Attached files

file filename
EX-32.1 - SECTION 906 CEO AND CFO CERTIFICATION - HERSHEY COhsy_20170702exhibit321.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - HERSHEY COhsy_20170702exhibit312.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - HERSHEY COhsy_20170702exhibit311.htm
EX-12.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - HERSHEY COhsy_20170702exhibit121.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 July 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—151,827,032 shares, as of July 21, 2017.
Class B Common Stock, one dollar par value—60,619,777 shares, as of July 21, 2017.






THE HERSHEY COMPANY
Quarterly Report on Form 10-Q
For the Period Ended July 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
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Net sales
 
$
1,662,991

 
$
1,637,671

 
$
3,542,669

 
$
3,466,483

Cost of sales
 
899,781

 
890,273

 
1,872,899

 
1,901,709

Gross profit
 
763,210


747,398

 
1,669,770

 
1,564,774

Selling, marketing and administrative expense
 
445,888

 
462,531

 
907,788

 
934,265

Long-lived asset impairment charges
 

 

 
208,712

 

Business realignment costs
 
1,981

 
22,105

 
45,998

 
28,238

Operating profit
 
315,341

 
262,762

 
507,272

 
602,271

Interest expense, net
 
24,126

 
21,338

 
47,867

 
42,343

Other (income) expense, net
 
10,098

 
8,128

 
9,927

 
(13,097
)
Income before income taxes
 
281,117

 
233,296

 
449,478

 
573,025

Provision for income taxes
 
78,390

 
87,340

 
148,503

 
197,237

Net income including noncontrolling interest
 
202,727

 
145,956

 
300,975

 
375,788

Less: Net loss attributable to noncontrolling interest
 
(774
)
 

 
(27,570
)
 

Net income attributable to The Hershey Company
 
$
203,501

 
$
145,956

 
$
328,545

 
$
375,788

 
 
 
 
 
 
 
 
 
Net income per share—basic:
 
 
 
 
 
 
 
 
Common stock
 
$
0.98

 
$
0.70

 
$
1.58

 
$
1.79

Class B common stock
 
$
0.89

 
$
0.64

 
$
1.44

 
$
1.64

 
 
 
 
 
 
 
 
 
Net income per share—diluted:
 
 
 
 
 
 
 
 
Common stock
 
$
0.95

 
$
0.68

 
$
1.53

 
$
1.74

Class B common stock
 
$
0.89

 
$
0.64

 
$
1.44

 
$
1.63

 
 
 
 
 
 
 
 
 
Dividends paid per share:
 
 
 
 
 
 
 
 
Common stock
 
$
0.618

 
$
0.583

 
$
1.236

 
$
1.166

Class B common stock
 
$
0.562

 
$
0.530

 
$
1.124

 
$
1.060


See Notes to Unaudited Consolidated Financial Statements.

3



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

 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
 
 
Pre-Tax Amount
 
Tax (Expense) Benefit
 
After-Tax Amount
 
Pre-Tax Amount
 
Tax (Expense) Benefit
 
After-Tax Amount
 
Pre-Tax Amount
 
Tax (Expense) Benefit
 
After-Tax Amount
 
Pre-Tax Amount
 
Tax (Expense) Benefit
 
After-Tax Amount
Net income including noncontrolling interest
 
 
 
 
 
$
202,727

 
 
 
 
 
$
145,956

 
 
 
 
 
$
300,975

 
 
 
 
 
$
375,788

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
$
4,322

 
$

 
4,322

 
$
1,420

 
$

 
1,420

 
$
18,273

 
$

 
18,273

 
$
13,586

 
$

 
13,586

Pension and post-retirement benefit plans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net actuarial loss and prior service cost
 

 

 

 
(29,806
)
 
11,350

 
(18,456
)
 
(196
)
 
74

 
(122
)
 
(29,806
)
 
11,350

 
(18,456
)
Reclassification to earnings
 
7,091

 
(10,984
)
 
(3,893
)
 
25,625

 
(9,781
)
 
15,844

 
14,244

 
(13,695
)
 
549

 
34,305

 
(13,360
)
 
20,945

Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses on cash flow hedging derivatives
 
(707
)
 
703

 
(4
)
 
(21,072
)
 
7,283

 
(13,789
)
 
(2,206
)
 
882

 
(1,324
)
 
(54,981
)
 
19,048

 
(35,933
)
Reclassification to earnings
 
2,379

 
(1,282
)
 
1,097

 
(3,867
)
 
1,692

 
(2,175
)
 
5,412

 
(2,448
)
 
2,964

 
(11,776
)
 
4,689

 
(7,087
)
Total other comprehensive income (loss), net of tax
 
$
13,085

 
$
(11,563
)
 
1,522

 
$
(27,700
)
 
$
10,544

 
(17,156
)
 
$
35,527

 
$
(15,187
)
 
20,340

 
$
(48,672
)
 
$
21,727

 
(26,945
)
Total comprehensive income including noncontrolling interest
 
 
 
 
 
$
204,249

 
 
 
 
 
$
128,800

 
 
 
 
 
$
321,315

 
 
 
 
 
$
348,843

Comprehensive loss attributable to noncontrolling interest
 
 
 
 
 
(698
)
 
 
 
 
 
(213
)
 
 
 
 
 
(27,154
)
 
 
 
 
 
(1,289
)
Comprehensive income attributable to The Hershey Company
 
 
 
 
 
$
204,947

 
 
 
 
 
$
129,013

 
 
 
 
 
$
348,469

 
 
 
 
 
$
350,132


See Notes to Unaudited Consolidated Financial Statements.

4



THE HERSHEY COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
July 2, 2017
 
December 31, 2016
ASSETS
 
(unaudited)
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
214,062

 
$
296,967

Accounts receivable—trade, net
 
417,457

 
581,381

Inventories
 
936,437

 
745,678

Prepaid expenses and other
 
343,573

 
192,752

Total current assets
 
1,911,529

 
1,816,778

Property, plant and equipment, net
 
2,033,790

 
2,177,248

Goodwill
 
818,068

 
812,344

Other intangibles
 
378,271

 
492,737

Other assets
 
182,980

 
168,365

Deferred income taxes
 
55,590

 
56,861

Total assets
 
$
5,380,228

 
$
5,524,333

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
471,545

 
$
522,536

Accrued liabilities
 
641,743

 
750,986

Accrued income taxes
 
6,863

 
3,207

Short-term debt
 
621,965

 
632,471

Current portion of long-term debt
 
89

 
243

Total current liabilities
 
1,742,205

 
1,909,443

Long-term debt
 
2,349,756

 
2,347,455

Other long-term liabilities
 
397,204

 
400,161

Deferred income taxes
 
21,081

 
39,587

Total liabilities
 
4,510,246

 
4,696,646

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

 

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

 
299,281

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

 
60,620

Additional paid-in capital
 
904,588

 
869,857

Retained earnings
 
6,187,409

 
6,115,961

Treasury—common stock shares, at cost: 147,487,088 at July 2, 2017 and 147,642,009 at December 31, 2016
 
(6,240,629
)
 
(6,183,975
)
Accumulated other comprehensive loss
 
(355,964
)
 
(375,888
)
Total—The Hershey Company stockholders’ equity
 
855,305

 
785,856

Noncontrolling interest in subsidiary
 
14,677

 
41,831

Total stockholders’ equity
 
869,982

 
827,687

Total liabilities and stockholders’ equity
 
$
5,380,228

 
$
5,524,333


See Notes to Unaudited Consolidated Financial Statements.

5



THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Six Months Ended
 
July 2, 2017
 
July 3, 2016
Operating Activities
 
 
 
Net income including noncontrolling interests
$
300,975

 
$
375,788

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
132,079

 
156,779

Stock-based compensation expense
24,557

 
26,208

Deferred income taxes
(44,484
)
 
(5,615
)
Impairment of long-lived assets (see Note 7)
208,712

 

Write-down of equity investments
10,263

 
15,061

Gain on settlement of SGM liability (see Note 2)

 
(26,650
)
Other
26,418

 
32,479

Changes in assets and liabilities, net of business acquisitions:
 
 
 
Accounts receivable—trade, net
163,924

 
118,932

Inventories
(190,759
)
 
(110,987
)
Prepaid expenses and other current assets
(40,162
)
 
(32,909
)
Accounts payable and accrued liabilities
(174,004
)
 
(140,937
)
Accrued income taxes
(74,638
)
 
(38,301
)
Contributions to pension and other benefits plans
(19,449
)
 
(16,544
)
Other assets and liabilities
12,302

 
15,406

Net cash provided by operating activities
335,734

 
368,710

Investing Activities
 
 
 
Capital additions (including software)
(84,687
)
 
(104,109
)
Proceeds from sales of property, plant and equipment
865

 
1,657

Equity investments in tax credit qualifying partnerships
(22,415
)
 
