Attached files

file filename
EX-32.1 - SECTION 906 CEO AND CFO CERTIFICATION - HERSHEY COhsy_20170402exhibit321.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - HERSHEY COhsy_20170402exhibit312.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - HERSHEY COhsy_20170402exhibit311.htm
EX-12.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - HERSHEY COhsy_20170402exhibit121.htm
EX-10.4 - FORM OF NOTICE OF AWARD OF PERFORMANCE STOCK UNITS (FEBRUARY 22, 2017) - HERSHEY COhsy_20170402exhibit104.htm
EX-10.3 - NONQUALIFIED STOCK OPTION AWARDS UNDER EQUITY AND INCENTIVE COMPENSATION PLAN - HERSHEY COhsy_20170402exhibit103.htm
EX-10.2(B) - NOTICE OF SPECIAL AWARD OF RESTRICTED STOCK UNITS (3-YEAR CLIFF, 02-22-2017) - HERSHEY COhsy_20170402exhibit102b.htm
EX-10.2(A) - NOTICE OF SPECIAL AWARD OF RESTRICTED STOCK UNITS (PRO-RATA, 02-22-2017) - HERSHEY COhsy_20170402exhibit102a.htm
EX-10.1 - FORM OF NOTICE OF AWARD OF RESTRICTED STOCK UNITS (FEBRUARY 22, 2017) - HERSHEY COhsy_20170402exhibit101.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 2, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period
from ______to_______

Commission file number 1-183
 
THE HERSHEY COMPANY
(Exact name of registrant as specified in its charter)
    
Delaware
 
23-0691590
(State or other jurisdiction of incorporation
or organization)
 
(I.R.S. Employer Identification No.)
100 Crystal A Drive, Hershey, PA
17033
(Address of principal executive offices)
(Zip Code)
717-534-4200
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
 
Accelerated filer
¨
 
Smaller reporting company
¨
 
 
 
 
 
 
 
 
 
 
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
 
Emerging growth company
¨
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No  x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.
Common Stock, one dollar par value—152,166,921 shares, as of April 21, 2017.
Class B Common Stock, one dollar par value—60,619,777 shares, as of April 21, 2017.






THE HERSHEY COMPANY
Quarterly Report on Form 10-Q
For the Period Ended April 2, 2017

TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




2



PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
 
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Net sales
 
$
1,879,678

 
$
1,828,812

Cost of sales
 
973,118

 
1,011,436

Gross profit
 
906,560

 
817,376

Selling, marketing and administrative expense
 
461,900

 
471,734

Long-lived asset impairment charges
 
208,712

 

Business realignment costs
 
44,017

 
6,133

Operating profit
 
191,931

 
339,509

Interest expense, net
 
23,741

 
21,005

Other (income) expense, net
 
(171
)
 
(21,225
)
Income before income taxes
 
168,361

 
339,729

Provision for income taxes
 
70,113

 
109,897

Net income including noncontrolling interest
 
98,248

 
229,832

Less: Net loss attributable to noncontrolling interest
 
(26,796
)
 

Net income attributable to The Hershey Company
 
$
125,044

 
$
229,832

 
 
 
 
 
Net income per share—basic:
 
 
 
 
Common stock
 
$
0.60

 
$
1.09

Class B common stock
 
$
0.55

 
$
0.99

 
 
 
 
 
Net income per share—diluted:
 
 
 
 
Common stock
 
$
0.58

 
$
1.06

Class B common stock
 
$
0.55

 
$
0.99

 
 
 
 
 
Dividends paid per share:
 
 
 
 
Common stock
 
$
0.618

 
$
0.583

Class B common stock
 
$
0.562

 
$
0.530


See Notes to Unaudited Consolidated Financial Statements.

3



THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)

 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
 
 
Pre-Tax Amount
 
Tax (Expense) Benefit
 
After-Tax Amount
 
Pre-Tax Amount
 
Tax (Expense) Benefit
 
After-Tax Amount
Net income including noncontrolling interest
 
 
 
 
 
$
98,248

 
 
 
 
 
$
229,832

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
$
13,951

 
$

 
13,951

 
$
12,166

 
$

 
12,166

Pension and post-retirement benefit plans:
 
 
 
 
 
 
 
 
 
 
 
 
Net actuarial loss and prior service cost
 
(196
)
 
74

 
(122
)
 

 

 

Reclassification to earnings
 
7,153

 
(2,711
)
 
4,442

 
8,680

 
(3,579
)
 
5,101

Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
Losses on cash flow hedging derivatives
 
(1,499
)
 
179

 
(1,320
)
 
(33,909
)
 
11,765

 
(22,144
)
Reclassification to earnings
 
3,033

 
(1,166
)
 
1,867

 
(7,909
)
 
2,997

 
(4,912
)
Total other comprehensive income (loss), net of tax
 
$
22,442

 
$
(3,624
)
 
18,818

 
$
(20,972
)
 
$
11,183

 
(9,789
)
Total comprehensive income including noncontrolling interest
 
 
 
 
 
$
117,066

 
 
 
 
 
$
220,043

Comprehensive income (loss) attributable to noncontrolling interest
 
 
 
 
 
(26,456
)
 
 
 
 
 
(1,076
)
Comprehensive income attributable to The Hershey Company
 
 
 
 
 
$
143,522

 
 
 
 
 
$
221,119


See Notes to Unaudited Consolidated Financial Statements.

4



THE HERSHEY COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
April 2, 2017
 
December 31, 2016
ASSETS
 
(unaudited)
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
235,031

 
$
296,967

Accounts receivable—trade, net
 
595,779

 
581,381

Inventories
 
795,404

 
745,678

Prepaid expenses and other
 
247,647

 
192,752

Total current assets
 
1,873,861

 
1,816,778

Property, plant and equipment, net
 
2,050,439

 
2,177,248

Goodwill
 
814,882

 
812,344

Other intangibles
 
381,716

 
492,737

Other assets
 
163,661

 
168,365

Deferred income taxes
 
57,826

 
56,861

Total assets
 
$
5,342,385

 
$
5,524,333

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
499,149

 
$
522,536

Accrued liabilities
 
646,879

 
750,986

Accrued income taxes
 
77,244

 
3,207

Short-term debt
 
487,487

 
632,471

Current portion of long-term debt
 
158

 
243

Total current liabilities
 
1,710,917

 
1,909,443

Long-term debt
 
2,350,941

 
2,347,455

Other long-term liabilities
 
399,575

 
400,161

Deferred income taxes
 
35,499

 
39,587

Total liabilities
 
4,496,932

 
4,696,646

 
 
 
 
 
Stockholders’ equity:
 
 
 
 
The Hershey Company stockholders’ equity
 
 
 
 
Preferred stock, shares issued: none at April 2, 2017 and December 31, 2016
 

 

Common stock, shares issued: 299,281,967 at April 2, 2017 and December 31, 2016
 
299,281

 
299,281

Class B common stock, shares issued: 60,619,777 at April 2, 2017 and December 31, 2016
 
60,620

 
60,620

Additional paid-in capital
 
878,650

 
869,857

Retained earnings
 
6,112,471

 
6,115,961

Treasury—common stock shares, at cost: 147,150,754 at April 2, 2017 and 147,642,009 at December 31, 2016
 
(6,163,534
)
 
(6,183,975
)
Accumulated other comprehensive loss
 
(357,410
)
 
(375,888
)
Total—The Hershey Company stockholders’ equity
 
830,078

 
785,856

Noncontrolling interests in subsidiaries
 
15,375

 
41,831

Total stockholders’ equity
 
845,453

 
827,687

Total liabilities and stockholders’ equity
 
$
5,342,385

 
$
5,524,333


See Notes to Unaudited Consolidated Financial Statements.

5



THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Three Months Ended
 
April 2, 2017
 
April 3, 2016
Operating Activities
 
 
 
Net income including noncontrolling interests
$
98,248

 
$
229,832

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
64,952

 
59,913

Stock-based compensation expense
12,122

 
11,678

Deferred income taxes
(14,780
)
 
(3,409
)
Impairment of long-lived assets (see Note 7)
208,712

 

Write-down of equity investments

 
5,593

Gain on settlement of SGM liability (see Note 2)

 
(26,650
)
Other
11,512

 
3,059

Changes in assets and liabilities, net of business acquisitions:
 
 
 
Accounts receivable—trade, net
(14,398
)
 
55,046

Inventories
(49,726
)
 
(19,412
)
Prepaid expenses and other current assets
(31,232
)
 
(24,303
)
Accounts payable and accrued liabilities
(124,664
)
 
(103,480
)
Accrued income taxes
76,779

 
83,553

Contributions to pension and other benefits plans
(11,576
)
 
(8,839
)
Other assets and liabilities
8,513

 
6,888

Net cash provided by operating activities
234,462

 
269,469

Investing Activities
 
 
 
Capital additions (including software)
(33,297
)
 
(41,439
)
Proceeds from sales of property, plant and equipment
561

 
1,934

Equity investments in tax credit qualifying partnerships
(7,948
)
 
(9,672
)
Net cash used in investing activities
(40,684
)
 
(49,177
)
Financing Activities
 
 
 
Net (decrease) increase in short-term debt
(146,604
)
 
153,863

Repayment of long-term debt
(94
)
 

Payment of SGM liability (see Note 2)

 
(35,762
)
Cash dividends paid
(128,017
)
 
(122,367
)
Repurchase of common stock

 
(303,950
)
Exercise of stock options
17,841

 
24,627

Net cash used in financing activities
(256,874
)
 
(283,589
)
Effect of exchange rate changes on cash and cash equivalents
1,160

 
2,726

Decrease in cash and cash equivalents
(61,936
)
 
(60,571
)
Cash and cash equivalents, beginning of period
296,967

 
346,529

Cash and cash equivalents, end of period
$
235,031

 
$
285,958

Supplemental Disclosure
 
 
 
Interest paid
$
33,732

 
$
27,786

Income taxes paid
7,532

 
29,574


See Notes to Unaudited Consolidated Financial Statements.

6



THE HERSHEY COMPANY
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)

 
Preferred
Stock
 
Common
Stock
 
Class B
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Treasury
Common
Stock
 
Accumulated Other
Comprehensive
Income (Loss)
 
Noncontrolling
Interests in
Subsidiaries
 
Total
Stockholders’
Equity
Balance, December 31, 2016
 
$

 
$
299,281

 
$
60,620

 
$
869,857

 
$
6,115,961

 
$
(6,183,975
)
 
$
(375,888
)
 
$
41,831

 
$
827,687

Net income (loss)
 
 
 
 
 
 
 
 
 
125,044

 
 
 
 
 
(26,796
)
 
98,248

Other comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
18,478

 
340

 
18,818

Dividends (including dividend equivalents):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock, $0.618 per share
 
 
 
 
 
 
 
 
 
(94,466
)
 
 
 
 
 
 
 
(94,466
)
Class B Common Stock, $0.562 per share
 
 
 
 
 
 
 
 
 
(34,068
)
 
 
 
 
 
 
 
(34,068
)
Stock-based compensation
 
 
 
 
 
 
 
11,393

 
 
 
 
 
 
 
 
 
11,393

Exercise of stock options and incentive-based transactions
 
 
 
 
 
 
 
(2,600
)
 
 
 
20,441

 
 
 
 
 
17,841

Balance, April 2, 2017
 
$

 
$
299,281

 
$
60,620

 
$
878,650

 
$
6,112,471

 
$
(6,163,534
)
 
$
(357,410
)
 
$
15,375

 
$
845,453


See Notes to Unaudited Consolidated Financial Statements.

