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 October 2, 2016
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” 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—151,609,649 shares, as of October 21, 2016.
Class B Common Stock, one dollar par value—60,619,777 shares, as of October 21, 2016.




THE HERSHEY COMPANY
Quarterly Report on Form 10-Q
For the Period Ended October 2, 2016

TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Net sales
 
$
2,003,454

 
$
1,960,779

 
$
5,469,937

 
$
5,477,404

Costs and expenses:
 
 
 
 
 
 
 
 
Cost of sales
 
1,152,606

 
1,068,715

 
3,054,315

 
2,949,089

Selling, marketing and administrative
 
474,494

 
500,306

 
1,408,759

 
1,469,861

Goodwill impairment
 
—

 
30,991

 
—

 
280,802

Business realignment charges
 
2,330

 
57,753

 
30,568

 
82,972

Total costs and expenses
 
1,629,430

 
1,657,765

 
4,493,642

 
4,782,724

Operating profit
 
374,024

 
303,014

 
976,295

 
694,680

Interest expense, net
 
24,387

 
46,967

 
66,730

 
85,046

Other (income) expense, net
 
21,800

 
9,409

 
8,703

 
4,328

Income before income taxes
 
327,837

 
246,638

 
900,862

 
605,306

Provision for income taxes
 
100,434

 
91,867

 
297,671

 
305,739

Net income
 
$
227,403

 
$
154,771

 
$
603,191

 
$
299,567

 
 
 
 
 
 
 
 
 
Net income per share—basic:
 
 
 
 
 
 
 
 
Common stock
 
$
1.09

 
$
0.73

 
$
2.88

 
$
1.40

Class B common stock
 
$
0.99

 
$
0.66

 
$
2.63

 
$
1.27

 
 
 
 
 
 
 
 
 
Net income per share—diluted:
 
 
 
 
 
 
 
 
Common stock
 
$
1.06

 
$
0.70

 
$
2.80

 
$
1.35

Class B common stock
 
$
0.99

 
$
0.66

 
$
2.62

 
$
1.28

 
 
 
 
 
 
 
 
 
Dividends paid per share:
 
 
 
 
 
 
 
 
Common stock
 
$
0.618

 
$
0.583

 
$
1.784

 
$
1.653

Class B common stock
 
$
0.562

 
$
0.530

 
$
1.622

 
$
1.502


See Notes to Unaudited Consolidated Financial Statements.

3


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

 
 
Three Months Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Net income
 
$
227,403

 
$
154,771

 
$
603,191

 
$
299,567

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
(8,533
)
 
(26,631
)
 
5,053

 
(51,681
)
Pension and post-retirement benefit plans
 
7,395

 
9,969

 
9,884

 
20,896

Cash flow hedges:
 
 
 
 
 
 
 
 
Gains (losses) on cash flow hedging derivatives
 
1,144

 
(43,914
)
 
(34,789
)
 
21,023

Reclassification adjustments
 
(898
)
 
(6,214
)
 
(7,985
)
 
(17,711
)
Total other comprehensive income (loss), net of tax
 
(892
)
 
(66,790
)
 
(27,837
)
 
(27,473
)
Total comprehensive income
 
$
226,511

 
$
87,981

 
$
575,354

 
$
272,094

Comprehensive loss (income) attributable to noncontrolling interests
 
751

 
(820
)
 
2,040

 
2,111

Comprehensive income attributable to The Hershey Company
 
$
227,262

 
$
87,161

 
$
577,394

 
$
274,205


See Notes to Unaudited Consolidated Financial Statements.

4


THE HERSHEY COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
October 2, 2016
 
December 31, 2015
ASSETS
 
(unaudited)
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
333,333

 
$
346,529

Accounts receivable—trade, net
 
759,619

 
599,073

Inventories
 
843,519

 
750,970

Prepaid expenses and other
 
194,046

 
152,026

Total current assets
 
2,130,517

 
1,848,598

Property, plant and equipment, net
 
2,159,589

 
2,240,460

Goodwill
 
816,133

 
684,252

Other intangibles
 
510,291

 
379,305

Other assets
 
169,753

 
155,366

Deferred income taxes
 
59,130

 
36,390

Total assets
 
$
5,845,413

 
$
5,344,371

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
458,028

 
$
474,266

Accrued liabilities
 
683,012

 
856,967

Accrued income taxes
 
13,588

 
23,243

Short-term debt
 
612,383

 
363,513

Current portion of long-term debt
 
250,024

 
499,923

Total current liabilities
 
2,017,035

 
2,217,912

Long-term debt
 
2,362,466

 
1,557,091

Other long-term liabilities
 
478,707

 
468,718

Deferred income taxes
 
45,133

 
53,188

Total liabilities
 
4,903,341

 
4,296,909

 
 
