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Edited Transcript of HSY earnings conference call or presentation 24-Oct-19 12:30pm GMT

Q3 2019 Hershey Co Earnings Call

HERSHEY Oct 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Hershey Co earnings conference call or presentation Thursday, October 24, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Melissa Poole

The Hershey Company - Senior Director of IR

* Michele Gross Buck

The Hershey Company - Chairman, President & CEO

* Steven E. Voskuil

The Hershey Company - Senior VP & CFO

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Conference Call Participants

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* Alexia Jane Burland Howard

Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst

* Andrew Lazar

Barclays Bank PLC, Research Division - MD & Senior Research Analyst

* Christopher Robert Growe

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Analyst

* David Sterling Palmer

Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst

* Jason M. English

Goldman Sachs Group Inc., Research Division - VP

* John Joseph Baumgartner

Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst

* Kenneth B. Goldman

JP Morgan Chase & Co, Research Division - Senior Analyst

* Kenneth Bryan Zaslow

BMO Capital Markets Equity Research - MD of Food & Agribusiness Research and Food & Beverage Analyst

* Michael Scott Lavery

Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst

* Robert Bain Moskow

Crédit Suisse AG, Research Division - Research Analyst

* Steven A. Strycula

UBS Investment Bank, Research Division - Director and Equity Research Analyst

* Sunil Harshad Modi

RBC Capital Markets, LLC, Research Division - MD of Tobacco, Household Products and Beverages

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to the Hershey Company's Third Quarter 2019 Results Conference Call. My name is Catherine, and I will be your conference operator today. (Operator Instructions) Please note, this call may be recorded.

I would like now to turn the call over to Melissa Poole, Vice President of Investor Relations. Ms. Poole, you may begin your conference.

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Melissa Poole, The Hershey Company - Senior Director of IR [2]

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Thank you, Catherine. Good morning, everyone. We appreciate you joining us for the Hershey Company's Third Quarter 2019 Earnings Conference Call and Webcast. Michele Buck, Chairman of the Board, President and CEO; and Steve Voskuil, Senior Vice President and CFO, will provide you with an overview of our results followed by a Q&A session.

Before we begin, please remember that during the course of this call, we may make forward-looking statements within the meaning of the federal securities laws. These statements are based on our current expectations and involve risks and uncertainties that could differ materially from actual events and those described in these forward-looking statements contained in our 2018 10-K filed with the SEC and today's press release.

Finally, please note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information for investors. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP.

With that, I would like to turn the call over to Michele.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [3]

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Thanks, Melissa. Good morning to all of you on the phone and on the webcast. We are pleased with our third quarter results and the momentum we are seeing on our core business, investments in our brands and capabilities as well as strong execution for driving solid confection sales and share gains in both our U.S. and international markets.

Our Amplify portfolio continues to deliver mid- to high single-digit growth. And we continue to execute against our broader snacking ambition with the acquisition of ONE Brands, a portfolio of high-growth, better-for-you nutrition bars that enables us to capture incremental consumer occasions.

I'd just like to pause briefly and say thank you to all of our employees who worked so incredibly hard to deliver today and also to create momentum for our future.

In the third quarter, net sales increased 2.6%. Organic constant currency net sales growth of approximately 1.1% was in line with expectations driven primarily by pricing in North America and volume growth in international. The net impact of acquisitions and divestitures was 120 basis point benefit driven by our Pirates Brand (sic) [Pirate Brands] acquisition. And FX was a 20 basis point headwind.

We had another strong quarter of gross margin expansion that enabled a double-digit increase in brand reinvestment as well as adjusted earnings per share growth of approximately 4%. We remain focused on investing in our brands and capabilities for growth while also delivering consistent earnings performance over time, something we believe is a differentiator for us and critical to driving shareholder value.

Our key initiatives within our U.S. core confection business continued to perform well and are driving strong retail takeaway and accelerating share performance. Per IRI, Hershey candy, mint and gum retail sales increased 2.2% versus prior year in the 12 weeks ending October 13. This resulted in a share gain of approximately 23 basis points.

Our $2 billion Reese's brand had another outstanding quarter, with retail sales growth of over 6%. Growth was balanced across multiple levers, including strong advertising, distribution gains, smart innovation, new packaging, seasons and pricing. Reese's Thins is performing well, and we are encouraged by the sustainability and incrementality of the launch. We also relaunched our Take5 brand under the Reese's umbrella late this summer, and early results are strong. As some of you may know, Take5 is my favorite Hershey candy. So I couldn't be more thrilled to see takeaway up over 50% since the relaunch, and we believe there is more opportunity to capture on this great-tasting product.

Reese's, along with several of our other brands like Hershey Miniatures, Kisses and Kit Kat, are seeing nice lifts from our new packaging in the take-home aisle. Performance on these improved bags has been consistently trending up since the transition. And we are achieving all of our key benchmarks and driving growth both for us and for our retailers.

Our Halloween season is off to a solid start, and selling was strong after a successful 2018 season. The power of our core brands, breadth of our product lineup and incremental capacity are enabling us to deliver great assortments and innovative packaging for our consumers. Additionally, this year, we have an Addams Family movie partnership that we will leverage to drive shopper engagement via advertising, merchandising and on-pack promotions for key items.