7

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The unaudited consolidated financial statements provided in this report include the accounts of The Hershey Company (the “Company,” “Hershey,” “we” or “us”) and our majority-owned subsidiaries and entities in which we have a controlling financial interest after the elimination of intercompany accounts and transactions. We have a controlling financial interest if we own a majority of the outstanding voting common stock and the noncontrolling shareholders do not have substantive participating rights, or we have significant control over an entity through contractual or economic interests in which we are the primary beneficiary.
The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not contain certain information and disclosures required by GAAP for comprehensive financial statements. The financial statements reflect all adjustments which are, in our opinion, necessary for a fair presentation of the results of operations, financial position, and cash flows for the indicated periods.
Operating results for the quarter ended April 2, 2017 may not be indicative of the results that may be expected for the year ending December 31, 2017 because of seasonal effects on our business. These financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016 (our “2016 Annual Report on Form 10-K”), which provides a more complete understanding of our accounting policies, financial position, operating results and other matters.
Reclassifications
Certain prior period amounts have been reclassified to conform to current year presentation. Specifically, this includes amounts reclassified to conform to the current year presentation in the Consolidated Statements of Cash Flows.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers that supersedes most current revenue recognition guidance. This guidance requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. The new standard was originally effective for us on January 1, 2017; however, in July 2015 the FASB decided to defer the effective date by one year. Early application is not permitted, but reporting entities may choose to adopt the standard as of the original effective date. The standard permits the use of either the retrospective or cumulative effect transition method.
In 2017, we continued our assessment of the new standard with a focus on identifying the performance obligations included within our revenue arrangements with customers and evaluating our methods of estimating the amount and timing of variable consideration. Based on our assessment to date, we do not currently expect adoption of the new standard to have a material impact on our consolidated financial statements. We currently plan to adopt the requirements of the new standard in the first quarter of 2018 utilizing the cumulative effect transition method. We are continuing our assessment, which may identify other impacts.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU will require lessees to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. This ASU also requires certain quantitative and qualitative disclosures. Accounting guidance for lessors is largely unchanged. The amendments should be applied on a modified retrospective basis. ASU 2016-02 is effective for us beginning January 1, 2019. We are in the process of developing an inventory of our lease arrangements in order to determine the impact that the adoption of ASU 2016-02 will have on our consolidated financial statements and related disclosures. Based on our

8

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


assessment to date, we expect adoption of this standard to result in a material increase in lease-related assets and liabilities on our Consolidated Balance Sheets; however, we do not expect it to have a significant impact on our Consolidated Statements of Income or Cash Flows.
In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. We adopted the provisions of this ASU in the first quarter of 2017. This update principally affects the recognition of excess tax benefits and deficiencies and the cash flow classification of share-based compensation-related transactions. The requirement to recognize excess tax benefits and deficiencies as income tax expense or benefit in the income statement was applied prospectively, with a benefit of $1,938 recognized during the three months ended April 2, 2017. Additionally, within the Consolidated Statement of Cash Flows, the impact of the adoption resulted in a $7,886 increase in net cash flow from operating activities and a corresponding decrease in net cash flow from financing activities for the three months ended April 2, 2017. These classification requirements were adopted retrospectively to the Consolidated Statement of Cash Flows for the three months ended April 3, 2016, resulting in a $12,354 increase in net cash flow from operating activities and a corresponding $12,354 decrease in net cash flow from financing activities.
No other new accounting pronouncement issued or effective during the fiscal year had or is expected to have a material impact on our consolidated financial statements or disclosures.
2. BUSINESS ACQUISITIONS
Acquisitions of businesses are accounted for as purchases and, accordingly, the results of operations of the businesses acquired have been included in the consolidated financial statements since the respective dates of the acquisitions. The purchase price for each of the acquisitions is allocated to the assets acquired and liabilities assumed.
2016 Acquisition
Ripple Brand Collective, LLC
On April 26, 2016, we completed the acquisition of all of the outstanding shares of Ripple Brand Collective, LLC, a privately held company based in Congers, New York that owns the barkTHINS mass premium chocolate snacking brand. The barkTHINS brand is largely sold in the United States in take-home resealable packages and is available in the club channel, as well as select natural and conventional grocers. Our consolidated net sales for the year ended December 31, 2016 included approximately $35,600 attributed to barkTHINS.
The purchase consideration was allocated to assets acquired and liabilities assumed based on their respective fair values as follows:
Goodwill
$
128,110

Trademarks
91,200

Other intangible assets
60,900

Other assets, primarily current assets, net of cash acquired totaling $674
12,375

Current liabilities
(7,211
)
Net assets acquired
$
285,374

Goodwill is calculated as the excess of the purchase price over the fair value of the net assets acquired. The goodwill resulting from the acquisition is attributable primarily to the value of leveraging our brand building expertise, consumer insights, supply chain capabilities and retail relationships to accelerate growth and access to barkTHINS products. Acquired trademarks were assigned estimated useful lives of 27 years, while other intangibles, including customer relationships and covenants not to compete, were assigned estimated useful lives ranging from 2 to 14 years. The recorded goodwill, trademarks and other intangibles are expected to be deductible for tax purposes.
Shanghai Golden Monkey (“SGM”)
On February 3, 2016, we completed the purchase of the remaining 20% of the outstanding shares of SGM for cash consideration totaling $35,762, pursuant to a new agreement entered into during the fourth quarter of 2015 with the SGM selling shareholders which revised the originally-agreed purchase price for these shares. For accounting purposes, we treated the acquisition as if we had acquired 100% at the initial acquisition date in 2014 and financed the

9

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


payment for the remaining 20% of the outstanding shares. Therefore, the cash settlement of the liability for the purchase of these remaining shares is reflected within the financing section of the Unaudited Consolidated Statements of Cash Flows.
The final settlement also resulted in an extinguishment gain of $26,650 representing the net carrying amount of the recorded liability in excess of the cash paid to settle the obligation for the remaining 20% of the outstanding shares. This gain is recorded within non-operating other (income) expense, net within the Unaudited Consolidated Statements of Income.
3. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying value of goodwill by reportable segment for the three months ended April 2, 2017 are as follows:
 
 
North America
 
    International and Other
 
Total
Balance at December 31, 2016
 
$
792,190

 
$
20,154

 
$
812,344

Foreign currency translation
 
1,691

 
847

 
2,538

Balance at April 2, 2017
 
793,881

 
21,001

 
814,882

The following table provides the gross carrying amount and accumulated amortization for each major class of intangible asset:
 
 
April 2, 2017
 
December 31, 2016
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Gross Carrying Amount
 
Accumulated Amortization
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
Trademarks
 
$
269,119

 
$
(27,580
)
 
$
317,023

 
$
(30,458
)
Customer-related
 
126,219

 
(28,375
)
 
200,409

 
(36,482
)
Patents
 
16,520

 
(14,209
)
 
16,426

 
(13,700
)
Total
 
411,858

 
(70,164
)
 
533,858

 
(80,640
)
 
 
 
 
 
 
 
 
 
Intangible assets not subject to amortization:
 
 
 
 
 
 
 
 
Trademarks
 
40,022

 
 
 
39,519

 
 
Total other intangible assets
 
$
381,716

 
 
 
$
492,737

 
 

As discussed in Note 7, in February 2017, we commenced the Margin for Growth Program which includes an initiative to optimize the manufacturing operations supporting our China business.  We deemed this to be a triggering event requiring us to test our China long-lived asset group for impairment by first determining whether the carrying value of the asset group was recovered by our current estimates of future cash flows associated with the asset group. Because this assessment indicated that the carrying value was not recoverable, we calculated an impairment loss as the excess of the asset group's carrying value over its fair value. The resulting impairment loss was allocated to the asset group's long-lived assets. Therefore, as a result of this testing, during the three months ended April 2, 2017 we recorded an impairment charge totaling $105,992 representing the portion of the impairment loss that was allocated to the distributor relationship and trademark intangible assets that had been recognized in connection with the 2014 SGM acquisition.
Total amortization expense for the three months ended April 2, 2017 and April 3, 2016 was $7,151 and $5,180, respectively.

10

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


4. SHORT AND LONG-TERM DEBT
Short-term Debt
As a source of short-term financing, we utilize cash on hand and commercial paper or bank loans with an original maturity of three months or less. We maintain a $1.0 billion unsecured revolving credit facility, which currently expires in November 2020. This agreement also includes an option to increase borrowings by an additional $400 million with the consent of the lenders.
The credit agreement contains certain financial and other covenants, customary representations, warranties and events of default. As of April 2, 2017, we were in compliance with all covenants pertaining to the credit agreement, and we had no significant compensating balance agreements that legally restricted these funds. For more information, refer to the Consolidated Financial Statements included in our 2016 Annual Report on Form 10-K.
In addition to the revolving credit facility, we maintain lines of credit with domestic and international commercial banks. We had short-term foreign bank loans against these lines of credit for $140,065 at April 2, 2017 and $158,805 at December 31, 2016. Commitment fees relating to our revolving credit facility and lines of credit are not material.
At April 2, 2017, we had outstanding commercial paper totaling $347,422, at a weighted average interest rate of 0.8%. At December 31, 2016, we had outstanding commercial paper totaling $473,666, at a weighted average interest rate of 0.6%.
Long-term Debt
Long-term debt consisted of the following:
December 31,
 
April 2, 2017
 
December 31, 2016
1.60% Notes due 2018
 
300,000

 
300,000

4.125% Notes due 2020
 
350,000

 
350,000

8.8% Debentures due 2021
 
84,715

 
84,715

2.625% Notes due 2023
 
250,000

 
250,000

3.20% Notes due 2025
 
300,000

 
300,000

2.30% Notes due 2026
 
500,000

 
500,000

7.2% Debentures due 2027
 
193,639

 
193,639

3.375% Notes due 2046
 
300,000

 
300,000

Lease obligations
 
83,985

 
83,619

Net impact of interest rate swaps, debt issuance costs and unamortized debt discounts
 
(11,240
)
 
(14,275
)
Total long-term debt
 
2,351,099

 
2,347,698

Less—current portion
 
158

 
243

Long-term portion
 
$
2,350,941

 
$
2,347,455

Interest Expense
Net interest expense consisted of the following:
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Interest expense
 
$
24,954

 
$
23,525

Capitalized interest
 
(984
)
 
(2,175
)
Interest expense
 
23,970

 
21,350

Interest income
 
(229
)
 
(345
)
Interest expense, net
 
$
23,741

 
$
21,005


11

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


5. DERIVATIVE INSTRUMENTS
We are exposed to market risks arising principally from changes in foreign currency exchange rates, interest rates and commodity prices. We use certain derivative instruments to manage these risks. These include interest rate swaps to manage interest rate risk, foreign currency forward exchange contracts and options to manage foreign currency exchange rate risk, and commodities futures and options contracts to manage commodity market price risk exposures.
In entering into these contracts, we have assumed the risk that might arise from the possible inability of counterparties to meet the terms of their contracts. We mitigate this risk by entering into exchanged-traded contracts with collateral posting requirements and/or by performing financial assessments prior to contract execution, conducting periodic evaluations of counterparty performance and maintaining a diverse portfolio of qualified counterparties. We do not expect any significant losses from counterparty defaults.
Commodity Price Risk
We enter into commodities futures and options contracts and other commodity derivative instruments to reduce the effect of future price fluctuations associated with the purchase of raw materials, energy requirements and transportation services. We generally hedge commodity price risks for 3- to 24-month periods. Our open commodity derivative contracts had a notional value of $609,221 as of April 2, 2017 and $739,374 as of December 31, 2016.
Derivatives used to manage commodity price risk are not designated for hedge accounting treatment. Therefore, the changes in fair value of these derivatives are recorded as incurred within cost of sales. As discussed in Note 11, we define our segment income to exclude gains and losses on commodity derivatives until the related inventory is sold, at which time the related gains and losses are reflected within segment income.  This enables us to continue to align the derivative gains and losses with the underlying economic exposure being hedged and thereby eliminate the mark-to-market volatility within our reported segment income.
Foreign Exchange Price Risk
We are exposed to foreign currency exchange rate risk related to our international operations, including non-functional currency intercompany debt and other non-functional currency transactions of certain subsidiaries. Principal currencies hedged include the euro, Canadian dollar, Japanese yen, and Brazilian real. We typically utilize foreign currency forward exchange contracts and options to hedge these exposures for periods ranging from 3 to 12 months. The contracts are either designated as cash flow hedges or are undesignated. The net notional amount of foreign exchange contracts accounted for as cash flow hedges was $111,589 at April 2, 2017 and $68,263 at December 31, 2016. The effective portion of the changes in fair value on these contracts is recorded in other comprehensive income and reclassified into earnings in the same period in which the hedged transactions affect earnings. The net notional amount of foreign exchange contracts that are not designated as accounting hedges was $2,791 at April 2, 2017 and December 31, 2016. The change in fair value on these instruments is recorded directly in cost of sales or selling, marketing and administrative expense, depending on the nature of the underlying exposure.
Interest Rate Risk
We manage our targeted mix of fixed and floating rate debt with debt issuances and by entering into fixed-to-floating interest rate swaps in order to mitigate fluctuations in earnings and cash flows that may result from interest rate volatility. These swaps are designated as fair value hedges, for which the gain or loss on the derivative and the offsetting loss or gain on the hedged item are recognized in current earnings as interest expense (income), net. At April 2, 2017 and December 31, 2016, we had interest rate derivative instruments in fair value hedging relationships with a total notional amount of $350,000.
In order to manage interest rate exposure, in previous years we utilized interest rate swap agreements to protect against unfavorable interest rate changes relating to forecasted debt transactions. These swaps, which were settled upon issuance of the related debt, were designated as cash flow hedges and the gains and losses that were deferred in other comprehensive income are being recognized as an adjustment to interest expense over the same period that the hedged interest payments affect earnings.