 
 
 
Stockholders’ equity:
 
 
 
 
The Hershey Company stockholders’ equity
 
 
 
 
Preferred stock, shares issued: none at October 2, 2016 and December 31, 2015, respectively
 
—

 
—

Common stock, shares issued: 299,281,967 at October 2, 2016 and December 31, 2015, respectively
 
299,281

 
299,281

Class B common stock, shares issued: 60,619,777 at October 2, 2016 and December 31, 2015, respectively
 
60,620

 
60,620

Additional paid-in capital
 
852,675

 
783,877

Retained earnings
 
6,129,088

 
5,897,603

Treasury—common stock shares, at cost: 146,305,207 at October 2, 2016 and 143,124,384 at December 31, 2015
 
(6,049,397
)
 
(5,672,359
)
Accumulated other comprehensive loss
 
(396,822
)
 
(371,025
)
The Hershey Company stockholders’ equity
 
895,445

 
997,997

Noncontrolling interests in subsidiaries
 
46,627

 
49,465

Total stockholders’ equity
 
942,072

 
1,047,462

Total liabilities and stockholders’ equity
 
$
5,845,413

 
$
5,344,371


See Notes to Unaudited Consolidated Financial Statements.

5


THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Nine Months Ended
 
October 2, 2016
 
October 4, 2015
Operating Activities
 
 
 
Net income
$
603,191

 
$
299,567

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
241,901

 
182,855

Stock-based compensation expense
40,699

 
39,989

Excess tax benefits from stock-based compensation
(20,978
)
 
(22,966
)
Deferred income taxes
(12,703
)
 
(10,385
)
Goodwill impairment
—

 
280,802

Contributions to pension and other benefits plans
(42,566
)
 
(45,187
)
Loss on early extinguishment of debt
—

 
28,326

Write-down of equity investments
35,862

 
13,895

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
(157,142
)
 
(186,156
)
Inventories
(83,221
)
 
(2,064
)
Accounts payable and accrued liabilities
(159,871
)
 
(55,890
)
Other assets and liabilities
4,017

 
72,299

Net cash provided by operating activities
422,539

 
595,085

Investing Activities
 
 
 
Capital additions (including software)
(168,225
)
 
(237,893
)
Proceeds from sales of property, plant and equipment
3,032

 
1,184

Proceeds from sale of business
—

 
32,408

Equity investments in tax credit qualifying partnerships
(35,395
)
 
(3,775
)
Business acquisitions, net of cash and cash equivalents acquired
(285,374
)
 
(218,654
)
Sale of short-term investments
—

 
95,316

Net cash used in investing activities
(485,962
)
 
(331,414
)
Financing Activities
 
 
 
Net increase in short-term debt
250,573

 
336,851

Long-term borrowings
792,923

 
599,031

Repayment of long-term debt
(250,000
)
 
(351,042
)
Payment of SGM liability (see Note 2)
(35,762
)
 
—

Cash dividends paid
(371,706
)
 
(353,070
)
Exercise of stock options
95,336

 
63,623

Excess tax benefits from stock-based compensation
20,978

 
22,966

Purchase of noncontrolling interest
—

 
(38,270
)
Repurchase of common stock
(452,580
)
 
(567,480
)
Net cash provided by (used in) financing activities
49,762

 
(287,391
)
Effect of exchange rate changes on cash and cash equivalents
465

 
(7,221
)
Decrease in cash and cash equivalents
(13,196
)
 
(30,941
)
Cash and cash equivalents, beginning of period
346,529

 
374,854

Cash and cash equivalents, end of period
$
333,333

 
$
343,913

Supplemental Disclosure
 
 
 
Interest paid (excluding loss on early extinguishment of debt in 2015)
$
72,925

 
$
71,124

Income taxes paid
306,580

 
256,610

See Notes to Unaudited Consolidated Financial Statements.

