Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management’s Discussion and Analysis (“MD&A”) is intended to provide an understanding of Hershey’s financial condition, results of operations and cash flows by focusing on changes in certain key measures from year to year. The MD&A should be read in conjunction with our Consolidated Financial Statements and accompanying Notes included in Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed elsewhere in this Annual Report on Form 10-K, particularly in Item 1A. “Risk Factors.”
The MD&A is organized in the following sections:
BUSINESS MODEL AND GROWTH STRATEGY
We are the largest producer of quality chocolate in North America, a leading snack maker in the United States and a global leader in chocolate and non-chocolate confectionery. We report our operations through three segments: (i) North America Confectionery, (ii) North America Salty Snacks and (iii) International, as discussed in Note 13 to the Consolidated Financial Statements.
Our vision is to be a leading snacking powerhouse. We aspire to be a leader in meeting consumers’ evolving snacking needs while strengthening the capabilities that drive our growth. We are focused on four strategic imperatives to ensure the Company’s success now and in the future:
•Drive Core Confection Business and Broaden Participation in Snacking. We continue to be the undisputed leader in U.S. confection by taking actions to deepen our consumer connections and utilize our beloved brands to deliver meaningful innovation, while also diversifying our portfolio to capture profitable and incremental growth across the broader snacking continuum.
◦Our products frequently play an important role in special moments among family and friends. Seasons are an important part of our business model and for consumers, as they are highly anticipated, cherished times, centered around traditions. For us, it’s an opportunity for our brands to be part of many connections during the year when family and friends gather.
◦Innovation is an important lever in this variety-seeking category and we are leveraging work from our proprietary demand landscape analytical tool to shape our future innovation and make it more impactful. We are becoming more disciplined in our focus on platform innovation, which should enable sustainable growth over time and significant extensions to our core.
◦To expand our breadth in snacking, we are focused on expanding the boundaries of our core confection brands to capture new snacking occasions and increasing our exposure into new snack categories through acquisitions. Our expansion into snacking recently has been fueled by the acquisitions of Dot’s and Pretzels in December 2021, which are included in our North America Salty Snacks segment.
•Deliver Profitable International Growth. We are focused on ensuring that we efficiently allocate our resources to the areas with the highest potential for profitable growth. We have reset our international investment strategy, while holding fast to our belief that our targeted emerging market strategy will deliver long-term, profitable growth. The uncertain macroeconomic environment in many of these markets is expected to continue and we aim to ensure our investments in these international markets are appropriate relative to the size of the opportunity.
•Expand Competitive Advantage through Differentiated Capabilities. In order to generate actionable insights, we must acquire, integrate, access and utilize vast sources of the right data in an effective manner. We are working to leverage our advanced data and analytical techniques to gain a deep understanding of our consumers, our customers, our shoppers, our end-to-end supply chain, our retail environment and key economic drivers at both a macro and precision level, including digital transformation and new media models. In addition, we are in the process of transforming our supply chain capabilities and enterprise resource planning system, which will enable employees to work more efficiently and effectively.
•Responsibly Manage Our Operations to Ensure the Long-Term Sustainability of Our Business, Our Planet and Our People. We are a purpose-driven company and for more than a century, our iconic brands have been built on a foundation of community investment and connections between people around the world. We could not have achieved this without our remarkable employees who make our purpose a reality. We believe our long-standing values make our Company a special place to work.
◦We believe our employees are among our most important resources and are critical to our continued success. We utilize continuous listening surveys that are distributed throughout the year to all employees globally. These short and fast surveys reach all of our employees around the world to hear their thoughts on the Company’s direction and their place in it. These continuous touchpoints allow for real-time feedback and action from the Company. These surveys are further supplemented with quarterly and informative enterprise and team town halls, which, in conjunction with the continuous listening surveys, generate stronger employee engagement with the Company’s strategy, initiatives and leadership.
◦Our diverse and inclusive culture makes the difference across all areas of the business. Our gender representation includes women occupying many of the top positions in the Company, including Chief Executive Officer and Chairman of the Board, Chief Accounting Officer and President, Salty Snacks, and approximately 50% representation across the Company. In 2022, we maintained fair and equitable pay achievements, including 1:1 aggregate people of color pay equity for salaried employees in the United States (2021) and 1:1 aggregate gender pay (2020).
◦We have made strong progress on our ESG priorities and continue to elevate these ESG initiatives for a greater global impact. While we focus on sustainability and social impact across our value chain, we continue to improve and focus on the lives of cocoa farmers and cocoa communities, the environmental priorities of climate change and the role of packaging in our business, responsibly and sustainably sourcing the inputs to our products and increasing investments in human rights and diversity initiatives and growing diverse representation across the organization.
Hershey is a global confectionery leader known for making more moments of goodness through chocolate, sweets, mints and other great tasting snacks. We are the largest producer of quality chocolate in North America, a leading snack maker in the United States and a global leader in chocolate and non-chocolate confectionery. We market, sell and distribute our products under more than 100 brand names in approximately 80 countries worldwide.
Our principal product offerings include chocolate and non-chocolate confectionery products; gum and mint refreshment products and protein bars; pantry items, such as baking ingredients, toppings and beverages; and snack items such as spreads, bars, and snack bites and mixes, popcorn and pretzels.
Business Acquisitions and Divestitures
In December 2021, we completed the acquisition of Pretzels Inc. (“Pretzels”), previously a privately held company that manufactures and sells pretzels and other salty snacks for other branded products and private labels in the United States. Pretzels is an industry leader in the pretzel category with a product portfolio that includes filled, gluten free and seasoned pretzels, as well as extruded snacks that complements Hershey’s snacks portfolio. Based in Bluffton, Indiana, Pretzels operates three manufacturing locations in Indiana and Kansas. Pretzels provides Hershey with deep pretzel category and product expertise and the manufacturing capabilities to support brand growth and future pretzel innovation. Additionally, we completed the acquisition of Dot’s Pretzels, LLC (“Dot’s”), previously a privately held company that produces and sells pretzels and other snack food products to retailers and distributors in the United States, with Dot’s Homestyle Pretzels snacks as its primary product. Dot’s is the fastest-growing scale brand in the pretzel category and complements Hershey’s snacks portfolio.
In June 2021, we completed the acquisition of Lily’s Sweets, LLC (“Lily’s”), previously a privately held company that sells a line of sugar-free and low-sugar confectionery foods to retailers and distributors in the United States and Canada. Lily’s products include dark and milk chocolate style bars, baking chips, peanut butter cups and other confection products that complement Hershey’s confectionery and confectionery-based portfolio.
In January 2021, we completed the divestiture of Lotte Shanghai Foods Co., Ltd. (“LSFC”), which was previously included within the International segment results in our consolidated financial statements. Total proceeds from the divestiture and the impact on our consolidated financial statements were immaterial.
During the second quarter of 2020, we completed the divestitures of KRAVE Pure Foods, Inc. (“Krave”), which was previously included within the North America Salty Snacks segment, and the Scharffen Berger and Dagoba brands, both of which were previously included within the North America Confectionery segment results in our consolidated financial statements.
TRENDS AFFECTING OUR BUSINESS
Demand for consumer goods has remained strong throughout 2022, with continued positive consumer patterns identified for our products, as well as increased consumer optimism and mobility, including retail foot traffic. However, negative macroeconomic conditions, including inflation on inputs to consumer products, labor shortages and demand outpacing supply, have led to broad-based supply chain disruptions across the U.S. and globally. As a result, we experienced corresponding incremental costs and gross margin pressures during the year ended December 31, 2022 (see Results of Operations included in this MD&A). We are continuing to work closely with our business units, contract manufacturers, distributors, contractors and other external business partners to minimize the potential impact on our business.
In addition to broad-based supply chain disruptions, certain geopolitical events, specifically the conflict between Russia and Ukraine, have increased global economic and political uncertainty. For the year ended December 31, 2022, this conflict did not have a material impact on our commodity prices or supply availability. However, we are continuing to monitor for any significant escalation or expansion of economic or supply chain disruptions or broader inflationary costs, which may result in material adverse effects on our results of operations.
Net sales and net income increased during the year ended December 31, 2022, which was primarily driven by strong everyday performance on our core U.S. confection brands and salty snack brands (see Segment Results included in this MD&A), partially offset by the aforementioned supply chain disruptions and gross margin pressures. As of December 31, 2022, we believe we have sufficient liquidity to satisfy our key strategic initiatives and other material cash requirements in both the short-term and in the long-term; however, we continue to evaluate and take action, as necessary, to preserve adequate liquidity and ensure that our business can operate effectively during the current economic environment. We continue to monitor our discretionary spending across the organization (see Liquidity and Capital Resources included in this MD&A).
Based on the length and severity of broad-based supply chain disruptions, fluctuating levels of inflation, changes in consumer shopping and consumption behavior, and the conflict between Russia and Ukraine, we may experience increasing supply chain costs and higher inflation. We will continue to evaluate the nature and extent of these potential and evolving impacts on our business, consolidated results of operations, segment results, liquidity and capital resources.