(16,763
)
Business acquisitions, net of cash and cash equivalents acquired

 
(285,374
)
Net cash used in investing activities
(106,237
)
 
(404,589
)
Financing Activities
 
 
 
Net (decrease) increase in short-term debt
(13,696
)
 
630,121

Repayment of long-term debt
(150
)
 

Payment of SGM liability (see Note 2)

 
(35,762
)
Cash dividends paid
(256,128
)
 
(243,139
)
Repurchase of common stock
(99,992
)
 
(452,580
)
Exercise of stock options
54,826

 
39,147

Net cash used in financing activities
(315,140
)
 
(62,213
)
Effect of exchange rate changes on cash and cash equivalents
2,738

 
1,748

Decrease in cash and cash equivalents
(82,905
)
 
(96,344
)
Cash and cash equivalents, beginning of period
296,967

 
346,529

Cash and cash equivalents, end of period
$
214,062

 
$
250,185

Supplemental Disclosure
 
 
 
Interest paid
$
49,565

 
$
42,005

Income taxes paid
265,756

 
239,501


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 Interest in Subsidiary
 
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)
 
 
 
 
 
 
 
 
 
328,545

 
 
 
 
 
(27,570
)
 
300,975

Other comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
19,924

 
416

 
20,340

Dividends (including dividend equivalents):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock, $1.236 per share
 
 
 
 
 
 
 
 
 
(188,961
)
 
 
 
 
 
 
 
(188,961
)
Class B Common Stock, $1.124 per share
 
 
 
 
 
 
 
 
 
(68,136
)
 
 
 
 
 
 
 
(68,136
)
Stock-based compensation
 
 
 
 
 
 
 
23,243

 
 
 
 
 
 
 
 
 
23,243

Exercise of stock options and incentive-based transactions
 
 
 
 
 
 
 
11,488

 
 
 
43,338

 
 
 
 
 
54,826

Repurchase of common stock
 
 
 
 
 
 
 
 
 
 
 
(99,992
)
 
 
 
 
 
(99,992
)
Balance, July 2, 2017
 
$

 
$
299,281

 
$
60,620

 
$
904,588

 
$
6,187,409

 
$
(6,240,629
)
 
$
(355,964
)
 
$
14,677

 
$
869,982


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 July 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 full retrospective or modified retrospective transition method.
In 2017, we have substantially completed our assessment of the new standard and we do not expect our 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 modified retrospective transition method.
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 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.

8

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


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 $7,228 recognized during the six months ended July 2, 2017. Additionally, within the Consolidated Statement of Cash Flows, the impact of the adoption resulted in a $14,551 increase in net cash flow from operating activities and a corresponding decrease in net cash flow from financing activities for the six months ended July 2, 2017. These classification requirements were adopted retrospectively to the Consolidated Statement of Cash Flows for the six months ended July 3, 2016, resulting in a $21,612 increase in net cash flow from operating activities and a corresponding $21,612 decrease in net cash flow from financing activities.
In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715). This ASU will require an employer to report the service cost component of net benefit cost in the same line item as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if presented, or disclosed separately. In addition, only the service cost component may be eligible for capitalization where applicable. The amendments should be applied on a retrospective basis. ASU 2017-07 is effective for us beginning January 1, 2018, with early adoption permitted as of the beginning of a financial year. We currently plan to adopt the requirements of the new standard in the first quarter of 2018 and expect the adoption to impact only classification within our Consolidated Statement of Income.
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.

9

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


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 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 six months ended July 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
 
3,975

 
1,749

 
5,724

Balance at July 2, 2017
 
796,165

 
21,903

 
818,068

The following table provides the gross carrying amount and accumulated amortization for each major class of intangible asset:
 
 
July 2, 2017
 
December 31, 2016
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Gross Carrying Amount
 
Accumulated Amortization
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
Trademarks
 
$
270,383

 
$
(30,953
)
 
$
317,023

 
$
(30,458
)
Customer-related
 
127,414

 
(30,729
)
 
200,409

 
(36,482
)
Patents
 
16,725

 
(14,822
)
 
16,426

 
(13,700
)
Total
 
414,522

 
(76,504
)
 
533,858

 
(80,640
)
 
 
 
 
 
 
 
 
 
Intangible assets not subject to amortization:
 
 
 
 
 
 
 
 
Trademarks
 
40,253

 
 
 
39,519

 
 
Total other intangible assets
 
$
378,271

 
 
 
$
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 first quarter of 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.

10

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


Total amortization expense for the three months ended July 2, 2017 and July 3, 2016 was $5,407 and $5,964, respectively. Total amortization expense for the six months ended July 2, 2017 and July 3, 2016 was $12,558 and $11,144, respectively.
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 July 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 $142,521 at July 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 July 2, 2017, we had outstanding commercial paper totaling $479,444, at a weighted average interest rate of 1.1%. 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,
 
July 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
 
84,890

 
83,619

Net impact of interest rate swaps, debt issuance costs and unamortized debt discounts
 
(13,399
)
 
(14,275
)
Total long-term debt
 
2,349,845

 
2,347,698

Less—current portion
 
89

 
243

Long-term portion
 
$
2,349,756

 
$
2,347,455


11

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


Interest Expense
Net interest expense consisted of the following:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Interest expense
 
$
25,299

 
$
22,997

 
$
50,253

 
$
46,522

Capitalized interest
 
(875
)
 
(1,386
)
 
(1,859
)
 
(3,561
)
Interest expense
 
24,424

 
21,611

 
48,394

 
42,961

Interest income
 
(298
)
 
(273
)
 
(527
)
 
(618
)
Interest expense, net
 
$
24,126

 
$
21,338

 
$
47,867

 
$
42,343

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 $423,345 as of July 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 $114,870 at July 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 July 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.

12

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


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 July 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.
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 July 2, 2017 and December 31, 2016 was $23,440 and $22,099, respectively.
The following table presents the classification of derivative assets and liabilities within the Consolidated Balance Sheets as of July 2, 2017 and December 31, 2016:
December 31,
 
July 2, 2017
 
December 31, 2016
 
 
Assets (1)
 
Liabilities (1)
 
Assets (1)
 
Liabilities (1)
Derivatives designated as cash flow hedging instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
398

 
$
1,853

 
$
2,229

 
$
809

 
 
 
 
 
 
 
 
 
Derivatives designated as fair value hedging instruments:
 
 
 
 
 
 
 
 
Interest rate swap agreements
 
1,941

 

 
1,768

 

 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Commodities futures and options (2)
 
14,050

 
179

 
2,348

 
10,000

Deferred compensation derivatives
 
645

 

 
717

 

Foreign exchange contracts
 
3

 

 

 
16

 
 
14,698

 
179

 
3,065

 
10,016

Total
 
$
17,037

 
$
2,032

 
$
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 July 2, 2017, assets and liabilities include the net of assets of $52,895 and liabilities of $41,337 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 July 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 July 2, 2017 and July 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
 
$
(32,519
)
 
$
39,011

 
$

 
$

 
$
(399
)
 
$
6,139

Foreign exchange contracts
 
44

 
(253
)
 
(707
)
 
(3,916
)
 
390

 
(761
)
Interest rate swap agreements
 

 

 

 
(17,156
)
 
(2,370
)
 
(1,511
)
Deferred compensation derivatives
 
(632
)
 
418

 

 

 

 

Total
 
$
(33,107
)
 
$
39,176

 
$
(707
)
 
$
(21,072
)
 
$
(2,379
)
 
$
3,867


(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 effect of derivative instruments on the Consolidated Statements of Income for the six months ended July 2, 2017 and July 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
 
$
(38,055
)
 
$
70

 
$

 
$

 
$
(837
)
 
$
15,869

Foreign exchange contracts
 
(51
)
 
(457
)
 
(2,206
)
 
(8,032
)
 
218

 
(1,022
)
Interest rate swap agreements
 

 

 

 
(46,949
)
 
(4,793
)
 
(3,071
)
Deferred compensation derivatives
 
645

 
821

 

 

 

 

Total
 
$
(37,461
)
 
$
434

 
$
(2,206
)
 
$
(54,981
)
 
$
(5,412
)
 
$
11,776


(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.

