Edgar Filing: HERSHEY CO

10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 3, 2016



¨	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” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	x	Accelerated filer	¨	Non-accelerated filer	¨	Smaller reporting company	¨
				(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.

Common Stock, one dollar par value—152,753,106 shares, as of April 22, 2016.

Class B Common Stock, one dollar par value—60,619,777 shares, as of April 22, 2016.

THE HERSHEY COMPANY

Quarterly Report on Form 10-Q

For the Period Ended April 3, 2016

TABLE OF CONTENTS



PART I. FINANCIAL INFORMATION		3
Item 1. Financial Statements		3
Consolidated Statements of Income for the Three Months Ended April 3, 2016 and April 5, 2015		3
Consolidated Statements of Comprehensive Income for the Three Months Ended April 3, 2016 and April 5, 2015		4
Consolidated Balance Sheets as of April 3, 2016 and December 31, 2015		5
Consolidated Statements of Cash Flows for the Three Months Ended April 3, 2016 and April 5, 2015		6
Consolidated Statement of Stockholders' Equity for the Three Months Ended April 3, 2016		7
Notes to Unaudited Consolidated Financial Statements		8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		27
Item 3. Quantitative and Qualitative Disclosures About Market Risk		41
Item 4. Controls and Procedures		41

PART II. OTHER INFORMATION		43
Item1. Legal Proceedings		43
Item 1A. Risk Factors		43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		43
Item 3. Defaults Upon Senior Securities		43
Item 4. Mine Safety Disclosures		43
Item 5. Other Information		43
Item 6. Exhibits		44

Signatures		45

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

THE HERSHEY COMPANY

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(unaudited)



	Three Months Ended
	April 3, 2016			April 5, 2015
Net sales	$	1,828,812		$	1,937,800
Costs and expenses:
Cost of sales	1,011,436			1,036,957
Selling, marketing and administrative	471,734			514,010
Business realignment charges	6,133			2,667
Total costs and expenses	1,489,303			1,553,634
Operating profit	339,509			384,166
Interest expense, net	21,005			19,202
Other (income) expense, net	(21,225		)	(9,840		)
Income before income taxes	339,729			374,804
Provision for income taxes	109,897			130,067
Net income	$	229,832		$	244,737

Net income per share—basic:
Common stock	$	1.09		$	1.14
Class B common stock	$	0.99		$	1.04

Net income per share—diluted:
Common stock	$	1.06		$	1.10
Class B common stock	$	0.99		$	1.03

Dividends paid per share:
Common stock	$	0.583		$	0.535
Class B common stock	$	0.530		$	0.486

See Notes to Unaudited Consolidated Financial Statements.

THE HERSHEY COMPANY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)



	Three Months Ended
	April 3, 2016			April 5, 2015
Net income	$	229,832		$	244,737
Other comprehensive (loss) income, net of tax:
Foreign currency translation adjustments	12,166			(27,718		)
Pension and post-retirement benefit plans	5,101			5,461
Cash flow hedges:
Losses on cash flow hedging derivatives	(22,144		)	(26,092		)
Reclassification adjustments	(4,912		)	(399		)
Total other comprehensive loss, net of tax	(9,789		)	(48,748		)
Total comprehensive income	$	220,043		$	195,989
Comprehensive loss attributable to noncontrolling interests	1,076			3,509
Comprehensive income attributable to The Hershey Company	$	221,119		$	199,498

See Notes to Unaudited Consolidated Financial Statements.

THE HERSHEY COMPANY

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



	April 3, 2016			December 31, 2015
ASSETS	(unaudited)
Current assets:
Cash and cash equivalents	$	285,958		$	346,529
Accounts receivable—trade, net	544,027			599,073
Inventories	770,382			750,970
Prepaid expenses and other	172,551			152,026
Total current assets	1,772,918			1,848,598
Property, plant and equipment, net	2,230,071			2,240,460
Goodwill	690,654			684,252
Other intangibles	375,309			379,305
Other assets	185,104			155,366
Deferred income taxes	51,784			36,390
Total assets	$	5,305,840		$	5,344,371
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	436,343		$	474,266
Accrued liabilities	769,793			856,967
Accrued income taxes	110,256			23,243
Short-term debt	520,564			363,513
Current portion of long-term debt	500,016			499,923
Total current liabilities	2,336,972			2,217,912
Long-term debt	1,571,388			1,557,091
Other long-term liabilities	465,523			468,718
Deferred income taxes	52,604			53,188
Total liabilities	4,426,487			4,296,909

Stockholders’ equity:
The Hershey Company stockholders’ equity
Preferred stock, shares issued: none at April 3, 2016 and December 31, 2015, respectively	—			—
Common stock, shares issued: 299,281,967 at April 3, 2016 and 299,281,967 at December 31, 2015, respectively	299,281			299,281
Class B common stock, shares issued: 60,619,777 at April 3, 2016 and 60,619,777 at December 31, 2015, respectively	60,620			60,620
Additional paid-in capital	792,620			783,877
Retained earnings	6,005,068			5,897,603
Treasury—common stock shares, at cost: 145,772,541 at April 3, 2016 and 143,124,384 at December 31, 2015, respectively	(5,946,412		)	(5,672,359		)
Accumulated other comprehensive loss	(379,738		)	(371,025		)
The Hershey Company stockholders’ equity	831,439			997,997
Noncontrolling interests in subsidiaries	47,914			49,465
Total stockholders’ equity	879,353			1,047,462
Total liabilities and stockholders’ equity	$	5,305,840		$	5,344,371

See Notes to Unaudited Consolidated Financial Statements.

