Hershey Company (HSY) — Q2 2020 Earnings Call Transcript

Good morning, everyone, and welcome to the prerecorded discussion of The Hershey Company’s Second Quarter 2020 Earnings Results. My name is Melissa Poole, and I’m the Vice President of Investor Relations at Hershey. Joining me today are Hershey’s Chairman and CEO, Michele Buck, and Hershey’s Senior Vice President and CFO, Steve Voskuil. In addition to these remarks, we will host an analyst Q&A-only session at 8:30 a.m. Eastern on the morning of July 23. A replay of this webcast and our subsequent Q&A session will be available on the Investor Relations section of our website, along with their corresponding transcripts. During the course of today’s discussion, Management will make forward-looking statements that are subject to various risks and uncertainties. These statements include expectations and assumptions regarding the Company’s future operations and financial performance, including expectations and assumptions related to the impact of the COVID-19 pandemic. Actual results could differ materially from those projected as a result of the COVID-19 pandemic, as well as other factors. The Company undertakes no obligation to update these statements based on subsequent events. A detailed listing of such risks and uncertainties can be found in today’s press release and the Company’s SEC filings. Finally, please note that during today’s discussions, 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. Reconciliations to the GAAP results are included in this morning’s press release. It is now my pleasure to introduce our Chairman and CEO, Michele Buck.