12

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


Equity Price Risk
We are exposed to market price changes in certain broad market indices related to our deferred compensation obligations to our employees. To mitigate this risk, we use equity swap contracts to hedge the portion of the exposure that is linked to market-level equity returns. These contracts are not designated as hedges for accounting purposes and are entered into for periods of 3 to 12 months. The change in fair value of these derivatives is recorded in selling, marketing and administrative expense, together with the change in the related liabilities. The notional amount of the contracts outstanding at April 2, 2017 and December 31, 2016 was $22,099.
The following table presents the classification of derivative assets and liabilities within the Consolidated Balance Sheets as of April 2, 2017 and December 31, 2016:
December 31,
 
April 2, 2017
 
December 31, 2016
 
 
Assets (1)
 
Liabilities (1)
 
Assets (1)
 
Liabilities (1)
Derivatives designated as cash flow hedging instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
1,199

 
$
1,271

 
$
2,229

 
$
809

 
 
 
 
 
 
 
 
 
Derivatives designated as fair value hedging instruments:
 
 
 
 
 
 
 
 
Interest rate swap agreements
 
4,432

 

 
1,768

 

 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Commodities futures and options (2)
 
562

 
3,887

 
2,348

 
10,000

Deferred compensation derivatives
 
1,277

 

 
717

 

Foreign exchange contracts
 

 
41

 

 
16

 
 
1,839

 
3,928

 
3,065

 
10,016

Total
 
$
7,470

 
$
5,199

 
$
7,062

 
$
10,825


(1)
Derivatives assets are classified on our balance sheet within prepaid expenses and other as well as other assets. Derivative liabilities are classified on our balance sheet within accrued liabilities and other long-term liabilities.
(2)
As of April 2, 2017, assets and liabilities include the net of assets of $61,140 and liabilities of $60,946 associated with cash transfers receivable or payable on commodities futures contracts reflecting the change in quoted market prices on the last trading day for the period. The comparable amounts reflected on a net basis in liabilities at December 31, 2016 were assets of $140,885 and liabilities of $150,872. At April 2, 2017 and December 31, 2016, the remaining amount reflected in assets and liabilities relates to the fair value of other non-exchange traded derivative instruments, respectively.


13

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


Income Statement Impact of Derivative Instruments
The effect of derivative instruments on the Consolidated Statements of Income for the three months ended April 2, 2017 and April 3, 2016 was as follows:
 
 
Non-designated Hedges
 
Cash Flow Hedges
 
 
 
 
 
Gains (losses) recognized in income (a)
 
Losses recognized in other comprehensive income (“OCI”) (effective portion)
 
Gains (losses) reclassified from accumulated OCI into income (effective portion) (b)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Commodities futures and options
 
$
(5,536
)
 
$
(38,941
)
 
$

 
$

 
$
(438
)
 
$
9,730

Foreign exchange contracts
 
(95
)
 
(204
)
 
(1,499
)
 
(4,116
)
 
(172
)
 
(261
)
Interest rate swap agreements
 

 

 

 
(29,793
)
 
(2,423
)
 
(1,560
)
Deferred compensation derivatives
 
1,277

 
403

 

 

 

 

Total
 
$
(4,354
)
 
$
(38,742
)
 
$
(1,499
)
 
$
(33,909
)
 
$
(3,033
)
 
$
7,909


(a)
Gains (losses) recognized in income for non-designated commodities futures and options contracts were included in cost of sales. Gains (losses) recognized in income for non-designated foreign currency forward exchange contracts and deferred compensation derivatives were included in selling, marketing and administrative expenses.
(b)
Gains (losses) reclassified from AOCI into income were included in cost of sales for commodities futures and options contracts and for foreign currency forward exchange contracts designated as hedges of purchases of inventory or other productive assets. Other gains (losses) for foreign currency forward exchange contracts were included in selling, marketing and administrative expenses. Losses reclassified from AOCI into income for interest rate swap agreements were included in interest expense.
The amount of pretax net losses on derivative instruments, including interest rate swap agreements, foreign currency forward exchange contracts and options, commodities futures and options contracts, and other commodity derivative instruments expected to be reclassified from AOCI into earnings in the next 12 months was approximately $9,730 as of April 2, 2017. This amount is primarily associated with deferred losses relating to interest rate swap agreements.
Fair Value Hedges
For the three months ended April 2, 2017 and April 3, 2016, we recognized a net pretax benefit to interest expense of $898 and $1,317 relating to our fixed-to-floating interest swap arrangements.
6. FAIR VALUE MEASUREMENTS
Accounting guidance on fair value measurements requires that financial assets and liabilities be classified and disclosed in one of the following categories of the fair value hierarchy:
Level 1 – Based on unadjusted quoted prices for identical assets or liabilities in an active market.
Level 2 – Based on observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3 – Based on unobservable inputs that reflect the entity's own assumptions about the assumptions that a market participant would use in pricing the asset or liability.

We did not have any level 3 financial assets or liabilities, nor were there any transfers between levels during the periods presented.

14

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheets on a recurring basis as of April 2, 2017 and December 31, 2016:
 
 
Assets (Liabilities)
 
 
Level 1
 
Level 2
 
Level 3
 
Total
April 2, 2017:
 
 
 
 
 
 
 
 
Derivative Instruments:
 
 
 
 
 
 
 
 
     Assets:
 
 
 
 
 
 
 
 
           Foreign exchange contracts (1)
 
$

 
$
1,199

 
$

 
$
1,199

           Interest rate swap agreements (2)
 

 
4,432

 

 
4,432

           Deferred compensation derivatives (3)
 

 
1,277

 

 
1,277

           Commodities futures and options (4)
 
562

 

 

 
562

     Liabilities:
 
 
 
 
 
 
 
 
            Foreign exchange contracts (1)
 

 
1,312

 

 
1,312

            Commodities futures and options (4)
 
3,887

 

 

 
3,887

December 31, 2016:
 
 
 
 
 
 
 
 
     Assets:
 
 
 
 
 
 
 
 
           Foreign exchange contracts (1)
 
$

 
$
2,229

 
$

 
$
2,229

           Interest rate swap agreements (2)
 

 
1,768

 

 
1,768

           Deferred compensation derivatives (3)
 

 
717

 

 
717

           Commodities futures and options (4)
 
2,348

 

 

 
2,348

     Liabilities:
 
 
 
 
 
 
 
 
           Foreign exchange contracts (1)
 

 
825

 

 
825

           Commodities futures and options (4)
 
10,000

 

 

 
10,000

(1)
The fair value of foreign currency forward exchange contracts is the difference between the contract and current market foreign currency exchange rates at the end of the period. We estimate the fair value of foreign currency forward exchange contracts on a quarterly basis by obtaining market quotes of spot and forward rates for contracts with similar terms, adjusted where necessary for maturity differences.
(2)
The fair value of interest rate swap agreements represents the difference in the present value of cash flows calculated at the contracted interest rates and at current market interest rates at the end of the period. We calculate the fair value of interest rate swap agreements quarterly based on the quoted market price for the same or similar financial instruments.
(3)
The fair value of deferred compensation derivatives is based on quoted prices for market interest rates and a broad market equity index.
(4)
The fair value of commodities futures and options contracts is based on quoted market prices.
Other Financial Instruments
The carrying amounts of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and short-term debt approximated fair values as of April 2, 2017 and April 3, 2016 because of the relatively short maturity of these instruments.

15

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


The estimated fair value of our long-term debt is based on quoted market prices for similar debt issues and is, therefore, classified as Level 2 within the valuation hierarchy. The fair values and carrying values of long-term debt, including the current portion, were as follows:
 
 
Fair Value
 
Carrying Value
 
 
April 2, 2017
 
December 31, 2016
 
April 2, 2017
 
December 31, 2016
Current portion of long-term debt
 
$
158

 
$
243

 
$
158

 
$
243

Long-term debt
 
2,385,100

 
2,379,054

 
2,350,941

 
2,347,455

Total
 
2,385,258

 
$
2,379,297

 
2,351,099

 
$
2,347,698

Other Fair Value Measurements
In addition to assets and liabilities that are recorded at fair value on a recurring basis, GAAP requires that, under certain circumstances, we also record assets and liabilities at fair value on a nonrecurring basis. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges. During the three months ended April 2, 2017, as discussed in Note 7, we recorded impairment charges totaling $105,992 to write-down distributor relationship and trademark intangible assets that had been recognized in connection with the 2014 SGM acquisition and wrote-down property, plant and equipment by $102,720. These charges were determined by comparing the fair value of the assets to their carrying value. The fair value of the assets were derived using a combination of an estimated market liquidation approach and discounted cash flow analyses based on Level 3 inputs.
7. BUSINESS REALIGNMENT ACTIVITIES
We are currently pursuing several business realignment activities designed to increase our efficiency and focus our business behind our key growth strategies. Costs recorded during the three months ended April 2, 2017 and April 3, 2016 related to these activities are as follows:
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Margin for Growth Program:
 
 
 
 
Severance
 
$
29,567

 
$

Other program costs
 
4,822

 

Operational Optimization Program:
 
 
 
 
Severance
 
13,828

 
7,427

Other program costs
 
(1,229
)
 
5,545

2015 Productivity Initiative:
 
 
 
 
Severance
 

 
(1,294
)
Other program costs
 

 
2,752

Total business realignment costs
 
$
46,988

 
$
14,430

The costs and related benefits to be derived from the Margin for Growth Program relate approximately 20% to the North America segment and 80% to the International and Other segment. The costs and related benefits to be derived from the Operational Optimization Program primarily relate to the North America segment in 2017 and to the International and Other segment in 2016. The costs and related benefits to be derived from the 2015 Productivity Initiative relate primarily to the North American segment. However, segment operating results do not include these business realignment expenses because we evaluate segment performance excluding such costs.
Margin for Growth Program
In February 2017, the Company's Board of Directors unanimously approved several initiatives under a single program designed to drive continued net sales, operating income and earnings per-share diluted growth over the next several years.  This program will focus on improving global efficiency and effectiveness, optimizing the Company’s supply