CONSOLIDATED RESULTS OF OPERATIONS
|For the years ended December 31,||2022||2021||2020||2022 vs 2021||2021 vs 2020|
|In millions of dollars except per share amounts|
|Net sales||$||10,419.3 ||$||8,971.3 ||$||8,149.7 ||16.1 ||%||10.1 ||%|
|Cost of sales||5,920.5 ||4,922.7 ||4,448.5 ||20.3 ||%||10.7 ||%|
|Gross profit||4,498.8 ||4,048.6 ||3,701.2 ||11.1 ||%||9.4 ||%|
|Gross margin||43.2 ||%||45.1 ||%||45.4 ||%|
|SM&A expense||2,236.0 ||2,001.4 ||1,890.9 ||11.7 ||%||5.8 ||%|
|SM&A expense as a percent of net sales||21.5 ||%||22.3%||23.2%|
|Long-lived asset impairment charges||— ||— ||9.1 ||NM||NM|
|Business realignment costs||2.0 ||3.5 ||18.5 ||(43.6)||%||(80.9)||%|
|Operating profit||2,260.8 ||2,043.7 ||1,782.7 ||10.6 ||%||14.6 ||%|
|Operating profit margin||21.7 ||%||22.8 ||%||21.9 ||%|
|Interest expense, net||137.6 ||127.4 ||149.4 ||8.0 ||%||(14.7)||%|
|Other (income) expense, net||206.1 ||119.1 ||138.3 ||73.1 ||%||(13.9)||%|
|Provision for income taxes||272.3 ||314.4 ||219.6 ||(13.4)||%||43.2 ||%|
|Effective income tax rate||14.2 ||%||17.5 ||%||14.7 ||%|
|Net income including noncontrolling interest||1,644.8 ||1,482.8 ||1,275.4 ||10.9 ||%||16.3 ||%|
|Less: Net gain (loss) attributable to noncontrolling interest||— ||5.3 ||(3.3)||NM||NM|
|Net income attributable to The Hershey Company||$||1,644.8||$||1,477.5||$||1,278.7||11.3 ||%||15.5 ||%|
|Net income per share—diluted||$||7.96||$||7.11||$||6.11||12.0 ||%||16.4 ||%|
Note: Percentage changes may not compute directly as shown due to rounding of amounts presented above.
| NM = not meaningful|
2022 compared with 2021
Net sales increased 16.1% in 2022 compared with 2021, reflecting a favorable price realization of 8.0% due to higher prices on certain products, a 4.3% benefit from net acquisitions and divestitures driven by the 2021 acquisitions of Lily’s, Dot’s and Pretzels and a volume increase of 4.0% due to an increase in consumer demand primarily in everyday core U.S. confection brands and salty snack brands. These increases were slightly offset by an unfavorable impact from foreign currency exchange rates of 0.2%.
2021 compared with 2020
Net sales increased 10.1% in 2021 compared with 2020, reflecting a volume increase of 5.6% due to an increase in everyday core U.S. confection brands and salty snack brands, a favorable price realization of 3.1% due to higher prices on certain products, a 1.0% benefit from net acquisitions and divestitures driven by the 2021 acquisitions of Lily’s, Dot's and Pretzels and a favorable impact from foreign currency exchange rates of 0.4%.
Key U.S. Marketplace Metrics
For the full year 2022, our total U.S. retail takeaway increased 11.4% in the expanded multi-outlet combined plus convenience store channels (IRI MULO + C-Stores), which includes candy, mint, gum, salty snacks and grocery items. Our U.S. candy, mint and gum (“CMG”) consumer takeaway increased 10.7%, resulting in a CMG market share decline of approximately 54 basis points.
The CMG consumer takeaway and market share information reflect measured channels of distribution accounting for approximately 90% of our U.S. confectionery retail business. These channels of distribution primarily include food, drug, mass merchandisers and convenience store channels, plus Wal-Mart Stores, Inc., partial dollar, club and military channels. These metrics are based on measured market scanned purchases as reported by Information Resources, Incorporated (“IRI”), the Company’s market insights and analytics provider, and provide a means to assess our retail takeaway and market position relative to the overall category.
Cost of Sales and Gross Margin
2022 compared with 2021
Cost of sales increased 20.3% in 2022 compared with 2021. The increase was driven by higher sales volume, higher supply chain inflation costs, including higher logistics and labor costs and an incremental $40.8 million of unfavorable mark-to-market activity on our commodity derivative instruments intended to economically hedge future years’ commodity purchases. Additionally, the increase was partially offset by favorable price realization and supply chain productivity.
Gross margin decreased by 200 basis points in 2022 compared with 2021. The decrease was driven by unfavorable year-over-year mark-to-market impact from commodity derivative instruments, higher supply chain inflation costs, including higher logistics and labor costs, and unfavorable product mix. These declines were offset by favorable price realization and volume increases.
2021 compared with 2020
Cost of sales increased 10.7% in 2021 compared with 2020. The increase was driven by higher sales volume, higher freight and logistics costs and additional plant costs. These drivers were partially offset by the incremental $78.8 million of favorable mark-to-market activity on our commodity derivative instruments intended to economically hedge future years’ commodity purchases; however, our mark-to-market activity was significantly impacted by financial market volatility during March 2020 amid the COVID-19 outbreak. Additionally, the increase was partially offset by favorable price realization and supply chain productivity.
Gross margin decreased by 30 basis points in 2021 compared with 2020. The decrease was driven by higher freight and logistics costs and additional plant costs. These factors were partially offset by favorable price realization, supply chain productivity and the favorable year-over-year mark-to-market impact from commodity derivative instruments.
Selling, Marketing and Administrative
2022 compared with 2021
Selling, marketing and administrative (“SM&A”) expenses increased $234.7 million, or 11.7%, in 2022 driven by increased corporate expenses. Total advertising and related consumer marketing expenses increased 2.7% driven by advertising increases in our confectionery brands and increased investment in our salty snacks portfolio, which were partially offset by cost efficiencies related to new media partners. SM&A expenses, excluding advertising and related consumer marketing, increased approximately 16.3% in 2022 driven by an increase in acquisition and integration related costs, as well as higher compensation costs, investments in capabilities and technology and broad-based marketplace inflation.
2021 compared with 2020
SM&A expenses increased $110.4 million, or 5.8%, in 2021 driven by increased corporate expenses. Total advertising and related consumer marketing expenses decreased 0.2% driven by lower advertising in our North America Confectionery segment. SM&A expenses, excluding advertising and related consumer marketing, increased approximately 9.2% in 2021 driven by higher compensation costs and investments in capabilities and technology.
Long-Lived Asset Impairment Charges
In 2022 and 2021, we recorded no impairments charges. In 2020, we recorded the following impairment charges:
|For the year ended December 31,||2020|
|In millions of dollars|
|Adjustment to disposal group (1)||$||6.2 |
|Other asset write-down (2)||2.9 |
|Long-lived asset impairment charges||$||9.1 |
(1)In connection with our LSFC disposal group, which was previously classified as held for sale during 2020, we recorded impairment charges to adjust long-lived asset values. The fair value of the disposal group was supported by potential sales prices with third-party buyers. The sale of the LSFC joint venture was completed in January 2021.
(2)In connection with a previous sale, the Company wrote-down certain receivables deemed uncollectible.
The assessment of the valuation of goodwill and other long-lived assets is based on management estimates and assumptions, as discussed in our critical accounting policies included in Item 7 of this Annual Report on Form 10-K. These estimates and assumptions are subject to change due to changing economic and competitive conditions.
Business Realignment Activities
We periodically undertake business realignment activities designed to increase our efficiency and focus our business in support of our key growth strategies. In 2022, 2021 and 2020 , we recorded business realignment costs of $2.0 million, $3.5 million and $18.5 million, respectively. The 2022, 2021, and 2020 costs related primarily to the International Optimization Program, a program focused on optimizing our China operating model to improve our operational efficiency and provide for a strong, sustainable and simplified base going forward. Costs associated with business realignment activities are classified in our Consolidated Statements of Income as described in Note 9 to the Consolidated Financial Statements.
Operating Profit and Operating Profit Margin
2022 compared with 2021
Operating profit increased 10.6% in 2022 compared with 2021 predominantly due to higher gross profit, partially offset by higher SM&A expenses, as noted above. Operating profit margin decreased to 21.7% in 2022 from 22.8% in 2021 by the same factors noted above that resulted in lower gross margin for the period.
2021 compared with 2020
Operating profit increased 14.6% in 2021 compared with 2020 due primarily to higher gross profit, lower business realignment costs and lower impairment charges, partially offset by higher SM&A in the 2021 period, as noted above. Operating profit margin increased to 22.8% in 2021 from 21.9% in 2020 driven by these same factors.