Thank you, Melissa, and good morning, everyone. On behalf of the entire company, we hope you, your colleagues, and your loved ones continue to stay safe and healthy. We have all experienced significant changes and new challenges over these past several months. Things we never predicted are now realities that we are all adapting to. Things we thought would evolve over the course of several years have changed in weeks. I could not be prouder of the Hershey organization for how they have responded. At the center of our culture is the shared belief that Hershey and its people stand for togetherness, integrity, excellence, and making a difference. These values have shined even more brightly over the past several months. Our teams have worked together tirelessly to keep each other safe, our supply chain running, our customers’ needs met, and our consumers stocked with snacks that make their lives a little more delicious during these very difficult times. Our teammates have done this with care and compassion for each other and the communities in which they live, and they are energized and inspired to leverage this moment to drive positive change for the future. I want to thank the entire organization, from retail to manufacturing and across our corporate international and regional offices, for the hard work and commitment they bring every day. The marketplace remains volatile as the virus and consumer behavior evolves. We saw significant changes as we progressed through the second quarter, but our teams did a fantastic job of adapting to these changes and continued to execute exceptionally well. The first half of the quarter was particularly challenging, as global economic growth contracted and government-mandated restrictions and closures impacted consumer mobility and, in turn, our performance. We did see an improvement later in the quarter as economies began to reopen and consumers returned to more activities outside the home. We continue to feel good about our long-term strategies and the strength we saw in our core products and channels during the quarter. Despite new challenges and increased complexities, we delivered profitable category-leading sales growth in North America. These gains were offset by sales declines in areas heavily impacted by the pandemic and related government restrictions and consumer mobility limitations. Our agile investment mindset enabled us to quickly pivot and mitigate sales declines in areas impacted by consumer mobility restrictions. In addition, our advantaged margin structure and strong cost management helped us to mitigate incremental COVID-19-related costs to enable us to deliver adjusted earnings per share in line with last year. We expect accelerated sales growth in the second half of the year, based on momentum exiting the quarter, assuming there’s no significant disruption to current consumer trends. We also expect pricing and strong cost management to drive margin expansion and earnings growth in the second half of the year. Now, let me share some details on our North American business. While we have seen significant channel disruption and changes in consumer behavior, our brands and categories remain an important part of consumers’ lives and have performed relatively well. We saw strong performance in the food, mass, dollar, and e-commerce classes of trade, consistent with broader channel trends. Our e-commerce sales growth remains significantly higher than our pre-COVID baseline, with year-over-year sales growth accelerating further in the second quarter to 200%. Category trends in drug, convenience, and club channels were more pressured, though all sequentially improved as we progressed through the quarter as consumers returned to more normal activities away from home. While COVID-19 has impacted traffic to some key channels in the short-term, we continue to believe our channel diversification is a long-term strategic advantage. Despite some of these pressures, our combined retail takeaway in measured channels was up over 4% in the quarter, and it was up almost 9% in June. Importantly, we are winning share in every channel this year, and our share growth is strongest in the largest channels that are experiencing the most growth. We are leading not only through our portfolio of iconic brands, consumer-relevant marketing, and strong execution, but with our thought leadership as well. Within confection, this has enabled us to drive growth that far exceeds the category and expand our number one share position in the U.S. Our category share grew 225 basis points in the second quarter, bringing our year-to-date share gain to 150 basis points. The chocolate category is performing well, with growth of approximately 4% in measured channels for the first half of the year, despite a shorter Easter. Everyday chocolate sales have consistently grown 9% since the pandemic began. While take-home products are driving outsized growth, instant consumable products are also growing. Hershey’s has outperformed the category, with sales growth across brands that accelerated as we progressed through the quarter. In June, Hershey’s chocolate portfolio grew 13%, with Reese’s, Hershey’s, and Kit Kat brands each growing 14%. Key variety brands, such as PayDay, York, Almond Joy, Mounds, Heath, and Rolo, also all grew during the month, resulting in a combined growth rate of over 11%. Our key chocolate innovation is also performing well. As we discussed in April, much of our innovation was launched prior to the pandemic hitting the U.S. Despite softening convenience store trends in the quarter, our instant consumable innovation remains on track. Our Reese’s Take 5 relaunch is set to double the size of the brand this year to approximately $70 million of retail sales, and our Kit Kat flavor innovation is doing very well, with Kit Kat Duos and Kit Kat Birthday Cake both driving incremental brand household penetration and frequency. Distribution of our new THINS innovation was delayed slightly by the pandemic at several customers, but it’s now in full distribution, and velocities are strong. We have secured strong merchandising in-store for our key summer promotions, including S'mores, Twizzlers, and our Reese’s Lovers In and Out Promotions. Our teams have shown great agility to adjust messaging and deliver consumer-relevant content to drive growth of 14% on these programs versus last year. Our Twizzlers and Jolly Rancher brands grew a combined 6% in the second quarter, also ahead of the category. Our strong in-store merchandising on Twizzlers has been amplified by consumer-relevant marketing to drive accelerated growth this summer as consumers enjoy this classic treat while watching movies at home or in the car on their summer road trips. As we mentioned in April, the refreshment category has been negatively impacted by social distancing, as the functional need for breath freshening has lessened. While trends have improved since April, the category continued to decline 20% to 25% in June. Our business has trended relatively in line with the category. We expect category trends to remain challenged until social distancing guidelines relax. Sales for our baking items are performing exceptionally well, with growth of over 40% in the second quarter. This growth was across products, including syrup, baking chips, toppings, and cocoa, as consumers spend more time at home together in the kitchen. We have capitalized on this trend to sustain momentum, increasing marketing spend and generating more content and recipes for our consumers. This is important for the second half of the year, when baking takes on an even bigger role in U.S. households. Finally, let me touch on our better-for-you snack portfolio. Our salty snack brands have shown solid growth this year. As we shared on our call in April, we did experience some softness early in the second quarter, as our in-store presence and supply were negatively impacted by COVID-19. We worked quickly to improve our execution and in-store distribution and merchandising, resulting in accelerated performance in late May and June. In the month of June, our Skinny Pop and Pirate’s Booty brands grew 8.4% and 3.7%, respectively, in measured channels, and total sales growth outpaced these levels, bolstered by strong growth in club and e-commerce. While we saw strong sales growth in measured channels, as expected, this was partially offset by significant declines in our food service and specialty retail businesses. Trends improved as we progressed through the quarter as many locations re-opened; however, traffic and sales remained below prior year levels in June. While we expect the second half headwind in these channels to be less severe than the second quarter impact, uncertainty remains as consumer behaviors continue to evolve, COVID-19 cases rise, and regions consider mitigative actions to control the spread of the virus. Before I discuss our international segment, let me spend a few minutes providing an update on Halloween. As many of you know, Halloween is our largest season and it represents approximately 10% of our annual sales. We begin manufacturing products in the second quarter and primarily ship products to stores in the third quarter. Halloween celebrations are likely to be different this year, with an earlier start to the season and more geographic differences than in prior years. We expect that there will be more at-home activities, with families sharing timeless traditions and new ways for people to celebrate with neighbors. It is important to note that nearly 50% of Halloween candy spend is on 'treat for me' and 'candy bowl' occasions, which start early in the season. Trick or treating represents the other 50% of the season, with sales concentrated in the last two weeks of October. While research indicates trick-or-treating participation will likely be below prior year levels due to COVID-19 concerns, the expectation of this holiday tradition has been consistently improving over the past several weeks. We expect to outperform the category given our iconic brands, strong innovation and merchandising, and great execution. While we have visibility to orders and current consumer intentions, we expect the virus and consumer sentiment to evolve in the months leading up to the season, which could present some risk to sell-through. We will continue to monitor consumer behavior and local guidelines and partner with our retailers to help consumers celebrate the Halloween season during this uncertain time. Now, let me shift gears and discuss our international and other segment. As anticipated, second quarter results were significantly impacted by COVID-19. As we shared in April, our owned retail Chocolate World locations were closed during the second quarter and we saw a meaningful impact on our travel retail business as air travel declined. While our locations have begun to reopen and air travel is beginning to improve, traffic remains well below historical levels, and we anticipate a slower recovery in these channels. In several of our key international markets -- notably, Mexico, India, and Brazil -- we have seen a significant increase in coronavirus cases over the past several months. While measures to stem the spread of the virus have varied by country, we have consistently seen these measures and their associated economic impact pressure chocolate category sales. In many of these markets, chocolate consumption is not as embedded in the culture as it is in the United States, and it is premium priced versus other food and snacking options. Category trends did improve as the quarter progressed, but they remain below prior year levels. While we saw strength in some of our other items in key markets, such as cocoa powder, syrup, and spreads, it wasn’t enough to offset the chocolate declines. We have responded to these recent trends and scaled back investments accordingly to help mitigate the COVID-19 impact on our business. We remain committed to our international strategy over the long term, and we will maintain an appropriate level of investment to capture opportunities as the macroeconomic environment and pandemic improve. Now, let me turn it over to Steve to provide some more details on our financial results, as well as our outlook for the rest of the year. Steve?

