Hershey Q2 2021 Earnings Call Transcript

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Provided by AlphaStreet
July 29, 2021
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Operator

Greetings, and welcome to the Hershey Company Second Quarter 2021 question-and-answer session. [Operator Instructions]

I'd now like to turn the call over to your host, Ms. Melissa Poole, Vice President of Investor Relations for The Hershey Company. Thank you. You may begin.

Melissa Poole
Vice President of Investor Relations and Corporate Finance at Hershey

Thank you. Good morning, everyone. Thank you for joining us today for The Hershey Company's 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.

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Operator

[Operator Instructions] Our first question comes from the line of Andrew Lazar with Barclays. Please proceed with your question.

Andrew Lazar
Analyst at Barclays

Good Morning, Everybody. [Technical Issues] First off, I guess, I wanted to dig in a little bit more on the cost to serve dynamic that you talked about in the prepared remarks. I guess it should not come as a surprise that 15% organic sales growth in a given quarter would kind of stress any supply chain, no matter how efficient. So my question is, I guess, are there any structural investments needed in the supply chain going forward? Or any capabilities that were exposed by the volume spike? Or is it simply you sort of suck up the higher cost as they're transitory, particularly the labor part and not need to necessarily make any changes as this sort of volume growth is really not likely sustainable at these extreme elevated levels?

Michele Buck
Chairman, President and Chief Executive Officer at Hershey

So Andrew, let me start, and then let me have Steve dig in with some more details. I would say at the highest level, there are certainly key parts of our portfolio that have had just extraordinary growth, and we cited some of the numbers, for example, on Reese's. So one thing that we are very focused on is investing in 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.

Steven Voskuil
Senior Vice President and Chief Financial Officer at Hershey

Yes. I would add to on the structural side, one of the benefits is we've been working on our Supply Chain 2.0 program and the inbuilt fulfillment center comes online later this year. That will provide some additional flexibility and agility. So that will certainly be helpful. And as Michele said, continuing to invest where we need to on capacity, especially on those fast-growing core brands, like Reese's. 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 often outside the 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 a result of the higher volume. And then in addition, I'd say labor rates in general and labor availability in general are a pressure points 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 in 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. And 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.

Andrew Lazar
Analyst at Barclays

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 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 kind of equal magnitude essentially.

Steven Voskuil
Senior Vice President and Chief Financial Officer at Hershey

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, but for the tax piece, we would have raised guidance. The cost to serve is a component, but think of that as a 10% or 15% of the impact where the majority really was the tax impact in the quarter. [Technical Issues]

Operator

Thank you! Our next question comes from the line of Ken Goldman with JPMorgan. Please proceed with your question.

Ken Goldman
Analyst at JPMorgan Chase & Co.

Hi thanks. Steve, you mentioned that there's a 130 basis point tailwind from inventory loading this quarter. 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? And 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?

Steven Voskuil
Senior Vice President and Chief Financial Officer at Hershey

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

Ken Goldman
Analyst at JPMorgan Chase & Co.

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?

Steven Voskuil
Senior Vice President and Chief Financial Officer at Hershey

Yes. I think, again, but for the tax piece, we would have risen -- or taken up our guidance. Certainly, there's caution in the back half relative to inflation and cost to serve. I think we have our hands around what that looks like and have a pretty good beat on that. But if that were the only piece, we would have 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.

Michele Buck
Chairman, President and Chief Executive Officer at Hershey

Yes. For perspective, tax was $0.17 on EPS. So very meaningful. [Technical Issues]

Operator

Thank you! Our next question comes from the line of Robert Moskow with Credit Suisse. Please proceed with your question.

Robert Moskow
Analyst at Credit Suisse Group

Hi thanks for the question. What do you think about the tax rate going forward for 2022, Steve? This looks like a onetime impact. So do you think you'll have an easy comp in 2022? And then secondly, you talked 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?