Interest Expense, Net
2022 compared with 2021
Net interest expense was $10.1 million higher in 2022 than in 2021. The increase was primarily due to higher rates on short-term debt balances in 2022 versus 2021, specifically related to outstanding commercial paper borrowings. The increase was partially offset due to lower average long-term debt balances, specifically resulting from the repayment of $84.7 million of 8.800% Debentures upon their maturity in February 2021 and $350 million of 3.100% Notes upon their maturity in May 2021.
2021 compared with 2020
Net interest expense was $22.0 million lower in 2021 than in 2020. The decrease was due to lower average long-term debt balances in 2021 versus 2020, specifically resulting from $435 million of long-term debt repayments with varying maturity dates during 2021.
Other (Income) Expense, Net
2022 compared with 2021
Other (income) expense, net totaled an expense of $206.1 million in 2022 versus an expense of $119.1 million in 2021. The increase in the net expense was primarily due to higher write-downs on equity investments qualifying for tax credits in 2022 versus 2021 and higher non-service cost components of net periodic benefit cost relating to pension and other post-retirement benefit plans.
2021 compared with 2020
Other (income) expense, net totaled an expense of $119.1 million in 2021 versus an expense of $138.3 million in 2020. The decrease in the net expense was primarily due to lower write-downs on equity investments qualifying for historic and renewable energy tax credits, in addition to lower non-service cost components of net periodic benefit cost relating to pension and other post-retirement benefit plans during 2021 compared to the 2020 period.
Income Taxes and Effective Tax Rate
2022 compared with 2021
Our effective income tax rate was 14.2% for 2022 compared with 17.5% for 2021. Relative to the 21% statutory rate, the 2022 effective tax rate benefited from investment tax credits, partially offset by state taxes. The 2021 effective rate, relative to the 21% statutory rate, benefited from investment tax credits, partially offset by incremental tax reserves incurred as a result of an adverse ruling in connection with a non-U.S. tax litigation matter, as well as state taxes.
2021 compared with 2020
Our effective income tax rate was 17.5% for 2021 compared with 14.7% for 2020. Relative to the 21% statutory rate, the 2021 effective tax rate benefited from investment tax credits, partially offset by incremental tax reserves incurred as a result of an adverse ruling in connection with a non-U.S. tax litigation matter, as well as state taxes. The 2020 effective rate, relative to the 21% statutory rate, benefited from investment tax credits and the benefit of employee share-based payments, partially offset by state taxes.
Net Income Attributable to The Hershey Company and Earnings Per Share-diluted
2022 compared with 2021
Net income increased $167.3 million, or 11.3%, while EPS-diluted increased $0.85, or 12.0%, in 2022 compared with 2021. The increase in both net income and EPS-diluted was driven primarily by higher gross profit and lower income taxes, partially offset by higher SM&A expenses and higher other income and expenses. Our 2022 EPS-diluted also benefited from lower weighted-average shares outstanding as a result of share repurchases pursuant to our Board-approved repurchase programs.
2021 compared with 2020
Net income increased $198.8 million, or 15.5%, while EPS-diluted increased $1.00, or 16.4%, in 2021 compared with 2020. The increase in both net income and EPS-diluted was driven primarily by higher gross profit, partially offset by higher SM&A and higher income taxes in 2021. Our 2021 EPS-diluted also benefited from lower weighted-average shares outstanding as a result of share repurchases pursuant to our Board-approved repurchase programs.
The summary that follows provides a discussion of the results of operations of our three segments: North America Confectionery, North America Salty Snacks and International. 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-related costs and other unusual gains or losses that are not part of our measurement of segment performance. These items of our operating income are largely managed centrally at the corporate level and are excluded from the measure of segment income reviewed by the Chief Operating Decision Maker and used for resource allocation and internal management reporting and performance evaluation. Segment income and segment income margin, which are presented in the segment discussion that follows, are non-GAAP measures and do not purport to be alternatives to operating income as a measure of operating performance. We believe that these measures are useful to investors and other users of our financial information in evaluating ongoing operating profitability as well as in evaluating operating performance in relation to our competitors, as they exclude the activities that are not directly attributable to our ongoing segment operations.
Our segment results, including a reconciliation to our consolidated results, were as follows:
|For the years ended December 31,||2022||2021||2020|
|In millions of dollars|
|North America Confectionery||$||8,536.5 ||$||7,682.4 ||$||7,084.9 |
|North America Salty Snacks||1,029.4 ||555.4 ||438.2 |
|International||853.4 ||733.5 ||626.6 |
|Total||$||10,419.3 ||$||8,971.3 ||$||8,149.7 |
|North America Confectionery||$||2,811.1 ||$||2,475.9 ||$||2,274.6 |
|North America Salty Snacks||159.9 ||100.7 ||75.8 |
|International||107.9 ||74.2 ||— |
|Total segment income||3,078.9 ||2,650.8 ||2,350.4 |
|Unallocated corporate expense (1)||735.5 ||614.9 ||520.7 |
|Unallocated mark-to-market losses (gains) on commodity derivatives (2)||78.2 ||(24.4)||6.4 |
|Long-lived asset impairment charges||— ||— ||9.1 |
|Costs associated with business realignment activities||4.4 ||16.6 ||31.5 |
|Operating profit||2,260.8 ||2,043.7 ||1,782.7 |
|Interest expense, net||137.6 ||127.4 ||149.4 |
|Other (income) expense, net||206.2 ||119.1 ||138.3 |
|Income before income taxes||$||1,917.0 ||$||1,797.2 ||$||1,495.0 |
(1)Includes centrally-managed (a) corporate functional costs relating to legal, treasury, finance and human resources, (b) expenses associated with the oversight and administration of our global operations, including warehousing, distribution and manufacturing, information systems and global shared services, (c) non-cash stock-based compensation expense, (d) acquisition-related costs and (e) other gains or losses that are not integral to segment performance.
(2)Net losses (gains) on mark-to-market valuation of commodity derivative positions recognized in unallocated derivative losses (gains). See Note 13 to the Consolidated Financial Statements.
North America Confectionery
The North America Confectionery segment is responsible for our chocolate and non-chocolate confectionery market position in the United States and Canada. This includes developing and growing our business in chocolate and non-chocolate confectionery, gum and refreshment products, protein bars, spreads, snack bites and mixes, as well as pantry and food service lines. While a less significant component, this segment also includes our retail operations, including Hershey’s Chocolate World stores in Hershey, Pennsylvania; New York, New York; Las Vegas, Nevada; Niagara Falls (Ontario) and Singapore, as well as operations associated with licensing the use of certain trademarks and products to third parties around the world. North America Confectionery accounted for 81.9%, 85.6% and 86.9% of our net sales in 2022, 2021 and 2020, respectively. North America Confectionery results for the years ended December 31, 2022, 2021 and 2020 were as follows:
|For the years ended December 31,||2022||2021||2020||2022 vs 2021||2021 vs 2020|
|In millions of dollars|
|Net sales||$||8,536.5 ||$||7,682.4 ||$||7,084.9 ||11.1 ||%||8.4 ||%|
|Segment income||2,811.1 ||2,475.9 ||2,274.6 ||13.5 ||%||8.8 ||%|
|Segment margin||32.9 ||%||32.2 ||%||32.1 ||%|
2022 compared with 2021
Net sales of our North America Confectionery segment increased $854.1 million, or 11.1%, in 2022 compared to 2021, reflecting a favorable price realization of 8.1% due to higher prices on certain products, a volume increase of 2.8% due to an increase in everyday core U.S. confection brands, and a 0.4% benefit from the 2021 acquisition of Lily’s. These increases were partially offset by an unfavorable impact from foreign currency exchange rates of 0.2%.
Our North America Confectionery segment also includes licensing and owned retail. This includes our Hershey’s Chocolate World stores in the United States (3 locations), Niagara Falls (Ontario) and Singapore. Our net sales for licensing and owned retail increased approximately 12.7% during 2022 compared to 2021.
Our North America Confectionery segment income increased $335.2 million, or 13.5%, in 2022 compared to 2021, primarily due to favorable price realization and volume increases, partially offset by higher supply chain inflation costs, including higher logistics and labor costs, as well as, unfavorable product mix.
2021 compared with 2020
Net sales of our North America Confectionery segment increased $597.5 million, or 8.4%, in 2021 compared to 2020, reflecting a volume increase of 5.1% due to an increase in everyday core U.S. confection brands, a favorable price realization of 2.1% due to higher prices on certain products, a 0.9% benefit from the 2021 acquisition of Lily’s and a favorable impact from foreign currency exchange rates of 0.3%.
Our North America Confectionery segment also includes licensing and owned retail. At the onset of the pandemic, all Hershey’s Chocolate World stores were temporarily closed and subsequently re-opened in July 2020 with increased safety measures. This included the United States (3 locations), Niagara Falls (Ontario) and Singapore. As a result, our net sales increased approximately 37.4% during 2021 compared to 2020.
Our North America Confectionery segment income increased $201.3 million, or 8.8%, in 2021 compared to 2020, primarily due to favorable price realization and volume increases, partially offset by higher supply chain-related costs, higher freight and logistics costs, as well as unfavorable product mix.