14

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


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 $11,017 as of July 2, 2017. This amount is primarily associated with deferred losses relating to interest rate swap agreements.
Fair Value Hedges
For the three months ended July 2, 2017 and July 3, 2016, we recognized a net pretax benefit to interest expense of $732 and $1,137 relating to our fixed-to-floating interest swap arrangements. For the six months ended July 2, 2017 and July 3, 2016, we recognized a net pretax benefit to interest expense of $1,630 and $2,454 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.
The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheets on a recurring basis as of July 2, 2017 and December 31, 2016:
 
 
Assets (Liabilities)
 
 
Level 1
 
Level 2
 
Level 3
 
Total
July 2, 2017:
 
 
 
 
 
 
 
 
Derivative Instruments:
 
 
 
 
 
 
 
 
     Assets:
 
 
 
 
 
 
 
 
           Foreign exchange contracts (1)
 
$

 
$
401

 
$

 
$
401

           Interest rate swap agreements (2)
 

 
1,941

 

 
1,941

           Deferred compensation derivatives (3)
 

 
645

 

 
645

           Commodities futures and options (4)
 
14,050

 

 

 
14,050

     Liabilities:
 
 
 
 
 
 
 
 
            Foreign exchange contracts (1)
 

 
1,853

 

 
1,853

            Commodities futures and options (4)
 
179

 

 

 
179

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


15

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


(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 July 2, 2017 and July 3, 2016 because of the relatively short maturity of these instruments.
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
 
 
July 2, 2017
 
December 31, 2016
 
July 2, 2017
 
December 31, 2016
Current portion of long-term debt
 
$
89

 
$
243

 
$
89

 
$
243

Long-term debt
 
2,410,521

 
2,379,054

 
2,349,756

 
2,347,455

Total
 
2,410,610

 
$
2,379,297

 
2,349,845

 
$
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 first quarter of 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.


16

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


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 and six months ended July 2, 2017 and July 3, 2016 related to these activities are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Margin for Growth Program:
 
 
 
 
 
 
 
 
Severance
 
$
888

 
$

 
$
30,455

 
$

Accelerated depreciation
 
6,873

 

 
6,873

 

Other program costs
 
6,381

 

 
11,203

 

Operational Optimization Program:
 
 
 
 
 
 
 
 
Accelerated depreciation and amortization
 

 
33,965

 

 
33,478

Severance
 

 
9,928

 
13,828

 
17,355

Other program costs
 
312

 
3,376

 
(917
)
 
9,408

2015 Productivity Initiative:
 
 
 
 
 
 
 
 
Pension settlement charge
 

 
12,646

 

 
12,646

Severance
 

 
(469
)
 

 
(1,763
)
Other program costs
 

 
2,649

 

 
5,401

Total business realignment costs
 
$
14,454

 
$
62,095

 
$
61,442

 
$
76,525

The costs and related benefits to be derived from the Margin for Growth Program relate approximately 80% to the North America segment and 20% to the International and Other segment for the three months ended July 2, 2017. The costs and related benefits to be derived from the Margin for Growth Program relate approximately 40% to the North America segment and 60% to the International and Other segment for the six months ended July 2, 2017. 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 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

17

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


first quarter of 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 and six months ended July 2, 2017, we recognized estimated employee severance totaling $888 and $30,455, respectively. These charges relate 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. We also recognized non-cash, asset-related incremental depreciation expense totaling $6,873 for the three and six months ended July 2, 2017 as part of optimizing the North America supply chain. During the three and six months ended July 2, 2017, we also recognized other program costs totaling $6,381 and $11,203, respectively. These charges relate primarily to third-party charges for our initiative of improving global efficiency and effectiveness.
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 July 2, 2017, we recognized costs of $312. During the six months ended July 2, 2017, we recognized costs of $12,911 primarily related to employee severance associated with the workforce planning efforts within North America. We currently expect to incur additional cash costs of approximately $9,000 over the next two years to complete this program.
During the first quarter of 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 to this program, including pension settlement charges of $12,646 recorded through the six months ended July 3, 2016 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 and six months ended July 2, 2017 and July 3, 2016 as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Cost of sales
 
$
5,772

 
$
33,965

 
$
6,262

 
$
33,478

Selling, marketing and administrative expense
 
6,701

 
6,025

 
9,182

 
14,809

Business realignment costs
 
1,981

 
22,105

 
45,998

 
28,238

Costs associated with business realignment activities
 
$
14,454

 
$
62,095

 
$
61,442

 
$
76,525


18

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


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)
53,591

Cash payments
(13,394
)
Other, net
(171
)
Liability balance at July 2, 2017 (reported within accrued and other long-term liabilities)
$
43,751

(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 six months ended July 2, 2017 and July 3, 2016 were 33.0% and 34.4%, respectively. Relative to the statutory rate, the 2017 effective tax rate was impacted by favorable foreign rate differential relating to our cocoa procurement operations, investment tax credits and the benefit of ASU 2016-09, which were partially offset by non-benefited costs resulting from the Margin for Growth Program. The 2016 effective rate benefited from investment tax credits and 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.
9. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
The components of net periodic benefit cost for the second quarter were as follows:  
 
 
Pension Benefits
 
Other Benefits
 
 
Three Months Ended
 
Three Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Service cost
 
$
5,051

 
$
5,699

 
$
66

 
$
75

Interest cost
 
10,200

 
10,999

 
2,204

 
2,429

Expected return on plan assets
 
(14,344
)
 
(14,832
)
 

 

Amortization of prior service (credit) cost
 
(1,455
)
 
(261
)
 
186

 
144

Amortization of net loss
 
8,360

 
8,801

 

 
6

Settlement loss
 

 
16,938

 

 

Total net periodic benefit cost
 
$
7,812

 
$
27,344

 
$
2,456

 
$
2,654


We made contributions of $293 and $7,580 to the pension plans and other benefits plans, respectively, during the second quarter of 2017. In the second quarter of 2016, we made contributions of $661 and $7,044 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.

19

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


The components of net periodic benefit cost for the year-to-date periods were as follows:  
 
 
Pension Benefits
 
Other Benefits
 
 
Six Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Service cost
 
$
10,225

 
$
11,583

 
$
131

 
$
149

Interest cost
 
20,499

 
21,834

 
4,412

 
4,865

Expected return on plan assets
 
(28,698
)
 
(29,373
)
 

 

Amortization of prior service (credit) cost
 
(2,911
)
 
(523
)
 
373

 
288

Amortization of net loss (gain)
 
16,782

 
17,608

 

 
(6
)
Settlement loss
 

 
16,938

 

 

Total net periodic benefit cost
 
$
15,897

 
$
38,067

 
$
4,916

 
$
5,296


We made contributions of $4,985 and $14,464 to the pension plans and other benefits plans, respectively, during the first six months of 2017. In the first six months of 2016, we made contributions of $1,836 and $14,708 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
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Pre-tax compensation expense
 
$
12,435

 
$
14,530

 
$
24,557

 
$
26,208

Related income tax benefit
 
3,230

 
4,693

 
7,048

 
8,780

Compensation costs for stock compensation plans are primarily included in selling, marketing and administrative expense. As of July 2, 2017, total stock-based compensation cost related to non-vested awards not yet recognized was $84,616 and the weighted-average period over which this amount is expected to be recognized was approximately 2.3 years.

20

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 July 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
1,086,175

$
108.05

 
 
Exercised
(908,712
)
$
70.13

 
 
Forfeited
(186,032
)
$
103.43

 
 
Outstanding as of July 2, 2017
6,183,439

$
88.35

6.2 years
$
150,493

Options exercisable as of July 2, 2017
3,870,198

$
80.60

4.7 years
$
124,202

The weighted-average fair value of options granted was $15.77 and $11.42 per share for the periods ended July 2, 2017 and July 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:
 
 
Six Months Ended
 
 
July 2, 2017
 
July 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 $36,507 and $49,091 for the periods ended July 2, 2017 and July 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 July 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
 
418,369

 
$111.06
Performance assumption change
 
19,671

 
$99.42
Vested
 
(205,327
)
 
$113.05
Forfeited
 
(109,328
)
 
$108.44
Outstanding as of July 2, 2017
 
951,613

 
$102.89
The table above includes 6,410 units of PSUs awarded to participants in a prior period for which the measurement (grant) date 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.

21

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


 
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
Units granted
 
418,369

 
514,089

Weighted-average fair value at date of grant
 
$
111.06

 
$
92.95

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 $22,206 and $18,079 for the periods ended July 2, 2017 and July 3, 2016, respectively.
Deferred PSUs, deferred RSUs and deferred stock units representing directors’ fees totaled 468,845 units as of July 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

22

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
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Net sales:
 
 
 
 
 
 
 
 
North America
 
$
1,477,014

 
$
1,444,841

 
$
3,154,160

 
$
3,078,312

International and Other
 
185,977

 
192,830

 
388,509

 
388,171

Total
 
$
1,662,991

 
$
1,637,671

 
$
3,542,669

 
$
3,466,483

 
 
 
 
 
 
 
 
 
Segment income (loss):
 
 
 
 
 
 
 
 
North America
 
$
460,382

 
$
425,723

 
$
1,013,520

 
$
955,113

International and Other
 
8,368

 
(3,462
)
 
10,091

 
(16,695
)
Total segment income
 
468,750

 
422,261

 
1,023,611

 
938,418

Unallocated corporate expense (1)
 
123,173

 
126,623

 
242,823

 
248,794

Unallocated mark-to-market losses (gains) on commodity derivatives
 
11,556

 
(39,886
)
 
(5,532
)
 
(4,940
)
Long-lived asset impairment charges
 

 

 
208,712

 

Costs associated with business realignment activities
 
14,454

 
62,095

 
61,442

 
76,525

Non-service related pension expense
 
4,215

 
9,205

 
8,583

 
14,306

Acquisition and integration costs
 
11

 
1,462

 
311

 
1,462

Operating profit
 
315,341

 
262,762

 
507,272

 
602,271

Interest expense, net
 
24,126

 
21,338

 
47,867

 
42,343

Other (income) expense, net
 
10,098

 
8,128

 
9,927

 
(13,097
)
Income before income taxes
 
$
281,117

 
$
233,296

 
$
449,478

 
$
573,025

(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.