Thanks, Michele, and good morning, everyone. Before reviewing the detailed results for the second quarter, I want to build on Michele’s remarks and commend our team’s ability to adapt, execute and make smart decisions quickly during this unprecedented time. While our top line was challenged due to COVID-19-related softness in certain areas of the business, and we incurred incremental costs related to the pandemic, strong price realization in North America and proactive cost management allowed us to sustain profitability and deliver earnings in line with last year. As we look to the balance of the year, we anticipate incremental improvement to our top line, and feel good about the plans we have in place to continue to adapt and manage the opportunities and challenges that may arise in this dynamic operating environment. During the second quarter, reported net sales decreased by 3.4% versus the same period a year ago, with an organic, constant currency decline of 3.5%. As Michele mentioned, these declines were driven by COVID-19-related pressures to our international and other segment, as well as non-traditional channels in the U.S., such as food service and specialty retail. These declines were partially offset by strength in our confection business in measured channels, which benefited from elevated at-home demand and strong price realization. Despite these top-line challenges and incremental COVID-19-related manufacturing costs, price realization and productivity savings enabled us to maintain our peer-leading adjusted gross margin of 46.4% in the second quarter, relatively in line with the prior year. Adjusted operating profit increased 4.4% in the second quarter, resulting in a 170-basis-point improvement to operating profit margin versus the prior year period. Incremental incentives, cleaning, and PPE costs were more than offset by travel and meeting expense favorability, as well as marketing spend optimization to align with consumer demand changes in the quarter. In North America, organic, constant currency sales growth of 0.4% was driven by pricing and elevated at-home consumption of our chocolate and baking items. This was partially offset by sales declines in foodservice, specialty retail, and our refreshment brands due to COVID-19. Price realization contributed 4.2 points in the quarter, which was slightly ahead of expectations, due to incremental trade efficiencies realized from revenue management and selective programming choices related to COVID-19. We continue to expect second half price realization to be approximately 1.5 to 2 points, driven primarily by our July 2019 price increase. Food service, specialty retail, and refreshment were each down approximately 40% during the second quarter. We continue to expect these businesses to be negatively impacted by COVID-19 during the balance of the year, but improve incrementally as the economy and consumer mobility continue to recover. In measured channels, retail takeaway for Hershey was 4.1% for the second quarter, driven by strength in demand for our take-home confection and baking businesses, and strong execution by our supply chain to ensure product was available and on-shelf. We did not see this fully flow through to net sales, as retailer inventory levels continued to be depleted to satisfy a portion of this demand. As a result, we expect these inventory levels to be replenished in the coming months, contributing approximately one to two points of growth in the second half of the year. Adjusted gross margin for the North America segment expanded 20 basis points to 47.5% for the second quarter, driven by strong price realization, which more than offset a challenging 2019 lap of favorable mix and incremental COVID-19-related costs for incentives, cleaning, and PPE. Mix was a slight headwind for the quarter, driven primarily by lapping the significant mix benefit from Q2 of 2019, versus COVID-19-driven mix shifts this year. As Michele mentioned, our instant consumable business has continued to grow, which has helped maintain our margin strength. As a result, we do not anticipate mix being a material driver of earnings in the second half. North America advertising and related consumer marketing spend decreased 10.8% in the second quarter, driven by media cost efficiencies and selective programming optimization related to COVID-19. Approximately half of our spend reduction was driven by favorable digital media costs in the marketplace, a portion of which we expect to sustain in the second half. The remaining declines were driven by reduced investment in brands negatively impacted by COVID-19 trends, including IceBreakers and select chocolate brands that are disproportionately sold in the convenience store class of trade. As consumer trends improved in May and June, we began reinvesting in these businesses. These actions are a testament to our capabilities and willingness to adapt quickly to changes in the marketplace. As we look to the balance of the year, we will continue to be mindful of the evolving operating environment, but plan to invest more in advertising and consumer marketing as sales trends improve. In our international and other segment, organic, constant currency sales declined 33.4% in the second quarter, driven by COVID-19-related softness in our owned Chocolate World retail locations, large declines in air travel and performance in key international markets. Combined constant currency net sales in Mexico, Brazil, India, and China declined 31.8% versus the second quarter in 2019. As Michele mentioned, we expect our international business to be slower to recover and likely challenged for the balance of the year because of both COVID-19-related restrictions and economic conditions impacting consumer participation in the chocolate category. Our owned retail businesses were closed for nearly the entire second quarter, though all have reopened on a limited basis with appropriate COVID-19-related precautions. While our stores have reopened, we do expect significantly decreased foot traffic during the second half of the year and, therefore, expect sales to remain below prior year levels. Given these declines to the top line, we have taken a disciplined look at our variable cost base and optimized where feasible while still maintaining the appropriate level of brand investment. This resulted in savings in advertising and related consumer marketing, along with travel expenses of approximately $15 million. The segment reported a slightly negative operating income of $4 million for the second quarter. We continue to expect gradual recovery throughout the second half of the year, but do not expect the segment to return to the same level as last year. While this segment has borne the greatest impact from COVID-19, we remain committed to the right balance of investment and support to ensure acceleration post-COVID-19. Shifting to items below operating profit, interest expense was $38 million for the second quarter, an increase of $4.3 million versus the same period a year ago, due to higher debt balances from debt issuances in October 2019. Other expense of $11.2 million represented a decline of $1.9 million, due to the purchase of fewer tax credits and lower non-service-related pension expense. The adjusted tax rate in the second quarter increased by 4.6% to 19.4%. This increase was due to the lapping of a prior period benefit related to the release of valuation allowances in select international markets. At this time, we do not anticipate any material changes to the tax and other income/expense outlook that we shared with you in January. We do, however, expect interest expense to marginally increase over the prior year due to the bond issuance in October 2019 and May 2020. Despite any short-term challenges posed by COVID-19, we remain confident in our strong cash flow and healthy balance sheet to manage through the current crisis and beyond. At the end of the second quarter, we had approximately $1.2 billion in cash and cash equivalents on our balance sheet, an increase of $800 million versus last year, and $614 million in operating cash flow. To further mitigate potential risk and to take advantage of favorable rates in the capital markets, we issued $1 billion of bonds in the second quarter with staggered maturities, while paying long-term debt of $350 million that came due in May. We continue to have a peer-leading capital structure, providing agility to adapt to the dynamic environment we are operating in. Given our strong free cash flow and liquidity, we remain committed to our long-term capital priorities, with a balanced approach to investing in the business and returning cash to our stockholders, all while managing through this volatile environment. First, let’s discuss our commitment to reinvestment. In the second quarter, total capital additions, including software, were approximately $87 million, bringing our year-to-date investment to $186 million. As discussed in April, our revised capital spending full-year outlook of $400 million to $450 million reflects selectively pausing portions of our ERP transformation and supply chain capacity and capability initiative. Both ERP and our supply chain initiative, while re-phased, remain on track and are critical capabilities to deliver our long-term strategic initiatives. Now, shifting to returning cash to our stockholders, which remains a steadfast priority in our capital allocation strategy, earlier this morning, we announced our third quarter dividend, reflecting a 4% increase. While the Company did not repurchase any shares in the second quarter against the July 2018 $500 million authorization, we did repurchase $42 million of common stock in connection with replenishment of stock options. We remain confident that our balanced approach to business investment and returning cash to stockholders will continue to provide sustained stockholder returns now and in the future. As you saw in the press release, we are not providing new 2020 fiscal guidance at this time. While the Company’s performance improved over the course of the second quarter, the impact of recent spikes in coronavirus cases on consumer mobility, retail operations, governmental regulations, and the macroeconomic environment remains unclear. With that being said, we do want to provide some visibility into our latest thinking for the balance of the year, which is based on our current understanding of the operating environment. In the North America segment, the Company expects accelerated sales growth in the second half of the year driven by elevated at-home consumption, price realization, and the replenishment of retailer and distributor inventory levels. These gains are anticipated to offset improving, but still pressured, sales in the food service and specialty retail channels. The Company does not currently expect seasonal performance to have a material impact on second half financial results, though the impact of a resurgence of COVID-19 cases on consumer participation in seasonal activities remains uncertain. In the international and other segment, the Company expects demand to slowly rebound in the second half of the year, but remain below prior year levels as owned stores, travel retail, and developing markets recover more slowly. Finally, as it relates to sales, during the second quarter, we completed the planned divestitures of our Krave, Dagoba, and Scharffenberger brands. These divestitures are expected to have a relatively small 20-basis-point impact on sales in the second half and an immaterial impact on earnings per share. Solid price realization and strong cost management are anticipated to offset some of the incremental COVID-19 costs we are facing. COVID-19 costs are expected to be less in the second half of the year, mainly for increased plant sanitation and personal protective equipment for Manufacturing and Sales Teams. We anticipate that price realization will continue to drive gross margin gains, though to a lesser extent than the first half of the year, as we begin to lap the announcement of the 2019 price increase. Selling, general and administrative expenses should continue to show favorability in the back half of the year, behind lower travel and meeting expenses and favorable incentive compensation versus the prior year. Finally, as it relates to brand investment, we intend to continue investing in North America and further optimize spend in the international and other segment in accordance with expected sales trends. While we have not issued new guidance today, we hope this additional perspective is helpful to understand our approach to managing through the crisis and our high-level expectations for the next several months pending the continued evolution of the pandemic. We remain confident in our team, our plan, and our agile operating model to deliver solid shareholder returns this year and in the future. Now, I will turn it back to Michele.

