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HSY > SEC Filings for HSY > Form 10-K on 21-Feb-2014All Recent SEC Filings

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Form 10-K for HERSHEY CO


21-Feb-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EXECUTIVE OVERVIEW
Results for the year ended December 31, 2013 were strong with increases in net sales, earnings per share and profitability despite continued macroeconomic challenges. Net sales increased 7.6% compared with 2012 due to sales volume increases in the United States and key international markets as we continued our focus on core brands and innovation. Advertising expense increased 21.3% for the year, supporting core brands along with new product launches. Net income and earnings per share-diluted also increased at greater rates than our long-term growth targets. The investments we have made in both productivity and cost savings resulted in a business model that is more efficient and effective, enabling us to deliver predictable, consistent and achievable marketplace and financial performance. We continue to generate strong cash flow from operations and our financial position remains solid. Adjusted Non-GAAP Financial Measures
Our "Management's Discussion and Analysis of Financial Condition and Results of Operations" section includes certain measures of financial performance that are not defined by U.S. generally accepted accounting principles ("GAAP"). For each of these non-GAAP financial measures, we are providing below (1) the most directly comparable GAAP measure; (2) a reconciliation of the differences between the non-GAAP measure and the most directly comparable GAAP measure;
(3) an explanation of why our management believes these non-GAAP measures provide useful information to investors; and (4) additional purposes for which we use these non-GAAP measures. We believe that the disclosure of these non-GAAP measures provides investors with a better comparison of our year-to-year operating results. We exclude the effects of certain items from Income before Interest and Income Taxes ("EBIT"), EBIT margin, Net Income and Income per Share-Diluted-Common Stock ("EPS") when we evaluate key measures of our performance internally, and in assessing the impact of known trends and uncertainties on our business. We also believe that excluding the effects of these items provides a more balanced view of the underlying dynamics of our business. Adjusted non-GAAP financial measures exclude the impacts of charges or credits recorded during the last four years associated with our business realignment initiatives and impairment charges. Non-service-related pension expenses also are excluded for each of the last four years, along with acquisition closing, integration and transaction costs, and a gain on the sale of certain non-core trademark licensing rights in 2011. Non-service-related pension expenses include interest costs, the expected return on pension plan assets, the amortization of actuarial gains and losses, and certain curtailment and settlement losses or credits. Non-service-related pension expenses may be very volatile from year-to-year as a result of changes in interest rates and market returns on pension plan assets. Therefore, we have excluded non-service-related pension expense from our results in accordance with GAAP. We believe that non-GAAP financial results excluding non-service-related pension expenses will provide investors with a better understanding of the underlying profitability of our ongoing business. We believe that the service cost component of our total pension benefit costs closely reflects the operating costs of our business and provides for a better comparison of our operating results from year-to-year. Our most significant defined benefit pension plans were closed to most new participants after 2007, resulting in ongoing service costs that are stable and predictable.


For the years ended December 31,                    2013                                  2012
                                                      Net                                   Net
                                        EBIT        Income        EPS         EBIT        Income       EPS
In millions of dollars except per
share amounts

Results in accordance with GAAP      $ 1,339.7     $  820.5     $ 3.61     $ 1,111.1     $ 660.9     $ 2.89
Adjustments:
Business realignment charges
included in cost of sales ("COS")          0.4          0.2          -          36.4        23.7       0.10
Non-service-related pension
expense included in COS                    5.4          3.3       0.02           8.6         5.3       0.03
Acquisition costs included in COS          0.3          0.2          -           4.1         3.0       0.01
Business realignment charges
included in selling, marketing and
administrative ("SM&A")                      -            -          -           2.4         1.6       0.01
Non-service-related pension
expense included in SM&A                   5.5          3.3       0.01          12.0         7.4       0.03
Acquisition costs included in SM&A         3.8          5.2       0.03           9.3         6.2       0.03
Business realignment and
impairment charges, net                   18.6         11.6       0.05          45.0        31.9       0.14

Adjusted non-GAAP results            $ 1,373.7     $  844.3     $ 3.72     $ 1,228.9     $ 740.0     $ 3.24



For the years ended December 31,                    2011                                 2010
                                                      Net                                  Net
                                        EBIT        Income       EPS         EBIT        Income       EPS
In millions of dollars except per
share amounts