Our e-commerce confection business continues to perform well with net sales growth of approximately 50% in the third quarter, driven by a strong Halloween sell-in and balanced performance across all fulfillment models, where measured Hershey's share of the chocolate category continues to increase with gains of 610 basis points in the quarter, according to third-party sources.

Our pricing initiatives remain on track and are performing in line with expectations. As we have discussed previously, we believe strategic pricing is an important lever for us to enable investment in our brands and capabilities. In 2019, we've invested in capabilities such as media targeting, digital commerce, new business models and supply chain. These capabilities, in addition to our brand investments in innovation, advertising, seasons and distribution, are driving balanced sustainable growth in the marketplace.

As we look ahead to the rest of the year, we are excited to keep the momentum going with some great activations. Our Ice Breakers brand is partnering with Disney to bring character packaging and high-impact merchandising to stores for the highly anticipated release of Frozen 2 next month. This is a great opportunity to capitalize on the cultural momentum of the movie and secure incremental merchandising opportunities in-store.

For our holiday program this year, we will build on last year's success by continuing to drive our core and leverage a hero innovation item to secure increased merchandising and engage with our consumers. This year's item is Reese's Mystery Shapes, which combines the anticipation and surprise of the holidays with the perfect ratio of peanut butter and chocolate that our consumers crave during the season. It is the first new Reese's holiday shape in 20 years, and it will be available nationwide for a limited time only.

And as we announced earlier this year, we will be launching Kit Kat Duos in December. Our supply chain investment in incremental capacity and new production capabilities allows us to bring consumers the crispy light wafer they love, surrounded by dark chocolate on the bottom and whipped cream on the top. The launch will be supported with merchandising, national TV and digital media.

Now for an update on our recent acquisitions. SkinnyPop continues to perform very well in the marketplace, with retail sales up over 10% in the latest 12 weeks. This growth has significantly outpaced competition, resulting in a share gain of 170 basis points in the ready-to-eat popcorn category.

Both household penetration and frequency have consistently grown this year, a testament to the underlying strength of this brand. We will leverage this strength to continue optimizing placement and facings on shelf as well as secure incremental space for new pack types that meet different consumer occasions.

Pirate's Booty performance is improving versus the first half of the year in line with our expectations. In the latest 12 weeks, the business has begun to stabilize, and trends are strong where distribution has been maintained. While performance is not yet where we want it to be, we remain confident in the strength of the brand and our visibility into recapturing lost distribution as planograms reset.

Now for a few more details on our most recent acquisition and venture investments. Last month, we closed our acquisition of ONE Brands, and I am excited to welcome the team to the Hershey family. ONE is a portfolio of low-sugar, high-protein nutrition bars with net sales of approximately $100 million. As many of you know, the nutrition bar category is approximately $3 billion and is growing mid- to high single digits. The ONE portfolio is growing 40% to 50% and has a strong presence outside of measured channels including a robust e-commerce business. We expect the acquisition to be slightly accretive to earnings in year 1 and highly incremental to our existing portfolio.

We also announced 2 minority investments in emerging snacking businesses, Fulfil Holdings and Blue Stripes in August. Fulfil is one of the leading makers of great-tasting, vitamin-fortified, high-protein nutrition bars in the U.K. and Ireland. And Blue Stripes Cacao Shop offers experiential retail that combines the goodness of cacao with a unique customer experience. This venture model provides the company with new avenues for growth through the deployment of small capital investments in disruptive or emerging platforms focused on new occasions, new technologies and new go-to-market opportunities.

Now for an update on our international markets. Constant currency organic sales grew 3.7% in the third quarter. And we continue to see strong segment operating income growth of almost 27% as we focus on increasing gross margins and rightsizing our brand and SG&A investments.

Our business in Mexico continues to show strong high single-digit growth behind increased distribution and innovation of our Hershey's and Pelon Pelo Rico brand. In India, we continue to see robust growth of over 16% behind distribution gains and our launch of Hershey Kisses. The Kisses launch remains on track and we plan to expand to additional cities in 2020. And our China business is also growing high single digits on an organic constant currency basis driven by improved velocity on our Hershey bars and region-specific flavor innovation, which is driving incremental growth. In Brazil, our performance has been challenged by a difficult macroeconomic environment and increased competition. While we have invested additional trade to remain competitive, we are also being disciplined about the returns on our investment as we look to bounce both the top and bottom line.

In summary, we continue to feel good about the momentum we have across our key strategies and the business results we are delivering. We will continue to invest in our brands and capabilities to take the business to the next level and drive sustainable top and bottom line growth.

I'll now turn it over to Steve, who will provide you with details on our financial results.

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Steven E. Voskuil, The Hershey Company - Senior VP & CFO [4]

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Thank you, Michele, and good morning, everyone. Third quarter net sales of $2.1 billion increased 2.6% versus the same period last year. The net impact of acquisitions and divestitures was a 120 basis point benefit and foreign currency translation was a 20 basis point headwind. Organic constant currency net sales growth of 1.6% was driven by pricing which contributed 1.1 points of growth while volume contributed 50 basis points of growth. Our 2018 price increase remains on track and as anticipated. The impact increased in the third quarter versus the first half. This was offset by our pricing transition period related to our July 2019 price increase, which executed in line with expectations. We continue to expect minimal full year sales and earnings impact from our most recent pricing action.

Adjusted earnings per share diluted were $1.61, an increase of 3.9% versus the same period last year. This was driven by continued gross margin gain partially offset by increased brand investments and higher incentive compensation versus prior year.

