Hershey Company (HSY) — Q2 2021 Earnings Call Transcript

Thank you. Good morning, everyone. Thank you for joining us today for The Hershey Company second quarter 2021 earnings Q&A session. I hope everyone has had the chance to read our press release and listen to our prerecorded Management presentation, both of which are available on our website. In addition, we have posted a transcript of the prerecorded remarks. At the conclusion of today's live Q&A session, we will also post a 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 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 we may 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. 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.

Good morning, everybody.

Good morning, Andrew.

Good morning.

Hi. I wanted to explore the cost to serve dynamic mentioned in the prepared remarks. It shouldn't be surprising that a 15% organic sales growth in a quarter can strain any supply chain, regardless of its efficiency. My question is whether any structural investments are required in the supply chain moving forward or if any capabilities were highlighted by the increase in volume. Alternatively, will we simply absorb the higher costs, particularly related to labor, since these are temporary and don't necessitate changes, given that such high levels of volume growth are unlikely to be sustainable?

So, Andrew, let me start, and then let me ask Steve to give some more details. I would say at the highest level, there are certainly key parts of our portfolio that have had extraordinary growth, and we cited some of the numbers, for example, on Reese’s. So, one thing that we are very focused on is investigating capacity behind the brands and businesses that we know have demonstrated track records of strong growth over time and particularly where we've seen strong spikes that we think will have continued strength going forward. Let me have Steve talk a little bit more about some of the other elements of cost and cost to serve.

Yeah. I would add on the structural side, one of the benefits is we’ve been working on our supply chain 2.0 program and the Annville fulfillment center comes online later this year, which will provide some additional flexibility and agility, so that will certainly be helpful. As Michele said, continuing to invest where we need to on capacity, especially on those fast-growing core brands like Reese. From a cost standpoint and getting into some of the pieces, clearly like you said, Andrew, putting that much pressure on the supply chain at one time pushed us in a number of spots. It pushed us from an overtime standpoint; it pushed us from getting to contract manufacturers and expanding some of their work off an onsite contract rate, and the same on the freight and warehousing side. So, I look at those as pressure points in particular on top of that, or as the result of the higher volumes. And then in addition, I would say labor rates in general and labor availability in general are a pressure point, beyond just volume. The market for labor is challenging, and so just like everyone, we want to make sure we are staying ahead of the curve on hiring, making sure our value proposition at our plants is attractive, and packaging inflation is similar. Packaging inflation we touched on a little bit on the last call. It’s still a pressure point. I think we’re still optimistic we’re going to see that moderate as we go forward, but we haven’t seen it yet. So, it is a combination of those transitory costs on the back of the higher volume, and a few things that are a little bit more sticky here as we look across the balance of the year.

Thanks for that. And then, just using our back of the envelope math, it seems like the operating profit upside in the quarter maybe is roughly offset in equal parts by a higher full year tax rate and some of the higher costs that you’ve talked about just now sort of leaving the full year EPS guidance intact. I just wanted to see if I had the magnitude of each of those impacts for the full year more or less right. It seems like they’re of equal magnitude essentially.

No, I would look at it as the tax piece was by far the biggest impact on us not taking up our earnings guidance alongside the top line. I think if it wasn’t for the tax piece, we would’ve raised guidance. The cost to serve is a component, but think of that as the 10% or the 15% of the impact where the majority really was the tax impact in the quarter.

Really helpful. Thank you.

Hi, thanks. Steve, you mentioned that there’s a 130 basis point tailwind from inventory loading this quarter, and you said there’ll be a de-load in the back half. Two questions on this. First, what’s your best estimate for how large the inventory reduction will be at retail in the back half? Number two, I know it’s not always easy to forecast this, but how should we think about the cadence of that? Is the majority in the third quarter, or the fourth quarter, just for modeling purposes?

Yeah. I think in terms of total magnitude for the back half, I think 1.5 to two points of impact. And I don’t think we’re clever enough to give you the precise quarter. I would say I’d look at it across both quarters, maybe a little bit skewed to the fourth quarter.

Okay. That’s helpful. Thank you. And then, I think it’s fair to say there’s some frustration among investors this morning that you didn’t raise your EPS guidance. I recognize the $0.04 beat wasn’t huge in the second quarter. There’s some uncertainty around the world in the back half of the year, but your business is doing great. So, I’m just curious, internally, was there any consideration of raising the bottom line guidance, or did you just feel it’s a little early given some of the inflation and the macro risks?

