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 October 1, 2017June 28, 2020
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) |
19 East Chocolate Avenue, Hershey, PA 17033
(Address of principal executive offices and Zip Code)
(717) 534-4200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| | | | | | | | | | | | | | |
Title of each class | | Trading Symbol(s) | | Name of each exchange on which registered |
Common Stock, one dollar par value | | HSY | | New York Stock Exchange |
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, or an emerging growth 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 | ¨ | | Non-accelerated filer | ¨ | | Smaller reporting company | ☐ |
| | | | | | | | |
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—150,075,619147,408,714 shares, as of October 20, 2017.July 17, 2020.
Class B Common Stock, one dollar par value—60,619,77760,613,777 shares, as of October 20, 2017.July 17, 2020.
THE HERSHEY COMPANY
Quarterly Report on Form 10-Q
For the Period Ended October 1, 2017June 28, 2020
TABLE OF CONTENTS
|
| | | | | | | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
Item 6. Exhibits | | |
| | |
| | |
| | |
The Hershey Company | Q2 2020 Form 10-Q | Page 1
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 | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Net sales | | $ | 1,707,329 | | | $ | 1,767,217 | | | $ | 3,744,646 | | | $ | 3,783,705 | |
Cost of sales | | 914,777 | | | 892,473 | | | 2,085,472 | | | 2,016,457 | |
Gross profit | | 792,552 | | | 874,744 | | | 1,659,174 | | | 1,767,248 | |
Selling, marketing and administrative expense | | 408,949 | | | 453,793 | | | 884,333 | | | 907,366 | |
Long-lived asset impairment charges | | 1,600 | | | 4,741 | | | 9,143 | | | 4,741 | |
| | | | | | | | |
Business realignment (benefits) costs | | (1,370) | | | 6,140 | | | (475) | | | 6,202 | |
Operating profit | | 383,373 | | | 410,070 | | | 766,173 | | | 848,939 | |
Interest expense, net | | 38,079 | | | 33,776 | | | 74,334 | | | 71,234 | |
Other (income) expense, net | | 11,217 | | | 13,125 | | | 22,750 | | | 18,602 | |
Income before income taxes | | 334,077 | | | 363,169 | | | 669,089 | | | 759,103 | |
Provision for income taxes | | 66,035 | | | 49,898 | | | 132,264 | | | 141,951 | |
Net income including noncontrolling interest | | 268,042 | | | 313,271 | | | 536,825 | | | 617,152 | |
Less: Net (loss) income attributable to noncontrolling interest | | (859) | | | 431 | | | (3,213) | | | (46) | |
Net income attributable to The Hershey Company | | $ | 268,901 | | | $ | 312,840 | | | $ | 540,038 | | | $ | 617,198 | |
| | | | | | | | |
Net income per share—basic: | | | | | | | | |
Common stock | | $ | 1.33 | | | $ | 1.54 | | | $ | 2.66 | | | $ | 3.03 | |
Class B common stock | | $ | 1.21 | | | $ | 1.39 | | | $ | 2.41 | | | $ | 2.75 | |
| | | | | | | | |
Net income per share—diluted: | | | | | | | | |
Common stock | | $ | 1.29 | | | $ | 1.48 | | | $ | 2.58 | | | $ | 2.93 | |
Class B common stock | | $ | 1.20 | | | $ | 1.38 | | | $ | 2.41 | | | $ | 2.74 | |
| | | | | | | | |
Dividends paid per share: | | | | | | | | |
Common stock | | $ | 0.773 | | | $ | 0.722 | | | $ | 1.546 | | | $ | 1.444 | |
Class B common stock | | $ | 0.702 | | | $ | 0.656 | | | $ | 1.404 | | | $ | 1.312 | |
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Net sales | | $ | 2,033,121 |
| | $ | 2,003,454 |
| | $ | 5,575,790 |
| | $ | 5,469,937 |
|
Cost of sales | | 1,092,899 |
| | 1,152,606 |
| | 2,965,798 |
| | 3,054,315 |
|
Gross profit | | 940,222 |
|
| 850,848 |
| | 2,609,992 |
| | 2,415,622 |
|
Selling, marketing and administrative expense | | 497,182 |
| | 474,494 |
| | 1,404,970 |
| | 1,408,759 |
|
Long-lived asset impairment charges | | — |
| | — |
| | 208,712 |
| | — |
|
Business realignment costs | | 4,020 |
| | 2,330 |
| | 50,018 |
| | 30,568 |
|
Operating profit | | 439,020 |
| | 374,024 |
| | 946,292 |
| | 976,295 |
|
Interest expense, net | | 24,589 |
| | 24,387 |
| | 72,456 |
| | 66,730 |
|
Other (income) expense, net | | 13,630 |
| | 21,800 |
| | 23,557 |
| | 8,703 |
|
Income before income taxes | | 400,801 |
| | 327,837 |
| | 850,279 |
| | 900,862 |
|
Provision for income taxes | | 126,788 |
| | 100,434 |
| | 275,291 |
| | 297,671 |
|
Net income including noncontrolling interest | | 274,013 |
| | 227,403 |
| | 574,988 |
| | 603,191 |
|
Less: Net income (loss) attributable to noncontrolling interest | | 710 |
| | — |
| | (26,860 | ) | | — |
|
Net income attributable to The Hershey Company | | $ | 273,303 |
| | $ | 227,403 |
| | $ | 601,848 |
| | $ | 603,191 |
|
| | | | | | | | |
Net income per share—basic: | | | | | | | | |
Common stock | | $ | 1.32 |
| | $ | 1.09 |
| | $ | 2.91 |
| | $ | 2.88 |
|
Class B common stock | | $ | 1.20 |
| | $ | 0.99 |
| | $ | 2.64 |
| | $ | 2.63 |
|
| | | | | | | | |
Net income per share—diluted: | | | | | | | | |
Common stock | | $ | 1.28 |
| | $ | 1.06 |
| | $ | 2.81 |
| | $ | 2.80 |
|
Class B common stock | | $ | 1.20 |
| | $ | 0.99 |
| | $ | 2.64 |
| | $ | 2.62 |
|
| | | | | | | | |
Dividends paid per share: | | | | | | | | |
Common stock | | $ | 0.656 |
| | $ | 0.618 |
| | $ | 1.892 |
| | $ | 1.784 |
|
Class B common stock | | $ | 0.596 |
| | $ | 0.562 |
| | $ | 1.720 |
| | $ | 1.622 |
|
See Notes to Unaudited Consolidated Financial Statements.
The Hershey Company | Q2 2020 Form 10-Q | Page 2
THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the three months ended | | | | | | | | | | | | For the six months ended | | | | | | | | | | |
| | June 28, 2020 | | | | | | June 30, 2019 | | | | | | June 28, 2020 | | | | | | June 30, 2019 | | | | |
| | 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 | | | | | | $ | 268,042 | | | | | | | $ | 313,271 | | | | | | | $ | 536,825 | | | | | | | $ | 617,152 | |
Other comprehensive (loss) income, net of tax: | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign currency translation adjustments: | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign currency translation gains (losses) during period | | $ | 3,052 | | | $ | — | | | 3,052 | | | $ | 7,651 | | | $ | — | | | 7,651 | | | $ | (48,292) | | | $ | — | | | (48,292) | | | $ | 11,079 | | | $ | — | | | 11,079 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Pension and post-retirement benefit plans: | | | | | | | | | | | | | | | | | | | | | | | | |
Net actuarial (loss) gain and prior service cost | | (16,685) | | | 3,954 | | | (12,731) | | | — | | | — | | | — | | | (16,685) | | | 3,954 | | | (12,731) | | | — | | | — | | | — | |
Reclassification to earnings | | 8,542 | | | (2,183) | | | 6,359 | | | 6,720 | | | (1,773) | | | 4,947 | | | 13,297 | | | (2,731) | | | 10,566 | | | 13,438 | | | (3,580) | | | 9,858 | |
Cash flow hedges: | | | | | | | | | | | | | | | | | | | | | | | | |
Gains (losses) on cash flow hedging derivatives | | 675 | | | 838 | | | 1,513 | | | (2,547) | | | 1,130 | | | (1,417) | | | 6,056 | | | (268) | | | 5,788 | | | (3,336) | | | 1,848 | | | (1,488) | |
Reclassification to earnings | | 1,205 | | | (817) | | | 388 | | | 1,395 | | | (885) | | | 510 | | | 3,297 | | | (1,930) | | | 1,367 | | | 2,833 | | | (1,776) | | | 1,057 | |
Total other comprehensive (loss) income, net of tax | | $ | (3,211) | | | $ | 1,792 | | | (1,419) | | | $ | 13,219 | | | $ | (1,528) | | | 11,691 | | | $ | (42,327) | | | $ | (975) | | | (43,302) | | | $ | 24,014 | | | $ | (3,508) | | | 20,506 | |
Total comprehensive income including noncontrolling interest | | | | | | $ | 266,623 | | | | | | | $ | 324,962 | | | | | | | $ | 493,523 | | | | | | | $ | 637,658 | |
Comprehensive (loss) income attributable to noncontrolling interest | | | | | | (826) | | | | | | | 338 | | | | | | | (3,288) | | | | | | | 416 | |
Comprehensive income attributable to The Hershey Company | | | | | | $ | 267,449 | | | | | | | $ | 324,624 | | | | | | | $ | 496,811 | | | | | | | $ | 637,242 | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 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 | | | | | | $ | 274,013 |
| | | | | | $ | 227,403 |
| | | | | | $ | 574,988 |
| | | | | | $ | 603,191 |
|
Other comprehensive income (loss), net of tax: | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign currency translation adjustments | | $ | 9,605 |
| | $ | — |
| | 9,605 |
| | $ | (8,533 | ) | | $ | — |
| | (8,533 | ) | | $ | 27,878 |
| | $ | — |
| | 27,878 |
| | $ | 5,053 |
| | $ | — |
| | 5,053 |
|
Pension and post-retirement benefit plans: | | | | | | | | | | | | | | | | | | | | | | | | |
Net actuarial loss and prior service cost | | (9,200 | ) | | 3,487 |
| | (5,713 | ) | | 68 |
| | (54 | ) | | 14 |
| | (9,396 | ) | | 3,561 |
| | (5,835 | ) | | (29,738 | ) | | 11,296 |
| | (18,442 | ) |
Reclassification to earnings | | 24,300 |
| | (8,941 | ) | | 15,359 |
| | 11,828 |
| | (4,447 | ) | | 7,381 |
| | 38,544 |
| | (22,636 | ) | | 15,908 |
| | 46,133 |
| | (17,807 | ) | | 28,326 |
|
Cash flow hedges: | | | | | | | | | | | | | | | | | | | | | | | | |
Losses on cash flow hedging derivatives | | (1,339 | ) | | 761 |
| | (578 | ) | | 1,354 |
| | (210 | ) | | 1,144 |
| | (3,545 | ) | | 1,643 |
| | (1,902 | ) | | (53,627 | ) | | 18,838 |
| | (34,789 | ) |
Reclassification to earnings | | 1,962 |
| | (1,380 | ) | | 582 |
| | (2,288 | ) | | 1,390 |
| | (898 | ) | | 7,374 |
| | (3,827 | ) | | 3,547 |
| | (14,064 | ) | | 6,079 |
| | (7,985 | ) |
Total other comprehensive income (loss), net of tax | | $ | 25,328 |
| | $ | (6,073 | ) | | 19,255 |
| | $ | 2,429 |
| | $ | (3,321 | ) | | (892 | ) | | $ | 60,855 |
| | $ | (21,259 | ) | | 39,596 |
| | $ | (46,243 | ) | | $ | 18,406 |
| | (27,837 | ) |
Total comprehensive income including noncontrolling interest | | | | | | $ | 293,268 |
| | | | | | $ | 226,511 |
| | | | | | $ | 614,584 |
| | | | | | $ | 575,354 |
|
Comprehensive income (loss) attributable to noncontrolling interest | | | | | | 1,029 |
| | | | | | (751 | ) | | | | | | (26,125 | ) | | | | | | (2,040 | ) |
Comprehensive income attributable to The Hershey Company | | | | | | $ | 292,239 |
| | | | | | $ | 227,262 |
| | | | | | $ | 640,709 |
| | | | | | $ | 577,394 |
|
See Notes to Unaudited Consolidated Financial Statements.
The Hershey Company | Q2 2020 Form 10-Q | Page 3
THE HERSHEY COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
| | | | | | | | | | | | | | |
| | June 28, 2020 | | December 31, 2019 |
| | (unaudited) | | |
ASSETS | | | | |
Current assets: | | | | |
Cash and cash equivalents | | $ | 1,165,331 | | | $ | 493,262 | |
Accounts receivable—trade, net | | 540,398 | | | 568,509 | |
Inventories | | 999,380 | | | 815,251 | |
| | | | |
Prepaid expenses and other | | 197,835 | | | 240,080 | |
Total current assets | | 2,902,944 | | | 2,117,102 | |
Property, plant and equipment, net | | 2,165,346 | | | 2,153,139 | |
Goodwill | | 1,979,002 | | | 1,985,955 | |
Other intangibles | | 1,314,332 | | | 1,341,166 | |
Other assets | | 524,687 | | | 512,000 | |
Deferred income taxes | | 24,760 | | | 31,033 | |
Total assets | | $ | 8,911,071 | | | $ | 8,140,395 | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | |
Current liabilities: | | | | |
Accounts payable | | $ | 530,042 | | | $ | 550,828 | |
Accrued liabilities | | 643,938 | | | 702,372 | |
Accrued income taxes | | 54,091 | | | 19,921 | |
Short-term debt | | 198,299 | | | 32,282 | |
Current portion of long-term debt | | 788,448 | | | 703,390 | |
Total current liabilities | | 2,214,818 | | | 2,008,793 | |
Long-term debt | | 4,091,211 | | | 3,530,813 | |
Other long-term liabilities | | 643,847 | | | 655,777 | |
Deferred income taxes | | 205,106 | | | 200,018 | |
Total liabilities | | 7,154,982 | | | 6,395,401 | |
| | | | |
Stockholders’ equity: | | | | |
The Hershey Company stockholders’ equity | | | | |
Preferred stock, shares issued: NaN in 2020 and 2019 | | — | | | — | |
Common stock, shares issued: 160,939,248 at June 28, 2020 and December 31, 2019 | | 160,939 | | | 160,939 | |
Class B common stock, shares issued: 60,613,777 at June 28, 2020 and December 31, 2019 | | 60,614 | | | 60,614 | |
Additional paid-in capital | | 1,161,878 | | | 1,142,210 | |
Retained earnings | | 1,516,543 | | | 1,290,461 | |
Treasury—common stock shares, at cost: 13,570,656 at June 28, 2020 and 12,723,592 at December 31, 2019 | | (779,176) | | | (591,036) | |
Accumulated other comprehensive loss | | (367,193) | | | (323,966) | |
Total—The Hershey Company stockholders’ equity | | 1,753,605 | | | 1,739,222 | |
Noncontrolling interest in subsidiary | | 2,484 | | | 5,772 | |
Total stockholders’ equity | | 1,756,089 | | | 1,744,994 | |
Total liabilities and stockholders’ equity | | $ | 8,911,071 | | | $ | 8,140,395 | |
|
| | | | | | | | |
| | October 1, 2017 | | December 31, 2016 |
ASSETS | | (unaudited) | | |
Current assets: | | | | |
Cash and cash equivalents | | $ | 275,056 |
| | $ | 296,967 |
|
Accounts receivable—trade, net | | 742,832 |
| | 581,381 |
|
Inventories | | 938,187 |
| | 745,678 |
|
Prepaid expenses and other | | 258,379 |
| | 192,752 |
|
Total current assets | | 2,214,454 |
| | 1,816,778 |
|
Property, plant and equipment, net | | 2,050,124 |
| | 2,177,248 |
|
Goodwill | | 822,348 |
| | 812,344 |
|
Other intangibles | | 375,455 |
| | 492,737 |
|
Other assets | | 174,611 |
| | 168,365 |
|
Deferred income taxes | | 18,485 |
| | 56,861 |
|
Total assets | | $ | 5,655,477 |
| | $ | 5,524,333 |
|
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | |
Current liabilities: | | | | |
Accounts payable | | $ | 529,442 |
| | $ | 522,536 |
|
Accrued liabilities | | 673,435 |
| | 750,986 |
|
Accrued income taxes | | 19,109 |
| | 3,207 |
|
Short-term debt | | 815,588 |
| | 632,471 |
|
Current portion of long-term debt | | 300,096 |
| | 243 |
|
Total current liabilities | | 2,337,670 |
| | 1,909,443 |
|
Long-term debt | | 2,054,132 |
| | 2,347,455 |
|
Other long-term liabilities | | 402,396 |
| | 400,161 |
|
Deferred income taxes | | 22,303 |
| | 39,587 |
|
Total liabilities | | 4,816,501 |
| | 4,696,646 |
|
| | | | |
Stockholders’ equity: | | | | |
The Hershey Company stockholders’ equity | | | | |
Preferred stock, shares issued: none at October 1, 2017 and December 31, 2016 | | — |
| | — |
|
Common stock, shares issued: 299,281,967 at October 1, 2017 and December 31, 2016 | | 299,281 |
| | 299,281 |
|
Class B common stock, shares issued: 60,619,777 at October 1, 2017 and December 31, 2016 | | 60,620 |
| | 60,620 |
|
Additional paid-in capital | | 910,246 |
| | 869,857 |
|
Retained earnings | | 6,325,011 |
| | 6,115,961 |
|
Treasury—common stock shares, at cost: 149,232,801 at October 1, 2017 and 147,642,009 at December 31, 2016 | | (6,434,861 | ) | | (6,183,975 | ) |
Accumulated other comprehensive loss | | (337,027 | ) | | (375,888 | ) |
Total—The Hershey Company stockholders’ equity | | 823,270 |
| | 785,856 |
|
Noncontrolling interest in subsidiary | | 15,706 |
| | 41,831 |
|
Total stockholders’ equity | | 838,976 |
| | 827,687 |
|
Total liabilities and stockholders’ equity | | $ | 5,655,477 |
| | $ | 5,524,333 |
|
See Notes to Unaudited Consolidated Financial Statements.
The Hershey Company | Q2 2020 Form 10-Q | Page 4
THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
| | | | | | | | | | | |
| Six Months Ended | | |
| June 28, 2020 | | June 30, 2019 |
Operating Activities | | | |
Net income including noncontrolling interest | $ | 536,825 | | | $ | 617,152 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 142,524 | | | 144,346 | |
Stock-based compensation expense | 25,490 | | | 23,712 | |
Deferred income taxes | 3,309 | | | 8,783 | |
Impairment of long-lived assets (see Note 6) | 9,143 | | | 4,741 | |
| | | |
Write-down of equity investments | 18,550 | | | 9,785 | |
| | | |
Other | 27,311 | | | 24,117 | |
Changes in assets and liabilities, net of business acquisitions and divestitures: | | | |
Accounts receivable—trade, net | 11,794 | | | 55,399 | |
Inventories | (194,396) | | | (173,074) | |
Prepaid expenses and other current assets | 15,730 | | | 18,175 | |
Accounts payable and accrued liabilities | (19,304) | | | (33,797) | |
Accrued income taxes | 65,169 | | | (15,499) | |
Contributions to pension and other benefit plans | (8,333) | | | (8,919) | |
Other assets and liabilities | (19,765) | | | 4,407 | |
Net cash provided by operating activities | 614,047 | | | 679,328 | |
Investing Activities | | | |
Capital additions (including software) | (185,784) | | | (176,270) | |
| | | |
| | | |
Equity investments in tax credit qualifying partnerships | (26,392) | | | (30,270) | |
| | | |
Other investing activities | 2,374 | | | 154 | |
| | | |
Net cash used in investing activities | (209,802) | | | (206,386) | |
Financing Activities | | | |
Net increase (decrease) in short-term debt | 166,017 | | | (311,183) | |
Long-term borrowings, net of debt issuance costs | 989,876 | | | 5,020 | |
Repayment of long-term debt and finance leases | (352,104) | | | (4,054) | |
| | | |
| | | |
Cash dividends paid | (314,279) | | | (295,483) | |
Repurchase of common stock | (211,196) | | | (254,429) | |
Exercise of stock options | 17,544 | | | 161,399 | |
| | | |
Net cash provided by (used in) financing activities | 295,858 | | | (698,730) | |
Effect of exchange rate changes on cash and cash equivalents | (17,351) | | | 3,753 | |
Increase (decrease) in cash and cash equivalents, including cash classified as held for sale | 682,752 | | | (222,035) | |
Less: Increase in cash and cash equivalents classified as held for sale (see Note 8) | (10,683) | | | — | |
Net increase (decrease) in cash and cash equivalents | 672,069 | | | (222,035) | |
Cash and cash equivalents, beginning of period | 493,262 | | | 587,998 | |
Cash and cash equivalents, end of period | $ | 1,165,331 | | | $ | 365,963 | |
Supplemental Disclosure | | | |
Interest paid | $ | 74,944 | | | $ | 72,167 | |
Income taxes paid | 71,633 | | | 136,922 | |
|
| | | | | | | |
| Nine Months Ended |
| October 1, 2017 | | October 2, 2016 |
Operating Activities | | | |
Net income including noncontrolling interests | $ | 574,988 |
| | $ | 603,191 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 194,313 |
| | 241,901 |
|
Stock-based compensation expense | 37,966 |
| | 40,699 |
|
Deferred income taxes | (14,859 | ) | | (12,703 | ) |
Impairment of long-lived assets (see Note 7) | 208,712 |
| | — |
|
Write-down of equity investments | 23,999 |
| | 35,862 |
|
Gain on settlement of SGM liability (see Note 2) | — |
| | (26,650 | ) |
Other | 60,129 |
| | 42,499 |
|
Changes in assets and liabilities, net of business acquisitions: | | | |
Accounts receivable—trade, net | (161,451 | ) | | (157,142 | ) |
Inventories | (192,509 | ) | | (83,221 | ) |
Prepaid expenses and other current assets | (33,581 | ) | | (44,254 | ) |
Accounts payable and accrued liabilities | (15,380 | ) | | (126,966 | ) |
Accrued income taxes | 18,849 |
| | 1,128 |
|
Contributions to pension and other benefits plans | (57,883 | ) | | (42,566 | ) |
Other assets and liabilities | (17,394 | ) | | (21,018 | ) |
Net cash provided by operating activities | 625,899 |
| | 450,760 |
|
Investing Activities | | | |
Capital additions (including software) | (148,923 | ) | | (168,225 | ) |
Proceeds from sales of property, plant and equipment | 1,758 |
| | 3,032 |
|
Equity investments in tax credit qualifying partnerships | (39,977 | ) | | (35,395 | ) |
Business acquisitions, net of cash and cash equivalents acquired | — |
| | (285,374 | ) |
Net cash used in investing activities | (187,142 | ) | | (485,962 | ) |
Financing Activities | | | |
Net increase in short-term debt | 173,110 |
| | 250,573 |
|
Long-term borrowings | — |
| | 792,923 |
|
Repayment of long-term debt | (204 | ) | | (250,000 | ) |
Payment of SGM liability (see Note 2) | — |
| | (35,762 | ) |
Cash dividends paid | (391,845 | ) | | (371,706 | ) |
Repurchase of common stock | (300,312 | ) | | (452,580 | ) |
Exercise of stock options | 53,532 |
| | 88,093 |
|
Net cash (used in) provided by financing activities | (465,719 | ) | | 21,541 |
|
Effect of exchange rate changes on cash and cash equivalents | 5,051 |
| | 465 |
|
Decrease in cash and cash equivalents | (21,911 | ) | | (13,196 | ) |
Cash and cash equivalents, beginning of period | 296,967 |
| | 346,529 |
|
Cash and cash equivalents, end of period | $ | 275,056 |
| | $ | 333,333 |
|
Supplemental Disclosure | | | |
Interest paid | $ | 81,497 |
| | $ | 72,925 |
|
Income taxes paid | 271,412 |
| | 306,580 |
|
See Notes to Unaudited Consolidated Financial Statements.
