10-Q 1 a2018_formx10-qq3.htm THE HERSHEY COMPANY FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018 Document



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 September 30, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period
from ______to_______

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

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

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

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

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

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

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.
Common Stock, one dollar par value—149,188,011 shares, as of October 19, 2018.
Class B Common Stock, one dollar par value—60,619,777 shares, as of October 19, 2018.






THE HERSHEY COMPANY
Quarterly Report on Form 10-Q
For the Period Ended September 30, 2018

TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





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
 
Nine Months Ended
 
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Net sales
 
$
2,079,593

 
$
2,033,121

 
$
5,803,167

 
$
5,575,790

Cost of sales
 
1,216,100

 
1,090,185

 
3,172,194

 
2,957,655

Gross profit
 
863,493

 
942,936

 
2,630,973

 
2,618,135

Selling, marketing and administrative expense
 
453,921

 
477,452

 
1,388,793

 
1,380,212

Long-lived asset impairment charges
 
1,649

 

 
28,817

 
208,712

Business realignment costs
 
1,660

 
4,020

 
10,864

 
50,018

Operating profit
 
406,263

 
461,464

 
1,202,499

 
979,193

Interest expense, net
 
36,916

 
24,589

 
101,207

 
72,456

Other (income) expense, net
 
12,493

 
36,074

 
35,201

 
56,458

Income before income taxes
 
356,854

 
400,801

 
1,066,091

 
850,279

Provision for income taxes
 
91,441

 
126,788

 
226,640

 
275,291

Net income including noncontrolling interest
 
265,413

 
274,013

 
839,451

 
574,988

Less: Net income (loss) attributable to noncontrolling interest
 
1,700

 
710

 
(1,320
)
 
(26,860
)
Net income attributable to The Hershey Company
 
$
263,713

 
$
273,303

 
$
840,771

 
$
601,848

 
 
 
 
 
 
 
 
 
Net income per share—basic:
 
 
 
 
 
 
 
 
Common stock
 
$
1.29

 
$
1.32

 
$
4.11

 
$
2.91

Class B common stock
 
$
1.17

 
$
1.20

 
$
3.74

 
$
2.64

 
 
 
 
 
 
 
 
 
Net income per share—diluted:
 
 
 
 
 
 
 
 
Common stock
 
$
1.25

 
$
1.28

 
$
3.99

 
$
2.81

Class B common stock
 
$
1.17

 
$
1.20

 
$
3.73

 
$
2.64

 
 
 
 
 
 
 
 
 
Dividends paid per share:
 
 
 
 
 
 
 
 
Common stock
 
$
0.722

 
$
0.656

 
$
2.034

 
$
1.892

Class B common stock
 
$
0.656

 
$
0.596

 
$
1.848

 
$
1.720


See Notes to Unaudited Consolidated Financial Statements.


1



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

 
 
For the three months ended
 
For the nine months ended
 
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
 
 
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
 
 
 
 
 
$
265,413

 
 
 
 
 
$
274,013

 
 
 
 
 
$
839,451

 
 
 
 
 
$
574,988

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation gains (losses) during period
 
$
5,365

 
$

 
5,365

 
$
9,605

 
$

 
9,605

 
$
(18,314
)
 
$

 
(18,314
)
 
$
27,878

 
$

 
27,878

Reclassification to earnings due to the sale of businesses
 
25,131

 

 
25,131

 

 

 

 
25,131

 

 
25,131

 

 

 

Pension and post-retirement benefit plans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net actuarial gain (loss) and prior service cost
 
(7,574
)
 
1,871

 
(5,703
)
 
(9,200
)
 
3,487

 
(5,713
)
 
(7,574
)
 
1,871

 
(5,703
)
 
(9,396
)
 
3,561

 
(5,835
)
Reclassification of tax effects relating to U.S. tax reform
 

 

 

 

 

 

 

 
(36,535
)
 
(36,535
)
 

 

 

Reclassification to earnings
 
12,082

 
(3,170
)
 
8,912

 
24,300

 
(8,941
)
 
15,359

 
22,273

 
(5,302
)
 
16,971

 
38,544

 
(22,636
)
 
15,908

Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on cash flow hedging derivatives
 
(1,484
)
 
1,207

 
(277
)
 
(1,339
)
 
761

 
(578
)
 
6,320

 
(256
)
 
6,064

 
(3,545
)
 
1,643

 
(1,902
)
Reclassification of tax effects relating to U.S. tax reform
 

 

 

 

 

 

 

 
(11,121
)
 
(11,121
)
 

 

 

Reclassification to earnings
 
(2,261
)
 
(479
)
 
(2,740
)
 
1,962

 
(1,380
)
 
582

 
2,462

 
(1,674
)
 
788

 
7,374

 
(3,827
)
 
3,547

Total other comprehensive income (loss), net of tax
 
$
31,259

 
$
(571
)
 
30,688

 
$
25,328

 
$
(6,073
)
 
19,255

 
$
30,298

 
$
(53,017
)
 
(22,719
)
 
$
60,855

 
$
(21,259
)
 
39,596

Total comprehensive income including noncontrolling interest
 
 
 
 
 
$
296,101

 
 
 
 
 
$
293,268

 
 
 
 
 
$
816,732

 
 
 
 
 
$
614,584

Comprehensive income (loss) attributable to noncontrolling interest
 
 
 
 
 
497

 
 
 
 
 
1,029

 
 
 
 
 
(1,857
)
 
 
 
 
 
(26,125
)
Comprehensive income attributable to The Hershey Company
 
 
 
 
 
$
295,604

 
 
 
 
 
$
292,239

 
 
 
 
 
$
818,589

 
 
 
 
 
$
640,709


See Notes to Unaudited Consolidated Financial Statements.