By segment, North America net sales increased 2.7% versus the same period last year. Price realization was a 150 basis point benefit and the net impact of acquisitions and divestitures was also a 150 basis point benefit. Volume was a 20 basis point headwind and foreign currency exchange was a 10 basis point headwind.

North America gross margins expanded 80 basis points in the quarter as favorable commodities and net price realization offset incremental logistics costs. This was slightly higher than our expectations. Recall in the second quarter, we experienced a gross margin benefit related to external inventory mix and fixed cost absorption, both related to our July price increase. While we expected most of this benefit to reverse in the third quarter as inventory levels normalize, we now expect the majority of the impact to occur in the fourth quarter. Given this timing shift and the more difficult laps from the year-ago period, we expect Q4 gross margin expansion to be less than the third quarter. We continue to be pleased with the underlying momentum in our margin expansion initiatives and the business reinvestment it is enabling.

North America advertising and related consumer marketing spend increased 14.4% in the quarter driven primarily by advertising. This increase is in line with expectations as we prioritize reinvesting gross margin expansion gains back into our brands to drive growth. As we have shared previously, the dollar spend increase is more meaningful in the second half of 2019 versus the first half as we are lapping significant media efficiency gains in the year-ago period.

Third quarter total international and other segment net sales decreased 1.8%. Volume was a 5.3 point benefit driven by organic growth in our key focus markets. Net price realization was a 160 basis point headwind as we invested more in response to increased competitive activity. Foreign currency exchange was a 100 basis point headwind and divestitures were a 90 basis point headwind. Combined, organic constant currency net sales in Mexico, Brazil, India and China grew 7.4% versus the third quarter of 2018. International and other advertising and related consumer marketing decreased 14% versus prior year as we continue to rightsize investment and increase ROI in China and our regional markets.

Total Hershey adjusted gross profit increased 4.4% resulting in an adjusted gross margin of 44.8%, an increase of 80 basis points versus the third quarter of 2018. This was driven by favorable commodities and net price realization. Third quarter adjusted operating profit of $477 million resulted in operating profit margin of 22.3%, a decrease of 30 basis points versus the third quarter of 2018 as gross margin gains were offset by incremental brand investments and higher incentive compensation.

Moving down the P&L. Interest expense of $35 million decreased $1.5 million versus Q3 last year due to lower short-term interest rates. We expect full year interest expense of approximately $145 million, the high end of our previous range due to our recent acquisition of ONE Brands. The adjusted tax rate for the third quarter was 20.1% versus 22.8% in the year-ago period. These gains were driven primarily by excess tax benefits from stock-based compensation along with higher tax investment credits. For the full year, we expect an adjusted tax rate of approximately 18.5%.

Third quarter other expense was $18 million, an increase of $5.5 million versus prior year, driven primarily by unfavorable pension expense. For the full year, we expect other expense of approximately $70 million to $75 million. This is below our previous estimate as we plan to exercise fewer tax investment credits and is offset by a slightly higher tax rate for the full year. The net impact of these 2 changes is negligible versus our previous estimates.

For the third quarter of 2019, weighted average shares outstanding on a diluted basis were 211 million, reflecting a slight increase versus the second quarter due to an increased number of stock option exercises in the quarter. The company repurchased $191 million of common shares in the third quarter in connection with the exercise of stock options. The company did not repurchase any shares in the third quarter against our July 2018 $500 million authorization and $410 million remain.

Total capital additions, including software, were $60 million in the third quarter. For the full year 2019, we continue to estimate CapEx of around $350 million.

We continue to return cash to our shareholders with third quarter dividends of $158 million. This was our 359th consecutive quarterly dividend on the common stock, a testament to our strong balance sheet and strong cash flow generation.

Before I close, let me provide additional information about the acquisition of ONE Brands. As Michele mentioned, net sales are approximately $100 million, given our mid-September close at approximately $25 million of sales in the fourth quarter for this acquisition. The margin profile on this portfolio is attractive and we expect it to be slightly accretive to earnings in year 1. Given acquisition-related costs, we expect it to be slightly dilutive to reported earnings in the fourth quarter and have a negligible impact to adjusted earnings in Q4. Our focus will be on maintaining the brand's current momentum, continuing to build brand equity and secure incremental distribution and capturing supply chain and procurement synergies.

To summarize, for the full year, we expect full year reported net sales to increase to around 2.5%, an increase versus the previous guidance driven by the acquisition of ONE Brands. The net benefit from acquisitions and divestitures increases to approximately 1 point. Full year FX impact is anticipated to be slightly negative based on current exchange rates. Full year reported earnings per share diluted are expected to be around $5.58, relatively flat to prior year. Full year adjusted earnings per share diluted are expected to grow 6% to 7%, consistent with our previous outlook as the impact of ONE Brands acquisition has a negligible impact on earnings in 2019.

That concludes my financial discussion, and I'll now turn it back to Michele.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [5]

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Thanks, Steve. We remain confident in our strategies and in our ability to deliver our financial commitments for the year. We are pleased with the progress we have made over the past 2 years, but we continue to operate with a healthy dissatisfaction that drives us to push and elevate the business even further. I continue to be energized by the opportunities presented by this rapidly changing environment and the power of our amazing brands and remarkable people to capitalize on this change to unlock new opportunities for the future. We will continue to focus on delivering today and building for the future in a way that is consistent with our values and purpose.