The Hershey Company | Q2 2020 Form 10-Q | Page 5
THE HERSHEY COMPANY
CONSOLIDATED STATEMENTSTATEMENTS OF STOCKHOLDERS’ EQUITY
For the Three Months Ended June 28, 2020 and June 30, 2019
(in thousands)
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 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) | | | | | | | | | | 601,848 |
| | | | | | (26,860 | ) | | 574,988 |
|
Other comprehensive income | | | | | | | | | | | | | | 38,861 |
| | 735 |
| | 39,596 |
|
Dividends (including dividend equivalents): | | | | | | | | | | | | | | | | | | |
Common Stock, $1.892 per share | | | | | | | | | | (288,533 | ) | | | | | | | | (288,533 | ) |
Class B Common Stock, $1.720 per share | | | | | | | | | | (104,265 | ) | | | | | | | | (104,265 | ) |
Stock-based compensation | | | | | | | | 36,283 |
| | | | | | | | | | 36,283 |
|
Exercise of stock options and incentive-based transactions | | | | | | | | 4,106 |
| | | | 49,426 |
| | | | | | 53,532 |
|
Repurchase of common stock | | | | | | | | | | | | (300,312 | ) | | | | | | (300,312 | ) |
Balance, October 1, 2017 | | $ | — |
| | $ | 299,281 |
| | $ | 60,620 |
| | $ | 910,246 |
| | $ | 6,325,011 |
| | $ | (6,434,861 | ) | | $ | (337,027 | ) | | $ | 15,706 |
| | $ | 838,976 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Preferred Stock | | Common Stock | | Class B
Common
Stock | | Additional Paid-in Capital | | Retained Earnings | | Treasury Common Stock | | Accumulated Other
Comprehensive
Income (Loss) | | Noncontrolling Interests in Subsidiaries | | Total Stockholders’ Equity |
Balance, March 29, 2020 | | — | | | 160,939 | | | 60,614 | | | 1,153,130 | | | 1,404,453 | | | (742,164) | | | (365,741) | | | 3,310 | | | 1,674,541 | |
Net income (loss) | | | | | | | | | | 268,901 | | | | | | | (859) | | | 268,042 | |
Other comprehensive (loss) income | | | | | | | | | | | | | | (1,452) | | | 33 | | | (1,419) | |
Dividends (including dividend equivalents): | | | | | | | | | | | | | | | | | | |
Common Stock, $0.773 per share | | | | | | | | | | (114,260) | | | | | | | | | (114,260) | |
Class B Common Stock, $0.702 per share | | | | | | | | | | (42,551) | | | | | | | | | (42,551) | |
| | | | | | | | | | | | | | | | | | |
Stock-based compensation | | | | | | | | 12,612 | | | | | | | | | | | 12,612 | |
Exercise of stock options and incentive-based transactions | | | | | | | | (3,864) | | | | | 5,008 | | | | | | | 1,144 | |
Repurchase of common stock | | | | | | | | | | | | (42,020) | | | | | | | (42,020) | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Balance, June 28, 2020 | | $ | — | | | $ | 160,939 | | | $ | 60,614 | | | $ | 1,161,878 | | | $ | 1,516,543 | | | $ | (779,176) | | | $ | (367,193) | | | $ | 2,484 | | | $ | 1,756,089 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Preferred Stock | | Common Stock | | Class B
Common
Stock | | Additional Paid-in Capital | | Retained Earnings | | Treasury Common Stock | | Accumulated Other
Comprehensive
Income (Loss) | | Noncontrolling Interests in Subsidiaries | | Total Stockholders’ Equity |
Balance, March 31, 2019 | | — | | | 299,287 | | | 60,614 | | | 996,181 | | | 7,193,240 | | | (6,786,065) | | | (348,520) | | | 8,623 | | | 1,423,360 | |
Net income | | | | | | | | | | 312,840 | | | | | | | 431 | | | 313,271 | |
Other comprehensive income (loss) | | | | | | | | | | | | | | 11,784 | | | (93) | | | 11,691 | |
Dividends (including dividend equivalents): | | | | | | | | | | | | | | | | | | |
Common Stock, $0.722 per share | | | | | | | | | | (108,041) | | | | | | | | | (108,041) | |
Class B Common Stock, $0.656 per share | | | | | | | | | | (39,762) | | | | | | | | | (39,762) | |
| | | | | | | | | | | | | | | | | | |
Stock-based compensation | | | | | | | | 12,665 | | | | | | | | | | | 12,665 | |
Exercise of stock options and incentive-based transactions | | | | | | | | 66,341 | | | | | 60,485 | | | | | | | 126,826 | |
Repurchase of common stock | | | | | | | | | | | | (55,929) | | | | | | | (55,929) | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Balance, June 30, 2019 | | $ | — | | | $ | 299,287 | | | $ | 60,614 | | | $ | 1,075,187 | | | $ | 7,358,277 | | | $ | (6,781,509) | | | $ | (336,736) | | | $ | 8,961 | | | $ | 1,684,081 | |
See Notes to Unaudited Consolidated Financial Statements.
The Hershey Company | Q2 2020 Form 10-Q | Page 6
THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Six Months Ended June 28, 2020 and June 30, 2019
(in thousands)
(unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Preferred Stock | | Common Stock | | Class B
Common
Stock | | Additional Paid-in Capital | | Retained Earnings | | Treasury Common Stock | | Accumulated Other
Comprehensive
Income (Loss) | | Noncontrolling Interests in Subsidiaries | | Total Stockholders’ Equity |
Balance, December 31, 2019 | | — | | | 160,939 | | | 60,614 | | | 1,142,210 | | | 1,290,461 | | | (591,036) | | | (323,966) | | | 5,772 | | | 1,744,994 | |
Net income (loss) | | | | | | | | | | 540,038 | | | | | | | (3,213) | | | 536,825 | |
Other comprehensive loss | | | | | | | | | | | | | | (43,227) | | | (75) | | | (43,302) | |
Dividends (including dividend equivalents): | | | | | | | | | | | | | | | | | | |
Common Stock, $1.546 per share | | | | | | | | | | (228,854) | | | | | | | | | (228,854) | |
Class B Common Stock, $1.404 per share | | | | | | | | | | (85,102) | | | | | | | | | (85,102) | |
| | | | | | | | | | | | | | | | | | |
Stock-based compensation | | | | | | | | 25,180 | | | | | | | | | | | 25,180 | |
Exercise of stock options and incentive-based transactions | | | | | | | | (5,512) | | | | | 23,056 | | | | | | | 17,544 | |
Repurchase of common stock | | | | | | | | | | | | (211,196) | | | | | | | (211,196) | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Balance, June 28, 2020 | | $ | — | | | $ | 160,939 | | | $ | 60,614 | | | $ | 1,161,878 | | | $ | 1,516,543 | | | $ | (779,176) | | | $ | (367,193) | | | $ | 2,484 | | | $ | 1,756,089 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Preferred Stock | | Common Stock | | Class B
Common
Stock | | Additional Paid-in Capital | | Retained Earnings | | Treasury Common Stock | | Accumulated Other
Comprehensive
Income (Loss) | | Noncontrolling Interests in Subsidiaries | | Total Stockholders’ Equity |
Balance, December 31, 2018 | | — | | | 299,287 | | | 60,614 | | | 982,205 | | | 7,032,020 | | | (6,618,625) | | | (356,780) | | | 8,545 | | | 1,407,266 | |
Net income (loss) | | | | | | | | | | 617,198 | | | | | | | (46) | | | 617,152 | |
Other comprehensive income | | | | | | | | | | | | | | 20,044 | | | 462 | | | 20,506 | |
Dividends (including dividend equivalents): | | | | | | | | | | | | | | | | | | |
Common Stock, $1.444 per share | | | | | | | | | | (215,329) | | | | | | | | | (215,329) | |
Class B Common Stock, $1.312 per share | | | | | | | | | | (79,525) | | | | | | | | | (79,525) | |
| | | | | | | | | | | | | | | | | | |
Stock-based compensation | | | | | | | | 23,128 | | | | | | | | | | | 23,128 | |
Exercise of stock options and incentive-based transactions | | | | | | | | 69,854 | | | | | 91,545 | | | | | | | 161,399 | |
Repurchase of common stock | | | | | | | | | | | | (254,429) | | | | | | | (254,429) | |
| | | | | | | | | | | | | | | | | | |
Impact of ASU 2016-02 related to leases | | | | | | | | | | 3,913 | | | | | | | | | 3,913 | |
| | | | | | | | | | | | | | | | | | |
Balance, June 30, 2019 | | $ | — | | | $ | 299,287 | | | $ | 60,614 | | | $ | 1,075,187 | | | $ | 7,358,277 | | | $ | (6,781,509) | | | $ | (336,736) | | | $ | 8,961 | | | $ | 1,684,081 | |
See Notes to Unaudited Consolidated Financial Statements.
The Hershey Company | Q2 2020 Form 10-Q | Page 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 noncontrollingminority 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.beneficiary or we have the power to direct the activities that most significantly impact the entity's economic performance. We use the equity method of accounting when we have a 20% to 50% interest in other companies and exercise significant influence. Other investments that are not controlled, and over which we do not have the ability to exercise significant influence, are accounted for under the cost method. Both equity and cost method investments are included as Other non-current assets in the Consolidated Balance Sheets.
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 (consisting of normal recurring 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 October 1, 2017June 28, 2020 may not be indicative of the results that may be expected for the year ending December 31, 20172020 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, 20162019 (our “2016“2019 Annual Report on Form 10-K”), which provides a more complete understanding of our accounting policies, financial position, operating results and other matters.
ReclassificationsCOVID-19
Certain prior period amounts haveOn March 11, 2020, the World Health Organization designated the recent novel coronavirus ("COVID-19") as a global pandemic. We continue to actively monitor COVID-19 and its potential impact on our operations and financial results. Employee health and safety remains our first priority while we continue our efforts to support community food supplies. To date, there has been reclassifiedminimal disruption to conformour supply chain network, and all our manufacturing plants are currently open. We are also working closely with our business units, contract manufacturers, distributors, contractors and other external business partners to current year presentation. Specifically, this includes amounts reclassified to conform tominimize the current year presentationpotential impact on our business.
As a result of shelter-in-place restrictions that were implemented in late March and early April, as well as decreases in retail foot traffic and volatility in consumer shopping and consumption behavior across several areas of our portfolio, we experienced a reduction in our net sales and earnings per share during the Consolidated Statementssecond quarter of Cash Flows.
Recent Accounting Pronouncements
In May 2014,2020. We believe the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenuefinancial impacts from Contracts with Customers, which outlines a single comprehensiveCOVID-19 are temporary in nature and do not significantly affect our business 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.
We have substantially completed our assessment of the new standard andgrowth strategy. Therefore, we do not expectconsider COVID-19 to be a triggering event to accelerate our adoption ofannual impairments tests.
We evaluated our goodwill and indefinite-lived intangible assets and determined there were no interim triggering events as it was not more likely than not that the new standard to have a material impact on our consolidated financial statements. We intend 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 inventoryfair value of our reporting units would be less than their respective carrying amounts. Additionally, we evaluated our long-lived assets, including our property, plant and equipment, lease arrangementsright-of-use assets and other intangible assets, noting no indicators of impairment.
In late May and early June, many state governments began a phased reopening of their economies. These phased approaches promote limited food service offerings, outdoor dining, increased travel and the reopening of retailing establishments while adhering to new guidelines and enhanced safety measures, including social distancing and face mask protocols. However, certain states have paused or reversed plans to reopen their economies as new cases of COVID-19 have been on the rise in order to determine therecent weeks.
The impact that the adoption of ASU 2016-02COVID-19 will have on our consolidated financial statements throughout 2020 remains uncertain and related disclosures. Based on our assessment to date, we expect adoptionultimately will be dictated by the length and severity of this standard to result in a material increase in lease-related assetsthe pandemic, as well as the economic recovery 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.federal,
The Hershey Company | Q2 2020 Form 10-Q | Page 8
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
state and local government actions taken in response. We will continue to evaluate the nature and extent of these potential impacts to our business and consolidated financial statements.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In MarchAugust 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General (Topic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans, which modifies the disclosure requirements for defined benefit pension plans and other post-retirement plans. ASU 2018-14 is effective for annual periods beginning after December 15, 2020, with early adoption permitted. The amendments in this ASU should be applied on a retrospective basis to all periods presented. We elected to early adopt the provisions of this ASU in the fourth quarter of 2019. Adoption of the new standard did not have a material impact on our consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation2016-13, Financial Instruments – Credit Losses (Topic 718)326): ImprovementsMeasurement of Credit Losses on Financial Instruments. This ASU modifies the measurement of expected credit losses of certain financial instruments. ASU 2016-13 is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods. The amendments in this ASU should be applied on a modified retrospective basis to Employee Share-Based Payment Accounting.all periods presented. 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 $7,927 recognized during the nine months ended October 1, 2017. Additionally, within the Consolidated Statement of Cash Flows, the impact2020. Adoption of the adoption resulted innew standard did not have a $19,916 increase in net cash flow from operating activities and a corresponding decrease in net cash flow from financing activities for the nine months ended October 1, 2017. These classification requirements were adopted retrospectively to the Consolidated Statement of Cash Flows for the nine months ended October 2, 2016, resulting in a $28,221 increase in net cash flow from operating activities and a corresponding $28,221 decrease in net cash flow from financing activities.material impact on our consolidated financial statements.
In March 2017,August 2018, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits2018-13, Fair Value Measurement (Topic 715)820), Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. This ASU will require an employer to reportmodifies the service cost component of net benefit cost in the same line item as other compensation costs arising from services rendereddisclosure requirements for fair value measurements 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,removing, modifying 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.adding certain disclosures. 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.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which amends ASC 815. The purpose of this ASU is to better align accounting rules with a company’s risk management activities and financial reporting for hedging relationships, better reflect economic results of hedging in financial statements, simplify hedge accounting requirements and improve the disclosures of hedging arrangements. The amendment should be applied using the modified retrospective transition method. ASU 2017-122018-13 is effective for annual periods beginning after December 15, 20182019 and interim periods within those annual periods, with early adoption permitted. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. We currently plan to adoptadopted the requirementsprovisions of the new standardthis ASU in the first quarter of 2018. We do2020. Adoption of the new standard did not expect it to have a significantmaterial impact on our Consolidatedconsolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40), Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods, with early adoption permitted. The amendments in this ASU should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. We adopted the provisions of this ASU in the first quarter of 2020 on a prospective basis. Adoption of the new standard did not have a material impact on our consolidated financial statements.
Recently Issued Accounting Pronouncements Not Yet Adopted
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU is intended to simplify various aspects related to accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and clarifying certain aspects of the current guidance to promote consistency among reporting entities. ASU 2019-12 is effective for annual periods beginning after December 15, 2020 and interim periods within those annual periods, with early adoption permitted. An entity that elects early adoption must adopt all the amendments in the same period. Most amendments within this ASU are required to be applied on a prospective basis, while certain amendments must be applied on a retrospective or modified retrospective basis. We are currently evaluating the impact of the new standard on our consolidated financial statements and related disclosures.
The Hershey Company | Q2 2020 Form 10-Q | Page 9
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Statements.Reporting. The ASU is intended to provide temporary optional expedients and exceptions to the GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates. Entities may apply this ASU upon issuance through December 31, 2022 on a prospective basis. We are currently evaluating the impact of the new standard on our consolidated financial statements and related disclosures.
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.
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
2. BUSINESS ACQUISITIONSACQUISITION AND DIVESTITURES
Acquisitions2020 Activity
During the second quarter of businesses are2020, we completed the divestitures of KRAVE Pure Foods, Inc., and the Scharffen Berger and Dagoba brands, all of which were previously included within the North America segment results in our consolidated financial statements. Total proceeds from the divestitures and the impact on our Consolidated Statements of Income, both individually and on an aggregate basis, were immaterial.
2019 Activity
ONE Brands, LLC
On September 23, 2019, we completed the acquisition of ONE Brands, LLC ("ONE Brands"), previously a privately held company that sells a line of low-sugar, high-protein nutrition bars to retailers and distributors in the United States, with the ONE Bar as its primary product. The purchase consideration for ONE Brands totaled $402,160 and consisted of cash on hand and short-term borrowings. Acquisition-related costs for the ONE Brands acquisition were immaterial.
The acquisition has been accounted for as purchasesa purchase and, accordingly, theONE Brands' results of operations of the businesses acquired have been included within the North America segment results in theour consolidated financial statements since the respective datesdate 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.
acquisition. The purchase consideration was allocated to assets acquired and liabilities assumed based on their respective fair values as follows:
| | | | | | | | | | | | | | | | | |
| Initial Allocation (1) | | Adjustments | | Final Allocation |
Goodwill | $ | 179,240 | | | $ | 825 | | | $ | 180,065 | |
Other intangible assets | 206,800 | | | — | | | 206,800 | |
Other assets acquired, primarily current assets | 25,926 | | | (491) | | | 25,435 | |
Other liabilities assumed, primarily current liabilities | (9,806) | | | (334) | | | (10,140) | |
Net assets acquired | $ | 402,160 | | | $ | — | | | $ | 402,160 | |
|
| | | |
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 |
|
(1)As reported in the Company's 2019 Annual Report on Form 10-K.
The purchase price allocation presented above has been finalized as of the end of the first quarter of 2020. The measurement period adjustments to the initial allocation are based on more detailed information obtained about the specific assets acquired and liabilities assumed.
Goodwill is calculatedwas determined as the excess of the purchase price over the fair value of the net assets acquired.acquired (including the identifiable intangible assets). The goodwill resultingderived from thethis acquisition is attributable primarilyexpected to be deductible for tax purposes and reflects the value of leveraging our brand building expertise, consumer insights, supply chain capabilities and retail relationships to accelerate growth and access to barkTHINSthe portfolio of ONE Brands products. Acquired
Other intangible assets include trademarks valued at $144,900, customer relationships valued at $58,800 and covenants not to compete valued at $3,100. Trademarks were assigned an estimated useful life of 33 years, customer relationships were assigned estimated useful lives of 27ranging from 17 to 19 years while other intangibles, including customer relationships and covenants not to compete were assigned an estimated useful lives ranging from 2 to 14life of 4 years. The recorded goodwill, trademarks and other intangibles are expected to be deductible for tax purposes.
Shanghai Golden Monkey (“SGM”)
On February 3, 2016, we completed the purchase of the remaining 20% of the outstanding shares of SGM for cash consideration totaling $35,762, pursuant to a new agreement entered into during the fourth quarter of 2015 with the SGM selling shareholders which revised the originally-agreed purchase price for these shares. For accounting purposes, we treated the acquisition as if we had acquired 100% at the initial acquisition date in 2014 and financed the 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 resultedHershey Company | Q2 2020 Form 10-Q | Page 10
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts 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.thousands, except share data or if otherwise indicated)
3. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying value of goodwill by reportable segment for the ninesix months ended October 1, 2017June 28, 2020 are as follows:
| | | | | | | | | | | | | | | | | | | | |
| | North America | | International and Other | | Total |
Balance at December 31, 2019 | | $ | 1,967,466 | | | $ | 18,489 | | | $ | 1,985,955 | |
| | | | | | |
Measurement period adjustments (see Note 2) | | 825 | | | — | | | 825 | |
| | | | | | |
Foreign currency translation | | (5,496) | | | (2,282) | | | (7,778) | |
Balance at June 28, 2020 | | $ | 1,962,795 | | | $ | 16,207 | | | $ | 1,979,002 | |
|
| | | | | | | | | | | | |
| | North America | | International and Other | | Total |
Balance at December 31, 2016 | | $ | 792,190 |
| | $ | 20,154 |
| | $ | 812,344 |
|
Foreign currency translation | | 8,401 |
| | 1,603 |
| | 10,004 |
|
Balance at October 1, 2017 | | 800,591 |
| | 21,757 |
| | 822,348 |
|
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
The following table provides the gross carrying amount and accumulated amortization for each major class of intangible asset:
|
| | | | | | | | | | | | | | | | |
| | October 1, 2017 | | December 31, 2016 |
| | Gross Carrying Amount | | Accumulated Amortization | | Gross Carrying Amount | | Accumulated Amortization |
Intangible assets subject to amortization: | | | | | | | | |
Trademarks | | $ | 272,599 |
| | $ | (34,516 | ) | | $ | 317,023 |
| | $ | (30,458 | ) |
Customer-related | | 128,722 |
| | (33,069 | ) | | 200,409 |
| | (36,482 | ) |
Patents | | 17,059 |
| | (15,562 | ) | | 16,426 |
| | (13,700 | ) |
Total | | 418,380 |
| | (83,147 | ) | | 533,858 |
| | (80,640 | ) |
| | | | | | | | |
Intangible assets not subject to amortization: | | | | | | | | |
Trademarks | | 40,222 |
| | | | 39,519 |
| | |
Total other intangible assets | | $ | 375,455 |
| | | | $ | 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. | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 28, 2020 | | | | December 31, 2019 | | |
| | Gross Carrying Amount | | Accumulated Amortization | | Gross Carrying Amount | | Accumulated Amortization |
Intangible assets subject to amortization: | | | | | | | | |
Trademarks | | $ | 1,207,594 | | | $ | (86,910) | | | $ | 1,212,172 | | | $ | (73,262) | |
Customer-related | | 202,371 | | | (42,670) | | | 207,749 | | | (40,544) | |
Patents | | 7,980 | | | (7,885) | | | 16,711 | | | (16,525) | |
| | | | | | | | |
Total | | 1,417,945 | | | (137,465) | | | 1,436,632 | | | (130,331) | |
| | | | | | | | |
Intangible assets not subject to amortization: | | | | | | | | |
Trademarks | | 33,852 | | | | | 34,865 | | | |
Total other intangible assets | | $ | 1,314,332 | | | | | $ | 1,341,166 | | | |
Total amortization expense for the three months ended October 1, 2017June 28, 2020 and October 2, 2016June 30, 2019 was $5,410$11,580 and $7,666,$12,672, respectively. Total amortization expense for the ninesix months ended October 1, 2017June 28, 2020 and October 2, 2016June 30, 2019 was $17,968$23,220 and $18,811,$24,910, 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$1.5 billion unsecured revolving credit facility which currently expires in November 2020. This agreement also includes anwith the option to increase borrowings by an additional $400$500 million with the consent of the lenders. This facility is scheduled to expire on July 2, 2024, however, we may extend the termination date for up to two additional one-year periods upon notice to the administrative agent under the facility.
The credit agreement contains certain financial and other covenants, customary representations, warranties and events of default. As of October 1, 2017,June 28, 2020, 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 Annual2019Annual Report on Form 10-K.
The Hershey Company | Q2 2020 Form 10-Q | Page 11
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
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 $175,279 at October 1, 2017 and $158,805 at December 31, 2016. Commitment fees relating to our revolving credit facility and lines of credit are not material. Short-term debt consisted of the following:
At October 1, 2017, we had outstanding commercial paper totaling $640,309, at a weighted average interest rate | | | | | | | | | | | |
| June 28, 2020 | | December 31, 2019 |
Short-term foreign bank borrowings against lines of credit | $ | 48,421 | | | $ | 32,282 | |
U.S. commercial paper | 149,878 | | | — | |
Total short-term debt | $ | 198,299 | | | $ | 32,282 | |
Weighted average interest rate on outstanding commercial paper | 0.4 | % | | N/A |
Long-term Debt
Long-term debt consisted of 1.2%. At December 31, 2016, we had outstanding commercial paper totaling $473,666, at a weighted average interest rate of 0.6%.the following:
| | | | | | | | | | | | | | | | | | | | |
Debt Type and Rate | | Maturity Date | | June 28, 2020 | | December 31, 2019 |
2.900% Notes (1) | | May 15, 2020 | | $ | — | | | $ | 350,000 | |
4.125% Notes | | December 1, 2020 | | 350,000 | | | 350,000 | |
8.800% Debentures | | February 15, 2021 | | 84,715 | | | 84,715 | |
3.100% Notes | | May 15, 2021 | | 350,000 | | | 350,000 | |
2.625% Notes | | May 1, 2023 | | 250,000 | | | 250,000 | |
3.375% Notes | | May 15, 2023 | | 500,000 | | | 500,000 | |
2.050% Notes | | November 15, 2024 | | 300,000 | | | 300,000 | |
0.900% Notes (2) | | June 1, 2025 | | 300,000 | | | — | |
3.200% Notes | | August 21, 2025 | | 300,000 | | | 300,000 | |
2.300% Notes | | August 15, 2026 | | 500,000 | | | 500,000 | |
7.200% Debentures | | August 15, 2027 | | 193,639 | | | 193,639 | |
2.450% Notes | | November 15, 2029 | | 300,000 | | | 300,000 | |
1.700% Notes (2) | | June 1, 2030 | | 350,000 | | | — | |
3.375% Notes | | August 15, 2046 | | 300,000 | | | 300,000 | |
3.125% Notes | | November 15, 2049 | | 400,000 | | | 400,000 | |
2.650% Notes (2) | | June 1, 2050 | | 350,000 | | | — | |
Finance lease obligations (see Note 7) | | | | 80,447 | | | 79,643 | |
Net impact of interest rate swaps, debt issuance costs and unamortized debt discounts | | | | (29,142) | | | (23,794) | |
Total long-term debt | | | | 4,879,659 | | | 4,234,203 | |
Less—current portion | | | | 788,448 | | | 703,390 | |
Long-term portion | | | | $ | 4,091,211 | | | $ | 3,530,813 | |
The Hershey Company | Q2 2020 Form 10-Q | Page 12
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
(1)In May 2020, we repaid $350,000 of 2.900% Notes due upon their maturity.
Long-term Debt
Long-term debt consisted(2)During the second quarter of 2020, we issued $300,000 of 0.900% Notes due in 2025, $350,000 of 1.700% Notes due in 2030 and $350,000 of 2.650% Notes due in 2050 (the "2020 Notes"). Proceeds from the issuance of the following: |
| | | | | | | | |
December 31, | | October 1, 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 | | 86,201 |
| | 83,619 |
|
Net impact of interest rate swaps, debt issuance costs and unamortized debt discounts | | (10,327 | ) | | (14,275 | ) |
Total long-term debt | | 2,354,228 |
| | 2,347,698 |
|
Less—current portion | | 300,096 |
| | 243 |
|
Long-term portion | | $ | 2,054,132 |
| | $ | 2,347,455 |
|
2020 Notes, net of discounts and issuance costs, totaled $989,876. The 2020 Notes were issued under a shelf registration statement on Form S-3 filed in May 2018 that registered an indeterminate amount of debt securities.Interest Expense
Net interest expense consistedconsists of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | | | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Interest expense | | $ | 40,520 | | | $ | 39,192 | | | $ | 79,776 | | | $ | 79,855 | |
Capitalized interest | | (1,664) | | | (1,391) | | | (3,081) | | | (2,648) | |
Interest expense | | 38,856 | | | 37,801 | | | 76,695 | | | 77,207 | |
Interest income | | (777) | | | (4,025) | | | (2,361) | | | (5,973) | |
Interest expense, net | | $ | 38,079 | | | $ | 33,776 | | | $ | 74,334 | | | $ | 71,234 | |
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Interest expense | | $ | 25,955 |
| | $ | 25,882 |
| | $ | 76,208 |
| | $ | 72,404 |
|
Capitalized interest | | (1,033 | ) | | (1,141 | ) | | (2,892 | ) | | (4,702 | ) |
Interest expense | | 24,922 |
| | 24,741 |
| | 73,316 |
| | 67,702 |
|
Interest income | | (333 | ) | | (354 | ) | | (860 | ) | | (972 | ) |
Interest expense, net | | $ | 24,589 |
| | $ | 24,387 |
| | $ | 72,456 |
| | $ | 66,730 |
|
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 assuming period-end market prices, of $408,983$817,521 as of October 1, 2017June 28, 2020 and $739,374$589,662 as of December 31, 2016.2019.
