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 July 2, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period
from ______to_______

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

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

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

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

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

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

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.
Common Stock, one dollar par value—151,827,032 shares, as of July 21, 2017.
Class B Common Stock, one dollar par value—60,619,777 shares, as of July 21, 2017.




THE HERSHEY COMPANY
Quarterly Report on Form 10-Q
For the Period Ended July 2, 2017

TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




2


PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
THE HERSHEY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
 
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Net sales
 
$
1,662,991

 
$
1,637,671

 
$
3,542,669

 
$
3,466,483

Cost of sales
 
899,781

 
890,273

 
1,872,899

 
1,901,709

Gross profit
 
763,210


747,398

 
1,669,770

 
1,564,774

Selling, marketing and administrative expense
 
445,888

 
462,531

 
907,788

 
934,265

Long-lived asset impairment charges
 
—

 
—

 
208,712

 
—

Business realignment costs
 
1,981

 
22,105

 
45,998

 
28,238

Operating profit
 
315,341

 
262,762

 
507,272

 
602,271

Interest expense, net
 
24,126

 
21,338

 
47,867

 
42,343

Other (income) expense, net
 
10,098

 
8,128

 
9,927

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

 
233,296

 
449,478

 
573,025

Provision for income taxes
 
78,390

 
87,340

 
148,503

 
197,237

Net income including noncontrolling interest
 
202,727

 
145,956

 
300,975

 
375,788

Less: Net loss attributable to noncontrolling interest
 
(774
)
 
—

 
(27,570
)
 
—

Net income attributable to The Hershey Company
 
$
203,501

 
$
145,956

 
$
328,545

 
$
375,788

 
 
 
 
 
 
 
 
 
Net income per share—basic:
 
 
 
 
 
 
 
 
Common stock
 
$
0.98

 
$
0.70

 
$
1.58

 
$
1.79

Class B common stock
 
$
0.89

 
$
0.64

 
$
1.44

 
$
1.64

 
 
 
 
 
 
 
 
 
Net income per share—diluted:
 
 
 
 
 
 
 
 
Common stock
 
$
0.95

 
$
0.68

 
$
1.53

 
$
1.74

Class B common stock
 
$
0.89

 
$
0.64

 
$
1.44

 
$
1.63

 
 
 
 
 
 
 
 
 
Dividends paid per share:
 
 
 
 
 
 
 
 
Common stock
 
$
0.618

 
$
0.583

 
$
1.236

 
$
1.166

Class B common stock
 
$
0.562

 
$
0.530

 
$
1.124

 
$
1.060


See Notes to Unaudited Consolidated Financial Statements.

3


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

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

 
 
 
 
 
$
145,956

 
 
 
 
 
$
300,975

 
 
 
 
 
$
375,788

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

 
$
—

 
4,322

 
$
1,420

 
$
—

 
1,420

 
$
18,273

 
$
—

 
18,273

 
$
13,586

 
$
—

 
13,586

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

 
—

 
—

 
(29,806
)
 
11,350

 
(18,456
)
 
(196
)
 
74

 
(122
)
 
(29,806
)
 
11,350

 
(18,456
)
Reclassification to earnings
 
7,091

 
(10,984
)
 
(3,893
)
 
25,625

 
(9,781
)
 
15,844

 
14,244

 
(13,695
)
 
549

 
34,305

 
(13,360
)
 
20,945

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

 
(4
)
 
(21,072
)
 
7,283

 
(13,789
)
 
(2,206
)
 
882

 
(1,324
)
 
(54,981
)
 
19,048

 
(35,933
)
Reclassification to earnings
 
2,379

 
(1,282
)
 
1,097

 
(3,867
)
 
1,692

 
(2,175
)
 
5,412

 
(2,448
)
 
2,964

 
(11,776
)
 
4,689

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

 
$
(11,563
)
 
1,522

 
$
(27,700
)
 
$
10,544

 
(17,156
)
 
$
35,527

 
$
(15,187
)
 
20,340

 
$
(48,672
)
 
$
21,727

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

 
 
 
 
 
$
128,800

 
 
 
 
 
$
321,315

 
 
 
 
 
$
348,843

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

 
 
 
 
 
$
129,013

 
 
 
 
 
$
348,469

 
 
 
 
 
$
350,132


See Notes to Unaudited Consolidated Financial Statements.

4


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

 
$
296,967

Accounts receivable—trade, net
 
417,457

 
581,381

Inventories
 
936,437

 
745,678

Prepaid expenses and other
 
343,573

 
192,752

Total current assets
 
1,911,529

 
1,816,778

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

 
2,177,248

Goodwill
 
818,068

 
812,344

Other intangibles
 
378,271

 
492,737

Other assets
 
182,980

 
168,365

Deferred income taxes
 
55,590

 
56,861

Total assets
 
$
5,380,228

 
$
5,524,333

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

 
$
522,536

Accrued liabilities
 
641,743

 
750,986

Accrued income taxes
 
6,863

 
3,207

Short-term debt
 
621,965

 
632,471

Current portion of long-term debt
 
89

 
243

Total current liabilities
 
1,742,205

 
1,909,443

Long-term debt
 
2,349,756

 
2,347,455

Other long-term liabilities
 
397,204

 
400,161

Deferred income taxes
 
21,081

 
39,587

Total liabilities
 
4,510,246

 
4,696,646

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

 
—

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

 
299,281

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

 
60,620

Additional paid-in capital
 
904,588

 
869,857

Retained earnings
 
6,187,409

 
6,115,961

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

 
785,856

Noncontrolling interest in subsidiary
 
14,677

 
41,831

Total stockholders’ equity
 
869,982

 
827,687

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

 
$
5,524,333


See Notes to Unaudited Consolidated Financial Statements.