Steve, Melissa and I are now available to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today will come from Andrew Lazar with Barclays.

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Andrew Lazar, Barclays Bank PLC, Research Division - MD & Senior Research Analyst [2]

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So I guess in thinking ahead a little bit, Hershey has already discussed some incremental pricing for 2020, roughly 2% on average. In terms of volume, the SKU rationalization drag, I think, is behind you at this point. The volume elasticity from the previous pricing, I think, is largely behind you. And obviously, Hershey's, you've talked about a stepped-up brand investment quite a bit. I do recognize there will be some volume elasticity on the new pricing increase could be a partial offset a little bit on volume going forward.

So I guess I was hoping you could just comment maybe even more broadly on how sort of all of these factors are expected to come together in terms of how we think about volume moving forward. At a high level, it would seem like volume could at least be maybe flattish or given the puts and takes, if not a bit better. Or are there discrete, maybe other volume headwinds we should be aware of? Maybe it's Easter timing or things along those lines?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [3]

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Yes. I think as we think about our retail takeaway trends and revenue going forward, I think that there is no reason to expect that the trends wouldn't be similar with what we have been seeing and are seeing here in the back half of this year. As you think about going from '19 into '20, clearly, we will gain a little bit from SKU wrap being behind us. We lose a little bit in terms of Easter and going to a shorter Easter, but net-net, I think those are 2 of the single biggest changes. You're right that pricing kind of continues at a pretty steady pace. So I think it's fair to assume that the trends would be roughly similar to what we've been seeing here in the back half of the year.

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Andrew Lazar, Barclays Bank PLC, Research Division - MD & Senior Research Analyst [4]

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Got it. And those trends in the back half have been around consumption. I think they've been, I guess, like you said today, around 2-ish or a little above 2-ish, more or less. Is that fair?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [5]

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Yes, exactly. That's fair. I think we've always said 1.5% to 2% of growth we would get from North America, and yes, retail trends, retail takeaway trends around 2%.

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Operator [6]

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Our next question comes from Ken Goldman with JPMorgan.

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Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [7]

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Michele, congrats on the added title and responsibilities.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [8]

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Thank you.

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Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [9]

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I wanted to ask 2 questions. One, sort of the mechanics of the gross margin impact by the benefit that you got in 2Q was originally expected to reverberate and hit 3Q. Now you're mentioning 4Q has the bigger impact. Can you walk through the mechanics of that? Because to me, it was more of a fixed cost absorption benefit and I just don't understand how the timing is delayed by a few months. So that would be helpful. And then I have a follow-up.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [10]

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Yes. I mean -- do you want to do it? Go ahead, Steve.

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Steven E. Voskuil, The Hershey Company - Senior VP & CFO [11]

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Sure. Happy to take that one. As we talked about in the second quarter and as you said, Ken, really 2 pieces there: one, mix driven. We were selling a richer mix for us of instant consumable that was a benefit for us; and then the inventory build, both our inventory build in the second quarter and third-party inventories. We expected to see more of that inventory come down in the third quarter. And we got a little bit of that benefit back probably about 1/3 of what we expected. We expect more inventory reduction in the fourth quarter, and that's really the reason for the delay. There was more inventory as we got into the third quarter, both the third party and ours, and it took longer to bleed it out.

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Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [12]

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Okay. And then my follow-up, Steve, is on the always exciting topic of working capital. But if you look at working capital, forget inventory for a second because I know there's timing issues there, but I look at your payables. And on the last 12-month basis as a percentage of COGS, they've been decreasing, the lowest they've been in a few years. Your last 12-month receivables as a percentage of sales, they're the highest they've been in over a decade. So can you just walk us through what's going on with these items that's running a little bit less favorably for you, at least as I look at it, and maybe what the opportunity is to turn them around?

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Steven E. Voskuil, The Hershey Company - Senior VP & CFO [13]

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Yes. It's a great question. If you look at, say, the face of the balance sheet and cash flow today, I think net working capital year-over-year through 9 months is about a $10 million drag across all 3 of those components. If you extract one out of there, so one sort of clouds up the numbers a little bit, it's just a slight positive cash generator year-over-year. But inside that, you're exactly right. We have opportunities to be more efficient on working capital. I think inventory, in particular, is one that's in our crosshairs here as we think about the future. But we do see the need to be efficient in working capital as one of the sources of funding that helps fund the investment and the other things we want to do with the business. So you can expect we'll probably talk more about that as we think about 2020 plans and beyond.

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Operator [14]

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We'll now go to Jason English with Goldman Sachs.

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Jason M. English, Goldman Sachs Group Inc., Research Division - VP [15]

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I wanted to, I guess, come back to the direction of the question that Mr. Lazar was asking in terms of price contribution as we look into next year. But first, kind of close out this year, do you still expect to see roughly 250 bps of price contribution in North America for this fiscal year?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [16]

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No. No. In the fourth quarter, yes. Not for -- the full year was always around more 1.5% because of the time it takes for pricing to build. So we took 2.5%, as we mentioned, until that hits fully through the year. Because of price protection timing, we expected more like 1.5% on the annual basis of -- to even out the year.

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Jason M. English, Goldman Sachs Group Inc., Research Division - VP [17]

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And that price protection timing, how much longer does it run for? Is it not behind us now?