2



THE HERSHEY COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
September 30, 2018
 
December 31, 2017
ASSETS
 
(unaudited)
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
823,787

 
$
380,179

Accounts receivable—trade, net
 
814,923

 
588,262

Inventories
 
880,673

 
752,836

Prepaid expenses and other
 
274,663

 
280,633

Total current assets
 
2,794,046

 
2,001,910

Property, plant and equipment, net
 
2,092,899

 
2,106,697

Goodwill
 
1,677,101

 
821,061

Other intangibles
 
1,008,051

 
369,156

Other assets
 
261,248

 
251,879

Deferred income taxes
 
2,844

 
3,023

Total assets
 
$
7,836,189

 
$
5,553,726

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
581,481

 
$
523,229

Accrued liabilities
 
663,974

 
676,134

Accrued income taxes
 
61,030

 
17,723

Short-term debt
 
1,449,226

 
559,359

Current portion of long-term debt
 
3,115

 
300,098

Total current liabilities
 
2,758,826

 
2,076,543

Long-term debt
 
3,253,879

 
2,061,023

Other long-term liabilities
 
429,232

 
438,939

Deferred income taxes
 
144,980

 
45,656

Total liabilities
 
6,586,917

 
4,622,161

 
 
 
 
 
Stockholders’ equity:
 
 
 
 
The Hershey Company stockholders’ equity
 
 
 
 
Preferred stock, shares issued: none at September 30, 2018 and December 31, 2017
 

 

Common stock, shares issued: 299,281,967 at September 30, 2018, 2018 and December 31, 2017
 
299,281

 
299,281

Class B common stock, shares issued: 60,619,777 at September 30, 2018 and December 31, 2017
 
60,620

 
60,620

Additional paid-in capital
 
957,759

 
924,978

Retained earnings
 
6,843,057

 
6,371,082

Treasury—common stock shares, at cost: 150,181,170 at September 30, 2018 and 149,040,927 at December 31, 2017
 
(6,589,861
)
 
(6,426,877
)
Accumulated other comprehensive loss
 
(335,954
)
 
(313,746
)
Total—The Hershey Company stockholders’ equity
 
1,234,902

 
915,338

Noncontrolling interest in subsidiary
 
14,370

 
16,227

Total stockholders’ equity
 
1,249,272

 
931,565

Total liabilities and stockholders’ equity
 
$
7,836,189

 
$
5,553,726


See Notes to Unaudited Consolidated Financial Statements.


3



THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Nine Months Ended
 
September 30, 2018
 
October 1, 2017
Operating Activities
 
 
 
Net income including noncontrolling interest
$
839,451

 
$
574,988

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
225,803

 
194,313

Stock-based compensation expense
35,668

 
37,966

Deferred income taxes
1,343

 
(14,859
)
Impairment of long-lived assets (see Notes 6 and 8)
28,817

 
208,712

Write-down of equity investments
23,067

 
23,999

Other
22,433

 
60,129

Changes in assets and liabilities, net of business acquisition and divestitures:
 
 
 
Accounts receivable—trade, net
(212,193
)
 
(161,451
)
Inventories
(111,901
)
 
(192,509
)
Prepaid expenses and other current assets
(59,182
)
 
(33,581
)
Accounts payable and accrued liabilities
(1,665
)
 
(15,380
)
Accrued income taxes
125,698

 
18,849

Contributions to pension and other benefit plans
(26,705
)
 
(57,883
)
Other assets and liabilities
2,227

 
(17,394
)
Net cash provided by operating activities
892,861

 
625,899

Investing Activities
 
 
 
Capital additions (including software)
(241,214
)
 
(148,923
)
Proceeds from sales of property, plant and equipment and other long-lived assets
46,652

 
1,758

Proceeds from sales of businesses, net of cash and cash equivalents divested
171,950

 

Equity investments in tax credit qualifying partnerships
(34,170
)
 
(39,977
)
Business acquisition, net of cash and cash equivalents acquired
(915,457
)
 

Net cash used in investing activities
(972,239
)
 
(187,142
)
Financing Activities
 
 
 
Net increase in short-term debt
893,365

 
173,110

Long-term borrowings
1,199,891

 

Repayment of long-term debt
(910,851
)
 
(204
)
Repayment of tax receivable obligation
(72,000
)
 

Cash dividends paid
(415,178
)
 
(391,845
)
Repurchase of common stock
(199,665
)
 
(300,312
)
Exercise of stock options
33,454

 
53,532

Net cash provided by (used in) financing activities
529,016

 
(465,719
)
Effect of exchange rate changes on cash and cash equivalents
(6,030
)
 
5,051

Increase (decrease) in cash and cash equivalents
443,608

 
(21,911
)
Cash and cash equivalents, beginning of period
380,179

 
296,967

Cash and cash equivalents, end of period
$
823,787

 
$
275,056

Supplemental Disclosure
 
 
 
Interest paid
$
99,886

 
$
81,497

Income taxes paid
94,969

 
271,412


See Notes to Unaudited Consolidated Financial Statements.


4



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


 
Preferred
Stock
 
Common
Stock
 
Class B
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Treasury
Common
Stock
 
Accumulated Other
Comprehensive
Income (Loss)
 
Noncontrolling
Interests in
Subsidiaries
 
Total
Stockholders’
Equity
Balance, December 31, 2017
 

 
299,281

 
60,620

 
924,978

 
6,371,082

 
(6,426,877
)
 
(313,746
)
 
16,227

 
931,565

Net income (loss)
 
 
 
 
 
 
 
 
 
840,771

 
 
 
 
 
(1,320
)
 
839,451

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
25,448

 
(537
)
 
24,911

Dividends (including dividend equivalents):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock, $2.034 per share
 
 
 
 
 
 
 
 
 
(304,426
)
 
 
 
 
 
 
 
(304,426
)
Class B Common Stock, $1.848 per share
 
 
 
 
 
 
 
 
 
(112,026
)
 
 
 
 
 
 
 
(112,026
)
Stock-based compensation
 
 
 
 
 
 
 
36,008

 
 
 
 
 
 
 
 
 
36,008

Exercise of stock options and incentive-based transactions
 
 
 
 
 
 
 
(3,227
)
 
 
 
36,681

 
 
 
 
 
33,454

Repurchase of common stock
 
 
 
 
 
 
 
 
 
 
 
(199,665
)
 
 
 
 
 
(199,665
)
Reclassification of tax effects relating to U.S. tax reform
 
 
 
 
 
 
 
 
 
47,656

 
 
 
(47,656
)
 
 
 

Balance, September 30, 2018
 
$

 
$
299,281

 
$
60,620

 
$
957,759

 
$
6,843,057

 
$
(6,589,861
)
 
$
(335,954
)
 
$
14,370

 
$
1,249,272


See Notes to Unaudited Consolidated Financial Statements.