Thanks, Steve. During a time of extraordinary changes and challenges this quarter, our teams responded with agility and executed well against factors within our control. We have balanced delivering today with making calculated investments that we believe will enable us to emerge even stronger after the pandemic. In times of risk and crisis, cultures are either strengthened or weakened. Hershey has come together and thrived as a team, committed to serving our consumers and our communities. Our purpose and commitment to operating sustainably and responsibly continue to move us forward. Last month, we released our 2019 sustainability report that highlights some of the great progress we have made in this space, as well as some of our key priorities for the future. I encourage you to go to our website and take a look. In addition to the sustainability report, you will also find information on some of our more recent actions and pledges. Let me take a minute to discuss two that are top of mind related to recent events. We have long supported our communities and given the unprecedented need many are facing right now, we have amplified these efforts. In addition to increasing our product and monetary donations, we have invested in our own mask production line to service our employees, their families, and our communities. Second, for many years, we have pursued a vision of building a more diverse and inclusive company. We have been recognized for our progress, including being named the top food company for diversity by Diversity Inc. Recently, we initiated a company-wide dialogue to listen, learn, and grow together. Through that dialogue, we have seen the very best of our Hershey culture, and a genuine desire to do more in the fight against systemic racism. We announced a set of initiatives to support Black and Brown communities and accelerate increasing Black and Brown representation and internal development at Hershey and amongst our key partners to promote social and economic progress. We believe these initiatives will help address the need for meaningful, long-term change in our society, and include evolving our approach to recruiting, talent development, training, and reporting, as well as pledging monetary donations to organizations that actively fight systematic racism. To close, we believe Hershey is well positioned to adapt and succeed over the long term. We have scale brands in growing categories that consumers love and trust, we have a highly efficient yet agile supply chain that we are investing in for the future, we have advantaged capabilities in analytics, media, category management, and sales, that we believe position us well to drive profitable growth in the future, and we have a team that is dedicated to our purpose of making more moments of goodness. We remain confident and committed to our long-term strategies and financial targets. With that, we conclude our prepared remarks this morning. Thank you for your time this morning. I invite you to listen to our live question-and-answer webcast, which will begin today at 8:30 a.m. Eastern Time, and will be available at thehersheycompany.com. Thank you.

Good morning, everyone. Thank you for joining us today for The Hershey Company's second quarter 2020 earnings Q&A session. I hope everyone has had the chance to read our press release and look into our pre-recorded management presentation, both of which are available on our website. In addition, we have posted the transcript of the pre-recorded remarks. At the conclusion of today's live Q&A session, we will also post the transcript and audio replay of this call. Please note that during today's Q&A session, we may make forward-looking statements that are subject to various risk and uncertainties. These statements include expectations and assumptions regarding the company's future operations and financial performance, including expectations and assumptions related to the impact of the COVID-19 pandemic. Actual results could differ materially from those projected as a result of the COVID-19 pandemic, as well as other factors. The company undertakes no obligation to update these statements based on subsequent events. A detailed listing of such risks and uncertainties can be found in today's press release on the company's SEC filings. Finally, please note that we may refer to certain non-GAAP financial measures that we believe will provide useful information for investors. The presentation of this information does not intend to be considered in isolation, or as a substitute for the financial information presented in accordance with GAAP. Reconciliations to the GAAP results are included in this morning's press release. Joining me today are Hershey's Chairman and CEO, Michele Buck, and Hershey's Senior Vice President and CFO, Steve Voskuil. With that, I will turn it over to the operator for the first question.