16

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


chain, streamlining the Company’s operating model and reducing administrative expenses to generate long-term savings. 
The Company estimates that the “Margin for Growth” program will result in total pre-tax charges of $375,000 to $425,000 over the next three years.  This estimate includes plant and office closure expenses of $100,000 to $115,000, net intangible asset impairment charges of $100,000 to $110,000, employee separation costs of $80,000 to $100,000, contract termination costs of approximately $25,000, and other business realignment costs of $70,000 to $75,000. The cash portion of the total charge is estimated to be $175,000 to $200,000. At the conclusion of the program in 2019, ongoing annual savings are expected to be approximately $150,000 to $175,000. The Company expects that implementation of the program will reduce its global workforce by approximately 15%, with a majority of the reductions coming from hourly headcount positions outside of the United States.
The program includes an initiative to optimize the manufacturing operations supporting our China business.  We deemed this to be a triggering event requiring us to test our China long-lived asset group for impairment by first determining whether the carrying value of the asset group was recovered by our current estimates of future cash flows associated with the asset group. Because this assessment indicated that the carrying value was not recoverable, we calculated an impairment loss as the excess of the asset group's carrying value over its fair value. The resulting impairment loss was allocated to the asset group's long-lived assets. Therefore, as a result of this testing, during the three months ended April 2, 2017 we recorded impairment charges totaling $208,712, with $105,992 representing the portion of the impairment loss that was allocated to the distributor relationship and trademark intangible assets that had been recognized in connection with the 2014 SGM acquisition and $102,720 representing the portion of the impairment loss that was allocated to property, plant and equipment. These impairment charges are recorded within the long-lived asset impairment charges caption within the Consolidated Statements of Operations.
During the three months ended April 2, 2017, we also recognized estimated employee severance and related charges totaling $29,567, relating largely to our initiative to improve the cost structure of our China business, as well as our initiative to further streamline our corporate operating model.
2016 Operational Optimization Program
In the second quarter of 2016, we commenced a program (the “Operational Optimization Program”) to optimize our production and supply chain network, which includes select facility consolidations. The program encompasses the continued transition of our China chocolate and SGM operations into a united Golden Hershey platform, including the integration of the China sales force, as well as workforce planning efforts and the consolidation of production within certain facilities in China and North America.
During the three months ended April 2, 2017, we recognized costs of $12,599 primarily related to employee severance associated with the workforce planning efforts within North America. We currently expect to incur additional cash costs of approximately $8,000 over the next two years to complete this program.
During the three months ended April 2, 2017, we reclassified property, plant and equipment and land use rights with a total book value of $20,303 to prepaid and other current assets within the Consolidated Balance Sheets. These represent select China facilities that were taken out of operation in connection with this program and are currently being marketed for sale.
2015 Productivity Initiative
In mid-2015, we initiated a productivity initiative (the “2015 Productivity Initiative”) intended to move decision making closer to the customer and the consumer, to enable a more enterprise-wide approach to innovation, to more swiftly advance our knowledge agenda, and to provide for a more efficient cost structure, while ensuring that we effectively allocate resources to future growth areas. Overall, the 2015 Productivity Initiative was undertaken to simplify the organizational structure to enhance the Company's ability to rapidly anticipate and respond to the changing demands of the global consumer.
The 2015 Productivity Initiative was executed throughout the third and fourth quarters of 2015, resulting in a net reduction of approximately 300 positions, with the majority of the departures taking place by the end of 2015. The 2015 Productivity Initiative was completed during the third quarter 2016. We incurred total costs of $125,031 relating

17

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


to this program, including pension settlement charges of $13,669 recorded in 2016 and $10,178 recorded in 2015 relating to lump sum withdrawals by employees retiring or leaving the Company as a result of this program.
Costs associated with business realignment activities are classified in our Consolidated Statements of Income for the three months ended April 2, 2017 and April 3, 2016 as follows:
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Cost of sales
 
$
490

 
$
(487
)
Selling, marketing and administrative expense
 
2,481

 
8,784

Business realignment costs
 
44,017

 
6,133

Costs associated with business realignment activities
 
$
46,988

 
$
14,430

The following table presents the liability activity for employee-related costs qualifying as exit and disposal costs:
 
Total
Liability balance at December 31, 2016
$
3,725

2017 business realignment charges (1)
45,913

Cash payments
(3,287
)
Other, net
(288
)
Liability balance at April 2, 2017 (reported within accrued and other long-term liabilities)
$
46,063

(1)
The costs reflected in the liability roll-forward above do not include items charged directly to expense, such as accelerated depreciation and amortization and certain of the third-party charges associated with various programs, as those items are not reflected in the business realignment liability in our Consolidated Balance Sheets.
8. INCOME TAXES
The majority of our taxable income is generated in the U.S. and taxed at the U.S. statutory rate of 35%. The effective tax rates for the three months ended April 2, 2017 and April 3, 2016 were 41.6% and 32.3%, respectively. Relative to the statutory rate, the 2017 effective tax rate was impacted by non-benefited costs resulting from the Margin for Growth Program, partially offset by a favorable foreign rate differential relating to our cocoa procurement operations. The 2016 effective rate benefited from the impact of non-taxable income related to the settlement of the SGM liability.
Hershey and its subsidiaries file tax returns in the U.S., including various state and local returns, and in foreign jurisdictions. We believe adequate provision has been made for all income tax uncertainties. We are routinely audited by taxing authorities in our filing jurisdictions, and a number of these audits are currently underway. We reasonably expect reductions in the liability for unrecognized tax benefits of approximately $3,910 within the next 12 months because of the expiration of statutes of limitations and settlements of tax audits.


18

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


9. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
The components of net periodic benefit cost for the three months ended April 2, 2017 were as follows:  
 
 
Pension Benefits
 
Other Benefits
 
 
Three Months Ended
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
 
April 2, 2017
 
April 3, 2016
Service cost
 
$
5,174

 
$
5,884

 
$
65

 
$
74

Interest cost
 
10,299

 
10,835

 
2,208

 
2,436

Expected return on plan assets
 
(14,354
)
 
(14,541
)
 

 

Amortization of prior service (credit) cost
 
(1,456
)
 
(262
)
 
187

 
144

Amortization of net loss (gain)
 
8,422

 
8,807

 

 
(12
)
Total net periodic benefit cost
 
$
8,085

 
$
10,723

 
$
2,460

 
$
2,642


We made contributions of $4,692 and $6,884 to the pension plans and other benefits plans, respectively, during the first quarter of 2017. In the first quarter of 2016, we made contributions of $1,175 and $7,664 to our pension plans and other benefits plans, respectively. The contributions in 2017 and 2016 also included benefit payments from our non-qualified pension plans and post-retirement benefit plans.

For 2017, there are no significant minimum funding requirements for our domestic pension plans and planned voluntary funding of our non-domestic pension plans in 2017 is not material.
10. STOCK COMPENSATION PLANS
We have various stock-based compensation programs under which awards, including stock options, performance stock units (“PSUs”) and performance stock, stock appreciation rights, restricted stock units (“RSUs”) and restricted stock may be granted to employees, non-employee directors and certain service providers upon whom the successful conduct of our business is dependent. These programs and the accounting treatment related thereto are described in Note 10 to the Consolidated Financial Statements included in our 2016 Annual Report on Form 10-K.
For the periods presented, compensation expense for all types of stock-based compensation programs and the related income tax benefit recognized were as follows:
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Pre-tax compensation expense
 
$
12,122

 
$
11,678

Related income tax benefit
 
3,818

 
4,087

Compensation costs for stock compensation plans are primarily included in selling, marketing and administrative expense. As of April 2, 2017, total stock-based compensation cost related to non-vested awards not yet recognized was $95,521 and the weighted-average period over which this amount is expected to be recognized was approximately 2.4 years.

19

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


Stock Options
A summary of activity relating to grants of stock options for the period ended April 2, 2017 is as follows:
Stock Options
Shares
Weighted-Average
Exercise Price (per share)
Weighted-Average Remaining
Contractual Term
Aggregate Intrinsic Value
Outstanding as of December 31, 2016
6,192,008

$
82.67

6.2 years
 
Granted
1,047,725

$
108.06

 
 
Exercised
(367,721
)
$
66.68

 
 
Forfeited
(112,089
)
$
106.25

 
 
Outstanding as of April 2, 2017
6,759,923

$
87.09

6.4 years
$
145,967

Options exercisable as of April 2, 2017
4,383,186

$
79.45

5.0 years
$
128,066

The weighted-average fair value of options granted was $15.78 and $11.42 per share for the periods ended April 2, 2017 and April 3, 2016, respectively. The fair value was estimated on the date of grant using a Black-Scholes option-pricing model and the following weighted-average assumptions:
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Dividend yields
 
2.4
%
 
2.4
%
Expected volatility
 
17.2
%
 
16.8
%
Risk-free interest rates
 
2.2
%
 
1.5
%
Expected term in years
 
6.8

 
6.8

The total intrinsic value of options exercised was $15,181 and $20,348 for the periods ended April 2, 2017 and April 3, 2016, respectively.
Performance Stock Units and Restricted Stock Units
A summary of activity relating to grants of PSUs and RSUs for the period ended April 2, 2017 is as follows:
Performance Stock Units and Restricted Stock Units
 
Number of units
 
Weighted-average grant date fair value
for equity awards (per unit)
Outstanding as of December 31, 2016
 
828,228

 
$102.66
Granted
 
351,793

 
$111.28
Performance assumption change
 
59,846

 
$95.80
Vested
 
(175,088
)
 
$115.05
Forfeited
 
(92,905
)
 
$109.85
Outstanding as of April 2, 2017
 
971,874

 
$101.84
The table above includes 6,410 units of PSUs awarded in a prior period for which the measurement (grant) date has occurred for accounting purposes in 2017.
The following table sets forth information about the fair value of the PSUs and RSUs granted for potential future distribution to employees and non-employee directors. In addition, the table provides assumptions used to determine the fair value of the market-based total shareholder return component using the Monte Carlo simulation model on the date of grant.

20

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Units granted
 
351,793

 
483,678

Weighted-average fair value at date of grant
 
$
111.28

 
$
92.88

Monte Carlo simulation assumptions:
 
 
 
 
Estimated values
 
$
46.85

 
$
38.02

Dividend yields
 
2.3
%
 
2.5
%
Expected volatility
 
20.4
%
 
17.0
%
The fair value of shares vested totaled $18,883 and $16,181 for the periods ended April 2, 2017 and April 3, 2016, respectively.
Deferred PSUs, deferred RSUs and deferred stock units representing directors’ fees totaled 461,338 units as of April 2, 2017. Each unit is equivalent to one share of the Company’s Common Stock.
11. SEGMENT INFORMATION
Our organizational structure is designed to ensure continued focus on North America, coupled with an emphasis on profitable growth in our focus international markets. Our business is organized around geographic regions, which enables us to build processes for repeatable success in our global markets. As a result, we have defined our operating segments on a geographic basis, as this aligns with how our Chief Operating Decision Maker (“CODM”) manages our business, including resource allocation and performance assessment. Our North America business, which generates approximately 89% of our consolidated revenue, is our only reportable segment. None of our other operating segments meet the quantitative thresholds to qualify as reportable segments; therefore, these operating segments are combined and disclosed below as International and Other.
North America - This segment is responsible for our traditional chocolate and non-chocolate confectionery market position, as well as our grocery and growing snacks market positions, in the United States and Canada. This includes developing and growing our business in chocolate and non-chocolate confectionery, pantry, food service and other snacking product lines.
International and Other - International and Other is a combination of all other operating segments that are not individually material, including those geographic regions where we operate outside of North America. We currently have operations and manufacture product in China, Mexico, Brazil, India and Malaysia, primarily for consumers in these regions, and also distribute and sell confectionery products in export markets of Asia, Latin America, Middle East, Europe, Africa and other regions. This segment also includes our global retail operations, including Hershey's Chocolate World stores in Hershey, Pennsylvania, New York City, Las Vegas, Shanghai, Niagara Falls (Ontario), Dubai, and Singapore, as well as operations associated with licensing the use of certain of the Company's trademarks and products to third parties around the world.
For segment reporting purposes, we use “segment income” to evaluate segment performance and allocate resources. Segment income excludes unallocated general corporate administrative expenses, unallocated mark-to-market gains and losses on commodity derivatives, business realignment and impairment charges, acquisition integration costs, the non-service related portion of pension expense and other unusual gains or losses that are not part of our measurement of segment performance. These components of our operating income are managed centrally at the corporate level and are excluded from the measure of segment income reviewed by the CODM as well the measure of segment performance used for incentive compensation purposes.
Accounting policies associated with our operating segments are generally the same as those described in Note 1 to the Consolidated Financial Statements included in our 2016 Annual Report on Form 10-K.
As discussed in Note 5, derivatives used to manage commodity price risk are not designated for hedge accounting treatment. These derivatives are recognized at fair market value with the resulting realized and unrealized losses recognized in unallocated derivative (gains) losses outside of the reporting segment results until the related inventory is sold, at which time the related gains and losses are reallocated to segment income. This enables us to align the

21

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


derivative gains and losses with the underlying economic exposure being hedged and thereby eliminate the mark-to-market volatility within our reported segment income.
Certain manufacturing, warehousing, distribution and other activities supporting our global operations are integrated to maximize efficiency and productivity. As a result, assets and capital expenditures are not managed on a segment basis and are not included in the information reported to the CODM for the purpose of evaluating performance or allocating resources. We disclose depreciation and amortization that is generated by segment-specific assets, since these amounts are included within the measure of segment income reported to the CODM.
Our segment net sales and earnings were as follows:
 
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Net sales:
 
 
 
 
North America
 
$
1,677,146

 
$
1,633,471

International and Other
 
202,532

 
195,341

Total
 
$
1,879,678

 
$
1,828,812

 
 
 
 
 
Segment income (loss):
 
 
 
 
North America
 
$
553,138

 
$
529,390

International and Other
 
1,723

 
(13,233
)
Total segment income
 
554,861

 
516,157

Unallocated corporate expense (1)
 
119,650

 
122,171

Unallocated mark-to-market (gains) losses on commodity derivatives
 
(17,088
)
 
34,946

Long-lived asset impairment charges
 
208,712

 

Costs associated with business realignment activities
 
46,988

 
14,430

Non-service related pension expense
 
4,368

 
5,101

Acquisition and integration costs
 
300

 

Operating profit
 
191,931

 
339,509

Interest expense, net
 
23,741

 
21,005

Other (income) expense, net
 
(171
)
 
(21,225
)
Income before income taxes
 
$
168,361

 
$
339,729

(1)
Includes centrally-managed (a) corporate functional costs relating to legal, treasury, finance, and human resources, (b) expenses associated with the oversight and administration of our global operations, including warehousing, distribution and manufacturing, information systems and global shared services, (c) non-cash stock-based compensation expense, and (d) other gains or losses that are not integral to segment performance.


