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HSY > SEC Filings for HSY > Form 10-Q on 1-Aug-2014All Recent SEC Filings

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Form 10-Q for HERSHEY CO


1-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Executive Overview and Outlook
This 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 the Risk Factors and other information contained in our 2013 Annual Report on Form 10-K for information concerning the key risks to achieving future performance goals.
For the second quarter of 2014, our revenue increased 4.6% and our net income was up 5.4% as compared to the same period of 2013. The quarter's results improved sequentially versus the first quarter. Our Easter sell through was strong and we expect our seasonal momentum to continue in the second half of the year as retail customer orders for Halloween and Holiday products are solid. In the second quarter, macroeconomic headwinds in the U.S. continued to be an issue for many retailers and consumers. Additionally, as it relates to the instant consumable pack type, increased levels of competitive in-store merchandising and programming from confection and other snack categories had an impact on our sales mix and profitability.
Our gross margin decreased 210 basis points in the second quarter of 2014 as input cost inflation, due primarily to higher dairy costs, and unfavorable sales mix more than offset supply chain productivity, lower pension costs and other cost savings initiatives. As we have disclosed in the past, there is not a well developed futures market to hedge dairy requirements, therefore, volatile and extended dairy price spikes impacted gross margin. Our second quarter earnings before interest and taxes ("EBIT") increased by 3.2%, while EBIT margin decreased by 20 basis points, reflecting lower selling, marketing and administrative expenses. The combination of these factors drove the increase in reported net income and growth of 7.1% in reported earnings per share-diluted. We currently expect 2014 net sales growth to be around the low end of our long range annual target of 5% to 7%, including the impact of foreign currency exchange rates. Over the remainder of the year, we expect net sales growth to be driven by strong Halloween and Holiday seasons as well as the continued roll-out of York Minis and Hershey's Spreads instant consumable, which launched in mid-May, and the fourth quarter introductions of Ice Breakers Cool Blasts Chews and Brookside Crunchy Clusters. Additionally, in the fourth quarter we will begin to ship Reese's Spreads as well as some other yet to be announced new products that will ensure 2015 gets off to a good start. In key international markets, we will continue to build on Hershey's chocolate and Hershey's Kisses momentum and will begin a broader roll-out of Reese's Peanut Butter Cups. We currently expect commodity costs to be greater than last year, resulting in adjusted gross margin that is slightly down versus 2013. Given the timing of new product launches in both North America and international markets, advertising and related consumer marketing expense is expected to increase low-single digits on a percentage basis versus 2013. Selling, marketing and administrative expenses, excluding advertising and related consumer marketing, is estimated to be slightly lower as a percent of net sales, leveraging the investments in go-to-market capabilities established over the last few years. Therefore, we are currently anticipating earnings per share-diluted, as reported in accordance with GAAP, to increase 10% to 13% in 2014 compared with 2013.
We anticipate adjusted earnings per share-diluted growth for the full year to be around the low end of our long-term target of 9% to 11% percent, as reflected in the reconciliation of reported to adjusted earnings per share-diluted projections provided below. This excludes estimated operating results for Shanghai Golden Monkey. Completion of the acquisition is currently expected to occur in the second half of 2014, subject to necessary government and regulatory approvals and satisfaction of other conditions. Upon completion, and excluding integration and transition costs, we expect the impact of the acquisition to be minimal on an adjusted basis in 2014.
On July 15, 2014, we announced a weighted average increase in wholesale prices of approximately 8% across the majority of our U.S., Puerto Rico and export portfolio, effective immediately, to help offset part of the significant increases in input costs, including raw materials, packaging, fuel, utilities and transportation, which we expect to incur in the future. The price increase applies to our instant consumable, multi-pack, packaged candy and grocery lines. Direct buying customers will be able to purchase transitional amounts of product into August, and we do not expect seasonal net price realization until Halloween 2015. Given this timing, we do not expect this action to materially impact our financial results this year. Instead, we expect the majority of the financial benefit from this pricing action to impact our earnings in 2015. As we have disclosed in the past, there is typically 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. NOTE: In the outlook section above, the Company has provided earnings per share measures excluding certain items. 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 2013, the Company recorded pre-tax acquisition closing and integration costs of $4.1 million, or $0.03 per share-diluted, related primarily to the Shanghai Golden Monkey acquisition. In 2013, the Company recorded charges of $19.0 million, or $0.05 per share-diluted, attributable to the Next Century program and $10.9 million, or $0.03 per share-diluted, of non-service related pension expense.
In 2014, the Company expects to record charges of approximately $18 million to $23 million, or $0.05 to $0.07 per share-diluted, principally related to acquisition and transaction costs for the Shanghai Golden Monkey acquisition. Charges attributable to the Next Century program are expected to be $0.01 to $0.02 per share-diluted, while non-service related pension income is expected to be a benefit of $0.01 to $0.02 per share-diluted.
Below is a reconciliation of full-year 2013 and projected 2014 earnings per share-diluted as reported in accordance with GAAP to non-GAAP 2013 adjusted earnings per share-diluted and projected adjusted earnings per share-diluted for 2014:

                                                             2014
                                              2013       (Projected)
Reported EPS-Diluted                         $ 3.61     $3.98 - $4.08
Acquisition closing and integration charges    0.03      0.05 - 0.07
Business realignment charges                   0.05      0.01 - 0.02
Non-service related pension expense (income)   0.03    (0.01) to (0.02)
Adjusted EPS-Diluted                         $ 3.72     $4.05 - $4.13


SUMMARY OF OPERATING RESULTS
                                   Three Months Ended                         Six Months Ended
                                                       Percent                                   Percent
                                                       Change                                    Change
                          June 29,      June 30,      Increase      June 29,      June 30,      Increase
                            2014          2013       (Decrease)       2014          2013       (Decrease)
In millions except per share amounts
Net Sales                $ 1,578.4     $ 1,508.5          4.6  %   $ 3,450.2     $ 3,335.9          3.4  %
Cost of Sales                860.9         789.9          9.0        1,861.2       1,768.0          5.3
Gross Profit                 717.5         718.6         (0.2 )      1,589.0       1,567.9          1.3
Gross Margin                  45.5 %        47.6 %                      46.1 %        47.0 %
Selling, Marketing &
Administrative ("SM&A")
Expense                      438.8         446.1         (1.6 )        903.7         896.7          0.8
SM&A Expense as a
percent of sales              27.8 %        29.6 %                      26.2 %        26.9 %
Business Realignment
Charges, net                   1.2           3.6        (65.2 )          4.2          10.4        (60.0 )
EBIT                         277.5         268.9          3.2          681.1         660.7          3.1
EBIT Margin                   17.6 %        17.8 %                      19.7 %        19.8 %
Interest Expense, net         20.7          21.1         (1.7 )         42.0          44.7         (6.1 )
Provision for Income
Taxes                         88.6          88.3          0.3          218.4         214.6          1.8
Effective Income Tax
Rate                          34.5 %        35.6 %                      34.2 %        34.8 %
Net Income               $   168.2     $   159.5          5.4      $   420.7     $   401.4          4.8
Net Income Per
Share-Diluted            $    0.75     $    0.70          7.1      $    1.86     $    1.77          5.1

Note: Percentage changes may not compute directly as shown, due to rounding of the amounts presented above.
Results of Operations - Second Quarter 2014 vs. Second Quarter 2013 Net Sales
Net sales increased 4.6% in the second quarter of 2014 over the comparable period of 2013, driven by higher volume, offset in part by a 0.7% unfavorable impact from foreign currency and higher levels of trade promotion. Excluding foreign currency, our organic net sales growth was 5.3%. The sales volume increase was primarily associated with incremental sales of new products in the United States and core volume growth in our key international markets. New products contributed 60% of our total volume increase in the quarter and included York Minis, Hershey Spreads, and Lancaster Creme Caramels. While new products performed well, our core, non-innovation volume growth of everyday, instant consumable products in the United States moderated, as we competed against increased levels of in-store activity across the broader snack continuum. Net sales outside of the United States and Canada increased by 7.0% due to volume increases, partially offset by unfavorable net price realization and foreign exchange impacts. Trade activities have contributed to volume growth in India, China, and certain other Asia markets, while Brazil realized benefits from the later Easter. Mexico net sales declined in the quarter as a result of the difficult macroeconomic environment. Key Marketplace Metrics
The 12-week U.S. candy, mint and gum (CMG) retail takeaway comparison is skewed due to the timing of Easter in 2014 versus 2013. Therefore, reference should be made to the 24-week takeaway comparison in the year-to-date results of operations discussion that follows this quarterly discussion.