5

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



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The unaudited consolidated financial statements provided in this report include the accounts of The Hershey Company (the “Company,” “Hershey,” “we” or “us”) and our majority-owned subsidiaries and entities in which we have a controlling financial interest after the elimination of intercompany accounts and transactions. We have a controlling financial interest if we own a majority of the outstanding voting common stock and the noncontrolling shareholders do not have substantive participating rights, or we have significant control over an entity through contractual or economic interests in which we are the primary beneficiary.
The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not contain certain information and disclosures required by GAAP for comprehensive financial statements. The financial statements reflect all adjustments which are, in our opinion, necessary for a fair presentation of the results of operations, financial position, and cash flows for the indicated periods.
Operating results for the quarter ended September 30, 2018 may not be indicative of the results that may be expected for the year ending December 31, 2018 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, 2017 (our “2017 Annual Report on Form 10-K”), which provides a more complete understanding of our accounting policies, financial position, operating results and other matters.
Revenue Recognition
The majority of our revenue is derived by fulfilling customer orders for the purchase of our products, including chocolate, sweets, mints and other grocery and snack offerings. We recognize revenue at the point in time that control of the ordered product(s) is transferred to the customer, which is typically upon delivery to the customer or other customer-designated delivery point. Shipping and handling costs incurred to deliver product to the customer are recorded within cost of sales. Amounts billed and due from our customers are classified as accounts receivables on the balance sheet and require payment on a short-term basis.

Revenue is measured as the amount of consideration we expect to receive in exchange for fulfilling product orders. Sales, value add, and other taxes we collect concurrent with revenue-producing activities are excluded from revenue. Incidental items that are immaterial in the context of the contract are recognized as expense. The amount of consideration we expect to receive and revenue we recognize includes estimates of variable consideration, including costs for trade promotional programs, consumer incentives, and allowances and discounts associated with aged or potentially unsaleable products. These estimates are based upon our analysis of the programs offered, historical trends, expectations regarding customer and consumer participation, sales and payment trends and our experience with payment patterns associated with similar programs offered in the past. We review and update these estimates regularly and the impact of any adjustments are recognized in the period the adjustments are identified. The adjustments recognized in 2018 and 2017 resulting from updated estimates of revenue for prior year product sales were not significant.

We also recognize a minor amount of royalty income (less than 1% of our consolidated net sales) from sales-based licensing arrangements, pursuant to which revenue is recognized as the third-party licensee sales occur.

The majority of our products are confectionery or confectionery-based and, therefore, exhibit similar economic characteristics, such that they are based on similar ingredients and are marketed and sold through the same channels to the same customers. See Note 12 for revenues reported by geographic segment, which is consistent with how we organize and manage our operations.


6

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


Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (ASC Topic 606), which replaces numerous requirements in U.S. GAAP, including industry-specific requirements, and provides companies with a single revenue recognition model for recognizing revenue from contracts with customers. On January 1, 2018, we adopted the requirements of ASC Topic 606 and all the related amendments to all of our contracts using the modified retrospective method. Upon completing our implementation assessment of Topic ASC 606, we concluded that no adjustment was required to the opening balance of retained earnings at the date of initial application. The comparative information was not restated and continues to be reported under the accounting standards in effect for those periods. Additional disclosures required by ASC Topic 606 are presented within the aforementioned Revenue Recognition policy disclosure.
In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This ASU requires the income tax consequences of intra-entity transfers of assets other than inventory to be recognized when the intra-entity transfer occurs rather than deferring recognition of income tax consequences until the transfer was made with an outside party. We adopted the provisions of this ASU in the first quarter of 2018. Adoption of the new standard did not have a material impact on our Consolidated Financial Statements.
In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715). This ASU requires an employer to report the service cost component of net benefit cost in the same line item as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if presented, or disclosed separately. In addition, only the service cost component may be eligible for capitalization where applicable. The amendments should be applied on a retrospective basis. We adopted the provisions of this ASU in the first quarter of 2018, with retrospective adjustment to the comparative periods determined using the previously disclosed service cost and other costs from our prior year pension and other post-retirement benefit plan footnote. As a result, the following amounts were reclassified for the three and nine months ended October 1, 2017 to correspond to the current year presentation:
 
Three Months Ended
 
Nine Months Ended
 
October 1, 2017
Reclassified from:
 
 
 
Cost of sales
$
2,714

 
$
8,143

Selling, marketing and administrative expense
19,730

 
24,758

Reclassified to Other (income) expense, net
$
22,444

 
$
32,901

The adoption of this ASU had no impact on our consolidated balance sheets or statements of cash flows.
In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU permits a company to reclassify the income tax effects of the 2017 Tax Cuts and Jobs Act (“U.S. tax reform”) on items within accumulated other comprehensive income (“AOCI”) to retained earnings. We adopted the provisions of this ASU in the first quarter of 2018. We elected to reclassify the income tax effects of the 2017 U.S. tax reform from items in AOCI as of January 1, 2018 so that the tax effects of items within AOCI are reflected at the appropriate tax rate. The impact of the reclassification resulted in a $47,656 decrease to AOCI and a corresponding increase to retained earnings. This amount is considered “provisional” based on reasonable estimates as the Company continues to collect and analyze detailed information about the associated impact of items under U.S. tax reform.


7

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


Recently Issued Accounting Pronouncements Not Yet Adopted
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU will require lessees to recognize most leases on their balance sheets as lease liabilities with corresponding right-of-use (“ROU”) assets.  Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease.  We are currently in the process of evaluating our existing lease portfolio, including accumulating all of the necessary information required to properly account for the leases under the new standard.  Additionally, we are implementing new software functionality to assist in the accounting and are evaluating changes to our processes and internal controls to ensure we meet the standard’s reporting and disclosure requirements.  In July 2018, the FASB issued ASU No. 2018-11, which provides entities with an additional transition method to adopt Topic 842. Under the new transition method, an entity initially applies the new leases standard at the adoption date, versus at the beginning of the earliest period presented, and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company expects to elect this transition method at the adoption date of January 1, 2019. We expect adoption of this standard to result in a material increase in lease-related assets and liabilities on our Consolidated Balance Sheets; however, we do not expect it to have a significant impact on our Consolidated Statements of Income or Cash Flows.
In 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 2017-12 is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods, with early adoption permitted. We will adopt the provisions of this ASU in the first quarter of 2019. Adoption of the new standard is not expected to have a material impact on our Consolidated Financial Statements.
In June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718), Improvements to Nonemployee Share-Based Payment Accounting. This ASU is intended to simplify aspects of share-based compensation issued to non-employees by making the guidance consistent accounting for employee share-based compensation. ASU 2018-07 is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods, with early adoption permitted but no earlier than an entity’s adoption date of Topic 606. We will adopt the provisions of this ASU in the first quarter of 2019. Adoption of the new standard is not expected to have a material impact on our Consolidated Financial Statements.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. ASU 2018-13 is effective for annual periods beginning after December 15, 2019 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 are currently evaluating the effect that ASU 2018-13 will have on our consolidated financial statements and related disclosures.
In August 2018, the FASB issued 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. We are currently evaluating the effect that ASU 2018-14 will have on our consolidated financial statements and related disclosures.