Results in accordance with GAAP      $ 1,055.0     $ 628.9     $ 2.74     $   905.3     $ 509.8     $ 2.21
Adjustments:
Business realignment charges
included in COS                           45.1        28.4       0.12          13.7         8.4       0.04
Non-service-related pension
expense included in COS                      -           -          -           0.9         0.6          -
Business realignment charges
included in SM&A                           5.0         3.0       0.01           1.5         0.9          -
Non-service-related pension
expense included in SM&A                   2.8         2.0       0.01           5.0         3.2       0.02
Gain on sale of trademark
licensing rights included in SM&A        (17.0 )     (11.1 )    (0.05 )           -           -          -
Business realignment and
impairment (credits) charges, net         (0.9 )      (0.5 )        -          83.4        68.6       0.30

Adjusted non-GAAP results            $ 1,090.0     $ 650.7     $ 2.83     $ 1,009.8     $ 591.5     $ 2.57


                                                            Adjusted Non-GAAP Results
Key Annual Performance Measures                          2013          2012         2011
Increase in Net Sales                                      7.6 %         9.3 %        7.2 %
Increase in adjusted EBIT                                 11.8 %        12.7 %        7.9 %
Improvement in adjusted EBIT Margin in basis points
("bps")                                                  70bps         60bps        10bps
Increase in adjusted EPS                                  14.8 %        14.5 %       10.1 %

SUMMARY OF OPERATING RESULTS
Analysis of Selected Items from Our GAAP Income Statement
                                                                               Percent Change
                                                                             Increase (Decrease)
For the years ended
December 31,                      2013          2012          2011         2013-2012      2012-2011
In millions of dollars except per share amounts

Net Sales                      $ 7,146.0     $ 6,644.3     $ 6,080.8           7.6  %          9.3 %
Cost of Sales                    3,865.2       3,784.4       3,548.9           2.1             6.6

Gross Profit                     3,280.8       2,859.9       2,531.9          14.7            13.0

Gross Margin                        45.9 %        43.0 %        41.6 %

SM&A Expense                     1,922.5       1,703.8       1,477.8          12.8            15.3

SM&A Expense as a percent of
sales                               26.9 %        25.6 %        24.3 %

Business Realignment and
Impairment
  Charges (Credits), Net            18.6          45.0          (0.9 )       (58.5 )           N/A

EBIT                             1,339.7       1,111.1       1,055.0          20.6             5.3
EBIT Margin                         18.7 %        16.7 %        17.4 %

Interest Expense, Net               88.4          95.6          92.2          (7.5 )           3.7
Provision for Income Taxes         430.8         354.6         333.9          21.5             6.2

Effective Income Tax Rate           34.4 %        34.9 %        34.7 %

Net Income                     $   820.5     $   660.9     $   628.9          24.1             5.1

Net Income Per Share-Diluted   $    3.61     $    2.89     $    2.74          24.9             5.5


Net Sales
2013 compared with 2012

Net sales increased 7.6% in 2013 compared with 2012 due primarily to sales volume increases. Sales volume increases of 7.8% reflected core brand sales increases and incremental sales of new products in the U.S. and our international businesses. Higher sales of Brookside products contributed approximately 1.3% to the net sales increase. These increases were partially offset by the unfavorable impact of foreign currency exchange rates which reduced net sales by approximately 0.3%. Net sales in U.S. dollars for our businesses outside of the U.S. and Canada increased approximately 15.7% in 2013 compared with 2012, reflecting sales volume increases primarily in our focus markets of China, Mexico and Brazil. Net sales increases for our international businesses were offset somewhat by the impact of unfavorable foreign currency exchange rates.


2012 compared with 2011
Net sales increased 9.3% in 2012 compared with 2011 due to net price realization and sales volume increases in the U.S. and for our international businesses. Net price realization contributed approximately 5.7% to the net sales increase. Sales volume increased net sales by approximately 2.2% due primarily to sales of new products in the U.S. The Brookside acquisition contributed approximately 1.9% to the net sales increase. These increases were partially offset by the unfavorable impact of foreign currency exchange rates which reduced net sales by approximately 0.5%.
Excluding incremental sales from the Brookside acquisition, net sales in the U.S. increased approximately 7.1% compared with 2011, primarily reflecting net price realization, along with sales volume increases from the introduction of new products. Net sales in U.S. dollars for our businesses outside of the U.S. increased approximately 9.1% in 2012 compared with 2011, reflecting sales volume increases and net price realization. Net sales increases for our international businesses were offset somewhat by the impact of unfavorable foreign currency exchange rates.
Key U.S. Marketplace Metrics
For the 52 weeks ended December 31, 2013 2012 2011 Consumer Takeaway Increase 6.3 % 5.7 % 7.8 % Market Share Increase 1.1 0.6 0.8