Steven Voskuil
Senior Vice President and Chief Financial Officer at Hershey

Sure. On the tax side, we look at it as a one-off. So if we were to reset next year -- and again, we'll talk a lot more later in the year about 2022. But as a starting point, we wouldn't factor this into the starting point for 2022. So I hope that's helpful. And then from a pricing standpoint, and Michele can add on here, we -- pricing is a key part of our strategy, maintaining and growing our gross margin is a key part of our strategy. And so we are -- we say we execute against that strategy, but we are very aware of the dynamics at play from an inflation standpoint and so on, and what competitors are doing, what retailers are doing. So we are evaluating that environment all the time. And as always, we're not going to kind of tip our hand as we think through it. But pricing is and will remain a key part of our strategy going forward.

Michele Buck
Chairman, President and Chief Executive Officer at Hershey

Yes. 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. [Technical Issues]

Operator

Thank you!. Our next question comes from the line of Alexia Howard with Bernstein. Please proceed with your question.

Alexia Howard
Analyst at Sanford C. Bernstein

Good morning, Everyone. [Technical Issues] So 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.

Steven Voskuil
Senior Vice President and Chief Financial Officer at Hershey

Sure. We were pleased with the Q2 gross margin. We were -- it was a little bit ahead of our plan. I think we managed it well. And of course, implied inside our guidance for the balance of the year is a little softening of the gross margin outlook from being up slightly to being in line with last year. And I think that performance in face of the inflation that we've seen would be good. But our goal, again, looking to next year, building on the last question a little bit is we want to continue to grow gross margin over time. And we want to do that through a pricing strategy. We want to do that through productivity. We want to do that through all the levers to manage inflation and commodity costs. And so driving that forward remains an important goal. We'll give more color on next year's gross margin as we get closer to the end of the year, but that goal remains firmly in our mind.

Alexia Howard
Analyst at Sanford C. Bernstein

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

Michele Buck
Chairman, President and Chief Executive Officer at Hershey

Yes. 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 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, kind of more broad-based marketing, etc, to really help to 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 being the lack of sugar. So that also gives us a lot of confidence, but 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 will -- better-for-you area is a big point of focus for us, and there's some nice synergy in terms of our focus there. [Technical Issues]

Operator

[Operator Instructions] Our next question comes from the line of Michael Lavery with Piper Sandler. Please proceed with your question.

Michael Lavery
Analyst at Piper Sandler Companies

Thank you! Good morning. [Technical Issues] Just curious how you think about elasticity. And I know it can be hard to measure. The ways we've tried to come at it, you tend to score quite well. Does that -- is that your sense as well? And how do you think about that in terms of your pricing, how aggressive you may try to be or not be and just how you anticipate the consumer response to that?

Michele Buck
Chairman, President and Chief Executive Officer at Hershey

Yes. We have seen -- we have a very complex and sophisticated price elasticity models where we look not only at price points within our own category, price gaps, price thresholds also with around other snack items as well. And I think over time, I think we've consistently seen that our business, our brand and our category tend to be on the less-elastic side versus perhaps some other categories, which is what gives us confidence in pricing power and the ability to take price when we feel it is the right time.

Michael Lavery
Analyst at Piper Sandler Companies

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?

Michele Buck
Chairman, President and Chief Executive Officer at Hershey

So it is performing in line with our expectations. It is early days, but it's absolutely in line with what we expected. 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. Yes. 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. [Technical Issues]

Operator

Thank you! Our next question comes from the line of Ed Zaslow with Bank of Montreal. Please proceed with your question.

Ed Zaslow
Analyst at Bank of Montreal

Hey Good morning, Everyone. I had just two quick questions. One is the tax -- is it a cash item or a noncash 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?

Steven Voskuil
Senior Vice President and Chief Financial Officer at Hershey

So the first question is, for the second quarter, it's noncash, but a portion will become or could become cash in the balance of the year and a portion will probably be noncash 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.

Ed Zaslow
Analyst at Bank of Montreal

Okay. And then just a follow-up on this. The magnitude of the increase on the EBITDA exceeds the amount of cash that will be needed to pay the taxes. Is that a fair way? And then I'll leave it there. I just want to make sure I understand the tax units. It just seems like it's more -- cash flow is actually coming up, not going down based on what you're saying. I just want to make sure I'm understanding correctly.