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
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 11,13, 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, British pound, Brazilian real and Brazilian real.Malaysian ringgit. We typically utilize foreign currency forward exchange contracts 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 $107,507$84,383 at October 1, 2017June 28, 2020 and $68,263$65,826 at December 31, 2016.2019. The effective portion of the changes in fair value on these contracts is recorded in other
The Hershey Company | Q2 2020 Form 10-Q | Page 13
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
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$42,057 at October 1, 2017June 28, 2020 and $50,831 at December 31, 2016.2019. The change in fair value on these instruments is recorded directly in cost of sales or selling, marketing and administrative expense, depending on the nature of the underlying exposure.
Interest Rate Risk
We manage our targeted mix of fixed and floating rate debt with debt issuances and by entering into fixed-to-floating interest rate swaps in order to mitigate fluctuations in earnings and cash flows that may result from interest rate volatility. These swaps are designated as fair value hedges, for which the gain or loss on the derivative and the offsetting loss or gain on the hedged item are recognized in current earnings as interest expense (income), net. At October 1, 2017We had one interest rate derivative instrument in a fair value hedging relationship with a notional amount of $350,000 at June 28, 2020 and December 31, 2016, we had interest rate derivative instruments in fair value hedging relationships with a total notional amount of $350,000.2019.
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 October 1, 2017June 28, 2020 and December 31, 20162019 was $24,164$22,995 and $22,099,$28,187, respectively.
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
The following table presents the classification of derivative assets and liabilities within the Consolidated Balance Sheets as of October 1, 2017June 28, 2020 and December 31, 2016:2019:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 28, 2020 | | | | December 31, 2019 | | |
| | Assets (1) | | Liabilities (1) | | Assets (1) | | Liabilities (1) |
Derivatives designated as cash flow hedging instruments: | | | | | | | | |
| | | | | | | | |
Foreign exchange contracts | | $ | 4,492 | | | $ | 370 | | | $ | 1,235 | | | $ | 1,779 | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Derivatives designated as fair value hedging instruments: | | | | | | | | |
Interest rate swap agreements | | 2,829 | | | — | | | 555 | | | — | |
| | | | | | | | |
Derivatives not designated as hedging instruments: | | | | | | | | |
Commodities futures and options (2) | | — | | | 23,840 | | | 9,080 | | | 626 | |
Deferred compensation derivatives | | 4,626 | | | — | | | 2,557 | | | — | |
Foreign exchange contracts | | — | | | 2,111 | | | 1,496 | | | — | |
| | 4,626 | | | 25,951 | | | 13,133 | | | 626 | |
Total | | $ | 11,947 | | | $ | 26,321 | | | $ | 14,923 | | | $ | 2,405 | |
(1)Derivatives assets are classified on our Consolidated Balance Sheets within prepaid expenses and other as well as other assets. Derivative liabilities are classified on our Consolidated Balance Sheets within accrued liabilities and other long-term liabilities.
The Hershey Company | Q2 2020 Form 10-Q | Page 14
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
|
| | | | | | | | | | | | | | | | |
December 31, | | October 1, 2017 | | December 31, 2016 |
| | Assets (1) | | Liabilities (1) | | Assets (1) | | Liabilities (1) |
Derivatives designated as cash flow hedging instruments: | | | | | | | | |
Foreign exchange contracts | | $ | 421 |
| | $ | 4,216 |
| | $ | 2,229 |
| | $ | 809 |
|
| | | | | | | | |
Derivatives designated as fair value hedging instruments: | | | | | | | | |
Interest rate swap agreements | | 4,571 |
| | — |
| | 1,768 |
| | — |
|
| | | | | | | | |
Derivatives not designated as hedging instruments: | | | | | | | | |
Commodities futures and options (2) | | 6,222 |
| | 295 |
| | 2,348 |
| | 10,000 |
|
Deferred compensation derivatives | | 994 |
| | — |
| | 717 |
| | — |
|
Foreign exchange contracts | | 14 |
| | — |
| | — |
| | 16 |
|
| | 7,230 |
| | 295 |
| | 3,065 |
| | 10,016 |
|
Total | | $ | 12,222 |
| | $ | 4,511 |
| | $ | 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 October 1, 2017, assets and liabilities include the net of assets of $38,963 and liabilities of $33,780 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 October 1, 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. |
(2)As of June 28, 2020, amounts reflected on a net basis in liabilities were assets of $95,969 and liabilities of $117,217, which are 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 assets at December 31, 2019 were assets of $46,075 and liabilities of $37,606. At June 28, 2020 and December 31, 2019, the remaining amount reflected in assets and liabilities related to the fair value of other non-exchange traded derivative instruments, respectively.
Income Statement Impact of Derivative Instruments
The effect of derivative instruments on the Consolidated Statements of Income for the three months ended October 1, 2017June 28, 2020 and October 2, 2016June 30, 2019 was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Non-designated Hedges | | | | Cash Flow Hedges | | | | | | | | | | |
| | Gains (losses) recognized in income (a) | | | | Gains (losses) recognized in other comprehensive income (“OCI”) | | | | Gains (losses) reclassified from accumulated OCI into income (b) | | | | | | |
| | | | | | | | | | | | | | | | |
| | 2020 | | 2019 | | 2020 | | 2019 | | 2020 | | 2019 | | | | |
Commodities futures and options | | $ | 2,624 | | | $ | 55,531 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | | | |
Foreign exchange contracts | | (554) | | | (526) | | | 675 | | | (2,547) | | | 1,138 | | | 975 | | | | | |
Interest rate swap agreements | | — | | | — | | | — | | | — | | | (2,343) | | | (2,370) | | | | | |
Deferred compensation derivatives | | 4,626 | | | (2,070) | | | — | | | — | | | — | | | — | | | | | |
Total | | $ | 6,696 | | | $ | 52,935 | | | $ | 675 | | | $ | (2,547) | | | $ | (1,205) | | | $ | (1,395) | | | | | |
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | 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 | | $ | (2,445 | ) | | $ | (37,246 | ) | | $ | — |
| | $ | — |
| | $ | (488 | ) | | $ | 7,780 |
|
Foreign exchange contracts | | 11 |
| | (27 | ) | | (1,339 | ) | | 1,628 |
| | 869 |
| | (2,659 | ) |
Interest rate swap agreements | | — |
| | — |
| | — |
| | (274 | ) | | (2,343 | ) | | (2,833 | ) |
Deferred compensation derivatives | | 349 |
| | 665 |
| | — |
| | — |
| | — |
| | — |
|
Total | | $ | (2,085 | ) | | $ | (36,608 | ) | | $ | (1,339 | ) | | $ | 1,354 |
| | $ | (1,962 | ) | | $ | 2,288 |
|
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
| |
(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 ninesix months ended October 1, 2017June 28, 2020 and October 2, 2016June 30, 2019 was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Non-designated Hedges | | | | Cash Flow Hedges | | | | | | | | | | |
| | Gains (losses) recognized in income (a) | | | | Gains (losses) recognized in OCI | | | | Gains (losses) reclassified from accumulated OCI into income (b) | | | | | | |
| | | | | | | | | | | | | | | | |
| | 2020 | | 2019 | | 2020 | | 2019 | | 2020 | | 2019 | | | | |
Commodities futures and options | | $ | (74,468) | | | $ | 28,890 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | | | |
Foreign exchange contracts | | (3,876) | | | (311) | | | 6,056 | | | (3,336) | | | 1,390 | | | 1,906 | | | | | |
Interest rate swap agreements | | — | | | — | | | — | | | — | | | (4,687) | | | (4,739) | | | | | |
Deferred compensation derivatives | | (1,133) | | | 973 | | | — | | | — | | | — | | | — | | | | | |
Total | | $ | (79,477) | | | $ | 29,552 | | | $ | 6,056 | | | $ | (3,336) | | | $ | (3,297) | | | $ | (2,833) | | | | | |
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | 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 | | $ | (40,500 | ) | | $ | (37,176 | ) | | $ | — |
| | $ | — |
| | $ | (1,325 | ) | | $ | 23,648 |
|
Foreign exchange contracts | | (40 | ) | | (484 | ) | | (3,545 | ) | | (6,404 | ) | | 1,087 |
| | (3,681 | ) |
Interest rate swap agreements | | — |
| | — |
| | — |
| | (47,223 | ) | | (7,136 | ) | | (5,903 | ) |
Deferred compensation derivatives | | 994 |
| | 1,486 |
| | — |
| | — |
| | — |
| | — |
|
Total | | $ | (39,546 | ) | | $ | (36,174 | ) | | $ | (3,545 | ) | | $ | (53,627 | ) | | $ | (7,374 | ) | | $ | 14,064 |
|
(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.
| |
(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. |
(b)Gains (losses) reclassified from AOCI into income for foreign currency forward exchange contracts were included in selling, marketing and administrative expenses. Losses reclassified from AOCI into income for interest rate swap agreements were included in interest expense.
The amount of pretax net losses on derivative instruments, including interest rate swap agreements and 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 $13,299$5,252 as of October 1, 2017.June 28, 2020. This amount is primarily associated with deferred losses relating to interest rate swap agreements.
Fair Value HedgesHedging Relationships
ForThe following table presents amounts that were recorded on the three months ended October 1, 2017Consolidated Balance Sheets related to cumulative basis adjustments for interest rate swap derivatives designated as fair value accounting hedges as of June 28, 2020 and October 2, 2016, we recognized a net pretax benefit to interest expense of $573 and $1,022 relating to our fixed-to-floating interest swap arrangements. For the nine months ended October 1, 2017 and October 2, 2016, we recognized a net pretax benefit to interest expense of $2,203 and $3,477 relating to our fixed-to-floating interest swap arrangements.December 31, 2019.
The Hershey Company | Q2 2020 Form 10-Q | Page 15
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Line Item in the Consolidated Balance Sheets in Which the Hedged Item is Included | | Carrying Amount of the Hedged Asset/(Liability) | | | | Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount Assets/(Liabilities) | | |
| | June 28, 2020 | | December 31, 2019 | | June 28, 2020 | | December 31, 2019 |
Long-term debt | | $ | (347,171) | | | $ | (349,445) | | | $ | 2,829 | | | $ | 555 | |
For the three months ended June 28, 2020 and June 30, 2019, we recognized a net pretax benefit to interest expense of $608 and net incremental interest expense of $584, respectively, relating to our fixed-to-floating interest swap arrangements. For the six months ended June 28, 2020 and June 30, 2019, we recognized a net pretax benefit to interest expense of $759 and net incremental interest expense of $1,214, respectively, 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 not0t 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 October 1, 2017June 28, 2020 and December 31, 2016:2019:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Assets (Liabilities) | | | | | | |
| | Level 1 | | Level 2 | | Level 3 | | Total |
June 28, 2020: | | | | | | | | |
Derivative Instruments: | | | | | | | | |
Assets: | | | | | | | | |
Foreign exchange contracts (1) | | $ | — | | | $ | 4,492 | | | $ | — | | | $ | 4,492 | |
Interest rate swap agreements (2) | | — | | | 2,829 | | | — | | | 2,829 | |
Deferred compensation derivatives (3) | | — | | | 4,626 | | | — | | | 4,626 | |
| | | | | | | | |
Liabilities: | | | | | | | | |
Foreign exchange contracts (1) | | — | | | 2,481 | | | — | | | 2,481 | |
| | | | | | | | |
| | | | | | | | |
Commodities futures and options (4) | | 23,840 | | | — | | | — | | | 23,840 | |
December 31, 2019: | | | | | | | | |
Assets: | | | | | | | | |
Foreign exchange contracts (1) | | $ | — | | | $ | 2,731 | | | $ | — | | | $ | 2,731 | |
Interest rate swap agreements (2) | | — | | | 555 | | | — | | | 555 | |
Deferred compensation derivatives (3) | | — | | | 2,557 | | | — | | | 2,557 | |
Commodities futures and options (4) | | 9,080 | | | — | | | — | | | 9,080 | |
Liabilities: | | | | | | | | |
Foreign exchange contracts (1) | | — | | | 1,779 | | | — | | | 1,779 | |
| | | | | | | | |
| | | | | | | | |
Commodities futures and options (4) | | 626 | | | — | | | — | | | 626 | |
(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
The Hershey Company | Q2 2020 Form 10-Q | Page 16
|
| | | | | | | | | | | | | | | | |
| | Level 1 | | Level 2 | | Level 3 | | Total |
October 1, 2017: | | | | | | | | |
Derivative Instruments: | | | | | | | | |
Assets: | | | | | | | | |
Foreign exchange contracts (1) | | $ | — |
| | $ | 435 |
| | $ | — |
| | $ | 435 |
|
Interest rate swap agreements (2) | | — |
| | 4,571 |
| | — |
| | 4,571 |
|
Deferred compensation derivatives (3) | | — |
| | 994 |
| | — |
| | 994 |
|
Commodities futures and options (4) | | 6,222 |
| | — |
| | — |
| | 6,222 |
|
Liabilities: | | | | | | | | |
Foreign exchange contracts (1) | | — |
| | 4,216 |
| | — |
| | 4,216 |
|
Commodities futures and options (4) | | 295 |
| | — |
| | — |
| | 295 |
|
December 31, 2016: | | | | | | | | |
Assets: | | | | | | | | |
Foreign exchange contracts (1) | | $ | — |
| | $ | 2,229 |
| | $ | — |
| | $ | 2,229 |
|
Interest rate swap agreements (2) | | — |
| | 1,768 |
| | — |
| | 1,768 |
|
Deferred compensation derivatives (3) | | — |
| | 717 |
| | — |
| | 717 |
|
Commodities futures and options (4) | | 2,348 |
| | — |
| | — |
| | 2,348 |
|
Liabilities: | | | | | | | | |
Foreign exchange contracts (1) | | — |
| | 825 |
| | — |
| | 825 |
|
Commodities futures and options (4) | | 10,000 |
| | — |
| | — |
| | 10,000 |
|
| |
(1) | The fair value of foreign currency forward exchange contracts is the difference between the contract and current market foreign currency exchange rates at the end of the period. We estimate the fair value of foreign currency forward exchange contracts on a quarterly basis by obtaining market quotes of spot and forward rates for contracts with similar terms, adjusted where necessary for maturity differences. |
| |
(2) | The fair value of interest rate swap agreements represents the difference in the present value of cash flows calculated at the contracted interest rates and at current market interest rates at the end of the period. We calculate the fair value of interest rate swap agreements quarterly based on the quoted market price for the same or similar financial instruments. |
| |
(3) | The fair value of deferred compensation derivatives is based on quoted prices for market interest rates and a broad market equity index. |
| |
(4) | The fair value of commodities futures and options contracts is based on quoted market prices. |
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
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 October 1, 2017June 28, 2020 and October 2, 2016December 31, 2019 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 | | Fair Value | | | Carrying Value | |
| | October 1, 2017 | | December 31, 2016 | | October 1, 2017 | | December 31, 2016 | | June 28, 2020 | | December 31, 2019 | | June 28, 2020 | | December 31, 2019 |
Current portion of long-term debt | | $ | 300,348 |
| | $ | 243 |
| | $ | 300,096 |
| | $ | 243 |
| Current portion of long-term debt | | $ | 806,276 | | | $ | 712,863 | | | $ | 788,448 | | | $ | 703,390 | |
Long-term debt | | 2,114,276 |
| | 2,379,054 |
| | 2,054,132 |
| | 2,347,455 |
| Long-term debt | | 4,402,998 | | | 3,656,540 | | | 4,091,211 | | | 3,530,813 | |
Total | | $ | 2,414,624 |
| | $ | 2,379,297 |
| | $ | 2,354,228 |
| | $ | 2,347,698 |
| Total | | $ | 5,209,274 | | | $ | 4,369,403 | | | $ | 4,879,659 | | | $ | 4,234,203 | |
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.
2020 Activity
During the first quarter of 2017,six months ended June 28, 2020, we recorded the following impairment charges, which use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy:
| | | | | | | | |
| | 2020 |
Adjustment to disposal group (1) | | $ | 6,200 | |
Other asset write-down (2) | | 2,943 | |
Long-lived asset impairment charges | | $ | 9,143 | |
(1)In connection with our disposal group classified as held for sale, as discussed in Note 7,8, during 2020, we recorded impairment charges to adjust long-lived asset values. The fair value of the disposal group was supported by potential sales prices with third-party buyers. We expect the sale of the disposal group to be completed during 2020. (2)In connection with a previous sale, the Company wrote-down certain receivables deemed uncollectible.
2019 Activity
During the second quarter of 2019, we recorded impairment charges totaling $105,992 to write-down distributor relationship and trademark intangible$4,741. These charges were predominantly comprised of select long-lived assets that had been recognized innot yet met the held for sale criteria.
In connection with the 2014 SGM acquisition of ONE Brands in the third quarter of 2019, as discussed in Note 2, we used various valuation techniques to determine fair value, with the primary techniques being discounted cash flow analysis, relief-from-royalty, a form of the multi-period excess earnings and wrote-down property, plant and equipmentthe with-and-without valuation approaches, which use significant unobservable inputs, or Level 3 inputs, as defined by $102,720. These charges were determined by comparing the fair value hierarchy.
The Hershey Company | Q2 2020 Form 10-Q | Page 17
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
7. LEASES
We lease office and retail space, warehouse and distribution facilities, land, vehicles, and equipment. We determine if an agreement is or contains a lease at inception. Leases with an initial term of 12 months or less are not recorded on the balance sheet.
Right-of-use ("ROU") assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and liabilities are based on the estimated present value of lease payments over the lease term and are recognized at the lease commencement date.
As most of our leases do not provide an implicit rate, we use our estimated incremental borrowing rate in determining the present value of lease payments. The estimated incremental borrowing rate is derived from information available at the lease commencement date.
Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. A limited number of our lease agreements include rental payments adjusted periodically for inflation. Our lease agreements generally do not contain residual value guarantees or material restrictive covenants.
For real estate, equipment and vehicles that support selling, marketing and general administrative activities the Company accounts for the lease and non-lease components as a single lease component. These asset categories comprise the majority of our leases. The lease and non-lease components of real estate and equipment leases supporting production activities are not accounted for as a single lease component. Consideration for such contracts are allocated to the lease component and non-lease components based upon relative standalone prices either observable or estimated if observable prices are not readily available.
As a result of the impact of COVID-19 on our ability to operate certain parts of our business, during the second quarter of 2020, we received immaterial rent concessions primarily on select office space. We will continue to evaluate the nature and extent of potential COVID-19 impacts on our long-lived asset groups, including any required reassessment of lease agreements.
The components of lease expense for the three months ended June 28, 2020 and June 30, 2019 were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended | | |
Lease expense | | Classification | | June 28, 2020 | | June 30, 2019 |
Operating lease cost | | Cost of sales or SM&A (1) | | $ | 10,673 | | | $ | 10,273 | |
Finance lease cost: | | | | | | |
Amortization of ROU assets | | Depreciation and amortization (1) | | 1,949 | | | 1,884 | |
Interest on lease liabilities | | Interest expense, net | | 1,112 | | | 1,112 | |
Net lease cost (2) | | | | $ | 13,734 | | | $ | 13,269 | |
The components of lease expense for the six months ended June 28, 2020 and June 30, 2019 were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | | | Six Months Ended | | |
Lease expense | | Classification | | June 28, 2020 | | June 30, 2019 |
Operating lease cost | | Cost of sales or SM&A (1) | | $ | 21,217 | | | $ | 20,487 | |
Finance lease cost: | | | | | | |
Amortization of ROU assets | | Depreciation and amortization (1) | | 3,979 | | | 3,818 | |
Interest on lease liabilities | | Interest expense, net | | 2,234 | | | 2,213 | |
Net lease cost (2) | | | | $ | 27,430 | | | $ | 26,518 | |
(1)Supply chain-related amounts were included in cost of sales.
(2)Net lease cost does not include short-term leases, variable lease costs or sublease income, all of which are immaterial.
The Hershey Company | Q2 2020 Form 10-Q | Page 18
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
Information regarding our lease terms and discount rates were as follows:
| | | | | | | | | | | | | | |
| | June 28, 2020 | | December 31, 2019 |
Weighted-average remaining lease term (years) | | | | |
Operating leases | | 13.2 | | 14.3 |
Finance leases | | 30.3 | | 31.4 |
| | | | |
Weighted-average discount rate | | | | |
Operating leases | | 3.9 | % | | 3.8 | % |
Finance leases | | 5.9 | % | | 6.0 | % |
Supplemental balance sheet information related to leases were as follows:
| | | | | | | | | | | | | | | | | | | | |
Leases | | Classification | | June 28, 2020 | | December 31, 2019 |
Assets | | | | | | |
Operating lease ROU assets | | Other assets (non-current) | | $ | 222,854 | | | $ | 220,678 | |
| | | | | | |
Finance lease ROU assets, at cost | | Property, plant and equipment, gross | | 100,841 | | | 101,142 | |
Accumulated amortization | | Accumulated depreciation | | (6,570) | | | (7,225) | |
Finance lease ROU assets, net | | Property, plant and equipment, net | | 94,271 | | | 93,917 | |
| | | | | | |
Total leased assets | | | | $ | 317,125 | | | $ | 314,595 | |
| | | | | | |
Liabilities | | | | | | |
Current | | | | | | |
Operating | | Accrued liabilities | | $ | 31,234 | | | $ | 29,209 | |
Finance | | Current portion of long-term debt | | 4,575 | | | 4,079 | |
Non-current | | | | | | |
Operating | | Other long-term liabilities | | 184,626 | | | 184,163 | |
Finance | | Long-term debt | | 75,872 | | | 75,564 | |
Total lease liabilities | | | | $ | 296,307 | | | $ | 293,015 | |
The maturity of our lease liabilities as of June 28, 2020 were as follows:
| | | | | | | | | | | | | | | | | |
| Operating leases | | Finance leases | | Total |
2020 (rest of year) | $ | 19,802 | | | $ | 4,260 | | | $ | 24,062 | |
2021 | 37,074 | | | 7,925 | | | 44,999 | |
2022 | 23,244 | | | 6,307 | | | 29,551 | |
2023 | 15,446 | | | 4,620 | | | 20,066 | |
2024 | 14,118 | | | 4,579 | | | 18,697 | |
Thereafter | 172,979 | | | 165,115 | | | 338,094 | |
Total lease payments | 282,663 | | | 192,806 | | | 475,469 | |
Less: Imputed interest | 66,803 | | | 112,359 | | | 179,162 | |
Total lease liabilities | $ | 215,860 | | | $ | 80,447 | | | $ | 296,307 | |
The Hershey Company | Q2 2020 Form 10-Q | Page 19
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
As of June 28, 2020, the Company had entered additional leases as a lessee, primarily for real estate. These leases have not yet commenced and will result in ROU assets and corresponding lease liabilities of approximately $13,000. These leases are expected to their carrying value. commence during the second half of 2020, with lease terms between a year and half and five years.
Supplemental cash flow and other information related to leases were as follows:
| | | | | | | | | | | | | | |
| | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 |
Cash paid for amounts included in the measurement of lease liabilities: | | | | |
Operating cash flows from operating leases | | 21,335 | | | 19,142 | |
Operating cash flows from finance leases | | 2,234 | | | 2,213 | |
Financing cash flows from finance leases | | 2,105 | | | 1,920 | |
| | | | |
ROU assets obtained in exchange for lease liabilities: | | | | |
Operating leases | | 20,814 | | | 21,838 | |
Finance leases | | 2,076 | | | 3,498 | |
8. ASSETS AND LIABILITIES HELD FOR SALE
As of June 28, 2020, the following disposal group has been classified as held for sale and stated at the lower of net book value or estimated sales value less costs to sell:
•The fair valueLotte Shanghai Foods Co., Ltd. ("LSFC") joint venture, which was taken out of operation and classified as held for sale during the second quarter of 2018. We sold a portion of the joint venture's equipment in the third and fourth quarters of 2018, and expect the sale of the remaining business to be completed during 2020.
The amounts classified as assets were derived using a combination of an estimated market liquidation approach and discounted cash flow analyses based on Level 3 inputs.liabilities held for sale at June 28, 2020 are not significant.