23

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
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Net losses (gains) on mark-to-market valuation of commodity derivative positions
 
$
32,519

 
$
(39,011
)
 
$
38,055

 
$
(70
)
Net losses on commodity derivative positions allocated to segment income
 
20,963

 
875

 
43,587

 
4,870

Net losses (gains) on mark-to-market valuation of commodity derivative positions remaining in unallocated derivative losses (gains)
 
$
11,556

 
$
(39,886
)
 
$
(5,532
)
 
$
(4,940
)
As of July 2, 2017, the cumulative amount of mark-to-market losses on commodity derivatives that have been recognized in our consolidated cost of sales and not yet allocated to reportable segments was $157,492. 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 $91,119 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
 
Six Months Ended
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
North America
$
41,751

 
$
39,844

 
$
82,988

 
$
78,786

International and Other
9,747

 
13,085

 
22,713

 
24,008

Corporate (1)
15,629

 
43,937

 
26,378

 
53,985

Total
$
67,127

 
$
96,866

 
$
132,079

 
$
156,779

(1)
Corporate includes non-cash asset-related accelerated depreciation and amortization related to business realignment activities, as discussed in Note 7. Such amounts are not included within our measure of segment income.
12. TREASURY STOCK ACTIVITY
A summary of our treasury stock activity is as follows:
 
Six Months Ended July 2, 2017
 
Shares
 
Dollars
 
 
 
In thousands
Shares repurchased in the open market under pre-approved share repurchase programs

 
$

Shares repurchased to replace Treasury Stock issued for stock options and incentive compensation
886,675

 
99,992

Total share repurchases
886,675

 
99,992

Shares issued for stock options and incentive compensation
(1,041,596
)
 
$
(43,338
)
Net change
(154,921
)
 
$
56,654

In January 2016, our Board of Directors approved a $500,000 authorization to repurchase shares of our Common Stock. As of July 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.

24

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 Interest
Balance, December 31, 2016
$
41,831

Net loss attributable to noncontrolling interest
(27,570
)
Other comprehensive income - foreign currency translation adjustments
416

Balance, July 2, 2017
$
14,677

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 six months ended July 3, 2016, the net loss attributable to noncontrolling interests totaled $1,465, which was presented within selling, marketing and administrative expense in the Consolidated Statements of Income since the amount was 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.

25

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
 
 
July 2, 2017
 
July 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)
 
$
94,043

 
$
34,068

 
$
88,615

 
$
32,129

Allocation of undistributed earnings
 
55,370

 
20,020

 
18,528

 
6,684

Total earnings—basic
 
$
149,413

 
$
54,088

 
$
107,143

 
$
38,813

 
 
 
 
 
 
 
 
 
Denominator (shares in thousands):
 
 
 
 
 
 
 
 
Total weighted-average shares—basic
 
152,466

 
60,620

 
152,774

 
60,620

 
 
 
 
 
 
 
 
 
Earnings Per Share—basic
 
$
0.98

 
$
0.89

 
$
0.70

 
$
0.64

 
 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
Allocation of total earnings used in basic computation
 
$
149,413

 
$
54,088

 
$
107,143

 
$
38,813

Reallocation of total earnings as a result of conversion of Class B common stock to Common stock
 
54,088

 

 
38,813

 

Reallocation of undistributed earnings
 

 
(149
)
 

 
(36
)
Total earnings—diluted
 
$
203,501

 
$
53,939

 
$
145,956

 
$
38,777

 
 
 
 
 
 
 
 
 
Denominator (shares in thousands):
 
 
 
 
 
 
 
 
Number of shares used in basic computation
 
152,466

 
60,620

 
152,774

 
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
 
1,229

 

 
973

 

Performance and restricted stock options
 
325

 

 
137

 

Total weighted-average shares—diluted
 
214,640

 
60,620

 
214,504

 
60,620

 
 
 
 
 
 
 
 
 
Earnings Per Share—diluted
 
$
0.95

 
$
0.89

 
$
0.68

 
$
0.64

The earnings per share calculations for the three months ended July 2, 2017 and July 3, 2016 excluded 1,808 and 3,601, respectively, of stock options (in thousands) that would have been antidilutive.

26

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


 
 
Six Months Ended
 
 
July 2, 2017
 
July 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)
 
$
187,992

 
$
68,136

 
$
178,882

 
$
64,257

Allocation of undistributed earnings
 
53,180

 
19,237

 
97,737

 
34,912

Total earnings—basic
 
$
241,172

 
$
87,373

 
$
276,619

 
$
99,169

 
 
 
 
 
 
 
 
 
Denominator (shares in thousands):
 
 
 
 
 
 
 
 
Total weighted-average shares—basic
 
152,393

 
60,620

 
154,283

 
60,620

 
 
 
 
 
 
 
 
 
Earnings Per Share—basic
 
$
1.58

 
$
1.44

 
$
1.79

 
$
1.64

 
 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
Allocation of total earnings used in basic computation
 
$
241,172

 
$
87,373

 
$
276,619

 
$
99,169

Reallocation of total earnings as a result of conversion of Class B common stock to Common stock
 
87,373

 

 
99,169

 

Reallocation of undistributed earnings
 

 
(145
)
 

 
(191
)
Total earnings—diluted
 
$
328,545

 
$
87,228

 
$
375,788

 
$
98,978

 
 
 
 
 
 
 
 
 
Denominator (shares in thousands):
 
 
 
 
 
 
 
 
Number of shares used in basic computation
 
152,393

 
60,620

 
154,283

 
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
 
1,248

 

 
989

 

Performance and restricted stock options
 
324

 

 
162

 

Total weighted-average shares—diluted
 
214,585

 
60,620

 
216,054

 
60,620

 
 
 
 
 
 
 
 
 
Earnings Per Share—diluted
 
$
1.53

 
$
1.44

 
$
1.74

 
$
1.63

The earnings per share calculations for the six months ended July 2, 2017 and July 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
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Write-down of equity investments in partnerships qualifying for tax credits
 
$
10,263

 
$
9,468

 
$
10,263

 
$
15,061

Settlement of SGM liability (see Note 2)
 

 

 

 
(26,650
)
Other (income) expense, net
 
(165
)
 
(1,340
)
 
(336
)
 
(1,508
)
Total
 
$
10,098

 
$
8,128

 
$
9,927

 
$
(13,097
)


27

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:
 
 
July 2, 2017
 
December 31, 2016
Inventories:
 
 
 
 
Raw materials
 
$
303,553

 
$
315,239

Goods in process
 
123,386

 
88,490

Finished goods
 
691,334

 
528,587

Inventories at FIFO
 
1,118,273

 
932,316

Adjustment to LIFO
 
(181,836
)
 
(186,638
)
Total inventories
 
$
936,437

 
$
745,678

 
 
 
 
 
Property, plant and equipment:
 
 
 
 
Land
 
$
106,662

 
$
103,865

Buildings
 
1,191,483

 
1,238,634

Machinery and equipment
 
2,871,889

 
3,001,552

Construction in progress
 
200,411

 
230,987

Property, plant and equipment, gross
 
4,370,445

 
4,575,038

Accumulated depreciation
 
(2,336,655
)
 
(2,397,790
)
Property, plant and equipment, net
 
$
2,033,790

 
$
2,177,248

 
 
 
 
 
Other assets:
 
 
 
 
Capitalized software, net
 
$
100,867

 
$
95,301

Income tax receivable
 

 
1,449

Other non-current assets
 
82,113

 
71,615

Total other assets
 
$
182,980

 
$
168,365

 
 
 
 
 
Accrued liabilities:
 
 
 
 
Payroll, compensation and benefits
 
$
194,368

 
$
240,080

Advertising and promotion
 
280,645

 
358,573

Other
 
166,730

 
152,333

Total accrued liabilities
 
$
641,743

 
$
750,986

 
 
 
 
 
Other long-term liabilities:
 
 
 
 
Post-retirement benefits liabilities
 
$
215,802

 
$
220,270

Pension benefits liabilities
 
61,748

 
65,687

Other
 
119,654

 
114,204

Total other long-term liabilities
 
$
397,204

 
$
400,161

 
 
 
 