Yeah. I think, again, but for the tax piece, we would’ve raised or taken up our guidance. Certainly, there’s caution in the back half relative to the inflation and cost to serve. I think we have our hands around what that looks like and have a pretty good understanding of that. But if that were the only piece, we would’ve taken up our guidance, but tax was really the piece that we had to take into account. And we want to make sure we’re not sacrificing investment in the back half of the year.

Yeah. For perspective, tax was $0.17 on EPS, so very meaningful.

Got it. Thanks so much.

Hi. Thanks for the question. What do you think about the tax rate going forward for 2022, Steve? This looks like a one-time impact, so do you think you’ll have an easy comp in 2022? And then secondly, you talk about some of the cost elements; some are structural, maybe some are short-term. Does any of this impact how you’re thinking about pricing going forward for this year and for 2022?

On the tax side, we view it as a one-time event, so if we were to reset for next year, we wouldn't include this in our starting point for 2022. I hope that clarifies things. Regarding pricing, it is a critical aspect of our strategy, and maintaining and enhancing our gross margin is also essential. We are executing based on current trends and are fully aware of inflation dynamics, competitor actions, and retailer strategies. We constantly evaluate this environment. As always, we won’t divulge too much of our strategy yet, but pricing will continue to be a central element of our approach moving forward.

Yeah. As you recall, we did take two different price increases earlier this year on our confection portfolio that will really just begin flowing through in the second half of the year. And we’ll also have some upside from that in the first half of next year.

Okay. All right. Well, thank you.

Good morning, everyone.

Good morning.

Good morning.

Hi, there. I guess, the first question is whether you can give us any thoughts on the gross margin outlook from here. Obviously, a lot of other companies are seeing an awful lot of pressure. I remember back in 2018 when there was freight cost inflation. I think you also saw some pressure. Input costs are going up, packaging costs are going up, and yet you held it pretty flat this time around. So, just some thoughts on that, and then I have a follow-up.

We were pleased with the Q2 gross margin, which slightly exceeded our expectations. We managed it well, but our guidance suggests a slight decrease in the outlook for the gross margin for the remainder of the year, moving from a small increase to aligning with last year. Given the inflation we've encountered, this performance is commendable. Looking ahead to next year, we aim to continue growing the gross margin over time. We'll achieve this through a pricing strategy, productivity improvements, and managing inflation and commodity costs. This goal remains a priority for us, and we'll provide more details on next year's gross margin as we approach the end of the year.

Okay. Great. And then just a question on the Lily's acquisition. You recently sold Scharffen Berger and DAGOBA. The company’s been trying to make premium work for quite some time. What’s the difference about Lily's that makes you confident that you can actually make this work this time, versus some of the problems that you’ve had in the past? Thank you. And I’ll pass it on.

Yeah. What we really like about Lily's is, it is a scale business, so it is close to that $100 million in size, whereas Scharffen Berger and DAGOBA were much smaller, in the $30 million range. And we’ve found over time, and I think we’ve shared this before, that for us, a good acquisition being around close to that $100 million mark has been built enough that we can really best apply our capabilities around distribution, manufacturing, synergies, additional marketing, and broader-based marketing, et cetera, to really help make the acquisition a success. The other thing I would say is Lily’s is single-mindedly focused on better-for-you. So, while it is premium, it has a very distinct understandable benefit that those consumers understand, which is about the lack of sugar. That also gives us a lot of confidence that it fits very neatly into our operating model. As you know, we have already launched a broader portfolio of better-for-you on our core brands, and so that whole better-for-you area is a big point of focus for us. And there’s some nice synergy in terms of our focus there.

Great. Thank you very much. I’ll pass it on.

Thank you. Good morning.

Good morning.

Good morning.

I'm curious about your perspective on elasticity, knowing it can be challenging to measure. From our evaluations, you typically perform quite well in this area. Is that also your impression? Additionally, how do you approach this regarding your pricing strategy? How aggressive do you plan to be, and what are your expectations for consumer reactions to that?

We have developed intricate and advanced price elasticity models where we examine not only our own price points, price gaps, and price thresholds but also those of other snack items. Over time, we have consistently observed that our business, brands, and category are generally less elastic compared to some other categories. This observation provides us with confidence in our pricing power and our ability to adjust prices when we determine it is appropriate.

Okay. That’s helpful. And just a follow-up on Reese's. Can you give a sense for the organic Reese's launch, just how that might be tracking versus your expectations, and maybe a little bit of how it compares from a margin perspective? It looks like, with its price point, it’s probably pretty nicely accretive. Is that directionally correct?