22

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


Activity within the unallocated mark-to-market (gains) losses on commodity derivatives is as follows:

 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Net losses on mark-to-market valuation of unallocated commodity derivative positions
 
$
5,536

 
$
38,941

Net losses on commodity derivative positions allocated to segment income
 
22,624

 
3,995

Net (gains) losses on mark-to-market valuation of commodity derivative positions remaining in unallocated derivative (gains) losses
 
$
(17,088
)
 
$
34,946

As of April 2, 2017, the cumulative amount of mark-to-market losses on commodity derivatives that had been recognized in our consolidated cost of sales and not yet allocated to reportable segments was $145,937. Based on our forecasts of the timing of the recognition of the underlying hedged items, we expect to reclassify net pre-tax losses on commodity derivatives of $88,675 to segment operating results in the next twelve months.
Depreciation and amortization expense included within segment income presented above is as follows:
 
 
Three Months Ended
 
April 2, 2017
 
April 3, 2016
North America
$
41,237

 
$
38,942

International and Other
12,966

 
10,923

Corporate
10,749

 
10,048

Total
$
64,952

 
$
59,913

12. TREASURY STOCK ACTIVITY
A summary of our treasury stock activity is as follows:

 
Three Months Ended April 2, 2017
 
Shares
 
Dollars
 
 
 
In thousands
Shares issued for stock options and incentive compensation
491,255

 
$
20,441

There were no purchases of our Common Stock during the three months ended April 2, 2017.
In January 2016, our Board of Directors approved a $500,000 authorization to repurchase shares of our Common Stock. As of April 2, 2017, $100,000 remained available for repurchases of our Common Stock under this program. We are authorized to purchase our outstanding shares in open market and privately negotiated transactions. The program has no expiration date and acquired shares of Common Stock will be held as treasury shares. Purchases under approved share repurchase authorizations are in addition to our practice of buying back shares sufficient to offset those issued under incentive compensation plans.


23

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


13. NONCONTROLLING INTEREST
We currently own a 50% controlling interest in Lotte Shanghai Foods Co., Ltd. (“LSFC”), a joint venture established in 2007 in China for the purpose of manufacturing and selling product to the venture partners.
A roll-forward showing the 2017 activity relating to the noncontrolling interest follows:
 
Noncontrolling Interests
Balance, December 31, 2016
$
41,831

Net loss attributable to noncontrolling interests
(26,796
)
Other comprehensive income - foreign currency translation adjustments
340

Balance, April 2, 2017
$
15,375

The 2017 net loss attributable to the noncontrolling interest reflects the 50% allocation of LSFC-related business realignment and impairment costs (see Note 7). For the three months ended April 3, 2016, the net loss attributable to noncontrolling interests totaled $475, which was presented within selling, marketing and administrative expense in the Consolidated Statements of Income since the amount not considered significant.
14. CONTINGENCIES

We are subject to various pending or threatened legal proceedings and claims that arise in the ordinary course of our business. While it is not feasible to predict or determine the outcome of such proceedings and claims with certainty, in our opinion these matters, both individually and in the aggregate, are not expected to have a material effect on our financial condition, results of operations or cash flows.
15. EARNINGS PER SHARE
We compute basic earnings per share for Common Stock and Class B common stock using the two-class method. The Class B common stock is convertible into Common Stock on a share-for-share basis at any time. With respect to dividend rights, the Common Stock holders are entitled to cash dividends 10% higher than those declared and paid on the Class B common stock. The computation of diluted earnings per share for Common Stock assumes the conversion of Class B common stock using the if-converted method, while the diluted earnings per share of Class B common stock does not assume the conversion of those shares.

24

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


We compute basic and diluted earnings per share based on the weighted-average number of shares of Common Stock and Class B common stock outstanding as follows:
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
 
 
Common Stock
 
Class B Common Stock
 
Common Stock
 
Class B Common Stock
Basic earnings per share:
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
Allocation of distributed earnings (cash dividends paid)
 
$
93,949

 
$
34,068

 
$
90,238

 
$
32,129

Allocation of undistributed (losses) earnings
 
(2,183
)
 
(790
)
 
79,376

 
28,089

Total earnings—basic
 
$
91,766

 
$
33,278

 
$
169,614

 
$
60,218

 
 
 
 
 
 
 
 
 
Denominator (shares in thousands):
 
 
 
 
 
 
 
 
Total weighted-average shares—basic
 
152,313

 
60,620

 
155,675

 
60,620

 
 
 
 
 
 
 
 
 
Earnings Per Share—basic
 
$
0.60

 
$
0.55

 
$
1.09

 
$
0.99

 
 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
Allocation of total earnings used in basic computation
 
$
91,766

 
$
33,278

 
$
169,614

 
$
60,218

Reallocation of total earnings as a result of conversion of Class B common stock to Common stock
 
33,278

 

 
60,218

 

Reallocation of undistributed earnings
 

 
(25
)
 

 
(158
)
Total earnings—diluted
 
$
125,044

 
$
33,253

 
$
229,832

 
$
60,060

 
 
 
 
 
 
 
 
 
Denominator (shares in thousands):
 
 
 
 
 
 
 
 
Number of shares used in basic computation
 
152,313

 
60,620

 
155,675

 
60,620

Weighted-average effect of dilutive securities:
 
 
 
 
 
 
 
 
Conversion of Class B common stock to Common shares outstanding
 
60,620

 

 
60,620

 

Employee stock options
 
1,265

 

 
1,005

 

Performance and restricted stock options
 
324

 

 
187

 

Total weighted-average shares—diluted
 
214,522

 
60,620

 
217,487

 
60,620

 
 
 
 
 
 
 
 
 
Earnings Per Share—diluted
 
$
0.58

 
$
0.55

 
$
1.06

 
$
0.99

The earnings per share calculations for the three months ended April 2, 2017 and April 3, 2016 excluded 2,067 and 3,680, respectively, of stock options (in thousands) that would have been antidilutive.
16. OTHER (INCOME) EXPENSE, NET
Other (income) expense, net reports certain gains and losses associated with activities not directly related to our core operations. A summary of the components of other (income) expense, net is as follows:
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Write-down of equity investments in partnerships qualifying for tax credits
 
$

 
$
5,593

Settlement of SGM liability (see Note 2)
 

 
(26,650
)
Other (income) expense, net
 
(171
)
 
(168
)
Total
 
$
(171
)
 
$
(21,225
)


25

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


17. SUPPLEMENTAL BALANCE SHEET INFORMATION
The components of certain Consolidated Balance Sheet accounts are as follows:
 
 
April 2, 2017
 
December 31, 2016
Inventories:
 
 
 
 
Raw materials
 
$
299,484

 
$
315,239

Goods in process
 
115,315

 
88,490

Finished goods
 
562,440

 
528,587

Inventories at FIFO
 
977,239

 
932,316

Adjustment to LIFO
 
(181,835
)
 
(186,638
)
Total inventories
 
$
795,404

 
$
745,678

 
 
 
 
 
Property, plant and equipment:
 
 
 
 
Land
 
$
104,400

 
$
103,865

Buildings
 
1,180,501

 
1,238,634

Machinery and equipment
 
2,948,697

 
3,001,552

Construction in progress
 
206,391

 
230,987

Property, plant and equipment, gross
 
4,439,989

 
4,575,038

Accumulated depreciation
 
(2,389,550
)
 
(2,397,790
)
Property, plant and equipment, net
 
$
2,050,439

 
$
2,177,248

 
 
 
 
 
Other assets:
 
 
 
 
Capitalized software, net
 
$
95,737

 
$
95,301

Income tax receivable
 
1,458

 
1,449

Other non-current assets
 
66,466

 
71,615

Total other assets
 
$
163,661

 
$
168,365

 
 
 
 
 
Accrued liabilities:
 
 
 
 
Payroll, compensation and benefits
 
$
176,704

 
$
240,080

Advertising and promotion
 
320,999

 
358,573

Other
 
149,176

 
152,333

Total accrued liabilities
 
$
646,879

 
$
750,986

 
 
 
 
 
Other long-term liabilities:
 
 
 
 
Post-retirement benefits liabilities
 
$
218,517

 
$
220,270

Pension benefits liabilities
 
61,346

 
65,687

Other
 
119,712

 
114,204

Total other long-term liabilities
 
$
399,575

 
$
400,161

 
 
 
 
 
Accumulated other comprehensive loss:
 
 
 
 
Foreign currency translation adjustments
 
$
(97,002
)
 
$
(110,613
)
Pension and post-retirement benefit plans, net of tax
 
(202,849
)
 
(207,169
)
Cash flow hedges, net of tax
 
(57,559
)
 
(58,106
)
Total accumulated other comprehensive loss
 
$
(357,410
)
 
$
(375,888
)


26



Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This Management's Discussion and Analysis (“MD&A”) is intended to provide an understanding of Hershey's financial condition, results of operations and cash flows by focusing on changes in certain key measures from year to year. The MD&A should be read in conjunction with our Consolidated Financial Statements and accompanying notes. This discussion 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 2016 Annual Report on Form 10-K for information concerning the key risks to achieving future performance goals.
The MD&A is organized in the following sections:
Overview and Outlook
Non-GAAP Information
Consolidated Results of Operations
Segment Results
Liquidity and Capital Resources
The Overview and Outlook presented below is an executive-level summary highlighting the key trends and measures on which the Company’s management focuses in evaluating its financial condition and operating performance. Certain earnings and performance measures within the Overview and Outlook include financial information determined on a non-GAAP basis, which aligns with how management internally evaluates the Company's results of operations, determines incentive compensation, and assesses the impact of known trends and uncertainties on the business. A detailed reconciliation of the non-GAAP financial measures referenced herein to their nearest comparable GAAP financial measures follows this summary. For a detailed analysis of the Company's operations prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), referred to as "reported" herein, refer to the discussion and analysis in the Consolidated Results of Operations.
OVERVIEW AND OUTLOOK
Our first quarter 2017 net sales totaled $1,879.7 million, an increase of 2.8%, versus $1,828.8 million in 2016. Excluding a 0.1% impact from favorable foreign exchange rates, our net sales increased 2.7%. The increase was primarily driven by favorable net price realization as trade promotional spending and returns, discounts and allowances in both our North America and International and Other segments were less than the prior year. Solid U.S. seasonal volume performance was largely offset by lower non-seasonal volumes. Revenue generated by barkTHINS brand, acquired in 2016, also benefited the quarter's performance.
Our reported gross margin was 48.2% in the first quarter of 2017, an increase of 350 basis points compared to the first quarter of 2016. Our non-GAAP gross margin increased 70 basis points in the first quarter of 2017, primarily due to lower levels of trade promotional spending, supply chain productivity and cost savings initiatives and lower commodity input costs, offset in part by increases in other supply chain costs.
In February 2017, the Company's Board of Directors unanimously approved several initiatives under a single program designed to drive continued net sales, operating income and earnings per-share diluted growth over the next several years.  This program will focus on improving global efficiency and effectiveness, optimizing the Company’s supply chain, streamlining the Company’s operating model and reducing administrative expenses to generate long-term savings. 
The Company estimates that this “Margin for Growth” program will result in total pre-tax charges of $375 million to $425 million over the next three years.  This estimate includes plant and office closure expenses of $100 million to $115 million, net intangible asset impairment charges of $100 million to $110 million, employee separation costs of $80 million to $100 million, contract termination costs of approximately $25 million, and other business realignment costs of $70 million to $75 million. The cash portion of the total charge is estimated to be $175 million to $200 million. At the conclusion of the program in 2019, ongoing annual savings are expected to be approximately $150 million to $175 million. The Company expects that implementation of the program will reduce its global workforce by