 
Accumulated other comprehensive loss:
 
 
 
 
Foreign currency translation adjustments
 
$
(92,756
)
 
$
(110,613
)
Pension and post-retirement benefit plans, net of tax
 
(206,742
)
 
(207,169
)
Cash flow hedges, net of tax
 
(56,466
)
 
(58,106
)
Total accumulated other comprehensive loss
 
$
(355,964
)
 
$
(375,888
)


28



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 second quarter 2017 net sales totaled $1,663.0 million, an increase of 1.5%, versus $1,637.7 million for the comparable period of 2016. Excluding a 0.3% impact from unfavorable foreign exchange rates, our net sales increased 1.8%. Net sales growth was driven by the North America segment, which benefited from innovation and the barkTHINS brand acquisition. Additionally, net sales growth benefited from the timing of new stand-up packaging as well as distributor changes by several retailers resulting in increased retail inventory.
Our reported gross margin was 45.9% in the second quarter of 2017, an increase of 30 basis points compared to the second quarter of 2016. Our non-GAAP gross margin increased 160 basis points in the second quarter of 2017, primarily due to lower commodity input costs, supply chain productivity and cost savings initiatives.
Our second quarter 2017 reported net income and earnings per share-diluted (EPS) totaled $203.5 million and $0.95, respectively, compared to the second quarter 2016 reported net income and EPS-diluted of $146.0 million and $0.68, respectively. From a non-GAAP perspective, second quarter 2017 adjusted net income was $233.1 million, an increase of 27.7% versus $182.6 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, discrete items and the benefit from the adoption of Accounting Standards Update ("ASU") 2016-09 for the accounting of employee share-based payments. Our adjusted EPS-diluted for the second quarter of 2017 was $1.09 compared to $0.85 for the same period of 2016, with this 28.2% increase attributable to the same factors driving the increase in non-GAAP net income.
Over the remainder of the year, we expect to continue the rollout of Hershey’s Cookie Layer Crunch bars, Reese’s and Hershey’s Crunchers candies and Reese’s Crunchy Cookie Cups. Additionally, we have solid Halloween and Holiday plans, and advertising and related consumer marketing expense is expected to be meaningfully higher over the remainder of the year. Despite the inconsistent shopping patterns and behavior that have resulted in a recent slowdown in retail trips, we believe CMG and snacks have inherent advantages such as impulsivity, seasons, and multiple pack

29



types, or usage occasions.  This facilitates merchandising and display within different parts of the box where there is foot traffic, like the perimeter and at checkout.
However, we expect that the broader industry challenges at the retail level will persist over the remainder of the year. Therefore, we currently estimate that full-year 2017 net sales growth will be approximately 1%. 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 $3.41 to $3.60 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 lower input costs, and 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.


30



Reconciliation of Certain Non-GAAP Financial Measures
Consolidated results
 
Three Months Ended
 
Six Months Ended
In thousands except per share data
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Reported gross profit
 
$
763,210

 
$
747,398

 
$
1,669,770

 
$
1,564,774

Derivative mark-to-market losses (gains)
 
11,556

 
(39,886
)
 
(5,532
)
 
(4,940
)
Business realignment activities
 
5,772

 
33,965

 
6,262

 
33,478

NSRPE
 
2,705

 
3,271

 
5,565

 
6,512

Non-GAAP gross profit
 
$
783,243

 
$
744,748

 
$
1,676,065

 
$
1,599,824

 
 
 
 
 
 
 
 
 
Reported operating profit
 
$
315,341

 
$
262,762

 
$
507,272

 
$
602,271

Derivative mark-to-market losses (gains)
 
11,556

 
(39,886
)
 
(5,532
)
 
(4,940
)
Business realignment activities
 
14,454

 
62,095

 
61,442

 
76,525

Acquisition integration costs
 
11

 
1,462

 
311

 
1,462

NSRPE
 
4,215

 
9,205

 
8,583

 
14,306

Long-lived asset impairment charges
 

 

 
208,712

 

Non-GAAP operating profit
 
$
345,577

 
$
295,638

 
$
780,788

 
$
689,624

 
 
 
 
 
 
 
 
 
Reported provision for income taxes
 
$
78,390

 
$
87,340

 
$
148,503

 
$
197,237

Derivative mark-to-market losses (gains)*
 
(847
)
 
(15,117
)
 
352

 
(1,872
)
Business realignment activities*
 
5,783

 
7,295

 
17,200

 
10,833

Acquisition integration costs*
 
4

 
554

 
118

 
554

NSRPE*
 
1,605

 
3,515

 
3,269

 
5,468

Long-lived asset impairment charges**
 
(7,227
)
 

 
37,974

 

Non-GAAP provision for income taxes
 
$
77,708

 
$
83,587

 
$
207,416

 
$
212,220

 
 
 
 
 
 
 
 
 
Reported net income
 
$
203,501

 
$
145,956

 
$
328,545

 
$
375,788

Derivative mark-to-market losses (gains)
 
12,403

 
(24,769
)
 
(5,884
)
 
(3,068
)
Business realignment activities
 
8,671

 
54,827

 
44,242

 
65,687

Acquisition integration costs
 
7

 
908

 
193

 
908

NSRPE
 
2,610

 
5,690

 
5,314

 
8,838

Long-lived asset impairment charges
 
7,227

 

 
170,738

 

Noncontrolling interest share of business realignment and impairment charges
 
(1,296
)
 

 
(27,962
)
 

Settlement of SGM liability
 

 

 

 
(26,650
)
Non-GAAP net income
 
$
233,123

 
$
182,612

 
$
515,186

 
$
421,503

 
 
 
 
 
 
 
 
 
Reported EPS - Diluted
 
$
0.95

 
$
0.68

 
$
1.53

 
$
1.74

Derivative mark-to-market losses (gains)
 
0.06

 
(0.11
)
 
(0.03
)
 
(0.01
)
Business realignment activities
 
0.04

 
0.25

 
0.21

 
0.30

NSRPE
 
0.01

 
0.03

 
0.02

 
0.04

Long-lived asset impairment charges
 
0.04

 

 
0.80

 

Noncontrolling interest share of business realignment and impairment charges
 
(0.01
)
 

 
(0.13
)
 

Settlement of SGM liability
 

 

 

 
(0.12
)
Non-GAAP EPS - Diluted
 
$
1.09

 
$
0.85

 
$
2.40

 
$
1.95


* The tax effect for each adjustment is determined by calculating the tax impact of the adjustment on the Company's quarterly effective tax rate.
** There were no pre-tax impairment charges associated with long-lived assets during the three months ended July 2, 2017. However, the long-lived asset impairment charge in the first quarter of 2017 was not treated as a discrete tax item. Therefore, the tax impact was included in the estimated annual effective tax rate resulting in an EPS-diluted impact for each of the quarters throughout 2017.



31




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
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
As reported gross margin
 
45.9
%
 
45.6
%
 
47.1
%
 
45.1
%
Non-GAAP gross margin (1)
 
47.1
%
 
45.5
%
 
47.3
%
 
46.2
%
 
 
 
 
 
 
 
 
 
As reported operating profit margin
 
19.0
%
 
16.0
%
 
14.3
%
 
17.4
%
Non-GAAP operating profit margin (2)
 
20.8
%
 
18.1
%
 
22.0
%
 
19.9
%
 
 
 
 
 
 
 
 
 
As reported effective tax rate
 
27.9
%
 
37.4
%
 
33.0
%
 
34.4
%
Non-GAAP effective tax rate (3)
 
25.0
%
 
31.4
%
 
28.7
%
 
33.5
%

(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 losses (gains) on commodity derivatives
Commensurate with our discontinuance of hedge accounting treatment for commodity derivatives, we are adjusting the mark-to-market losses (gains) 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 July 2, 2017 and July 3, 2016, unallocated mark-to-market adjustment on commodity derivatives totaled pre-tax losses of $11.6 million and gains of $39.9 million, respectively. For the six months ended July 2, 2017 and July 3, 2016, unallocated mark-to-market adjustment on commodity derivatives totaled pre-tax gains of $5.5 million and $4.9 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 July 2, 2017 and July 3, 2016, we incurred $14.5 million and $62.1 million, respectively, of pre-tax costs related to business realignment activities. For the six months ended July 2, 2017 and July 3, 2016, we incurred $61.4 million and $76.5 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 and six months ended July 2, 2017 and 2016 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.


32



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 $4.2 million and $9.2 million, respectively, for the three months ended July 2, 2017 and July 3, 2016, respectively. We recorded pre-tax NSRPE of $8.6 million and $14.3 million, respectively, for the six months ended July 2, 2017 and July 3, 2016, respectively.

Long-lived asset impairment charges
For the six months ended July 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.