So, it is performing in line with our expectations. It is really in kind of a test-and-learn phase as we move forward. And it’s not, I would say, a big material piece of our better-for-you launch at this point in time, as organic is a little bit more of a targeted offering than say, zero sugar or sugar free.

Okay. Great. Thanks so much.

Yeah. And to your second part of your question, from a margin perspective, we do charge a higher price point for it. But it also does cost more, obviously, so the margins are comparable to the core.

Okay. Thank you.

Hi. Good morning, everyone. I had just two quick questions. One is the tax, is it a cash item or a non-cash item? And then the second thing I’ll ask is, implicitly, you’re actually raising the EBITDA, which is more cash oriented. Am I not understanding it correctly?

So, the first question is for the second quarter, it’s non-cash, but a portion will become or could become cash in the balance of the year, and that portion will probably be non-cash for the balance of the year, so it is a mix of both for the balance of the year. On your second question, yes, you’re thinking about it the right way from an EBITDA standpoint.

Okay. To follow up on this, the increase in EBITDA is greater than the cash needed for taxes. Is that accurate? I want to clarify my understanding of the tax situation, as it seems like cash flow is increasing rather than decreasing based on what you’ve mentioned. I just want to ensure I have this correct.

Yes, that’s true, but I’d say the caveat is time. All right. So, if you’re looking at a longer period of time, it’s more possible that a portion of that reserve could become cash. And so, if you’re looking at next quarter or the balance of the year, that might lead to one answer. If you’re looking at the next two years, it could be a different answer.

Great. I appreciate it. Thank you.

Hey, good morning, everyone.

Good morning.

Good morning.

Hi. I wanted to follow up on Andrew’s earlier questions. Michele, taking a step back in this environment where we are seeing not only increased cost inflation but also labor shortages, a trend evident across many companies in our coverage universe. I have two questions related to this. First, if supply chains are operating at full capacity, how do you plan to stimulate demand given the challenges in getting products on the shelves? Second, as you evaluate the various economic dynamics and the overall environment, it seems to be a somewhat unique situation. Have you encountered anything like this before? Additionally, how are you planning for the business over the next 12 to 24 months if this situation persists?

We invest a lot of time considering and working on these issues. We recognize that the situation remains somewhat volatile, particularly with discussions around the Delta variant and recent CDC guidance, which serves as a reminder that the pandemic is not completely behind us. In September, many companies are transitioning back to the office, and children are returning to school. This will provide us with more insights into consumer behavior and the implications of these changes. Our approach to managing the supply chain involves maximizing revenue efficiently and profitably. A key focus is analyzing our portfolio to ensure we are utilizing available capacity effectively and increasing investments in brands and businesses that show promise. For instance, we are confident in making substantial capacity investments in Reese due to its significant growth and positive track record. However, there are areas within our portfolio where we will hold off on immediate capacity investments until we have more clarity on market conditions. One of our strengths is the breadth of our portfolio, which includes a variety of seasonal and consumable brands. We aim to leverage this diversity to navigate the current landscape. Our strategy involves strengthening the supply chain continuously while making prudent decisions to prepare for various potential outcomes in the future.

Okay. Thanks for that. If I could just follow-up with one quick one. Just as you’ve sold in merchandising for holidays in the back half of the year and maybe just more in general, have service levels come up more as sort of a factor that retailers are focusing on? Like, you can sell a program or they can take a program, but are they more sensitive to actually planning to be in stock? Is that becoming more of sort of a factor in that decision-making right now?

Yeah. I mean, I would say absolutely. Retailers were under tremendous pressure this past year with all of the huge shifts that COVID caused on many manufacturers’ businesses. They had, as we all know, tremendous issues with out-of-stocks. And so, their goal is to make sure they remain in stock. In fact, right now, we’ve seen retailers really lean in a bit to inventory and carry a bit more inventory than they have in the past, because I think there’s a little bit of a scarcity mentality. They want to make sure they have product. They also know that manufacturers are taking price, and so in some cases it may allow them to hedge a little bit there. So, I think it is definitely a focal area and, of course, something that we always focus on and are proud of how we’ve been able to deliver for retailers. They’ve continued to come to us, given how we were able to deliver during the worst of the pandemic last year, and have continued to rely on us this year.

Okay. Thanks, Michele.

Absolutely.

Thank you for joining us this morning. I’ll be available throughout the day for any other follow-up questions you may have.