6


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

 
Preferred
Stock
 
Common
Stock
 
Class B
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Treasury
Common
Stock
 
Accumulated Other
Comprehensive
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
 
 
 
 
 
 
 
 
 
603,191

 
 
 
 
 
 
 
603,191

Other comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
(25,797
)
 
(2,040
)
 
(27,837
)
Dividends:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock, $1.784 per share
 
 
 
 
 
 
 
 
 
(273,380
)
 
 
 
 
 
 
 
(273,380
)
Class B Common Stock, $1.622 per share
 
 
 
 
 
 
 
 
 
(98,326
)
 
 
 
 
 
 
 
(98,326
)
Stock-based compensation
 
 
 
 
 
 
 
39,621

 
 
 
 
 
 
 
 
 
39,621

Exercise of stock options and incentive-based transactions
 
 
 
 
 
 
 
29,177

 
 
 
75,542

 
 
 
 
 
104,719

Repurchase of common stock
 
 
 
 
 
 
 
 
 
 
 
(452,580
)
 
 
 
 
 
(452,580
)
Net loss attributable to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(798
)
 
(798
)
Balance, October 2, 2016
 
$
—

 
$
299,281

 
$
60,620

 
$
852,675

 
$
6,129,088

 
$
(6,049,397
)
 
$
(396,822
)
 
$
46,627

 
$
942,072

See Notes to Unaudited Consolidated Financial Statements.

7
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The unaudited consolidated financial statements provided in this report include the accounts of The Hershey Company (the “Company,” “Hershey,” “we” or “us”) and our majority-owned subsidiaries and entities in which we have a controlling financial interest after the elimination of intercompany accounts and transactions. We have a controlling financial interest if we own a majority of the outstanding voting common stock and the noncontrolling shareholders do not have substantive participating rights, or we have significant control over an entity through contractual or economic interests in which we are the primary beneficiary.
The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not contain certain information and disclosures required by GAAP for comprehensive financial statements. 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 October 2, 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 presented in the Consolidated Statements of Cash Flows have been reclassified to conform to the current year presentation.
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 lessees to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. This ASU also requires certain quantitative and qualitative disclosures. Accounting guidance for lessors is largely unchanged. The amendments should be applied on a modified retrospective basis. ASU 2016-02 is effective for us beginning January 1, 2019. We are 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 adopt the standard as of the original effective date. The standard permits the use of either the retrospective or

8
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


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. The business enables us to expand our mass premium offerings and is expected to generate 2016 annual net sales of approximately $65 million to $75 million.
The purchase consideration was allocated to assets acquired and liabilities assumed based on their respective fair values as follows:
Goodwill
$
127,455

Trademarks
91,200

Other intangible assets
60,900

Other assets, primarily current assets, net of cash acquired totaling $674
13,030

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

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

9
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


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 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

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 Unaudited Consolidated Statements of Income.

10
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


3. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying value of goodwill by reportable segment for the nine months ended October 2, 2016 are as follows:
 
 
North America
 
    International and Other
 
Total
Balance at December 31, 2015
 
$
662,083

 
$
22,169

 
$
684,252

Acquired during the period (see Note 2)
 
127,455

 
—

 
127,455

Foreign currency translation
 
5,709

 
(1,283
)
 
4,426

Balance at October 2, 2016
 
$
795,247

 
$
20,886

 
$
816,133

The following table provides the gross carrying amount and accumulated amortization for each major class of intangible asset:
 
 
October 2, 2016
 
December 31, 2015
Intangible assets not subject to amortization:
 
 
 
 
Trademarks
 
43,072

 
43,775

Intangible assets subject to amortization:
 
 
 
 
Trademarks, customer relationships, patents and other finite-lived intangibles
 
538,753

 
390,900

Less: accumulated amortization
 
(71,534
)
 
(55,370
)
Total other intangible assets
 
$
510,291

 
$
379,305

Total amortization expense for the three months ended October 2, 2016 and October 4, 2015 was $7,666 and $5,340, respectively. Total amortization expense for the nine months ended October 2, 2016 and October 4, 2015 was $18,811 and $16,469, 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 $400,000 with the consent of the lenders. On June 16, 2016, we entered into an additional unsecured revolving credit facility that provided for borrowings up to $500,000. We terminated this facility, which was scheduled to expire on June 15, 2017, effective October 24, 2016.
The credit agreement contains (and the credit agreement terminated effective October 24, 2016) certain financial and other covenants, customary representations, warranties and events of default. As of October 2, 2016, we were in compliance with all covenants pertaining to the credit agreements, 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 $217,017 and $313,520 at October 2, 2016 and December 31, 2015, respectively. Commitment fees relating to our revolving credit facility and lines of credit are not material.
At October 2, 2016, we had outstanding commercial paper totaling $395,366, at a weighted average interest rate of 0.45%. At December 31, 2015, we had outstanding commercial paper totaling $49,993, at a weighted average interest rate of 0.40%.