North America Salty Snacks
The North America Salty Snacks segment is responsible for our grocery and snacks market positions, including our salty snacking products. North America Salty Snacks accounted for 9.9%, 6.2% and 5.4% of our net sales in 2022, 2021 and 2020, respectively. North America Salty Snacks results for the years ended December 31, 2022, 2021 and 2020 were as follows:
|For the years ended December 31,||2022||2021||2020||2022 vs 2021||2021 vs 2020|
|In millions of dollars|
|Net sales||$||1,029.4 ||$||555.4 ||$||438.2 ||85.3 ||%||26.7 ||%|
|Segment income||159.9 ||100.7 ||75.8 ||58.8 ||%||32.8 ||%|
|Segment margin||15.5 ||%||18.1 ||%||17.3 ||%|
2022 compared with 2021
Net sales for our North America Salty Snacks segment increased $474 million, or 85.3%, in 2022 compared to 2021, reflecting a 64.0% benefit from the 2021 acquisitions of Dot’s and Pretzels, a favorable price realization of 12.0% due to higher prices on certain products and a volume increase of 9.3% primarily related to SkinnyPop and Pirates Booty snacks.
Our North America Salty Snacks segment income increased $59.2 million, or 58.8%, in 2022 compared to 2021, primarily due to favorable price realization and volume increases, partially offset by higher supply chain inflation costs, including higher logistics and labor costs, as well as, unfavorable product mix.
2021 compared with 2020
Net sales for our North America Salty Snacks segment increased $117.2 million, or 26.7%, in 2021 compared to 2020, reflecting a volume increase of 16.9%, primarily related to SkinnyPop and Pirates Booty snacks, a favorable price realization of 5.7% due to higher prices on certain products and a 4.1% benefit from net acquisitions and divestitures driven by the 2021 acquisitions of Dot’s and Pretzels.
Our North America Salty Snacks segment income increased $24.9 million, or 32.8%, in 2021 compared to 2020, primarily due to favorable price realization and volume increases, partially offset by higher supply chain-related costs, higher freight and logistics costs, as well as unfavorable product mix.
The International segment includes all other countries where we currently manufacture, import, market, sell or distribute chocolate and non-chocolate confectionery and other products. We currently, have operations and manufacture product in Mexico, Brazil, India and Malaysia, primarily for consumers in these regions, and also distribute and sell confectionery products in export markets of Latin America, as well as Asia, Europe, the Middle East and Africa (“AEMEA”) and other regions. International accounted for 8.2%, 8.2% and 7.7% of our net sales in 2022, 2021 and 2020, respectively. International results for the years ended December 31, 2022, 2021 and 2020 were as follows:
|For the years ended December 31,||2022||2021||2020||2022 vs 2021||2021 vs 2020|
|In millions of dollars|
|Net sales||$||853.4 ||$||733.5 ||$||626.6 ||16.3 ||%||17.1 ||%|
|Segment income||107.9 ||74.2 ||— ||45.4 ||%||NM|
|Segment margin||12.6 ||%||10.1 ||%||— ||%|
NM = not meaningful
2022 compared with 2021
Net sales of our International segment increased $119.9 million, or 16.3%, in 2022 compared to 2021, reflecting a volume increase of 11.9%, a favorable price realization of 4.1%, and a favorable impact from foreign currency exchange rates of 0.3%. The volume increase was primarily attributed to solid marketplace growth in Brazil, Mexico and India, where net sales increased by 21.6%, 20.6% and 13.7%, respectively. Our International segment also includes world travel retail, where net sales increased approximately 28.6%.
Our International segment income increased $33.7 million in 2022 compared to 2021 primarily resulting from volume increases, favorable price realization, and the execution of our International Optimization Program in China, as we streamline and optimize our China operating model.
2021 compared with 2020
Net sales of our International segment increased $106.9 million, or 17.1%, in 2021 compared to 2020, reflecting a favorable price realization of 12.1%, a volume increase of 4.2% and a favorable impact from foreign currency exchange rates of 0.8%. The volume increase was primarily attributed to solid marketplace growth in Mexico, India, and Brazil, where net sales increased by 39.0%, 23.9% and 21.3%, respectively. Our International segment also includes world travel retail, where net sales increased approximately 27.1%. These increases also benefited from a favorable impact from foreign currency exchange rates of 1.0%.
Our International segment income increased $74.2 million in 2021 compared to 2020 with the improvement primarily resulting from execution of our International Optimization Program in China, as we streamline and optimize our China operating model, as well as volume increases and favorable price realization.
Unallocated Corporate Expense
Unallocated corporate expense includes centrally-managed (a) corporate functional costs relating to legal, treasury, finance and human resources, (b) expenses associated with the oversight and administration of our global operations, including warehousing, distribution and manufacturing, information systems and global shared services, (c) non-cash stock-based compensation expense and (d) other gains or losses that are not integral to segment performance.
Unallocated corporate expense totaled $735.5 million in 2022 as compared to $614.9 million in 2021. The increase was primarily driven by an increase in acquisition and integration related costs, as well as higher compensation costs, investments in capabilities and technology and broad-based marketplace inflation.
Unallocated corporate expense totaled $614.9 million in 2021 as compared to $520.7 million in 2020 primarily driven by higher incentive compensation, higher group insurance costs from COVID-19-related delays in preventive care and incremental investments in capabilities and technology.
LIQUIDITY AND CAPITAL RESOURCES
We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Significant factors affecting liquidity include cash flows generated from operating activities, capital expenditures, acquisitions, dividends, repurchases of outstanding shares, the adequacy of available commercial paper and bank lines of credit, and the ability to attract long-term capital with satisfactory terms. We generate substantial amounts of cash from operations and remain in a strong financial position, with sufficient liquidity available for capital reinvestment, strategic acquisitions and the payment of dividends.
Cash Flow Summary
The following table is derived from our Consolidated Statements of Cash Flows:
|In millions of dollars||2022||2021||2020|
|Net cash provided by (used in):|
|Effect of exchange rate changes on cash and cash equivalents||9.9 ||(5.1)||(7.0)|
|Less: Cash classified as assets held for sale||— ||11.4 ||(11.4)|
|Increase (decrease) in cash and cash equivalents||$||134.6 ||$||(814.7)||$||650.7 |
Our principal source of liquidity is cash flow from operations. Our net income and, consequently, our cash provided by operations are impacted by sales volume, seasonal sales patterns, timing of new product introductions, profit margins and price changes. Sales are typically higher during the third and fourth quarters of the year due to seasonal and holiday-related sales patterns. Generally, working capital needs peak during the summer months. We meet these needs primarily with cash on hand, bank borrowings or the issuance of commercial paper.
We generated cash of $2.3 billion from operating activities in 2022, an increase of $244.9 million compared to $2.1 billion in 2021. This increase in net cash provided by operating activities was mainly driven by the following factors:
•In the aggregate, select net working capital items, specifically, trade accounts receivable, inventory, accounts payable and accrued liabilities, consumed cash of $9 million in 2022 and generated cash of $47 million in 2021. This $56 million fluctuation was mainly driven by a higher year-over-year build up of U.S. inventories to satisfy product requirements and maintain sufficient levels to accommodate customer requirements, partially offset by the timing of vendor and supplier payments.
•Net income adjusted for non-cash charges to operations (including depreciation, amortization, stock-based compensation, deferred income taxes, write-down of equity investments and other charges) resulted in $348 million of higher cash flow in 2022 relative to 2021.
We generated cash of $2.1 billion from operating activities in 2021, an increase of $383.3 million compared to $1.7 billion in 2020. This increase in net cash provided by operating activities was mainly driven by the following factors:
•In the aggregate, select net working capital items, specifically, trade accounts receivable, inventory, accounts payable and accrued liabilities, generated cash of $47 million in 2021 and consumed cash of $166 million in 2020. This $213 million fluctuation was mainly driven by strong demand of U.S. inventories, specifically our everyday core U.S. confection brands and salty snack brands.
•Net income adjusted for non-cash charges to operations (including depreciation, amortization, stock-based compensation, deferred income taxes, long-lived asset charges, write-down of equity investments and other charges) resulted in $185 million of higher cash flow in 2021 relative to 2020.
Pension and Post-Retirement Activity. We recorded net periodic benefit costs of $36.3 million, $28.4 million and $34.5 million in 2022, 2021 and 2020, respectively, relating to our benefit plans (including our defined benefit and other post retirement plans). The main drivers of fluctuations in expense from year to year are assumptions in formulating our long-term estimates, including discount rates used to value plan obligations, expected returns on plan assets, the service and interest costs and the amortization of actuarial gains and losses.
The funded status of our qualified defined benefit pension plans is dependent upon many factors, including returns on invested assets, the level of market interest rates and the level of funding. We contribute cash to our plans at our discretion, subject to applicable regulations and minimum contribution requirements. Cash contributions to our pension and post retirement plans totaled $78.5 million, $51.1 million and $11.7 million in 2022, 2021 and 2020, respectively.