I was muted there. I am so sorry. Thank you. Good morning.

Good morning.

I hope you're all well. I would like to ask a question regarding the second half of the year. You mentioned that the seasons would have less of a material effect on business performance during that time. I'm curious about how Halloween is shaping up based on orders and how it might influence Q3 sales. Additionally, last quarter you discussed having some early seasonal fall products. Are those available in the market now or will they be released soon? How might that impact your overall seasonal sales in Q3?

For Halloween, we have received orders from retailers, starting back in May, and we aim to finalize those orders by the end of that month. We've already shipped some products, and we continue to send out shipments from June through early October, which gives us good visibility on the orders. While there's always a chance that orders may change in the coming months, such occurrences are quite rare. Additionally, around half of our Halloween products are intended for personal use, such as for candy bowls or family treats, while about 40% relate to trick-or-treat sales towards the end of October. We're optimistic based on our observations and the collaboration we've had with retailers. We believe consumers will find safe and creative ways to trick-or-treat, considering it's an outdoor activity where many already wear masks. There's no evidence that the virus spreads through packaging or food, so we're encouraged by the consumer feedback. If trick-or-treating ends up being less than anticipated, we'll concentrate more on the treat-for-me and candy bowl segments. We've adapted our product portfolio to include more everyday packaging to mitigate risks if Halloween sales fall short, which helps manage our liability. Currently, we feel positive about the situation. Regarding the holiday season, we have a preliminary understanding and have begun producing holiday products. At this moment, we don't foresee significant disruptions in seasonal participation, mainly because many holiday celebrations happen at home. We plan to keep a close eye on developments and continue our collaboration with retailers as we did for Halloween.

That's great. Thank you. And just one quick follow-up if I could, which is in relation to retailer inventory levels. As you ended the quarter, I just want to get a sense of where they were. Obviously, you did under-ship demand in the quarter. There is an expectation for an increase in the second half of the year. And I just want to kind of tie into that seasonal discussion. Is that a component of the expectation for higher inventories in the second half of the year? Thank you.

Yes. So inventory was about a 1.5 point to 2 point headwind on our first half growth, and there were really a couple of factors that drove that. Part of it is, as you recall last year, we had a build of inventory as retailers were perhaps anticipating a price increase. So the lap from that creates part of that. Secondly, we were depleting inventory as a result of consumer stock-ups and the acceleration that we saw in takeaway across our portfolio. So we've been working really hard and had very strong customer service levels versus the industry. But yet, we've still been continuing to replenish to kind of catch up with that accelerated demand. And then, the third factor that really falls into that equation is non-measured channel softness. We've talked to you about owned retail locations, world travel retail, the foodservice, some of those businesses that don't show up in measured happen to be the same ones where we have some of the greatest softness. So the Halloween piece is not really a factor in that inventory piece. It is much more around the everyday businesses on the non-measured channel.

Hey good morning.

Good morning.

Congratulations to you and your organization for navigating everything so smoothly right now. But looking at the forward, I'm kind of curious of the pricing outlook. You guys mentioned that you expect pricing in North America to moderate to 1.5% to 2%, which I believe is pretty much singularly the effect of last year's price increases. Said differently, it suggests you're not expecting some of this trade efficiency and benefits of lower promotions to sustain. If so, why not? Because it looks like the promotional environment for both you and your competitors remains pretty subdued in July, why would it come back so quickly?

So first of all, as we look at the promotional pricing that you see as you look at some of the retail scanner data, we do not believe that data is correct. There is a lot less auditing going on during this time than previously. So the biggest issue we think there is we think simply the data is just not correct. We are continuing to see the kind of promotional activity that we had planned in the second quarter behind S'mores, Twizzlers, and our Reese's In and Out lever promotion. And going forward, we feel good about the promotional plans that we have in the back half of the year with our retail partners.

We constantly review revenue management. While boosting trade efficiency is part of our fundamental strategy, the significant impact we experienced in the second quarter was primarily due to data inaccuracies. We had a strong presence in stores with promotions for S'mores and Twizzlers, which contributed to our activity.

Interesting, I heard that. Thank you for the context. Continuing with the topic of pricing, as you mentioned, you are nearing the point of cycling last year's price increases. Pricing has contributed to your growth strategy in North America over the past couple of years. I don't think you have announced anything new, and you are about to cycle these. As we look beyond this year, should we anticipate that pricing will no longer be part of the growth strategy for the foreseeable future? If that isn't the case, could you explain why?

No. I mean, we remain committed to the pricing strategy that we've discussed with all of you before, and that's really behind smaller, more frequent price increases. While we have priced each of the last two years, that certainly doesn't mean within our strategy that we have plans to price every single year. We really take a strategic approach where we look at opportunities across the portfolio. Right now, all of our pricing initiatives remain on track, and we continue to think that we're going to see price realization in the second half. But as you know, we have several different levers that we rely on to drive the business. Pricing is one of those, but brand investment, key retailer initiatives, innovation, merchandising, and new capabilities— that balanced portfolio of levers to drive growth is something we really believe in, and we think that that's very important. So we take a lot of variables into consideration when we decide what to price, when to price, how to price, and we will be consistent with the stated strategy going forward.

Understood. Thank you so much.

Hi, thanks for the question. I guess, two smaller ones. A follow-up to Jason's: my understanding is, over the past couple of years, you had taken pricing on about two-thirds of the portfolio, which left another third. It's likely to be raised as well. I mean, has something changed since the start of the year with how you're looking at your list price increased plan? I guess, that's the key thing; has something changed? And then just a quick follow-up on Mexico, I was surprised to see Mexico down so much. Do you put that in the category of countries where chocolate is just not part of the overall embedded culture of the country? Because I thought Mexico had been pretty resilient in the past? Thanks.