11
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:
 
 
October 2, 2016
 
December 31, 2015
5.45% Notes due 2016 (1)
 
$
—

 
$
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

2.30% Notes due 2026 (2)
 
500,000

 
—

7.2% Debentures due 2027
 
193,639

 
193,639

3.375% Notes due 2046 (2)
 
300,000

 
—

Other obligations, net of debt issuance costs and unamortized debt discount
 
84,136

 
78,660

Total long-term debt
 
2,612,490

 
2,057,014

Less—current portion
 
250,024

 
499,923

Long-term portion
 
$
2,362,466

 
$
1,557,091

(1)
In September 2016, we repaid $250,000 of 5.45% Notes due in 2016 upon their maturity.
(2)
In August 2016, we issued $500,000 of 2.30% Notes due in 2026 and $300,000 of 3.375% Notes due in 2046 (the "Notes"). Proceeds from the issuance of the Notes, net of discounts and issuance costs, totaled $792,923. 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 consisted of the following:
 
 
Three Months Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Interest expense
 
$
25,882

 
$
22,590

 
$
72,404

 
$
68,874

Less: Capitalized interest
 
(1,141
)
 
(3,071
)
 
(4,702
)
 
(9,314
)
Loss on extinguishment of debt
 
—

 
28,326

 
—

 
28,326

Interest expense
 
24,741

 
47,845

 
67,702

 
87,886

Interest income
 
(354
)
 
(878
)
 
(972
)
 
(2,840
)
Interest expense, net
 
$
24,387

 
$
46,967

 
$
66,730

 
$
85,046

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.

12
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


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. Under hedge accounting, 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 cost of sales.
Effective July 6, 2015 for cocoa commodity derivatives and January 1, 2016 for other commodity derivatives, we discontinued the designation of any of our existing or new cocoa or other commodity derivatives for hedge accounting treatment.  Since such dates, changes in the fair value of these derivatives have been recorded as incurred within cost of sales. Effective as of such dates, we also 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 enables us to continue to align the derivative gains and losses with the underlying economic exposure being hedged and thereby eliminate the mark-to-market volatility within our reported segment income.
Foreign Exchange Price Risk
We are exposed to foreign currency exchange rate risk related to our international operations, including non-functional currency intercompany debt and other non-functional currency transactions of certain subsidiaries. Principal currencies hedged include the euro, Canadian dollar, Japanese yen, and Brazilian real. We typically utilize foreign currency forward exchange contracts and options to hedge these exposures for 3- to 12-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 $86,896 at October 2, 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 October 2, 2016 and December 31, 2015, 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
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. We had one interest rate swap agreement in a cash flow hedging relationship with a notional amount of $500,000 at December 31, 2015. This interest rate swap agreement was settled in connection with the issuance of debt in August 2016, resulting in a payment of approximately $87,000, which is reflected as an operating outflow within the Consolidated Statement of Cash Flows.
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 October 2, 2016 and December 31, 2015, respectively.
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

13
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


administrative expense, together with the change in the related liabilities. The notional amount of the contracts outstanding was $19,740 at October 2, 2016 and $22,230 at December 31, 2015.
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 October 2, 2016 and December 31, 2015:
 
 
October 2, 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)
 
944

 
2,419

 
367

 
475

Interest rate swap agreements (4)
 
—

 
—

 
—

 
40,299

 
 
944

 
2,419

 
367

 
41,253

Derivatives designated as fair value hedging instruments:
 
 
 
 
 
 
 
 
Interest rate swap agreements (4)
 
15,349

 
—

 
4,313

 
—

 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Commodities futures and options (2)
 
425

 
730

 
—

 
1,574

Deferred compensation derivatives (5)
 
665

 
—

 
1,198

 
—

Foreign exchange contracts (3)
 
—

 
454

 
69

 
—

 
 
1,090

 
1,184

 
1,267

 
1,574

Total
 
$
17,383

 
$
3,603

 
$
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 October 2, 2016, assets included the net of assets of $35,999 and liabilities of $35,574 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. At October 2, 2016 and December 31, 2015, the remaining amount in liabilities related to the fair value of other non-exchange traded derivative instruments.
(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

14
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


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 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 October 2, 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
 
 
October 2, 2016
 
December 31, 2015
 
October 2, 2016
 
December 31, 2015
Current portion of long-term debt
 
$
250,130

 
$
509,580

 
$
250,024

 
$
499,923

Long-term debt
 
2,510,841

 
1,668,379

 
2,362,466

 
1,557,091

Total
 
$
2,760,971

 
$
2,177,959

 
$
2,612,490

 
$
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 October 2, 2016 and October 4, 2015 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)
 
Gains recognized in income (ineffective portion) (c)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Commodities futures and options
 
$
(37,246
)
 
$
—

 
$
—

 
$
(34,571
)
 