7.9. BUSINESS REALIGNMENT ACTIVITIES
We are currently pursuing severalperiodically undertake business realignment activities designed to increase our efficiency and focus our business behindin support of our key growth strategies. Severance and other program costs associated with business realignment activities are classified in our Consolidated Statements of Income as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | | | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Selling, marketing and administrative expense | | $ | 2,645 | | | $ | 238 | | | $ | 2,645 | | | $ | 660 | |
Business realignment (benefits) costs | | (1,370) | | | 6,140 | | | (475) | | | 6,202 | |
Costs associated with business realignment activities | | $ | 1,275 | | | $ | 6,378 | | | $ | 2,170 | | | $ | 6,862 | |
Costs recorded
by program during the three and
ninesix months ended
October 1, 2017June 28, 2020 and
October 2, 2016June 30, 2019 related to these activities
arewere as follows:
| | | | Three Months Ended | | Nine Months Ended | | Three Months Ended | | | Six Months Ended | |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 | | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Margin for Growth Program: | | | | | | | | | Margin for Growth Program: | | | | | | | | |
Severance | | $ | 2,876 |
| | $ | — |
| | $ | 33,331 |
| | $ | — |
| Severance | | $ | (1,410) | | | $ | 5,823 | | | $ | (653) | | | $ | 5,823 | |
Accelerated depreciation | | — |
| | — |
| | 6,873 |
| | — |
| |
Other program costs | | 5,013 |
| | — |
| | 16,216 |
| | — |
| Other program costs | | 2,685 | | | 555 | | | 2,823 | | | 1,039 | |
Operational Optimization Program: | | | | | | | | | |
Accelerated depreciation and amortization | | — |
| | 24,470 |
| | — |
| | 57,948 |
| |
Severance | | — |
| | 87 |
| | 13,828 |
| | 17,442 |
| |
Other program costs | | 368 |
| | 414 |
| | (549 | ) | | 9,822 |
| |
2015 Productivity Initiative: | | | | | | | | | |
Pension settlement charge | | — |
| | — |
| | — |
| | 13,669 |
| |
Severance | | — |
| | 2,243 |
| | — |
| | (543 | ) | |
Other program costs | | — |
| | 748 |
| | — |
| | 6,149 |
| |
Total business realignment costs | | $ | 8,257 |
| | $ | 27,962 |
| | $ | 69,699 |
| | $ | 104,487 |
| |
Total | | Total | | $ | 1,275 | | | $ | 6,378 | | | $ | 2,170 | | | $ | 6,862 | |
The costs and related benefits to be derived from the Margin for Growth Program relate approximately 85% to the North America segment and 15% to the International and Other segment for the three months ended October 1, 2017.Hershey Company | Q2 2020 Form 10-Q | Page 20
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
The following table presents the liability activity for costs qualifying as exit and disposal costs for the six months ended June 28, 2020:
| | | | | |
| Total |
Liability balance at December 31, 2019 | $ | 9,118 | |
2020 business realignment charges (1) | 2,170 | |
Cash payments | (8,192) | |
| |
Liability balance at June 28, 2020 (reported within accrued liabilities) | $ | 3,096 | |
(1)The costs reflected in the liability roll-forward represent employee-related and certain third-party service provider charges.
The costs and related benefits to be derived fromof the Margin for Growth Program relate approximately 45%63% to the North America segment and 55%37% to the International and Other segment for the nine months ended October 1, 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 Februarythe first quarter 2017, the Company's Board of Directors ("Board") 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 focusfocused 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 totalTotal pre-tax charges of $375,000 to $425,000 over the next three years.execute this Margin for Growth Program were $347,704. This estimate includes plant and office closure expenses of $100,000 to $115,000, net intangiblelong-lived asset impairment charges of $100,000$208,712 related to $110,000,the operations supporting our China business in 2017, as well as a $16,300 incremental impairment charge resulting from the sale of our Shanghai Golden Monkey business. In addition to the impairment charges, we incurred employee separation costs of $80,000 to $100,000, contract termination costs of approximately $25,000,$52,457 and other business realignment costs of $70,000 to $75,000.$70,235. The program was completed during the second quarter of 2020 and 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.charges was $105,130. The Company expects that implementation of the program will reducereduced its global workforce by approximately 15%, as a result of this program, with a majority of the reductions coming from hourly headcount positions outside of the United States.
The program includes an initiative to optimizeFor 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 flowsthree and six months ended June 28, 2020, we recognized total costs associated with the asset group. Because this assessment indicated that the carrying value was not recoverable, we calculated an impairment loss as the excessMargin for Growth Program 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 impairment charges totaling $208,712, with $105,992 representing the portion of the impairment loss that was allocated to the distributor relationship$1,275 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 in the long-lived asset impairment charges caption within the Consolidated Statements of Operations.
During$2,170, respectively. For the three and ninesix months ended October 1, 2017,June 30, 2019, we recognized estimated employee severance totaling $2,876total costs associated with the Margin for Growth Program of $6,378 and $33,331,$6,862, respectively. These charges relateincluded employee severance, largely relating to our initiativeinitiatives 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 nine months ended October 1, 2017model as part of optimizing the North Americaour global supply chain. During the three and nine months ended October 1, 2017,In addition, we also recognizedincurred other program costs, totaling $5,013 and $16,216, respectively. These charges relatewhich related primarily to third-party charges forin support of our initiative of improvingto improve 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 October 1, 2017, we recognized costs of $368. During the nine months ended October 1, 2017, we recognized costs of $13,279 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 18 months to complete this program.
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
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 $13,669 recorded through the nine months ended October 2, 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 nine months ended October 1, 2017 and October 2, 2016 as follows:
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Cost of sales | | $ | 213 |
| | $ | 24,470 |
| | $ | 6,475 |
| | $ | 57,948 |
|
Selling, marketing and administrative expense | | 4,024 |
| | 1,162 |
| | 13,206 |
| | 15,971 |
|
Business realignment costs | | 4,020 |
| | 2,330 |
| | 50,018 |
| | 30,568 |
|
Costs associated with business realignment activities | | $ | 8,257 |
| | $ | 27,962 |
| | $ | 69,699 |
| | $ | 104,487 |
|
The following table presents the liability activity for costs qualifying as exit and disposal costs:
|
| | | |
| Total |
Liability balance at December 31, 2016 | $ | 3,725 |
|
2017 business realignment charges (1) | 61,253 |
|
Cash payments | (23,742 | ) |
Other, net | (69 | ) |
Liability balance at October 1, 2017 (reported within accrued and other long-term liabilities) | $ | 41,167 |
|
| |
(1) | The costs reflected in the liability roll-forward represents employee-related and third-party service provider charges. These costs 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. |
8.10. INCOME TAXES
The majority of our taxable income is generated in the U.S.United States and taxed at the U.S. statutory rate of 35%21%. The effective tax rates for the ninesix months ended October 1, 2017June 28, 2020 and October 2, 2016June 30, 2019 were 32.4%19.8% and 33.0%18.7%, respectively. Relative to the statutory rate, the 20172020 effective tax rate was impacted by a favorable foreign rate differential relating to foreign operations and cocoa procurement, investment tax credits and the benefit of ASU 2016-09, which wereemployee share-based payments, 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.
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
state taxes.
Hershey and its subsidiaries file tax returns in the U.S.,United States, including various state and local returns, and in other 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.underway, including multi-year audits at various stages of review in Malaysia, Mexico and the United States. The outcome of tax audits cannot be predicted with certainty, including the timing of resolution or potential settlements. If any issues addressed in our tax audits are resolved in a manner not consistent with management’s expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Based on our current assessments, we believe adequate provision has been made for all income tax uncertainties. We reasonably expect reductions in the liability for unrecognized tax benefits of approximately $7,191$3,353 within the next 12 months because of the expiration of statutes of limitations and settlements of tax audits.
9.
The Hershey Company | Q2 2020 Form 10-Q | Page 21
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
Coronavirus Aid, Relief, and Economic Security Act
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. The CARES Act provides a substantial stimulus and assistance package intended to address the impact of the COVID-19 pandemic, including tax relief and government loans, grants and investments. The CARES Act did not have a material impact on our consolidated financial statements for the three and six months ended June 28, 2020.
11. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
Net Periodic Benefit Cost
The components of net periodic benefit cost for the third quarterthree months ended June 28, 2020 and June 30, 2019 were as follows:
| | | | Pension Benefits | | Other Benefits | | Pension Benefits | | | Other Benefits | |
| | Three Months Ended | | Three Months Ended | | Three Months Ended | | | Three Months Ended | |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 | | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Service cost | | $ | 5,262 |
| | $ | 5,794 |
| | $ | 66 |
| | $ | 75 |
| Service cost | | $ | 5,411 | | | $ | 5,210 | | | $ | 41 | | | $ | 37 | |
Interest cost | | 10,320 |
| | 10,130 |
| | 2,214 |
| | 2,435 |
| Interest cost | | 6,966 | | | 9,150 | | | 1,505 | | | 1,959 | |
Expected return on plan assets | | (14,390 | ) | | (14,700 | ) | | — |
| | — |
| Expected return on plan assets | | (13,142) | | | (13,493) | | | — | | | — | |
Amortization of prior service (credit) cost | | (1,455 | ) | | (262 | ) | | 187 |
| | 144 |
| Amortization of prior service (credit) cost | | (1,824) | | | (1,808) | | | 75 | | | 203 | |
Amortization of net loss | | 8,526 |
| | 8,803 |
| | (1 | ) | | (4 | ) | |
Amortization of net loss (gain) | | Amortization of net loss (gain) | | 6,582 | | | 8,421 | | | (10) | | | (96) | |
Settlement loss | | 17,043 |
| | 3,147 |
| | — |
| | — |
| Settlement loss | | 3,653 | | | — | | | — | | | — | |
Total net periodic benefit cost | | $ | 25,306 |
| | $ | 12,912 |
| | $ | 2,466 |
| | $ | 2,650 |
| Total net periodic benefit cost | | $ | 7,646 | | | $ | 7,480 | | | $ | 1,611 | | | $ | 2,103 | |
We made contributions of $31,512$248 and $6,922$3,976 to the pension plans and other benefits plans, respectively, during the thirdsecond quarter of 2017.2020. In the thirdsecond quarter of 2016,2019, we made contributions of $18,549$272 and $7,473$3,986 to our pension plans and other benefitsbenefit plans, respectively. The contributions in 20172020 and 20162019 also included benefit payments from our non-qualified pension plans and post-retirement benefit plans.
The components of net periodic benefit cost for the year-to-date periodssix months ended June 28, 2020 and June 30, 2019 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Pension Benefits | | | | Other Benefits | | |
| | Six Months Ended | | | | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Service cost | | $ | 10,843 | | | $ | 10,417 | | | $ | 80 | | | $ | 75 | |
Interest cost | | 13,956 | | | 18,306 | | | 3,012 | | | 3,918 | |
Expected return on plan assets | | (26,310) | | | (26,989) | | | — | | | — | |
Amortization of prior service (credit) cost | | (3,651) | | | (3,617) | | | 150 | | | 406 | |
Amortization of net loss (gain) | | 13,164 | | | 16,841 | | | (19) | | | (192) | |
Settlement loss | | 3,653 | | | — | | | — | | | — | |
Total net periodic benefit cost | | $ | 11,655 | | | $ | 14,958 | | | $ | 3,223 | | | $ | 4,207 | |
|
| | | | | | | | | | | | | | | | |
| | Pension Benefits | | Other Benefits |
| | Nine Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Service cost | | $ | 15,487 |
| | $ | 17,377 |
| | $ | 197 |
| | $ | 224 |
|
Interest cost | | 30,819 |
| | 31,914 |
| | 6,626 |
| | 7,300 |
|
Expected return on plan assets | | (43,088 | ) | | (44,073 | ) | | — |
| | — |
|
Amortization of prior service (credit) cost | | (4,366 | ) | | (785 | ) | | 560 |
| | 432 |
|
Amortization of net loss (gain) | | 25,308 |
| | 26,411 |
| | (1 | ) | | (10 | ) |
Settlement loss | | 17,043 |
| | 20,085 |
| | — |
| | — |
|
Total net periodic benefit cost | | $ | 41,203 |
| | $ | 50,929 |
| | $ | 7,382 |
| | $ | 7,946 |
|
We made contributions of $36,497$1,005 and $21,386$7,328 to the pension plans and other benefits plans, respectively, during the first ninesix months of 2017.2020. In the first ninesix months of 2016,2019, we made contributions of $20,385$1,170 and $22,181$7,749 to our pension plans and other benefitsbenefit plans, respectively. The contributions in 20172020 and 20162019 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 domesticThe non-service cost components of net periodic benefit cost relating to pension and other post-retirement benefit plans and planned voluntary fundingis reflected within other (income) expense, net in the Consolidated Statements of our non-domestic pension plans in 2017 is not material.Income (see Note 18).
The Hershey Company | Q2 2020 Form 10-Q | Page 22
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
During the thirdsecond quarter of 2017, cumulative lump sum distributions from our supplemental executive retirement plan exceeded the plan’s anticipated annual service and interest costs, triggering the recognition of non-cash2020, we recognized pension settlement charges due to the acceleration of a portion of the accumulated unrecognized actuarial loss. In addition, settlement charges were also triggered in the pension plan benefiting our employees in Puerto Rico as a result of lump sum distributions and the purchase of annuity contracts relating to the termination of this plan. In connection with these settlements, the related plan assets and liabilities were remeasured at September 1, 2017 using a discount rate of 3.44%, compared to 3.81% as of December 31, 2016 and an expected rate of return on plan assets of 5.8%.
During the three and nine months ended October 2, 2016, settlement charges in our salaried defined benefit pensionhourly retirement plan were triggered bydue to lump sum withdrawals by employees retiring or leaving the Company as a result of the 2015 Productivity Initiative.Margin for Growth Program.
The non-cash settlement charges, which represent the acceleration of a portion of the respective plan’s accumulated unrecognized actuarial loss, were triggered when the cumulative lump sum distributions exceeded the plan's anticipated annual service and interest costs. In connection with the second quarter 2020 settlements, the related plan assets and liabilities were remeasured using a discount rate as of the remeasurement date that was 69 basis points lower than the rate as of December 31, 2019 and an expected rate of return on plan assets of 5.3%. 10.
12. STOCK COMPENSATION PLANS
We have variousShare-based grants for compensation and incentive purposes are made pursuant to the Equity and Incentive Compensation Plan (“EICP”). The EICP provides for grants of one or more of the following 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 programsdependent:
•Non-qualified stock options ("stock options");
•Performance stock units ("PSUs") and performance stock;
•Stock appreciation rights;
•Restricted stock units ("RSUs") and restricted stock; and
•Other stock-based awards.
The EICP also provides for the accounting treatment related theretodeferral of stock-based compensation awards by participants if approved by the Compensation and Executive Organization Committee of our Board and if in accordance with an applicable deferred compensation plan of the Company. Currently, the Compensation and Executive Organization Committee has authorized the deferral of PSU and RSU awards by certain eligible employees under the Company’s Deferred Compensation Plan. Our Board has authorized our non-employee directors to defer any portion of their cash retainer, committee chair fees and RSUs awarded that they elect to convert into deferred stock units under our Directors’ Compensation Plan.
At the time stock options are describedexercised or PSUs and RSUs become payable, Common Stock is issued from our accumulated treasury shares. Dividend equivalents are credited on RSUs on the same date and at the same rate as dividends paid on our Common Stock. Dividend equivalents are charged to retained earnings and included in Note 10accrued liabilities until paid.
Awards to employees eligible for retirement prior to the Consolidated Financial Statements included in our 2016 Annual Report on Form 10-K.award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, historical data is used to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest.
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 | | Nine Months Ended | | Three Months Ended | | | Six Months Ended | |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 | | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Pre-tax compensation expense | | $ | 13,409 |
| | $ | 14,491 |
| | $ | 37,966 |
| | $ | 40,699 |
| Pre-tax compensation expense | | $ | 12,915 | | | $ | 13,156 | | | $ | 25,490 | | | $ | 23,712 | |
Related income tax benefit | | 4,076 |
| | 4,406 |
| | 11,124 |
| | 13,186 |
| Related income tax benefit | | 2,492 | | | 2,160 | | | 4,894 | | | 4,482 | |
Compensation costsexpenses for stock-basedstock compensation plans are primarily included in selling, marketing and administrative expense. As of October 1, 2017,June 28, 2020, total stock-based compensation costexpense related to non-vested awards not yet recognized was $71,908$71,898 and the weighted-average period over which this amount is expected to be recognized was approximately 2.22.1 years.
Stock Options
The exercise price of each stock option awarded under the EICP equals the closing price of our Common Stock on the New York Stock Exchange on the date of grant. Each stock option has a maximum term of 10 years. Grants of stock
The Hershey Company | Q2 2020 Form 10-Q | Page 23
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
options provide for pro-rated vesting, typically over a four-year period.Expense for stock options is based on grant date fair value and recognized on a straight-line method over the vesting period, net of estimated forfeitures.
A summary of activity relating to grants of stock options for the period ended
October 1, 2017June 28, 2020 is as follows:
| | Stock Options | Shares | Weighted-Average Exercise Price (per share) | Weighted-Average Remaining Contractual Term | Aggregate Intrinsic Value | 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 | | |
Outstanding at beginning of the period | | Outstanding at beginning of the period | 2,420,461 | | $97.80 | 5.7 years | |
Granted | 1,086,175 |
| $ | 108.05 |
| | | Granted | 15,260 | | $157.32 | |
Exercised | (966,532 | ) | $ | 69.95 |
| | | Exercised | (406,121) | | $93.17 | |
Forfeited | (219,456 | ) | $ | 103.08 |
| | | Forfeited | (39,181) | | $102.36 | |
Outstanding as of October 1, 2017 | 6,092,195 |
| $ | 88.47 |
| 6.0 years | $ | 115,872 |
| |
Options exercisable as of October 1, 2017 | 3,848,894 |
| $ | 80.96 |
| 4.5 years | $ | 101,692 |
| |
Outstanding as of June 28, 2020 | | Outstanding as of June 28, 2020 | 1,990,419 | | $99.11 | 5.3 years | $ | 53,705 | |
Options exercisable as of June 28, 2020 | | Options exercisable as of June 28, 2020 | 1,533,325 | | $97.56 | 4.6 years | $ | 43,378 | |
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
The weighted-average fair value of options granted was $15.77$21.31 and $11.46$15.25 per share for the periods ended October 1, 2017June 28, 2020 and October 2, 2016,June 30, 2019, respectively. The fair value was estimated on the date of grant using a Black-Scholes option-pricing model and the following weighted-average assumptions: | | | | Nine Months Ended | | Six Months Ended | |
| | October 1, 2017 | | October 2, 2016 | | June 28, 2020 | | June 30, 2019 |
Dividend yields | | 2.4 | % | | 2.4 | % | Dividend yields | | 2.1 | % | | 2.7 | % |
Expected volatility | | 17.2 | % | | 16.8 | % | Expected volatility | | 17.5 | % | | 17.0 | % |
Risk-free interest rates | | 2.2 | % | | 1.5 | % | Risk-free interest rates | | 1.3 | % | | 2.5 | % |
Expected term in years | | 6.8 |
| | 6.8 |
| Expected term in years | | 6.7 | | 6.5 |
The total intrinsic value of options exercised was $38,845$23,597 and $70,009$67,117 for the periods ended October 1, 2017June 28, 2020 and October 2, 2016,June 30, 2019, respectively.
Performance Stock Units and Restricted Stock Units
Under the EICP, we grant PSUs to selected executives and other key employees. Vesting is contingent upon the achievement of certain performance objectives. We grant PSUs over 3-year performance cycles. If we meet targets for financial measures at the end of the applicable 3-year performance cycle, we award a resulting number of shares of our Common Stock to the participants. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award.
For PSUs granted, the target award is a combination of a market-based total shareholder return and performance-based components. For market-based condition components, market volatility and other factors are taken into consideration in determining the grant date fair value and the related compensation expense is recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided. For performance-based condition components, we estimate the probability that the performance conditions will be achieved each quarter and adjust compensation expenses accordingly. The performance scores of PSU grants during the six months ended June 28, 2020 and June 30, 2019 can range from 0% to 250% of the targeted amounts.
We recognize the compensation expenses associated with PSUs ratably over the 3-year term. Compensation expenses is based on the grant date fair value because the grants can only be settled in shares of our Common Stock. The grant date fair value of PSUs is determined based on the Monte Carlo simulation model for the market-based total shareholder return component and the closing market price of the Company’s Common Stock on the date of grant for performance-based components.
During the six months ended June 28, 2020 and June 30, 2019, we awarded RSUs to certain executive officers and other key employees under the EICP. We also awarded RSUs to non-employee directors.
The Hershey Company | Q2 2020 Form 10-Q | Page 24
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
We recognize the compensation expenses associated with employee RSUs over a specified award vesting period based on the grant date fair value of our Common Stock. We recognize expense for employee RSUs based on the straight-line method. The compensation expenses associated with non-employee director RSUs is recognized ratably over the vesting period, net of estimated forfeitures.
A summary of activity relating to grants of PSUs and RSUs for the period ended October 1, 2017June 28, 2020 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 at beginning of year | | 1,089,916 | | | $112.52 |
Granted | | 326,283 | | | $163.30 |
Performance assumption change (1) | | (13,443) | | | $110.27 |
Vested | | (276,924) | | | $109.32 |
Forfeited | | (106,304) | | | $119.00 |
Outstanding as of June 28, 2020 | | 1,019,528 | | | $131.88 |
|
| | | | | |
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 | | 441,634 |
| | $111.00 |
Performance assumption change | | 23,780 |
| | $101.40 |
Vested | | (242,011 | ) | | $111.19 |
Forfeited | | (125,782 | ) | | $107.73 |
Outstanding as of October 1, 2017 | | 925,849 |
| | $102.36 |
The table above includes 6,410 units(1)Reflects the net number of PSUs awarded to participants in a prior period for whichabove and below target levels based on the measurement (grant) date occurred for accounting purposes in 2017.performance metrics.
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.
| | | | | | | | | | | | | | |
| | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 |
Units granted | | 326,283 | | | 442,672 | |
Weighted-average fair value at date of grant | | $ | 163.30 | | | $ | 113.71 | |
Monte Carlo simulation assumptions: | | | | |
Estimated values | | $ | 80.08 | | | $ | 48.40 | |
Dividend yields | | 2.0 | % | | 2.6 | % |
Expected volatility | | 17.3 | % | | 20.3 | % |
|
| | | | | | | | |
| | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 |
Units granted | | 441,634 |
| | 531,019 |
|
Weighted-average fair value at date of grant | | $ | 111.00 |
| | $ | 93.47 |
|
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 $26,097$41,874 and $19,673$40,163 for the periods ended October 1, 2017June 28, 2020 and October 2, 2016,June 30, 2019, respectively.
Deferred PSUs, deferred RSUs and deferred stock units representing directors’ fees totaled 369,037280,980 units as of October 1, 2017.June 28, 2020. Each unit is equivalent to one1 share of the Company’s Common Stock.
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
11.13. 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 primarily 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%92% 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.
The Hershey Company | Q2 2020 Form 10-Q | Page 25
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
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 integrationacquisition-related 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 componentsitems 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 (gains) 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 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 | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Net sales: | | | | | | | | |
North America | | $ | 1,583,787 | | | $ | 1,568,040 | | | $ | 3,428,608 | | | $ | 3,374,998 | |
International and Other | | 123,542 | | | 199,177 | | | 316,038 | | | 408,707 | |
Total | | $ | 1,707,329 | | | $ | 1,767,217 | | | $ | 3,744,646 | | | $ | 3,783,705 | |
| | | | | | | | |
Segment income (loss): | | | | | | | | |
North America | | $ | 497,587 | | | $ | 470,898 | | | $ | 1,079,142 | | | $ | 1,035,659 | |
International and Other | | (3,969) | | | 21,944 | | | 12,035 | | | 42,187 | |
Total segment income | | 493,618 | | | 492,842 | | | 1,091,177 | | | 1,077,846 | |
Unallocated corporate expense (1) | | 106,883 | | | 125,205 | | | 231,450 | | | 242,889 | |
Unallocated mark-to-market losses (gains) on commodity derivatives | | 487 | | | (53,552) | | | 82,241 | | | (25,585) | |
Long-lived asset impairment charges (see Note 6) | | 1,600 | | | 4,741 | | | 9,143 | | | 4,741 | |
Costs associated with business realignment activities (see Note 9) | | 1,275 | | | 6,378 | | | 2,170 | | | 6,862 | |
| | | | | | | | |
| | | | | | | | |
Operating profit | | 383,373 | | | 410,070 | | | 766,173 | | | 848,939 | |
Interest expense, net (see Note 4) | | 38,079 | | | 33,776 | | | 74,334 | | | 71,234 | |
Other (income) expense, net (see Note 18) | | 11,217 | | | 13,125 | | | 22,750 | | | 18,602 | |
Income before income taxes | | $ | 334,077 | | | $ | 363,169 | | | $ | 669,089 | | | $ | 759,103 | |
The Hershey Company | Q2 2020 Form 10-Q | Page 26
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
(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, (d) acquisition-related costs, and (e) other gains or losses that are not integral to segment performance.