27



approximately 15%, with a majority of the reductions coming from hourly headcount positions outside of the United States.
Our first quarter 2017 reported net income and earnings per share-diluted (EPS) totaled $125.0 million and $0.58, respectively, compared to the first quarter 2016 reported net income and EPS-diluted of $229.8 million and $1.06, respectively. From a non-GAAP perspective, first quarter 2017 adjusted net income was $282.1 million, an increase of 18.1% versus $238.9 million in 2016, primarily driven by the improvement in our non-GAAP gross margin, as well as a lower non-GAAP effective tax rate, due mainly to a favorable foreign tax rate differential. Our adjusted EPS-diluted for the first quarter of 2017 was $1.31 compared to $1.10 for the same period of 2016, with this 19.1% increase attributable to the same factors driving the increase in non-GAAP net income.
Over the remainder of the year, we remain focused on driving growth in our North America core brands and achieving trial and repeat targets related to the launch of of Hershey’s Cookie Layer Crunch, Reese’s and Hershey’s Crunchers and Reese’s Crunchy Cookie Cups. We anticipate that our innovation, as well as our consumer marketing plans, will enable us to build on our first quarter 2017 momentum.
We currently estimate that full-year 2017 net sales growth will be towards the low end of our 2% to 3% outlook, due primarily to trends within the non-seasonal U.S. CMG category and continued macroeconomic challenges in China. This outlook includes a 0.5% net benefit from acquisitions. The impact of foreign currency exchange rates is expected to be minimal. We currently expect full-year 2017 reported EPS-diluted to be in the $3.31 to $3.55 range. From a non-GAAP perspective, we expect 2017 adjusted EPS-diluted to be towards the high end of our outlook of $4.72 to $4.81, an increase of 7% to 9%, primarily due to gross margin expansion from strong productivity and cost savings initiatives, as well as a lower effective tax rate driven by a favorable foreign rate differential and benefit from tax credits. A reconciliation of reported to adjusted projections for 2017 are reflected in the non-GAAP reconciliations that follow.
NON-GAAP INFORMATION
The comparability of certain of our financial measures is impacted by unallocated mark-to-market (gains) losses on commodity derivatives, costs associated with business realignment activities, costs relating to the integration of acquisitions, non-service related components of our pension expense ("NSRPE"), impairment of long-lived assets, and settlement of the SGM liability in conjunction with the purchase of the remaining 20% of the outstanding shares of SGM.
To provide additional information to investors to facilitate the comparison of past and present performance, we use non-GAAP financial measures within MD&A that exclude the financial impact of these activities. These non-GAAP financial measures are used internally by management in evaluating results of operations and determining incentive compensation, and in assessing the impact of known trends and uncertainties on our business, but they are not intended to replace the presentation of financial results in accordance with GAAP. A reconciliation of the non-GAAP financial measures referenced in MD&A to their nearest comparable GAAP financial measures as presented in the Consolidated Statements of Income is provided below.


28



Reconciliation of Certain Non-GAAP Financial Measures
Consolidated results
Three Months Ended
In thousands except per share data
April 2, 2017
 
April 3, 2016
Reported gross profit
$
906,560

 
$
817,376

Derivative mark-to-market (gains) losses
(17,088
)
 
34,946

Business realignment activities
490

 
(487
)
NSRPE
2,860

 
3,241

Non-GAAP gross profit
$
892,822

 
$
855,076

 
 
 
 
Reported operating profit
$
191,931

 
$
339,509

Derivative mark-to-market (gains) losses
(17,088
)
 
34,946

Business realignment activities
46,988

 
14,430

Acquisition integration costs
300

 

NSRPE
4,368

 
5,101

Long-lived asset impairment charges
208,712

 

Non-GAAP operating profit
$
435,211

 
$
393,986

 
 
 
 
Reported provision for income taxes
$
70,113

 
$
109,897

Derivative mark-to-market (gains) losses*
1,199

 
13,245

Business realignment activities*
11,417

 
3,538

Acquisition integration costs*
114

 

NSRPE*
1,664

 
1,953

Long-lived asset impairment charges*
45,201

 

Non-GAAP provision for income taxes
$
129,708

 
$
128,633

 
 
 
 
Reported net income
$
125,044

 
$
229,832

Derivative mark-to-market (gains) losses
(18,287
)
 
21,701

Business realignment activities
35,571

 
10,860

Acquisition integration costs
186

 

NSRPE
2,704

 
3,148

Long-lived asset impairment charges
163,511

 

Noncontrolling interest share of business realignment and impairment charges
(26,666
)
 

Settlement of SGM liability

 
(26,650
)
Non-GAAP net income
$
282,063

 
$
238,891

 
 
 
 
Reported EPS - Diluted
$
0.58

 
$
1.06

Derivative mark-to-market (gains) losses
(0.09
)
 
0.10

Business realignment activities
0.17

 
0.05

NSRPE
0.01

 
0.01

Long-lived asset impairment charges
0.76

 

Noncontrolling interest share of business realignment and impairment charges
(0.12
)
 

Settlement of SGM liability

 
(0.12
)
Non-GAAP EPS - Diluted
$
1.31

 
$
1.10


* The tax effect for each adjustment is determined by calculating the tax impact of the adjustment on the Company's quarterly effective tax rate.




29



In the assessment of our results, we review and discuss the following financial metrics that are derived from the reported and non-GAAP financial measures presented above:
 
Three Months Ended
 
April 2, 2017
 
April 3, 2016
As reported gross margin
48.2
%
 
44.7
%
Non-GAAP gross margin (1)
47.5
%
 
46.8
%
 
 
 
 
As reported operating profit margin
10.2
%
 
18.6
%
Non-GAAP operating profit margin (2)
23.2
%
 
21.5
%
 
 
 
 
As reported effective tax rate
41.6
%
 
32.3
%
Non-GAAP effective tax rate (3)
31.5
%
 
35.0
%

(1)
Calculated as non-GAAP gross profit as a percentage of net sales for each period presented.
(2)
Calculated as non-GAAP operating profit as a percentage of net sales for each period presented.
(3)
Calculated as non-GAAP provision for income taxes as a percentage of non-GAAP income before taxes (calculated as non-GAAP operating profit minus non-GAAP interest expense, net plus or minus non-GAAP other (income) expense, net).

Details of the activities impacting comparability that are presented as reconciling items to derive the non-GAAP financial measures in the tables above are as follows:

Mark-to-market (gains) losses on commodity derivatives
Commensurate with our discontinuance of hedge accounting treatment for commodity derivatives, we are adjusting the mark-to-market (gains) losses on such commodity derivatives, until such time as the related inventory is sold. Since we often purchase commodity contracts to price inventory requirements in future years, we make this adjustment to facilitate the year-over-year comparison of cost of sales on a basis that matches the derivative gains and losses with the underlying economic exposure being hedged for the period. For the three months ended April 2, 2017 and April 3, 2016, unallocated mark-to-market adjustment on commodity derivatives totaled pre-tax gains of $17.1 million and losses of $34.9 million, respectively.

Business realignment activities
We periodically undertake restructuring and cost reduction activities as part of ongoing efforts to enhance long-term profitability. For the three months ended April 2, 2017 and April 3, 2016, we incurred $47.0 million and $14.4 million, respectively, of pre-tax costs related to business realignment activities. See Note 7 to the Consolidated Financial Statements for more information.
 
Acquisition integration costs
Costs incurred during the three months ended April 2, 2017 relate to the integration of the 2016 acquisition of Ripple Brand Collective, LLC as we incorporate this business into our operating practices and information systems.

Non-service related pension expense
NSRPE includes interest costs, the expected return on pension plan assets, the amortization of actuarial gains and losses, and certain curtailment and settlement losses or credits. NSRPE can fluctuate from year to year as a result of changes in market interest rates and market returns on pension plan assets. 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. Therefore, we exclude NSRPE from our internal performance measures. Our most significant defined benefit pension plans have been closed to new participants for a number of years, resulting in ongoing service costs that are stable and predictable. We recorded pre-tax NSRPE of $4.4 million and $5.1 million, respectively, for the three months ended April 2, 2017 and April 3, 2016, respectively.


30



Long-lived asset impairment charges
For the three months ended April 2, 2017, we incurred $208.7 million of pre-tax long-lived asset impairment charges related to certain business realignment activities. This includes a write-down of certain intangible assets that had been recognized in connection with the 2014 SGM acquisition and write-down of property, plant and equipment. See Note 7 to the Consolidated Financial Statements for more information.

Noncontrolling interest share of business realignment and impairment charges
Certain of the business realignment and impairment charges recorded in connection with the Margin for Growth Program related to Lotte Shanghai Foods Co., Ltd., a joint venture in which we own a 50% controlling interest. Therefore, we have also adjusted for the portion of these charges included within the loss attributed to the non-controlling interest.
 
Settlement of SGM liability
In the fourth quarter of 2015, we reached an agreement with the SGM selling shareholders to reduce the originally-agreed purchase price for the remaining 20% of SGM, and we completed the purchase on February 3, 2016. In the first quarter of 2016, we recorded a $26.7 million gain relating to the settlement of the SGM liability, representing the net carrying amount of the recorded liability in excess of the cash paid to settle the obligation for the remaining 20% of the outstanding shares.

Constant Currency Net Sales Growth
We present certain percentage changes in net sales on a constant currency basis, which excludes the impact of foreign currency exchange.  This measure is used internally by management in evaluating results of operations and determining incentive compensation.  We believe that this measure provides useful information to investors because it provides transparency to underlying performance in our net sales by excluding the effect that foreign currency exchange rate fluctuations have on the year-to-year comparability given volatility in foreign currency exchange markets.

To present this information for historical periods, current period net sales for entities reporting in other than the U.S. dollar are translated into U.S. dollars at the average monthly exchange rates in effect during the corresponding period of the prior fiscal year, rather than at the actual average monthly exchange rates in effect during the current period of the current fiscal year. As a result, the foreign currency impact is equal to the current year results in local currencies multiplied by the change in average foreign currency exchange rate between the current fiscal period and the corresponding period of the prior fiscal year. 

A reconciliation between reported and constant currency growth rates is provided below:
 
Three Months Ended April 2, 2017
 
Percentage Change as Reported
 
Impact of Foreign Currency Exchange
 
Percentage Change on Constant Currency Basis
North America segment
 
 
 
 
 
Canada
5.4
 %
 
3.6
 %
 
1.8
%
Total North America segment
2.7
 %
 
0.2
 %
 
2.5
%
 
 
 
 
 
 
International and Other segment
 
 
 
 
 
Mexico
(0.2
)%
 
(13.2
)%
 
13.0
%
Brazil
48.1
 %
 
30.0
 %
 
18.1
%
India
16.6
 %
 
0.9
 %
 
15.7
%
Greater China
4.1
 %
 
(3.3
)%
 
7.4
%
Total International and Other segment
3.7
 %
 
(0.5
)%
 
4.2
%
 
 
 
 
 
 
Total Company
2.8
 %
 
0.1
 %
 
2.7
%

31



2017 Outlook
The following table provides a reconciliation of projected 2017 EPS-diluted, prepared in accordance with GAAP, to projected non-GAAP EPS-diluted for 2017, prepared on a non-GAAP basis, with adjustments consistent to those discussed previously. The reconciliation of 2016 EPS-diluted, prepared in accordance with GAAP, to 2016 non-GAAP EPS-diluted is provided below for comparison.
 
