Hershey (HSY)

Q3 2011 Earnings Call

October 27, 2011 8:30 am ET

Executives

John P. Bilbrey - Chief Executive Officer and President

Humberto P. Alfonso - Chief Financial Officer, Chief Administrative Officer and Executive Vice President

Mark K. Pogharian - Director of Investor Relations

Analysts

Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division

Jason English - Goldman Sachs Group Inc., Research Division

David Palmer - UBS Investment Bank, Research Division

David Driscoll - Citigroup Inc, Research Division

Eric Serotta - Wells Fargo Securities, LLC, Research Division

John Baumgartner

Robert Moskow - Crédit Suisse AG, Research Division

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

Robert Dickerson - Consumer Edge Research, LLC

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Todd Duvick - BofA Merrill Lynch, Research Division

Unknown Analyst -

Eric R. Katzman - Deutsche Bank AG, Research Division

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Presentation

Operator

Good morning, my name is Denise, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Hershey Company Third Quarter 2011 Results Conference Call. [Operator Instructions] Mr. Mark Pogharian, you may begin your conference.

Mark K. Pogharian

Thank you, Denise. Good morning, ladies and gentlemen. Welcome to the Hershey Company's Third Quarter 2011 Conference Call. J.P. Bilbrey, President and CEO; Bert Alfonso, Senior Vice President and CFO; and I will represent Hershey on this morning's call. We also welcome those of you listening via the webcast.

Let me remind everyone listening that today's conference call may contain statements, which are forward-looking. These statements are based on current expectations, which are subject to risks and uncertainty. Actual results may vary materially from those contained in the forward-looking statements because of factors such as those listed in this morning's press release and in our 10-K for 2010 filed with the SEC.

If you have not seen the press release, a copy is posted on our corporate website in the Investor Relations section. Included in the press release is a consolidated balance sheet and a summary of consolidated statements of income prepared in accordance with GAAP.

Within the Notes section of the press release, we have provided adjusted pro forma reconciliations of select income statement line items quantitatively reconciled to GAAP.

As we've said within the Notes, the company uses these non-GAAP measures as key metrics for evaluating performance internally. These non-GAAP measures are not intended to replace the presentation of financial results in accordance with GAAP. Rather, the company believes the presentation of earnings excluding certain items, provides additional information to investors to facilitate the comparison of past and present operations.

We will discuss third quarter results excluding net pretax charges related to Project Next Century of $13.5 million in 2011 and $4.5 million in 2010, as well as our third quarter 2011 net pretax gain on the sale of non-core trait licensing rights of $17 million. Our discussion of any future projections will also exclude the impact of these net charges. With that out of the way, let me now turn the call over to J.P. Bilbrey.

John P. Bilbrey

Thanks, Mark, and good morning, everyone. Before I start, I just want to make sure that this question doesn't come up later. Bert Alfonso is the Executive Vice President, CFO and CIO, so nothing happened to him on the way to this call. Results for the third quarter were solid, and I'm pleased with our financial and marketplace performance despite the macroeconomic challenges that persists. The CMG can be meant and on category continues to grow above the historical growth rate and is outpacing salty snacks, cookies and crackers. Our business is strong in all class of the trade and our collaborative partnership with retailers continues as they value the importance of the confectionery category in the leadership that Hershey provides.

Hershey's third quarter results reflect the continued momentum of our brands. Net sales increased 5%, slightly ahead of our expectations. Seasonal volume which were sold in at previously agreed upon price points and represents about 1/3 of our total U.S. net sales in the third quarter increased and, for the year, will be greater than our initial expectations. Price realization on nonseasonal items in the U.S. was also ahead of our estimates. Importantly, volume elasticity on this pack types was in line with our modeling and better than the historical staples group average.

For a profitability perspective, earnings came in a bit better than our expectations. Our overall commodity cost profile was significantly higher this quarter than in 2010. However, cost savings and productivity initiatives as well as net price realization helped mitigate the impact. Our solid results enabled us to be flexible in our approach to incremental brand investment. In 2011, we estimate that advertising will increase high single digits on a percentage basis versus the prior year, enabling us to support new advertising on Jolly Rancher and Hershey's cookies and cream. This greater than our previous estimates of a mid-single-digit increase.

Full year adjusted SM&A, excluding advertising, is also expected to increase slightly versus our initial estimates as we accelerate investments in our go-to-market strategies and capabilities. Year-to-date, CMG is up 4.4% in the measured FDMxC channels, greater than historical growth rate of about 3% to 4%. In the third quarter, CMG was up 4.5%. As we look to 2012, we would expect historical growth rates to prevail in the category, although the underlying drivers of growth may differ as pricing is implemented in the marketplace.

In terms of Hershey's marketplace performance, total CMG retail consumer takeaway for the 12 weeks ending October 8 and year-to-date periods for our custom database and channels of accounts for over 80% of our retail business was up a strong 8.7% and 8.3%, respectively. As a reminder, these channels include food, drug, mass, here including Walmart and convenient stores. In the channels measured by syndicated data, FDMxC, or food, drug, mass, excluding Walmart and including convenience stores, Hershey's Q3 CMG retail takeaway was 8.4%, resulting in a market share gain of 1 point. On a year-to-date basis, we've also gained 1 point of market share. Specifically within the food class-of-trade, CMG grew by 2.3% in the third quarter less than the historical category growth rate due largely to gum performance.

Chocolate category performance within the food channel was solid, up 4.7%, driven by new products and seasonal items. Investments in the category in the form of innovation and advertising are present for most major manufacturers. Hershey's food channel retail takeaway increased 3.8% in the third quarter, driven by our chocolate and non-chocolate performance, up 3% and 8.7%, respectively. This resulted in a Q3 food channel market share gain of 0.4 point. These results were driven by core brand performance, new advertising on PayDay and Jolly Rancher and our in-store merchandising and programming. For perspective, PayDay retail takeaway was up 37% over the last 12 weeks and retail takeaway on Jolly Rancher, up 20%. Today, retail customer Halloween order shipments and sell-through is on track, although we've not had a complete read on sell-through for another couple of weeks. Seasonal specific advertising, coupons and programming support is greater than last year. And we believe this is the right mix that sets the stage for another winning season.

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