5


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

 
$
375,788

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

 
156,779

Stock-based compensation expense
24,557

 
26,208

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

 
—

Write-down of equity investments
10,263

 
15,061

Gain on settlement of SGM liability (see Note 2)
—

 
(26,650
)
Other
26,418

 
32,479

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

 
118,932

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

 
15,406

Net cash provided by operating activities
335,734

 
368,710

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

 
1,657

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

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

Repayment of long-term debt
(150
)
 
—

Payment of SGM liability (see Note 2)
—

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

 
39,147

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

 
1,748

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

 
346,529

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

 
$
250,185

Supplemental Disclosure
 
 
 
Interest paid
$
49,565

 
$
42,005

Income taxes paid
265,756

 
239,501


See Notes to Unaudited Consolidated Financial Statements.

6


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

 
Preferred Stock
 
Common Stock
 
Class B Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Treasury Common Stock
 
Accumulated Other Comprehensive Income (Loss)
 
Noncontrolling Interest in Subsidiary
 
Total Stockholders’ Equity
Balance, December 31, 2016
 
$
—

 
$
299,281

 
$
60,620

 
$
869,857

 
$
6,115,961

 
$
(6,183,975
)
 
$
(375,888
)
 
$
41,831

 
$
827,687

Net income (loss)
 
 
 
 
 
 
 
 
 
328,545

 
 
 
 
 
(27,570
)
 
300,975

Other comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
19,924

 
416

 
20,340

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

 
 
 
 
 
 
 
 
 
23,243

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

 
 
 
43,338

 
 
 
 
 
54,826

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

 
$
299,281

 
$
60,620

 
$
904,588

 
$
6,187,409

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

 
$
869,982


See Notes to Unaudited Consolidated Financial Statements.

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



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The unaudited consolidated financial statements provided in this report include the accounts of The Hershey Company (the “Company,” “Hershey,” “we” or “us”) and our majority-owned subsidiaries and entities in which we have a controlling financial interest after the elimination of intercompany accounts and transactions. We have a controlling financial interest if we own a majority of the outstanding voting common stock and the noncontrolling shareholders do not have substantive participating rights, or we have significant control over an entity through contractual or economic interests in which we are the primary beneficiary.
The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not contain certain information and disclosures required by GAAP for comprehensive financial statements. The financial statements reflect all adjustments which are, in our opinion, necessary for a fair presentation of the results of operations, financial position, and cash flows for the indicated periods.
Operating results for the quarter ended July 2, 2017 may not be indicative of the results that may be expected for the year ending December 31, 2017 because of seasonal effects on our business. These financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016 (our “2016 Annual Report on Form 10-K”), which provides a more complete understanding of our accounting policies, financial position, operating results and other matters.
Reclassifications
Certain prior period amounts have been reclassified to conform to current year presentation. Specifically, this includes amounts reclassified to conform to the current year presentation in the Consolidated Statements of Cash Flows.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers that supersedes most current revenue recognition guidance. This guidance requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. The new standard was originally effective for us on January 1, 2017; however, in July 2015 the FASB decided to defer the effective date by one year. Early application is not permitted, but reporting entities may choose to adopt the standard as of the original effective date. The standard permits the use of either the full retrospective or modified retrospective transition method.
In 2017, we have substantially completed our assessment of the new standard and we do not expect our adoption of the new standard to have a material impact on our consolidated financial statements. We currently plan to adopt the requirements of the new standard in the first quarter of 2018 utilizing the modified retrospective transition method.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU will require lessees to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. This ASU also requires certain quantitative and qualitative disclosures. Accounting guidance for lessors is largely unchanged. The amendments should be applied on a modified retrospective basis. ASU 2016-02 is effective for us beginning January 1, 2019. We are in the process of developing an inventory of our lease arrangements in order to determine the impact that the adoption of ASU 2016-02 will have on our consolidated financial statements and related disclosures. Based on our assessment to date, we expect adoption of this standard to result in a material increase in lease-related assets and liabilities on our Consolidated Balance Sheets; however, we do not expect it to have a significant impact on our Consolidated Statements of Income or Cash Flows.

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


In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. We adopted the provisions of this ASU in the first quarter of 2017. This update principally affects the recognition of excess tax benefits and deficiencies and the cash flow classification of share-based compensation-related transactions. The requirement to recognize excess tax benefits and deficiencies as income tax expense or benefit in the income statement was applied prospectively, with a benefit of $7,228 recognized during the six months ended July 2, 2017. Additionally, within the Consolidated Statement of Cash Flows, the impact of the adoption resulted in a $14,551 increase in net cash flow from operating activities and a corresponding decrease in net cash flow from financing activities for the six months ended July 2, 2017. These classification requirements were adopted retrospectively to the Consolidated Statement of Cash Flows for the six months ended July 3, 2016, resulting in a $21,612 increase in net cash flow from operating activities and a corresponding $21,612 decrease in net cash flow from financing activities.
In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715). This ASU will require an employer to report the service cost component of net benefit cost in the same line item as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if presented, or disclosed separately. In addition, only the service cost component may be eligible for capitalization where applicable. The amendments should be applied on a retrospective basis. ASU 2017-07 is effective for us beginning January 1, 2018, with early adoption permitted as of the beginning of a financial year. We currently plan to adopt the requirements of the new standard in the first quarter of 2018 and expect the adoption to impact only classification within our Consolidated Statement of Income.
No other new accounting pronouncement issued or effective during the fiscal year had or is expected to have a material impact on our consolidated financial statements or disclosures.
2. BUSINESS ACQUISITIONS
Acquisitions of businesses are accounted for as purchases and, accordingly, the results of operations of the businesses acquired have been included in the consolidated financial statements since the respective dates of the acquisitions. The purchase price for each of the acquisitions is allocated to the assets acquired and liabilities assumed.
2016 Acquisition
Ripple Brand Collective, LLC
On April 26, 2016, we completed the acquisition of all of the outstanding shares of Ripple Brand Collective, LLC, a privately held company based in Congers, New York that owns the barkTHINS mass premium chocolate snacking brand. The barkTHINS brand is largely sold in the United States in take-home resealable packages and is available in the club channel, as well as select natural and conventional grocers. Our consolidated net sales for the year ended December 31, 2016 included approximately $35,600 attributed to barkTHINS.
The purchase consideration was allocated to assets acquired and liabilities assumed based on their respective fair values as follows:
Goodwill
$
128,110

Trademarks
91,200

Other intangible assets
60,900

Other assets, primarily current assets, net of cash acquired totaling $674
12,375

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

Goodwill is calculated as the excess of the purchase price over the fair value of the net assets acquired. The goodwill resulting from the acquisition is attributable primarily to the value of leveraging our brand building expertise, consumer insights, supply chain capabilities and retail relationships to accelerate growth and access to barkTHINS products. Acquired trademarks were assigned estimated useful lives of 27 years, while other intangibles, including customer relationships and covenants not to compete, were assigned estimated useful lives ranging from 2 to 14 years. The recorded goodwill, trademarks and other intangibles are expected to be deductible for tax purposes.