Consumer takeaway and the change in market share for 2013 and 2012 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.
Consumer takeaway for 2011 is provided for channels of distribution accounting for approximately 80% of our U.S. confectionery retail business. These channels of distribution include food, drug, mass merchandisers, including Wal-Mart Stores, Inc., and convenience stores. The change in market share for 2011 is provided for channels measured by syndicated data which include sales in the food, drug, convenience store and mass merchandiser classes of trade, excluding sales of Wal-Mart Stores, Inc.
Cost of Sales and Gross Margin
2013 compared with 2012
Cost of sales increased 2.1% in 2013 compared with 2012. The impact of sales volume increases and supply chain cost inflation together increased cost of sales by approximately 9.4%. Lower input costs, supply chain productivity improvements and a favorable sales mix reduced cost of sales by approximately 6.3%. Business realignment and impairment charges of $0.4 million were included in cost of sales in 2013, compared with $36.4 million in the prior year, reducing cost of sales by 1.0%.
Gross margin increased by 2.9 percentage points in 2013 compared with 2012. 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 3.9 percentage points. These improvements were partially offset by supply chain cost inflation which reduced gross margin by 1.6 percentage points. The impact of lower business realignment and impairment charges recorded in 2013 compared with 2012 increased gross margin by 0.6 percentage points. 2012 compared with 2011
The cost of sales increase of 6.6% in 2012 compared with 2011 was primarily due to higher input costs, the impact of sales volume increases and higher supply chain costs which together increased cost of sales by approximately 7.1%. The Brookside acquisition further increased cost of sales by approximately 2.0%. Supply chain productivity improvements reduced cost of sales by approximately 2.5%. Business realignment and impairment charges of $36.4 million were included in cost of sales in 2012, compared with $45.1 million in the prior year. Gross margin increased by 1.4 percentage points in 2012 compared with 2011, primarily as a result of price realization and supply chain productivity improvements which together improved gross margin by 4.1 percentage points. These improvements were substantially offset by higher input and supply chain costs which reduced gross margin by a total of 2.9 percentage points. The impact of lower business realignment and impairment charges recorded in 2012 compared with 2011 increased gross margin by 0.2 percentage points.


Selling, Marketing and Administrative
2013 compared with 2012
Selling, marketing and administrative expenses increased $218.7 million or 12.8% in 2013. Contributing to the overall increase was a 19.7% increase in advertising, consumer promotions and other marketing expenses to support core brands and the introduction of new products in the U.S. and international markets. Advertising expenses increased 21.3% compared with 2012. Additionally, selling and administrative expenses increased 8.8% primarily as a result of higher employee-related expenses, increased incentive compensation costs, legal fees and increased marketing research expenses, along with the write-off of certain assets associated with the remodeling of increased office space. There were minimal business realignment charges included in SM&A in 2013 compared with $2.5 million in 2012.
2012 compared with 2011
Selling, marketing and administrative expenses increased $226.0 million or 15.3% in 2012. The increase was primarily a result of increased advertising, marketing research and consumer promotion expenses, higher employee-related expenses, increased incentive compensation costs and expenses associated with the Brookside acquisition. In addition, selling, marketing and administrative costs were reduced in 2011 by a $17.0 million gain on the sale of non-core trademark licensing rights. Advertising expense increased approximately 15.9% compared with 2011. Business realignment charges of $2.5 million were included in selling, marketing and administrative expenses in 2012 compared with $5.0 million in 2011.
Business Realignment and Impairment Charges In June 2010, we announced Project Next Century (the "Next Century program") as part of our ongoing efforts to create an advantaged supply chain and competitive cost structure. As part of the program, production was transitioned from the Company's century-old facility at 19 East Chocolate Avenue in Hershey, Pennsylvania, to an expanded West Hershey facility, which was built in 1992. Production from the 19 East Chocolate Avenue plant, as well as a portion of the workforce, was fully transitioned to the West Hershey facility during 2012. We estimate that the Next Century program will incur total pre-tax charges and non-recurring project implementation costs of $190 million to $200 million. As of December 31, 2013, total costs of $190.4 million have been recorded over the last four years for the Next Century program. Total costs of $16.8 million were recorded during 2013. Total costs of $76.3 million were recorded in 2012, total costs of $43.4 million were recorded in 2011 and total costs of $53.9 million were recorded in 2010.
During 2009, we completed our comprehensive, supply chain transformation program initiated in 2006 (the "global supply chain transformation program"). In December 2012, the Company recorded non-cash asset impairment charges of approximately $7.5 million, primarily associated with the write off of goodwill and other intangible assets of Tri-US, Inc., a subsidiary in which we held a controlling interest.