8

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


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 are currently evaluating the effect that ASU 2018-15 will have 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.
2. BUSINESS ACQUISITION
On January 31, 2018, we completed the acquisition of all of the outstanding shares of Amplify Snack Brands, Inc. (“Amplify”), a publicly traded company based in Austin, Texas that owns several popular better-for-you snack brands such as SkinnyPop, OatmegaPaqui and Tyrrells. Amplify's anchor brand, SkinnyPop, is a market-leading ready-to-eat popcorn brand and is available in a wide range of food distribution channels in the United States. Total consideration of $968,781 included payment of $12.00 per share for Amplify's outstanding common stock (for a total of $907,766), as well as payment of Amplify's transaction related expenses, including accelerated equity compensation, consultant fees and other deal costs. The business enables us to capture more consumer snacking occasions by contributing a new portfolio of brands.
The acquisition has been accounted for as a purchase and, accordingly, Amplify's results of operations have been included within the North America segment results in our consolidated financial statements since the date of acquisition. The purchase consideration, net of cash acquired totaling $53,324, was allocated to assets acquired and liabilities assumed based on their respective fair values as follows:
Accounts receivable
$
41,152

Other current assets
35,509

Plant, property and equipment, net
71,093

Goodwill
939,388

Other intangible assets
682,000

Other non-current assets
1,049

Accounts payable
(32,394
)
Accrued liabilities
(109,565
)
Current debt
(610,836
)
Other current liabilities
(2,931
)
Non-current deferred income taxes
(93,859
)
Non-current liabilities
(5,149
)
Net assets acquired
$
915,457


In connection with the acquisition, the Company agreed to pay in full all outstanding debt owed by Amplify under its existing credit agreement as of January 31, 2018, as well as the amount due under Amplify's existing tax receivable obligation. The Company funded the acquisition and repayment of the acquired debt utilizing the proceeds from the issuance of commercial paper.

During 2018, we recorded measurement period adjustments totaling $26,865, the majority of which related to an increase in the final valuation of the assumed tax receivable obligation. The purchase price allocation has been concluded as of the end of the second quarter, except for the valuation of income tax-related liabilities, which we are still in the process of finalizing.


9

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



Goodwill is being determined as the excess of the purchase price over the fair value of the net assets acquired (including the identifiable intangible assets) and is not expected to be deductible for tax purposes. The goodwill that will result from the acquisition is attributable primarily to cost-reduction synergies as Amplify leverages Hershey's resources, expertise and capability-building.

Other intangible assets includes trademarks of $648,000 and customer relationships of $34,000. Trademarks were assigned estimated useful lives ranging from 28 to 38 years and customer relationships were assigned estimated useful lives ranging from 14 to 18 years.

We used various valuation techniques to determine fair value, with the primary techniques being discounted cash flow analysis, relief-from-royalty, and a form of the multi-period excess earnings valuation approaches, which use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under these valuation approaches, we are required to make estimates and assumptions about sales, operating margins, growth rates, royalty rates and discount rates based on budgets, business plans, economic projections, anticipated future cash flows and marketplace data.

The Company incurred acquisition-related costs of $20,577 related to the acquisition of Amplify, the majority of which were incurred during the first quarter of 2018. Acquisition-related costs consisted primarily of legal fees, consultant fees, valuation fees and other deal costs and are recorded in the selling, marketing and administrative expense caption within the Consolidated Statements of Operations.
3. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying value of goodwill by reportable segment for the nine months ended September 30, 2018 are as follows:
 
 
North America
 
    International and Other
 
Total
Balance at December 31, 2017
 
$
799,929

 
$
21,132

 
$
821,061

Acquired during the period (see Note 2)
 
939,388

 

 
939,388

Purchase price allocation adjustments (see Note 2)
 
26,865

 

 
26,865

Divested during the period (see Note 7)
 
(98,379
)
 

 
(98,379
)
Foreign currency translation and other
 
(9,150
)
 
(2,684
)
 
(11,834
)
Balance at September 30, 2018
 
$
1,658,653

 
$
18,448

 
$
1,677,101

The following table provides the gross carrying amount and accumulated amortization for each major class of intangible asset:
 
 
September 30, 2018
 
December 31, 2017
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Gross Carrying Amount
 
Accumulated Amortization
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
Trademarks
 
$
909,624

 
$
(55,266
)
 
$
277,473

 
$
(37,510
)
Customer-related
 
157,168

 
(39,028
)
 
128,182

 
(34,659
)
Patents
 
16,753

 
(16,109
)
 
17,009

 
(15,975
)
Total
 
1,083,545

 
(110,403
)
 
422,664

 
(88,144
)
 
 
 
 
 
 
 
 
 
Intangible assets not subject to amortization:
 
 
 
 
 
 
 
 
Trademarks
 
34,909

 
 
 
34,636

 
 
Total other intangible assets
 
$
1,008,051

 
 
 
$
369,156

 
 


10

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


Total amortization expense for the three months ended September 30, 2018 and October 1, 2017 was $9,573 and $5,410, respectively. Total amortization expense for the nine months ended September 30, 2018 and October 1, 2017 was $27,858 and $17,968, respectively.
4. SHORT AND LONG-TERM DEBT
Short-term Debt
As a source of short-term financing, we utilize cash on hand and commercial paper or bank loans with an original maturity of three months or less. We maintain a $1.0 billion unsecured revolving credit facility, which currently expires in November 2020. This agreement also includes an option to increase borrowings by an additional $400 million with the consent of the lenders, which we exercised on October 24, 2018, bringing the total amount we may borrow under this credit facility to $1.4 billion. On January 8, 2018, we entered into an additional unsecured revolving credit facility that provided for borrowings up to $1.5 billion. This facility was scheduled to expire on January 7, 2019; however, we terminated it effective October 24, 2018.
The credit agreement contains certain financial and other covenants, customary representations, warranties and events of default. As of September 30, 2018, 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 2017 Annual Report on Form 10-K.
In addition to the revolving credit facility, we maintain lines of credit with domestic and international commercial banks. We had short-term foreign bank loans against these lines of credit for $89,875 at September 30, 2018 and $110,684 at December 31, 2017. Commitment fees relating to our revolving credit facility and lines of credit are not material.
At September 30, 2018, we had outstanding commercial paper totaling $1,359,351, at a weighted average interest rate of 2.1%. At December 31, 2017, we had outstanding commercial paper totaling $448,675, at a weighted average interest rate of 1.4%.
Long-term Debt
Long-term debt consisted of the following:
 