Cost of Sales and Gross Margin
Cost of sales increased by 9.0% in the second quarter of 2014 compared to the same period of 2013. Higher commodity and other input costs, higher costs associated with sales volume increases, and unfavorable sales mix increased total cost of sales by approximately 11.4%. These increases were offset in part by supply chain productivity and lower pension costs, which together lowered cost of sales by 2.4%.
Gross margin decreased by 210 basis points in the second quarter of 2014 compared to the same period of 2013. Higher commodity and other input costs, supply chain cost inflation, and unfavorable sales mix together reduced gross profit margin by approximately 350 basis points. These reductions were partially offset by supply chain productivity improvements, lower pension costs, and operating leverage, which together improved gross margin by 140 basis points. Selling, Marketing and Administrative
Total selling, marketing and administrative expenses decreased by 1.6% in the second quarter of 2014 compared to the same period of 2013. Advertising and related consumer marketing expense decreased 4.7% during the quarter. Excluding these advertising and related consumer marketing costs, the second quarter's selling and administrative expenses were flat as compared to the second quarter of 2013. Our selling and administrative expenses increased incrementally during the second quarter of 2014, principally as a result of additional investment in our International businesses and selling resources in North America; however these increases were largely offset by reduced incentive costs, lower legal settlement charges and $5.6 million in foreign currency gains realized on forward contracts related to the manufacturing facility under construction in Johor, Malaysia.
Business Realignment Charges
In the second quarter of 2014 and 2013, we recorded business realignment charges of $1.2 million and $3.6 million, respectively, primarily related to costs for the demolition of a former manufacturing facility, as part of the Next Century program.
Income Before Interest and Income Taxes and EBIT Margin EBIT increased 3.2% in the second quarter of 2014 compared with the second quarter of 2013 due primarily to lower business realignment charges and lower advertising and related consumer marketing costs.
EBIT margin decreased 20 basis points to 17.6% for the second quarter of 2014 from 17.8% for the second quarter of 2013, due to the decrease in gross margin, partially offset by lower selling, marketing and administrative expenses as a percent of sales as well as lower business realignment charges as a percent of sales.
Interest Expense, Net
Net interest expense was $0.4 million lower in the second quarter of 2014 than the comparable period of 2013. We incurred higher interest expense in the 2014 quarter on our long-term notes, since the portion of notes refinanced in 2013 were not outstanding for the full 2013 quarter, which benefited interest expense in the 2013 quarter. However, this increase in interest expense was more than offset by higher interest income earned on short-term investments and a greater level of capitalized interest in 2014.
Income Taxes and Effective Tax Rate
Our effective income tax rate was 34.5% for the second quarter of 2014 compared with 35.6% for the second quarter of 2013. The lower effective income tax rate in 2014 reflects the benefit of favorable effectively settled U.S. audit issues, partially offset by reduced benefits associated with business realignment and acquisition-related costs, relative to the 2013 period.