Our principal uses of cash for investment purposes relate to purchases of property, plant and equipment and capitalized software, as well as acquisitions of businesses, partially offset by proceeds from sales of property, plant and equipment. We used cash of $787.4 million for investing activities in 2022 compared to $2.2 billion in 2021, with the decrease in cash spend driven by lower levels of acquisition activity, partially offset by higher capital spend and investment tax credits. We used cash of $531.3 million for investing activities in 2020, with the increase in 2021 in cash spend driven by higher levels acquisition activity.
Primary investing activities include the following:
•Capital spending. Capital expenditures, including capitalized software, primarily to support our ERP system implementation, capacity expansion, innovation and cost savings, were $519.5 million in 2022, $495.9 million in 2021 and $441.6 million in 2020. For each of the years presented, our expenditures increased due to progress on capacity expansion projects and our ERP system implementation. We expect 2023 capital expenditures, including capitalized software, to approximate $800 million to $900 million. The increase in our 2023 capital expenditures is largely driven by our key strategic initiatives, including core confection capacity expansion and continued investments in a digital infrastructure including the build and upgrade of a new ERP system across the enterprise. We intend to use our existing cash and internally generated funds to meet our 2023 capital requirements.
•Investments in partnerships qualifying for tax credits. We make investments in partnership entities that in turn make equity investments in projects eligible to receive federal historic and energy tax credits. We invested approximately $275.5 million in 2022, $128.4 million in 2021 and $87.2 million in 2020 in projects qualifying for tax credits.
•Business acquisitions. In 2022 and 2020, we had no acquisition activity. In 2021, we spent an aggregate $1.6 billion to acquire Lily's (June 2021), as well as Dot’s and Pretzels (December 2021). Further details regarding our business acquisition activity is provided in Note 2 to the Consolidated Financial Statements.
•Other investing activities. In 2022, 2021, and 2020, our other investing activities were minimal.
Our cash flow from financing activities generally relates to the use of cash for purchases of our Common Stock and payment of dividends, offset by net borrowing activity and proceeds from the exercise of stock options. Financing activities in 2022 used cash of $1.4 billion, compared to cash used of $681.1 million in 2021. We used cash of $499.2 million for financing activities in 2020.
The majority of our financing activity was attributed to the following:
•Short-term borrowings, net. In addition to utilizing cash on hand, we use short-term borrowings (commercial paper and bank borrowings) to fund seasonal working capital requirements and ongoing business needs. In 2022, used cash of $245.6 million to reduce a portion of our short-term commercial paper borrowings originally used to fund our 2021 acquisitions of Dot’s and Pretzels, partially offset by an increase in short-term foreign bank borrowings. In 2021, we generated cash flow of $869.0 million predominantly through the issuance of short-term commercial paper. In 2020, we generated cash flow of $41.8 million due to an increase in short-term foreign bank borrowings.
•Long-term debt borrowings and repayments. In 2022, long-term debt activity was minimal. In February 2021 and May 2021, we repaid $84.7 million of 8.800% Debentures and $350 million of 3.100% Notes due upon their maturities, respectively. In May 2020, we issued $300 million of 0.900% Notes due in 2025, $350 million of 1.700% Notes due in 2030 and $350 million of 2.650% Notes due in 2050 (the “2020 Notes”). Proceeds from the issuance of the 2020 Notes, net of discounts and issuance costs, totaled $989.9 million. Additionally, in May 2020 and December 2020, we repaid $350 million of 2.900% Notes and $350 million of 4.125% Notes due upon their maturities, respectively. In 2023, we expect our long-term debt repayments to approximate $750 million upon the maturity of $250 million of 2.625% Notes and $500 million of 3.375% Notes, both due in May 2023.
•Dividend payments. Total dividend payments to holders of our Common Stock and Class B Common Stock were $775.0 million in 2022, $686.0 million in 2021 and $640.7 million in 2020. Dividends per share of Common Stock increased 13.6% to $3.874 per share in 2022 compared to $3.410 per share in 2021, while dividends per share of Class B Common Stock increased 13.6% in 2022. Details regarding our 2022 cash dividends paid to stockholders are as follows:
|In millions of dollars except per share amounts||April 3, 2022||July 3, 2022||October 2, 2022||December 31, 2022|
|Dividends paid per share – Common stock||$||0.901 ||$||0.901 ||$||1.036 ||$||1.036 |
|Dividends paid per share – Class B common stock||$||0.819 ||$||0.819 ||$||0.942 ||$||0.942 |
|Total cash dividends paid||$||181.1 ||$||179.9 ||$||207.0 ||$||207.0 |
|Declaration date||February 2, 2022||April 27, 2022||July 27, 2022||November 2, 2022|
|Record date||February 18, 2022||May 20, 2022||August 19, 2022||November 18, 2022|
|Payment date||March 15, 2022||June 15, 2022||September 15, 2022||December 15, 2022|
•Share repurchases. We repurchase shares of Common Stock to offset the dilutive impact of treasury shares issued under our equity compensation plans. The value of these share repurchases in a given period varies based on the volume of stock options exercised and our market price. In addition, we periodically repurchase shares of Common Stock pursuant to Board-authorized programs intended to drive additional stockholder value. Details regarding our share repurchases are as follows:
|Milton Hershey School Trust repurchase (1)||$||203.4 ||$||— ||$||— |
|Shares repurchased in the open market under pre-approved share repurchase programs (2)||— ||150.0 ||150.0 |
|Shares repurchased in the open market to replace Treasury Stock issued for stock options and incentive compensation||$||185.6 ||$||308.0 ||$||61.2 |
|Cash used for total share repurchases||389.0||458.0||211.2|
|Total shares repurchased under pre-approved share repurchase programs||— ||0.9 ||1.0 |
(1) In February 2022, the Company entered into a Stock Purchase Agreement with Hershey Trust Company, as trustee for the School Trust, pursuant to which the Company purchased 1,000,000 shares of the Company’s Common Stock from the School Trust at a price equal to $203.35 per share, for a total purchase price of $203.4 million.
(2) In July 2018, our Board of Directors approved a $500 million share repurchase authorization. As of December 31, 2022, approximately $110 million remained available for repurchases of our Common Stock under this program. In May 2021, our Board of Directors approved an additional $500 million share repurchase authorization. This program is to commence after the existing 2018 authorization is completed and is to be utilized at management’s discretion. These share repurchase programs do not have an expiration date. We expect 2023 share repurchases to be in line with our traditional buyback strategy.
Additionally, in February 2023, the Company entered into a Stock Purchase Agreement with Hershey Trust Company, as trustee for the School Trust, pursuant to which the Company purchased 1,000,000 shares of the Company’s Common Stock from the School Trust at a price equal to $239.91 per share, for a total purchase price of $239.9 million. As a result of this repurchase, our July 2018 share repurchase authorization program was completed in February 2023, and approximately $370 million remains available for repurchases under our May 2021 share repurchase authorization.
•Proceeds from the exercise of stock options, including tax benefits. In 2022 we received $34.2 million from employee exercises of stock options and paid $35.5 million of employee taxes withheld from share-based awards. We received $33.2 million and $25.5 million from employee exercises of stock options, net of employee taxes withheld from share-based awards in 2021 and 2020, respectively. Variances are driven primarily by the number of shares exercised and the share price at the date of grant.
At December 31, 2022, our cash and cash equivalents totaled $463.9 million. At December 31, 2021, our cash and cash equivalents totaled $329.3 million. Our cash and cash equivalents at the end of 2022 increased $134.6 million compared to the 2021 year-end balance as a result of the net sources of cash outlined in the previous discussion.
Approximately 90% of the balance of our cash and cash equivalents at December 31, 2022 was held by subsidiaries domiciled outside of the United States. A majority of this balance is distributable to the United States without material tax implications, such as withholding tax. We intend to continue to reinvest the remainder of the earnings outside of the United States for which there would be a material tax implication to distributing for the foreseeable future and, therefore, have not recognized additional tax expense on these earnings. We believe that our existing sources of liquidity are adequate to meet anticipated funding needs at comparable risk-based interest rates for the foreseeable future. Acquisition spending and/or share repurchases could potentially increase our debt. Operating cash flow and access to capital markets are expected to satisfy our various short- and long-term cash flow requirements, including acquisitions and capital expenditures.
We maintain debt levels we consider prudent based on our cash flow, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital which increases our return on stockholders’ equity. Our total short- and long-term debt was $4.8 billion at December 31, 2022 and $5.0 billion at December 31, 2021. Our total debt decreased in 2022 mainly due the repayment of short-term commercial paper borrowings originally used to fund our 2021 acquisitions of Dot’s and Pretzels.