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


Shanghai Golden Monkey (“SGM”)
On February 3, 2016, we completed the purchase of the remaining 20% of the outstanding shares of SGM for cash consideration totaling $35,762, pursuant to a new agreement entered into during the fourth quarter of 2015 with the SGM selling shareholders which revised the originally-agreed purchase price for these shares. For accounting purposes, we treated the acquisition as if we had acquired 100% at the initial acquisition date in 2014 and financed the payment for the remaining 20% of the outstanding shares. Therefore, the cash settlement of the liability for the purchase of these remaining shares is reflected within the financing section of the Unaudited Consolidated Statements of Cash Flows.
The final settlement also resulted in an extinguishment gain of $26,650 representing the net carrying amount of the recorded liability in excess of the cash paid to settle the obligation for the remaining 20% of the outstanding shares. This gain is recorded within non-operating other (income) expense, net within the Unaudited Consolidated Statements of Income.
3. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying value of goodwill by reportable segment for the six months ended July 2, 2017 are as follows:
 
 
North America
 
    International and Other
 
Total
Balance at December 31, 2016
 
$
792,190

 
$
20,154

 
$
812,344

Foreign currency translation
 
3,975

 
1,749

 
5,724

Balance at July 2, 2017
 
796,165

 
21,903

 
818,068

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

 
$
(30,953
)
 
$
317,023

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

 
(30,729
)
 
200,409

 
(36,482
)
Patents
 
16,725

 
(14,822
)
 
16,426

 
(13,700
)
Total
 
414,522

 
(76,504
)
 
533,858

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

 
 
 
39,519

 
 
Total other intangible assets
 
$
378,271

 
 
 
$
492,737

 
 

As discussed in Note 7, in February 2017, we commenced the Margin for Growth Program which includes an initiative to optimize the manufacturing operations supporting our China business.  We deemed this to be a triggering event requiring us to test our China long-lived asset group for impairment by first determining whether the carrying value of the asset group was recovered by our current estimates of future cash flows associated with the asset group. Because this assessment indicated that the carrying value was not recoverable, we calculated an impairment loss as the excess of the asset group's carrying value over its fair value. The resulting impairment loss was allocated to the asset group's long-lived assets. Therefore, as a result of this testing, during the first quarter of 2017, we recorded an impairment charge totaling $105,992 representing the portion of the impairment loss that was allocated to the distributor relationship and trademark intangible assets that had been recognized in connection with the 2014 SGM acquisition.

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


Total amortization expense for the three months ended July 2, 2017 and July 3, 2016 was $5,407 and $5,964, respectively. Total amortization expense for the six months ended July 2, 2017 and July 3, 2016 was $12,558 and $11,144, respectively.
4. SHORT AND LONG-TERM DEBT
Short-term Debt
As a source of short-term financing, we utilize cash on hand and commercial paper or bank loans with an original maturity of three months or less. We maintain a $1.0 billion unsecured revolving credit facility, which currently expires in November 2020. This agreement also includes an option to increase borrowings by an additional $400 million with the consent of the lenders.
The credit agreement contains certain financial and other covenants, customary representations, warranties and events of default. As of July 2, 2017, we were in compliance with all covenants pertaining to the credit agreement, and we had no significant compensating balance agreements that legally restricted these funds. For more information, refer to the Consolidated Financial Statements included in our 2016 Annual Report on Form 10-K.
In addition to the revolving credit facility, we maintain lines of credit with domestic and international commercial banks. We had short-term foreign bank loans against these lines of credit for $142,521 at July 2, 2017 and $158,805 at December 31, 2016. Commitment fees relating to our revolving credit facility and lines of credit are not material.
At July 2, 2017, we had outstanding commercial paper totaling $479,444, at a weighted average interest rate of 1.1%. At December 31, 2016, we had outstanding commercial paper totaling $473,666, at a weighted average interest rate of 0.6%.
Long-term Debt
Long-term debt consisted of the following:
December 31,
 
