form 10-Q for HERSHEY CO


1-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
SUMMARY OF OPERATING RESULTS
              Analysis of Selected Items from Our Income Statement
                              For the Three Months Ended                           For the Nine Months Ended
                                                           Percent                                             Percent
                                                           Change                                              Change
                    September 29,      September 30,      Increase      September 29,      September 30,      Increase
                         2013               2012         (Decrease)          2013               2012         (Decrease)
In millions except per share
amounts
Net Sales          $      1,853.9     $      1,746.7          6.1  %   $      5,189.8     $      4,893.2          6.1  %
Cost of Sales               998.4            1,003.9         (0.6 )           2,766.3            2,788.5         (0.8 )
Gross Profit                855.5              742.8         15.2             2,423.5            2,104.7         15.1
Gross Margin                 46.1 %             42.5 %                           46.7 %             43.0 %
SM&A Expense                482.0              421.0         14.5             1,378.7            1,218.0         13.2
SM&A Expense as a
percent of sales             26.0 %             24.1 %                           26.6 %             24.9 %
Business
Realignment and
Impairment
Charges, net                  2.9               20.1        (85.4 )              13.4               28.2        (52.6 )
EBIT                        370.6              301.7         22.8             1,031.4              858.5         20.1
EBIT Margin                  20.0 %             17.3 %                           19.9 %             17.5 %
Interest Expense,
net                          21.7               24.5        (11.3 )              66.5               72.9         (8.8 )
Provision for
Income Taxes                115.9              100.5         15.3               330.5              274.6         20.4
Effective Income
Tax Rate                     33.2 %             36.2 %                           34.3 %             34.9 %
Net Income         $        233.0     $        176.7         31.8      $        634.4     $        511.0         24.1
Net Income Per
Share-Diluted      $         1.03     $         0.77         33.8      $         2.79     $         2.23         25.1

Results of Operations - Third Quarter 2013 vs. Third Quarter 2012 Net Sales
Net sales increased 6.1% in the third quarter of 2013 over the comparable period of 2012 due to sales volume increases. Sales volume increases were primarily associated with core brand sales increases and incremental sales of new products in the United States and our key international markets, along with higher sales of Brookside products. Net sales outside of the U.S. and Canada increased 14.2%, driven by sales volume increases primarily in our focus markets of China, Mexico and Brazil. Net price realization increased net sales by 0.5% but was offset by unfavorable foreign currency exchange rates which decreased net sales by the same percentage.
Key Marketplace Metrics
For the twelve-week period ending October 5, 2013, consumer takeaway increased 5.0% in 2013 compared with the same period of 2012. Market share in measured channels increased by 0.7 share points in the twelve-week period ending October 5, 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 0.6% in the third quarter of 2013. Lower input costs, supply chain productivity and a favorable sales mix together decreased total cost of sales by approximately 5.9%. These decreases were offset by higher costs associated with sales volume increases and supply chain cost inflation, which increased cost of sales by the same percentage. There were no business realignment and impairment charges included in cost of sales in the third quarter of 2013 compared with $5.2 million in the third quarter of 2012, resulting in a reduction in cost of sales of 0.5%.
Gross margin increased by 3.6 percentage points in the third quarter of 2013. Lower input costs, supply chain productivity improvements, a favorable sales mix, lower fixed costs as a percent of sales and net price realization together improved gross margin by 4.1 percentage points. These improvements were offset somewhat by supply chain cost inflation which reduced gross margin by approximately 0.8 percentage points. The impact of lower business realignment and impairment charges recorded in the third quarter of 2013 compared with the same period of 2012 increased gross margin by 0.2 percentage points. Selling, Marketing and Administrative
Selling, marketing and administrative expenses increased by 14.5% in the third quarter of 2013 due to increased marketing and administrative expenses. Advertising, consumer promotions and other marketing expenses increased 21.0%, supporting core brands and the introduction of new products in the U.S. and international markets. Advertising costs in the third quarter of 2013 increased by 21.8% from the same period in 2012. Selling and administrative expenses increased 10.6% primarily reflecting higher employee-related expenses and increased legal fees, along with the write-off of certain assets associated with the remodeling of office space.
Business Realignment and Impairment Charges Business realignment and impairment charges of $2.9 million primarily associated with the Next Century program were recorded in the third quarter of 2013. These charges were principally related to costs for the demolition of a former manufacturing facility.
Business realignment and impairment charges of $20.1 million were recorded in the third quarter of 2012 associated with the Next Century program. The 2012 charges were primarily associated with a non-cash pension settlement loss of $13.1 million and charges associated with the closure of a manufacturing facility.
Income Before Interest and Income Taxes and EBIT Margin EBIT increased in the third quarter of 2013 compared with the third 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 $3.0 million were recorded in the third quarter of 2013. Net pre-tax business realignment and impairment charges of $25.8 million were recorded in the third quarter of 2012.
EBIT margin increased from 17.3% for the third quarter of 2012 to 20.0% for the third 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 third quarter of 2013 than the comparable period of 2012. Lower interest expense was primarily associated with a decrease in short-term borrowings, partially offset by lower capitalized interest. Income Taxes and Effective Tax Rate
Our effective income tax rate was 33.2% for the third quarter of 2013 compared with 36.2% for the third quarter of 2012. The lower effective income tax rate resulted primarily from the impact of discrete tax items recognized in the third quarter of 2013 and the prior year rate included the unfavorable impact of Pennsylvania state tax legislation enacted in the third quarter of 2012.