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Steven E. Voskuil, The Hershey Company - Senior VP & CFO [18]

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Largely behind us as we exit the third quarter, but there's still inventory that will be getting run down in the fourth quarter, some of which are still price protected but they're largely behind us.

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Jason M. English, Goldman Sachs Group Inc., Research Division - VP [19]

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Right. Right. So I guess that's the component where I'm just having a hard time bridging because we've got the bracket changes of 50 bps, the gum, et cetera, and sugar confection. We've got the wait-out benefit, and we should start to see price protection behind us, albeit volume is muted because of the inventory reduction. I would expect to see some of that single-serve pricing come through.

I mean you add all that up, and it's a much bigger chunk than, say, 250 bps in the fourth quarter. What am I missing in the math? And maybe what I'm missing is just sort of reinvest -- we're seeing you reinvest in SG&A. Maybe there's a reinvestment in above-the-line type investment as well. If you could help me understand that, I'd really appreciate it.

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Steven E. Voskuil, The Hershey Company - Senior VP & CFO [20]

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I'll take maybe the total P&L side, and then we can talk about -- Melissa wants to add on the growth front. When you look at the fourth quarter P&L in total, you've got a couple of headwinds. One is the incentives that we mentioned on the call that was an impact in the third quarter will also be a drag in the fourth quarter. We've got a tax drag in the fourth quarter. This year, we've had a lot of our tax planning benefit across the first 3 quarters. Last year, the fourth quarter was a big tax planning quarter. And so that by itself is, order of magnitude, an $0.08 drag. So you have those 2 pieces working against.

We'll have some more DME investment in the fourth quarter, similar to what we saw here. And then that gross margin, roughly a reversal from the second quarter that Ken talked about just a few minutes ago. So from a total P&L standpoint below sales, that's really some of the big drivers driving the, I'll say, deceleration in the fourth quarter P&L.

Melissa, do you want to add anything on the top line specifically?

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Melissa Poole, The Hershey Company - Senior Director of IR [21]

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Yes. Just on the pricing piece, you're right in how you're thinking about the build of last year's and this year is kind of compounding. I guess the 2 pieces I would point you to is we did have most of our Halloween business shifts in the third quarter. So that -- the jolt we get from that is mostly behind us. So we don't have Halloween pricing in the fourth quarter just because we don't really ship too much in the fourth quarter.

And then the last piece on price protection, there is still a little bit of price protection for some of the promotional activities of our most recent price increase. So we kind of give -- in the third quarter, it would have been more around kind of base volume time to transition to the new prices that everybody gets on everything. In the fourth quarter, there's a little bit of promotional activity that we will also deal back. So absolutely right that it should be higher than what it was in -- so far year-to-date and in the third quarter, but I don't know that it's enough to kind of trip you into a pretty significant pop in earnings given all the points that Steve had walked you through.

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Jason M. English, Goldman Sachs Group Inc., Research Division - VP [22]

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That's helpful. And the elevated trade in the fourth quarter, would we expect that to persist into next year?

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Melissa Poole, The Hershey Company - Senior Director of IR [23]

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No.

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Operator [24]

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We'll now go to Alexia Howard with Bernstein.

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Alexia Jane Burland Howard, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [25]

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This is probably quite linked, I guess, to Jason's question, but -- and it's again focusing on pricing in North America. But the measured channel pricing was up pretty sharply, sort of mid-single-digit numbers on the whole portfolio and particularly on chocolate this time around. That's obviously meaningfully higher than the 1.5% price growth that you reported this morning. Is that just a timing effect because of the timing of shipments? Or are the retailers temporarily increasing the markups on the product because of the upcoming price increases?

And similarly, the volumes were down only 2.2% in the numbers you reported this morning, and that's a lot better than the mid-single-digit declines that we're seeing in measured channels. So I'm just trying to figure out whether there's something going on in nonmeasured channels that were better or whether the inventory -- some inventory shifts are affecting that. If you could maybe speak to that?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [26]

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Sure. So it is not a measured channel, nonmeasured channel. There are a couple of different factors going on. So first of all, you're right. Retail takeaway is trending a little bit ahead of shipments in North America and we expected some of this. And part of that's tied to the inventory contraction that's associated with our SKU rationalization program. So we knew that shipments will have a little bit of a drag there, where shipments would be later than takeaway.

We also know that as we take price, there is some retailer margin expansion from our price increase. So you do see retail prices go up slightly higher than the Hershey prices. And then some of that is just tied to the timing of that new price increase because, as you know, we've got kind of the 2 price increases, the one from last year that hit and then the new one where, again, retail prices will go up before we see that in our data because of how we manage those price increases and allow a buy-in period.

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Steven E. Voskuil, The Hershey Company - Senior VP & CFO [27]

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Yes. And I would say, all I would add is by the end of the year, we expect those 2 to tighten up between shipments and takeaway.

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Operator [28]

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We'll now go to Chris Growe with Stifel.