2017 (Projected)
 
2016
Reported EPS – Diluted
$3.31 - $3.55
 
$3.34
Derivative mark-to-market losses
 
0.66
Business realignment costs (including Margin for Growth Program costs)
0.35 - 0.50
 
0.42
Acquisition and integration costs
 
0.02
Non-service related pension expense
0.06
 
0.08
Settlement of SGM liability
 
(0.12)
Long-lived asset impairment charges
0.85
 
0.01
Adjusted EPS – Diluted
$4.72 - $4.81
 
$4.41

Our 2017 projected EPS-diluted, as presented above, does not include the impact of mark-to-market gains and losses on our commodity derivative contracts that will be reflected within corporate unallocated expenses in our segment results until the related inventory is sold, since we are not able to forecast the impact of the market changes.


32



CONSOLIDATED RESULTS OF OPERATIONS
 
 
Three Months Ended
 
Percent
 
 
April 2, 2017
 
April 3, 2016
 
Change
In millions of dollars except per share amounts
 
 
 
 
 
 
Net Sales
 
$
1,879.7

 
$
1,828.8

 
2.8
 %
Cost of Sales
 
973.1

 
1,011.4

 
(3.8
)%
Gross Profit
 
906.6

 
817.4

 
10.9
 %
Gross Margin
 
48.2
%
 
44.7
%
 
 
SM&A Expense
 
461.9

 
471.7

 
(2.1
)%
SM&A Expense as a percent of net sales
 
24.6
%
 
25.8
%
 
 
Long-lived Asset Impairment Charges
 
208.7

 

 
NM

Business Realignment Costs
 
44.0

 
6.1

 
NM

Operating Profit
 
191.9

 
339.5

 
(43.5
)%
Operating Profit Margin
 
10.2
%
 
18.6
%
 
 
Interest Expense, Net
 
23.7

 
21.0

 
13.0
 %
Other (Income) Expense, Net
 
(0.2
)
 
(21.2
)
 
NM

Provision for Income Taxes
 
70.1

 
109.9

 
(36.2
)%
Effective Income Tax Rate
 
41.6
%
 
32.3
%
 
 
Net Income Including Noncontrolling Interest
 
98.2

 
229.8

 
(57.3
)%
Less: Net Loss Attributable to Noncontrolling Interest
 
(26.8
)
 

 
NM

Net Income Attributable to The Hershey Company
 
$
125.0

 
$
229.8

 
(45.6
)%
Net Income Per Share—Diluted
 
$
0.58

 
$
1.06

 
(45.3
)%
 
 
 
 
 
 
 
Note: Percentage changes may not compute directly as shown due to rounding of amounts presented above.
NM = not meaningful.
Results of Operations - First Quarter 2017 vs. First Quarter 2016
Net Sales
Net sales increased 2.8% in the first quarter of 2017 compared to the same period of 2016, reflecting favorable price realization of 2.0%, a 0.9% benefit from acquisitions and a favorable impact from foreign currency exchange rates of 0.1%, partially offset by volume decreases of 0.2%. Excluding foreign currency, our net sales increased 2.7% in 2017. The favorable net price realization was attributed to lower levels of trade promotional spending and returns, discounts and allowances in both the North America and International and Other segments versus the prior year. Although consolidated volumes declined slightly as a result of macroeconomic challenges in China, this was partially offset by volume improvements in the United States driven by a longer Easter season in 2017 versus 2016, as well as new chocolate products launched in the second half of 2016, including Reese's Pieces Peanut Butter Cups and Hershey's Cookie Layer Crunch bars.
Key U.S. CMG Marketplace Metrics
For the 12 week period ended
 
April 8, 2017
 
April 3, 2016
Hershey's Consumer Takeaway (Decrease) Increase
 
(8.4
)%
 
8.2
%
Hershey's Market Share Increase (Decrease)
 
0.4

 
(0.1
)
The consumer takeaway and market share information provided for the twelve-week period above are 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, and convenience store channels, plus Wal-Mart Stores, Inc., partial dollar, club and military channels. These metrics are based on measured market scanned purchases as reported by Nielsen and provide a means to assess our retail takeaway and market position relative to the overall

33



category. In 2017, takeaway declined relative to the prior year mainly due to the timing of Easter, which shifted into mid-April, versus March in 2016. The amounts presented above are solely for the U.S. CMG category which does not include revenue from our snack mixes and grocery items.
Cost of Sales and Gross Margin
Cost of sales decreased 3.8% in the first quarter of 2017 compared to the same period of 2016. The improvement was driven by lower input costs, with a $52 million year-over-year favorable impact from marking-to-market our commodity derivative instruments, coupled with benefits from supply chain productivity. The benefits were offset in part by unfavorable manufacturing variances and higher freight and warehousing costs.
Gross margin increased by 350 basis points in the first quarter of 2017 compared to the same period of 2016. Lower commodity costs, including a favorable mark-to-market impact from commodity derivative instruments, drove a 340 basis point increase in gross margin. Lower trade promotional spending and supply chain productivity also contributed to the increased gross margin, but were partially offset by higher supply chain costs.
Selling, Marketing and Administrative
Selling, marketing and administrative (“SM&A”) expenses decreased $9.8 million or 2.1% in the first quarter of 2017. Advertising and related consumer marketing expense decreased 0.5% during this period. Excluding these advertising and related consumer marketing costs, selling and administrative expenses for 2017 decreased by 3.0% as compared to 2016. SM&A benefited from lower business realignment costs as well as costs savings and efficiency initiatives, partially offset by higher investments in go-to-market capabilities and increased depreciation and amortization.
Long-lived Asset Impairment Charges
In the first quarter of 2017, we recorded long-lived asset impairment charges of $208.7 million. This includes a write-down of certain intangible assets that had been recognized in connection with the 2014 SGM acquisition and write-down of property, plant and equipment. See Note 7 to the Unaudited Consolidated Financial Statements.
Business Realignment Activities
In the first quarter of 2017 and 2016, we recorded business realignment costs of $44.0 million and $6.1 million, respectively. The 2017 costs related primarily to severance and other program costs attributed to the Margin for Growth Program that commenced in the first quarter of 2017. The 2016 costs related primarily to the Operational Optimization Program, as described in Note 7 to the Unaudited Consolidated Financial Statements.
Operating Profit and Operating Profit Margin
Operating profit decreased 43.5% in the first quarter of 2017 compared to the same period of 2016 due primarily to the long-lived asset impairment charges and higher business realignment costs, partially offset by lower cost of sales and SM&A expenses, as discussed above. Operating profit margin decreased to 10.2% in 2017 from 18.6% in 2016 driven by these same factors.
Interest Expense, Net
Net interest expense was $2.7 million higher in the first quarter of 2017 compared to the same period of 2016. The increase was due to higher levels of debt outstanding during the first quarter of 2017 as compared to the 2016 quarter.
Other (Income) Expense, Net
Other (income) expense, net included income of $0.2 million during first quarter of 2017 versus income, net of expenses of $21.2 million for the same period of 2016. The 2016 income, net of expense included an extinguishment gain of $26.7 million related to the settlement of the SGM liability. Additionally, in 2016, we recognized a $5.6 million write-down on equity investments qualifying for federal historic and energy tax credits, while there was no corresponding expense in the first quarter of 2017.

34



Income Taxes and Effective Tax Rate
Income taxes decreased $39.8 million in the first quarter of 2017 compared to the same period of 2016, primarily due to lower income before taxes. Our effective income tax rate was 41.6% for the first quarter of 2017 compared with 32.3% for the same period of 2016. Relative to the statutory rate, the 2017 effective tax rate was impacted by non-benefited costs resulting from the Margin for Growth Program, partially offset by a favorable foreign rate differential relating to our cocoa procurement operations. The 2016 effective rate benefited from the impact of non-taxable income related to the settlement of the SGM liability.
Net Income attributable to The Hershey Company and Earnings Per Share-diluted
Net income decreased $104.8 million, or 45.6%, while EPS-diluted decreased $0.48, or 45.3%, in the first quarter of 2017 compared to the same period of 2016. The decreases in both net income and EPS-diluted were driven by the long-lived asset impairment charges and higher business realignment costs, as noted above.

35



SEGMENT RESULTS
The summary that follows provides a discussion of the results of operations of our two reportable segments: North America and International and Other. The segments reflect our operations on a geographic basis. For segment reporting purposes, we use “segment income” to evaluate segment performance and allocate resources. Segment income excludes unallocated general corporate administrative expenses, unallocated mark-to-market gains and losses on commodity derivatives, business realignment and impairment charges, acquisition integration costs and NSRPE that are not part of our measurement of segment performance. These items of our operating income are largely managed centrally at the corporate level and are excluded from the measure of segment income reviewed by the CODM and used for resource allocation and internal management reporting and performance evaluation. Segment income and segment income margin, which are presented in the segment discussion that follows, are non-GAAP measures and do not purport to be alternatives to operating income as a measure of operating performance. We believe that these measures are useful to investors and other users of our financial information in evaluating ongoing operating profitability as well as in evaluating operating performance in relation to our competitors, as they exclude the activities that are not integral to our ongoing operations. For further information, see the Non-GAAP Information section of this MD&A.
Our segment results, including a reconciliation to our consolidated results, were as follows:
 
 
 
Three Months Ended
 
 
April 2, 2017
 
April 3, 2016
Net Sales:
 
 
 
 
North America
 
$
1,677,146

 
$
1,633,471

International and Other
 
202,532

 
195,341

Total
 
$
1,879,678

 
$
1,828,812

 
 
 
 
 
Segment Income (Loss):
 
 
 
 
North America
 
$
553,138

 
$
529,390

International and Other
 
1,723

 
(13,233
)
Total segment income
 
554,861

 
516,157

Unallocated corporate expense (1)
 
119,650

 
122,171

Unallocated mark-to-market (gains) losses on commodity derivatives (2)
 
(17,088
)
 
34,946

Long-lived asset impairment charges
 
208,712

 

Costs associated with business realignment activities
 
46,988

 
14,430

Non-service related pension expense
 
4,368

 
5,101

Acquisition and integration costs
 
300

 

Operating profit
 
191,931

 
339,509

Interest expense, net
 
23,741

 
21,005

Other (income) expense, net
 
(171
)
 
(21,225
)
Income before income taxes
 
$
168,361

 
$
339,729

(1)
Includes centrally-managed (a) corporate functional costs relating to legal, treasury, finance and human resources, (b) expenses associated with the oversight and administration of our global operations, including warehousing, distribution and manufacturing, information systems and global shared services, (c) non-cash stock-based compensation expense and (d) other gains or losses that are not integral to segment performance.
(2)
Reflects gains and losses on commodity derivative instruments that are excluded from segment income until the related inventory is sold. See Note 11 to the Consolidated Financial Statements.