Net Income and Net Income Per Share
Earnings per share-diluted in the third quarter of 2013 increased $0.26, or 33.8%, compared with the third quarter of 2012. Net income was reduced by $1.9 million, or $0.01 per share-diluted, in the third quarter of 2013, and 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. There was no impact on net income in the third quarter of 2013 from integration costs for business acquisitions. Net income was reduced by $3.5 million, or $0.02 per share-diluted, in the third quarter of 2012 due to integration costs associated with the Brookside acquisition. Net income was reduced by $1.7 million, in the third quarter of 2013 with no impact on earnings per share-diluted, and was reduced by $2.7 million, or $0.01 per share-diluted, in the third 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 $0.17 per share, or 19.5%, in 2013 compared with 2012.
Results of Operations - First Nine Months 2013 vs. First Nine Months 2012 Net Sales
Net sales increased 6.1% for the first nine months of 2013 over the comparable period of 2012 due primarily to sales volume increases. Sales volume increases of 6.0% reflected core brand sales increases and incremental sales of new products in the United States and our key international markets. Higher sales of Brookside products contributed 1.3% to the sales volume increase primarily as a result of expanded distribution in the United States. Net sales for our businesses outside of the U.S. and Canada increased 10.6% primarily reflecting sales volume gains in our focus markets of China, Mexico and Brazil. Net price realization increased net sales by 0.3%, but was substantially offset by the impact of unfavorable foreign currency exchange rates which decreased net sales by 0.2%.
Key Marketplace Metrics
For the year-to-date period ended October 5, 2013, consumer takeaway increased 6.7% compared with the same period of 2012. Market share in measured channels increased 1.2 share points in the first nine 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 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 first nine months of 2013. Lower input costs, supply chain productivity and a favorable sales mix decreased cost of sales by a total of about 6.6%. The impact of sales volume increases and supply chain cost inflation increased cost of sales by approximately 7.1%. Significantly lower business realignment and impairment charges in the first nine months of 2013 compared with the first nine months of 2012, decreased cost of sales by approximately 1.4%.
Gross margin increased by 3.7 percentage points for the first nine months of 2013. Reduced input costs, supply chain productivity improvements, a favorable sales mix and lower fixed costs as a percent of sales together improved gross margin by 4.2 percentage points. These improvements were partially offset by supply chain cost inflation of approximately 1.3 percentage points. The impact of lower business realignment and impairment charges recorded in the first nine months of 2013 compared with the same period of 2012 increased gross margin by 0.8 percentage points.
Selling, Marketing and Administrative
Selling, marketing and administrative expenses increased by 13.2% in the first nine months of 2013 from the same period in 2012. Advertising, consumer promotions, and other marketing expenses increased 20.1%, supporting core brands and the introduction of new products in the U.S. and international markets. Advertising costs in the first nine months of 2013 increased by 21.9% from the same period in 2012. Selling and administrative expenses increased 9.3% primarily as a result of higher employee-related expenses, increased incentive compensation costs and legal fees, along with the write-off of certain assets associated with the remodeling of office space and increased marketing research expenses. These increases were partially offset by lower business realignment and acquisition costs compared with the first nine months of 2012.


Business Realignment and Impairment Charges Business realignment and impairment charges of $13.4 million associated with the Next Century program were recorded in the first nine 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 $28.2 million were recorded in the first nine months of 2012 associated with the Next Century program. 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. Income Before Interest and Income Taxes and EBIT Margin EBIT increased in the first nine months of 2013 compared with the first nine months of 2012 as a result of higher 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 $13.6 million were recorded in the first nine months of 2013. Net pre-tax business realignment and impairment charges of $68.4 million were recorded in the first nine months of 2012.
EBIT margin increased from 17.5% for the first nine months of 2012 to 19.9% for the first nine 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 nine months of 2013 than the comparable period of 2012 primarily reflecting decreased interest expense associated with reduced short-term borrowings, partially offset by a decrease in capitalized interest.
Income Taxes and Effective Tax Rate
Our effective income tax rate was 34.3% for the first nine months of 2013 compared with 34.9% for the first nine months of 2012. We expect our income tax rate for the full year 2013 to be approximately 34.5%. Net Income and Net Income Per Share
Earnings per share-diluted for the first nine months of 2013 were $2.79 compared with $2.23 for the first nine months of 2012. Net income was reduced by $8.4 million, or $0.04 per share-diluted, in the first nine months of 2013 as a result of business realignment and impairment charges. 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 $5.2 million, or $0.03 per share-diluted, associated with non-service related pension expenses in the first nine months of 2013 and was reduced by $8.0 million, or $0.04 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 $0.36 per share, or 14.4%, 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 nine months of 2013, cash and cash equivalents decreased by $26.9 million to $701.3 million.
Net cash provided from operating activities was $623.7 million in 2013 and $605.9 million in 2012. The increase primarily reflected higher net income in 2013, substantially offset by an increase in cash used by the impact of adjustments for business realignment charges and deferred income taxes, along with contributions to pension and other benefit plans. Cash used by working capital was $268.4 million in 2013 compared with $284.5 million in 2012. The decrease in cash used by working capital was principally associated with the impact of the timing of customer collection patterns on accounts receivable and an increase in accounts payable in 2013 compared with 2012, primarily associated