Our segment net sales and earnings were as follows:
|
| | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Net sales: | | | | | | | | |
North America | | $ | 1,792,377 |
| | $ | 1,764,528 |
| | $ | 4,946,537 |
| | $ | 4,842,840 |
|
International and Other | | 240,744 |
| | 238,926 |
| | 629,253 |
| | 627,097 |
|
Total | | $ | 2,033,121 |
| | $ | 2,003,454 |
| | $ | 5,575,790 |
| | $ | 5,469,937 |
|
| | | | | | | | |
Segment income (loss): | | | | | | | | |
North America | | $ | 554,578 |
| | $ | 563,946 |
| | $ | 1,568,098 |
| | $ | 1,519,059 |
|
International and Other | | 16,400 |
| | 4,284 |
| | 26,491 |
| | (12,411 | ) |
Total segment income | | 570,978 |
| | 568,230 |
| | 1,594,589 |
| | 1,506,648 |
|
Unallocated corporate expense (1) | | 124,115 |
| | 121,828 |
| | 366,938 |
| | 370,622 |
|
Unallocated mark-to-market (gains) losses on commodity derivatives | | (21,954 | ) | | 35,791 |
| | (27,486 | ) | | 30,851 |
|
Long-lived asset impairment charges | | — |
| | — |
| | 208,712 |
| | — |
|
Costs associated with business realignment activities | | 8,257 |
| | 27,962 |
| | 69,699 |
| | 104,487 |
|
Non-service related pension expense | | 21,540 |
| | 6,360 |
| | 30,123 |
| | 20,666 |
|
Acquisition and integration costs | | — |
| | 2,265 |
| | 311 |
| | 3,727 |
|
Operating profit | | 439,020 |
| | 374,024 |
| | 946,292 |
| | 976,295 |
|
Interest expense, net | | 24,589 |
| | 24,387 |
| | 72,456 |
| | 66,730 |
|
Other (income) expense, net | | 13,630 |
| | 21,800 |
| | 23,557 |
| | 8,703 |
|
Income before income taxes | | $ | 400,801 |
| | $ | 327,837 |
| | $ | 850,279 |
| | $ | 900,862 |
|
| |
(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. |
Activity within the unallocated mark-to-market (gains) losses onadjustment for commodity derivatives is as follows:
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Net losses on mark-to-market valuation of commodity derivative positions recognized in income | | $ | 2,445 |
| | $ | 37,246 |
| | $ | 40,500 |
| | $ | 37,176 |
|
Net losses on commodity derivative positions reclassified from unallocated to segment income | | (24,399 | ) | | (1,455 | ) | | (67,986 | ) | | (6,325 | ) |
Net (gains) losses on mark-to-market valuation of commodity derivative positions recognized in unallocated derivative (gains) losses | | $ | (21,954 | ) | | $ | 35,791 |
| | $ | (27,486 | ) | | $ | 30,851 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | | | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Net (gains) losses on mark-to-market valuation of commodity derivative positions recognized in income | | $ | (2,624) | | | $ | (55,531) | | | $ | 74,468 | | | $ | (28,890) | |
Net gains on commodity derivative positions reclassified from unallocated to segment income | | 3,111 | | | 1,979 | | | 7,773 | | | 3,305 | |
Net losses (gains) on mark-to-market valuation of commodity derivative positions recognized in unallocated derivative losses (gains) | | $ | 487 | | | $ | (53,552) | | | $ | 82,241 | | | $ | (25,585) | |
As of October 1, 2017,June 28, 2020, 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 $135,538.$13,274. Based on our forecasts of the timing of the recognition of the underlying hedged items, we expect to reclassify net pre-taxpretax losses on commodity derivatives of $93,814$165 to segment operating results in the next twelve months.
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)
Depreciation and amortization expense included within segment income presented above is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | | | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
North America | | $ | 54,379 | | | $ | 55,137 | | | $ | 108,081 | | | $ | 109,082 | |
International and Other | | 7,037 | | | 7,314 | | | 14,246 | | | 14,664 | |
Corporate | | 10,484 | | | 9,566 | | | 20,197 | | | 20,600 | |
Total | | $ | 71,900 | | | $ | 72,017 | | | $ | 142,524 | | | $ | 144,346 | |
Additional information regarding our net sales disaggregated by geographical region is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | | | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Net sales: | | | | | | | | |
United States | | $ | 1,504,266 | | | $ | 1,493,283 | | | $ | 3,271,542 | | | $ | 3,221,543 | |
All other countries | | 203,063 | | | 273,934 | | | 473,104 | | | 562,162 | |
Total | | $ | 1,707,329 | | | $ | 1,767,217 | | | $ | 3,744,646 | | | $ | 3,783,705 | |
The Hershey Company | Q2 2020 Form 10-Q | Page 27
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
North America | $ | 42,544 |
| | $ | 41,592 |
| | $ | 125,532 |
| | $ | 120,378 |
|
International and Other | 9,397 |
| | 13,515 |
| | 32,110 |
| | 37,523 |
|
Corporate (1) | 10,293 |
| | 30,015 |
| | 36,671 |
| | 84,000 |
|
Total | $ | 62,234 |
| | $ | 85,122 |
| | $ | 194,313 |
| | $ | 241,901 |
|
| |
(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.The majority of our products are confectionery or confectionery-based and include chocolate and non-chocolate confectionery products, gum and mint refreshment products, spreads, snack bites and mixes, as well as pantry items such as baking ingredients, toppings and sundae syrups. Our snacks portfolio includes ready-to-eat popcorn, baked and trans fat free snacks, protein bars and other better-for-you snacks. Additional information regarding our net sales disaggregated by product line is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | | | Six Months Ended | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Net sales: | | | | | | | | |
Confectionery and confectionery-based portfolio | | $ | 1,592,181 | | | $ | 1,663,225 | | | $ | 3,500,415 | | | $ | 3,587,155 | |
Snacks portfolio | | 115,148 | | | 103,992 | | | 244,231 | | | 196,550 | |
Total | | $ | 1,707,329 | | | $ | 1,767,217 | | | $ | 3,744,646 | | | $ | 3,783,705 | |
14. TREASURY STOCK ACTIVITY
A summary of our treasury stock activity is as follows: | | | Nine Months Ended October 1, 2017 | | Six Months Ended June 28, 2020 | |
| Shares | | Dollars | | Shares | | Dollars |
| | | In thousands | | | | In thousands |
Shares repurchased in the open market under pre-approved share repurchase programs | — |
| | $ | — |
| Shares repurchased in the open market under pre-approved share repurchase programs | 951,138 | | | $ | 150,000 | |
Milton Hershey School Trust repurchase | 1,500,000 |
| | 159,015 |
| |
| Shares repurchased to replace Treasury Stock issued for stock options and incentive compensation | 1,278,675 |
| | 141,297 |
| Shares repurchased to replace Treasury Stock issued for stock options and incentive compensation | 450,000 | | | 61,196 | |
Total share repurchases | 2,778,675 |
| | 300,312 |
| Total share repurchases | 1,401,138 | | | 211,196 | |
Shares issued for stock options and incentive compensation | (1,187,883 | ) | | $ | (49,426 | ) | Shares issued for stock options and incentive compensation | (554,074) | | | (23,056) | |
Net change | 1,590,792 |
| | $ | 250,886 |
| Net change | 847,064 | | | $ | 188,140 | |
In August 2017, the Company entered into a Stock Purchase Agreement with Hershey Trust Company, as trustee for the Milton Hershey School Trust (the “Trust”), pursuant to which the Company agreed to purchase 1,500,000 shares of the Company’s common stock from the Trust at a price equal to $106.01 per share, for a total purchase price of $159,015.
In January 2016,July 2018, our Board of Directors approved a $500,000 share repurchase authorization to repurchase shares of our Common Stock. As of October 1, 2017, $100,000June 28, 2020, $260,000 remained available for repurchases of our Common Stock under this program. In October 2017, our Board of Directors approved an additional $100,000 share repurchase authorization, to commence after the existing 2016 authorization is completed. We are authorized to purchase our outstanding shares in open market and privately negotiated transactions. The programs haveprogram 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.
The Hershey Company | Q2 2020 Form 10-Q | Page 28
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
13.15. NONCONTROLLING INTEREST
Noncontrolling Interest in Subsidiary
We currently own a 50% controlling interest in Lotte Shanghai Foods Co., Ltd. (“LSFC”),LSFC, a joint venture established in 2007 in China for the purpose of manufacturing and selling product to the joint venture partners.
A roll-forward showing the 20172020 activity relating to the noncontrolling interest follows: |
| | | |
| Noncontrolling Interest |
Balance, December 31, 2016 | $ | 41,831 |
|
Net loss attributable to noncontrolling interest | (26,860 | ) |
Other comprehensive income - foreign currency translation adjustments | 735 |
|
Balance, October 1, 2017 | $ | 15,706 |
|
| | | | | |
| Noncontrolling Interest |
Balance, December 31, 2019 | $ | 5,772 | |
Net loss attributable to noncontrolling interest | (3,213) | |
Other comprehensive loss - foreign currency translation adjustments | (75) | |
Balance, June 28, 2020 | $ | 2,484 | |
The 20172020 net loss attributable to the noncontrolling interest reflects the 50% allocation of LSFC-related business realignment and impairment costs (see Note 7)9). For the nine months ended October 2, 2016, the net loss attributable to noncontrolling interests totaled $798, which was presented within selling, marketing and administrative expense in the Consolidated Statements of Income since the amount was not considered significant. 14.16. 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.
15.17. 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.
The Hershey Company | Q2 2020 Form 10-Q | Page 29
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(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 | | Three Months Ended | |
| | October 1, 2017 | | October 2, 2016 | | June 28, 2020 | | | June 30, 2019 | |
| | Common Stock | | Class B Common Stock | | Common Stock | | Class B Common Stock | | Common Stock | | Class B Common Stock | | Common Stock | | Class B Common Stock |
Basic earnings per share: | | | | | | | | | Basic earnings per share: | | | | | | | | |
Numerator: | | | | | | | | | Numerator: | |
Allocation of distributed earnings (cash dividends paid) | | $ | 99,588 |
| | $ | 36,129 |
| | $ | 94,498 |
| | $ | 34,068 |
| Allocation of distributed earnings (cash dividends paid) | | $ | 113,925 | | | $ | 42,551 | | | $ | 109,258 | | | $ | 39,762 | |
Allocation of undistributed earnings | | 100,892 |
| | 36,694 |
| | 72,691 |
| | 26,146 |
| Allocation of undistributed earnings | | 81,891 | | | 30,534 | | | 119,616 | | | 44,204 | |
Total earnings—basic | | $ | 200,480 |
| | $ | 72,823 |
| | $ | 167,189 |
| | $ | 60,214 |
| Total earnings—basic | | $ | 195,816 | | | $ | 73,085 | | | $ | 228,874 | | | $ | 83,966 | |
| | | | | | | | | | |
Denominator (shares in thousands): | | | | | | | | | Denominator (shares in thousands): | | |
Total weighted-average shares—basic | | 151,418 |
| | 60,620 |
| | 153,259 |
| | 60,620 |
| Total weighted-average shares—basic | | 147,635 | | | 60,614 | | | 149,025 | | | 60,614 | |
| | | | | | | | | | | | | | | | |
Earnings Per Share—basic | | $ | 1.32 |
| | $ | 1.20 |
| | $ | 1.09 |
| | $ | 0.99 |
| Earnings Per Share—basic | | $ | 1.33 | | | $ | 1.21 | | | $ | 1.54 | | | $ | 1.39 | |
| | | | | | | | | | | | | | | | |
Diluted earnings per share: | | | | | | | | | Diluted earnings per share: | | |
Numerator: | | | | | | | | | Numerator: | | |
Allocation of total earnings used in basic computation | | $ | 200,480 |
| | $ | 72,823 |
| | $ | 167,189 |
| | $ | 60,214 |
| Allocation of total earnings used in basic computation | | $ | 195,816 | | | $ | 73,085 | | | $ | 228,874 | | | $ | 83,966 | |
Reallocation of total earnings as a result of conversion of Class B common stock to Common stock | | 72,823 |
| | — |
| | 60,214 |
| | — |
| Reallocation of total earnings as a result of conversion of Class B common stock to Common stock | | 73,085 | | | — | | | 83,966 | | | — | |
Reallocation of undistributed earnings | | — |
| | (239 | ) | | — |
| | (160 | ) | Reallocation of undistributed earnings | | — | | | (123) | | | — | | | (254) | |
Total earnings—diluted | | $ | 273,303 |
| | $ | 72,584 |
| | $ | 227,403 |
| | $ | 60,054 |
| Total earnings—diluted | | $ | 268,901 | | | $ | 72,962 | | | $ | 312,840 | | | $ | 83,712 | |
| | | | | | | | | | |
Denominator (shares in thousands): | | | | | | | | | Denominator (shares in thousands): | | |
Number of shares used in basic computation | | 151,418 |
| | 60,620 |
| | 153,259 |
| | 60,620 |
| Number of shares used in basic computation | | 147,635 | | | 60,614 | | | 149,025 | | | 60,614 | |
Weighted-average effect of dilutive securities: | | | | | | | | | Weighted-average effect of dilutive securities: | | |
Conversion of Class B common stock to Common shares outstanding | | 60,620 |
| | — |
| | 60,620 |
| | — |
| Conversion of Class B common stock to Common shares outstanding | | 60,614 | | | — | | | 60,614 | | | — | |
Employee stock options | | 1,002 |
| | — |
| | 1,062 |
| | — |
| Employee stock options | | 521 | | | — | | | 817 | | | — | |
Performance and restricted stock units | | 352 |
| | — |
| | 220 |
| | — |
| Performance and restricted stock units | | 300 | | | — | | | 361 | | | — | |
Total weighted-average shares—diluted | | 213,392 |
| | 60,620 |
| | 215,161 |
| | 60,620 |
| Total weighted-average shares—diluted | | 209,070 | | | 60,614 | | | 210,817 | | | 60,614 | |
| | | | | | | | | | |
Earnings Per Share—diluted | | $ | 1.28 |
| | $ | 1.20 |
| | $ | 1.06 |
| | $ | 0.99 |
| Earnings Per Share—diluted | | $ | 1.29 | | | $ | 1.20 | | | $ | 1.48 | | | $ | 1.38 | |
The earnings per share calculations for the three months ended October 1, 2017June 28, 2020 and October 2, 2016June 30, 2019 excluded 2,37415 and 2,921, respectively, of47 stock options (in thousands), respectively, that would have been antidilutive.
The Hershey Company | Q2 2020 Form 10-Q | Page 30
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
| | | | Nine Months Ended | | Six Months Ended | |
| | October 1, 2017 | | October 2, 2016 | | June 28, 2020 | | | June 30, 2019 | |
| | Common Stock | | Class B Common Stock | | Common Stock | | Class B Common Stock | | Common Stock | | Class B Common Stock | | Common Stock | | Class B Common Stock |
Basic earnings per share: | | | | | | | | | Basic earnings per share: | | | | | | | | |
Numerator: | | | | | | | | | Numerator: | |
Allocation of distributed earnings (cash dividends paid) | | $ | 287,580 |
| | $ | 104,265 |
| | $ | 273,380 |
| | $ | 98,326 |
| Allocation of distributed earnings (cash dividends paid) | | $ | 229,177 | | | $ | 85,102 | | | $ | 215,958 | | | $ | 79,525 | |
Allocation of undistributed earnings | | 154,128 |
| | 55,875 |
| | 170,458 |
| | 61,027 |
| Allocation of undistributed earnings | | 164,541 | | | 61,218 | | | 234,836 | | | 86,879 | |
Total earnings—basic | | $ | 441,708 |
| | $ | 160,140 |
| | $ | 443,838 |
| | $ | 159,353 |
| Total earnings—basic | | $ | 393,718 | | | $ | 146,320 | | | $ | 450,794 | | | $ | 166,404 | |
| | | | | | | | | |
Denominator (shares in thousands): | | | | | | | | | Denominator (shares in thousands): | |
Total weighted-average shares—basic | | 152,004 |
| | 60,620 |
| | 153,943 |
| | 60,620 |
| Total weighted-average shares—basic | | 147,954 | | | 60,614 | | | 148,864 | | | 60,614 | |
| | | | | | | | | | | | | | | | |
Earnings Per Share—basic | | $ | 2.91 |
| | $ | 2.64 |
| | $ | 2.88 |
| | $ | 2.63 |
| Earnings Per Share—basic | | $ | 2.66 | | | $ | 2.41 | | | $ | 3.03 | | | $ | 2.75 | |
| | | | | | | | | | | | | | | | |
Diluted earnings per share: | | | | | | | | | Diluted earnings per share: | |
Numerator: | | | | | | | | | Numerator: | |
Allocation of total earnings used in basic computation | | $ | 441,708 |
| | $ | 160,140 |
| | $ | 443,838 |
| | $ | 159,353 |
| Allocation of total earnings used in basic computation | | $ | 393,718 | | | $ | 146,320 | | | $ | 450,794 | | | $ | 166,404 | |
Reallocation of total earnings as a result of conversion of Class B common stock to Common stock | | 160,140 |
| | — |
| | 159,353 |
| | — |
| Reallocation of total earnings as a result of conversion of Class B common stock to Common stock | | 146,320 | | | — | | | 166,404 | | | — | |
Reallocation of undistributed earnings | | — |
| | (401 | ) | | — |
| | (347 | ) | Reallocation of undistributed earnings | | — | | | (309) | | | — | | | (462) | |
Total earnings—diluted | | $ | 601,848 |
| | $ | 159,739 |
| | $ | 603,191 |
| | $ | 159,006 |
| Total earnings—diluted | | $ | 540,038 | | | $ | 146,011 | | | $ | 617,198 | | | $ | 165,942 | |
| | | | | | | | | |
Denominator (shares in thousands): | | | | | | | | | Denominator (shares in thousands): | |
Number of shares used in basic computation | | 152,004 |
| | 60,620 |
| | 153,943 |
| | 60,620 |
| Number of shares used in basic computation | | 147,954 | | | 60,614 | | | 148,864 | | | 60,614 | |
Weighted-average effect of dilutive securities: | | | | | | | | | Weighted-average effect of dilutive securities: | |
Conversion of Class B common stock to Common shares outstanding | | 60,620 |
| | — |
| | 60,620 |
| | — |
| Conversion of Class B common stock to Common shares outstanding | | 60,614 | | | — | | | 60,614 | | | — | |
Employee stock options | | 1,165 |
| | — |
| | 1,013 |
| | — |
| Employee stock options | | 620 | | | — | | | 699 | | | — | |
Performance and restricted stock units | | 334 |
| | — |
| | 182 |
| | — |
| Performance and restricted stock units | | 408 | | | — | | | 391 | | | — | |
Total weighted-average shares—diluted | | 214,123 |
| | 60,620 |
| | 215,758 |
| | 60,620 |
| Total weighted-average shares—diluted | | 209,596 | | | 60,614 | | | 210,568 | | | 60,614 | |
| | | | | | | | | |
Earnings Per Share—diluted | | $ | 2.81 |
| | $ | 2.64 |
| | $ | 2.80 |
| | $ | 2.62 |
| Earnings Per Share—diluted | | $ | 2.58 | | | $ | 2.41 | | | $ | 2.93 | | | $ | 2.74 | |
The earnings per share calculations for the ninesix months ended October 1, 2017June 28, 2020 and October 2, 2016June 30, 2019 excluded 2,37415 and 3,680, respectively, of1,476 stock options (in thousands), respectively, that would have been antidilutive.
16.
The Hershey Company | Q2 2020 Form 10-Q | Page 31
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
18. 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 | | |
| June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
Write-down of equity investments in partnership qualifying for historic tax credits (see Note 10) | $ | 7,447 | | | $ | 8,633 | | | $ | 18,550 | | | $ | 9,785 | |
Non-service cost components of net periodic benefit cost relating to pension and other post-retirement benefit plans (see Note 11) | 3,806 | | | 4,336 | | | 3,955 | | | 8,673 | |
| | | | | | | |
Other (income) expense, net | (36) | | | 156 | | | 245 | | | 144 | |
Total | $ | 11,217 | | | $ | 13,125 | | | $ | 22,750 | | | $ | 18,602 | |
The Hershey Company | Q2 2020 Form 10-Q | Page 32
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Write-down of equity investments in partnerships qualifying for tax credits | | $ | 13,736 |
| | $ | 20,801 |
| | $ | 23,999 |
| | $ | 35,862 |
|
Settlement of SGM liability (see Note 2) | | — |
| | — |
| | — |
| | (26,650 | ) |
Other (income) expense, net | | (106 | ) | | 999 |
| | (442 | ) | | (509 | ) |
Total | | $ | 13,630 |
| | $ | 21,800 |
| | $ | 23,557 |
| | $ | 8,703 |
|
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSTATEMENTS—(Continued)
(amounts in thousands, except share data or if otherwise indicated)
17.19. SUPPLEMENTAL BALANCE SHEET INFORMATION
The components of certain Consolidated Balance Sheet accounts are as follows:
| | | | | | | | | | | | | | |
| | June 28, 2020 | | December 31, 2019 |
Inventories: | | | | |
Raw materials | | $ | 347,999 | | | $ | 271,125 | |
Goods in process | | 132,235 | | | 98,842 | |
Finished goods | | 694,351 | | | 614,698 | |
Inventories at FIFO | | 1,174,585 | | | 984,665 | |
Adjustment to LIFO | | (175,205) | | | (169,414) | |
Total inventories | | $ | 999,380 | | | $ | 815,251 | |
| | | | |
Prepaid expenses and other: | | | | |
Prepaid expenses | | $ | 40,816 | | | $ | 84,058 | |
| | | | |
Other current assets | | 157,019 | | | 156,022 | |
Total prepaid expenses and other | | $ | 197,835 | | | $ | 240,080 | |
| | | | |
Property, plant and equipment: | | | | |
Land | | $ | 106,745 | | | $ | 105,627 | |
Buildings | | 1,300,667 | | | 1,298,985 | |
Machinery and equipment | | 3,143,217 | | | 3,120,003 | |
Construction in progress | | 254,041 | | | 209,788 | |
Property, plant and equipment, gross | | 4,804,670 | | | 4,734,403 | |
Accumulated depreciation | | (2,639,324) | | | (2,581,264) | |
Property, plant and equipment, net | | $ | 2,165,346 | | | $ | 2,153,139 | |
| | | | |
Other assets: | | | | |
| | | | |
Capitalized software, net | | $ | 168,187 | | | $ | 153,842 | |
| | | | |
Operating lease ROU assets | | 222,854 | | | 220,678 | |
Other non-current assets | | 133,646 | | | 137,480 | |
Total other assets | | $ | 524,687 | | | $ | 512,000 | |
| | | | |
Accrued liabilities: | | | | |
Payroll, compensation and benefits | | $ | 160,864 | | | $ | 230,518 | |
Advertising, promotion and product allowances | | 272,984 | | | 279,440 | |
Operating lease liabilities | | 31,234 | | | 29,209 | |
| | | | |
Other | | 178,856 | | | 163,205 | |
Total accrued liabilities | | $ | 643,938 | | | $ | 702,372 | |
| | | | |
Other long-term liabilities: | | | | |
Post-retirement benefits liabilities | | $ | 206,382 | | | $ | 211,206 | |
Pension benefits liabilities | | 60,579 | | | 58,773 | |
Operating lease liabilities | | 184,626 | | | 184,163 | |
Other | | 192,260 | | | 201,635 | |
Total other long-term liabilities | | $ | 643,847 | | | $ | 655,777 | |
| | | | |
Accumulated other comprehensive loss: | | | | |
Foreign currency translation adjustments | | $ | (131,922) | | | $ | (83,704) | |
Pension and post-retirement benefit plans, net of tax | | (191,352) | | | (189,187) | |
Cash flow hedges, net of tax | | (43,919) | | | (51,075) | |
Total accumulated other comprehensive loss | | $ | (367,193) | | | $ | (323,966) | |
The Hershey Company | Q2 2020 Form 10-Q | Page 33
|
| | | | | | | | |
| | October 1, 2017 | | December 31, 2016 |
Inventories: | | | | |
Raw materials | | $ | 292,976 |
| | $ | 315,239 |
|
Goods in process | | 102,292 |
| | 88,490 |
|
Finished goods | | 724,754 |
| | 528,587 |
|
Inventories at FIFO | | 1,120,022 |
| | 932,316 |
|
Adjustment to LIFO | | (181,835 | ) | | (186,638 | ) |
Total inventories | | $ | 938,187 |
| | $ | 745,678 |
|
| | | | |
Property, plant and equipment: | | | | |
Land | | $ | 108,173 |
| | $ | 103,865 |
|
Buildings | | 1,200,194 |
| | 1,238,634 |
|
Machinery and equipment | | 2,910,916 |
| | 3,001,552 |
|
Construction in progress | | 191,805 |
| | 230,987 |
|
Property, plant and equipment, gross | | 4,411,088 |
| | 4,575,038 |
|
Accumulated depreciation | | (2,360,964 | ) | | (2,397,790 | ) |
Property, plant and equipment, net | | $ | 2,050,124 |
| | $ | 2,177,248 |
|
| | | | |
Other assets: | | | | |
Capitalized software, net | | $ | 99,329 |
| | $ | 95,301 |
|
Income tax receivable | | — |
| | 1,449 |
|
Other non-current assets | | 75,282 |
| | 71,615 |
|
Total other assets | | $ | 174,611 |
| | $ | 168,365 |
|
| | | | |
Accrued liabilities: | | | | |
Payroll, compensation and benefits | | $ | 181,167 |
| | $ | 240,080 |
|
Advertising and promotion | | 320,788 |
| | 358,573 |
|
Other | | 171,480 |
| | 152,333 |
|
Total accrued liabilities | | $ | 673,435 |
| | $ | 750,986 |
|
| | | | |
Other long-term liabilities: | | | | |
Post-retirement benefits liabilities | | $ | 213,986 |
| | $ | 220,270 |
|
Pension benefits liabilities | | 67,681 |
| | 65,687 |
|
Other | | 120,729 |
| | 114,204 |
|
Total other long-term liabilities | | $ | 402,396 |
| | $ | 400,161 |
|
| | | | |
Accumulated other comprehensive loss: | | | | |
Foreign currency translation adjustments | | $ | (83,470 | ) | | $ | (110,613 | ) |
Pension and post-retirement benefit plans, net of tax | | (197,095 | ) | | (207,169 | ) |
Cash flow hedges, net of tax | | (56,462 | ) | | (58,106 | ) |
Total accumulated other comprehensive loss | | $ | (337,027 | ) | | $ | (375,888 | ) |
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.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 Unaudited 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 20162019 Annual Report on Form 10-K, our Quarterly Report on Form 10-Q for the quarterly period ended March 29, 2020, and our Current Report on Form 8-K filed May 27, 2020.
for information concerning the key risks to achieving future performance goals.