Yes. So relative to pricing, our plans were not impacted or changed for the year. It is correct that we have a third in portfolio that wasn't priced in those actions, but we did not change our plans throughout the year on pricing. So we just continue to look across and decide when and what, and Halloween was the right time. Relative to Mexico, we certainly have seen big disruptions in that market. And I would say—I wouldn't put it as much certainly—there are certainly pockets of Mexico where there are economic issues, but the biggest factor in Mexico has really been the trade, the spread of the virus, and then the shutdown of key elements of the trade, specifically, the wholesaler network, distributor network, where we have about 50% of our business. And so, it was really the trade shutdown that impacted our business in Mexico.

Okay. Can I sneak one more in? Your outlook is very robust for Q3. Based on the strong exit rate and the visibility at Halloween, is your assumption that the other 40% of the element that's based on sell-through is your assumption that that part will be down year-over-year? Have you been appropriately conservative on that element in your outlook?

I think that we have been appropriately conservative. I think we have partnered with our retailers. So we've utilized that visibility. We've taken into account what we think the category will be. And importantly, we've also taken into account what we believe our market share of the category will be based on recent performance and what's happening in the marketplace right now. So I think if we see pressures in Halloween, that's probably going to show up more toward Q4 than Q3 as it will be at those end periods post the holiday relative to sell-through at that point in time.

Great. Thank you very much. Even in Q2, even with the weaker volume and elevated COVID costs that you incurred, the company was still able to expand operating margin by 170 basis points or so. So just as we think through the second half, some of those, I guess, COVID discrete costs begin to dissipate, volume starts to pick up based on some of the comments you made about exit rate and things of that nature. So, perhaps investment spending, I guess, picks up as well. So I guess, as we think about margins in the second half, what would be maybe the key points to consider versus, let's say, where Hershey came out in Q2? In other words, where do you expect margins to be up similarly to what you saw in Q2 or what are some of the discrete factors that could change that one way or the other? Thank you.

Steve, you want to hit that one?

Yes, I'd be happy to take that. You're quite right. Q2 turned out to be more favorable from a margin standpoint than we expected going in. While we had incentives, some of those incentives were less than what we had expected for the quarter. Insurance costs that we had expected for the second quarter came out more favorably. We talked on the last call about productivity, and productivity being a risk for the quarter and in fact, the productivity goals in manufacturing were still achieved. Probably, the lingering piece, PPE and cleaning costs that will continue. So we kind of take Q2 and look to the future, obviously the incentives based on everything we know today are about returning. Productivity, we expect to continue along with our full-year plan. PP&E is not a big cost in the quarter, so I think $3 million, $4 million a quarter as a benchmark. We will continue to drive SG&A savings both at the corporate level with travel and meetings, as well as at the division level. And then, as you said, we're going to spend a little bit more back from a DME standpoint. So while we had an opportunity in Q2 to optimize, probably optimize a little bit more than we had expected. We are going to invest back more behind the brands as we get to the back half of the year, so—and a little bit less pricing benefit as well. We've had a lot of pricing benefit across the first half. As we lap now, that will also start to come off. So those are the big drivers. That's the reason, again not giving specific guidance, but expecting some margin acceleration in the back half.

Very helpful there. And then, just one last one, Michele. The market share gains that Hershey has been seeing, right, have been pretty phenomenal and unprecedented in many ways and certainly, a big part of that has been the company's execution, right, particularly at the point of sale and in-store and leveraging the advantaged distribution model that you have. I know there have been some issues that competitors, let's say, around—let's say, supply chain resiliency and things like that. So I'm just trying to get a sense, as you think through how market share can sometimes be pretty sticky, both when it's gained and when it's lost, how do you think about the share that Hershey has picked up? I would assume that at some point, as things normalize and competitors get back there, whatever supply chain resiliency, there'll be some additional pressure on that front, but I'm trying to get a sense of how much do you think of share can kind of structurally remain or be sticky versus let's say, some that might be more transitory, if you get what I'm asking?

Yes, absolutely. I guess I'd start by saying, even pre-COVID, we had very good momentum in both takeaway and market share starting last year. And we really attribute that to the balanced activation plan and great execution that we had even then, which was a good—I think the right balance across advertising, distribution, pricing, seasons, and innovation, kinds of that suite of levers that we have. Obviously, since COVID, as you mentioned, our team has really stepped up relative to execution keeping product on shelf, while there were some struggles among some other competitors in the marketplace. And certainly, we do know some competitors also begin to rationalize SKUs to simplify their portfolios. So we do believe that the recent share performance is likely to persist for several more months. And while we do think that huge game that we're seeing is likely to revert next year as we lap the strengths, we do believe that some of the gains will remain in the long term and sustain.

Hi, thank you. I also wanted to follow up on Jason English's question, really just to make sure I understood your response, because you did say in the prepared remarks, price realization contributed 4.2 points in the quarter, slightly ahead of expectations due to incremental trade efficiencies realized from revenue management and selective programming choices related to COVID-19. So sorry for reading all of that, but I did interpret this quote, especially the part about selective programming choices to mean that you did reduce your reliance on discounting in the second quarter. So I guess, given that you're not changing your guidance for the back half of the year, doesn't that imply that you're going from a period of less discounting to a period of sort of more normal discounting, or what am I missing there? I'm just still not sure I understand exactly sure what that quote means, maybe.

So we did pull back a little bit in the second quarter, and that was primarily around refreshment given what was going on with refreshment being so incredibly soft and the functional demand just not being there as much for that product, especially given its presence in convenience stores and also a bit on grocery just because that part of the business was doing so incredibly well on its own. A little bit on S'mores, we had really strong demand on S'mores, but what I would say is, the trends are now stabilizing as the most severe declines on certain parts or most severe accelerations on parts of the portfolio in Q2. We saw the wildest swings, and those tend to be stabilizing a bit now. So we are kind of going back to a more normalizing approach. It wasn't a huge pullback in Q2. It was very selective against those parts of the portfolio. Does that help?