$
7,780

 
$
11,000

 
$
—

 
$
1,288

Foreign exchange contracts
 
(27
)
 
750

 
1,628

 
662

 
(2,659
)
 
185

 
—

 
—

Interest rate swap agreements
 
—

 
—

 
(274
)
 
(36,187
)
 
(2,833
)
 
(1,166
)
 
—

 
—

Deferred compensation derivatives
 
665

 
(1,403
)
 
—

 
—

 
—

 
—

 
—

 
—

Total
 
$
(36,608
)
 
$
(653
)
 
$
1,354

 
$
(70,096
)
 
$
2,288

 
$
10,019

 
$
—

 
$
1,288


(a)
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 accumulated OCI ("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

15
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


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 effect of derivative instruments on the Consolidated Statements of Income for the nine months ended October 2, 2016 and October 4, 2015 was as follows:
 
 
Non-designated Hedges
 
Cash Flow Hedges
 
 
 
 
 
Gains (losses) recognized in income (a)
 
Gains (losses) recognized in OCI (effective portion)
 
Gains (losses) reclassified from AOCI into income (effective portion) (b)
 
Gains recognized in income (ineffective portion) (c)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Commodities futures and options
 
$
(37,176
)
 
$
(2,777
)
 
$
—

 
$
62,619

 
$
23,648

 
$
31,300

 
$
—

 
$
2,142

Foreign exchange contracts
 
(484
)
 
474

 
(6,404
)
 
158

 
(3,681
)
 
273

 
—

 
—

Interest rate swap agreements
 
—

 
—

 
(47,223
)
 
(28,184
)
 
(5,903
)
 
(3,479
)
 
—

 
—

Deferred compensation derivatives
 
1,486

 
(1,024
)
 
—

 
—

 
—

 
—

 
—

 
—

Total
 
$
(36,174
)
 
$
(3,327
)
 
$
(53,627
)
 
$
34,593

 
$
14,064

 
$
28,094

 
$
—

 
$
2,142


(a)
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 amount of net losses on derivative instruments, including interest rate swap agreements, foreign currency forward exchange contracts and options, commodities futures and options contracts, and other commodity derivative instruments expected to be reclassified from AOCI into earnings in the next 12 months was approximately $5,270 after tax as of October 2, 2016. This amount is primarily associated with losses on interest rate swap agreements and foreign currency forward exchange contracts, which more than offset gains on commodities futures contracts.
Fair Value Hedges
For the three months ended October 2, 2016 and October 4, 2015, we recognized a pretax benefit to interest expense of $1,022 and $1,548, respectively, relating to our fixed-to-floating interest swap agreements. For the nine months ended October 2, 2016 and October 4, 2015, we recognized a pretax benefit to interest expense of $3,477 and $5,597, respectively, relating to our fixed-to-floating interest swap arrangements.


16
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


6. NONCONTROLLING INTEREST IN SUBSIDIARY
We currently own a 50% controlling interest in Lotte Shanghai Foods Co., Ltd. (“LSFC”), a joint venture established in 2007 in China for the purpose of manufacturing and selling product to the venture partners.
A roll-forward showing the 2016 activity relating to the noncontrolling interest follows:
 
Noncontrolling Interests
Balance, December 31, 2015
$
49,465

Net loss attributable to noncontrolling interests (1)
(798
)
Other comprehensive loss - foreign currency translation adjustments
(2,040
)
Balance, October 2, 2016
$
46,627

(1) Amount is not considered significant and is presented within selling, marketing and administrative expenses.
7. COMPREHENSIVE INCOME
A summary of the components of comprehensive income is as follows:
 
 
Three Months Ended
 
Three Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
 
Pre-Tax
Amount
 
Tax
(Expense)
Benefit
 
After-Tax
Amount
 
Pre-Tax
Amount
 
Tax
(Expense)
Benefit
 
After-Tax
Amount
Net income
 
 
 
 
 
$
227,403

 
 
 
 
 
$
154,771

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
$
(8,533
)
 
$
—

 
(8,533
)
 
$
(26,631
)
 
$
—

 
(26,631
)
Pension and post-retirement benefit plans (a)
 
11,896

 
(4,501
)
 
7,395

 
15,962

 
(5,993
)
 
9,969

Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on cash flow hedging derivatives
 
1,354

 
(210
)
 
1,144

 
(70,096
)
 
26,182

 
(43,914
)
Reclassification adjustments (b)
 
(2,288
)
 
1,390

 
(898
)
 
(10,019
)
 
3,805

 
(6,214
)
Total other comprehensive loss
 
$
2,429

 
$
(3,321
)
 
(892
)
 
$
(90,784
)
 