THE HERSHEY COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



	Three Months Ended
	April 3, 2016			April 5, 2015
Operating Activities
Net income	$	229,832		$	244,737
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	59,913			58,338
Stock-based compensation expense	11,678			13,889
Excess tax benefits from stock-based compensation	(6,091		)	(17,066		)
Deferred income taxes	(3,409		)	(11,577		)
Non-cash business realignment and impairment charges	—			4,934
Contributions to pension and other benefits plans	(8,839		)	(5,307		)
Write-down of equity investments	5,593			—
Gain on settlement of SGM liability (see Note 2)	(26,650		)	—
Changes in assets and liabilities, net of effects from business acquisitions and divestitures:
Accounts receivable—trade, net	55,046			(5,965		)
Inventories	(19,412		)	79,220
Accounts payable and accrued liabilities	(106,279		)	(124,585		)
Other assets and liabilities	65,733			22,615
Net cash provided by operating activities	257,115			259,233
Investing Activities
Capital additions	(33,607		)	(57,781		)
Capitalized software additions	(7,832		)	(4,954		)
Proceeds from sales of property, plant and equipment	1,934			214
Proceeds from sale of business	—			32,408
Equity investments in tax credit qualifying partnerships	(9,672		)	—
Business acquisitions, net of cash and cash equivalents acquired	—			(218,952		)
Net cash used in investing activities	(49,177		)	(249,065		)
Financing Activities
Net increase in short-term debt	153,863			288,946
Long-term borrowings	—			944
Repayment of long-term debt	—			(328		)
Payment of SGM liability (see Note 2)	(35,762		)	—
Cash dividends paid	(122,367		)	(114,381		)
Exercise of stock options	30,890			37,925
Excess tax benefits from stock-based compensation	6,091			17,066
Repurchase of common stock	(303,950		)	(306,673		)
Net cash used in financing activities	(271,235		)	(76,501		)
Effect of exchange rate changes on cash and cash equivalents	2,726			(2,831		)
Decrease in cash and cash equivalents	(60,571		)	(69,164		)
Cash and cash equivalents, beginning of period	346,529			374,854
Cash and cash equivalents, end of period	$	285,958		$	305,690
Supplemental Disclosure
Interest paid	$	27,786		$	27,745
Income taxes paid	29,574			17,845

See Notes to Unaudited Consolidated Financial Statements.

THE HERSHEY COMPANY

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(in thousands)

(unaudited)



	Preferred Stock		Common Stock		Class B Common Stock		Additional Paid-in Capital			Retained Earnings			Treasury Common Stock			Accumulated Other Comprehensive Loss			Noncontrolling Interests in Subsidiaries			Total Stockholders’ Equity
Balance, December 31, 2015	$	—	$	299,281	$	60,620	$	783,877		$	5,897,603		$	(5,672,359	)	$	(371,025	)	$	49,465		$	1,047,462
Net income										229,832												229,832
Other comprehensive loss																(8,713		)	(1,076		)	(9,789		)
Dividends:
Common Stock, $0.583 per share										(90,238		)										(90,238		)
Class B Common Stock, $0.53 per share										(32,129		)										(32,129		)
Stock-based compensation							11,693															11,693
Exercise of stock options and incentive-based transactions							(2,950		)				29,897									26,947
Repurchase of common stock													(303,950		)							(303,950		)
Net loss attributable to noncontrolling interests																			(475		)	(475		)
Balance, April 3, 2016	$	—	$	299,281	$	60,620	$	792,620		$	6,005,068		$	(5,946,412	)	$	(379,738	)	$	47,914		$	879,353

See Notes to Unaudited Consolidated Financial Statements.

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. Our significant interim accounting policies include the recognition of a pro-rata share of certain estimated annual amounts primarily for raw material purchase price variances, advertising expense, incentive compensation expenses and the effective income tax rate. We have included all adjustments (consisting only of normal recurring accruals) that we believe are considered necessary for a fair presentation.

Operating results for the quarter ended April 3, 2016 may not be indicative of the results that may be expected for the year ending December 31, 2016 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, 2015 (our “2015 Annual Report on Form 10-K”), which provides a more complete understanding of our accounting policies, financial position, operating results and other matters.

Reclassifications

Certain prior period amounts have been reclassified to conform to current year presentation. Specifically, this includes amounts presented in our “other (income) expense, net” caption included in our Consolidated Statements of Income and the “effect of exchange rate changes on cash and cash equivalents” included in our Consolidated Statements of Cash Flows.

Recent Accounting Pronouncements

In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU is part of the FASB's simplification initiative. The areas for simplification in this ASU involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods, with early adoption permitted. We are currently evaluating the impact that the adoption of ASU 2016-09 will have on our consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU will require lesses 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 beginning to evaluate the impact that the adoption of ASU 2016-02 will have on our consolidated financial statements and related disclosures.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU No. 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. 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

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

adopt the standard as of the original effective date. The standard permits the use of either the retrospective or cumulative effect transition method. We are currently evaluating the effect that ASU No. 2014-09 will have on our consolidated financial statements and related disclosures, our transition date and transition method.

No other new accounting pronouncement issued or effective during the fiscal year had or is expected to have a material impact on our consolidated financial statements or disclosures.

2. BUSINESS ACQUISITIONS AND DIVESTITURES

Acquisitions of businesses are accounted for as purchases and, accordingly, the results of operations of the businesses acquired have been included in the consolidated financial statements since the respective dates of the acquisitions. The purchase price for each of the acquisitions is allocated to the assets acquired and liabilities assumed.

2016 Activity

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.

Shanghai Golden Monkey (“SGM”)

On February 3, 2016, we completed the purchase of the remaining 20% of the outstanding shares of SGM for cash consideration totaling $35,762, pursuant to a new agreement entered into during the fourth quarter of 2015 with the SGM selling shareholders which revised the originally-agreed purchase price for these shares. For accounting purposes, we treated the acquisition as if we had acquired 100% at the initial acquisition date in 2014 and financed the payment for the remaining 20% of the outstanding shares. Therefore, the cash settlement of the liability for the purchase of these remaining shares is reflected within the financing section of the Unaudited Consolidated Statements of Cash Flows.

The final settlement also resulted in an extinguishment gain of $26,650 representing the net carrying amount of the recorded liability in excess of the cash paid to settle the obligation for the remaining 20% of the outstanding shares. This gain is recorded within non-operating other (income) expense, net within the Unaudited Consolidated Statements of Income.

2015 Acquisition

KRAVE Pure Foods

In March 2015, we completed the acquisition of all of the outstanding shares of KRAVE Pure Foods, Inc. (“Krave”), manufacturer of KRAVE jerky, a leading all-natural snack brand of premium jerky products. The transaction was undertaken to allow Hershey to tap into the rapidly growing meat snacks category and further expand into the broader snacks space. Krave is headquartered in Sonoma, California and generated 2014 annual sales of approximately $35 million.