Steven Voskuil
Senior Vice President and Chief Financial Officer at Hershey

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

Operator

Thank you! Our next question comes from the line of Bryan Spillane with Bank of America. Please proceed with your question.

Bryan Spillane
Analyst at Bank of America

Hey Good morning, Everyone. [Technical Issues] Hi So I guess I wanted to maybe follow up a little bit on Andrew's kind of questioning at the beginning. And Michele, maybe just stepping back a little bit, in this environment, right, where we're seeing not just higher cost inflation, but in addition to that, with effectively labor shortages, right, when we've seen this across a lot of the companies in our coverage universe. So I guess I had two questions related to that. One is if supply chains are kind of running all out, just how you think about stimulating demand when there's some challenges in terms of just getting product on the shelf? And I guess the second is just as you step back and you look at all these different dynamics in the economy and the environment in general, it's definitely a situation that is in some ways unique. So just your perspective, have you seen some of this before? And maybe just how you're thinking about approaching planning for the business over the next, I don't know, 12 to 24 months, if we continue to be in this type of environment?

Michele Buck
Chairman, President and Chief Executive Officer at Hershey

Yes. It's certainly something that we spend a lot of time thinking about and working on. And I guess what I would say is, yes, we do realize that it is somewhat of a volatile time still, certainly with all the talk of the Delta variant and CDC guidance recently. So too much of a reminder that we clearly aren't fully out of the pandemic. And I personally believe, in September, we know that a lot of companies are implementing kind of a return to office. It seems like a lot of companies are doing that then, kids going back to school. And so there will be more for all of us to learn about consumer behaviors and what some of those changes mean for that. The way that we think about the supply chain and managing where we are right now is, I guess, in a couple of ways.

So how do we maximize -- how do we efficiently maximize and profitably maximize revenue. And so one of the key things we do focus on is really looking across the portfolio and focusing on really maxing out where we have available capacity and leaning into some of those brands and businesses with greater investment, reallocating investment to those businesses so that we can really take full advantage of that. If there are areas in the portfolio where we -- like a Reese's, for example. I think we keep pointing it out as an example because it's such a big piece of our business and growing at such a hefty rate. We have total confidence making big capacity investments on that one just because of the track record and the dynamics around that.

And then -- so we'll invest in capacity as a piece of that. And then there are parts of the portfolio where we're not going to lean in right away in investing capacity because we want things to play out a bit here more. So we really leverage the breadth, one of the strengths we have is the breadth of our portfolio. We've got our seasonal portfolio. It's the consumable take home. We have a range of different brands. And so we really try and leverage that as best possible to manage through. So it's kind of a balance of investing to build supply chain even stronger, which we're always doing, but we're doing even more of that right now. Doing what we need now, kind of no regret move and then planning for the future from a contingency perspective, depending on what the potential outcomes are.

Bryan Spillane
Analyst at Bank of America

Okay. Thanks for that. And if I could just follow up with one quick one. Just as you -- as you've sold in merchandising for holidays in the back half of the year and maybe just more in general, has -- have service levels come up more as a 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 wanting to be in stock? Is that becoming more of a sort of a factor in that decision-making right now?

Michele Buck
Chairman, President and Chief Executive Officer at Hershey

Yes, I mean I would say absolutely. I mean retailers were under tremendous pressure this past year with all of the huge shifts that COVID caused on many manufacturers' businesses. And 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 because 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. [Technical Issues]

Operator

[Operator Instructions] Thank you! It seems there are no other questions at this time. I'll turn the floor back to Ms. Poole for any final comments.

Melissa Poole
Vice President of Investor Relations and Corporate Finance at Hershey

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

Operator

[Operator Closing Remarks]

Corporate Executives
  • Melissa Poole
    Vice President of Investor Relations and Corporate Finance
  • Michele Buck
    Chairman, President and Chief Executive Officer
  • Steven Voskuil
    Senior Vice President and Chief Financial Officer
Analysts

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