 
September 30, 2018
 
December 31, 2017
1.60% Notes due 2018 (1)
 
$

 
$
300,000

2.90% Notes due 2020 (2)
 
350,000

 

4.125% Notes due 2020
 
350,000

 
350,000

3.10% Notes due 2021 (2)
 
350,000

 

8.8% Debentures due 2021
 
84,715

 
84,715

3.375% Notes due 2023 (2)
 
500,000

 

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

Capital lease obligations
 
98,417

 
99,194

Net impact of interest rate swaps, debt issuance costs and unamortized debt discounts
 
(19,777
)
 
(16,427
)
Total long-term debt
 
3,256,994

 
2,361,121

Less—current portion
 
3,115

 
300,098

Long-term portion
 
$
3,253,879

 
$
2,061,023



11

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



(1)
In August 2018, we repaid $300,000 of 1.60% Notes due in 2018 upon their maturity.
(2)
In May 2018, we issued $350,000 of 2.90% Notes due in 2020, $350,000 of 3.10% Notes due in 2021 and $500,000 of 3.375% Notes due in 2023 (the "Notes"). Proceeds from the issuance of the Notes, net of discounts and issuance costs, totaled $1,193,827. The Notes were issued under a shelf registration statement on Form S-3 filed in June 2015 that registered an indeterminate amount of debt securities.
Interest Expense
Net interest expense consists of the following:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Interest expense
 
$
39,978

 
$
25,955

 
$
110,929

 
$
76,208

Capitalized interest
 
(1,243
)
 
(1,033
)
 
(3,876
)
 
(2,892
)
Interest expense
 
38,735

 
24,922

 
107,053

 
73,316

Interest income
 
(1,819
)
 
(333
)
 
(5,846
)
 
(860
)
Interest expense, net
 
$
36,916

 
$
24,589

 
$
101,207

 
$
72,456

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 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 6- to 24-month periods. Our open commodity derivative contracts had a notional value of $823,798 as of September 30, 2018 and $405,288 as of December 31, 2017.
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 12, 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, and Brazilian real. We typically utilize foreign currency forward exchange contracts to hedge these exposures for periods ranging from 6 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 $63,801 at September 30, 2018 and $135,962 at December 31, 2017. The effective portion of the changes in fair value on these contracts is recorded in other


12

THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(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 $144,577 at September 30, 2018 and $2,791 at December 31, 2017, respectively. 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. We had one interest rate derivative instrument in a fair value hedging relationship with a notional amount of $350,000 at September 30, 2018 and December 31, 2017.
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 6 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 September 30, 2018 and December 31, 2017 was $30,794 and $25,246, respectively.
The following table presents the classification of derivative assets and liabilities within the Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017:
 
 
September 30, 2018
 
December 31, 2017
 
 
Assets (1)
 
Liabilities (1)
 
Assets (1)
 
Liabilities (1)
Derivatives designated as cash flow hedging instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
2,915

 
$
250

 
$
423

 
$
1,427

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

 
4,001

 

 
1,897

 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Commodities futures and options (2)
 
51

 
16,684

 
390

 
3,054

Deferred compensation derivatives
 
2,151

 

 
1,581

 

Foreign exchange contracts
 
1,658

 
508

 
31

 

 
 
3,860

 
17,192

 
2,002

 
3,054

Total
 
$
6,775

 
$
21,443

 
$
2,425

 
$
6,378


(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.


13

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


(2)
As of September 30, 2018, amounts reflected on a net basis in liabilities were assets of $116,225 and liabilities of $132,837, 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 liabilities at December 31, 2017 were assets of $48,505 and liabilities of $50,179. At September 30, 2018 and December 31, 2017, 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 September 30, 2018 and October 1, 2017 was as follows:
 
 
Non-designated Hedges
 
Cash Flow Hedges
 
 
 
 
 
Gains (losses) recognized in income (a)
 
Gains (losses) recognized in other comprehensive income (“OCI”) (effective portion)
 
Gains (losses) reclassified from accumulated OCI into income (effective portion) (b)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Commodities futures and options
 
$
(71,088
)
 
$
(2,445
)
 
$

 
$

 
$

 
$
(488
)
Foreign exchange contracts
 
1,595

 
11

 
(1,484
)
 
(1,339
)
 
4,605

 
869

Interest rate swap agreements
 

 

 

 

 
(2,344
)
 
(2,343
)
Deferred compensation derivatives
 
1,345

 
349

 

 

 

 

Total
 
$
(68,148
)
 
$
(2,085
)
 
$
(1,484
)
 
$
(1,339
)
 
$
2,261

 
$
(1,962
)

The effect of derivative instruments on the Consolidated Statements of Income for the nine months ended September 30, 2018 and October 1, 2017 was as follows:
 
 
Non-designated Hedges
 
Cash Flow Hedges
 
 
 
 
 
Gains (losses) recognized in income (a)
 
Gains (losses) recognized in other comprehensive income (“OCI”) (effective portion)
 
Gains (losses) reclassified from accumulated OCI into income (effective portion) (b)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Commodities futures and options
 
$
(4,315
)
 
$
(40,500
)
 
$

 
$

 
$

 
$
(1,325
)
Foreign exchange contracts
 
1,580

 
(40
)
 
6,320

 
(3,545
)
 
4,648

 
1,087

Interest rate swap agreements
 

 

 

 

 
(7,110
)
 
(7,136
)
Deferred compensation derivatives
 
2,151

 
994

 

 

 

 

Total
 
$
(584
)
 
$
(39,546
)
 
$
6,320

 
$
(3,545
)
 
$
(2,462
)
 
$
(7,374
)

(a)
Gains (losses) recognized in income for non-designated commodities futures and options contracts were included in cost of sales. Gains (losses) recognized in income for non-designated foreign currency forward exchange contracts and deferred compensation derivatives were included in selling, marketing and administrative expenses.
(b)
Gains (losses) reclassified from AOCI into income were included in cost of sales for commodities futures and options contracts and for foreign currency forward exchange contracts designated as hedges of purchases of inventory or other productive assets. Other gains (losses) for foreign currency forward exchange contracts were included in selling, marketing and administrative expenses. Losses reclassified from AOCI into income for interest rate swap agreements were included in interest expense.