Total purchase consideration included cash consideration of $220,016, as well as agreement to pay additional cash consideration of up to $20,000 to the Krave shareholders if certain defined targets related to net sales and gross profit margin are met or exceeded during the twelve-month periods ending December 31, 2015 or March 31, 2016. The fair value of the contingent cash consideration was appropriately classified as a liability of $16,800 as of the acquisition date. Based on revised targets in a subsequent agreement with the Krave shareholders, the fair value was reduced over the second and third quarters of 2015 to $10,000, with the adjustment to fair value recorded within selling, marketing and administrative expenses. The remaining $10,000 was paid in December 2015.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

The purchase consideration was allocated to assets acquired and liabilities assumed based on their respective fair values as follows:



Goodwill	$	147,089
Trademarks	112,000
Other intangible assets	17,000
Other assets, primarily current assets, net of cash acquired totaling $1,362	9,465
Current liabilities	(2,756		)
Non-current deferred tax liabilities	(47,344		)
Net assets acquired	$	235,454

Goodwill is calculated as the excess of the purchase price over the fair value of the net assets acquired. The goodwill resulting from the acquisition is attributable primarily to the value of leveraging our brand building expertise, consumer insights, supply chain capabilities and retail relationships to accelerate growth and access to KRAVE products. The recorded goodwill is not expected to be deductible for tax purposes. The purchase price allocation for Krave was concluded in the third quarter of 2015.

Acquired trademarks were assigned estimated useful lives of 22 years, while other intangibles, including customer relationships and covenants not to compete, were assigned estimated useful lives ranging from 5 to 16 years.

2015 Divestiture

In December 2014, we entered into an agreement to sell the Mauna Loa Macadamia Nut Corporation (“Mauna Loa”). The transaction closed in the first quarter of 2015, resulting in proceeds, net of selling expenses and an estimated working capital adjustment, of approximately $32,400. As a result of the expected sale, in 2014, we recorded an estimated loss on the anticipated sale of $22,256 to reflect the disposal entity at fair value, less an estimate of the selling costs. This amount included impairment charges totaling $18,531 to write down goodwill and the indefinite-lived trademark intangible asset, based on the valuation of these assets as implied by the agreed-upon sales price. The sale of Mauna Loa resulted in the recording of an additional loss on sale of $2,667 in the first quarter of 2015, based on updates to the selling expenses and tax benefits. The loss on the sale is reflected within business realignment charges in the Consolidated Statements of Income.

3. GOODWILL AND INTANGIBLE ASSETS

The changes in the carrying value of goodwill by reportable segment for the three months ended April 3, 2016 are as follows:



	North America		International and Other			Total
Balance at December 31, 2015	$	662,083	$	22,169		$	684,252
Foreign currency translation	6,471		(69		)	6,402
Balance at April 3, 2016	$	668,554	$	22,100		$	690,654

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:



	April 3, 2016			December 31, 2015
Intangible assets not subject to amortization:
Trademarks	43,738			43,775
Intangible assets subject to amortization:
Trademarks, customer relationships, patents and other finite-lived intangibles	393,146			390,900
Less: accumulated amortization	(61,575		)	(55,370		)
Total other intangible assets	$	375,309		$	379,305

Total amortization expense for the three months ended April 3, 2016 and April 5, 2015 was $5,180 and $5,014, 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. The agreement also includes an option to increase borrowings by an additional $400,000 with the consent of the lenders.

The credit agreement contains certain financial and other covenants, customary representations, warranties and events of default. As of April 3, 2016, 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 2015 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 $219,622 and $313,520 in April 3, 2016 and December 31, 2015, respectively. Commitment fees relating to our revolving credit facility and lines of credit are not material.

At April 3, 2016, we had outstanding commercial paper totaling $300,942, at a weighted average interest rate of 0.39%. At December 31, 2015, we had outstanding commercial paper totaling $49,993, at a weighted average interest rate of 0.40%.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

Long-term Debt

Long-term debt consisted of the following:



	April 3, 2016		December 31, 2015
5.45% Notes due 2016	250,000		250,000
1.50% Notes due 2016	250,000		250,000
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
7.2% Debentures due 2027	193,639		193,639
Other obligations, net of debt issuance costs and unamortized debt discount	93,050		78,660
Total long-term debt	2,071,404		2,057,014
Less—current portion	500,016		499,923
Long-term portion	$	1,571,388	$	1,557,091

Interest Expense

Net interest expense consisted of the following:



	Three Months Ended
	April 3, 2016			April 5, 2015
Interest expense	$	23,525		$	23,024
Less: Capitalized interest	(2,175		)	(3,017		)
Interest expense	21,350			20,007
Interest income	(345		)	(805		)
Interest expense, net	$	21,005		$	19,202

5. DERIVATIVE INSTRUMENTS AND FAIR VALUE MEASUREMENTS

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. Through 2015, we designated the majority of our commodity derivative instruments as cash flow hedges under the hedge accounting requirements. We account for the effective portion of mark-to-market gains and losses on commodity derivative instruments in other comprehensive income, to be recognized in cost of sales in the same period that we record the hedged raw material requirements in cost of sales. The ineffective portion of gains and losses is recorded currently in

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

cost of sales. Cocoa commodity derivatives did not qualify for hedge accounting treatment as of the beginning of the third quarter of 2015. Therefore, changes in the fair value of these derivatives were recorded as incurred within cost of sales for the third and fourth quarters of 2015.

Effective July 6, 2015 for cocoa commodity derivatives and January 1, 2016 for other commodity derivatives, we are no longer electing to designate any of our existing or new cocoa or other commodity derivatives for hedge accounting treatment. Additionally, we have revised our definition of segment income to exclude gains and losses on commodity derivatives until the related inventory is sold. This change to our definition of segment income will continue to reflect 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, Malaysian ringgit, Swiss franc, Chinese renminbi, Japanese yen, and Brazilian real. We typically utilize foreign currency forward exchange contracts and options to hedge these exposures for 3- to 24-month periods. 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 $53,646 at April 3, 2016 and $10,752 at December 31, 2015. The effective portion of the changes in fair value on these contracts is recorded in other comprehensive income and reclassified into earnings in the same period in which the hedged transactions affect earnings. The net notional amount of foreign exchange contracts that are not designated as accounting hedges was $2,791 at April 3, 2016 and $2,791 at December 31, 2015. 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

In order to manage interest rate exposure, we enter into interest rate swap agreements to protect against unfavorable interest rate changes relating to forecasted debt transactions. These swaps are designated as cash flow hedges, with gains and losses deferred in other comprehensive income to be recognized as an adjustment to interest expense in the same period that the hedged interest payments affect earnings. The notional amount of interest rate derivative instruments in cash flow hedging relationships was $500,000 at April 3, 2016 and $500,000 at December 31, 2015.