33



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 July 2, 2017
 
Percentage Change as Reported
 
Impact of Foreign Currency Exchange
 
Percentage Change on Constant Currency Basis
North America segment
 
 
 
 
 
Canada
6.8
 %
 
(5.6
)%
 
12.4
 %
Total North America segment
2.2
 %
 
(0.3
)%
 
2.5
 %
 
 
 
 
 
 
International and Other segment
 
 
 
 
 
Mexico
13.9
 %
 
(3.0
)%
 
16.9
 %
Brazil
12.4
 %
 
9.6
 %
 
2.8
 %
India
5.4
 %
 
3.7
 %
 
1.7
 %
Greater China
(31.2
)%
 
(2.4
)%
 
(28.8
)%
Total International and Other segment
(3.6
)%
 
(0.1
)%
 
(3.5
)%
 
 
 
 
 
 
Total Company
1.5
 %
 
(0.3
)%
 
1.8
 %
 
Six Months Ended July 2, 2017
 
Percentage Change as Reported
 
Impact of Foreign Currency Exchange
 
Percentage Change on Constant Currency Basis
North America segment
 
 
 
 
 
Canada
6.1
 %
 
(1.0
)%
 
7.1
 %
Total North America segment
2.5
 %
 
 %
 
2.5
 %
 
 
 
 
 
 
International and Other segment
 
 
 
 
 
Mexico
6.3
 %
 
(8.5
)%
 
14.8
 %
Brazil
31.3
 %
 
20.4
 %
 
10.9
 %
India
11.0
 %
 
2.3
 %
 
8.7
 %
Greater China
(14.4
)%
 
(2.8
)%
 
(11.6
)%
Total International and Other segment
0.1
 %
 
(0.3
)%
 
0.4
 %
 
 
 
 
 
 
Total Company
2.2
 %
 
(0.1
)%
 
2.3
 %

34



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
$3.41 - $3.60
 
$3.34
Derivative mark-to-market losses
 
0.66
Business realignment costs (including Margin for Growth Program costs)
0.30 - 0.40
 
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.


35



CONSOLIDATED RESULTS OF OPERATIONS
 
 
Three Months Ended
 
Percent
 
Six Months Ended
 
Percent
 
 
July 2, 2017
 
July 3, 2016
 
Change
 
July 2, 2017
 
July 3, 2016
 
Change
In millions of dollars except per share amounts
 
 
 
 
 
 
 
 
 
 
 
 
Net Sales
 
$
1,663.0

 
$
1,637.7

 
1.5
 %
 
$
3,542.7

 
$
3,466.5

 
2.2
 %
Cost of Sales
 
899.8

 
890.3

 
1.1
 %
 
1,872.9

 
1,901.7

 
(1.5
)%
Gross Profit
 
763.2

 
747.4

 
2.1
 %
 
1,669.8

 
1,564.8

 
6.7
 %
Gross Margin
 
45.9
%
 
45.6
%
 
 
 
47.1
%
 
45.1
%
 
 
SM&A Expense
 
445.9

 
462.5

 
(3.6
)%
 
907.8

 
934.3

 
(2.8
)%
SM&A Expense as a percent of net sales
 
26.8
%
 
28.2
%
 
 
 
25.6
%
 
27.0
%
 
 
Long-lived Asset Impairment Charges
 

 

 
NM

 
208.7

 

 
NM

Business Realignment Costs
 
2.0

 
22.1

 
(91.0
)%
 
46.0

 
28.2

 
62.9
 %
Operating Profit
 
315.3

 
262.8

 
20.0
 %
 
507.3

 
602.3

 
(15.8
)%
Operating Profit Margin
 
19.0
%
 
16.0
%
 
 
 
14.3
%
 
17.4
%
 
 
Interest Expense, Net
 
24.1

 
21.3

 
13.1
 %
 
47.9

 
42.3

 
13.0
 %
Other (Income) Expense, Net
 
10.1

 
8.2

 
24.2
 %
 
9.9

 
(13.0
)
 
NM

Provision for Income Taxes
 
78.4

 
87.3

 
(10.2
)%
 
148.5

 
197.2

 
(24.7
)%
Effective Income Tax Rate
 
27.9
%
 
37.4
%
 
 
 
33.0
%
 
34.4
%
 
 
Net Income Including Noncontrolling Interest
 
202.7

 
146.0

 
38.9
 %
 
301.0

 
375.8

 
(19.9
)%
Less: Net Loss Attributable to Noncontrolling Interest
 
(0.8
)
 

 
NM

 
(27.5
)
 

 
NM

Net Income Attributable to The Hershey Company
 
$
203.5

 
$
146.0

 
39.4
 %
 
$
328.5

 
$
375.8

 
(12.6
)%
Net Income Per Share—Diluted
 
$
0.95

 
$
0.68

 
39.7
 %
 
$
1.53

 
$
1.74

 
(12.1
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Note: Percentage changes may not compute directly as shown due to rounding of amounts presented above.
NM = not meaningful.
Results of Operations - Second Quarter 2017 vs. Second Quarter 2016
Net Sales
Net sales increased 1.5% in the second quarter of 2017 compared to the same period of 2016, reflecting volume increases of 1.2%, favorable price realization of 0.1% and a 0.5% benefit from acquisitions, partially offset by an unfavorable impact from foreign currency exchange rates of 0.3%. Excluding foreign currency, our net sales increased 1.8% in the second quarter of 2017. Consolidated volumes increased as a result of higher sales volume in the United States, which benefited from innovation and the barkTHINS brand acquisition. Additionally, net sales growth benefited from the timing of new stand-up packaging as well as distributor changes by several retailers resulting in increased retail inventory. These volume increases were partially offset by volume declines in our International and Other segment primarily due to macroeconomic challenges in China. Favorable net price realization was attributed to lower levels of trade promotional spending in the North America segment versus the prior year.
Key U.S. CMG Marketplace Metrics
For the 12 week period ended
 
July 8, 2017
 
July 9, 2016
Hershey's Consumer Takeaway Increase (Decrease)
 
5.2
%
 
(1.1
)%
Hershey's Market Share Increase (Decrease)
 
0.2

 
(0.7
)

36



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 category. In 2017, takeaway improved relative to the prior year mainly driven by our core brands at Easter. 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 increased 1.1% in the second quarter of 2017 compared to the same period of 2016. The increase was driven by higher sales volume and an incremental $51 million unfavorable impact from marking-to-market our commodity derivative instruments intended to economically hedge future years' commodity purchases, offset in part by supply chain productivity and costs savings initiatives as well as a $28.2 million decrease in business realignment costs.
Gross margin increased by 30 basis points in the second quarter of 2017 compared to the same period of 2016. Lower business realignment costs and supply chain productivity contributed to the improvement in gross margin. However, higher commodity costs, driven by the unfavorable mark-to-market impact from commodity derivative instruments, and higher supply chain costs partially offset the increase in gross margin.
Selling, Marketing and Administrative
Selling, marketing and administrative (“SM&A”) expenses decreased $16.6 million or 3.6% in the second quarter of 2017. Advertising and related consumer marketing expense decreased 0.2% during this period. Excluding these advertising and related consumer marketing costs, selling and administrative expenses for 2017 decreased by 5.2% 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.
Business Realignment Activities
In the second quarter of 2017 and 2016, we recorded business realignment costs of $2.0 million and $22.1 million, respectively. The 2017 costs related primarily to severance and other program costs associated with 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 increased 20.0% in the second quarter of 2017 compared to the same period of 2016 due primarily to the higher gross margin, lower business realignment costs and lower SM&A expenses, as discussed above. Operating profit margin increased to 19.0% in 2017 from 16.0% in 2016 driven by these same factors.
Interest Expense, Net
Net interest expense was $2.8 million higher in the second quarter of 2017 compared to the same period of 2016. The increase was due to higher levels of long-term debt as well as higher interest rates on commercial paper during the second quarter of 2017 as compared to the 2016 quarter.
Other (Income) Expense, Net
Other (income) expense, net totaled $10.1 million in the second quarter of 2017 compared to $8.2 million for the same period of 2016, driven in both periods by the write-down on equity investments qualifying for federal historic and energy tax credits.