with manufacturing and commodity purchases. This was substantially offset by an increase in cash used by inventory. Cash provided from other assets and liabilities was $171.6 million for the first nine months of 2013 compared with $184.7 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 a decrease in cash used by hedging transactions and the impact of changes in accrued income taxes and various accrued liabilities totaling $125.9 million. These decreases were substantially offset by the effect of business realignment and impairment charges and the timing of payments associated with income taxes, a total of $112.8 million.
During the first quarter of 2012, the Company acquired Brookside for approximately $172.9 million. Also during the first nine 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 $77.2 million during the first nine months of 2013 versus $82.1 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 $240.3 million during the first nine months of 2013 versus $233.7 million for the comparable period of 2012. The increase in taxes paid in 2013 was primarily related to the impact of higher annualized taxable income in 2013 compared with 2012, which was partially offset by 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 1.9:1.0 as of September 29, 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 59% as of September 29, 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 September 29, 2013, we had no commercial paper borrowings. Recent Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2013-11-Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force) ("ASU No. 2013-11"). ASU No. 2013-11 provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU No. 2013-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU No. 2013-11 will not have a significant impact on our consolidated financial statements.
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 nine months of 2013 were strong and we expect to continue our marketplace momentum. During the remainder of the year, net sales growth will be driven by increased advertising and solid 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 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 310 to 320 basis points and we now expect expansion of adjusted gross margin to be 240 to 250 basis points, after excluding expected charges of approximately $6.1 million in 2013, principally related to non-service related pension expenses, and actual charges of $49.1 million in 2012 that were included in cost of sales and associated primarily with the Next Century program.
We expect to accelerate our investments in 2013 for advertising, go-to-market capabilities and expansion of our Insights Driven Performance initiatives. Advertising is now expected to increase approximately 22% to 23% 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, including a meaningful increase in the fourth quarter of 2013 compared with the prior year. 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 expected to be about 14%, as reflected in the reconciliation of reported to adjusted earnings per share-diluted projections provided below.
As we look to 2014 and beyond, we will continue to focus on U.S. core brands and leverage our scale at retail. Our international business continues to progress and we are optimistic about the potential to accelerate our international presence behind our disciplined approach to organic investments and acquisitions or joint ventures. We believe the investments we have made, and will continue to make, have resulted in an advantaged business model enabling us to deliver predictable and sustainable results. As a result, this gives us the confidence to increase our target for annual long-term earnings per share-diluted growth to 9% to 11%.
In 2014, we will maintain our focus on core brands and continue to drive growth with quality merchandising, programming and advertising. Additionally, we have a solid pipeline of new products, including York Minis, Hershey's spreads and Lancaster Soft Crèmes caramels, and expect innovation to contribute meaningfully to our net sales growth in 2014. Our international business is on track and we expect solid double-digit net sales growth on a percentage basis compared with 2013. Therefore, we expect 2014 net sales growth to be within our 5% to 7% long-term target, including the impact of foreign currency exchange rates. We remain focused on gross margin. We have solid productivity and cost savings initiatives in place and, while early in the planning cycle, we expect gross margin expansion next year that will drive 2014 growth in reported earnings per share-diluted in a range from 10% to 12%. We expect growth in adjusted earnings per share-diluted in the 9% to 11% range, consistent with our revised long-term target, as reflected in the reconciliation of reported to adjusted projections for 2014 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 and 2014 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 and 2014:

                                                       2013            2014
                                        2012        (Projected)     (Projected)
Reported EPS-Diluted                 $    2.89     $3.60 - $3.65   $3.97 - $4.09
Acquisition closing and integration
charges                                   0.04           -               -
Total Business Realignment and
Impairment Charges                        0.25      0.03 - 0.05    0.01
Non-service related pension expenses      0.06         0.03         0.02 - 0.03
Adjusted EPS-Diluted                 $    3.24     $3.68 - $3.71   $4.01 - $4.12

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