We also 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. The notional amount, interest payment and maturity date of these swaps generally match the principal, interest payment and maturity date of the related debt, and the swaps are valued using observable benchmark rates (Level 2 valuation). The notional amount of interest rate derivative instruments in fair value hedge relationships was $350,000 at April 3, 2016. We had $350,000 derivative instruments in fair value hedge relationships at December 31, 2015.

Equity Price Risk

We are exposed to market price changes in certain broad market indices related to our deferred compensation obligations to our employees. 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 3- to 12-month periods. The change in fair value of these derivatives is recorded in selling, marketing and administrative expense, together with the change in the related liabilities. The notional amount of the contracts outstanding at April 3, 2016 was $22,672.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

Fair Value

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 April 3, 2016 and December 31, 2015:



	April 3, 2016				December 31, 2015
	Assets (1)		Liabilities (1)		Assets (1)		Liabilities (1)
Derivatives designated as cash flow hedging instruments:
Commodities futures and options (2)	$	—	$	—	$	—	$	479
Foreign exchange contracts (3)	345		4,132		367		475
Interest rate swap agreements (4)	—		70,092		—		40,299
	345		74,224		367		41,253
Derivatives designated as fair value hedging instruments:
Interest rate swap agreements (4)	16,236		—		4,313		—

Derivatives not designated as hedging instruments:
Commodities futures and options (2)	—		13,678		—		1,574
Deferred compensation derivatives (5)	403		—		1,198		—
Foreign exchange contracts (3)	—		172		69		—
	403		13,850		1,267		1,574
Total	$	16,984	$	88,074	$	5,947	$	42,827


(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)

The fair value of commodities futures and options contracts is based on quoted market prices and is, therefore, categorized as Level 1 within the fair value hierarchy. As of April 3, 2016, liabilities include the net of assets of $56,866 and liabilities of $68,030 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, 2015 were assets of $54,090 and liabilities of $54,860.

(3)

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. These contracts are classified as Level 2 within the fair value hierarchy.


(4)	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

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

calculate the fair value of interest rate swap agreements quarterly based on the quoted market price for the same or similar financial instruments. Such contracts are categorized as Level 2 within the fair value hierarchy.


(5)	The fair value of deferred compensation derivatives is based on quoted prices for market interest rates and a broad market equity index and is, therefore, categorized as Level 2 within the fair value hierarchy.

Other Financial Instruments

The carrying amounts of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and short-term debt approximated fair value as of April 3, 2016 and December 31, 2015 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, was as follows:



	Fair Value				Carrying Value
	April 3, 2016		December 31, 2015		April 3, 2016		December 31, 2015
Current portion of long-term debt	$	504,835	$	509,580	$	500,016	$	499,923
Long-term debt	1,733,643		1,668,379		1,571,388		1,557,091
Total	$	2,238,478	$	2,177,959	$	2,071,404	$	2,057,014

Income Statement Impact of Derivative Instruments

The effect of derivative instruments on the Consolidated Statements of Income for the three months ended April 3, 2016 and April 5, 2015 was as follows:



	Non-designated Hedges						Cash Flow Hedges
	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)						Losses recognized in income (ineffective portion) (c)

	2016			2015			2016			2015			2016			2015			2016		2015
Commodities futures and options	$	(38,941	)	$	(2,777	)	$	—		$	(15,098	)	$	9,730		$	1,200		$	—	$	(287	)
Foreign exchange contracts	(204		)	(67		)	(4,116		)	1,240			(261		)	341			—		—
Interest rate swap agreements	—			—			(29,793		)	(28,354		)	(1,560		)	(1,189		)	—		—
Deferred compensation derivatives	403			172			—			—			—			—			—		—
Total	$	(38,742	)	$	(2,672	)	$	(33,909	)	$	(42,212	)	$	7,909		$	352		$	—	$	(287	)


(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.


(c)	Gains representing hedge ineffectiveness were included in cost of sales for commodities futures and options contracts.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

The amount of net gains on derivative instruments, including interest rate swap agreements, foreign currency forward exchange contracts and options, commodities futures and options contracts, and other commodity derivative instruments expected to be reclassified into earnings in the next 12 months was approximately $6,112 after tax as of April 3, 2016. This amount was primarily associated with commodities futures contracts.

Fair Value Hedges

For the three months ended April 3, 2016 and April 5, 2015, we recognized a net pretax benefit to interest expense of $1,317 and $2,095 relating to our fixed-to-floating interest swap arrangements.

6. NONCONTROLLING INTERESTS IN SUBSIDIARIES

We currently own a 50% controlling interest in Lotte Shanghai Food Company (“LSFC”), a joint venture established in 2007 in China for the purpose of manufacturing and selling product to the venture partners.

A roll-forward showing the 2016 activity relating to the noncontrolling interest follows:



	Noncontrolling Interests
Balance, December 31, 2015	$	49,465
Net loss attributable to noncontrolling interests (1)	(475		)
Other comprehensive loss - foreign currency translation adjustments	(1,076		)
Balance, April 3, 2016	$	47,914

(1) Amounts are not considered significant and are presented within selling, marketing and administrative expenses.

7. COMPREHENSIVE INCOME

A summary of the components of comprehensive income is as follows:



Three Months Ended April 3, 2016	Pre-Tax Amount			Tax (Expense) Benefit			After-Tax Amount
Net income							$	229,832
Other comprehensive income (loss):
Foreign currency translation adjustments	$	12,166		$	—		12,166
Pension and post-retirement benefit plans (a)	8,680			(3,579		)	5,101
Cash flow hedges:
Losses on cash flow hedging derivatives	(33,909		)	11,765			(22,144		)
Reclassification adjustments (b)	(7,909		)	2,997			(4,912		)
Total other comprehensive loss	$	(20,972	)	$	11,183		(9,789		)
Total comprehensive income							$	220,043
Comprehensive loss attributable to noncontrolling interests							1,076
Comprehensive income attributable to The Hershey Company							$	221,119

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)



Three Months Ended April 5, 2015	Pre-Tax Amount			Tax (Expense) Benefit			After-Tax Amount
Net income							$	244,737
Other comprehensive loss:
Foreign currency translation adjustments	$	(27,718	)	$	—		(27,718		)
Pension and post-retirement benefit plans (a)	8,662			(3,201		)	5,461
Cash flow hedges:
Losses on cash flow hedging derivatives	(42,212		)	16,120			(26,092		)
Reclassification adjustments (b)	(352		)	(47		)	(399		)
Total other comprehensive loss	$	(61,620	)	$	12,872		(48,748		)
Total comprehensive income							$	195,989
Comprehensive loss attributable to noncontrolling interests							3,509
Comprehensive income attributable to The Hershey Company							$	199,498


(a)	These amounts are included in the computation of net periodic benefit costs. For more information, see Note 11.