$
23,994

 
(66,790
)
Total comprehensive income
 
 
 
 
 
$
226,511

 
 
 
 
 
$
87,981

Comprehensive loss (gain) attributable to noncontrolling interests
 
 
 
 
 
751

 
 
 
 
 
(820
)
Comprehensive income attributable to The Hershey Company
 
 
 
 
 
$
227,262

 
 
 
 
 
$
87,161

 

17
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


 
 
Nine Months Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
 
Pre-Tax
Amount
 
Tax
(Expense)
Benefit
 
After-Tax
Amount
 
Pre-Tax
Amount
 
Tax
(Expense)
Benefit
 
After-Tax
Amount
Net income
 
 
 
 
 
$
603,191

 
 
 
 
 
$
299,567

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
$
5,053

 
$
—

 
5,053

 
$
(51,681
)
 
$
—

 
(51,681
)
Pension and post-retirement benefit plans (a)
 
16,395

 
(6,511
)
 
9,884

 
32,776

 
(11,880
)
 
20,896

Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on cash flow hedging derivatives
 
(53,627
)
 
18,838

 
(34,789
)
 
34,593

 
(13,570
)
 
21,023

Reclassification adjustments (b)
 
(14,064
)
 
6,079

 
(7,985
)
 
(28,094
)
 
10,383

 
(17,711
)
Total other comprehensive loss
 
$
(46,243
)
 
$
18,406

 
(27,837
)
 
$
(12,406
)
 
$
(15,067
)
 
(27,473
)
Total comprehensive income
 
 
 
 
 
$
575,354

 
 
 
 
 
$
272,094

Comprehensive loss attributable to noncontrolling interests
 
 
 
 
 
2,040

 
 
 
 
 
2,111

Comprehensive income attributable to The Hershey Company
 
 
 
 
 
$
577,394

 
 
 
 
 
$
274,205

 
(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:
 
 
October 2, 2016
 
December 31, 2015
Foreign currency translation adjustments
 
$
(94,143
)
 
$
(101,236
)
Pension and post-retirement benefit plans, net of tax
 
(244,764
)
 
(254,648
)
Cash flow hedges, net of tax
 
(57,915
)
 
(15,141
)
Total accumulated other comprehensive loss
 
$
(396,822
)
 
$
(371,025
)
8. OTHER (INCOME) EXPENSE, NET
Other (income) expense, net reports certain gains and losses associated with activities not directly related to our core operations. A summary of the components of other (income) expense, net include the following:
 
Three Months Ended
 
Nine Months Ended
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Write-down of equity investments in partnerships qualifying for tax credits
$
20,801

 
$
9,249

 
$
35,862

 
$
13,893

Settlement of SGM (see Note 2)
—

 
—

 
(26,650
)
 
—

Gain on sale of non-core trademark
—

 
—

 
—

 
(9,950
)
Other (income) expense, net
999

 
160

 
(509
)
 
385

Total
$
21,800


$
9,409

 
$
8,703

 
$
4,328


18
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 nine months ended October 2, 2016 and October 4, 2015 were 33.0% and 50.5%, respectively. Adjusting for the impact of the 2015 non-deductible goodwill impairment charge, the 2015 year to date effective income tax rate was 34.5%. The 2016 effective tax rate benefited from the impact of non-taxable income related to the settlement of the SGM liability and investment and research and development tax credits, which were partially offset by the current period SGM valuation allowance.
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 $12,175 within the next 12 months because of the expiration of statutes of limitations and settlement of tax audits.
10. BUSINESS REALIGNMENT ACTIVITIES
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 will result in select facility consolidations. The program encompasses the continued transition of our China chocolate and SGM operations into a united Golden Hershey platform, including the integration of the China sales force, as well as the consolidation of production within certain facilities in China and North America.
We expect to incur pre-tax costs of approximately $120 million over three years, including approximately $65 million in non-cash asset-related incremental depreciation costs, with the remainder relating to severance and employee benefit costs, costs to consolidate and relocate production, and third-party costs incurred to execute these activities. The program is expected to drive annual savings of approximately $45 million by 2018.
2015 Productivity Initiative
In mid-2015, we initiated a productivity initiative (the “2015 Productivity Initiative”) intended to move decision making closer to the customer and the consumer, to enable a more enterprise-wide approach to innovation, to more swiftly advance our knowledge agenda, and to provide for a more efficient cost structure, while ensuring that we effectively allocate resources to future growth areas. Overall, the 2015 Productivity Initiative was undertaken to simplify the organizational structure to enhance the Company's ability to rapidly anticipate and respond to the changing demands of the global consumer.
The 2015 Productivity Initiative was executed throughout the third and fourth quarters of 2015, resulting in a net reduction of approximately 300 positions, with the majority of the departures taking place by the end of 2015. For the three and nine months ended October 2, 2016, we incurred charges totaling $2,991 and $19,278, respectively, representing pension settlement charges, adjustments to estimated severance benefits and incremental third-party costs related to the design and implementation of the new organizational structure. As of October 2, 2016, we have completed the 2015 Productivity Initiative. We incurred total costs of $125,031 relating to this program, including pension settlement charges of $13,669 recorded in 2016 and $10,178 recorded in 2015 relating to lump sum withdrawals by employees retiring or leaving the Company as a result of this program.
Other international programs
Costs incurred for the three and nine months ended October 4, 2015 related 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.