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Christopher Robert Growe, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Analyst [29]

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And as a follow-on to Alexia's question there because related to the -- what we're seeing in measured channels, the increased level of price realization, we're seeing an equally or weakening volume performance as well. So I just want to understand how that -- maybe from a higher level, how elasticity is playing out for you right now. And then how we should read, again, what we're seeing in the measured channel data, which is obviously an increase in pricing, but a much weaker volume performance overall.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [30]

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Yes. So what we're seeing at retail is very consistent with what our models would indicate. We normally see a conversion time frame. When we take price, retail prices up, we see volume go down. Obviously, we do a lot of work with a lot of our programming to mitigate some of that volume decline during that conversion time frame to bring back the volume even more quickly. But typically, in periods of price increase, we do see those volume declines and they are pretty much in line with all of our elasticity models.

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Melissa Poole, The Hershey Company - Senior Director of IR [31]

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Yes. Just to build on that, Chris, and we can talk about this a little bit more offline because it is -- there is some extra noise in the third quarter. But if you kind of break them into pieces and think about last year's price increase, the prices at retailer are, to Michele's point, pretty much in line with expectations. So they're a little bit ahead of us as retailers are expanding margins but nothing out of bounds by any stretch.

I think a lot of the noise in this quarter, there's some timing of promotional activity where there were some lapses and some higher prices on promotion that you're seeing play through and part of why those retail prices are a little bit more elevated in the quarter. Year-to-date, they're pretty much in line with what we're seeing on the P&L but a little bit of noise in the quarter. And then especially this most recent price increase to the timing of the protection causes a pretty big disconnect as they start rising prices and we don't see that in our P&L right away. So overall, feeling really good. They're where we expected. It's just there's a little bit more noise in this quarter.

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Christopher Robert Growe, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Analyst [32]

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Okay. And then just a quick follow-on in terms of how that relates to the gross margin. As I think about the fourth quarter, you do have a bit of an easy comparison on the gross margin. Have you given an indication in terms of your pricing in relation to cost inflation, kind of how that stands today? You talked about input cost being down and then what that would mean for the full year gross margin, and we can kind of imply what that can mean for the fourth quarter.

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Steven E. Voskuil, The Hershey Company - Senior VP & CFO [33]

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Yes. I mean our full year gross margin guidance isn't changing. We kind of said in the order of 100 basis points up year-over-year and we're sort of tracking to that. I'd say there's nothing new relative to commodities versus price. It's sort of playing out the way we expected, again, because we've got the hedging program against some of the commodities that smooths out and gives some forward visibility. So not a lot of change there. So I don't know if that answers your question.

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Christopher Robert Growe, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Analyst [34]

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Yes, it does.

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Operator [35]

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We'll now go to Robert Moskow with Crédit Suisse.

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Robert Bain Moskow, Crédit Suisse AG, Research Division - Research Analyst [36]

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I'll second your remarks, Michele, on Take5. And in my channel checks, what I keep hearing is that actual physical shopping trips to stores are on the rise, which is not what you would expect with the growth of e-commerce. And I think that's a positive for your business, more impulse purchases. And then secondly, I saw in the data that it looks like your points of distribution are rising. You didn't really talk about those in your prepared remarks. Can you comment on those 2 things? And would you confirm or not?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [37]

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Yes. I think if you look at the IRI data, it can be -- there is a little bit of noise in that this year because of the standup packaging bag transition, where we had an overlap of inventories transitioning from the old laid-down bags to the stand-up bags. So we are always pushing to drive against distribution, getting additional points of distribution and actually additional disruptive placements in-store primarily.

So we did have the -- a program at one of our big retailers where we got significantly expanded distribution points around the front end. But -- so it's a little bit of both. We are expanding some distribution with some customer-specific programs. But there's also -- it probably looks a little higher in the numbers, in the IRR data than it actually is just because of that conversion on stand-up bags.

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Robert Bain Moskow, Crédit Suisse AG, Research Division - Research Analyst [38]

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Okay. I tried to tee up. So there's a -- so net-net, it's a little higher but it might be temporary? Or it's, say...

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [39]

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No. I would kind of say it's higher but not as high as the numbers would show. So there is growth, but it's just not as high as the total IRI looks.

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Robert Bain Moskow, Crédit Suisse AG, Research Division - Research Analyst [40]

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Okay. And physical shopping trips to stores, I think IRI also indicates that people are going to stores more frequently.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [41]

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Yes. Now we are seeing some good signs there relative to consumers. And I think as consumers are shopping on an omnichannel basis, we see them in stores, also looking at the retailer's websites while they're in-store. So we're seeing a lot more of that versus a net shift.

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Operator [42]

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Our next question comes from Nik Modi with RBC.

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Sunil Harshad Modi, RBC Capital Markets, LLC, Research Division - MD of Tobacco, Household Products and Beverages [43]

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Yes. Michele, maybe you can just give us some perspective on some channel dynamics. Maybe just talk about what you're seeing in big box versus -- and the convenience store channel. And then maybe, Steve, if you could just address -- they recently talked about inflation and the excited sugar and milk prices. So I just wanted to get your thoughts around that, kind of what you guys are seeing and if you're hedged for 2020.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [44]

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Yes. So if we look from a channel perspective, we are really seeing growth across most all classes of trade with the exception of drug, which tends to be a little bit soft, particularly given some of the strategies and actions taken -- focused in that class of trade. I would say particular strengths in big box for sure, in club stores and in the dollar class of trade but pretty much growth across everything except for drug.

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Steven E. Voskuil, The Hershey Company - Senior VP & CFO [45]

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And Nik, on the commodity side, obviously we're watching commodity prices very closely as we put together our plan for 2020. Our hedging gives us some visibility.