July 2, 2017
 
December 31, 2016
1.60% Notes due 2018
 
300,000

 
300,000

4.125% Notes due 2020
 
350,000

 
350,000

8.8% Debentures due 2021
 
84,715

 
84,715

2.625% Notes due 2023
 
250,000

 
250,000

3.20% Notes due 2025
 
300,000

 
300,000

2.30% Notes due 2026
 
500,000

 
500,000

7.2% Debentures due 2027
 
193,639

 
193,639

3.375% Notes due 2046
 
300,000

 
300,000

Lease obligations
 
84,890

 
83,619

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

 
2,347,698

Less—current portion
 
89

 
243

Long-term portion
 
$
2,349,756

 
$
2,347,455


11
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


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

 
$
22,997

 
$
50,253

 
$
46,522

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

 
21,611

 
48,394

 
42,961

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

 
$
21,338

 
$
47,867

 
$
42,343

5. DERIVATIVE INSTRUMENTS
We are exposed to market risks arising principally from changes in foreign currency exchange rates, interest rates and commodity prices. We use certain derivative instruments to manage these risks. These include interest rate swaps to manage interest rate risk, foreign currency forward exchange contracts and options to manage foreign currency exchange rate risk, and commodities futures and options contracts to manage commodity market price risk exposures.
In entering into these contracts, we have assumed the risk that might arise from the possible inability of counterparties to meet the terms of their contracts. We mitigate this risk by entering into exchanged-traded contracts with collateral posting requirements and/or by performing financial assessments prior to contract execution, conducting periodic evaluations of counterparty performance and maintaining a diverse portfolio of qualified counterparties. We do not expect any significant losses from counterparty defaults.
Commodity Price Risk
We enter into commodities futures and options contracts and other commodity derivative instruments to reduce the effect of future price fluctuations associated with the purchase of raw materials, energy requirements and transportation services. We generally hedge commodity price risks for 3- to 24-month periods. Our open commodity derivative contracts had a notional value of $423,345 as of July 2, 2017 and $739,374 as of December 31, 2016.
Derivatives used to manage commodity price risk are not designated for hedge accounting treatment. Therefore, the changes in fair value of these derivatives are recorded as incurred within cost of sales. As discussed in Note 11, we define our segment income to exclude gains and losses on commodity derivatives until the related inventory is sold, at which time the related gains and losses are reflected within segment income.  This enables us to continue to align the derivative gains and losses with the underlying economic exposure being hedged and thereby eliminate the mark-to-market volatility within our reported segment income.
Foreign Exchange Price Risk
We are exposed to foreign currency exchange rate risk related to our international operations, including non-functional currency intercompany debt and other non-functional currency transactions of certain subsidiaries. Principal currencies hedged include the euro, Canadian dollar, Japanese yen, and Brazilian real. We typically utilize foreign currency forward exchange contracts and options to hedge these exposures for periods ranging from 3 to 12 months. The contracts are either designated as cash flow hedges or are undesignated. The net notional amount of foreign exchange contracts accounted for as cash flow hedges was $114,870 at July 2, 2017 and $68,263 at December 31, 2016. The effective portion of the changes in fair value on these contracts is recorded in other comprehensive income and reclassified into earnings in the same period in which the hedged transactions affect earnings. The net notional amount of foreign exchange contracts that are not designated as accounting hedges was $2,791 at July 2, 2017 and December 31, 2016. The change in fair value on these instruments is recorded directly in cost of sales or selling, marketing and administrative expense, depending on the nature of the underlying exposure.

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


Interest Rate Risk
We manage our targeted mix of fixed and floating rate debt with debt issuances and by entering into fixed-to-floating interest rate swaps in order to mitigate fluctuations in earnings and cash flows that may result from interest rate volatility. These swaps are designated as fair value hedges, for which the gain or loss on the derivative and the offsetting loss or gain on the hedged item are recognized in current earnings as interest expense (income), net. At July 2, 2017 and December 31, 2016, we had interest rate derivative instruments in fair value hedging relationships with a total notional amount of $350,000.
In order to manage interest rate exposure, in previous years we utilized interest rate swap agreements to protect against unfavorable interest rate changes relating to forecasted debt transactions. These swaps, which were settled upon issuance of the related debt, were designated as cash flow hedges and the gains and losses that were deferred in other comprehensive income are being recognized as an adjustment to interest expense over the same period that the hedged interest payments affect earnings.
Equity Price Risk
We are exposed to market price changes in certain broad market indices related to our deferred compensation obligations to our employees. To mitigate this risk, we use equity swap contracts to hedge the portion of the exposure that is linked to market-level equity returns. These contracts are not designated as hedges for accounting purposes and are entered into for periods of 3 to 12 months. The change in fair value of these derivatives is recorded in selling, marketing and administrative expense, together with the change in the related liabilities. The notional amount of the contracts outstanding at July 2, 2017 and December 31, 2016 was $23,440 and $22,099, respectively.
The following table presents the classification of derivative assets and liabilities within the Consolidated Balance Sheets as of July 2, 2017 and December 31, 2016:
December 31,
 
July 2, 2017
 
December 31, 2016
 
 
Assets (1)
 
Liabilities (1)
 
Assets (1)
 
Liabilities (1)
Derivatives designated as cash flow hedging instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
398

 
$
1,853

 
$
2,229

 
$
809

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

 
—

 
1,768

 
—

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

 
179

 
2,348

 
10,000

Deferred compensation derivatives
 
645

 
—

 
717

 
—

Foreign exchange contracts
 
3

 
—

 
—

 
16

 
 
14,698

 
179

 
3,065

 
10,016

Total
 
$
17,037

 
$
2,032

 
$
7,062

 
$
10,825


(1)
Derivatives assets are classified on our balance sheet within prepaid expenses and other as well as other assets. Derivative liabilities are classified on our balance sheet within accrued liabilities and other long-term liabilities.
(2)
As of July 2, 2017, assets and liabilities include the net of assets of $52,895 and liabilities of $41,337 associated with cash transfers receivable or payable on commodities futures contracts reflecting the change in quoted market prices on the last trading day for the period. The comparable amounts reflected on a net basis in liabilities at December 31, 2016 were assets of $140,885 and liabilities of $150,872. At July 2, 2017 and December 31, 2016, the remaining amount reflected in assets and liabilities relates to the fair value of other non-exchange traded derivative instruments, respectively.

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



Income Statement Impact of Derivative Instruments
The effect of derivative instruments on the Consolidated Statements of Income for the three months ended July 2, 2017 and July 3, 2016 was as follows:
 
 
Non-designated Hedges
 
Cash Flow Hedges
 
 
 
 
 
Gains (losses) recognized in income (a)
 
Losses recognized in other comprehensive income (“OCI”) (effective portion)
 
Gains (losses) reclassified from accumulated OCI into income (effective portion) (b)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Commodities futures and options
 
$
(32,519
)
 
$
39,011

 
$
—

 
$
—

 
$
(399
)
 
$
6,139

Foreign exchange contracts
 
44

 
(253
)
 
(707
)
 
(3,916
)
 
390

 
(761
)
Interest rate swap agreements
 
—

 
—

 
—

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

 
—

 
—

 
—

 
—

Total
 
$
(33,107
)
 