As a source of short-term financing, we maintain a $1.5 billion unsecured revolving credit facility with the option to increase borrowings by an additional $500 million with the consent of the lenders. As of December 31, 2022, the termination date of this agreement is July 2, 2024, however, we may extend the termination date for up to two additional one-year periods upon notice to the administrative agent under the facility. We may use these funds for general corporate purposes, including commercial paper backstop and business acquisitions. As of December 31, 2022, we had $942 million of available capacity under the agreement. The unsecured revolving credit agreement contains certain financial and other covenants, customary representations, warranties and events of default. We were in compliance with all covenants as of December 31, 2022.
In addition to the revolving credit facility, we maintain lines of credit in various currencies with domestic and international commercial banks. As of December 31, 2022, we had available capacity of $178 million under these lines of credit.
Furthermore, we have a current shelf registration statement filed with the SEC that allows for the issuance of an indeterminate amount of debt securities. Proceeds from the debt issuances and any other offerings under the current registration statement may be used for general corporate requirements, including reducing existing borrowings, financing capital additions and funding contributions to our pension plans, future business acquisitions and working capital requirements.
Our ability to obtain debt financing at comparable risk-based interest rates is partly a function of our existing cash-flow-to-debt and debt-to-capitalization levels as well as our current credit rating.
We believe that our existing sources of liquidity are adequate to meet anticipated funding needs at comparable risk-based interest rates for the foreseeable future. Acquisition spending and/or share repurchases could potentially increase our debt. Operating cash flow and access to capital markets are expected to satisfy our various short- and long-term cash flow requirements, including acquisitions and capital expenditures.
We have two classes of stock outstanding – Common Stock and Class B Stock. Holders of the Common Stock and the Class B Stock generally vote together without regard to class on matters submitted to stockholders, including the election of directors. Holders of the Common Stock have 1 vote per share. Holders of the Class B Stock have 10 votes per share. Holders of the Common Stock, voting separately as a class, are entitled to elect one-sixth of our Board. With respect to dividend rights, holders of the Common Stock are entitled to cash dividends 10% higher than those declared and paid on the Class B Stock.
Hershey Trust Company, as trustee for the trust established by Milton S. and Catherine S. Hershey that has as its sole beneficiary Milton Hershey School, maintains voting control over The Hershey Company. In addition, three representatives of Hershey Trust Company currently serve as members of the Company's Board. In performing their responsibilities on the Company’s Board, these representatives may from time to time exercise influence with regard to the ongoing business decisions of our Board or management. Hershey Trust Company, as trustee for the Trust, in its role as controlling stockholder of the Company, has indicated it intends to retain its controlling interest in The Hershey Company. The Company’s Board, and not the Hershey Trust Company board, is solely responsible and accountable for the Company’s management and performance.
Pennsylvania law requires that the Office of Attorney General be provided advance notice of any transaction that would result in Hershey Trust Company, as trustee for the Trust, no longer having voting control of the Company. The law provides specific statutory authority for the Attorney General to intercede and petition the court having jurisdiction over Hershey Trust Company, as trustee for the Trust, to stop such a transaction if the Attorney General can prove that the transaction is unnecessary for the future economic viability of the Company and is inconsistent with investment and management considerations under fiduciary obligations. This legislation makes it more difficult for a third party to acquire a majority of our outstanding voting stock and thereby may delay or prevent a change in control of the Company.
Material Cash Requirements
The following table summarizes our future material cash requirements as of December 31, 2022:
|Payments due by Period|
|In millions of dollars||Total||Less than 1 year||1-3 years||3-5 years||More than 5 years|
|Short-term debt (primarily U.S. commercial paper)||$||693.8 ||$||693.8 ||$||— ||$||— ||$||— |
|Long-term notes (excluding finance lease obligations)||4,043.6 ||750.0 ||900.0 ||693.6 ||1,700.0 |
|Interest expense (1)||1,080.8 ||99.0 ||164.3 ||120.2 ||697.3 |
|Operating lease obligations (2)||419.7 ||41.4 ||66.3 ||47.4 ||264.6 |
|Finance lease obligations (3)||171.4 ||8.3 ||13.0 ||8.1 ||142.0 |
|Unconditional purchase obligations (4)||2,246.4 ||1,871.0 ||215.1 ||25.0 ||135.3 |
(1) Includes the net interest payments on fixed rate debt associated with long-term notes.
(2) Includes the minimum rental commitments (including imputed interest) under non-cancelable operating leases primarily for offices, retail stores, warehouses and distribution facilities.
(3) Includes the minimum rental commitments (including imputed interest) under non-cancelable finance leases primarily for offices and warehouse facilities, as well as vehicles.
(4) Purchase obligations consist primarily of fixed commitments for the purchase of raw materials to be utilized in the normal course of business. Amounts presented include fixed price forward contracts and unpriced contracts that were valued using market prices as of December 31, 2022. The amounts presented in the table do not include items already recorded in accounts payable or accrued liabilities at year-end 2022, nor does the table reflect cash flows we are likely to incur based on our plans, but are not obligated to incur. Such amounts are part of normal operations and are reflected in historical operating cash flow trends. We do not believe such purchase obligations will adversely affect our liquidity position.
In entering into contractual obligations, 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 performing financial assessments prior to contract execution, conducting periodic evaluations of counterparty performance and maintaining a diverse portfolio of qualified counterparties. Our risk is limited to replacing the contracts at prevailing market rates. We do not expect any significant losses resulting from counterparty defaults.
These obligations impact our liquidity and capital resource needs. To meet those cash requirements, we intend to use our existing cash and internally generated funds. To the extent necessary, we may also borrow under our existing unsecured revolving credit facility or under other short-term borrowings, and depending on market conditions and upon the significance of the cost of a particular Note maturity or acquisition to our then-available sources of funds, to obtain additional short- and long-term financing. We believe that cash provided from these sources will be adequate to meet our future short- and long-term cash requirements.
Asset Retirement Obligations
We have a number of facilities that contain varying amounts of asbestos in certain locations within the facilities. Our asbestos management program is compliant with current applicable regulations, which require that we handle or dispose of asbestos in a specified manner if such facilities undergo major renovations or are demolished. We do not have sufficient information to estimate the fair value of any asset retirement obligations related to these facilities. We cannot specify the settlement date or range of potential settlement dates and, therefore, sufficient information is not available to apply an expected present value technique. We expect to maintain the facilities with repairs and maintenance activities that would not involve or require the removal of significant quantities of asbestos.
Income Tax Obligations
Liabilities for unrecognized income tax benefits are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of a settlement of these potential liabilities. See Note 10 to the Consolidated Financial Statements for more information.
Recent Accounting Pronouncements
Information on recently adopted and issued accounting standards is included in Note 1 to the Consolidated Financial Statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements requires management to use judgment and make estimates and assumptions. We believe that our most critical accounting policies and estimates relate to the following:
•Accrued Liabilities for Trade Promotion Activities
•Pension and Other Post-Retirement Benefits Plans
•Business Acquisitions, Valuation and Impairment of Goodwill and Other Intangible Assets
Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of our Board. While we base estimates and assumptions on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Other significant accounting policies are outlined in Note 1 to the Consolidated Financial Statements.
Accrued Liabilities for Trade Promotion Activities
We promote our products with advertising, trade promotions and consumer incentives. These programs include, but are not limited to, discounts, coupons, rebates, in-store display incentives and volume-based incentives. We expense advertising costs and other direct marketing expenses as incurred. We recognize the costs of trade promotion and consumer incentive activities as a reduction to net sales along with a corresponding accrued liability based on estimates at the time of revenue recognition. These estimates are based on our analysis of the programs offered, historical trends, expectations regarding customer and consumer participation, sales and payment trends and our experience with payment patterns associated with similar programs offered in the past. The estimated costs of these programs are reasonably likely to change in future periods due to changes in trends with regard to customer and consumer participation, particularly for new programs and for programs related to the introduction of new products. Differences between estimated expense and actual program performance are recognized as a change in estimate in a subsequent period and are normally not significant. During 2022, 2021, and 2020, actual annual promotional costs have not deviated from the estimated amount by more than 3%. Our trade promotion and consumer incentive accrued liabilities totaled $215.7 million and $174.0 million at December 31, 2022 and 2021, respectively.
Pension and Other Post-Retirement Benefits Plans
We sponsor various defined benefit pension plans. The primary plans are The Hershey Company Retirement Plan and The Hershey Company Retirement Plan for Hourly Employees, which are cash balance plans that provide pension benefits for most U.S. employees hired prior to January 1, 2007. We also sponsor two primary other post-employment benefit (“OPEB”) plans, consisting of a health care plan and life insurance plan for retirees. The health care plan is contributory, with participants’ contributions adjusted annually, and the life insurance plan is non-contributory.
For accounting purposes, the defined benefit pension and OPEB plans require assumptions to estimate the projected and accumulated benefit obligations, including the following variables: discount rate; expected salary increases; certain employee-related factors, such as turnover, retirement age and mortality; expected return on assets; and health care cost trend rates. These and other assumptions affect the annual expense and obligations recognized for the underlying plans. Our assumptions reflect our historical experiences and management’s best judgment regarding future expectations. Our related accounting policies, accounting balances and plan assumptions are discussed in Note 11 to the Consolidated Financial Statements.