The MD&A is organized in the following sections:
The Overview
OVERVIEW
Hershey is a global confectionery leader known for bringing goodness to the world through chocolate, sweets, mints, gum and Outlook presented below is an executive-level summary highlightingother great tasting snacks. We are the key trends and measures on which the Company’s management focuseslargest producer of quality chocolate in evaluating its financial condition and operating performance. Certain earnings and performance measures within the Overview and Outlook include financial information determined onNorth America, 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 acceptedleading snack maker in the United States of America ("GAAP"), referred to as "reported" herein, refer to the discussion and analysisa global leader in the Consolidated Results of Operations.chocolate and non-chocolate confectionery. We market, sell and distribute our products under more than 80 brand names in approximately 85 countries worldwide.
OVERVIEW AND OUTLOOK
Our third quarter 2017 net sales totaled $2,033.1 million, an increase of 1.5%, versus $2,003.5 million for the comparable period of 2016. Excluding a 0.4% impact from favorable foreign exchange rates,We report our net sales increased 1.1%. Net sales growth was driven by theoperations through two segments: North America segment, which benefited from core brand growth and innovation, including Hershey's Cookie Layer Crunch,International and the launchOther. The majority of Hershey'sour products are confectionery or confectionery-based and Reese's Popped Snack Mixinclude chocolate and Chocolate Dipped Pretzels.
Our reported gross margin was 46.2% in the third quarter of 2017, an increase of 370 basis points compared to the third quarter of 2016. Our non-GAAP gross margin decreased 30 basis points in the third quarter of 2017, with the benefits from supply chain productivitynon-chocolate confectionery products, gum and cost savings initiatives,mint refreshment products, spreads, snack bites and mixes, as well as lower input costs, being more than offset by higher freight ratespantry items such as baking ingredients, toppings and increased levelssundae syrups. The confectionery and confectionery-based portfolio is predominantly sold under the renowned brands of manufacturingHershey's, Reese's and distribution costs associated with an effort to maintain customer service targets at fast growing retail customers.
Our third quarter 2017 reported net income and earnings per share-diluted (EPS) totaled $273.3 million and $1.28, respectively, compared to the third quarter 2016 reported net income and EPS-diluted of $227.4 million and $1.06, respectively. From a non-GAAP perspective, third quarter 2017 adjusted net income was $283.6 million, an increase of 2.3% versus $277.3 million in 2016. Our adjusted EPS-diluted for the third quarter of 2017 was $1.33 compared to $1.29 for the same period of 2016, with this 3.1% increase attributable to the same factors driving the increase in non-GAAP net income.
Over the remainder of the year, our outlook remains unchanged and we are focused on executing the priorities we outlined earlier this year. Our seasonal business and programs are on track and the upcoming launch of Hershey's GoldKisses, a caramelized creme with peanuts and pretzels, should enable us to deliver on our objectives.
We currently estimate that full-year 2017 net sales growth will be approximately 1.25%. The impact of foreign currency exchange rates is expected to be minimal versus a prior estimate of 0.25% unfavorable impact. We currently expect full-year 2017 reported EPS-diluted to be in the $3.54 to $3.68 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 strong productivity and cost savings initiatives, as well as Kit Kat®, Jolly Rancher, Ice Breakers, Twizzlers, Heath, Payday, Cadbury and a lower effective tax rate.variety of other popular brands. Our snacks portfolio includes ready-to-eat popcorn, baked and trans fat free snacks, protein bars and other better-for-you snacks. The reduction in our full-year 2017 effective tax ratesnacks portfolio is primarily driven by a favorable foreign rate differentialpredominantly sold under the brands of SkinnyPop, Pirate's Booty, ONE Bar, Paqui and benefitOatmega.
Divestitures
During the second quarter of 2020, we completed the divestitures of KRAVE Pure Foods, Inc. ("Krave") and the Scharffen Berger and Dagoba brands. Total proceeds from tax credits, as well as the adoption of ASU 2016-09 for the accounting of employee share-based payments. 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,divestitures 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, both individually and on an aggregate basis, were immaterial.
TRENDS AFFECTING OUR BUSINESS
On March 11, 2020, the World Health Organization designated the recent novel coronavirus ("COVID-19") as a global pandemic. COVID-19 was first detected in Wuhan City, Hubei Province, China and continued to spread, significantly impacting various markets around the world, including the United States. Various policies and initiatives have been implemented to reduce the global transmission of COVID-19.
Local, state and national governments continue to emphasize the importance of food supply during this pandemic and asked that food manufacturers and retailers remain open to meet the needs of our communities. Employee safety is provided below.
our first priority, and as a result, we put preparedness plans in place at our manufacturing facilities. Our manufacturing facilities are currently open, however, we have adjusted shift schedules, enforced social distancing, increased sanitation and adjusted time and attendance policies for worker absenteeism. Our sales teams continue to support
The Hershey Company | Q2 2020 Form 10-Q | Page 34
|
| | | | | | | | | | | | | | | | |
Reconciliation of Certain Non-GAAP Financial Measures |
Consolidated results | | Three Months Ended | | Nine Months Ended |
In thousands except per share data | | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Reported gross profit | | $ | 940,222 |
| | $ | 850,848 |
| | $ | 2,609,992 |
| | $ | 2,415,622 |
|
Derivative mark-to-market (gains) losses | | (21,954 | ) | | 35,791 |
| | (27,486 | ) | | 30,851 |
|
Business realignment activities | | 213 |
| | 24,470 |
| | 6,475 |
| | 57,948 |
|
NSRPE | | 2,779 |
| | 2,620 |
| | 8,344 |
| | 9,132 |
|
Non-GAAP gross profit | | $ | 921,260 |
| | $ | 913,729 |
| | $ | 2,597,325 |
| | $ | 2,513,553 |
|
| | | | | | | | |
Reported operating profit | | $ | 439,020 |
| | $ | 374,024 |
| | $ | 946,292 |
| | $ | 976,295 |
|
Derivative mark-to-market (gains) losses | | (21,954 | ) | | 35,791 |
| | (27,486 | ) | | 30,851 |
|
Business realignment activities | | 8,257 |
| | 27,962 |
| | 69,699 |
| | 104,487 |
|
Acquisition integration costs | | — |
| | 2,265 |
| | 311 |
| | 3,727 |
|
NSRPE | | 21,540 |
| | 6,360 |
| | 30,123 |
| | 20,666 |
|
Long-lived asset impairment charges | | — |
| | — |
| | 208,712 |
| | — |
|
Non-GAAP operating profit | | $ | 446,863 |
| | $ | 446,402 |
| | $ | 1,227,651 |
| | $ | 1,136,026 |
|
| | | | | | | | |
Reported provision for income taxes | | $ | 126,788 |
| | $ | 100,434 |
| | $ | 275,291 |
| | $ | 297,671 |
|
Derivative mark-to-market (gains) losses * | | (3,078 | ) | | 13,566 |
| | (2,726 | ) | | 11,694 |
|
Business realignment activities* | | 1,112 |
| | 5,576 |
| | 18,312 |
| | 16,409 |
|
Acquisition integration costs* | | — |
| | 859 |
| | 118 |
| | 1,413 |
|
NSRPE* | | 8,171 |
| | 2,432 |
| | 11,440 |
| | 7,900 |
|
Long-lived asset impairment charges** | | (8,710 | ) | | — |
| | 29,264 |
| | — |
|
Non-GAAP provision for income taxes | | $ | 124,283 |
| | $ | 122,867 |
| | $ | 331,699 |
| | $ | 335,087 |
|
| | | | | | | | |
Reported net income | | $ | 273,303 |
| | $ | 227,403 |
| | $ | 601,848 |
| | $ | 603,191 |
|
Derivative mark-to-market (gains) losses | | (18,876 | ) | | 22,225 |
| | (24,760 | ) | | 19,157 |
|
Business realignment activities | | 7,145 |
| | 22,386 |
| | 51,387 |
| | 88,073 |
|
Acquisition integration costs | | — |
| | 1,406 |
| | 193 |
| | 2,314 |
|
NSRPE | | 13,369 |
| | 3,928 |
| | 18,683 |
| | 12,766 |
|
Long-lived asset impairment charges | | 8,710 |
| | — |
| | 179,448 |
| | — |
|
Noncontrolling interest share of business realignment and impairment charges | | (5 | ) | | — |
| | (27,967 | ) | | — |
|
Settlement of SGM liability | | — |
| | — |
| | — |
| | (26,650 | ) |
Non-GAAP net income | | $ | 283,646 |
| | $ | 277,348 |
| | $ | 798,832 |
| | $ | 698,851 |
|
| | | | | | | | |
Reported EPS - Diluted | | $ | 1.28 |
| | $ | 1.06 |
| | $ | 2.81 |
| | $ | 2.80 |
|
Derivative mark-to-market (gains) losses | | (0.08 | ) | | 0.10 |
| | (0.11 | ) | | 0.09 |
|
Business realignment activities | | 0.03 |
| | 0.10 |
| | 0.24 |
| | 0.40 |
|
Acquisition integration costs | | — |
| | 0.01 |
| | — |
| | 0.01 |
|
NSRPE | | 0.06 |
| | 0.02 |
| | 0.08 |
| | 0.06 |
|
Long-lived asset impairment charges | | 0.04 |
| | — |
| | 0.84 |
| | — |
|
Noncontrolling interest share of business realignment and impairment charges | | — |
| | — |
| | (0.13 | ) | | — |
|
Settlement of SGM liability | | — |
| | — |
| | — |
| | (0.12 | ) |
Non-GAAP EPS - Diluted | | $ | 1.33 |
| | $ | 1.29 |
| | $ | 3.73 |
| | $ | 3.24 |
|
community food supplies, while adhering to social distancing guidelines, implementing flexible hours, reducing person-to-person interaction and increasing safety measures. Additionally, in June, the Company re-opened Hershey’s Chocolate World stores in the United States (3 locations) and Niagara Falls (Ontario) on a limited capacity basis with increased safety measures and enforced social distancing. The Company's Chocolate World store in Singapore remains temporarily closed.
* The tax effect for each adjustmentAlso in June, we commenced a phased in approach to reopen our corporate headquarters in Hershey, Pennsylvania and other select offices with increased safety protocols. We have successfully onboarded several teams, however, occupancy levels remain low as we continue to monitor the latest COVID-19 related public health and government guidance. As a result, a majority of our office-based employees continue to work remotely where possible. We have crisis management teams in place to monitor the continually evolving situation and recommending risk mitigation actions as deemed necessary. To date, there has been minimal disruption to our supply chain network, including the supply of our ingredients, packaging or other sourced materials, though it is determined by calculatingpossible that more significant disruptions could occur if the taxCOVID-19 pandemic continues to impact markets around the world. We are also working closely with our business units, contract manufacturers, distributors, contractors and other external business partners to minimize the potential impact on our business.
We believe we have sufficient liquidity to satisfy our cash needs, however, we continue to evaluate and take action, as necessary, to preserve adequate liquidity and ensure that our business can continue to operate during these uncertain times. Our most recent liquidity measures include an increase in our short-term commercial paper balances and the $1 billion Notes issuance in May 2020 with varying rates ranging from 0.900% to 2.650% and maturity dates ranging from 2025 to 2050. Additionally, we continue to limit discretionary spending across the organization and re-prioritizing our capital projects amid the COVID-19 pandemic. We plan to move forward with our new global enterprise resource planning (“ERP”) system implementation and supply chain capacity projects, as these investments are of strategic importance to our long-term growth. However, as previously announced, we did selectively pause certain aspects of the adjustment on the Company's quarterly effective tax rate.
** There were no pre-tax impairment chargesERP system implementation due to resource constraints and challenges associated with long-lived assetsthe critical design phase during the three months ended October 1, 2017. However, the long-lived asset impairment chargethese uncertain times. We expect this to delay our overall ERP implementation by approximately one year.
As a result of shelter-in-place restrictions that were implemented in the first quarter of 2017 was not treatedlate March and early April, as a discrete tax item. Therefore, the tax impact was includedwell as decreases in the estimated annual effective tax rate resultingretail foot traffic and volatility in an EPS-diluted impact for each of the quarters throughout 2017.
In the assessmentconsumer shopping and consumption behavior across several areas of our results,portfolio, we reviewexperienced a reduction in our net sales and discuss the following financial metrics that are derived from the reported and non-GAAP financial measures presented above:
|
| | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
As reported gross margin | | 46.2 | % | | 42.5 | % | | 46.8 | % | | 44.2 | % |
Non-GAAP gross margin (1) | | 45.3 | % | | 45.6 | % | | 46.6 | % | | 46.0 | % |
| | | | | | | | |
As reported operating profit margin | | 21.6 | % | | 18.7 | % | | 17.0 | % | | 17.8 | % |
Non-GAAP operating profit margin (2) | | 22.0 | % | | 22.3 | % | | 22.0 | % | | 20.8 | % |
| | | | | | | | |
As reported effective tax rate | | 31.6 | % | | 30.6 | % | | 32.4 | % | | 33.0 | % |
Non-GAAP effective tax rate (3) | | 30.4 | % | | 30.7 | % | | 29.3 | % | | 32.4 | % |
| |
(1) | Calculated as non-GAAP gross profit as a percentage of net sales for each period presented. |
| |
(2) | Calculated as non-GAAP operating profit as a percentage of net sales for each period presented. |
| |
(3) | Calculated as non-GAAP provision for income taxes as a percentage of non-GAAP income before taxes (calculated as non-GAAP operating profit minus non-GAAP interest expense, net plus or minus non-GAAP other (income) expense, net). |
Details of the activities impacting comparability that are presented as reconciling items to derive the non-GAAP financial measures in the tables above are as follows:
Mark-to-market (gains) losses on commodity derivatives
Commensurate with our discontinuance of hedge accounting treatment for commodity derivatives, we are adjusting the mark-to-market 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 October 1, 2017 and October 2, 2016, the net unallocated mark-to-market adjustment on commodity derivatives totaled pre-tax gains of $22.0 million and losses of $35.8 million, respectively. For the nine months ended October 1, 2017 and October 2, 2016, the net unallocated mark-to-market adjustment on commodity derivatives totaled pre-tax gains of $27.5 million and losses of $30.9 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 October 1, 2017 and October 2, 2016, we incurred $8.3 million and $28.0 million, respectively, of pre-tax costs related to business realignment activities. For the nine months ended October 1, 2017 and October 2, 2016, we incurred $69.7 million and $104.5 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
ninesix months ended
October 1, 2017June 28, 2020. The unfavorable impacts predominantly related to our International and
2016 relate to the integration of the 2016 acquisition of Ripple Brand Collective, LLC as we incorporateOther segment (see Segment Results included in this business into our operating practices and information systems.
Non-service related pension expense
NSRPE includes interest costs, the expected return on pension plan assets, the amortization of actuarial gains and losses, and certain curtailment and settlement losses or credits. NSRPE can fluctuate from year to year as a result of changes in market interest rates and market returns on pension plan assets.MD&A). We believe that the service cost component of our total pension benefit costs closely reflects the operating costs offinancial impacts from COVID-19 are temporary in nature and do not significantly affect our business model and provides forgrowth strategy.
In late May and early June, many state governments began a better comparisonphased reopening of our operating results from yeartheir economies. These phased approaches promote limited food service offerings, outdoor dining, increased travel and the reopening of retailing establishments while adhering to year. Therefore, we exclude NSRPE from our internal performance measures. Our most significant defined benefit pensionnew guidelines and enhanced safety measures, including social distancing and face mask protocols. However, certain states have paused or reversed plans to reopen their economies as new cases of COVID-19 have been closedon the rise in recent weeks. Based on the length and severity of COVID-19, we may experience continued volatility in retail foot traffic, consumer shopping and consumption behavior. We will continue to new participants for a number of years, resulting in ongoing service costs that are stableevaluate the nature and predictable. We recorded pre-tax NSRPE of $21.5 million and $6.4 million, respectively, for the three months ended October 1, 2017 and October 2, 2016, respectively. We recorded pre-tax NSRPE of $30.1 million and $20.7 million, respectively, for the nine months ended October 1, 2017 and October 2, 2016, respectively.
Long-lived asset impairment charges
For the nine months ended October 1, 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 portionextent of these charges included within the loss attributedpotential impacts to the non-controlling interest.
Settlement of SGM liability
In the fourth quarter of 2015, we reached an agreement with the SGM selling shareholders to reduce the originally-agreed purchase price for the remaining 20% of SGM, and we completed the purchase on February 3, 2016. In the first quarter of 2016, we recorded a $26.7 million gain relating to the settlement of the SGM liability, representing the net carrying amount of the recorded liability in excess of the cash paid to settle the obligation for the remaining 20% of the outstanding shares.
Constant Currency Net Sales Growth
We present certain percentage changes in net sales on a constant currency basis, which excludes the impact of foreign currency exchange. This measure is used internally by management in evaluatingour business, consolidated results of operations, segment results, liquidity 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:capital resources.
|
| | | | | | | | |
| Three Months Ended October 1, 2017 |
| Percentage Change as Reported | | Impact of Foreign Currency Exchange | | Percentage Change on Constant Currency Basis |
North America segment | | | | | |
Canada | 12.1 | % | | 4.6 | % | | 7.5 | % |
Total North America segment | 1.6 | % | | 0.3 | % | | 1.3 | % |
| | | | | |
International and Other segment | | | | | |
Mexico | 15.5 | % | | 5.9 | % | | 9.6 | % |
Brazil | 6.4 | % | | 3.1 | % | | 3.3 | % |
India | 20.9 | % | | 4.9 | % | | 16.0 | % |
Greater China | (7.3 | )% | | (0.2 | )% | | (7.1 | )% |
Total International and Other segment | 0.8 | % | | 1.3 | % | | (0.5 | )% |
| | | | | |
Total Company | 1.5 | % | | 0.4 | % | | 1.1 | % |
|
| | | | | | | | |
| Nine Months Ended October 1, 2017 |
| Percentage Change as Reported | | Impact of Foreign Currency Exchange | | Percentage Change on Constant Currency Basis |
North America segment | | | | | |
Canada | 8.3 | % | | 1.0 | % | | 7.3 | % |
Total North America segment | 2.1 | % | | — | % | | 2.1 | % |
| | | | | |
International and Other segment | | | | | |
Mexico | 9.4 | % | | (3.7 | )% | | 13.1 | % |
Brazil | 20.7 | % | | 13.0 | % | | 7.7 | % |
India | 13.9 | % | | 3.0 | % | | 10.9 | % |
Greater China | (11.2 | )% | | (1.6 | )% | | (9.6 | )% |
Total International and Other segment | 0.3 | % | | 0.3 | % | | — | % |
| | | | | |
Total Company | 1.9 | % | | — | % | | 1.9 | % |
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.Hershey Company | Q2 2020 Form 10-Q | Page 35
|
| | | |
| 2017 (Projected) | | 2016 |
Reported EPS – Diluted | $3.54 - $3.68 | | $3.34 |
Derivative mark-to-market losses | — | | 0.66 |
Business realignment costs (including Margin for Growth Program costs) | 0.16 - 0.21 | | 0.42 |
Acquisition and integration costs | — | | 0.02 |
Non-service related pension expense | 0.10 | | 0.08 |
Settlement of SGM liability | — | | (0.12) |
Long-lived asset impairment charges | 0.87 | | 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.
CONSOLIDATED RESULTS OF OPERATIONS
| | | | Three Months Ended | | Percent | | Nine Months Ended | | Percent | | Three Months Ended | | | | | Six Months Ended | | | |
| | October 1, 2017 | | October 2, 2016 | | Change | | October 1, 2017 | | October 2, 2016 | | Change | | June 28, 2020 | | June 30, 2019 | | Percent Change | | June 28, 2020 | | June 30, 2019 | | Percent Change |
In millions of dollars except per share amounts | | | | | | | | | | | | | In millions of dollars except per share amounts | | | | | | | | | | | | |
Net Sales | | $ | 2,033.1 |
| | $ | 2,003.5 |
| | 1.5 | % | | $ | 5,575.8 |
| | $ | 5,469.9 |
| | 1.9 | % | Net Sales | | $ | 1,707.3 | | | $ | 1,767.2 | | | (3.4) | % | | $ | 3,744.6 | | | $ | 3,783.7 | | | (1.0) | % |
Cost of Sales | | 1,092.9 |
| | 1,152.6 |
| | (5.2 | )% | | 2,965.8 |
| | 3,054.3 |
| | (2.9 | )% | Cost of Sales | | 914.8 | | | 892.5 | | | 2.5 | % | | 2,085.5 | | | 2,016.5 | | | 3.4 | % |
Gross Profit | | 940.2 |
| | 850.8 |
| | 10.5 | % | | 2,610.0 |
| | 2,415.6 |
| | 8.0 | % | Gross Profit | | 792.5 | | | 874.7 | | | (9.4) | % | | 1,659.1 | | | 1,767.2 | | | (6.1) | % |
Gross Margin | | 46.2 | % | | 42.5 | % | | | | 46.8 | % | | 44.2 | % | | | Gross Margin | | 46.4 | % | | 49.5 | % | | | | 44.3 | % | | 46.7 | % | |
SM&A Expense | | 497.2 |
| | 474.5 |
| | 4.8 | % | | 1,405.0 |
| | 1,408.8 |
| | (0.3 | )% | SM&A Expense | | 408.9 | | | 453.8 | | | (9.9) | % | | 884.3 | | | 907.4 | | | (2.5) | % |
SM&A Expense as a percent of net sales | | 24.5 | % | | 23.7 | % | | | | 25.2 | % | | 25.8 | % | | | SM&A Expense as a percent of net sales | | 24.0 | % | | 25.7 | % | | | | 23.6 | % | | 24.0 | % | |
Long-lived Asset Impairment Charges | | — |
| | — |
| | — | % | | 208.7 |
| | — |
| | NM |
| |
Business Realignment Costs | | 4.0 |
| | 2.3 |
| | 72.5 | % | | 50.0 |
| | 30.6 |
| | 63.6 | % | |
Long-Lived Asset Impairment Charges | | Long-Lived Asset Impairment Charges | | 1.6 | | | 4.7 | | | (66.3) | % | | 9.1 | | | 4.7 | | | 92.8 | % |
Business Realignment (Benefits) Costs | | Business Realignment (Benefits) Costs | | (1.4) | | | 6.1 | | | (122.3) | % | | (0.5) | | | 6.2 | | | (107.7) | % |
Operating Profit | | 439.0 |
| | 374.0 |
| | 17.4 | % | | 946.3 |
| | 976.3 |
| | (3.1 | )% | Operating Profit | | 383.4 | | | 410.1 | | | (6.5) | % | | 766.2 | | | 848.9 | | | (9.7) | % |
Operating Profit Margin | | 21.6 | % | | 18.7 | % | | | | 17.0 | % | | 17.8 | % | | | Operating Profit Margin | | 22.5 | % | | 23.2 | % | | | | 20.5 | % | | 22.4 | % | |
Interest Expense, Net | | 24.6 |
| | 24.4 |
| | 0.8 | % | | 72.5 |
| | 66.7 |
| | 8.6 | % | Interest Expense, Net | | 38.1 | | | 33.8 | | | 12.7 | % | | 74.3 | | | 71.2 | | | 4.4 | % |
Other (Income) Expense, Net | | 13.6 |
| | 21.8 |
| | (37.5 | )% | | 23.6 |
| | 8.7 |
| | NM |
| Other (Income) Expense, Net | | 11.2 | | | 13.1 | | | (14.5) | % | | 22.8 | | | 18.6 | | | 22.3 | % |
Provision for Income Taxes | | 126.8 |
| | 100.4 |
| | 26.2 | % | | 275.3 |
| | 297.7 |
| | (7.5 | )% | Provision for Income Taxes | | 66.1 | | | 50.0 | | | 32.3 | % | | 132.3 | | | 141.9 | | | (6.8) | % |
Effective Income Tax Rate | | 31.6 | % | | 30.6 | % | | | | 32.4 | % | | 33.0 | % | | | Effective Income Tax Rate | | 19.8 | % | | 13.7 | % | | | | 19.8 | % | | 18.7 | % | |
Net Income Including Noncontrolling Interest | | 274.0 |
| | 227.4 |
| | 20.5 | % | | 575.0 |
| | 603.2 |
| | (4.7 | )% | Net Income Including Noncontrolling Interest | | 268.0 | | | 313.2 | | | (14.4) | % | | 536.8 | | | 617.2 | | | (13.0) | % |
Less: Net Gain (Loss) Attributable to Noncontrolling Interest | | 0.7 |
| | — |
| | NM |
| | (26.9 | ) | | — |
| | NM |
| |
Less: Net (Loss) Income Attributable to Noncontrolling Interest | | Less: Net (Loss) Income Attributable to Noncontrolling Interest | | (0.9) | | | 0.4 | | | (299.3) | % | | (3.2) | | | — | | | NM |
Net Income Attributable to The Hershey Company | | $ | 273.3 |
| | $ | 227.4 |
| | 20.2 | % | | $ | 601.8 |
| | $ | 603.2 |
| | (0.2 | )% | Net Income Attributable to The Hershey Company | | $ | 268.9 | | | $ | 312.8 | | | (14.0) | % | | $ | 540.0 | | | $ | 617.2 | | | (12.5) | % |
Net Income Per Share—Diluted | | $ | 1.28 |
| | $ | 1.06 |
| | 20.8 | % | | $ | 2.81 |
| | $ | 2.80 |
| | 0.4 | % | Net Income Per Share—Diluted | | $ | 1.29 | | | $ | 1.48 | | | (12.8) | % | | $ | 2.58 | | | $ | 2.93 | | | (11.9) | % |
| | | | | | | | | | | | | | | | | | | | | |
Note: Percentage changes may not compute directly as shown due to rounding of amounts presented above. | |
NM = not meaningful. | |
NOTE: Percentage changes may not compute directly as shown due to rounding of amounts presented above. | | NOTE: Percentage changes may not compute directly as shown due to rounding of amounts presented above. | |
NM = not meaningful | | NM = not meaningful | |
Results of Operations - ThirdSecond Quarter 20172020 vs. ThirdSecond Quarter 20162019
Net Sales
Net sales increased 1.5%decreased 3.4% in the thirdsecond quarter of 20172020 compared to the same period of 2016,2019, reflecting a volume decrease of 7.0% due to the impact of COVID-19 on sales in our international markets, as well as declines in owned retail and world travel retail and elasticity-driven impacts due to price increases of 0.7%, favorable price realization of 0.4%on certain products, and a favorablean unfavorable impact from foreign currency exchange rates of 0.4%0.7%. Excluding foreign currency, our net sales increased 1.1% in the third quarter of 2017. Consolidated volumes increased as a result of higher sales volume in the North America segment, which benefited from core brand growth and innovation, including Hershey's Cookie Layer Crunch, and the launch of Hershey's and Reese's Popped Snack Mix and Chocolate Dipped Pretzels. These volume increasesdecreases were partially offset by volume declines in our International and Other segment, where growth, driven by measured investments in Mexico, Brazil and India, was more than offset by declines in China. Favorable netfavorable price realization was attributedof 3.5% due to higher prices in select markets within our Internationalon certain products and Other segment versusa 0.8% benefit from net acquisitions and divestitures (predominantly driven by the prior year.2019 acquisition of ONE Brands, LLC ("ONE Brands"), partially offset by the 2020 divestitures of Krave and the Scharffen Berger and Dagoba brands).