Net Income and Net Income Per Share
Net income in the second quarter of 2014 increased $8.7 million, or 5.4%, while earnings per share-diluted (EPS) in the second quarter of 2014 increased $0.05, or 7.1%, compared with the second quarter of 2013. The increases in both net income and EPS were driven by higher sales and lower selling, marketing and administrative expenses, offset by higher commodity costs and unfavorable sales mix, as noted above. Our second quarter 2014 EPS also benefited from lower weighted-average shares outstanding, resulting from recent share repurchases pursuant to our Board-approved repurchase program.
Net income and EPS for the second quarter of 2014 include the impacts of 1) $1.3 million, or $0.01 EPS, of acquisition and transaction costs, principally associated with the Shanghai Golden Monkey acquisition, 2) $0.7 million of business realignment charges, with an insignificant impact on EPS, and 3) the benefit of $0.2 million of non-service related pension income, which also had an insignificant impact on EPS. Net income and EPS for the second quarter of 2013 include the impacts of 1) $0.1 million related to acquisition transaction and integration costs, with an insignificant impact on EPS, 2) $2.2 million, or $0.01 EPS, from business realignment charges, and 3) $1.7 million, or $0.01 EPS, of non-service related pension expense. Excluding the impact of these items from the second quarter of 2014 and 2013, net income increased $6.4 million, or 3.9%, and EPS increased $0.04, or 5.6%, also for the reasons noted above. Results of Operations - First Six Months 2014 vs. First Six Months 2013 Net Sales
Net sales increased 3.4% in the first six months of 2014 over the comparable period of 2013, up 4.7% on higher volume, offset in part by a 0.8% unfavorable impact from foreign currency and higher trade promotions. Excluding foreign currency, our organic net sales growth was 4.2%. The sales volume increase was primarily associated with incremental sales of new products in the United States and our key international markets. New products contributing most significantly to our year-over-year increase included Kit Kat Minis, York Minis, Hershey Spreads, and Lancaster Creme Caramels. Net sales outside of the United States and Canada increased by 1.9% due to modest volume increases, partially offset by unfavorable foreign exchange impacts and unfavorable net price realization. Key Marketplace Metrics
For the 24-week period ended June 14, 2014, which included 2014's entire Easter season results, our U.S. CMG retail takeaway increased 2.2% compared with the same period of 2013, which also encompassed that year's entire Easter season results. For the same 24-week period, Hershey's U.S. market share in measured channels was an industry leading 31.1%, unchanged from the comparable prior year period. Consumer takeaway and 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. Hershey's Spreads, the jar and instant consumable pack types, is not captured in the CMG database referenced herein, as Nielsen captures this within grocery items.
Cost of Sales and Gross Margin
Cost of sales increased by approximately 5.3% in the first six months of 2014. Higher commodity and other input costs, higher costs associated with sales volume increases, and unfavorable sales mix increased total cost of sales by approximately 7.2%. These increases were offset in part by supply chain productivity and lower pension costs, which together lowered cost of sales by 1.9%.
Gross margin decreased by 90 basis points in the first six months of 2014 compared to the same period of 2013. Higher commodity and other input costs, supply chain cost inflation, and unfavorable sales mix together reduced gross profit margin by approximately 200 basis points. These reductions were partially offset by supply chain productivity improvements, lower pension costs and operating leverage, which together improved gross margin by 110 basis points. Selling, Marketing and Administrative
Selling, marketing and administrative expenses increased by 0.8% in the first six months of 2014. This includes a reduction of 4% in advertising and related consumer marketing expenses due to the timing of new product launches, a reduction in media production costs and a decision to shift resources to other more productive areas. Despite the decline in advertising and related consumer marketing expenses through the first half, for the full year, advertising gross rating points are on track to increase mid-single digits on a percentage basis versus last year.