Changes in certain assumptions could significantly affect pension expense and benefit obligations, particularly the estimated long-term rate of return on plan assets and the discount rates used to calculate such obligations:
•Long-term rate of return on plan assets. The expected long-term rate of return is evaluated on an annual basis. We consider a number of factors when setting assumptions with respect to the long-term rate of return, including current and expected asset allocation and historical and expected returns on the plan asset categories. Actual asset allocations are regularly reviewed and periodically rebalanced to the targeted allocations when considered appropriate. Investment gains or losses represent the difference between the expected return estimated using the
long-term rate of return and the actual return realized. For 2022, we increased the expected return on plan assets assumption to 6.3% from the 4.9% assumption used during 2021. The historical average return (compounded annually) over the 20 years prior to December 31, 2022 was approximately 6.4%.
As of December 31, 2022, our primary plans had cumulative unrecognized investment and actuarial losses of approximately $213 million. We amortize the unrecognized net actuarial gains and losses in excess of the corridor amount, which is the greater of 10% of a respective plan’s projected benefit obligation or the fair market value of plan assets. These unrecognized net losses may increase future pension expense if not offset by (i) actual investment returns that exceed the expected long-term rate of investment returns, (ii) other factors, including reduced pension liabilities arising from higher discount rates used to calculate pension obligations or (iii) other actuarial gains when actual plan experience is favorable as compared to the assumed experience. A 100 basis point decrease or increase in the long-term rate of return on pension assets would correspondingly increase or decrease annual net periodic pension benefit expense by approximately $7 million.
•Discount rate. We utilize a full yield curve approach in the estimation of service and interest costs by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. This approach provides a more precise measurement of service and interest costs by improving the correlation between the projected cash flows to the corresponding spot rates along the yield curve. This approach does not affect the measurement of our pension and other post-retirement benefit liabilities but generally results in lower benefit expense in periods when the yield curve is upward sloping.
A 100 basis point decrease (increase) in the weighted-average pension discount rate would increase (decrease) annual net periodic pension benefit expense by approximately $5 million and the December 31, 2022 pension liability would increase by approximately $57 million or decrease by approximately $50 million, respectively.
Pension expense for defined benefit pension plans is expected to be approximately $21 million in 2023. Pension expense beyond 2023 will depend on future investment performance, our contributions to the pension trusts, changes in discount rates and various other factors related to the covered employees in the plans.
Other Post-Employment Benefit Plans
Changes in significant assumptions could affect consolidated expense and benefit obligations, particularly the discount rates used to calculate such obligations:
•Discount rate. The determination of the discount rate used to calculate the benefit obligations of the OPEB plans is discussed in the pension plans section above. A 100 basis point decrease (increase) in the discount rate assumption for these plans would not be material to the OPEB plans’ consolidated expense and the December 31, 2022 benefit liability would increase by approximately $13 million or decrease by approximately $12 million, respectively.
Business Acquisitions, Valuation and Impairment of Goodwill and Other Intangible Assets
We use the acquisition method of accounting for business acquisitions. Under the acquisition method, the results of operations of the acquired business have been included in the consolidated financial statements since the respective dates of the acquisitions. The assets acquired and liabilities assumed are recorded at their respective estimated fair values at the date of the acquisition. Any excess of the purchase price over the estimated fair values of the identifiable net assets acquired is recorded as goodwill. Significant judgment is often required in estimating the fair value of assets acquired, particularly intangible assets. As a result, we normally obtain the assistance of a third-party valuation specialist in estimating fair values of tangible and intangible assets. The fair value estimates are based on available historical information and on expectations and assumptions about the future, considering the perspective of marketplace participants. While management believes those expectations and assumptions are reasonable, they are inherently uncertain. Unanticipated market or macroeconomic events and circumstances may occur, which could affect the accuracy or validity of the estimates and assumptions.
Goodwill and indefinite-lived intangible assets are not amortized, but instead, are evaluated for impairment annually or more often if indicators of a potential impairment are present. Our annual impairment tests are conducted at the beginning of the fourth quarter.
We test goodwill for impairment by performing either a qualitative or quantitative assessment. If we choose to perform a qualitative assessment, we evaluate economic, industry and company-specific factors in assessing the fair value of the related reporting unit. If we determine that it is more likely than not that the fair value of the reporting unit is less than its carrying value, a quantitative test is then performed. Otherwise, no further testing is required. For those reporting units tested using a quantitative approach, we compare the fair value of each reporting unit with the carrying amount of the reporting unit, including goodwill. If the estimated fair value of the reporting unit is less than the carrying amount of the reporting unit, impairment is indicated, requiring recognition of a goodwill impairment charge for the differential (up to the carrying value of goodwill). We test individual indefinite-lived intangible assets by comparing the estimated fair values with the book values of each asset.
We determine the fair value of our reporting units and indefinite-lived intangible assets using an income approach. Under the income approach, we calculate the fair value of our reporting units and indefinite-lived intangible assets based on the present value of estimated future cash flows. Considerable management judgment is necessary to evaluate the impact of operating and macroeconomic changes and to estimate the future cash flows used to measure fair value. Our estimates of future cash flows consider past performance, current and anticipated market conditions and internal projections and operating plans which incorporate estimates for sales growth and profitability, and cash flows associated with taxes and capital spending. Additional assumptions include forecasted growth rates, estimated discount rates, which may be risk-adjusted for the operating market of the reporting unit, and estimated royalty rates that would be charged for comparable branded licenses. We believe such assumptions also reflect current and anticipated market conditions and are consistent with those that would be used by other marketplace participants for similar valuation purposes. Such assumptions are subject to change due to changing economic and competitive conditions.
We also have intangible assets, consisting primarily of certain trademarks, customer-related intangible assets and patents obtained through business acquisitions, that are expected to have determinable useful lives. The costs of finite-lived intangible assets are amortized to expense over their estimated lives. Our estimates of the useful lives of finite-lived intangible assets consider judgments regarding the future effects of obsolescence, demand, competition and other economic factors. We conduct impairment tests when events or changes in circumstances indicate that the carrying value of these finite-lived assets may not be recoverable. Undiscounted cash flow analyses are used to determine if an impairment exists. If an impairment is determined to exist, the loss is calculated based on the estimated fair value of the assets.
Results of Impairment Tests
At December 31, 2022, the net book value of our goodwill totaled $2.6 billion. As it relates to our 2022 annual testing performed at the beginning of the fourth quarter, we tested all of our reporting units using a qualitative assessment and determined that no quantitative testing was deemed necessary. Based on our testing, all of our reporting units had an excess fair value well over the their respective carrying values. There were no other events or circumstances that would indicate that impairment may exist. We had no goodwill impairment charges in 2022, 2021 or 2020.
We base our deferred income taxes, accrued income taxes and provision for income taxes upon income, statutory tax rates, the legal structure of our Company, interpretation of tax laws and tax planning opportunities available to us in the various jurisdictions in which we operate. We file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. We are regularly audited by federal, state and foreign tax authorities; a number of years may elapse before an uncertain tax position, for which we have unrecognized tax benefits, is audited and finally resolved. From time to time, these audits result in assessments of additional tax. We maintain reserves for such assessments.
We apply a more-likely-than-not threshold to the recognition and derecognition of uncertain tax positions. Accordingly, we recognize the amount of tax benefit that has a greater than 50% likelihood of being ultimately realized upon settlement. Future changes in judgments and estimates related to the expected ultimate resolution of uncertain tax positions will affect income in the quarter of such change. While it is often difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, we believe that our unrecognized tax benefits reflect the most likely outcome. Accrued interest and penalties related to unrecognized tax benefits are included in income tax expense. We adjust these unrecognized tax benefits, as well as the related interest, in light of
changing facts and circumstances, such as receiving audit assessments or clearing of an item for which a reserve has been established. Settlement of any particular position could require the use of cash. Favorable resolution would be recognized as a reduction to our effective income tax rate in the period of resolution.
We believe it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets, net of valuation allowances. Our valuation allowances are primarily related to U.S. capital loss carryforwards and various foreign jurisdictions’ net operating loss carryforwards and other deferred tax assets for which we do not expect to realize a benefit. Refer to Note 10 to the Consolidated Financial Statements for further discussion of our deferred tax assets and liabilities.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use certain derivative instruments to manage our interest rate, foreign currency exchange rate and commodity price risks. We monitor and manage these exposures as part of our overall risk management program.
We enter into interest rate swap agreements and foreign currency forward exchange contracts for periods consistent with related underlying exposures. We enter into commodities futures and options contracts and other derivative instruments for varying periods. These commodity derivative instruments are intended to be, and are effective as, economic hedges of market price risks associated with anticipated raw material purchases, energy requirements and transportation costs. We do not hold or issue derivative instruments for trading purposes and are not a party to any instruments with leverage or prepayment features.
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 exchange-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.