Yes, I know that is—that's clear. Thank you. And then, for my follow-up, some of your peers in the broader sort of food and beverage industry have talked about making some pretty meaningful reductions to their product portfolios in terms of SKUs. We haven't heard quite as much from Hershey on that. I'm just trying to, or I'm hoping to get an update from you in terms of how you think the breadth of your portfolio is right now in a post-COVID world and whether there are any plans, I guess, for sort of major reductions or minors to some of the products that you might have.

Yes. So we had already really embarked upon a SKU rationalization program over the past two, 2.5 years. So we had pretty aggressively taken a look across our portfolio and made a lot of those cuts. So at this point in time, we're feeling pretty good about where we are. I don't see a major program. Obviously, it's always an ongoing focus to optimize and to cut some of the small things, but the biggest steps we had already taken previously.

And meanwhile, some of the new innovations that we brought to market have done quite well. So where we brought in new SKUs, whether it was Kit Kat Birthday or Take 5.

Great. Thank you.

Yes. Thanks. Good morning, everyone. So just kind of a two-parter on innovation. It's nice to see retailers picking on new products. We've been seeing that trend now. Obviously, people were a little doubtful of how much new product would actually get into retail, given the focus on A-level SKUs, but Michele, I was wondering if you can just opine on. Has there been a philosophical difference at retail that you can discern in terms of what products they are actually taking on the shelf? And I'm really kind of get at our large companies like Hershey advantage from the situation in terms of new product given well-known brands, etc. And then on the second piece of that, just some of the work we've done looking at numerator data would suggest there's a heavy degree of interaction between the Hershey portfolio and the snack cake category. And I know you've dabbled in that area to some degree with Mrs. Freshley's, but can you just give us some thoughts on how you're thinking about that adjacency kind of opportunity a little bit more broadly?

Yes. So starting with your first question, we definitely have seen retailers, especially during the COVID situation, dial up their focus on power SKUs, must-have SKUs, really because of the huge consumer demand and needing to make sure that they were in stock on the most important items and also just because of labor needs and all of that just a focus on what's really going to deliver the business. I think that's why you're seeing. Many of the manufacturers also now started to really rethink their portfolios to do the same. So I would say, yes, I think the retail trade is saying, hey, right now, this is a time where we need to focus on those biggest, most important items. So I think you're right about that. And then, I'm sorry, remind me again, your second question?

Yes. No problem. Snack cake category.

Snack cake. Yes. So we have seen some similarity, some crossover in terms of candy and snack cake consumption. They both have some similar traits in terms of really hitting the kind of the treat sweet tooth and filling certain needs for consumers that are similar. So I think we have seen some of that crossover certainly from consumers.

Hey, good morning everyone. Just two quick ones for me. One, you gave some color in the press release about performance in June. So, just curious if July has continued to progress the same way. And then, the second question is more around distribution gains. I think you referenced in response to Andrew's question some of the issues that some of your competitors have had. So I guess, if they're reducing SKUs and maybe having trouble keeping some things in stock, have you actually gained shelf space or gained distribution in this time period? And if so, kind of, if you could give some color in terms of which channels, is it more convenience and gas, more in grocery? Just some more color there would be helpful. Thanks.

So we haven't really seen any material changes in July versus our trends. So there are some geographic differences, just given the big differential across geographies as a result of COVID. So now, I would say we're feeling good about what we continue to see. And market share is pretty consistent though. In terms of our market share performance, I would say we're feeling pretty good in terms of continuation of that trend.

And I think wherever we've had the opportunity to take advantage of getting shelf space or a broader distribution, it's crossed over all classes of trade.

Yes. And we certainly—those are some of the benefits that I think you don't always see immediately because you have planogram timing, etc., to realize those benefits. So some of those benefits, I think, we started to see in June, and that might be what's driving some of our continued trends—positive trends in July.

Great. Thank you and good morning.

Good morning.

Great. Good morning. I wanted to ask about a little bit on the seasonal candy and then a specific question on Halloween with the related. So I know for the full year, roughly a third of the portfolio was seasonal candy. But in just the second half of the year, can you give us the breakdown between your seasonal sales in your everyday sales? What percent of the second half is actual seasonal?

Well, Halloween, we've said previously, is about 10% of our full-year business. Certainly, seasons are higher in the second half than they are in the first half because Valentine's is our smallest holiday. So you really have Easter as a big one in the first half. We don't really want to get into some of the specifics by quarter. But I would say that the season's impact is definitely bigger in the second half than the first half.

And then I just—just to be clear, I think you said this in the release that you don't expect Halloween to have a material impact. So it sounds like it's flat. And if seasons are 40% or something like that of the second half and the seasonal numbers are expected to be roughly flattish and your everyday is running up 9%, I think that's what you also said in the release. And is that not a decent way to think about how to model North America in the second half?

I think your math is generally correct. I can't argue with the math. The one thing I would say is you're speaking specifically to measured channels, and you need to remember the impact of non-measured channels, owned retail, foodservice, air travel, world travel retail, which is airline, and the trends on those businesses as that does—that has been as we've shared the biggest hit in our business. So while those channels are certainly not shut down like they were in Q2, they're in the recovery mode. And the recovery mode is definitely going to be a slow uptick.

Okay. So that—in terms of the everyday 9% that I quoted because of those unmeasured channels, and then seasonal is where the expectation is roughly flattish given what you know today. Obviously, there's plenty of caveats and what could change. So I think I'm understanding you. My follow-up question is just on your marketing and your overall expenses. So a tremendous job. I'll give you guys huge kudos on what you did in the second quarter to get your margins where they came out. I'm just curious that is there a learning here that you can actually run a significantly tighter expense budget on a go-forward basis? I'm guessing that the COVID made you do certain things that you normally wouldn't have done, and the results here are, market share gains are fantastic. When you think a year forward, two years forward, can some of these cost reductions be very sticky because it's proving that you didn't need to spend some of those monies in order to produce, I think, excellent results at retail?