19
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


Expenses recorded for business realignment activities during the three and nine months ended October 2, 2016 and October 4, 2015 were classified as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Cost of sales (1):
 
 
 
 
 
 
 
 
Operational optimization program
 
$
24,470

 
$
—

 
$
57,948

 
$
—

Other international restructuring programs
 
—

 
2,529

 
—

 
5,205

Total cost of sales
 
24,470

 
2,529

 
57,948

 
5,205

Selling, marketing and administrative (2):
 
 
 
 
 
 
 
 
Operational optimization program
 
414

 
—

 
9,822

 
—

2015 productivity initiative
 
748

 
6,515

 
6,149

 
10,017

Other international restructuring programs
 
—

 
666

 
—

 
3,234

Total selling, marketing and administrative
 
1,162

 
7,181

 
15,971

 
13,251

Business realignment charges (3):
 
 
 
 
 
 
 
 
Operational optimization program
 
87

 
—

 
17,442

 
—

2015 productivity initiative
 
2,243

 
57,753

 
13,126

 
80,305

Divestiture of Mauna Loa (see Note 2)
 
—

 
—

 
—

 
2,667

Total business realignment charges
 
2,330

 
57,753

 
30,568

 
82,972

Total charges associated with business realignment activities
 
$
27,962

 
$
67,463

 
$
104,487

 
$
101,428

(1)
Charges primarily relate to non-cash asset-related accelerated depreciation and amortization.
(2)
Charges primarily relate to third-party costs incurred to execute the restructuring initiatives.
(3)
Charges largely relate to employee severance and benefits, including pension settlement costs for the 2015 Productivity Initiative.
The costs and related benefits of the Operational Optimization Program relate approximately 15% to the North America segment and 85% to the International and Other segment. 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 other international programs relate primary to the International and Other segment. However, segment operating results do not include these 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
 
16,899

Cash payments
 
(28,150
)
Other, net
 
(206
)
Liability balance at October 2, 2016
 
$
4,853

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.


20
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 third quarter were as follows:  
 
 
Pension Benefits
 
Other Benefits
 
 
Three Months Ended
 
Three Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Service cost
 
$
5,794

 
$
7,068

 
$
75

 
$
135

Interest cost
 
10,130

 
11,025

 
2,435

 
2,516

Expected return on plan assets
 
(14,700
)
 
(17,146
)
 
—

 
—

Amortization of prior service (credit) cost
 
(262
)
 
(294
)
 
144

 
151

Amortization of net loss (gains)
 
8,803

 
7,595

 
(4
)
 
(11
)
Net periodic benefit cost
 
9,765

 
8,248

 
2,650

 
2,791

Settlement cost
 
3,147

 
2,583

 
—

 
—

Total net periodic benefit cost
 
$
12,912

 
$
10,831

 
$
2,650

 
$
2,791


We made contributions of $18,549 and $7,473 to the pension plans and other benefits plans, respectively, during the third quarter of 2016. In the third quarter of 2015, we made contributions of $29,349 and $5,174 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.

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
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Service cost
 
$
17,377

 
$
21,301

 
$
224

 
$
406

Interest cost
 
31,914

 
33,187

 
7,300

 
7,617

Expected return on plan assets
 
(44,073
)
 
(51,685
)
 
—

 
—

Amortization of prior service (credit) cost
 
(785
)
 
(881
)
 
432

 
457

Amortization of net loss (gains)
 
26,411

 
22,899

 
(10
)
 
(40
)
Net periodic benefit cost
 
30,844

 
24,821

 
7,946

 
8,440

Settlement cost
 
20,085

 
2,583

 
—

 
—

Total net periodic benefit cost
 
$
50,929

 
$
27,404

 
$
7,946

 
$
8,440


We made contributions of $20,385 and $22,181 to the pension plans and other benefits plans, respectively, during the first nine months of 2016. In the first nine months of 2015, we made contributions of $30,685 and $14,502 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.