(b)	For information on the presentation of reclassification adjustments for cash flow hedges on the Consolidated Statements of Income, see Note 5.

The components of accumulated other comprehensive loss, as shown on the Consolidated Balance Sheets, are as follows:



	April 3, 2016			December 31, 2015
Foreign currency translation adjustments	$	(87,994	)	$	(101,236	)
Pension and post-retirement benefit plans, net of tax	(249,547		)	(254,648		)
Cash flow hedges, net of tax	(42,197		)	(15,141		)
Total accumulated other comprehensive loss	$	(379,738	)	$	(371,025	)

8. OTHER (INCOME) EXPENSE, NET

In the second quarter of 2015, we began presenting a new non-operating "other (income) expense, net" classification to report certain gains and losses associated with activities not directly related to our core operations. For the three months ended April 5, 2015, we reclassified from selling, marketing and administrative expenses to other (income) expense, net total net gains of $9,840 to conform to the current year presentation. After considering these reclassifications, amounts reflected in other (income) expense, net include the following:



	Three Months Ended
	April 3, 2016			April 5, 2015
Write-down of equity investments in partnerships qualifying for tax credits (see Note 9)	$	5,593		$	—
Settlement of Shanghai Golden Monkey liability (see Note 2)	(26,650		)	—
Gain on sale of non-core trademark	—			(9,950		)
Other (income) expense, net	(168		)	110
Total	$	(21,225	)	$	(9,840	)

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

9. INCOME TAXES

The majority of our taxable income is generated in the U.S. and taxed at the U.S. statutory rate of 35%. The effective tax rates for the three months ended April 3, 2016 and April 5, 2015 were 32.3% and 34.7%, respectively. The 2016 effective tax rate benefited from the impacts of non-taxable income related to the settlement of the SGM liability and income tax benefits from historic and energy tax credits, which were partially offset by the valuation allowance recorded against current year SGM operating losses.

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 $6,433 within the next 12 months because of the expiration of statutes of limitations and settlement of tax audits.

Investments in Partnerships Qualifying for Tax Credits

The Company continued to invest in partnerships which make equity investments in projects eligible to receive federal historic and energy tax credits. The investments are accounted for under the equity method and reported within other assets in our Consolidated Balance Sheets. The tax credits, when realized, are recognized as a reduction of tax expense, at which time the corresponding equity investment is written-down to reflect the remaining value of the future benefits to be realized. For the three months ended April 3, 2016, we recognized investment tax credits and related outside basis difference benefit totaling $6,618 and wrote-down the equity investment by $5,593 to reflect the realization of these benefits. The equity investment write-down is reflected within other (income) expense, net in the Consolidated Statements of Income.

10. BUSINESS REALIGNMENT ACTIVITIES

2015 Productivity Initiative

In mid-2015, we announced a new 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 is intended 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. For the three months ended April 3, 2016, we incurred charges totaling $1,458, representing adjustments to estimated severance benefits as well as incremental third-party costs related to the design and implementation of the new organizational structure. Since the program's inception, we have incurred total costs of $107,211, including a pension settlement charge of $10,178 recorded in the fourth quarter of 2015, relating to lump sum withdrawals by employees retiring or leaving the Company as a result of this program.

Total pre-tax charges and costs for this program are currently expected to be approximately $110 million, the majority of which are cash. This excludes the pension settlement cost recorded in 2015 and any additional pension settlement costs that could be triggered by additional lump sum withdrawals in 2016. The remaining costs for the 2015 Productivity Initiative are expected to be incurred over the next two quarters.

China structure optimization

During the first quarter of 2016, we initiated the process of optimizing the China business and workforce structure and incurred initial costs totaling $12,972, relating primarily to severance and other third party charges. In addition, given the challenges impacting the retail landscape in China, we continue to assess the impact of potential excess capacity on operational efficiencies as well as the carrying value of our long-lived assets in the region.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

Other international programs

Costs incurred for the three months ended April 5, 2015 relate principally to accelerated depreciation and amortization and employee severance costs for a couple of programs commenced in 2014 to rationalize certain non-U.S. manufacturing and distribution activities and to establish our own sales and distribution teams in Brazil in connection with our exit from the Bauducco joint venture.

Expenses recorded for business realignment activities during the three months ended April 3, 2016 and April 5, 2015 were classified as follows:



	Three Months Ended
	April 3, 2016			April 5, 2015
Cost of sales:
China structure optimization	$	(487	)	$	—
Other international restructuring programs	—			1,348
Total cost of sales	(487		)	1,348
Selling, marketing and administrative:
2015 productivity initiative	2,752			—
China structure optimization	6,032
Other international restructuring programs	—			1,125
Total selling, marketing and administrative	8,784			1,125
Business realignment charges:
2015 productivity initiative	(1,294		)	—
China integration initiative	7,427			—
Divestiture of Mauna Loa (see Note 2)	—			2,667
Total business realignment charges	6,133			2,667
Total charges associated with business realignment activities	$	14,430		$	5,140

The costs and related benefits to be derived from the 2015 Productivity Initiative relate primarily to the North American segment, while the costs and related benefits of the China integration initiative and other international programs relate primary to the International and Other segment. However, segment operating results do not include business realignment and related charges because we evaluate segment performance excluding such charges.

The following table presents the liability activity for employee related costs qualifying as exit and disposal costs:



	Total
Liability balance at December 31, 2015	$	16,310
2016 business realignment charges	6,133
Cash payments	(6,918		)
Other, net	(161		)
Liability balance at April 3, 2016	$	15,364

The charges reflected in the liability roll-forward above do not include items charged directly to expense, such as accelerated depreciation and amortization and the loss on the Mauna Loa divestiture 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.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

11. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS

The components of net periodic benefit cost for the first quarter were as follows:



	Pension Benefits						Other Benefits
	Three Months Ended						Three Months Ended
	April 3, 2016			April 5, 2015			April 3, 2016			April 5, 2015
Service cost	$	5,884		$	7,423		$	74		$	172
Interest cost	10,835			11,305			2,436			2,588
Expected return on plan assets	(14,541		)	(17,381		)	—			—
Amortization of prior service (credit) cost	(262		)	(291		)	144			153
Amortization of net loss	8,807			8,072			(12		)	—
Total net periodic benefit cost	$	10,723		$	9,128		$	2,642		$	2,913

We made contributions of $1,175 and $7,664 to the pension plans and other benefits plans, respectively, during the first quarter of 2016. In the first quarter of 2015, we made contributions of $851 and $4,456 to our pension plans and other benefits plans, respectively. The contributions in 2016 and 2015 also included benefit payments from our non-qualified pension plans and post-retirement benefit plans.