$
39,176

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


(a)
Gains (losses) recognized in income for non-designated commodities futures and options contracts were included in cost of sales. Gains (losses) recognized in income for non-designated foreign currency forward exchange contracts and deferred compensation derivatives were included in selling, marketing and administrative expenses.
(b)
Gains (losses) reclassified from AOCI into income were included in cost of sales for commodities futures and options contracts and for foreign currency forward exchange contracts designated as hedges of purchases of inventory or other productive assets. Other gains (losses) for foreign currency forward exchange contracts were included in selling, marketing and administrative expenses. Losses reclassified from AOCI into income for interest rate swap agreements were included in interest expense.
The effect of derivative instruments on the Consolidated Statements of Income for the six months ended July 2, 2017 and July 3, 2016 was as follows:
 
 
Non-designated Hedges
 
Cash Flow Hedges
 
 
 
 
 
Gains (losses) recognized in income (a)
 
Losses recognized in other comprehensive income (“OCI”) (effective portion)
 
Gains (losses) reclassified from accumulated OCI into income (effective portion) (b)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Commodities futures and options
 
$
(38,055
)
 
$
70

 
$
—

 
$
—

 
$
(837
)
 
$
15,869

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

 
(1,022
)
Interest rate swap agreements
 
—

 
—

 
—

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

 
821

 
—

 
—

 
—

 
—

Total
 
$
(37,461
)
 
$
434

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


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

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


The amount of pretax net losses on derivative instruments, including interest rate swap agreements, foreign currency forward exchange contracts and options, commodities futures and options contracts, and other commodity derivative instruments expected to be reclassified from AOCI into earnings in the next 12 months was approximately $11,017 as of July 2, 2017. This amount is primarily associated with deferred losses relating to interest rate swap agreements.
Fair Value Hedges
For the three months ended July 2, 2017 and July 3, 2016, we recognized a net pretax benefit to interest expense of $732 and $1,137 relating to our fixed-to-floating interest swap arrangements. For the six months ended July 2, 2017 and July 3, 2016, we recognized a net pretax benefit to interest expense of $1,630 and $2,454 relating to our fixed-to-floating interest swap arrangements.
6. FAIR VALUE MEASUREMENTS
Accounting guidance on fair value measurements requires that financial assets and liabilities be classified and disclosed in one of the following categories of the fair value hierarchy:
Level 1 – Based on unadjusted quoted prices for identical assets or liabilities in an active market.
Level 2 – Based on observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3 – Based on unobservable inputs that reflect the entity's own assumptions about the assumptions that a market participant would use in pricing the asset or liability.

We did not have any level 3 financial assets or liabilities, nor were there any transfers between levels during the periods presented.
The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheets on a recurring basis as of July 2, 2017 and December 31, 2016:
 
 
Assets (Liabilities)
 
 
Level 1
 
Level 2
 
Level 3
 
Total
July 2, 2017:
 
 
 
 
 
 
 
 
Derivative Instruments:
 
 
 
 
 
 
 
 
     Assets:
 
 
 
 
 
 
 
 
           Foreign exchange contracts (1)
 
$
—

 
$
401

 
$
—

 
$
401

           Interest rate swap agreements (2)
 
—

 
1,941

 
—

 
1,941

           Deferred compensation derivatives (3)
 
—

 
645

 
—

 
645

           Commodities futures and options (4)
 
14,050

 
—

 
—

 
14,050

     Liabilities:
 
 
 
 
 
 
 
 
            Foreign exchange contracts (1)
 
—

 
1,853

 
—

 
1,853

            Commodities futures and options (4)
 
179

 
—

 
—

 
179

December 31, 2016:
 
 
 
 
 
 
 
 
     Assets:
 
 
 
 
 
 
 
 
           Foreign exchange contracts (1)
 
$
—

 
$
2,229

 
$
—

 
$
2,229

           Interest rate swap agreements (2)
 
—

 
1,768

 
—

 
1,768

           Deferred compensation derivatives (3)
 
—

 
717

 
—

 
717

           Commodities futures and options (4)
 
2,348

 
—

 
—

 
2,348

     Liabilities:
 
 
 
 
 
 
 
 
           Foreign exchange contracts (1)
 
—

 
825

 
—

 
825

           Commodities futures and options (4)
 
10,000

 
—

 
—

 
10,000


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


(1)
The fair value of foreign currency forward exchange contracts is the difference between the contract and current market foreign currency exchange rates at the end of the period. We estimate the fair value of foreign currency forward exchange contracts on a quarterly basis by obtaining market quotes of spot and forward rates for contracts with similar terms, adjusted where necessary for maturity differences.
(2)
The fair value of interest rate swap agreements represents the difference in the present value of cash flows calculated at the contracted interest rates and at current market interest rates at the end of the period. We calculate the fair value of interest rate swap agreements quarterly based on the quoted market price for the same or similar financial instruments.
(3)
The fair value of deferred compensation derivatives is based on quoted prices for market interest rates and a broad market equity index.
(4)
The fair value of commodities futures and options contracts is based on quoted market prices.
Other Financial Instruments
The carrying amounts of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and short-term debt approximated fair values as of July 2, 2017 and July 3, 2016 because of the relatively short maturity of these instruments.
The estimated fair value of our long-term debt is based on quoted market prices for similar debt issues and is, therefore, classified as Level 2 within the valuation hierarchy. The fair values and carrying values of long-term debt, including the current portion, were as follows:
 
 
Fair Value
 
Carrying Value
 
 
July 2, 2017
 
December 31, 2016
 
July 2, 2017
 
December 31, 2016
Current portion of long-term debt
 
$
89

 
$
243

 
$
89

 
$
243

Long-term debt
 
2,410,521

 
2,379,054

 
2,349,756

 
2,347,455

Total
 
2,410,610

 
$
2,379,297

 
2,349,845

 
$
2,347,698

Other Fair Value Measurements
In addition to assets and liabilities that are recorded at fair value on a recurring basis, GAAP requires that, under certain circumstances, we also record assets and liabilities at fair value on a nonrecurring basis. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges. During the first quarter of 2017, as discussed in Note 7, we recorded impairment charges totaling $105,992 to write-down distributor relationship and trademark intangible assets that had been recognized in connection with the 2014 SGM acquisition and wrote-down property, plant and equipment by $102,720. These charges were determined by comparing the fair value of the assets to their carrying value. The fair value of the assets were derived using a combination of an estimated market liquidation approach and discounted cash flow analyses based on Level 3 inputs.