I think probably the biggest takeaway across that group is that, as we talked about in the prepared remarks, we've got a tailwind this year on cocoa. But if you look at cocoa prices today versus the last 12 to 24 months, they're higher. And so at minimum, we're not likely to have a tailwind in 2020 that we've been able to enjoy this year on cocoa. Hedging will help to smooth out that transition and we'll get more guidance on commodities in general as we get closer to 2020.

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Operator [46]

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We'll now go to John Baumgartner with Wells Fargo.

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John Joseph Baumgartner, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [47]

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Wanted to dig into the ONE Brands acquisition a bit because that nutrition bar space is increasingly crowded. Can you speak a bit to the diligence that went into that and how you're thinking about the competitive tensions there? How do you think one stands out and maybe how you're envisioning growing that business, whether it's in distribution channels or different product formats?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [48]

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Absolutely. So we continue to be excited with the growth that we're seeing in that snack bar segment. And particularly, if you look across total snack bars and you really dissect that market, you see that the real sweet spot where -- that has the strongest growth is that high-protein and particularly high protein with low sugar. So I think my first direction would be we kind of dissect within that category to say where's the sweet spot where we think that there really is growth. And we certainly think that there's room to have a couple of brands that play in that space in the marketplace consistent with other categories.

What we really liked about it is it's very consistent and fits right into our stated desire for scale, growing assets in attractive categories that give us access to incremental snacking occasions. High protein, low sugar, it provides on-the-go convenience. It also gives us a play in the morning snacking occasion where we are underdeveloped.

We like a lot that, that business has a strong presence in growth in e-commerce and nontraditional channels, which again provides some incrementality for us. And we certainly like the growth rate that we're seeing on this business. We think it fits in a sweet spot for us in terms of where we can add value because there's still distribution opportunity.

So I'd say, job 1, as we look at growing the business is securing that incremental measured distribution expansion, continuing to build on the brand equity. We like the fact that this asset has good margins that are in line with Hershey margins, and that's one thing that's always been important to us. Those are the kind of businesses that we run best. And then of course, we will capture any opportunities for supply chain and procurement synergies. So we see it as a platform that has -- our primary focus for growth will be around the close end -- at least for the next several years, the close end driving against the core. So unlike some of -- perhaps some of the other assets in that space, where maybe some of their focus is expanding to a lot of other categories, I think there's a lot of upside within expanding within snack bars, but then later some opportunity to take that one trademark more broadly in terms of the platform it stands for.

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John Joseph Baumgartner, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [49]

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And is it fair to think, just given your know-how in the bar business already, that this is something you could repatriate over time internally in-house?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [50]

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I mean we certainly make a lot of bars and that technology of kind of slab and slip is something certainly we do well. So we always take an approach of getting our arms around the business and then looking at how we leverage repatriating for opportunity whenever and if it is appropriate.

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Operator [51]

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We'll now go to Steven Strycula with UBS.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [52]

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I have a question. Michele, can you walk us around the globe, some of your key markets internationally such as Brazil, China and Mexico, and just give us a feel for how Hershey is performing versus the competition, whether you're seeing more competitive dynamics or macro acceleration or deceleration, multinational brands versus local? Because you called out specifically Brazil, but it would be helpful to understand the dynamics across Brazil, China and Mexico. And then I have a follow-up.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [53]

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Yes. I would say across all of our international markets, we are feeling good and performing well. In most of those markets, we are gaining share. For some of my highlights in my opening comments, I feel particularly good about Mexico, where we have strong -- very strong growth with a real focus on Hershey's and Pelon Pelo Rico, but we're seeing growth in India and China.

Brazil is really the market that's been challenged given that combination of macroeconomic as well as some competitive activity around deep discounting, where we've just made some choices around investing additionally, but still being very rational about balanced top and bottom line. But I feel good growth and good share progress in all the other markets.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [54]

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Okay. And just to clarify, was Brazil more of a multinational or a local competition?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [55]

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Yes. Brazil is more multinational competition.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [56]

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Okay. And then to close out a question on pricing, I know you guys have 3 levers you pulled for pricing this year that are kind of cascading or phasing in throughout the year. And then we have another piece from the price increase announced this summer. So can you help us understand as we go from fourth quarter into the first half of next year how do we stack pricing on top of pricing? So basically, when does it peak out versus when does it start to kind of like normalize to a more moderate rate?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [57]

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So we will start to see the pricing come into our P&L mostly as we get into Q1 and flow from there. So Q1 should be a little bit higher. But I would expect on an annual basis, you're going to see similar to what we saw with our last price increase of around 2% that we'll see on an annual basis next year. And it will build -- we won't get from the second price increase any impact this year. But as we go into next year, you'll see that build in the marketplace. Does that answer your question?

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [58]

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It does.

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Operator [59]

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We'll now go to David Palmer with Evercore ISI.