Charges (credits) associated with business realignment initiatives and impairment recorded during 2013, 2012 and 2011 were as follows:

For the years ended December 31,                        2013         2012         2011
In thousands of dollars

Cost of sales
Next Century program                                 $    402     $ 36,383     $ 39,280
Global supply chain transformation program                  -            -        5,816

Total cost of sales                                       402       36,383       45,096

Selling, marketing and administrative - Next
Century program                                            18        2,446        4,961

Business realignment and impairment charges, net
Next Century program:
Pension settlement loss                                     -       15,787            -
Plant closure expenses                                 16,387       20,780        8,620
Employee separation costs (credits)                         -          914       (9,506 )
India voluntary retirement program                      2,278            -            -
Tri-US, Inc. asset impairment charges                       -        7,457            -

Total business realignment and impairment charges
(credits), net                                         18,665       44,938         (886 )

Total net charges associated with business
realignment initiatives and impairment               $ 19,085     $ 83,767     $ 49,171

Next Century Program
Plant closure expenses of $16.4 million were recorded during 2013, primarily related to costs associated with the demolition of a former manufacturing facility.
The charge of $36.4 million recorded in cost of sales during 2012 related primarily to start-up costs and accelerated depreciation of fixed assets over a reduced estimated remaining useful life associated with the Next Century program. A charge of $2.4 million was recorded in selling, marketing and administrative expenses during 2012 for project administration related to the Next Century program. The level of lump sum withdrawals during 2012 from one of the Company's pension plans by employees retiring or leaving the Company, primarily under the Next Century program, resulted in a non-cash pension settlement loss of $15.8 million. Expenses of $20.8 million were recorded in 2012 primarily related to costs associated with the closure of a manufacturing facility and the relocation of production lines.
The charge of $39.3 million recorded in cost of sales during 2011 related primarily to accelerated depreciation of fixed assets over a reduced estimated remaining useful life associated with the Next Century program. A charge of $5.0 million was recorded in selling, marketing and administrative expenses during 2011 for project administration related to the Next Century program. Plant closure expenses of $8.6 million were recorded in 2011 primarily related to costs associated with the relocation of production lines. Employee separation costs were reduced by $9.5 million during 2011, which consisted of an $11.2 million credit reflecting lower expected costs related to voluntary and involuntary terminations at the two manufacturing facilities and a net benefits curtailment loss of $1.7 million also related to the employee terminations. Global Supply Chain Transformation Program The charge of $5.8 million recorded in 2011 was due to a decline in the estimated net realizable value of two properties being held for sale.