37



Income Taxes and Effective Tax Rate
Our effective income tax rate was 27.9% for the second quarter of 2017 compared to 37.4% for the same period of 2016. Relative to the statutory rate, the 2017 effective tax rate was impacted by a favorable foreign rate differential relating to our cocoa procurement operations, investment tax credits, and the benefit of ASU 2016-09, which were partially offset by non-benefited costs resulting from the Margin for Growth Program. The higher 2016 effective rate reflected the SGM valuation allowance impact.
Net Income Attributable to The Hershey Company and Earnings Per Share-diluted
Net income increased $57.5 million, or 39.4%, while EPS-diluted increased $0.27, or 39.7%, in the second quarter of 2017 compared to the same period of 2016. The increases in both net income and EPS-diluted were driven by the higher gross margin, lower business realignment costs and lower SM&A expenses, as discussed above.
Results of Operations - First Six Months 2017 vs. First Six Months 2016
Net Sales
Net sales increased 2.2% in the first six months of 2017 compared to the same period of 2016, reflecting favorable price realization of 1.1%, volume increases of 0.5% and a 0.7% benefit from acquisitions, partially offset by an unfavorable impact from foreign currency exchange rates of 0.1%. Excluding foreign currency, our net sales increased 2.3% in first six months of 2017. The favorable net price realization was attributed to lower levels of trade promotional spending in both the North America and International and Other segments versus the prior year. Consolidated volumes increased as a result of higher sales volume in North America, driven by a stronger Easter season, as well as benefits from innovation and the barkTHINS brand acquisition. Additionally, net sales growth benefited from the timing of new stand-up packaging as well as distributor changes by several retailers resulting in increased retail inventory. These volume increases were partially offset by volume declines in our International and Other segment primarily due to macroeconomic challenges in China.
Cost of Sales and Gross Margin
Cost of sales decreased 1.5% in the first six months of 2017 compared to the same period of 2016. The improvement was driven by favorable commodity costs, a $27.2 million year-over-year decrease in business realignment costs, and supply chain productivity. These benefits were offset in part by unfavorable manufacturing variances and higher freight and warehousing costs.
Gross margin increased by 200 basis points in the first six months of 2017 compared to the same period of 2016, driven by lower trade promotional spending, lower commodity and business realignment costs and supply chain productivity, partially offset by higher supply chain costs.
Selling, Marketing and Administrative
Selling, marketing and administrative (“SM&A”) expenses decreased $26.5 million or 2.8% in the first six months of 2017. Advertising and related consumer marketing expense decreased 0.3% during this period. Excluding these advertising and related consumer marketing costs, selling and administrative expenses for 2017 decreased by 4.1% 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.
Long-lived Asset Impairment Charges
In the first six months of 2017, we recorded long-lived asset impairment charges of $208.7 million. This relates to a first quarter 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.

38



Business Realignment Activities
In the first six months of 2017 and 2016, we recorded business realignment costs of $46.0 million and $28.2 million, respectively. The 2017 costs related primarily to severance and other program costs associated with 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 15.8% in the first six months 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 higher gross margin and lower SM&A expenses, as discussed above. Operating profit margin decreased to 14.3% in 2017 from 17.4% in 2016 driven by these same factors.
Interest Expense, Net
Net interest expense was $5.5 million higher in the first six months of 2017 compared to the same period of 2016. The increase was due to higher levels of long-term debt as well as higher interest rates on commercial paper during the second six months of 2017 as compared to the 2016 period.
Other (Income) Expense, Net
Other (income) expense, net totaled expense of $9.9 million during the first six months of 2017 versus income of $13.1 million for the same period of 2016. The 2016 income included an extinguishment gain of $26.7 million related to the settlement of the SGM liability. Additionally, in 2016, we recognized a $15.1 million write-down on equity investments qualifying for federal historic and energy tax credits, compared to a $10.3 million write-down in the first six months of 2017.
Income Taxes and Effective Tax Rate
Our effective income tax rate was 33.0% for the first six months of 2017 compared with 34.4% for the same period of 2016. Relative to the statutory rate, the 2017 effective tax rate was impacted by a favorable foreign rate differential relating to our cocoa procurement operations, investment tax credits and the benefit of ASU 2016-09, which were partially offset by non-benefited costs resulting from the Margin for Growth Program. The 2016 effective rate benefited from the impact of non-taxable income related to the settlement of the SGM liability and investment tax credits.
Net Income attributable to The Hershey Company and Earnings Per Share-diluted
Net income decreased $47.2 million, or 12.6%, while EPS-diluted decreased $0.21, or 12.1%, in the first six months 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.


39



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
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Net Sales:
 
 
 
 
 
 
 
 
North America
 
$
1,477,014

 
$
1,444,841

 
$
3,154,160

 
$
3,078,312

International and Other
 
185,977

 
192,830

 
388,509

 
388,171

Total
 
$
1,662,991

 
$
1,637,671

 
$
3,542,669

 
$
3,466,483

 
 
 
 
 
 
 
 
 
Segment Income (Loss):
 
 
 
 
 
 
 
 
North America
 
$
460,382

 
$
425,723

 
$
1,013,520

 
$
955,113

International and Other
 
8,368

 
(3,462
)
 
10,091

 
(16,695
)
Total segment income
 
468,750

 
422,261

 
1,023,611

 
938,418

Unallocated corporate expense (1)
 
123,173

 
126,623

 
242,823

 
248,794

Unallocated mark-to-market losses (gains) on commodity derivatives (2)
 
11,556

 
(39,886
)
 
(5,532
)
 
(4,940
)
Long-lived asset impairment charges
 

 

 
208,712

 

Costs associated with business realignment activities
 
14,454

 
62,095

 
61,442

 
76,525

Non-service related pension expense
 
4,215

 
9,205

 
8,583

 
14,306

Acquisition and integration costs
 
11

 
1,462

 
311

 
1,462

Operating profit
 
315,341

 
262,762

 
507,272

 
602,271

Interest expense, net
 
24,126

 
21,338

 
47,867

 
42,343

Other (income) expense, net
 
10,098

 
8,128

 
9,927

 
(13,097
)
Income before income taxes
 
$
281,117

 
$
233,296

 
$
449,478

 
$
573,025

(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.

40



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 88.8% and 88.2% of our net sales for the three months ended July 2, 2017 and July 3, 2016, respectively. North America results for the three and six months ended July 2, 2017 and July 3, 2016 were as follows:
 
 
Three Months Ended
 
Percent
 
Six Months Ended
 
Percent

 
July 2, 2017
 
July 3, 2016
 
Change
 
July 2, 2017
 
July 3, 2016
 
Change
In millions of dollars
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
1,477.0

 
$
1,444.8

 
2.2
%
 
$
3,154.2

 
$
3,078.3

 
2.5
%
Segment income
 
460.4

 
425.7

 
8.1
%
 
1,013.5

 
955.1

 
6.1
%
Segment margin
 
31.2
%
 
29.5
%
 
 
 
32.1
%
 
31.0
%
 
 
Results of Operations - Second Quarter 2017 vs. Second Quarter 2016
Net sales of our North America segment increased $32.2 million or 2.2% in 2017 compared to 2016, driven by increased volume of 1.7% due to benefits from innovation and 0.6% from the barkTHINS brand acquisition. Additionally, net sales growth benefited from the timing of new stand-up packaging as well as distributor changes by several retailers resulting in increased retail inventory. Net price realization increased by 0.2% due to decreased levels of trade promotional spending. Excluding a 0.3% unfavorable impact of foreign currency exchange rates, the net sales of our North America segment increased by approximately 2.5%.
Our North America segment income increased $34.7 million or 8.1% in 2017 compared to 2016, driven by higher gross profit, partially offset by investments in greater levels of selling expense and go-to-market capabilities and increased depreciation and amortization resulting from the recent barkTHINS brand acquisition.
Results of Operations - First Six Months 2017 vs. First Six Months 2016
Net sales of our North America segment increased $75.9 million or 2.5% in 2017 compared to 2016, driven by increased volume of 0.9% due to a strong Easter season, as well as benefits from innovation and the barkTHINS brand acquisition. Additionally, net sales growth benefited from the timing of new stand-up packaging as well as distributor changes by several retailers resulting in increased retail inventory. Net price realization increased by 0.8% due to decreased levels of trade promotional spending.
Our North America segment income increased $58.4 million or 6.1% in 2017 compared to 2016, driven by higher gross profit, partially offset by investments in greater levels of selling expense and go-to-market capabilities and increased depreciation and amortization resulting from the recent barkTHINS brand acquisition.