Key U.S. CMG Marketplace Metrics
|
| | | | | | |
For the 12 week period ended | | October 8, 2017 | | October 8, 2016 |
Hershey's Consumer Takeaway Increase (Decrease) | | 1.4 | % | | (0.4 | )% |
Hershey's Market Share Decrease | | (0.3 | ) | | (0.1 | ) |
For the second quarter of 2020, our total U.S. retail takeaway increased 4.1% in the expanded multi-outlet combined plus convenience store channels (IRI MULO + C-Stores), which includes candy, mint, gum, salty snacks, meat snacks and grocery items. Our U.S. candy, mint and gum ("CMG") consumer takeaway increased 3.2%, resulting in a CMG market share gain of approximately 227 basis points.
The CMG consumer takeaway and market share information provided for the twelve week period above are forreflect 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 NielsenInformation Resources,
The Hershey Company | Q2 2020 Form 10-Q | Page 36
Incorporated ("IRI"), the Company's market insights and analytics provider, 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 core brand growth and innovation. The amounts presented above are solely for the U.S. CMG category which does not include revenue from our snack mixes and grocery items.
Cost of Sales and Gross Margin
Cost of sales decreased 5.2%increased 2.5% in the thirdsecond quarter of 20172020 compared to the same period of 2016.2019. The improvementincrease was driven by an incremental $57.7$52.9 million favorable impact from marking-to-marketof unfavorable mark-to-market activity on our commodity derivative instruments, which are intended to economically hedge future years' commodity purchases, a $24.3 million decreasepurchases. Additionally, the increase in business realignment costs, and supply chain productivity and cost savings initiatives. These benefits were offset in part by unfavorable manufacturing variances andof sales was attributed to higher freight and warehousing costs.logistics costs, and additional plant costs, specifically, personal protective equipment ("PPE") costs, increased sanitation and wage incentives associated with COVID-19. These drivers were partially offset by favorable supply chain productivity.
Gross margin increaseddecreased by 370310 basis points in the thirdsecond quarter of 20172020 compared to the same period of 2016. Favorable2019. The decrease was primarily due to an unfavorable year-over-year mark-to-market impact from commodity derivative instruments, lower commodityhigher freight and business realignmentlogistics costs and supply chain productivity contributed to the improvement in gross margin. However, higher supply chain costs partially offset the increase in gross margin.
Selling, Marketing and Administrative
Selling, marketing and administrative (“SM&A”) expenses increased $22.7 million or 4.8% in the third quarter of 2017. Advertising and related consumer marketing expense increased 3.7% during this period. Excluding these advertising and related consumer marketing costs, selling and administrative expenses for 2017 increased by 5.4% as compared to 2016. SM&A was impacted by pension settlement charges and higher costs associated with business realignment programs and investments in go-to-market capabilities, partially offset by costs savings and efficiency initiatives.
Business Realignment Activities
In the third quarter of 2017 and 2016, we recorded business realignment costs of $4.0 million and $2.3 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 17.4% in the third quarter of 2017 compared to the same period of 2016 due primarily to the higher gross margin as discussed above. Operating profit margin increased to 21.6% in 2017 from 18.7% in 2016 also driven by the improvement in gross margin.
Interest Expense, Net
Net interest expense was $0.2 million higher in the third quarter of 2017 compared to the same period of 2016. The increase was due to higher interest rates on higher levels of short-term debt outstanding during the 2017 quarter, as well as a decreased benefit on the fixed to floating swaps during the third quarter of 2017 as compared to the 2016 quarter.
Other (Income) Expense, Net
Other (income) expense, net totaled $13.6 million in the third quarter of 2017 compared to $21.8 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.
Income Taxes and Effective Tax Rate
Our effective income tax rate was 31.6% for the third quarter of 2017 compared to 30.6% for the same period of 2016. Relative to the statutory rate, the 2017 effective tax rate was impacted by favorable foreign rate differential relating to our cocoa procurement operations and investment tax credits, whichadditional plant costs. These factors were partially offset by non-benefited costs resulting from the Margin for Growth Program. The 2016 tax rate benefited from a one time tax return amendment for research and development credits and other tax deductions.
Net Income Attributable to The Hershey Company and Earnings Per Share-diluted
Net income increased $45.9 million, or 20.2%, while EPS-diluted increased $0.22, or 20.8%, in the third 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 as discussed above.
Results of Operations - First Nine Months 2017 vs. First Nine Months 2016
Net Sales
Net sales increased 1.9% in the first nine months of 2017 compared to the same period of 2016, reflecting favorable price realization of 0.8%, volume increases of 0.7% and a 0.4% benefit from acquisitions. There was no impact from foreign currency exchange rates during the period. 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, specifically from core brand growth throughout 2017 and innovation, including new product launches and stand-up packaging. These volume increases were partially offset by volume declines in our International and Other segment, where growth, driven by measured investments in Mexico, Brazil and India, was more than offset by declines in China.
Cost of Sales and Gross Margin
Cost of sales decreased 2.9% in the first nine months of 2017 compared to the same period of 2016. The improvement was driven by lower commodity costs, including an incremental $58.3 million favorable impact from marking-to-market our commodity derivative instruments intended to economically hedge future years' commodity purchases, a $51.5 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 260 basis points in the first nine months of 2017 compared to the same period of 2016, driven by lower commodity and business realignment costs, and supply chain productivity. However, the increase in gross margin was partially offset by higher supply chain costs.
Selling, Marketing and Administrative
Selling, marketing and administrative (“SM&A”) expenses decreased $3.8$44.8 million or 0.3%9.9% in the first nine monthssecond quarter of 2017. Advertising and related consumer marketing expense increased 1.1% during this period. Excluding these2020. Total advertising and related consumer marketing costs, sellingexpenses decreased 14.0% driven by media cost efficiencies and administrativeselect brand investment optimization related to COVID-19 in both the North America and International and Other segments. SM&A expenses, for 2017excluding advertising and related consumer marketing, decreased by 1.0%approximately 7.6% in the second quarter of 2020 primarily due to savings in travel and meeting expenses as compared to 2016. SM&A benefited froma result of COVID-19 related travel restrictions and lower costs relating to business realignment activities as well as costs savings and efficiency initiatives, partially offset by higher pension settlement charges and investments in go-to-market capabilities.incentive compensation.
Long-livedLong-Lived Asset Impairment Charges
InDuring the first nine monthssecond quarter of 2017,2020, we recorded impairment charges of $1.6 million to adjust long-lived asset values in connection with our disposal group classified as held for sale, as discussed in Note8 to the Unaudited Consolidated Financial Statements. The fair value of the disposal group was supported by potential sales prices with third-party buyers. We expect the sale of the disposal group to be completed during 2020. During the second quarter of 2019, we recorded long-lived asset impairment charges of $208.7 million. This relates to a first quarter write-down$4.7 million, which were predominantly comprised of certain intangible assetsselect land that had been recognizednot yet met the held for sale criteria.Business Realignment Activities
Business realignment benefits of $1.4 million in connection with the 2014 SGM acquisition and write-downsecond quarter of property, plant and equipment. See 2020 versus costs of $6.1 million in the second quarter of 2019 related primarily to the Margin for Growth Program, which is discussed in more detail in Note 79 to the Unaudited Consolidated Financial Statements.
Business Realignment Activities
In the first nine months of 2017 and 2016, we recorded business realignment costs of $50.0 million and $30.6 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 3.1%6.5% in the first nine monthssecond quarter of 20172020 compared to the same period of 20162019 due primarily to the long-lived asset impairment charges and higher business realignment costs,lower gross profit, partially offset by higher gross margin and lower SM&A expenses, as discussednoted above. Operating profit margin decreased to 17.0%22.5% in 20172020 from 17.8%23.2% in 20162019 driven by these same factors.
Interest Expense, Net
Net interest expense was $5.7$4.3 million higher in the first nine monthssecond quarter of 20172020 compared to the same period of 2016.2019. The increase was primarily due to higher levels of long-term debt outstanding and higherlower interest rates on commercial paper during the 2017 period,income in 2020 as we recognized a benefit in 2019 related to an international local tax settlement, as well as a decreased benefit from the fixedhigher long-term debt balances in 2020 versus 2019 (predominantly due to floating swaps during the nine months$1.0 billion of 2017 as compared to the 2016 period.notes issued in October 2019).
Other (Income) Expense, Net
Other (income) expense, net totaled expense of $23.6$11.2 million duringin the first nine monthssecond quarter of 20172020 versus expense of $8.7$13.1 million forin the same periodsecond quarter of 2016. In 2017 we recognized a $24.0 million write-down2019. The decrease in the net expense was primarily due to lower write-downs on equity investments qualifying for federal historic and energy tax credits comparedand lower non-service cost components of net periodic benefit cost relating to a $35.9 million write down in the first nine month of 2016. Additionally, 2016 was offset by an extinguishment gain of $26.7 million related to the settlement of the SGM liability.pension and other post-retirement benefit plans during 2020.
The Hershey Company | Q2 2020 Form 10-Q | Page 37
Income Taxes and Effective Tax Rate
Our effective income tax rate was 32.4%19.8% for the first nine monthssecond quarter of 20172020 compared with 33.0%13.7% for the same periodsecond quarter of 2016.2019. Relative to the 21% statutory rate, the 20172020 effective tax rate benefited from investment tax credits and changes in tax reserves, partially offset by state taxes. The 2019 effective tax rate, relative to the 21% statutory rate, was impacted by a favorable foreign rate differential relatingchange to foreign operations and cocoa procurement, investment tax credits andvaluation allowances, the benefit of ASU 2016-09,employee share-based payments, and investment tax credits, 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.state taxes.
Net Income attributable to The Hershey Company and Earnings Per Share-diluted
Net income decreased $1.3$45.2 million, or 0.2%14.0%, while EPS-diluted increased $0.01,decreased $0.19, or 0.4%12.8%, in the first nine monthssecond quarter of 20172020 compared to the same period of 2016.2019. The decrease in both net income and EPS-diluted was driven primarily by lower gross profit and higher income taxes, partially offset by lower SM&A expenses, as noted above. Our 2020 EPS-diluted also benefited from lower weighted-average shares outstanding as a result of share repurchases pursuant to our Board-approved repurchase programs.
Results of Operations - First Six Months 2020 vs. First Six Months 2019
Net Sales
Net sales decreased 1.0% in the first six months of 2020 compared to the same period of 2019, reflecting a volume decrease of 4.5% due to the impact of COVID-19 on sales in our international markets, as well as declines in owned retail and world travel retail and elasticity-driven impacts due to price increases on certain products, and an unfavorable impact from foreign currency exchange rates of 0.4%. These decreases were partially offset by a favorable price realization of 3.1% due to higher prices on certain products and a 0.8% benefit from net acquisitions and divestitures (predominantly driven by the 2019 acquisition of ONE Brands, partially offset by the 2020 divestitures of Krave and the Scharffen Berger and Dagoba brands).
Cost of Sales and Gross Margin
Cost of sales increased 3.4% in the first six months of 2020 compared to the same period of 2019. The increase was driven by an incremental $103.4 million of unfavorable mark-to-market activity on our commodity derivative instruments. These derivative instruments are intended to economically hedge future years' commodity purchases, however, they were significantly impacted by financial market volatility during the first six months of 2020. Additionally, the increase in cost of sales was attributed to higher freight and logistics costs and additional plant costs, specifically, PPE costs, increased sanitation and wage incentives associated with COVID-19. These drivers were partially offset by favorable supply chain productivity.
Gross margin decreased by 240 basis points in in the first six months of 2020 compared to the same period of 2019. The decrease was primarily due to unfavorable year-over-year mark-to-market impact from commodity derivative instruments, the higher freight and logistics costs and additional plant costs. These factors were partially offset by favorable price realization and supply chain productivity.
Selling, Marketing and Administrative
SM&A expenses decreased $23.0 million or 2.5% in the first six months of 2020. Total advertising and related consumer marketing expenses decreased 4.5% driven by media cost efficiencies and select brand investment optimization related to COVID-19 in both the North America and International and Other segments. SM&A expenses, excluding advertising and related consumer marketing, decreased approximately 1.4% in the first six months of 2020 primarily due to savings in travel and meeting expenses as a result of COVID-19 related travel restrictions.
The Hershey Company | Q2 2020 Form 10-Q | Page 38
Long-Lived Asset Impairment Charges
During the first six months of 2020, we recorded the following impairment charges:
| | | | | | | | |
In millions of dollars | | |
Adjustment to disposal group (1) | | $ | 6.2 | |
Other asset write-down (2) | | 2.9 | |
Long-lived asset impairment charges | | $ | 9.1 | |
(1)In connection with our disposal group classified as held for sale, as discussed in Note 8 to the Unaudited Consolidated Financial Statements, during the first six months of 2020, we recorded impairment charges to adjust long-lived asset values. The fair value of the disposal group was supported by potential sales prices with third-party buyers. We expect the sale of the disposal group to be completed during 2020. (2)In connection with a previous sale, the Company wrote-down certain receivables deemed uncollectible.
During the first six months of 2019, we recorded long-lived asset impairment charges of $4.7 million, which were
predominantly comprised of select land that had not yet met the held for sale criteria.
Business Realignment Activities
Business realignment benefits of $0.5 million in the first six months of 2020 versus costs of $6.2 million in the first six months of 2019 related primarily to the Margin for Growth Program, which is discussed in more detail in Note 9 to the Unaudited Consolidated Financial Statements. Operating Profit and higher business realignment costs,Operating Profit Margin
Operating profit decreased 9.7% in the first six months of 2020 compared to the same period of 2019 due primarily to lower gross profit, partially offset by lower SM&A expenses, as noted above, whereas,above. Operating profit margin decreased to 20.5% in 2020 from 22.4% in 2019 driven by these same factors.
Interest Expense, Net
Net interest expense was $3.1 million higher in the first six months of 2020 compared to the same period of 2019. The increase was primarily due to lower interest income in 2020 as we recognized a benefit in 2019 related to an international local tax settlement, as well as higher long-term debt balances in 2020 versus 2019 (predominantly due to $1.0 billion of notes issued in October 2019).
Other (Income) Expense, Net
Other (income) expense, net totaled expense of $22.8 million in the first six months of 2020 versus expense of $18.6 million in the first six months of 2019. The increase in EPSthe net expense was primarily due to higher write-downs on equity investments qualifying for federal historic and energy tax credits, partially offset by lower non-service cost components of net periodic benefit cost relating to pension and other post-retirement benefit plans during 2020.
Income Taxes and Effective Tax Rate
Our effective income tax rate was 19.8% for the first six months of 2020 compared with 18.7% for the first six months of 2019. Relative to the 21% statutory rate, the 2020 effective tax rate was favorably impacted by investment tax credits and the benefit of employee share-based payments, partially offset by state taxes. The 2019 effective tax rate, relative to the 21% statutory rate, was impacted by a change to foreign valuation allowances, the benefit of employee share-based payments, and investment tax credits, which were partially offset by state taxes.
Net Income attributable to The Hershey Company and Earnings Per Share-diluted
Net income decreased $77.2 million, or 12.5%, while EPS-diluted decreased $0.35, or 11.9%, in the first six months of 2020 compared to the same period of 2019. The decrease in both net income and EPS-diluted was driven primarily by lower dilutedgross profit, partially offset by lower SM&A expenses and lower taxes. Our 2020 EPS-diluted also benefited from lower weighted-average shares outstanding.outstanding as a result of share repurchases pursuant to our Board-approved repurchase programs.
The Hershey Company | Q2 2020 Form 10-Q | Page 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 integrationacquisition-related costs and NSRPEother unusual gains or losses 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 integraldirectly attributable to our ongoing segment 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 | | |
| | June 28, 2020 | | June 30, 2019 | | June 28, 2020 | | June 30, 2019 |
In millions of dollars | | | | | | | | |
Net Sales: | | | | | | | | |
North America | | $ | 1,583.8 | | | $ | 1,568.0 | | | $ | 3,428.6 | | | $ | 3,375.0 | |
International and Other | | 123.5 | | | 199.2 | | | 316.0 | | | 408.7 | |
Total | | $ | 1,707.3 | | | $ | 1,767.2 | | | $ | 3,744.6 | | | $ | 3,783.7 | |
| | | | | | | | |
Segment Income (Loss): | | | | | | | | |
North America | | $ | 497.6 | | | $ | 470.9 | | | $ | 1,079.1 | | | $ | 1,035.7 | |
International and Other | | (4.0) | | | 21.9 | | | 12.0 | | | 42.2 | |
Total segment income | | 493.6 | | | 492.8 | | | 1,091.1 | | | 1,077.9 | |
Unallocated corporate expense (1) | | 106.9 | | | 125.2 | | | 231.4 | | | 242.9 | |
Unallocated mark-to-market losses (gains) on commodity derivatives (2) | | 0.5 | | | (53.6) | | | 82.2 | | | (25.6) | |
Long-lived asset impairment charges | | 1.6 | | | 4.7 | | | 9.1 | | | 4.7 | |
Costs associated with business realignment activities | | 1.3 | | | 6.4 | | | 2.2 | | | 6.9 | |
Operating profit | | 383.3 | | | 410.1 | | | 766.2 | | | 849.0 | |
Interest expense, net | | 38.1 | | | 33.8 | | | 74.3 | | | 71.2 | |
Other (income) expense, net | | 11.2 | | | 13.1 | | | 22.8 | | | 18.6 | |
Income before income taxes | | $ | 334.0 | | | $ | 363.2 | | | $ | 669.1 | | | $ | 759.2 | |
(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, (d) acquisition-related costs and (e) other gains or losses that are not integral to segment performance.
(2)Net losses (gains) losses on mark-to-market valuation of commodity derivative positions recognized in unallocated derivative losses (gains). See Note 13 to the Unaudited Consolidated Financial Statements.
The Hershey Company | Q2 2020 Form 10-Q | Page 40
|
| | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Nine Months Ended |
| | October 1, 2017 | | October 2, 2016 | | October 1, 2017 | | October 2, 2016 |
Net Sales: | | | | | | | | |
North America | | $ | 1,792,377 |
| | $ | 1,764,528 |
| | $ | 4,946,537 |
| | $ | 4,842,840 |
|
International and Other | | 240,744 |
| | 238,926 |
| | 629,253 |
| | 627,097 |
|
Total | | $ | 2,033,121 |
| | $ | 2,003,454 |
| | $ | 5,575,790 |
| | $ | 5,469,937 |
|
| | | | | | | | |
Segment Income (Loss): | | | | | | | | |
North America | | $ | 554,578 |
| | $ | 563,946 |
| | $ | 1,568,098 |
| | $ | 1,519,059 |
|
International and Other | | 16,400 |
| | 4,284 |
| | 26,491 |
| | (12,411 | ) |
Total segment income | | 570,978 |
| | 568,230 |
| | 1,594,589 |
| | 1,506,648 |
|
Unallocated corporate expense (1) | | 124,115 |
| | 121,828 |
| | 366,938 |
| | 370,622 |
|
Unallocated mark-to-market (gains) losses on commodity derivatives (2) | | (21,954 | ) | | 35,791 |
| | (27,486 | ) | | 30,851 |
|
Long-lived asset impairment charges | | — |
| | — |
| | 208,712 |
| | — |
|
Costs associated with business realignment activities | | 8,257 |
| | 27,962 |
| | 69,699 |
| | 104,487 |
|
Non-service related pension expense | | 21,540 |
| | 6,360 |
| | 30,123 |
| | 20,666 |
|
Acquisition and integration costs | | — |
| | 2,265 |
| | 311 |
| | 3,727 |
|
Operating profit | | 439,020 |
| | 374,024 |
| | 946,292 |
| | 976,295 |
|
Interest expense, net | | 24,589 |
| | 24,387 |
| | 72,456 |
| | 66,730 |
|
Other (income) expense, net | | 13,630 |
| | 21,800 |
| | 23,557 |
| | 8,703 |
|
Income before income taxes | | $ | 400,801 |
| | $ | 327,837 |
| | $ | 850,279 |
| | $ | 900,862 |
|
| |
(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) | Net (gains) losses on mark-to-market valuation of commodity derivative positions recognized in unallocated derivative (gains) losses. See Note 11 to the Consolidated Financial Statements. |
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 results, which accounted for 88.2%92.8% and 88.1%88.7% of our net sales for the three months ended October 1, 2017June 28, 2020 and October 2, 2016, respectively. North America results for the three and nine months ended October 1, 2017 and October 2, 2016June 30, 2019, respectively, were as follows: | | | | Three Months Ended | | Percent | | Nine Months Ended | | Percent | | Three Months Ended | | | Percent | | Six Months Ended | | | Percent |
| | October 1, 2017 | | October 2, 2016 | | Change | | October 1, 2017 | | October 2, 2016 | | Change | | June 28, 2020 | | June 30, 2019 | | Change | | June 28, 2020 | | June 30, 2019 | | Change |
In millions of dollars | | | | | | | | | | | | | In millions of dollars | | | | | | | | | | | | |
Net sales | | $ | 1,792.4 |
| | $ | 1,764.5 |
| | 1.6 | % | | $ | 4,946.5 |
| | $ | 4,842.8 |
| | 2.1 | % | Net sales | | $ | 1,583.8 | | | $ | 1,568.0 | | | 1.0 | % | | $ | 3,428.6 | | | $ | 3,375.0 | | | 1.6 | % |
Segment income | | 554.6 |
| | 563.9 |
| | (1.7 | )% | | 1,568.1 |
| | 1,519.1 |
| | 3.2 | % | Segment income | | 497.6 | | | 470.9 | | | 5.7 | % | | 1,079.1 | | | 1,035.7 | | | 4.2 | % |
Segment margin | | 30.9 | % | | 32.0 | % | | | | 31.7 | % | | 31.4 | % | | | Segment margin | | 31.4 | % | | 30.0 | % | | 31.5 | % | | 30.7 | % | |
Results of Operations - ThirdSecond Quarter 20172020 vs. ThirdSecond Quarter 20162019
Net sales of our North America segment increased $27.9$15.8 million or 1.6%1.0% in 2017the second quarter of 2020 compared to 2016, driven by increased volumethe same period of 1.6% due to core brand growth and innovation, specifically, Hershey's Cookie Layer Crunch, and the launch of Hershey's and Reese's Popped Snack Mix and Chocolate Dipped Pretzels. Net2019, reflecting favorable price realization decreased by 0.3% dueof 4.2% attributed to increasedhigher prices on certain products and decreased levels of trade promotional spending. Excludingspending compared to prior year, as well as a 0.8% benefit from net acquisitions and divestitures (predominantly driven by the favorable impact2019 acquisition of ONE Brands, partially offset by the 2020 divestitures of Krave and the Scharffen Berger and Dagoba brands). These increases were partially offset by a volume decrease of 3.8%, which was primarily elasticity-driven due to the aforementioned price increases and COVID-19 related impacts to the business, as well as unfavorable foreign currency exchange rates of 0.3%, the net sales of our North America segment increased by approximately 1.3%0.2%.