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David Sterling Palmer, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [60]

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Taking on 2019 as it's coming to an end here. How do you think this year will shape up versus what you think will be a typical year for your growth in terms of the complexion of the growth? And on the face of it, it looks like there's been some nice pricing gains relative to input inflation. You even had some pretty clever way of doing pricing with the stand-up bags that wait out there. You're reinvesting heavily in advertising. You're getting some very nice growth out of your Reese's trademark, which is sort of the trademark of growth of your year. So in some ways, it feels like an unusual period in terms of reinvestment room and reinvestment behind what might be your best trademark there. And in some ways, you might be thinking about a different type of growth going forward. Any thoughts there would be helpful.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [61]

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Yes. I guess as I think about the growth model this year and then the growth model for next year, I would say that there are some similarities and I can call out a few differences. So I think in terms of similarities, pricing. Certainly this year, pricing will play a key role next year. So I think that's kind of one platform that you could think is, even though taking a little bit differently, comparable on a year-to-year basis. While we don't get into specific guidance, we are continuing to look -- it's our strategy to continue to reinvest and invest in our brands and capabilities. And certainly, that will be a priority for us next year as was this year.

We always focus on trying to achieve that balance between driving our everyday brands and really driving the core brand. So you should continue to expect to see strong support and programming around Reese's. When you have built a brand that's $2 billion in revenue, there will always be a focus on that brand just because of how big a piece it is as a portfolio but also supported by some of our other big brands. We talked about Kit Kat Duos and Kit Kat will certainly be a brand that will have a lot of focus next year as well.

So I think some -- I think a lot of commonality in terms of some of those elements that you called out, I think, relative to growth, where the biggest differences are is more around the timing of Easter, which is a little bit of a hurt, about 0.5 point for next year, but then the benefit around SKU wrap cycling, which is a help. Did that provide perspective?

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David Sterling Palmer, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [62]

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Yes. That's helpful.

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Operator [63]

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(Operator Instructions) And our next question comes from Michael Lavery with Piper Jaffray.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [64]

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Can you just touch on your thinking on the consumer marketing spending? It's obviously up very strongly in the quarter. But looking at the last few years, it's typically been 7%, 7.5% of sales. In 2018, it was just a little bit above 6%. Should we expect it to get back above a 7% level? Or is some of the increase this year a little more one-off? Can you just give us a sense of how sticky it is and where your optimal range might be?

And maybe just related to that, what were some of the things that changed last year where there were the cutbacks? And what are some of the things that are coming back or new this year in terms of how you're deploying the spending?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [65]

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So our kind of stated strategy around marketing investment is to grow in line or slightly ahead of our sales growth, so to grow the dollar investment in line or slightly ahead. There can be some noise around that because sometimes we are able to get efficiencies in how we're buying and so we can actually get greater impressions than the dollar budget. So it's not always perfect, but I would say that's overall how you should think about it.

When we took our spend back from 7%, 7.5% down to 6%, there were 2 key places that the spend really came out of. One was we did start gaining some efficiencies as we started developing some of our creative in-house and also some media efficiencies from very strengthened targeting capabilities. And then we also cut back on some of the smaller emerging brands where we believe that frankly we were overinvesting beyond what we should.

As you look at where we are now and the reinstatement of spend, you'll certainly see that in terms of strength behind the core brands but then also really tapping in to unleash some of our smaller brands like a Rolo, Heath, brands that have been around forever, brands that are very stable, and with a slight amount of increase in advertising, we can drive some significant growth. So that's, I'd say, where the biggest priority of reinvestment has been.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [66]

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And just when you talk about some of the cuts on emerging brands, could you give any example of what those might have been?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [67]

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Yes. I would say I think Krave would be an example, some of the emerging brands that we have in our Amplify portfolio, some of our snack mixes that were in the warehouse aisle under the Reese or Hershey trademark, things like that.

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Operator [68]

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We'll now go to Ken Zaslow with Bank of Montreal.

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Kenneth Bryan Zaslow, BMO Capital Markets Equity Research - MD of Food & Agribusiness Research and Food & Beverage Analyst [69]

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Just have one follow-up question here. On the Thins platform, can you talk about how broad that could be to other products, how big you think that could be? It just seems like that's something very similar to the expansion of other product that you have? And are there real opportunities that this can actually become a bigger product offering? Can you talk about that?

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [70]

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Yes. Absolutely. So we feel great, first of all, about Reese's Thins performance in the marketplace. It is on track with our expectations. We're seeing signs of sustainability and incrementality. So certainly, we always look as we develop innovation to see if there's an opportunity to develop the platform. And certainly, this does feel like one that could cut across multiple brands, and that's certainly an opportunity that we are evaluating.

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Kenneth Bryan Zaslow, BMO Capital Markets Equity Research - MD of Food & Agribusiness Research and Food & Beverage Analyst [71]

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Is there -- how big do you think the platform can be? Can you put any like parameters around it about which brands it could go to? It just seems like there's a lot that can be happening with this. Can you kind of put some parameters to it? And I'll leave it there.

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Michele Gross Buck, The Hershey Company - Chairman, President & CEO [72]

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Yes. I mean I think there are multiple brands it can go to. I think what we always try and focus on with our platform is not spreading it too far but having it focused on a couple of brands where it really makes the most sense. And clearly, if you look at the history of how we've built other platforms in the past and just the size of brands, Reese's, given its size, will definitely be the largest of opportunities, but I do believe that there can be growth beyond that.

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Operator [73]

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We have no further questions at this time. I would like now to turn the call back to our speakers for any additional remarks.

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Melissa Poole, The Hershey Company - Senior Director of IR [74]

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Thanks so much for joining us this morning. The team will be available today and all of next week for any follow-up questions you may have. Thanks so much.

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Operator [75]

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This does conclude today's program. Thank you for your participation. You may disconnect at any time.