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


7. BUSINESS REALIGNMENT ACTIVITIES
We are currently pursuing several business realignment activities designed to increase our efficiency and focus our business behind our key growth strategies. Costs recorded during the three and six months ended July 2, 2017 and July 3, 2016 related to these activities are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Margin for Growth Program:
 
 
 
 
 
 
 
 
Severance
 
$
888

 
$
—

 
$
30,455

 
$
—

Accelerated depreciation
 
6,873

 
—

 
6,873

 
—

Other program costs
 
6,381

 
—

 
11,203

 
—

Operational Optimization Program:
 
 
 
 
 
 
 
 
Accelerated depreciation and amortization
 
—

 
33,965

 
—

 
33,478

Severance
 
—

 
9,928

 
13,828

 
17,355

Other program costs
 
312

 
3,376

 
(917
)
 
9,408

2015 Productivity Initiative:
 
 
 
 
 
 
 
 
Pension settlement charge
 
—

 
12,646

 
—

 
12,646

Severance
 
—

 
(469
)
 
—

 
(1,763
)
Other program costs
 
—

 
2,649

 
—

 
5,401

Total business realignment costs
 
$
14,454

 
$
62,095

 
$
61,442

 
$
76,525

The costs and related benefits to be derived from the Margin for Growth Program relate approximately 80% to the North America segment and 20% to the International and Other segment for the three months ended July 2, 2017. The costs and related benefits to be derived from the Margin for Growth Program relate approximately 40% to the North America segment and 60% to the International and Other segment for the six months ended July 2, 2017. The costs and related benefits to be derived from the Operational Optimization Program primarily relate to the North America segment in 2017 and to the International and Other segment in 2016. The costs and related benefits to be derived from the 2015 Productivity Initiative relate primarily to the North American segment. However, segment operating results do not include these business realignment expenses because we evaluate segment performance excluding such costs.
Margin for Growth Program
In February 2017, the Company's Board of Directors unanimously approved several initiatives under a single program designed to drive continued net sales, operating income and earnings per-share diluted growth over the next several years.  This program will focus on improving global efficiency and effectiveness, optimizing the Company’s supply chain, streamlining the Company’s operating model and reducing administrative expenses to generate long-term savings. 
The Company estimates that the “Margin for Growth” program will result in total pre-tax charges of $375,000 to $425,000 over the next three years.  This estimate includes plant and office closure expenses of $100,000 to $115,000, net intangible asset impairment charges of $100,000 to $110,000, employee separation costs of $80,000 to $100,000, contract termination costs of approximately $25,000, and other business realignment costs of $70,000 to $75,000. The cash portion of the total charge is estimated to be $175,000 to $200,000. At the conclusion of the program in 2019, ongoing annual savings are expected to be approximately $150,000 to $175,000. The Company expects that implementation of the program will reduce its global workforce by approximately 15%, with a majority of the reductions coming from hourly headcount positions outside of the United States.
The program includes an initiative to optimize the manufacturing operations supporting our China business.  We deemed this to be a triggering event requiring us to test our China long-lived asset group for impairment by first determining whether the carrying value of the asset group was recovered by our current estimates of future cash flows associated with the asset group. Because this assessment indicated that the carrying value was not recoverable, we calculated an impairment loss as the excess of the asset group's carrying value over its fair value. The resulting impairment loss was allocated to the asset group's long-lived assets. Therefore, as a result of this testing, during the

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


first quarter of 2017, we recorded impairment charges totaling $208,712, with $105,992 representing the portion of the impairment loss that was allocated to the distributor relationship and trademark intangible assets that had been recognized in connection with the 2014 SGM acquisition and $102,720 representing the portion of the impairment loss that was allocated to property, plant and equipment. These impairment charges are recorded within the long-lived asset impairment charges caption within the Consolidated Statements of Operations.
During the three and six months ended July 2, 2017, we recognized estimated employee severance totaling $888 and $30,455, respectively. These charges relate largely to our initiative to improve the cost structure of our China business, as well as our initiative to further streamline our corporate operating model. We also recognized non-cash, asset-related incremental depreciation expense totaling $6,873 for the three and six months ended July 2, 2017 as part of optimizing the North America supply chain. During the three and six months ended July 2, 2017, we also recognized other program costs totaling $6,381 and $11,203, respectively. These charges relate primarily to third-party charges for our initiative of improving global efficiency and effectiveness.
2016 Operational Optimization Program
In the second quarter of 2016, we commenced a program (the “Operational Optimization Program”) to optimize our production and supply chain network, which includes select facility consolidations. The program encompasses the continued transition of our China chocolate and SGM operations into a united Golden Hershey platform, including the integration of the China sales force, as well as workforce planning efforts and the consolidation of production within certain facilities in China and North America.
During the three months ended July 2, 2017, we recognized costs of $312. During the six months ended July 2, 2017, we recognized costs of $12,911 primarily related to employee severance associated with the workforce planning efforts within North America. We currently expect to incur additional cash costs of approximately $9,000 over the next two years to complete this program.
During the first quarter of 2017, we reclassified property, plant and equipment and land use rights with a total book value of $20,303 to prepaid and other current assets within the Consolidated Balance Sheets. These represent select China facilities that were taken out of operation in connection with this program and are currently being marketed for sale.
2015 Productivity Initiative
In mid-2015, we initiated a productivity initiative (the “2015 Productivity Initiative”) intended to move decision making closer to the customer and the consumer, to enable a more enterprise-wide approach to innovation, to more swiftly advance our knowledge agenda, and to provide for a more efficient cost structure, while ensuring that we effectively allocate resources to future growth areas. Overall, the 2015 Productivity Initiative was undertaken to simplify the organizational structure to enhance the Company's ability to rapidly anticipate and respond to the changing demands of the global consumer.
The 2015 Productivity Initiative was executed throughout the third and fourth quarters of 2015, resulting in a net reduction of approximately 300 positions, with the majority of the departures taking place by the end of 2015. The 2015 Productivity Initiative was completed during the third quarter 2016. We incurred total costs of $125,031 relating to this program, including pension settlement charges of $12,646 recorded through the six months ended July 3, 2016 relating to lump sum withdrawals by employees retiring or leaving the Company as a result of this program.
Costs associated with business realignment activities are classified in our Consolidated Statements of Income for the three and six months ended July 2, 2017 and July 3, 2016 as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Cost of sales
 