For 2016, there are no significant minimum funding requirements for our domestic pension plans; however, we expect to make additional contributions of approximately $18,500 to maintain the funded status. Planned voluntary funding of our non-domestic pension plans in 2016 is not material.

12. 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 2015 Annual Report on Form 10-K.

For the periods presented, compensation expense for all types of stock-based compensation programs and the related income tax benefit recognized were as follows:



	Three Months Ended
	April 3, 2016		April 5, 2015
Pre-tax compensation expense	$	11,678	$	13,889
Related income tax benefit	4,087		4,861

Compensation costs for stock compensation plans are primarily included in selling, marketing and administrative expense. As of April 3, 2016, total stock-based compensation cost related to non-vested awards not yet recognized was $99,775 and the weighted-average period over which this amount is expected to be recognized was approximately 2.3 years.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

Stock Options

A summary of activity relating to grants of stock options for the period ended April 3, 2016 is as follows:



Stock Options	Shares		Weighted-Average Exercise Price (per share)	Weighted-Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at beginning of the period	6,842,563		$75.48	5.8 years
Granted	1,326,045		$90.38
Exercised	(583,269	)	$54.65
Forfeited	(96,163	)	$104.33
Outstanding as of April 3, 2016	7,489,176		$79.34	6.6 years	$	114,827
Options exercisable as of April 3, 2016	4,596,241		$68.79	5.1 years	$	112,614

The weighted-average fair value of options granted was $11.42 and $19.31 per share for the periods ended April 3, 2016 and April 5, 2015, respectively. The fair value was estimated on the date of grant using a Black-Scholes option-pricing model and the following weighted-average assumptions:



	Three Months Ended
	April 3, 2016		April 5, 2015
Dividend yields	2.4	%	2.0	%
Expected volatility	16.8	%	20.8	%
Risk-free interest rates	1.5	%	1.9	%
Expected lives in years	6.8		6.7

The total intrinsic value of options exercised was $20,348 and $39,606 for the periods ended April 3, 2016 and April 5, 2015, respectively.

Performance Stock Units and Restricted Stock Units

A summary of activity relating to grants of PSUs and RSUs for the period ended April 3, 2016 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	495,207		$106.40
Granted	483,678		$92.88
Performance assumption change	(16,056	)	$97.33
Vested	(179,866	)	$95.78
Forfeited	(10,056	)	$95.07
Outstanding as of April 3, 2016	772,907		$102.24

The table above excludes PSU awards for 6,893 units as of April 3, 2016 and 20,586 units as of December 31, 2015 for which the measurement date has not yet occurred for accounting purposes.

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.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)



	Three Months Ended
	April 3, 2016			April 5, 2015
Units granted	483,678			266,099
Weighted-average fair value at date of grant	$	92.88		$	109.35
Monte Carlo simulation assumptions:
Estimated values	$	38.02		$	61.22
Dividend yields	2.5		%	2.0		%
Expected volatility	17.0		%	14.9		%

The intrinsic value of share-based liabilities paid, combined with the fair value of shares vested, totaled $16,181 and $37,464 for the periods ended April 3, 2016 and April 5, 2015, respectively.

Deferred PSUs, deferred RSUs and deferred stock units representing directors’ fees totaled 474,483 units as of April 3, 2016. Each unit is equivalent to one share of the Company’s Common Stock.

13. SEGMENT INFORMATION

Our organizational structure is designed to ensure continued focus on North America, coupled with an emphasis on accelerating growth in our focus international markets, as we transform into a more global company. Our business is organized around geographic regions, which enables us to build processes for repeatable success in our global markets. The Presidents of our geographic regions, along with the Senior Vice President responsible for our Global Retail and Licensing business, are accountable for delivering our annual financial plans and report into our CEO, who serves as our Chief Operating Decision Maker (“CODM”), so we have defined our operating segments on a geographic basis. Our North America business currently generates over 89% of our consolidated revenue and none of our other geographic regions are individually significant. Therefore, we currently define our reportable segments as follows:


•	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 - This segment includes all other countries where The Hershey Company currently manufactures, imports, markets, sells or distributes chocolate and non-chocolate confectionery and other products. We currently have operations and manufacture product in China, Mexico, Brazil and India, primarily for consumers in these markets, 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, Chicago, Las Vegas, Shanghai, Niagara Falls (Ontario), Dubai, and Singapore, as well as operations associated with licensing the use of certain of the Company's trademarks and products to third parties around the world.

For segment reporting purposes, we use “segment income” to evaluate segment performance and allocate resources. Segment income excludes unallocated general corporate administrative expenses, unallocated mark-to-market gains and losses on commodity derivatives, business realignment and impairment charges, acquisition integration costs, the non-service related portion of pension expense and other unusual gains or losses that are not part of our measurement of segment performance. These items 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 2015 Annual Report on Form 10-K, with the exception of our accounting methodology for commodities derivatives. As discussed in Note 5, derivatives used to manage commodity price risk are not designated for hedge accounting treatment. These derivatives are recognized at fair market value with the resulting realized and unrealized losses recognized in unallocated derivative gains (losses) outside of the

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

reporting segment results. The gains and losses are subsequently recognized in the operating results of the segments in the period in which the underlying transaction being economically hedged is included in earnings.

Certain manufacturing, warehousing, distribution and other activities supporting our global operations are integrated to maximize efficiency and productivity. As a result, assets and capital expenditures are not managed on a segment basis and are not included in the information reported to the CODM for the purpose of evaluating performance or allocating resources. We disclose depreciation and amortization that is generated by segment-specific assets, since these amounts are included within the measure of segment income reported to the CODM.