Tri-US, Inc. Impairment Charges
In February 2011, we acquired a 49% interest in Tri-US, Inc. of Boulder, Colorado, a company that manufactured, marketed and sold nutritional beverages under the "mix1" brand name. We invested $5.8 million and accounted for this investment using the equity method until January 2012. In January 2012, we made an additional investment of $6.0 million in Tri-US, Inc., resulting in a controlling ownership interest of approximately 69%. In December 2012, the Board of Directors of Tri-US, Inc. decided to immediately cease operations and dissolve the company as a result of operational difficulties, quality issues and competitive constraints. It was determined that investments necessary to continue the business would not generate a sufficient return. Accordingly, in December 2012, the Company recorded non-cash asset impairment charges of approximately $7.5 million, primarily associated with the write off of goodwill and other intangible assets. These charges excluded the portion of the losses attributable to the noncontrolling interests.
Liabilities Associated with Business Realignment Initiatives As of December 31, 2013, there was no remaining liability balance relating to the Next Century program. We made payments against the liabilities recorded for the Next Century program of $7.6 million in 2013 and $12.8 million in 2012 related to employee separation and project administration costs. Income Before Interest and Income Taxes and EBIT Margin 2013 compared with 2012
EBIT increased in 2013 compared with 2012 as a result of higher gross profit and lower business realignment charges, partially offset by higher selling, marketing and administrative expenses. Pre-tax net business realignment and impairment charges of $19.1 million were recorded in 2013 compared with $83.8 million recorded in 2012.
EBIT margin increased from 16.7% in 2012 to 18.7% in 2013 as a result of higher gross margin and lower business realignment charges, partially offset by higher selling, marketing and administrative expenses as a percent of sales. The net impact of business realignment, impairment and acquisition charges recorded in 2013 reduced EBIT margin by 0.3 percentage points. Net business realignment and impairment charges recorded in 2012 reduced EBIT margin by 1.3 percentage points.
2012 compared with 2011
EBIT increased in 2012 compared with 2011 as a result of higher gross profit, substantially offset by higher selling, marketing and administrative expenses, and business realignment and impairment charges. Pre-tax net business realignment and impairment charges of $83.8 million were recorded in 2012 compared with $49.2 million recorded in 2011.
EBIT margin decreased from 17.4% in 2011 to 16.7% in 2012 primarily as a result of higher selling, marketing and administrative expenses as a percent of sales and the impact of higher business realignment and impairment costs which more than offset the increase in gross margin. EBIT margin in 2012 was reduced by 0.3 percentage points compared with 2011 as a result of the gain on the sale of trademark licensing rights recorded in 2011. The net impact of business realignment, impairment and acquisition charges recorded in 2012 reduced EBIT margin by 1.3 percentage points. Net business realignment and impairment charges recorded in 2011 reduced EBIT margin by 0.8 percentage points. Interest Expense, Net
2013 compared with 2012
Net interest expense in 2013 was lower than in 2012 primarily as a result of lower short-term borrowings, partially offset by a decrease in capitalized interest and higher interest expense on long-term debt. 2012 compared with 2011
Net interest expense in 2012 was higher than in 2011 primarily as a result of higher short-term borrowings and a decrease in capitalized interest, partially offset by lower interest expense on long-term debt.


Income Taxes and Effective Tax Rate
2013 compared with 2012
Our effective income tax rate was 34.4% for 2013 compared with 34.9% for 2012. The decrease in the effective income tax rate in 2013 reflected lower state income taxes, which were higher in 2012 as a result of the impact of certain state tax legislation, and an increase in deductions associated with certain foreign tax jurisdictions, partially offset by a higher benefit in 2012 resulting from the completion of tax audits. 2012 compared with 2011
Our effective income tax rate was 34.9% for 2012 compared with 34.7% for 2011. The effective income tax rate was slightly higher in 2012 primarily reflecting the impact of tax rates associated with business realignment and impairment charges recorded in 2012 compared with 2011 and the mix of the Company's income among various tax jurisdictions.
Net Income and Net Income Per Share
2013 compared with 2012
Earnings per share-diluted increased $0.72, or 24.9% in 2013 compared with 2012. Net income in 2013 was reduced by $11.8 million, or $0.05 per share-diluted, as a result of net business realignment and impairment charges and, in 2012, was reduced by $57.2 million, or $0.25 per share-diluted. In 2013, net income was reduced by $6.6 million, or $0.03 per share-diluted, as a result of non-service-related pension expenses. Non-service-related pension expenses reduced net income by $12.7 million, or $0.06 per share-diluted in 2012. Excluding the impact of business realignment and impairment charges and non-service-related pension expenses from both periods and the acquisition closing, integration and transaction costs of $5.4 million, or $0.03 per share-diluted, in 2013, and $9.2 million, or $0.04 per share-diluted, in 2012, adjusted earnings per share-diluted increased $0.48 per share, or 14.8% in 2013 compared with 2012.
2012 compared with 2011
Earnings per share-diluted increased $0.15, or 5.5% in 2012 compared with 2011. Net income in 2012 was reduced by $57.2 million, or $0.25 per share-diluted, as a result of net business realignment and impairment charges. Net income was reduced by $9.2 million, or $0.04 per share-diluted, in 2012 as a result of closing and integration costs for the Brookside acquisition and by $12.7 million or $0.06 per share-diluted related to non-service-related pension expenses in 2012. In 2011, net income was increased by $11.1 million, or $0.05 per share-diluted, as a result of the gain on sale of trademark licensing rights and reduced by $30.9 million, or $0.13 per share-diluted, as a result of net business realignment and impairment charges. Non-service-related pension expenses reduced net income by $2.0 million, or $0.01 per share-diluted in 2011. Excluding the impact of business realignment and impairment charges and non-service-related pension expenses from both periods, the acquisition closing . . .

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