During the second quarter of 2016, the cumulative lump sum settlement distributions in the salaried defined benefit pension plan exceeded the anticipated annual service and interest costs, triggering the recognition of non-cash pension settlement charges due to the acceleration of a portion of the accumulated unrecognized actuarial loss. We recorded additional pension settlement charges of $3,147 in the third quarter of 2016, bringing the total to $20,085 for the first nine months of 2016. This includes lump sum withdrawals by employees retiring or leaving the Company as a result of the 2015 Productivity Initiative (see Note 10). As a result of the lump sum settlements, certain U.S. pension plan assets and liabilities were remeasured at July 3, 2016 using a discount rate of 3.25%, compared to 4.0% as of December 31, 2015 and an expected rate of return on plan assets of 6.1%.

21
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


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
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Pre-tax compensation expense
 
$
14,491

 
$
13,374

 
$
40,699

 
$
39,989

Related income tax benefit
 
4,406

 
4,334

 
13,186

 
13,676

Compensation costs for stock compensation plans are primarily included in selling, marketing and administrative expense. As of October 2, 2016, total stock-based compensation cost related to non-vested awards not yet recognized was $74,083 and the weighted-average period over which this amount is expected to be recognized was approximately 2.2 years.
Stock Options
A summary of activity relating to grants of stock options for the period ended October 2, 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
1,354,390

$90.72
 
 
Exercised
(1,649,402
)
$58.19
 
 
Forfeited
(189,933
)
$100.65
 
 
Outstanding as of October 2, 2016
6,357,618

$82.46
6.5 years
$
113,418

Options exercisable as of October 2, 2016
3,597,028

$71.87
4.9 years
$
100,042

The weighted-average fair value of options granted was $11.46 and $19.18 per share for the periods ended October 2, 2016 and October 4, 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:
 
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
Dividend yields
 
2.4
%
 
2.0
%
Expected volatility
 
16.8
%
 
20.2
%
Risk-free interest rates
 
1.5
%
 
1.9
%
Expected lives in years
 
6.8

 
6.6

The total intrinsic value of options exercised was $70,009 and $60,425 for the periods ended October 2, 2016 and October 4, 2015, respectively.

22
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


Performance Stock Units and Restricted Stock Units
A summary of activity relating to grants of PSUs and RSUs for the period ended October 2, 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
 
531,019

 
$93.47
Performance assumption change
 
5,276

 
$97.32
Vested
 
(214,577
)
 
$94.95
Forfeited
 
(32,512
)
 
$100.45
Outstanding as of October 2, 2016
 
784,413

 
$102.53
The table above excludes PSU awards for 6,410 units as of October 2, 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.
 
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
Units granted
 
531,019

 
315,443

Weighted-average fair value at date of grant
 
$
93.47

 
$
107.53

Monte Carlo simulation assumptions:
 
 
 
 
Estimated values
 
$
38.02

 
$
61.22

Dividend yields
 
2.5
%
 
2.0
%
Expected volatility
 
17.0
%
 
14.9
%
The fair value of shares vested totaled $19,673 and $40,220 for the periods ended October 2, 2016 and October 4, 2015, respectively.
Deferred PSUs, deferred RSUs and deferred stock units representing directors’ fees totaled 483,286 units as of October 2, 2016. Each unit is equivalent to one share of the Company’s Common Stock.


23
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


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. As a result, we have defined our operating segments on a geographic basis, as this aligns with how our Chief Operating Decision Maker (“CODM”) manages our business, including resource allocation and performance assessment. Our North America business, which generates over 85% of our annual consolidated revenue, is our only reportable segment. None of our other operating segments meet the quantitative thresholds to qualify as reportable segments; therefore, these operating segments are combined and disclosed below as International and Other.
•
North America - This segment is responsible for our traditional chocolate and non-chocolate confectionery market position, as well as our grocery and growing snacks market positions, in the United States and Canada. This includes developing and growing our business in chocolate and non-chocolate confectionery, pantry, food service and other snacking product lines.
•
International and Other - International and Other is a combination of all other operating segments that are not individually material, including those geographic regions where we operate outside of North America. We currently have operations and manufacture product in China, Mexico, Brazil, India and Malaysia, primarily for consumers in these regions, and also distribute and sell confectionery products in export markets of Asia, Latin America, Middle East, Europe, Africa and other regions. This segment also includes our global retail operations, including Hershey's Chocolate World stores in Hershey, Pennsylvania, New York City, 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 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.

24
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


Our segment net sales and earnings were as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
October 2, 2016