14

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


The amount of pretax net losses on derivative instruments, including interest rate swap agreements and foreign currency forward exchange contracts expected to be reclassified from accumulated OCI into earnings in the next 12 months was approximately $6,814 as of September 30, 2018. This amount was primarily associated with interest rate swap agreements.
Fair Value Hedges
For the three months ended September 30, 2018 and 2017, we recognized net incremental interest expense of $370 and a net benefit to interest expense of $573 relating to our fixed-to-floating interest swap arrangements. For the nine months ended September 30, 2018 and 2017, we recognized net incremental interest expense of $245 and a net benefit of $2,203 relating to our fixed-to-floating interest swap arrangements.
6. FAIR VALUE MEASUREMENTS
Accounting guidance on fair value measurements requires that financial assets and liabilities be classified and disclosed in one of the following categories of the fair value hierarchy:
Level 1 – Based on unadjusted quoted prices for identical assets or liabilities in an active market.
Level 2 – Based on observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3 – Based on unobservable inputs that reflect the entity's own assumptions about the assumptions that a market participant would use in pricing the asset or liability.

We did not have any level 3 financial assets or liabilities, nor were there any transfers between levels during the periods presented.
The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheet on a recurring basis as of September 30, 2018 and December 31, 2017:
 
 
Assets (Liabilities)
 
 
Level 1
 
Level 2
 
Level 3
 
Total
September 30, 2018:
 
 
 
 
 
 
 
 
Derivative Instruments:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Foreign exchange contracts (1)
 
$

 
$
4,573

 
$

 
$
4,573

Deferred compensation derivatives (3)
 

 
2,151

 

 
2,151

Commodities futures and options (4)
 
51

 

 

 
51

Liabilities:
 
 
 
 
 
 
 
 
Foreign exchange contracts (1)
 

 
758

 

 
758

Interest rate swap agreements (2)
 

 
4,001

 

 
4,001

Commodities futures and options (4)
 
16,684

 

 

 
16,684

December 31, 2017:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Foreign exchange contracts (1)
 
$

 
$
454

 
$

 
$
454

Deferred compensation derivatives (3)
 

 
1,581

 

 
1,581

Commodities futures and options (4)
 
390

 

 

 
390

Liabilities:
 
 
 
 
 
 
 
 
Foreign exchange contracts (1)
 

 
1,427

 

 
1,427

Interest rate swap agreements (2)
 

 
1,897

 

 
1,897

Commodities futures and options (4)
 
3,054

 

 

 
3,054



15

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


(1)
The fair value of foreign currency forward exchange contracts is the difference between the contract and current market foreign currency exchange rates at the end of the period. We estimate the fair value of foreign currency forward exchange contracts on a quarterly basis by obtaining market quotes of spot and forward rates for contracts with similar terms, adjusted where necessary for maturity differences.
(2)
The fair value of interest rate swap agreements represents the difference in the present value of cash flows calculated at the contracted interest rates and at current market interest rates at the end of the period. We calculate the fair value of interest rate swap agreements quarterly based on the quoted market price for the same or similar financial instruments.
(3)
The fair value of deferred compensation derivatives is based on quoted prices for market interest rates and a broad market equity index.
(4)
The fair value of commodities futures and options contracts is based on quoted market prices.
Other Financial Instruments
The carrying amounts of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and short-term debt approximated fair values as of September 30, 2018 and December 31, 2017 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
 
 
September 30, 2018
 
December 31, 2017
 
September 30, 2018
 
December 31, 2017
Current portion of long-term debt
 
$
3,115

 
$
299,430

 
$
3,115

 
$
300,098

Long-term debt
 
3,221,093

 
2,113,296

 
3,253,879

 
2,061,023

Total
 
$
3,224,208

 
$
2,412,726

 
$
3,256,994

 
$
2,361,121

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.
In connection with the Amplify acquisition, during the first quarter of 2018, 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, and a form of the multi-period excess earnings valuation approaches, which use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. In connection with disposal groups previously classified as held for sale, as discussed in Note 7, during 2018, we recorded impairment charges totaling $28,817 to adjust the long-lived asset values within the Shanghai Golden Monkey ("SGM") and Tyrrells disposal groups. These charges represent the excess of the disposal groups' carrying values, including the related currency translation adjustment amounts realized upon completion of the sales, over the sales values less costs to sell for the respective businesses. The fair values of the disposal groups were supported by the sales prices agreed with the third-party buyers. The sale of SGM and Tyrrells were both completed in July 2018.
During the first quarter of 2017, as discussed in Note 8, we recorded impairment charges totaling $105,992 to write down distributor relationship and trademark intangible assets that had been recognized in connection with the 2014 SGM acquisition and wrote down property, plant and equipment by $102,720. These charges were determined by comparing the fair value of the assets to their carrying value. The fair value of the assets were derived using a combination of an estimated market liquidation approach and discounted cash flow analyses based on Level 3 inputs.


16

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


7. ASSETS HELD FOR SALE
As of September 30, 2018, the following two disposal groups have been classified as held for sale, in each case stated at the lower of net book value or estimated sales value less costs to sell:
The long-lived assets of Lotte Shanghai Foods Co., Ltd. that were taken out of operation and classified as held for sale during the second quarter of 2018. We sold a portion of the equipment assets in the third quarter of 2018.
Select Pennsylvania facilities and land that met the held for sale criteria in the third quarter of 2018. We expect these long-lived assets to be sold by the end of 2019.

The amounts classified as assets held for sale (included in prepaid expenses and other assets) at September 30, 2018 include the following:
Property, plant and equipment, net
 
$
40,551

Other assets
 
3,278

 
 
$
43,829


During the nine months ended September 30, 2018, the following disposal groups were sold:
In April 2018, we sold the licensing rights for a non-core trademark relating to a brand marketed outside of the U.S. for sale proceeds of approximately $13,000, realizing a gain on the sale of $2,658.
During the second and third quarters of 2018, we sold select China facilities that were taken out of operation and classified as assets held for sale during the first quarter of 2017 in connection with the 2016 Operational Optimization Program. Proceeds from the sale of these facilities totaled $27,468, resulting in a gain on the sale of $6,562.
In July 2018, we sold the Tyrrells and Shanghai Golden Monkey ("SGM") businesses, both of which were previously classified as held for sale. Total proceeds from the sale of Tyrrells and SGM, net of cash divested, were approximately $171,950. We recorded impairment charges of $28,817 to adjust the book value of the disposal groups to the sales value less costs to sell.
8. BUSINESS REALIGNMENT ACTIVITIES
We are currently executing upon several business realignment initiatives designed to increase our efficiency and focus our business in support of our key growth strategies. Costs recorded during the three and nine months ended September 30, 2018 and October 1, 2017 related to these activities are as follows:
 