41



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 11.2% and 11.8% of our net sales for the three months ended July 2, 2017 and July 3, 2016, respectively. International and Other results for the three and six months ended July 2, 2017 and July 3, 2016 were as follows:
 
 
Three Months Ended
 
Percent
 
Six Months Ended
 
Percent

 
July 2, 2017
 
July 3, 2016
 
Change
 
July 2, 2017
 
July 3, 2016
 
Change
In millions of dollars
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
186.0

 
$
192.8

 
(3.6
)%
 
$
388.5

 
$
388.2

 
0.1
%
Segment income (loss)
 
8.4

 
(3.5
)
 
NM

 
10.1

 
(16.7
)
 
NM

Segment margin
 
4.5
%
 
(1.8
)%
 
 
 
2.6
%
 
(4.3
)%
 
 
Results of Operations - Second Quarter 2017 vs. Second Quarter 2016
Net sales of our International and Other segment decreased $6.8 million or 3.6% in 2017 compared to 2016, reflecting volume declines of 2.1%, unfavorable price realization of 1.4% and an unfavorable impact from foreign currency exchange rates of 0.1%. Excluding the unfavorable impact of foreign currency exchange rates, the net sales of our International and Other segment decreased by approximately 3.5%.
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 and Brazil increased by 16.9% and 2.8%, respectively, driven by solid chocolate marketplace performance. India also experienced constant currency net sales growth of 1.7%. The unfavorable net price realization was mainly driven by increased levels of returns, discounts and allowances in China compared to the prior year.
Our International and Other segment generated income of $8.4 million in 2017 compared to a loss of $3.5 million in 2016. Combined income in Latin America and export markets improved versus the prior year and lower operating expenses in China as a result of our Margin for Growth Program contributed to the positive segment income.
Results of Operations - First Six Months 2017 vs. First Six Months 2016
Net sales of our International and Other segment increased $0.3 million or 0.1% in 2017 compared to 2016, reflecting favorable price realization of 3.6%, partially offset by volume declines of 3.2% and an unfavorable impact from foreign currency exchange rates of 0.3%. Excluding the unfavorable impact of foreign currency exchange rates, the net sales of our International and Other segment increased by approximately 0.4%.
The favorable net price realization was driven by decreased levels of trade promotional spending, 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 and Brazil increased by 14.8% and 10.9%, respectively, driven by solid chocolate marketplace performance. India also experienced constant currency net sales growth of 8.7%.
Our International and Other segment generated income of $10.1 million in 2017 compared to a loss of $16.7 million in 2016. Combined income in Latin America and export markets improved versus the prior year and lower operating expenses in China as a result of our Margin for Growth Program contributed to the positive segment income.

42



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 second quarter of 2017, unallocated corporate expense totaled $123.2 million, as compared to $126.6 million in the same period of 2016, primarily due to savings realized in 2017 from our productivity and cost savings initiatives. In the first six months of 2017, unallocated corporate expense totaled $242.8 million, as compared to $248.8 million in the same period of 2016, primarily due to savings realized in 2017 from our productivity and cost savings initiatives.

43



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 July 2, 2017, our cash and cash equivalents totaled $214.1 million. At December 31, 2016, our cash and cash equivalents totaled $297.0 million. Our cash and cash equivalents during the first six months of 2017 declined $82.9 million compared to the 2016 year-end balance as a result of the net uses of cash outlined in the following discussion.
Approximately two-thirds of the balance of our cash and cash equivalents at July 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:
 
 
Six Months Ended
In millions of dollars
 
July 2, 2017
 
July 3, 2016
Net cash provided by (used in):
 
 
 
 
Operating activities
 
$
335.7

 
$
368.7

Investing activities
 
(106.2
)
 
(404.5
)
Financing activities
 
(315.1
)
 
(62.2
)
Effect of exchange rate changes on cash and cash equivalents
 
2.7

 
1.7

Decrease in cash and cash equivalents
 
$
(82.9
)
 
$
(96.3
)
Operating activities
We generated net cash from operating activities of $335.7 million in the first six months of 2017, a decrease of $33.0 million compared to $368.7 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 $200.8 million in the 2017 period compared to $133.0 million during the same period of 2016. This $67.8 million fluctuation was mainly driven by:    
$45.0 million increase in cash generated by accounts receivable, primarily attributed to higher net sales during the first six months of 2017 versus 2016.
$79.8 million increase in cash used by inventories, due to a higher year-over-year build up of U.S. inventories to satisfy seasonal core and variety product requirements, coupled with a higher investment in inventory in Brazil, driven by volume and pricing growth in that market.
$33.1 million increase in cash used by accounts payable and accrued liabilities, mainly due to the timing of payments for trade-related and other accounts payables.
Cash used by accrued income taxes increased $36.3 million, mainly due to the timing of estimated tax payments in the 2017 period compared to the same period of 2016.

44



The net uses of cash noted above were offset in part by higher net income adjusted for non-cash charges to operations (including depreciation, amortization, stock-based compensation, deferred income taxes, long-lived asset impairment charges, write-down of equity investments, the gain on settlement of the SGM liability and other charges). Our incremental net income adjusted for non-cash charges increased by $84.5 million in the 2017 period relative to the same period of 2016.
Investing activities
We used net cash for investing activities of $106.2 million in the first six months of 2017, a decrease of $298.3 million compared to $404.5 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 $19.4 million less for property, plant and equipment, including capitalized software, during the first six 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 $5.7 million more in projects qualifying for tax credits during the first six months of 2017 compared to the same period of 2016.
Business acquisitions. In April 2016, we acquired Ripple Brand Collective, LLC for $285 million. Further details regarding our business acquisition activity are provided in Note 2 to the Unaudited Consolidated Financial Statements.
Financing activities
We used net cash for financing activities of $315.1 million in the first six months of 2017, an increase of $252.9 million compared to $62.2 million in the same period of 2016. This increase 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 six months of 2017, we had a net reduction in short-term borrowings of $14 million primarily due to repayments on short-term foreign bank borrowings. During the first six months of 2016, we generated cash flow of $742 million from proceeds on short-term commercial paper issuances, partially offset by a $112 million reduction in short-term foreign bank borrowings.
Share repurchases. We used cash for total share repurchases of $100 million during the first six months of 2017 pursuant to our practice of replenishing shares issued for stock options and incentive compensation. We used cash for total share repurchases of $453 million during the first six months of 2016, which also included shares repurchased in the open market under pre-approved share repurchase programs.
Dividend payments. Total dividend payments to holders of our Common Stock and Class B Common Stock were $256.1 million during the first six months of 2017, an increase of $13.0 million compared to $243.1 million in the same period of 2016.
Proceeds from the exercise of stock options. We received $54.8 million from employee exercises of stock options, net of payments of employee taxes withheld from share-based awards, during the first six months of 2017, an increase of $15.7 million compared to $39.1 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.

45



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.


46



Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The total notional amount of interest rate swaps outstanding was $350 million at July 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 July 2, 2017 and December 31, 2016. A hypothetical 100 basis point increase in interest rates applied to this now variable rate debt as of July 2, 2017 would have increased interest expense by approximately $1.8 million for the first six 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 July 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 $14.7 million as of July 2, 2017 and $9.6 million as of December 31, 2016. Our open commodity contracts had a notional value of $423.3 million as of July 2, 2017 and $739.4 million as of December 31, 2016. At the end of the second 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 $42.3 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 July 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 July 2, 2017.
There have been no changes in our internal control over financial reporting during the quarter ended July 2, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

47



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.
When evaluating an investment in our Common Stock, investors should consider carefully, among other things, the risk factors previously disclosed in Part I, Item 1A, “Risk Factors,” of our 2016 Annual Report on Form 10-K, as well as the information contained in this Quarterly Report on Form 10-Q and our other reports and registration statements filed with the SEC.  There have been no material changes in our risk factors since the filing of our 2016 Annual Report on Form 10-K, other than to include the following risk factor related to our implementation of a new enterprise resource planning system.

Complications with the design or implementation of our new enterprise resource planning system could adversely impact our business and operations.

We rely extensively on information systems and technology to manage our business and summarize operating results. We are in the process of a multi-year implementation of a new global enterprise resource planning (“ERP”) system. This ERP system will replace our existing operating and financial systems. The ERP system is designed to accurately maintain the Company’s financial records, enhance operational functionality and provide timely information to the Company’s management team related to the operation of the business. The ERP system implementation process has required, and will continue to require, the investment of significant personnel and financial resources. We may not be able to successfully implement the ERP system without experiencing delays, increased costs and other difficulties. If we are unable to successfully design and implement the new ERP system as planned, our financial positions, results of operations and cash flows could be negatively impacted. Additionally, if we do not effectively implement the ERP system as planned or the ERP system does not operate as intended, the effectiveness of our internal control over financial reporting could be adversely affected or our ability to assess those controls adequately could be delayed.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases of Equity Securities
he following table shows the purchases of shares of Common Stock made by or on behalf of Hershey, or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended) of Hershey, for each fiscal month in the three months ended July 2, 2017:
Period 
 
Total Number
of Shares
Purchased (1)
 
Average Price
Paid
per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans 
or Programs (2)
 
Approximate
Dollar Value of
Shares that May
Yet Be Purchased
Under the Plans or
Programs (2)
 
 
 
 
 
 
 
 
(in thousands of dollars)
April 3 through April 30
 

 
$

 

 
$
100,000

May 1 through May 28
 
600,000

 
$
111.99

 

 
$
100,000

May 29 through July 2
 
286,675

 
$
114.42

 

 
$
100,000

Total
 
886,675

 
$
112.77

 

 
 
(1) During the three months ended July 2, 2017, 886,675 shares of Common Stock were purchased in connection with our practice of buying back shares sufficient to offset those issued under incentive compensation plans. All of the shares of Common Stock purchased during the period were purchased in open market transactions.
(2) In January 2016, our Board of Directors approved an additional $500 million share repurchase authorization.  As of July 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.

48



Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Not applicable.
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


49



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


50