I mean, I think SG&A is clearly an area that we're expecting that how much we need to spend will change permanently over time. So I think that piece, yes. I think on the marketing expenses, it's a little bit different. Certainly, some of our pullbacks were as a result of certain businesses like refreshment that were down 40%. We just didn't think it made sense to be spending into that. Then, part of what we were able to do was to leverage the fact that a lot of advertisers dropped out of the marketplace and as a result, the costs of media were less than we had planned them to be. And so, we were able to have a nice outcome there. As advertisers come back into the marketplace, some of that pricing benefit is not going to be available anymore. So while there may be some ongoing efficiencies and we are always looking to tighten our data knowledge and have capabilities around media since we are big spenders to get more for our money, and we're always building capability to take it to the next level. There were some unique circumstances there as well.

Yes, I agree. Certainly on the pricing for some of the media exposure that came down, that was a big benefit. I think we did benefit from tools and investments we made around marketing efficiencies and driving ROI and optimizing. We haven't talked as much about some of those tools, tools both on trade efficiency, but also marketing spend efficiency. And those tools allowed us also to be more agile as things evolved quickly. And so, that part is something we'll look to leverage further in the future.

I really appreciate it. Those are helpful comments. Thank you.

Thanks. I just want to follow up on that Halloween comment. In your prepared remarks, you mentioned that the seasonal performance would not have a material impact on second half results. That's an interesting comment. I mean, we're not doing the official guidance here. If you would think that, that would be a big variable, it might be 20% of your second half revenue. So is there something that's giving you confidence there? I know that you wouldn't be making such a comment without perhaps orders in hand or some insights around the ability for you to sell some of that through, even if it doesn't happen to trick-or-treaters, and I have a follow-up.

Yes. I mean, I think the confidence drivers are orders in hand. Some of the dynamics that exist around the fact that only half of that Halloween volume is trick-or-treat. The fact that the trick-or-treat behavior is outdoor. People do wear masks. So as we get closer, we're feeling good about that. Now obviously—certainly, we didn't provide official guidance in the back half of the year. And there is uncertainty and volatility overall given the virus, but based on everything that we know and the visibility we have and with every day we get closer, we feel that we've taken an appropriate look at what we think can happen and have really factored that into our outlook as best possible. We've mitigated some of the downside risks with the everyday portfolio versus all the Halloween packaging. Steve, anything you would like—

No. I agree. I think for the things we can see and certainly, the things we can control, we're optimistic, but part of the reason for not providing more specific guidance is, there are things we can't control and probably can't see. And for those reasons, there still is potential variability in the back half, but everything we can see gives us a plenty of confidence.

That's helpful. And with regard to COVID-related costs, you mentioned those were a gross margin headwind in the second quarter. Could you give some color as to how much that might have been? And how much of a gross margin headwind do you think it's going to be for the year? Thanks.

Yes, in terms of just COVID related costs? Yes. Probably on the order of—for the gross margin somewhere between $15 million and $20 million of COVID-related costs. Again, we had predicted it might be more than that. In fact, it came out less. As we go forward in the rest of the year, the biggest piece that will stick around is going to be that personal protective equipment, cleaning costs, and so if I take that $15 million to $20 million, think about maybe a third or a quarter becomes sticky to the back half.

Thank you.

Great. Thanks so much. I had a question on c-store traffic momentum there. We've obviously seen convenience store channel improve throughout the quarter overall. It seems like hopefully that momentum is sustainable as long as people are leaving their homes more and going to the channel, but also the channel is more relevant for using a lot of other companies in this space and usually. I would think there is a little bit more of a margin benefit just given the single-serve product that you're sold there that you saw there, but with remarks, you said that margin mix really didn't have much of a headwind. It doesn't sound like you're really speaking to that as a risk going forward, which is great. I'm just kind of curious where I'd be wrong in thinking that some of that single-serve product that usually have a better price per pound and potentially better margin impact, and why it didn't and why it might not?

Yes. I mean, I think that's generally correct. We are seeing a rebound in convenience stores as people are out and about more. And I think also as some people are choosing not to travel via air, but do vacations that are more driving vacation, so I think that's helping as well. So yes, I think certainly instant consumable and that class of trade are helping the business. We're also seeing instant consumable strong and strength in other classes of trade as people have returned more now to grocery stores and trips and shopping. So the strength is not just in convenience stores. So that is helping our margin mix.

So, it sounds like even though—if I think about a movie theater, right, even though consumers might not be going to movie theaters and buying Hershey products there in a single-serve format as well as traffic of C-stores that maybe like you're seeing in grocery stores a bit, that is still trying to get their fix, right? So they might not be buying the big bag, but they're going to check out. It sounds like what you're saying is maybe some of your checkout momentum in traditional mass in grocery is doing better than maybe it had. I know if we go back a couple of years that at one point in time, that was a focus of yours. Is that fair?

Yes. That is fair. It has definitely— we're seeing growth on the instant consumable piece of the business, and again, I think a lot of that due to more traffic in those channels.

Alright. So it's Michele. I just want to thank you all for joining us this morning. As you know, this was a new format for us, and I hope that you found it helpful. Let me close with some very brief remarks. Over the years, our great brands, our advantaged margin structure, and our consumer-centric strategies have enabled us to navigate volatile environments and consistently deliver strong stockholder returns. We take great pride in our passion to create new ideas, innovation, and ways to connect consumers to continue to make moments of goodness in their lives. With our relentless focus on the consumer, an adaptive operating model, and our remarkable team of people, we are confident that we can once again respond to the changes in the marketplace to deliver growth and unlock long-term value for our stockholders. Melissa, we'll be available after the call to answer any additional questions you may have. Thank you very much. Stay safe and have a great day.