$
5,772

 
$
33,965

 
$
6,262

 
$
33,478

Selling, marketing and administrative expense
 
6,701

 
6,025

 
9,182

 
14,809

Business realignment costs
 
1,981

 
22,105

 
45,998

 
28,238

Costs associated with business realignment activities
 
$
14,454

 
$
62,095

 
$
61,442

 
$
76,525


18
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


The following table presents the liability activity for employee-related costs qualifying as exit and disposal costs:
 
Total
Liability balance at December 31, 2016
$
3,725

2017 business realignment charges (1)
53,591

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

(1)
The costs reflected in the liability roll-forward above do not include items charged directly to expense, such as accelerated depreciation and amortization and certain of the third-party charges associated with various programs, as those items are not reflected in the business realignment liability in our Consolidated Balance Sheets.
8. INCOME TAXES
The majority of our taxable income is generated in the U.S. and taxed at the U.S. statutory rate of 35%. The effective tax rates for the six months ended July 2, 2017 and July 3, 2016 were 33.0% and 34.4%, respectively. Relative to the statutory rate, the 2017 effective tax rate was impacted by favorable foreign rate differential relating to our cocoa procurement operations, investment tax credits and the benefit of ASU 2016-09, which were partially offset by non-benefited costs resulting from the Margin for Growth Program. The 2016 effective rate benefited from investment tax credits and from the impact of non-taxable income related to the settlement of the SGM liability.
Hershey and its subsidiaries file tax returns in the U.S., including various state and local returns, and in foreign jurisdictions. We believe adequate provision has been made for all income tax uncertainties. We are routinely audited by taxing authorities in our filing jurisdictions, and a number of these audits are currently underway. We reasonably expect reductions in the liability for unrecognized tax benefits of approximately $3,910 within the next 12 months because of the expiration of statutes of limitations and settlements of tax audits.
9. PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
The components of net periodic benefit cost for the second quarter were as follows:  
 
 
Pension Benefits
 
Other Benefits
 
 
Three Months Ended
 
Three Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Service cost
 
$
5,051

 
$
5,699

 
$
66

 
$
75

Interest cost
 
10,200

 
10,999

 
2,204

 
2,429

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

 
—

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

 
144

Amortization of net loss
 
8,360

 
8,801

 
—

 
6

Settlement loss
 
—

 
16,938

 
—

 
—

Total net periodic benefit cost
 
$
7,812

 
$
27,344

 
$
2,456

 
$
2,654


We made contributions of $293 and $7,580 to the pension plans and other benefits plans, respectively, during the second quarter of 2017. In the second quarter of 2016, we made contributions of $661 and $7,044 to our pension plans and other benefits plans, respectively. The contributions in 2017 and 2016 also included benefit payments from our non-qualified pension plans and post-retirement benefit plans.

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


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

 
$
11,583

 
$
131

 
$
149

Interest cost
 
20,499

 
21,834

 
4,412

 
4,865

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

 
—

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

 
288

Amortization of net loss (gain)
 
16,782

 
17,608

 
—

 
(6
)
Settlement loss
 
—

 
16,938

 
—

 
—

Total net periodic benefit cost
 
$
15,897

 
$
38,067

 
$
4,916

 
$
5,296


We made contributions of $4,985 and $14,464 to the pension plans and other benefits plans, respectively, during the first six months of 2017. In the first six months of 2016, we made contributions of $1,836 and $14,708 to our pension plans and other benefits plans, respectively. The contributions in 2017 and 2016 also included benefit payments from our non-qualified pension plans and post-retirement benefit plans.

For 2017, there are no significant minimum funding requirements for our domestic pension plans and planned voluntary funding of our non-domestic pension plans in 2017 is not material.
10. STOCK COMPENSATION PLANS
We have various stock-based compensation programs under which awards, including stock options, performance stock units (“PSUs”) and performance stock, stock appreciation rights, restricted stock units (“RSUs”) and restricted stock may be granted to employees, non-employee directors and certain service providers upon whom the successful conduct of our business is dependent. These programs and the accounting treatment related thereto are described in Note 10 to the Consolidated Financial Statements included in our 2016 Annual Report on Form 10-K.
For the periods presented, compensation expense for all types of stock-based compensation programs and the related income tax benefit recognized were as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Pre-tax compensation expense
 
$
12,435

 
$
14,530

 
$
24,557

 
$
26,208

Related income tax benefit
 
3,230

 
4,693

 
7,048

 
8,780

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

20
THE HERSHEY COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share data or if otherwise indicated)


Stock Options
A summary of activity relating to grants of stock options for the period ended July 2, 2017 is as follows:
Stock Options
Shares
Weighted-Average
Exercise Price (per share)
Weighted-Average Remaining
Contractual Term
Aggregate Intrinsic Value
Outstanding as of December 31, 2016
6,192,008

$
82.67

6.2 years
 
Granted
1,086,175

$
108.05

 
 
Exercised
(908,712
)
$
70.13

 
 
Forfeited
(186,032
)
$
103.43

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

$
88.35

6.2 years
$
150,493

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

$
80.60

4.7 years
$
124,202

The weighted-average fair value of options granted was $15.77 and $11.42 per share for the periods ended July 2, 2017 and July 3, 2016, respectively. The fair value was estimated on the date of grant using a Black-Scholes option-pricing model and the following weighted-average assumptions:
 