 
Three Months Ended
 
Nine Months Ended

 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Margin for Growth Program:
 
 
 
 
 
 
 
 
Severance
 
$
5,573

 
$
2,876

 
$
12,635

 
$
33,331

Accelerated depreciation
 
4,786

 

 
12,030

 
6,873

Other program costs
 
6,549

 
5,013

 
21,754

 
16,216

Operational Optimization Program:
 
 
 
 
 
 
 
 
Severance
 

 

 

 
13,828

Gain on sale of facilities
 
(6,562
)
 

 
(6,562
)
 

Other program costs
 
1,077

 
368

 
2,813

 
(549
)
Total
 
$
11,423

 
$
8,257

 
$
42,670

 
$
69,699



17

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


Margin for Growth Program
In the first quarter 2017, the Company's Board of Directors unanimously approved several initiatives under a single program designed to drive continued net sales, operating income and earnings per-share diluted growth over the next several years.  This program is focused 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. 
We originally estimated that the Margin for Growth Program would result in total pre-tax charges of $375,000 to $425,000, to be incurred from 2017 to 2019. The majority of the initiatives relating to the program have been executed, with the final initiatives to be completed over the next six to twelve months. To date, we have incurred pre-tax charges to execute the program totaling $327,265. This includes long-lived asset impairment charges of $208,712 related to the operations supporting our China business as noted below, as well as the $16,300 incremental impairment resulting from the sale of Shanghai Golden Monkey (see Note 7). In addition to the impairment charges, we have incurred employee separation costs of $45,189, and other business realignment costs of $57,064. We currently expect to incur additional pre-tax costs of $13,000 to $28,000 over the remainder of the program, primarily related to cash costs for employee separation and other business realignment activities, bring total estimated project costs to approximately $340,000 to $355,000. The cash portion of the total program charges are estimated to be $97,000 to $112,000. The Company expects that implementation of the program will reduce its global workforce by approximately 15%, with a majority of the reductions coming from hourly headcount positions outside of the United States.
For the three and nine months ended September 30, 2018, we recognized total costs associated with the Margin for Growth Program of $16,908 and $46,419, respectively. These charges include employee severance, largely relating to initiatives to improve the cost structure of our China business and to further streamline our corporate operating model, as well as non-cash, asset-related incremental depreciation expense as part of optimizing the global supply chain. In addition, we incurred other program costs, which relate primarily to third-party charges in support of our initiative to improve global efficiency and effectiveness. For the three and nine months ended October 1, 2017, we recognized total costs associated with the Margin for Growth Program of $7,889 and $56,420, respectively. The 2017 charges are consistent in nature to the 2018 activity.
The program included an initiative to optimize the manufacturing operations supporting our China business.  When the program was approved in 2017, 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 impairment charges totaling $208,712, with $105,992 representing the portion of the impairment loss that was allocated to the distributor relationship and trademark intangible assets that had been recognized in connection with the 2014 SGM acquisition and $102,720 representing the portion of the impairment loss that was allocated to property, plant and equipment. These impairment charges are recorded in the long-lived asset impairment charges caption within the Consolidated Statements of Operations.
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 included select facility consolidations. The program encompassed the 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.
For the three and nine months ended September 30, 2018, we incurred pre-tax costs totaling $1,077 and $2,813, respectively, relating primarily to third-party charges in support of our initiative to optimize our production and supply chain network. In addition, we completed the sale of select China facilities that had been taken out of service in connection with the 2016 Operational Optimization Program. The sale resulted in a gain of $6,562 for the three and nine months ended September 30, 2018. For the three and nine months ended October 1, 2017, we incurred pre-tax costs totaling $368 and $13,279, respectively, primarily related to employee severance associated with the workforce planning efforts within North America. We have substantially completed the efforts relating to this program.


18

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


Costs associated with business realignment activities are classified in our Consolidated Statements of Income for the three and nine months ended September 30, 2018 and October 1, 2017 as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Cost of sales
 
$
4,565

 
$
213

 
$
14,101

 
$
6,475

Selling, marketing and administrative expense
 
4,598

 
4,024

 
17,105

 
13,206

Business realignment costs
 
2,260

 
4,020

 
11,464

 
50,018

Costs associated with business realignment activities
 
$
11,423

 
$
8,257

 
$
42,670

 
$
69,699

On a cumulative program to date basis, the costs and related benefits of the Margin for Growth Program are approximately 65% to the North America segment and 35% to the International and Other segment. In addition, the costs and related benefits of the Operational Optimization Program relate approximately 40% to the North America segment and 60% to the International and Other segment. However, segment operating results do not include these business realignment expenses because we evaluate segment performance excluding such costs.
The following table presents the liability activity for costs qualifying as exit and disposal costs for the nine months ended September 30, 2018:
 
Total
Liability balance at December 31, 2017
$
38,992

2018 business realignment charges (1)
23,087

Cash payments
(43,884
)
Other, net
669

Liability balance at September 30, 2018 (reported within accrued and other long-term liabilities)
$
18,864

(1)
The costs reflected in the liability roll-forward represent employee-related and certain 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.
9. INCOME TAXES
The majority of our taxable income is generated in the U.S. and taxed at the U.S. statutory rate of 21%. The effective tax rates for the nine months ended September 30, 2018 and October 1, 2017 were 21.3% and 32.4%, respectively. Relative to the statutory rate, the 2018 effective tax rate was impacted by investment tax credits and favorable rate differential relating to foreign operations, partially offset by state and local taxes.  The 2017 effective rate, relative to the previous U.S. statutory rate of 35%, was impacted by favorable rate differential relating to foreign operations, investment tax credits and the benefit of ASU 2016-09, which were partially offset by non-benefited costs resulting from the Margin for Growth Program.
Hershey and its subsidiaries file tax returns in the U.S., including various state and local returns, and in foreign jurisdictions. We believe adequate provision has been made for all income tax uncertainties. We are routinely audited by taxing authorities in our filing jurisdictions, and a number of these audits are currently underway. We reasonably expect reductions in the liability for unrecognized tax benefits of approximately $6,751 within the next 12 months because of the expiration of statutes of limitations and settlements of tax audits.