Our segment net sales and earnings were as follows:



	Three Months Ended
	April 3, 2016			April 5, 2015
Net sales:
North America	$	1,633,471		$	1,706,995
International and Other	195,341			230,805
Total	$	1,828,812		$	1,937,800

Segment income:
North America	$	529,390		$	554,306
International and Other	(13,233		)	(21,759		)
Total segment income	516,157			532,547
Unallocated corporate expense (1)	122,171			138,672
Unallocated mark-to-market losses on commodity derivatives (2)	34,946			—
Charges associated with business realignment activities	14,430			5,140
Non-service related pension expense	5,101			1,996
Acquisition integration costs	—			2,573
Operating profit	339,509			384,166
Interest expense, net	21,005			19,202
Other (income) expense, net	(21,225		)	(9,840		)
Income before income taxes	$	339,729		$	374,804

(1)

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


(2)	Reflects gains and losses on commodity derivative instruments that are excluded from segment income until the related inventory is sold.

The activity within the unallocated mark-to-market gains (losses) on commodity derivatives for the quarter ended April 3, 2016 included:



	Three Months Ended
	April 3, 2016
Net losses on mark-to-market valuation of unallocated commodity derivative positions	$	(38,941	)
Net losses on commodity derivative positions allocated to segment income	(3,995		)
Net losses on mark-to-market valuation of commodity derivative positions remaining in unallocated derivative gains (losses)	$	(34,946	)

Based on our forecasts of the timing of the recognition of the underlying hedged items, we expect to reclassify losses on commodity derivatives of $13.6 million after tax 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
	April 3, 2016		April 5, 2015
North America	$	38,942	$	35,440
International and Other	10,923		11,124
Corporate	10,048		11,774
Total	$	59,913	$	58,338

14. TREASURY STOCK ACTIVITY

A summary of our treasury stock activity is as follows:



	Three Months Ended April 3, 2016
	Shares		Dollars
			In thousands
Shares repurchased in the open market under pre-approved share repurchase programs	3,366,761		$	303,950
Shares issued for stock options and incentive compensation	(718,604	)	(29,897		)
Net change	2,648,157		$	274,053

The $250 million share repurchase program approved by our Board of Directors in February 2015 was completed in the first quarter of 2016.

In February 2016, our Board of Directors approved an additional $500 million authorization to repurchase shares of our Common Stock. As of April 3, 2016, $216 million remained available for repurchases of our Common Stock under this program. We are authorized to purchase our outstanding shares in open market and privately negotiated transactions. The program has no expiration date and acquired shares of Common Stock will be held as treasury shares. Purchases under approved share repurchase authorizations are in addition to our practice of buying back shares sufficient to offset those issued under incentive compensation plans.

15. 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.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

16. 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.

We compute basic and diluted earnings per share based on the weighted-average number of shares of Common Stock and Class B common stock outstanding as follows:



	Three Months Ended
	April 3, 2016					April 5, 2015
	Common Stock		Class B Common Stock			Common Stock		Class B Common Stock
Basic earnings per share:
Numerator:
Allocation of distributed earnings (cash dividends paid)	$	90,238	$	32,129		$	84,920	$	29,461
Allocation of undistributed earnings	79,376		28,089			97,066		33,290
Total earnings—basic	$	169,614	$	60,218		$	181,986	$	62,751

Denominator (shares in thousands):
Total weighted-average shares—basic	155,675		60,620			160,024		60,620

Earnings Per Share—basic	$	1.09	$	0.99		$	1.14	$	1.04

Diluted earnings per share:
Numerator:
Allocation of total earnings used in basic computation	$	169,614	$	60,218		$	181,986	$	62,751
Reallocation of total earnings as a result of conversion of Class B common stock to Common stock	60,218		—			62,751		—
Reallocation of undistributed earnings	—		(158		)	—		(318		)
Total earnings—diluted	$	229,832	$	60,060		$	244,737	$	62,433

Denominator (shares in thousands):
Number of shares used in basic computation	155,675		60,620			160,024		60,620
Weighted-average effect of dilutive securities:
Conversion of Class B common stock to Common shares outstanding	60,620		—			60,620		—
Employee stock options	1,005		—			1,687		—
Performance and restricted stock options	187		—			388		—
Total weighted-average shares—diluted	217,487		60,620			222,719		60,620

Earnings Per Share—diluted	$	1.06	$	0.99		$	1.10	$	1.03

The earnings per share calculations for the three months ended April 3, 2016 and April 5, 2015 excluded 3,680 and 2,545, respectively, of stock options that would have been antidilutive.

THE HERSHEY COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share data or if otherwise indicated)

17. SUPPLEMENTAL BALANCE SHEET INFORMATION

The components of certain Consolidated Balance Sheet accounts are as follows:



Inventories:	April 3, 2016			December 31, 2015
Raw materials	$	335,838		$	353,451
Goods in process	107,055			67,745
Finished goods	516,365			534,983
Inventories at FIFO	959,258			956,179
Adjustment to LIFO	(188,876		)	(205,209		)
Total inventories	$	770,382		$	750,970



Property, plant and equipment:	April 3, 2016			December 31, 2015
Land	$	96,893		$	96,666
Buildings	1,217,106			1,084,958
Machinery and equipment	2,945,966			2,886,723
Construction in progress	285,761			448,956
Property, plant and equipment, gross	4,545,726			4,517,303
Accumulated depreciation	(2,315,655		)	(2,276,843		)
Property, plant and equipment, net	$	2,230,071		$	2,240,460



Other assets:	April 3, 2016		December 31, 2015
Capitalized software, net	$	69,726	$	68,004
Income tax receivable	1,474		1,428
Other non-current assets	113,904		85,934
Total other assets	$	185,104	$	155,366



Accrued liabilities:	April 3, 2016		December 31, 2015
Payroll, compensations and benefits	$	162,465	$	215,638
Advertising and promotion	351,561		337,945
Due to SGM shareholders	—		72,025
Other	255,767		231,359
Total accrued liabilities	$	769,793	$	856,967



Other long-term liabilities:	April 3, 2016		December 31, 2015
Post-retirement benefits liabilities	$	229,832	$	231,412
Pension benefits liabilities	124,740		122,681
Other	110,951		114,625
Total other long-term liabilities	$	465,523	$	468,718

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

This Management's Discussion and Analysis (“MD&A”) is intended to provide an understanding of Hershey's financial condition, results of operations and cash flows by focusing on changes in certain key measures from year to year. The MD&A should be read in conjunction with our Consolidated Financial Statements and accompanying notes. This discussion contains a number of forward-looking statements, all of which are based on current expectations. Actual results may differ materially. Refer to the Safe Harbor Statement below as well as the Risk Factors and other information contained in our 2015 Annual Report on Form 10-K for information concerning the key risks to achieving future performance goals.