36



North America
The North America segment is responsible for our chocolate and non-chocolate confectionery market position, as well as our grocery and growing snacks market positions, in the United States and Canada. This includes developing and growing our business in chocolate and non-chocolate confectionery, pantry, food service and other snacking product lines. North America accounted for 89.2% and 89.3% of our net sales for the three months ended April 2, 2017 and April 3, 2016, respectively. North America results for the three months ended April 2, 2017 and April 3, 2016 were as follows:
 
 
Three Months Ended
 
Percent

 
April 2, 2017
 
April 3, 2016
 
Change
In millions of dollars
 
 
 
 
 
 
Net sales
 
$
1,677.1

 
$
1,633.5

 
2.7
%
Segment income
 
553.1

 
529.4

 
4.5
%
Segment margin
 
33.0
%
 
32.4
%
 
 
Results of Operations - First Quarter 2017 vs. First Quarter 2016
Net sales of our North America segment increased $43.6 million or 2.7% in 2017 compared to 2016, driven by favorable net price realization of 1.2% due to lower direct trade expense. Additionally, volume increased 0.3% driven by stronger Easter sales, partially offset by lower everyday product volume due in part to the challenging consumer packaged goods retail trends. In addition, the barkTHINS acquisition contributed 1% of net sales growth and a favorable impact from foreign currency exchange rates increased net sales by approximately 0.2%.
Our North America segment income increased $23.7 million or 4.5% in 2017 compared to 2016, driven by higher gross profit, partially offset by investments in greater levels of selling expense, go-to-market capabilities and increased depreciation and amortization resulting from the recent barkTHINS acquisition.
International and Other
The International and Other segment includes all other countries where we currently manufacture, import, market, sell or distribute chocolate and non-chocolate confectionery and other products. Currently, this includes our operations in China and other Asia markets, Latin America, Europe, Africa and the Middle East, along with exports to these regions. While a less significant component, this segment also includes our global retail operations, including Hershey’s Chocolate World stores in Hershey, Pennsylvania, New York City, Las Vegas, Shanghai, Niagara Falls (Ontario), Dubai and Singapore, as well as operations associated with licensing the use of certain trademarks and products to third parties around the world. International and Other accounted for 10.8% and 10.7% of our net sales for the three months ended April 2, 2017 and April 3, 2016, respectively. International and Other results for the three months ended April 2, 2017 and April 3, 2016 were as follows:
 
 
Three Months Ended
 
Percent

 
April 2, 2017
 
April 3, 2016
 
Change
In millions of dollars
 
 
 
 
 
 
Net sales
 
$
202.5

 
$
195.3

 
3.7
%
Segment income (loss)
 
1.7

 
(13.2
)
 
NM

Segment margin
 
0.9
%
 
(6.8
)%
 
 

37



Results of Operations - First Quarter 2017 vs. First Quarter 2016
Net sales of our International and Other segment increased $7.2 million or 3.7% in 2017 compared to 2016, reflecting favorable price realization of 8.7%, partially offset by volume declines of 4.5% and an unfavorable impact from foreign currency exchange rates of 0.5%. Excluding the unfavorable impact of foreign currency exchange rates, the net sales of our International and Other segment increased by approximately 4.2%.
The favorable net price realization was driven by lower direct trade expense as well as lower returns, discounts and allowances in China, which declined significantly compared to the prior year. The volume decrease primarily related to continued softness in the China chocolate category due to macroeconomic challenges, partially offset by net sales increases in Latin America and select export markets. Constant currency net sales in Mexico, Brazil and India increased by 13.0%, 18.1%, and 15.7%, respectively, driven by solid chocolate marketplace performance.
Our International and Other segment generated income of $1.7 million in 2017 compared to a loss of $13.2 million in 2016. Combined income in Latin America and export markets improved versus the prior year and performance in China benefited from significantly lower levels of direct trade and returns, discounts and allowances.
Unallocated Corporate Expense
Unallocated corporate expense includes centrally-managed (a) corporate functional costs relating to legal, treasury, finance and human resources, (b) expenses associated with the oversight and administration of our global operations, including warehousing, distribution and manufacturing, information systems and global shared services, (c) non-cash stock-based compensation expense and (d) other gains or losses that are not integral to segment performance.
In the first quarter of 2017, unallocated corporate expense totaled $119.7 million, as compared to $122.2 million in the same period of 2016. Savings realized in 2017 from our productivity and cost savings initiatives were partially offset by higher employee-related costs and an increase in depreciation and amortization.

38



Liquidity and Capital Resources
Historically, our primary source of liquidity 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, bank borrowings or the issuance of 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 April 2, 2017, our cash and cash equivalents totaled $235.0 million. At December 31, 2016, our cash and cash equivalents totaled $297.0 million. Our cash and cash equivalents during the first three months of 2017 declined $62.0 million compared to the 2016 year-end balance as a result of the net uses of cash outlined in the previous discussion.
Approximately 70% of the balance of our cash and cash equivalents at April 2, 2017 was held by subsidiaries domiciled outside of the United States. If these amounts held outside of the United States were to be repatriated, under current law they would be subject to U.S. federal income taxes, less applicable foreign tax credits. However, our intent is to permanently reinvest these funds outside of the United States. The cash that our foreign subsidiaries hold for indefinite reinvestment is expected to be used to finance foreign operations and investments. We believe we have sufficient liquidity to satisfy our cash needs, including our cash needs in the United States.
Cash Flow Summary
The following table is derived from our Consolidated Statement of Cash Flows:
 
 
Three Months Ended
In millions of dollars
 
April 2, 2017
 
April 3, 2016
Net cash provided by (used in):
 
 
 
 
Operating activities
 
$
234.5

 
$
269.5

Investing activities
 
(40.7
)
 
(49.2
)
Financing activities
 
(256.9
)
 
(283.6
)
Effect of exchange rate changes on cash and cash equivalents
 
1.1

 
2.7

Decrease in cash and cash equivalents
 
$
(62.0
)
 
$
(60.6
)
Operating activities
We generated net cash from operating activities of $234.5 million in the first three months of 2017, a decrease of $35.0 million compared to $269.5 million in the same period of 2016. This decrease in net cash from operating activities was mainly driven by the following factors:
Working capital (comprised of trade accounts receivable, inventory, accounts payable and accrued liabilities) used cash of $188.3 million in the 2017 period compared to $67.8 million during the same period of 2016. This $120.5 million fluctuation was mainly driven by:
$69.4 million decrease in cash generated by accounts receivable, primarily attributed to the timing of sales during the quarter. U.S. sales were measurably higher in the last 15 days of the first quarter of 2017 versus the first quarter of 2016 due to timing of shipments, which drove a higher investment in accounts receivable as of the 2017 quarter-end.
$30.4 million increase in cash used by inventories, due to a higher year-over-year build up of U.S. inventories for new product launches and summer volumes, coupled with a higher investment in inventory in Brazil, driven by volume and pricing growth in that market.
$20.7 million increase in cash used by accounts payable and accrued liabilities, mainly due to higher incentive payments in the 2017 period versus the prior year as well as the timing of payments for trade-related and other accounts payables.

39



The net uses of cash noted above were offset in part by higher cash-based net income in the 2017 period. Net income adjusted for non-cash charges to operations (including depreciation, amortization, stock-based compensation, deferred income taxes, asset impairment charges, write-down of equity investments, the gain on settlement of the SGM liability and other charges) increased cash flow by $100.8 million in the 2017 period relative to the same period of 2016.
Investing activities
We used net cash from investing activities of $40.7 million in the first three months of 2017, a decrease of $8.5 million compared to $49.2 million in the same period of 2016. This decrease in net cash used in investing activities was mainly driven by the following factors:
Capital spending. We spent approximately $8.1 million less in capital expenditures, including capitalized software, during the first three months of 2017 compared to the same period of 2016. For the full year 2017, we expect capital expenditures, including capitalized software, to approximate $270 million to $290 million.
Investments in partnerships qualifying for tax credits. We make investments in partnership entities that in turn make equity investments in projects eligible to receive federal historic and energy tax credits. We invested approximately $1.7 million less in projects qualifying for tax credits during the first three months of 2017 compared to the same period of 2016.
Financing activities
We used net cash from financing activities of $256.9 million in the first three months of 2017, a decrease of $26.7 million compared to $283.6 million in the same period of 2016. This decrease in net cash used in financing activities was mainly driven by the following factors:
Short-term borrowings, net. In addition to utilizing cash on hand, we use short-term borrowings (commercial paper and bank borrowings) to fund seasonal working capital requirements and ongoing business needs. During the first three months of 2017, we reduced commercial paper borrowings by $126 million and repaid $19 million of short-term foreign borrowings. During the first three months of 2016, we generated cash flow of $250 million from proceeds on short-term commercial paper issuances, partially offset by a $94 million reduction in short-term foreign borrowings.
Share repurchases. We had no share repurchases during the first three months of 2017. We used cash for total share repurchases of $304 million during the first three months of 2016.
Dividend payments. Total dividend payments to holders of our Common Stock and Class B Common Stock were $128.0 million during the first three months of 2017, an increase of $5.6 million compared to $122.4 million in the same period of 2016.
Proceeds from the exercise of stock options. We received $17.8 million from employee exercises of stock options, net of payments of employee taxes withheld from share-based awards, during the first three months of 2017, a decrease of $6.8 million compared to $24.6 million in the same period of 2016.
Other. In February 2016, we used $35.8 million to purchase the remaining 20% of the outstanding shares of SGM.
Recent Accounting Pronouncements
Information on recently adopted and recently issued accounting standards is included in Note 1 to the Unaudited Consolidated Financial Statements.

40



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 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 manufacturing operations or supply chain could impair our ability to produce or deliver 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;
Our international operations may not achieve projected growth objectives, which could adversely impact our overall business and results of operations;
Disruptions, failures or security breaches of our information technology infrastructure could have a negative impact on our operations;
We might not be able to hire, engage and retain the talented global workforce we need to drive our growth strategies;
We may not fully realize the expected costs savings and/or operating efficiencies associated with our strategic initiatives or restructuring programs, which may have an adverse impact on our business; and
Such other matters as discussed in our 2016 Annual Report on Form 10-K.
We undertake no obligation to publicly update or revise any forward-looking statements to reflect actual results, changes in expectations or events or circumstances after the date this Quarterly Report on Form 10-Q is filed.


41



Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The total notional amount of interest rate swaps outstanding was $350 million at April 2, 2017 and December 31, 2016. The notional amount relates to fixed-to-floating interest rate swaps which convert a comparable amount of fixed-rate debt to variable rate debt at April 2, 2017 and December 31, 2016. A hypothetical 100 basis point increase in interest rates applied to this now variable rate debt as of April 2, 2017 would have increased interest expense by approximately $0.9 million for the first three months of 2017 and $3.6 million for the full year 2016.
We consider our current risk related to market fluctuations in interest rates on our remaining debt portfolio, excluding fixed-rate debt converted to variable with fixed-to-floating instruments, to be minimal since this debt is largely long-term and fixed-rate in nature. Generally, the fair market value of fixed-rate debt will increase as interest rates fall and decrease as interest rates rise. A 100 basis point increase in market interest rates would decrease the fair value of our fixed-rate long-term debt at April 2, 2017 and December 31, 2016 by approximately $140 million and $142 million, respectively. However, since we currently have no plans to repurchase our outstanding fixed-rate instruments before their maturities, the impact of market interest rate fluctuations on our long-term debt does not affect our results of operations or financial position.
The potential decline in fair value of foreign currency forward exchange contracts resulting from a hypothetical near-term adverse change in market rates of 10% was $14.8 million as of April 2, 2017 and $9.6 million as of December 31, 2016. Our open commodity contracts had a notional value of $609.2 million as of April 2, 2017 and $739.4 million as of December 31, 2016. At the end of the first quarter of 2017, the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have increased our net unrealized losses by $60.9 million, generally offset by a reduction in the cost of the underlying commodity purchases.
Other than as described above, market risks have not changed significantly from those described in our 2016 Annual Report on Form 10-K.
Item 4. CONTROLS AND PROCEDURES    
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of April 2, 2017. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of April 2, 2017.
There have been no changes in our internal control over financial reporting during the quarter ended April 2, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

42



PART II — OTHER INFORMATION
Item 1. Legal Proceedings.
Information on legal proceedings is included in Note 14 to the Unaudited Consolidated Financial Statements.
Item 1A. Risk Factors.
Risk Factors as of April 2, 2017 have not changed materially from those described in Part 1, Item 1A, “Risk Factors,” of our 2016 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases of Equity Securities
There were no purchases of our Common Stock during the three months ended April 2, 2017.
In January 2016, our Board of Directors approved an additional $500 million share repurchase authorization.  As of April 2, 2017, approximately $100 million remained available for repurchases of our Common Stock under this program. The share repurchase program does not have an expiration date.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Not applicable.

43



Item 6. Exhibits.
The following exhibits are filed as part of this Quarterly Report on Form 10-Q:
Exhibit Number
 
Description
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
*
 
Filed herewith
**
 
Furnished herewith
+
 
Management contract, compensatory plan or arrangement


44



SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
 
THE HERSHEY COMPANY
 
 
 
 
 (Registrant)
 
 
 
 
 
 
Date:
April 28, 2017
 
/s/ Patricia A. Little
 
 
 
 
Patricia A. Little
 
 
 
 
Senior Vice President, Chief Financial Officer
 
 
 
 
(Principal Financial Officer)
 
 
 
 
 
 
Date:
April 28, 2017
 
/s/ Javier H. Idrovo
 
 
 
 
Javier H. Idrovo
 
 
 
 
Chief Accounting Officer
 
 
 
 
(Principal Accounting Officer)
 


45