Our North America segment income decreased $9.3increased $26.7 million or 1.7%5.7% in 2017the second quarter of 2020 compared to 2016, driventhe same period of 2019, primarily due to favorable price realization, lower trade promotional spending and lower advertising and related consumer marketing expenses as a result of COVID-19, partially offset by investments in greater levels of advertising expensehigher supply chain-related costs, specifically, PPE costs, increased sanitation and go-to-market capabilities,wage incentives associated with COVID-19, as well as unfavorable manufacturing variances and higher freight and warehousing costs.volume decreases.
Results of Operations - First NineSix Months 20172020 vs. First NineSix Months 20162019
Net sales of our North America segment increased $103.7$53.6 million or 2.1%1.6% in 2017the first six months of 2020 compared to 2016,the same period of 2019, reflecting favorable price realization of 3.5% attributed to higher prices on certain products and a 0.9% benefit from net acquisitions and divestitures (predominantly driven by increasedthe 2019 acquisition of ONE Brands, partially offset by the 2020 divestitures of Krave and the Scharffen Berger and Dagoba brands). These increases were partially offset by a volume decrease of 1.3%2.7%, which was primarily elasticity-driven due to core brand growth throughout 2017the aforementioned price increases and innovation, specifically, new product launches. Additionally,COVID-19 related impacts to the barkTHINS brand acquisition contributed 0.4%. Net price realization increased by 0.4% due to decreased levels of trade promotional spending. There was nobusiness, as well as unfavorable foreign currency exchange rate impact during the period.rates of 0.1%.
Our North America segment income increased $49.0$43.4 million or 3.2%4.2% in 2017the first six months of 2020 compared to 2016, driven by higher gross profit,the same period of 2019, primarily due to favorable price realization, lower trade promotional spending and lower advertising and related consumer marketing expenses as a result of COVID-19, partially offset by investments in greater levels of selling expensehigher supply chain-related costs, specifically, PPE costs, increased sanitation and go-to-market capabilities and increased depreciation and amortization resulting from the recent barkTHINS brand acquisition.wage incentives associated with COVID-19, as well as volume decreases.
The Hershey Company | Q2 2020 Form 10-Q | Page 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 results, which accounted for 11.8%7.2% and 11.9%11.3% of our net sales for the three months ended October 1, 2017June 28, 2020 and October 2, 2016, respectively. International and Other results for the three and nine months ended October 1, 2017 and October 2, 2016June 30, 2019, respectively, were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | | | Percent | | Six Months Ended | | | | Percent |
| | June 28, 2020 | | June 30, 2019 | | Change | | June 28, 2020 | | June 30, 2019 | | Change |
In millions of dollars | | | | | | | | | | | | |
Net sales | | $ | 123.5 | | | $ | 199.2 | | | (38.0) | % | | $ | 316.0 | | | $ | 408.7 | | | (22.7) | % |
Segment (loss) income | | (4.0) | | | 21.9 | | | (118.3) | % | | 12.0 | | | 42.2 | | | (71.6) | % |
Segment margin | | (3.2) | % | | 11.0 | % | | | | 3.8 | % | | 10.3 | % | | |
|
| | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Percent | | Nine Months Ended | | Percent |
| | October 1, 2017 | | October 2, 2016 | | Change | | October 1, 2017 | | October 2, 2016 | | Change |
In millions of dollars | | | | | | | | | | | | |
Net sales | | $ | 240.7 |
| | $ | 238.9 |
| | 0.8 | % | | $ | 629.3 |
| | $ | 627.1 |
| | 0.3 | % |
Segment income (loss) | | 16.4 |
| | 4.3 |
| | 282.8 | % | | 26.5 |
| | (12.4 | ) | | NM |
|
Segment margin | | 6.8 | % | | 1.8 | % | | | | 4.2 | % | | (2.0 | )% | | |
Results of Operations - ThirdSecond Quarter 20172020 vs. ThirdSecond Quarter 20162019
Net sales of our International and Other segment increased $1.8decreased $75.7 million or 0.8%38.0% in 2017the second quarter of 2020 compared to 2016,the same period of 2019, reflecting favorable price realizationa volume decrease of 4.7% and a favorable31.3%, an unfavorable impact from foreign currency exchange rates of 1.3%4.6%, partially offsetand unfavorable price realization of 2.1%. The volume decrease was attributed to significant sales declines in our strategic focus markets, most notably Mexico, where net sales declined by volume declines54.5%, as well as reduced sales in our export markets, due to the implementation of 5.2%. Excludingquarantine protocols by local governments to mitigate the favorable impactspread of foreign currency exchange rates,COVID-19.
Our International and Other segment also includes licensing, owned retail and world travel retail, where net sales declined approximately 51.0% during the second quarter of 2020 as the Company temporarily closed all Hershey’s Chocolate World stores in the United States (3 locations), Niagara Falls (Ontario) and Singapore in March amid the COVID-19 pandemic. In June, the Company re-opened Hershey’s Chocolate World stores in the United States and Niagara Falls (Ontario) on a limited capacity basis with increased safety measures and enforced social distancing. The Company's Chocolate World store in Singapore remains temporarily closed.
Our International and Other segment generated losses of $4.0 million in the second quarter of 2020 compared to income of $21.9 million in the second quarter of 2019. This decrease was driven by the lower level of net sales associated with the COVID-19 disruption.
Results of Operations - First Six Months 2020 vs. First Six Months 2019
Net sales of our International and Other segment decreased by approximately 0.5%.
The favorable net$92.7 million or 22.7% in the first six months of 2020 compared to the same period of 2019, reflecting a volume decrease of 19.0%, an unfavorable impact from foreign currency exchange rates of 3.4%, and unfavorable price realization of 0.3%. The volume decrease was drivenattributed to significant sales declines in our strategic focus markets, most notably China and Mexico, where net sales declined by higher prices in select markets,41.4% and 26.4%, respectively, as well as reduced levels of trade promotional spending, which declined significantly comparedsales in our export markets, due to the prior year. Constant currencyimplementation of quarantine protocols by local governments to mitigate the spread of COVID-19.
Our International and Other segment also includes licensing, owned retail and world travel retail, where net sales in Mexico and Brazil increased by 9.6% and 3.3%, respectively, driven by solid chocolate marketplace performance. India also experienced constant currency net sales growthdeclined approximately 31.5% during the first six months of 16.0%. The volume decrease is primarily attributed to our China business, driven by softness2020 as the Company temporarily closed all Hershey’s Chocolate World stores in the modern trade channel coupledUnited States (3 locations), Niagara Falls (Ontario) and Singapore in March amid the COVID-19 pandemic. In June, the Company re-opened Hershey’s Chocolate World stores in the United States and Niagara Falls (Ontario) on a limited capacity basis with a focus on optimizing our product offerings.increased safety measures and enforced social distancing. The Company's Chocolate World store in Singapore remains temporarily closed.
The Hershey Company | Q2 2020 Form 10-Q | Page 42
Our International and Other segment generated income of $16.4$12.0 million in 2017the first six months of 2020 compared to $4.3$42.2 million in 2016, driven by reduced trade promotional spending and lower operating expenses in China as a resultthe first six months of our Margin for Growth Program.
Results of Operations - First Nine Months 2017 vs. First Nine Months 2016
Net sales of our International and Other segment increased $2.2 million or 0.3% in 2017 compared to 2016, reflecting favorable price realization of 3.8%, favorable impact from foreign currency exchange rates of 0.3%, partially offset by volume declines of 3.8%. Excluding the favorable impact of foreign currency exchange rates, the net sales of our International and Other segment were flat.
The favorable net price realization2019. This decrease was driven by reduced levelsthe lower level of trade promotional spending, which declined significantly compared to the prior year, as well as higher prices in select markets. Constant currency net sales in Mexico and Brazil increased by 13.1% and 7.7%, respectively, driven by solid chocolate marketplace performance. India also experienced constant currency net sales growth of 10.9%. The volume decrease is primarily attributed to our China business, driven by softness inassociated with the modern trade channel coupled with a focus on optimizing our product offerings.
Our International and Other segment generated income of $26.5 million in 2017 compared to a loss of $12.4 million in 2016 due to improved combined income in Latin America and export markets versus the prior year. Additionally, segment income benefited from reduced trade promotional spending and lower operating expenses in China as a result of our Margin for Growth Program.
COVID-19 disruption.
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 thirdsecond quarter of 2017,2020, unallocated corporate expense totaled $124.1$106.9 million, as compared to $121.8$125.2 million in the same periodsecond quarter of 2016,2019, primarily duedriven by savings in travel and meeting expenses related to higher employee related costs.COVID-19 travel restrictions and lower incentive compensation. In the first ninesix months of 2017,2020, unallocated corporate expense totaled $366.9$231.4 million, as compared to $370.6$242.9 million in the same periodfirst six months of 2016,2019 primarily duedriven by savings in travel and meeting expenses related to savings realized in 2017 from our productivity and cost savings initiatives.COVID-19 travel restrictions.
Liquidity and Capital ResourcesThe Hershey Company | Q2 2020 Form 10-Q | Page 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 October 1, 2017,June 28, 2020, our cash and cash equivalents totaled $275.1 million.$1.2 billion. At December 31, 2016,2019, our cash and cash equivalents totaled $297.0$493.3 million. Our cash and cash equivalents during the first ninesix months of 2017 declined $21.92020 increased $672.1 million compared to the 20162019 year-end balancebalance. This increase was predominantly due to our $1 billion Notes issuance in May 2020 as a resultwe intend to mitigate any potential COVID-19 risks, partially offset by the repayment of $350 million Notes that matured in May 2020. Additional detail regarding the net usessources of cash are outlined in the following discussion.
Approximately 80%30% of the balance of our cash and cash equivalents at October 1, 2017June 28, 2020 was held by subsidiaries domiciled outside of the United States. If these amounts held outsideDuring the first six months of 2020, previously undistributed earnings of certain international subsidiaries were no longer considered indefinitely reinvested; however, the Company had previously recognized a one-time U.S. repatriation tax due under U.S. tax reform, and as a result, only an immaterial amount of withholding tax was recognized. For the remainder of the United States wereCompany’s cash held by international subsidiaries, we intend to be repatriated, under current law they would be subjectcontinue 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.undistributed earnings indefinitely. 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 StatementStatements of Cash Flows:
| | | | Nine Months Ended | | Six Months Ended | |
In millions of dollars | | October 1, 2017 | | October 2, 2016 | In millions of dollars | | June 28, 2020 | | June 30, 2019 | |
Net cash provided by (used in): | | | | | Net cash provided by (used in): | | | |
Operating activities | | $ | 625.9 |
| | $ | 450.8 |
| Operating activities | | $ | 614.0 | | | $ | 679.3 | | |
Investing activities | | (187.1 | ) | | (486.0 | ) | Investing activities | | (209.8) | | | (206.4) | | |
Financing activities | | (465.7 | ) | | 21.5 |
| Financing activities | | 295.9 | | | (698.7) | | |
Effect of exchange rate changes on cash and cash equivalents | | 5.0 |
| | 0.5 |
| Effect of exchange rate changes on cash and cash equivalents | | (17.3) | | | 3.8 | | |
Decrease in cash and cash equivalents | | $ | (21.9 | ) | | $ | (13.2 | ) | |
Less: Cash classified as assets held for sale (see Note 8) | | Less: Cash classified as assets held for sale (see Note 8) | | (10.7) | | | — | | |
Increase (decrease) in cash and cash equivalents | | Increase (decrease) in cash and cash equivalents | | $ | 672.1 | | | $ | (222.0) | | |
Operating activities
We generated net cash of $614.0 million from operating activities of $625.9 million in the first ninesix months of 2017, an increase2020, a decrease of $175.1$65.3 million compared to $450.8$679.3 million in the same period of 2016.2019. This increasedecrease in net cash fromprovided by operating activities was mainly driven by the following factors:
•Net income adjusted for non-cash charges to operations (including depreciation, amortization, stock-based compensation, deferred income taxes, long-lived asset impairment charges, a write-down of equity investments the gain on settlement of the SGM liability and other charges) resulted in an incremental $160.4$69.5 million of lower cash flow in the 2017 period2020 relative to the same period of 2016.2019.
Working•Net working capital (comprised of trade accounts receivable, inventory, accounts payable and accrued liabilities) usedconsumed cash of $369.3$201.9 million in 2020 and $151.5 million in 2019. This $50.4 million fluctuation was mainly driven by the 2017 periodfollowing factor:
◦$43.6 million decrease in cash provided by accounts receivable, primarily driven by a decrease in shorter term sales as well as timing of customer payments, resulting in a slightly higher investment in accounts receivable at the end of the second quarter of 2020 compared to $367.3 million during the same period of 2016. This $2.02019.
•$24.2 million unfavorable fluctuation was mainlyincrease in cash used by other assets and liabilities, primarily driven by: by the effect of commodity derivative activity in 2020 relative to 2019.
| |
◦ | Increase in cash used by inventories of $109.3 million, due to a higher year-over-year build up of U.S. inventories to satisfy seasonal product requirements and maintain sufficient levels to accommodate customer requirements, coupled with a higher investment in inventory in Brazil and Mexico, driven by volume growth in those markets. |
The Hershey Company | Q2 2020 Form 10-Q | Page 44
•The decrease in working capitalcash provided by operating activities was partially offset by the following net cash inflow:
| |
◦ | Reduction in cash used by accounts payable and accrued liabilities of $111.6 million, due to the timing of payments for trade-related and other accounts payables, as well as an increase in our liability for business realignment activities (see Note 7 to the Consolidated Financial Statements for more information). Additionally, derivative activity in 2016 included an $87 million payment to settle an interest rate swap in connection with the issuance of new debt in August 2016. |
Investing activities
We used net◦Incomes taxes generated cash for investing activities of $187.1$65.2 million in the first nine months of 2017, a decrease of $298.9 million2020, compared to $486.0cash used of $15.5 million in 2019. This $80.7 million fluctuation was primarily due to the deferral of quarterly estimated tax payments in 2020 as a result of the CARES Act. We paid income taxes of $71.6 million during 2020 compared to $136.9 million in the same period of 2016.2019.
Investing activities
We used cash of $209.8 million for investing activities in the first six months of 2020, an increase of $3.4 million compared to $206.4 million in the same period of 2019. This decreaseincrease in net cash used in investing activities was mainly driven by the following factors:
•Capital spending. We spent $19.3 million less for property, plant and equipment,Capital expenditures, including capitalized software, duringprimarily to support capacity expansion, innovation and cost savings, were $185.8 million in the first ninesix months of 20172020 compared to $176.3 million in the same period of 2016.2019. For the full year 2017,2020, we expect capital expenditures, including capitalized software, to approximate $260$400 million to $275 million.
$450 million, as we continue to evaluate and re-prioritize our capital projects amid the COVID-19 pandemic.•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 $4.6 million more in projects qualifying for tax credits during the first nine 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 $465.7$26.4 million in the first ninesix months of 2017,2020, compared to net cash generated of $21.5$30.3 million in the same period of 2016.2019.
Financing activities
We generated cash of $295.9 million from financing activities in the first six months of 2020, an increase of $994.6 million compared to cash used of $698.7 million in the same period of 2019. This $487.2 million incremental changeincrease in net cash forprovided by 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 ninesix months of 2017,2020, we generated cash flow of $173$166.0 million primarily from proceeds onpredominantly through the issuance of short-term commercial paper, issuances. During the first nine months of 2016, we generated cash flow of $345 million from proceeds on short-term commercial paper issuances, partially offset by a $97 million reductionas well as an increase in short-term foreign bank borrowings.
During the first six months of 2019, we had a net reduction in short-term borrowings of $311.2 million primarily due to repayments on commercial paper, partially offset by increases in short-term foreign borrowings.
•Long-term debt borrowings and repayments. We had no long-term issuance or repayment activity during the first nine months of 2017. During the first ninesix months of 2016, we used $250 million to repay long-term debt. Additionally, in 2016,2020, we issued $500$300 million of 2.30%0.900% Notes due in 2026 and $3002025, $350 million of 3.375%1.700% Notes due in 2046.
Share repurchases2030 and $350 million of 2.650% Notes due in 2050 (the "2020 Notes"). We used cash for total share repurchasesProceeds from the issuance of $300.3the 2020 Notes, net of discounts and issuance costs, totaled $989.9 million. Additionally, in May 2020, we repaid $350 million duringof 2.900% Notes due upon their maturity. During the first ninesix months of 2017 pursuant to2019, our practice of replenishing shares issued for stock optionslong-term debt borrowings and incentive compensation. Additionally, our 2017 share repurchases included a privately negotiated repurchase transaction with the Milton Hershey School Trust. We used cash for total share repurchases of $452.6 million during the first nine months of 2016, which included shares repurchased in the open market under pre-approved share repurchase programs. In October 2017, our Board of Directors approved an additional $100 million share repurchase authorization, to commence after the existing 2016 authorization is completed.
repayments activity was minimal.•Dividend payments. Total dividend payments to holders of our Common Stock and Class B Common Stock were $391.8$314.3 million during the first ninesix months of 2017,2020, an increase of $20.1$18.8 million compared to $371.7$295.5 million in the same period of 2016.2019. Details regarding our 2020 cash dividends paid to stockholders are as follows:
| | | | | | | | | | | | | | |
| | Quarter Ended | | |
In millions of dollars except per share amounts | | March 29, 2020 | | June 28, 2020 |
Dividends paid per share – Common stock | | $ | 0.773 | | | $ | 0.773 | |
Dividends paid per share – Class B common stock | | $ | 0.702 | | | $ | 0.702 | |
Total cash dividends paid | | $ | 157.8 | | | $ | 156.5 | |
Declaration date | | January 28, 2020 | | April 21, 2020 |
Record date | | February 21, 2020 | | May 22, 2020 |
Payment date | | March 16, 2020 | | June 15, 2020 |
The Hershey Company | Q2 2020 Form 10-Q | Page 45
•Share repurchases. We used cash for total share repurchases of $211.2 million and $254.4 million during the first six months of 2020 and 2019, respectively, pursuant to our practice of replenishing shares issued for stock options and incentive compensation, as well as shares repurchased in the open market under pre-approved share repurchase programs.
•Proceeds from the exercise of stock options. options, including tax benefits. We received $53.5$17.5 million from employee exercises of stock options, net of payments of employee taxes withheld from share-based awards, during the first ninesix months of 2017,2020, a decrease of $34.6$143.9 million compared to $88.1$161.4 million in the same period of 2016.
2019.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.
The Hershey Company | Q2 2020 Form 10-Q | Page 46
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•Our Company’s reputation or brand image might be impacted as a result of issues or concerns relatedrelating to the quality and safety of our products, ingredients or packaging, human and workplace rights, and other environmental, social or governance matters, which in turn could cause a product recall and/or result in harm to the Company's reputation, negatively impactingimpact 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;
•Complications with the design or implementation of our new enterprise resource planning system could adversely impact our business and operations;
•Our business and financial results may be negatively impacted by the failure to successfully manage a disruption in consumer and trade patterns, as well as operational challenges associated with the actual or perceived effects of a disease outbreak, including epidemics, pandemics or similar widespread public health concerns, such as the current COVID-19 global pandemic; and
The Hershey Company | Q2 2020 Form 10-Q | Page 47
•Such other matters as discussed in our 20162019 Annual Report on Form 10-K.10-K, our Quarterly Report on Form 10-Q for the quarterly period ended March 29, 2020, and our Current Report on Form 8-K filed May 27, 2020.
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.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.RISK
The total notional amount of interest rate swaps outstanding was $350 million at October 1, 2017June 28, 2020 and December 31, 2016.2019 was $350 million. 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 October 1, 2017June 28, 2020 and December 31, 2016.2019. A hypothetical 100 basis point increase in interest rates applied to this now variable ratevariable-rate debt as of October 1, 2017June 28, 2020 would have increased interest expense by approximately $2.7$1.8 million for the first ninesix months of 20172020 and $3.6$3.5 million for the full year 2016.2019.
In addition, the total amount of short-term debt, net of cash, amounted to net cash positions of $257 million and $461 million, respectively, at June 28, 2020 and December 31, 2019. A hypothetical 100 basis point increase in interest rates applied to this variable-rate short-term debt as of June 28, 2020 would have changed interest expense by approximately $3.1 million for the first six months of 2020 and $4.3 million for the full year 2019.
We consider our current risk related to market fluctuations in interest rates on our remaining debt portfolio, excluding fixed-rate debt converted to variable rates 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 October 1, 2017June 28, 2020 and December 31, 20162019 by approximately $137$365 million and $142$246 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 $17.6$24.3 million as of October 1, 2017June 28, 2020 and $9.6$55.4 million as of December 31, 2016. 2019, generally offset by a reduction in foreign exchange associated with our transactional activities.
Our open commodity derivative contracts had a notional value assuming period-end market prices, of $408.9$817.5 million as of October 1, 2017June 28, 2020 and $739.4$589.7 million as of December 31, 2016.2019. At the end of the thirdsecond quarter of 2017,2020, 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 $40.9$74.8 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 20162019 Annual Report on Form 10-K.
The Hershey Company | Q2 2020 Form 10-Q | Page 48
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 October 1, 2017.June 28, 2020. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of October 1, 2017.June 28, 2020.
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, which 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 implementation is expected to occur in phases over the next several years. We have completed the implementation of certain processes, including our consolidated financial reporting platform in the second quarter of 2018, as well as our trade promotions and direct marketing systems in the first quarter of 2019. These transitions did not result in significant changes in our internal control over financial reporting. However, as the next phases of the updated processes are rolled out in connection with the ERP implementation, we will give appropriate consideration to whether these process changes necessitate changes in the design of and testing for effectiveness of internal controls over financial reporting.
There have been no changes in our internal control over financial reporting during the quarter ended October 1, 2017June 28, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The Hershey Company | Q2 2020 Form 10-Q | Page 49
PART II — OTHER INFORMATION
Item 1. Legal Proceedings.
Information on legal proceedings is included in Note 1416to 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 20162019 Annual Report on Form 10-K, the risk factor previously disclosed in Part II, Item 1A, "Risk“Risk Factors,"” of our Quarterly Report on Form 10-Q for the quarterquarterly period ended July 2, 2017,March 29, 2020 (the “Q2 2020 Quarterly Report”), Item 8.01 of our Current Report on Form 8-K filed May 27, 2020 and the information contained in this Quarterly Report on Form 10-Q and our other reports and registration statements filed with the SEC. ThereExcept as described in our Q2 2020 Quarterly Report and our Current Report on Form 8-K filed on May 27, 2020, there have been no material changes with respect to the risk factors disclosed in our risk factors since the filing of our Quarterly2019 Annual Report on Form 10-Q for the quarter ended July 2, 2017.10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases of Equity Securities
The 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 October 1, 2017:June 28, 2020:
|
| | | | | | | | | | | | | | |
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) |
July 3 through July 30 | | — |
| | $ | — |
| | — |
| | $ | 100,000 |
|
July 31 through August 27 | | 392,000 |
| | $ | 105.37 |
| | — |
| | $ | 100,000 |
|
August 28 through October 1 | | 1,500,000 |
| | $ | 106.01 |
| | — |
| | $ | 100,000 |
|
Total | | 1,892,000 |
| | $ | 105.88 |
| | — |
| | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
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) |
March 30 through April 26 | | 285,000 | | | $ | 140.15 | | | — | | | $ | 260,000 | |
April 27 through May 24 | | 15,000 | | | $ | 138.38 | | | — | | | $ | 260,000 | |
May 25 through June 28 | | — | | | $ | — | | | — | | | $ | 260,000 | |
Total | | 300,000 | | | $ | 140.07 | | | — | | | |
(1) During the three months ended October 1, 2017, 392,000June 28, 2020, 300,000 shares of Common Stock were purchased in open market transactions in connection with our practice of buying back shares sufficient to offset those issued under incentive compensation plans. Additionally, our 2017 share repurchases included 1,500,000 shares repurchased under a privately negotiated repurchase transaction with the Milton Hershey School Trust.
(2) In January 2016,July 2018, our Board of Directors approved a $500 million share repurchase authorization. As of October 1, 2017,June 28, 2020, approximately $100$260 million remained available for repurchases of our Common Stock under this program. In October 2017, our Board of Directors approved an additional $100 millionThe share repurchase authorization (excluded from the table above), to commence after the existing 2016 authorization is completed. Neither the 2016 or 2017 share repurchase authorizations hasprogram does not have an expiration date.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Not applicable.
The Hershey Company | Q2 2020 Form 10-Q | Page 50
Item 6. Exhibits.
The following exhibits are filed as part of this Quarterly Report on Form 10-Q:
|
| | | | | | | |
Exhibit Number | | Description |
| | |
| | |
| | |
| | |
| | |
| | - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. |
| | |
| | |
| | |
| | |
| | |
104 | | The cover page from the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 28, 2020, formatted in Inline XBRL and contained in Exhibit 101. |
* | | |
* | | Filed herewith |
** | | Furnished herewith |
| | |
SIGNATURES
The Hershey Company | Q2 2020 Form 10-Q | Page 51
SIGNATURE
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 23, 2020 | | THE HERSHEY COMPANY | |
| | | (Registrant) | |
| | | | |
Date: | October 27, 2017 | | /s/ Patricia A. LittleSteven E. Voskuil | |
| | | Patricia A. LittleSteven E. Voskuil | |
| | | Senior Vice President, Chief Financial Officer and Chief Accounting Officer | |
| | | (Principal Financial Officer) | |
| | | | |
Date: | October 27, 2017 | | /s/ Javier H. Idrovo | |
| | | Javier H. Idrovo | |
| | | Chief Accounting Officer | |
| | | (Principaland Accounting Officer) | |
51
The Hershey Company | Q2 2020 Form 10-Q | Page 52