The MD&A is organized in the following sections:


•	Overview and Outlook


•	Non-GAAP Information


•	Consolidated Results of Operations


•	Segment Results


•	Liquidity and Capital Resources

OVERVIEW AND OUTLOOK

Our 2016 first quarter net sales totaled $1,828.8 million, a decline of 5.6% versus our 2015 first quarter sales of $1,937.8 million. Excluding a 1.2% impact from unfavorable foreign currency exchange rates, our net sales decreased 4.4%. The decline was driven by lower North America volumes due primarily to a shorter Easter season in 2016 and lower non-seasonal activity as greater levels of innovation and in-store merchandising are anticipated over the remainder of the year, coupled with lower net sales in China, as we had anticipated. In addition, net price realization was slightly unfavorable, as the benefit of price realization on our seasonal confectionery products was more than offset by increased levels of direct trade.

Our reported gross margin decreased 180 basis points in the first quarter of 2016, primarily driven by mark-to-market losses on commodity derivatives since we are no longer electing to designate any of our existing or new commodity derivatives for hedge accounting treatment. Our non-GAAP gross margin (as defined in the Non-GAAP Information section of this MD&A) increased 20 basis points in the first quarter of 2016 as a result of supply chain productivity and cost savings initiatives as well as lower commodity costs.

In the fourth quarter of 2015, we reached an agreement with the Shanghai Golden Monkey (“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. We are directing our efforts currently on executing an integration plan that is focused on the optimal structure for top-line growth.

Building on our snacks strategy, in late April 2016, we purchased Ripple Brand Collective, LLC, a privately held company that owns the barkTHINS mass premium chocolate snacking brand. Since its launch in 2013, barkTHINS has quickly become a favorite snack brand due to its commitment to using simple ingredients, fair trade cocoa and non-GMO certification. barkTHINS is a very attractive and uniquely crafted brand that essentially created the chocolate “thins” category, a new form of chocolate snacking. We anticipate building barkTHINS by leveraging Hershey’s scale at retail.

We expect total consolidated net sales to accelerate over the remainder of the year driven by core brands and innovation. Our new products will bring variety and news to the category such as Reese's Snack Mix, Hershey's Snack Bites, Cadbury chocolates targeting the mass premium market, Reese's white minis and Kit Kat big Kat. We believe these investments should enable us to continue to gain share in the U.S. market. Additionally, new advertising campaigns on many of our key brands, including Hershey's, Kit Kat and Ice Breakers will begin in the second quarter.

We currently estimate full year 2016 constant currency net sales growth of approximately 2.5%, which includes a 0.5% net benefit from acquisitions and divestitures. The Company expects a 1.0% unfavorable impact from foreign currency exchange rates. Excluding unfavorable foreign currency exchange rates and the barkTHINS acquisition, full-year net sales are expected to increase about 2.0%. This is less than the previous estimate of 3.0%, primarily due to lower than expected non-seasonal growth over the remainder of the year. The Company expects gross margin, as determined on a non-GAAP basis, to be slightly below 2015 levels due to unfavorable sales mix. We expect to exceed our initial 2016 productivity and cost savings target by $10 million to $15 million, and we will continue to invest in advertising and related consumer marketing, including a greater shift to digital and mobile communications. As a result, we currently expect adjusted earnings per share-diluted for 2016 to increase 3.0% to 4.0%, including barkTHINS dilution of $0.05 to $0.06 per share, and be in the $4.24 to $4.28 range.

NON-GAAP INFORMATION

The comparability of certain of our financial measures is impacted by unallocated mark-to-market gains and losses on commodity derivatives, business realignment charges, costs relating to the integration of acquisitions, non-service related components of our pension expense ("NSRPE"), and other non-recurring gains and losses.

To provide additional information to investors to facilitate the comparison of past and present performance, we use non-GAAP financial measures within MD&A that exclude the financial impact of these activities. These non-GAAP financial measures are used internally by management in evaluating results of operations and determining incentive compensation, and in assessing the impact of known trends and uncertainties on our business, but they are not intended to replace the presentation of financial results in accordance with GAAP. A reconciliation of the non-GAAP financial measures referenced in MD&A to their nearest comparable GAAP financial measures as presented in the Consolidated Statements of Income is provided below.



Reconciliation of Certain Non-GAAP Financial Measures
Consolidated results	Three Months Ended
In thousands except per share data	April 3, 2016			April 5, 2015
Reported gross profit	$	817,376		$	900,843
Derivative mark-to-market losses	34,946			—
Business realignment activities	(487		)	1,348
Acquisition integration costs	—			134
NSRPE	3,241			761
Non-GAAP gross profit	$	855,076		$	903,086

Reported operating profit	$	339,509		$	384,166
Derivative mark-to-market losses	34,946			—
Business realignment activities	14,430			5,140
Acquisition integration costs	—			2,573
NSRPE	5,101			1,996
Non-GAAP operating profit	$	393,986		$	393,875

Reported provision for income taxes	$	109,897		$	130,067
Derivative mark-to-market losses	13,245			—
Business realignment activities	3,538			3,068
Acquisition integration costs	—			842
NSRPE	1,953			782
Gain on sale of trademark	—			(3,662		)
Non-GAAP provision for income taxes	$	128,633		$	131,097

Reported net income	$	229,832		$	244,737
Derivative mark-to-market losses	21,701			—
Business realignment activities	10,860			2,072
Acquisition integration costs	—			1,731
NSRPE	3,148			1,214
Settlement of SGM liability	(26,650		)	—
Gain on sale of trademark	—			(6,288		)
Non-GAAP net income	$	238,891		$	243,466

Reported EPS - Diluted	$	1.06		$	1.10
Derivative mark-to-market losses	0.10			—
Business realignment activities	0.05			0.01
Acquisition integration costs	—			0.01
NSRPE	0.01			—
Settlement of SGM liability	(0.12		)	—
Gain on sale of trademark	—			(0.03		)
Non-GAAP EPS - Diluted	$	1.10		$	1.09

In the assessment of our results, we review and discuss the following financial metrics that are derived from the reported and non-GAAP financial measures presented above:



	Three Months Ended
	April 3, 2016		April 5, 2015
As reported gross margin	44.7	%	46.5	%
Non-GAAP gross margin (1)	46.8	%	46.6	%

As reported operating profit margin	18.6	%	19.8	%
Non-GAAP operating profit margin (2)	21.5	%	20.3	%