Excluding advertising and related consumer marketing costs, selling and administrative expenses increased 2.0%, primarily reflecting higher employee-related expenses and transaction costs associated with the anticipated acquisition of Shanghai Golden Monkey, including $12.4 million relating to our strategy to cap the acquisition price as denominated in U.S. dollars. These costs were partially offset by the $4.6 million gain recorded on the LSFC acquisition and the $5.6 million in foreign currency gains realized on forward contracts related to the manufacturing facility under construction in Johor, Malaysia.
Business Realignment Charges
In the first six months of 2014 and 2013, we recorded business realignment charges of $4.2 million and $10.4 million, respectively, primarily related to costs for the demolition of a former manufacturing facility, as part of the Next Century program.
Income Before Interest and Income Taxes and EBIT Margin EBIT increased 3.1% in the first six months of 2014 compared with the same period of 2013 due primarily to lower business realignment charges and lower advertising and consumer marketing costs.
EBIT margin decreased 10 basis points to 19.7% for the first six months of 2014 from 19.8% for the first six months of 2013, due mainly to lower gross margin, partially offset by lower selling, marketing and administrative expenses as a percent of net sales.
Interest Expense, Net
Net interest expense was $2.7 million lower in the first six months of 2014 than the comparable period of 2013 due to lower interest expense and an increase in capitalized interest. The lower interest expense was primarily associated with a lower interest rate on a portion of our long-term notes that were refinanced in the second quarter of 2013.
Income Taxes and Effective Tax Rate
Our effective income tax rate was 34.2% for the first six months of 2014 compared with 34.8% for the first six months of 2013. The lower effective income tax rate resulted primarily from the benefit of favorable effectively settled U.S. audits in the second quarter of 2014, partially offset by unfavorable shifts of taxable income to higher tax jurisdictions. Net Income and Net Income Per Share
Net income for the first six months of 2014 increased $19.3 million, or 4.8%, while EPS increased $0.09, or 5.1%, compared with the same period of 2013. The increases in both net income and EPS were driven by higher sales, offset by higher commodity costs, unfavorable sales mix, and higher selling, marketing and administrative expenses, as noted above. Our 2014 EPS also benefited from lower weighted-average shares outstanding, resulting from recent share repurchases pursuant to our Board-approved repurchase program.
Net income and EPS for the first six months of 2014 include the impacts of 1) $7.3 million, or $0.03 EPS, of acquisition and transaction costs, 2) $2.6 million, or $0.01 EPS, of business realignment charges, and 3) the benefit of $0.6 million of non-service related pension income, which had an insignificant impact on EPS. Net income and EPS for the first six months of 2013 include the impacts of 1) $0.6 million related to acquisition transaction and integration costs, with an insignificant impact on EPS, 2) $6.6 million, or $0.03 EPS, of business realignment charges, and 3) $3.5 million, or $0.01 EPS, of non-service related pension expense. Excluding the impact of these items from the first six months of 2014 and 2013, net income increased $17.9 million, or 4.3%, and EPS increased $0.09, or 5.0%, also for the reasons noted above.


Liquidity and Capital Resources
Historically, our primary source of financing has been cash generated from operations. Domestic seasonal working capital needs, which typically peak during the summer months, are generally met by utilizing cash on hand and issuing commercial paper. Commercial paper may also 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. At June 29, 2014, we had no commercial paper borrowings, and our cash and cash equivalents totaled $562.6 million, the majority of which was held in the United States. We also held short-term investments, in the form of term deposits with maturities of one-year, totaling $97.2 million.
We generated net cash from operating activities of $171.9 million in the first six months of 2014, $177.5 million less than was generated in the same period of 2013. The decrease in cash generated year-over-year was primarily due to a $89.3 million reduction in accrued liabilities associated with advertising and consumer marketing programs, coupled with higher income tax payments in 2014. We paid income taxes of $266.5 million during the first six months of 2014 versus $190.8 million for the comparable period of 2013, with the increase relating primarily to the timing of estimated tax payments in 2014 compared with 2013 and the receipt of a tax refund in 2013.
We used net cash in investing activities of $235.8 million in the first six months of 2014, $76.3 million more than we used in the same period of 2013, with the increase due mainly to a purchase of short-term investments in 2014. We also received net cash of $10.0 million relating to the LSCF acquisition, as described in Note 2. Business Acquisition, whereby cash acquired in the transaction exceeded the $5.6 million paid for the controlling interest. We used net cash in financing activities of $492.0 million in the first six months of 2014, which was $142.2 million more than we used in the same period of 2013, with the increase due in large part to higher cash dividend payments and share repurchases made at higher average market prices.
On July 23, 2014, our Board of Directors declared a quarterly dividend of $0.535 on the Common Stock, an increase of $0.05 per share, and a dividend of $0.486 on the Class B Common Stock, an increase of $0.051 per share, to be payable on September 15, 2014 to stockholders of record as of August 25, 2014. Recent Accounting Pronouncements
Information on recently adopted and recently issued accounting standards is included in Note 15. Recent Accounting Pronouncements, in Part I, Item 1, Notes to Unaudited Consolidated Financial Statements.


Safe Harbor Statement
We are subject to changing economic, competitive, regulatory and technological risks and uncertainties that could have a material impact on our business, financial condition or results of 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 . . .

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