Refer to Note 1 and Note 5 to the Consolidated Financial Statements for further discussion of these derivative instruments and our hedging policies.
Interest Rate Risk
In December 2020, our fixed-to-floating interest rate swap matured in connection with the repayment of certain long-term debt upon its maturity. Therefore, as of December 31, 2022 and December 31, 2021, we had no interest rate swap derivative instruments in a fair value hedging relationship. Prior to maturing in December 2020, the total notional amount of interest rate swaps was $350 million. The notional amount relates to fixed-to-floating interest rate swaps which convert a comparable amount of fixed-rate debt to variable rate debt. A hypothetical 100 basis point increase in interest rates applied to this variable-rate debt through its December 2020 maturity would have increased interest expense by approximately $3.2 million for 2020.
In addition, the total amount of short-term debt, net of cash, amounted to net debt of $230 million and net debt of $610 million, respectively, at December 31, 2022 and 2021. A hypothetical 100 basis point increase in interest rates applied to this variable-rate short-term debt as of December 31, 2022 would have changed interest expense by approximately $4.5 million for 2022 and $2.4 million for 2021.
We consider our current risk related to market fluctuations in interest rates on our remaining debt portfolio, excluding fixed-rate debt converted to variable rates with fixed-to-floating instruments, to be minimal since this debt is largely long-term and fixed-rate in nature. Generally, the fair market value of fixed-rate debt will increase as interest rates fall and decrease as interest rates rise. A 100 basis point increase in market interest rates would decrease the fair value of our fixed-rate long-term debt at December 31, 2022 and December 31, 2021 by approximately $187 million and $319 million, respectively. However, since we currently have no plans to repurchase our outstanding fixed-rate instruments before their maturities, the impact of market interest rate fluctuations on our long-term debt does not affect our results of operations or financial position.
Foreign Currency Exchange Rate Risk
We are exposed to currency fluctuations related to manufacturing or selling products in currencies other than the U.S. dollar. We may enter into foreign currency forward exchange contracts to reduce fluctuations in our long or short currency positions relating primarily to purchase commitments or forecasted purchases for equipment, raw materials and finished goods denominated in foreign currencies. We also may hedge payment of forecasted intercompany transactions with our subsidiaries outside of the United States. We generally hedge foreign currency price risks for periods from 3 to 12 months.
A summary of foreign currency forward exchange contracts and the corresponding amounts at contracted forward rates is as follows:
In millions of dollars
|Foreign currency forward exchange contracts to purchase foreign currencies||$||58.3||Euros|
|Foreign currency forward exchange contracts to sell foreign currencies||$||119.6||Canadian dollars|
The fair value of foreign currency forward exchange contracts represents the difference between the contracted 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. At December 31, 2022 and 2021, the net fair value of these instruments was an asset of $3.9 million and an asset of $2.8 million, respectively. In addition, assuming an unfavorable 10% change in year-end foreign currency exchange rates, the fair value of these instruments would have declined by $18.4 million and $24.8 million, respectively, generally offset by a reduction in foreign exchange associated with our transactional activities.
Commodities—Price Risk Management and Futures Contracts
Our most significant raw material requirements include cocoa products, sugar, corn products, dairy products, wheat, peanuts and almonds. The cost of cocoa products and prices for related futures contracts and costs for certain other raw materials historically have been subject to wide fluctuations attributable to a variety of factors. These factors include:
•Commodity market fluctuations;
•Currency exchanges rates;
•Imbalances between supply and demand;
•Rising levels of inflation and interest rates related to domestic and global economic conditions or supply chain issues;
•The effects of climate change and extreme weather on crop yield and quality;
•Trade agreements among producing and consuming nations;
•Supplier compliance with commitments;
•Import/export requirements for raw materials and finished goods;
•Political unrest in producing countries;
•Introduction of living income premiums or similar requirements;
•Changes in governmental agricultural programs and energy policies; and
•Other events beyond our control such as the impacts on the business or supply chain arising from the conflict between Russia and Ukraine.
We use futures and options contracts and other commodity derivative instruments in combination with forward purchasing of cocoa products, sugar, corn products, certain dairy products, wheat products, natural gas and diesel fuel primarily to mitigate price volatility and provide visibility to future costs within our supply chain. Currently, active futures contracts are not available for use in pricing our other major raw material requirements, primarily peanuts and almonds. We attempt to minimize the effect of future raw material and energy price fluctuations by using derivatives and forward purchasing to cover future manufacturing requirements generally for 3 to 24 months. However, dairy futures liquidity is not as developed as many of the other commodity futures markets and, therefore, it can be difficult to hedge dairy costs for extended periods of time. We use diesel fuel futures to minimize price fluctuations associated with our transportation costs. Our commodity procurement practices are intended to mitigate price volatility and provide visibility to future costs, but also may potentially limit our ability to benefit from possible price decreases. Our costs for major raw materials will not necessarily reflect market price fluctuations because of our forward purchasing and hedging practices.
During 2022, average cocoa futures contract prices decreased 0.9% compared with 2021 and continued to trade in a narrow range between $1.06 and $1.22 per pound, based on the Intercontinental Exchange futures contract. Production was down significantly in Ghana by nearly 30%, while it was stable in the rest of West Africa. As consumption remained strong, the large surplus in the 2020 - 2021 season became a small deficit in the 2022 season. The global surplus of the 2020 - 2021 season weighed on the price outlook for the first half of 2022 and the futures market corrected to accommodate the Living Income Differential being imposed by the Ghana and Ivory Coast cocoa marketing boards, leading to fairly similar price levels to the previous year. The table below shows annual average cocoa futures prices and the highest and lowest monthly averages for each of the calendar years indicated. The prices reflect the monthly averages of the quotations at noon of the three active futures trading contracts closest to maturity on the Intercontinental Exchange.
|Cocoa Futures Contract Prices|
(dollars per pound)
|Annual Average||$||1.13 ||$||1.14 ||$||1.11 ||$||1.03 ||$||1.06 |
|High||1.22 ||1.27 ||1.29 ||1.14 ||1.23 |
|Low||1.06 ||1.04 ||1.00 ||0.90 ||0.88 |
Source: International Cocoa Organization Quarterly Bulletin of Cocoa Statistics
Our costs for cocoa products will not necessarily reflect market price fluctuations because of our forward purchasing and hedging practices, premiums and discounts reflective of varying delivery times, and supply and demand for our specific varieties and grades of cocoa liquor, cocoa butter and cocoa powder. As a result, the average futures contract prices are not necessarily indicative of our average costs.
The price of sugar is subject to price supports under U.S. farm legislation. Such legislation establishes import quotas and duties to support the price of sugar. As a result, sugar prices paid by users in the U.S. are currently higher than prices on the world sugar market. The U.S. delivered east coast refined sugar prices traded in a range from $0.53 to $0.71 per pound during 2022. Prices were historically high throughout 2022 due to lack of imports by the U.S. government resulting in an extremely tight domestic raw sugar market and strong demand which resulted in a scarcity market for much of the year.
We use corn futures to price our corn sweetener product requirements. The conflict between Russia and Ukraine caused a tightness for global grain stocks in 2022. Corn prices traded in a range from $5.62 to $8.25 per bushel during 2022. Corn sweetener prices were also higher as strong demand resulted in a scarcity market during the year.
During 2022 prices for fluid dairy milk ranged from a low of $0.23 per pound to a high of $0.26 per pound, on a Class IV milk basis. Fluid dairy milk prices were higher than 2021, driven by declines in U.S. milk production and higher global dairy demand.
In 2022 we continued utilizing soft and hard wheat futures as a risk management tool for our flour purchasing. The conflict between Russia and Ukraine, in addition to poor U.S. weather, resulted in uncertainty in the wheat market and impacted global availability of supplies. Wheat stock levels were at historic 15-year lows and prices reached historic highs in 2022. Hard wheat prices traded in the range of $7.72 to $13.21 per bushel during 2022, while soft wheat prices traded in the range of $7.40 to $12.29 per bushel during 2022.
Peanuts and Almonds
Peanut prices in the U.S. ranged from a low of $0.55 per pound to a high of $0.64 per pound during 2022. Prices rose this year due to higher competing crop prices and a smaller peanut crop. Almond prices traded in the range of $2.00 per pound to $2.25 per pound during 2022. Prices were lower than 2021 as a result of large crop and high inventory levels.
Changes in the Value of Futures Contracts
We make or receive cash transfers to or from commodity futures brokers on a daily basis reflecting changes in the value of futures contracts on the Intercontinental Exchange or various other exchanges. These changes in value represent unrealized gains and losses. The cash transfers offset higher or lower cash requirements for the payment of future invoice prices of raw materials, energy requirements and transportation costs.
Commodity Sensitivity Analysis
Our open commodity derivative contracts had a notional value of $243.0 million as of December 31, 2022 and $313.2 million as of December 31, 2021. At the end of 2022, the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have increased our net unrealized losses in 2022 by $25.1 million, generally offset by a reduction in the cost of the underlying commodity purchases.