19

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


U.S. Tax Cuts and Jobs Act of 2017
The U.S. Tax Cuts and Jobs Act, enacted in December 2017, (“U.S. tax reform”) significantly changed U.S. corporate income tax laws by, among other things, reducing the U.S. corporate income tax rate to 21% starting in 2018 and creating a territorial tax system with a one-time mandatory tax on previously deferred foreign earnings of U.S. subsidiaries.  Under GAAP (specifically, ASC Topic 740), the effects of changes in tax rates and laws on deferred tax balances are recognized in the period in which the new legislation is enacted.
During the fourth quarter of 2017, we recorded a net provisional charge of $32,500, which included the estimated impact of the one-time mandatory tax on previously deferred earnings of non-U.S. subsidiaries offset in part by the benefit from revaluation of net deferred tax liabilities based on the new lower corporate income tax rate.  The impact of the U.S. tax reform may differ from this estimate, possibly materially, due to, among other things, changes in interpretations and assumptions made, additional guidance that may be issued and actions taken by Hershey as a result of the U.S. tax reform. During the nine months ended September 30, 2018, there were no adjustments to the recorded provisional amount.
10. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
The components of net periodic benefit cost for the third quarter were as follows:  
 
 
Pension Benefits
 
Other Benefits
 
 
Three Months Ended
 
Three Months Ended
 
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Service cost
 
$
5,272

 
$
5,262

 
$
56

 
$
66

Interest cost
 
7,487

 
10,320

 
1,730

 
2,214

Expected return on plan assets
 
(14,455
)
 
(14,390
)
 

 

Amortization of prior service (credit) cost
 
(1,804
)
 
(1,455
)
 
209

 
187

Amortization of net loss
 
6,784

 
8,526

 

 
(1
)
Settlement loss
 
6,893

 
17,043

 

 

Total net periodic benefit cost
 
$
10,177

 
$
25,306

 
$
1,995

 
$
2,466


We made contributions of $6,350 and $6,276 to the pension plans and other benefits plans, respectively, during the third quarter of 2018. In the third quarter of 2017, we made contributions of $31,512 and $6,922 to our pension plans and other benefit plans, respectively. The contributions in 2018 and 2017 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 periods were as follows:  
 
 
Pension Benefits
 
Other Benefits
 
 
Nine Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Service cost
 
$
15,931

 
$
15,487

 
$
172

 
$
197

Interest cost
 
23,153

 
30,819

 
5,194

 
6,626

Expected return on plan assets
 
(43,973
)
 
(43,088
)
 

 

Amortization of prior service (credit) cost
 
(5,402
)
 
(4,366
)
 
627

 
560

Amortization of net loss
 
20,155

 
25,308

 

 
(1
)
Settlement loss
 
6,893

 
17,043

 

 

Total net periodic benefit cost
 
$
16,757

 
$
41,203

 
$
5,993

 
$
7,382




20

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


We made contributions of $7,651 and $19,054 to the pension plans and other benefits plans, respectively, during the first nine months of 2018. During the first nine months of 2017, we made contributions of $36,497 and $21,386 to our pension plans and other benefit plans, respectively. The contributions in 2018 and 2017 also included benefit payments from our non-qualified pension plans and post-retirement benefit plans.

During the third quarter of 2018, we recognized pension settlement charges in our hourly retirement plan due to lump sum withdrawals by employees retiring or leaving the Company as a result of the Operational Optimization Program and due to lump sum distributions in our supplemental executive retirement plan.   In the third quarter of 2017, we recognized pension settlement charges 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 and due to lump sum distributions in our supplemental executive retirement plan.  In each case, 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 third quarter 2018 settlements, the related plan assets and liabilities were remeasured using a discount rate as of the remeasurement date that was 72 basis points higher than the rate as of December 31, 2017 and an expected rate of return on plan assets of 5.8%.
11. STOCK COMPENSATION PLANS
We have various stock-based compensation programs under which awards, including stock options, performance stock units (“PSUs”) and performance stock, stock appreciation rights, restricted stock units (“RSUs”) and restricted stock may be granted to employees, non-employee directors and certain service providers upon whom the successful conduct of our business is dependent. These programs and the accounting treatment related thereto are described in Note 10 to the Consolidated Financial Statements included in our 2017 Annual Report on Form 10-K.
For the periods presented, compensation expense for all types of stock-based compensation programs and the related income tax benefit recognized were as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Pre-tax compensation expense
 
$
12,122

 
$
13,409

 
$
35,668

 
$
37,966

Related income tax benefit
 
2,808

 
4,076

 
7,776

 
11,124

Compensation costs for stock compensation plans are primarily included in selling, marketing and administrative expense. As of September 30, 2018, total stock-based compensation cost related to non-vested awards not yet recognized was $68,498 and the weighted-average period over which this amount is expected to be recognized was approximately 2.1 years.
Stock Options
A summary of activity relating to grants of stock options for the period ended September 30, 2018 is as follows:
Stock Options
Shares
Weighted-Average
Exercise Price (per share)
Weighted-Average Remaining
Contractual Term
Aggregate Intrinsic Value
Outstanding as of December 31, 2017
5,921,062

$89.06
5.8 years
 
Granted
927,775

$99.86
 
 
Exercised
(680,028
)
$62.25
 
 
Forfeited
(311,438
)
$102.16
 
 
Outstanding as of September 30, 2018
5,857,371

$93.18
5.7 years
$
63,665

Options exercisable as of September 30, 2018
3,907,324

$89.41
4.3 years
$
57,198



21

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 $15.57 and $15.77 per share for the periods ended September 30, 2018 and October 1, 2017, 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
 
 
September 30, 2018
 
October 1, 2017
Dividend yields
 
2.3
%
 
2.4
%
Expected volatility
 
16.6
%
 
17.2
%
Risk-free interest rates
 
2.8
%
 
2.2
%
Expected term in years
 
6.6

 
6.8

The total intrinsic value of options exercised was $26,006 and $38,845 for the periods ended September 30, 2018 and October 1, 2017, respectively.
Performance Stock Units and Restricted Stock Units
A summary of activity relating to grants of PSUs and RSUs for the period ended September 30, 2018 is as follows:
Performance Stock Units and Restricted Stock Units
 
Number of units
 
Weighted-average grant date fair value
for equity awards (per unit)
Outstanding as of December 31, 2017
 
923,364

 
$103.11
Granted
 
435,096

 
$97.74
Performance assumption change (1)
 
(68,625
)
 
$102.24
Vested