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
Dividend yields
 
2.4
%
 
2.4
%
Expected volatility
 
17.2
%
 
16.8
%
Risk-free interest rates
 
2.2
%
 
1.5
%
Expected term in years
 
6.8

 
6.8

The total intrinsic value of options exercised was $36,507 and $49,091 for the periods ended July 2, 2017 and July 3, 2016, respectively.
Performance Stock Units and Restricted Stock Units
A summary of activity relating to grants of PSUs and RSUs for the period ended July 2, 2017 is as follows:
Performance Stock Units and Restricted Stock Units
 
Number of units
 
Weighted-average grant date fair value
for equity awards (per unit)
Outstanding as of December 31, 2016
 
828,228

 
$102.66
Granted
 
418,369

 
$111.06
Performance assumption change
 
19,671

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

 
$102.89
The table above includes 6,410 units of PSUs awarded to participants in a prior period for which the measurement (grant) date occurred for accounting purposes in 2017.
The following table sets forth information about the fair value of the PSUs and RSUs granted for potential future distribution to employees and non-employee directors. In addition, the table provides assumptions used to determine the fair value of the market-based total shareholder return component using the Monte Carlo simulation model on the date of grant.

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


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

 
514,089

Weighted-average fair value at date of grant
 
$
111.06

 
$
92.95

Monte Carlo simulation assumptions:
 
 
 
 
Estimated values
 
$
46.85

 
$
38.02

Dividend yields
 
2.3
%
 
2.5
%
Expected volatility
 
20.4
%
 
17.0
%
The fair value of shares vested totaled $22,206 and $18,079 for the periods ended July 2, 2017 and July 3, 2016, respectively.
Deferred PSUs, deferred RSUs and deferred stock units representing directors’ fees totaled 468,845 units as of July 2, 2017. Each unit is equivalent to one share of the Company’s Common Stock.
11. SEGMENT INFORMATION
Our organizational structure is designed to ensure continued focus on North America, coupled with an emphasis on profitable growth in our focus international markets. Our business is organized around geographic regions, which enables us to build processes for repeatable success in our global markets. As a result, we have defined our operating segments on a geographic basis, as this aligns with how our Chief Operating Decision Maker (“CODM”) manages our business, including resource allocation and performance assessment. Our North America business, which generates approximately 89% of our consolidated revenue, is our only reportable segment. None of our other operating segments meet the quantitative thresholds to qualify as reportable segments; therefore, these operating segments are combined and disclosed below as International and Other.
•
North America - This segment is responsible for our traditional chocolate and non-chocolate confectionery market position, as well as our grocery and growing snacks market positions, in the United States and Canada. This includes developing and growing our business in chocolate and non-chocolate confectionery, pantry, food service and other snacking product lines.
•
International and Other - International and Other is a combination of all other operating segments that are not individually material, including those geographic regions where we operate outside of North America. We currently have operations and manufacture product in China, Mexico, Brazil, India and Malaysia, primarily for consumers in these regions, and also distribute and sell confectionery products in export markets of Asia, Latin America, Middle East, Europe, Africa and other regions. This segment also includes our global retail operations, including Hershey's Chocolate World stores in Hershey, Pennsylvania, New York City, Las Vegas, Shanghai, Niagara Falls (Ontario), Dubai, and Singapore, as well as operations associated with licensing the use of certain of the Company's trademarks and products to third parties around the world.
For segment reporting purposes, we use “segment income” to evaluate segment performance and allocate resources. Segment income excludes unallocated general corporate administrative expenses, unallocated mark-to-market gains and losses on commodity derivatives, business realignment and impairment charges, acquisition integration costs, the non-service related portion of pension expense and other unusual gains or losses that are not part of our measurement of segment performance. These components of our operating income are managed centrally at the corporate level and are excluded from the measure of segment income reviewed by the CODM as well the measure of segment performance used for incentive compensation purposes.
Accounting policies associated with our operating segments are generally the same as those described in Note 1 to the Consolidated Financial Statements included in our 2016 Annual Report on Form 10-K.
As discussed in Note 5, derivatives used to manage commodity price risk are not designated for hedge accounting treatment. These derivatives are recognized at fair market value with the resulting realized and unrealized losses recognized in unallocated derivative (gains) losses outside of the reporting segment results until the related inventory is sold, at which time the related gains and losses are reallocated to segment income. This enables us to align the

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


derivative gains and losses with the underlying economic exposure being hedged and thereby eliminate the mark-to-market volatility within our reported segment income.
Certain manufacturing, warehousing, distribution and other activities supporting our global operations are integrated to maximize efficiency and productivity. As a result, assets and capital expenditures are not managed on a segment basis and are not included in the information reported to the CODM for the purpose of evaluating performance or allocating resources. We disclose depreciation and amortization that is generated by segment-specific assets, since these amounts are included within the measure of segment income reported to the CODM.
Our segment net sales and earnings were as follows:
 
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2, 2017
 
July 3, 2016
 
July 2, 2017
 
July 3, 2016
Net sales:
 
 
 
 
 
 
 
 
North America
 
$
1,477,014

 
$
1,444,841

 
$
3,154,160

 
$
3,078,312

International and Other
 
185,977

 
192,830

 
388,509

 
388,171

Total
 
$
1,662,991

 
$
1,637,671

 
$
3,542,669

 
$
3,466,483

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

 
$
425,723

 
$
1,013,520

 
$
955,113

International and Other
 
8,368

 
(3,462
)
 
10,091

 
(16,695
)
Total segment income
 
468,750

 
422,261

 
1,023,611

 
938,418

Unallocated corporate expense (1)
 
123,173

 
126,623

 
242,823

 
248,794

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

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

 
—

 
208,712

 
—

Costs associated with business realignment activities
 
14,454

 
62,095

 
61,442

 
76,525

Non-service related pension expense
 
4,215

 
9,205

 
8,583

 
14,306

Acquisition and integration costs
 
11