Hershey Q4 2022 Earnings Call Transcript

Presentation

[Operator]

Greetings, and welcome to the Hershey Company Fourth Quarter 2022 Question-and-Answer Session. [Operator Instructions] As a reminder, this conference is being recorded.

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 at Hershey]

Good morning, everyone. Thank you for joining us today for the Hershey Company's fourth quarter 2022 earnings Q&A session. I hope everyone has had the chance to read our press release and listen to our prerecorded management remarks, 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. Actual results could differ materially from those projected. 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.

Questions and Answers

[Operator]

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

[Andrew Lazar, Analyst at Barclays]

Thanks so much. Good morning, everybody.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Good morning, Andrew.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Good morning.

[Andrew Lazar, Analyst at Barclays]

I guess, just one for me. I'm trying to get a better sense of how you're thinking about elasticity for '23 versus what you saw in '22, which was very little? And what percentage increase in capacity you're expecting for this year? And I guess I asked because if elasticity were to stay as benign as it has been and you ramp some capacity, trying to get a sense of whether it could render you're flat-to-slightly down volume outlook for the year somewhat conservative or could continued capacity constraints limit the potential for top line upside from here?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes. Thanks, Andrew. As we look at price elasticities, we are assuming that they will be closer to last year than they were to historic, but not quite as good as last year. And as we look at our capacity, we will have low single-digit increases in capacity, which do give us some ability to flex with demand as we see it. Steve, anything to add?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

No, that's fine.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes.

[Andrew Lazar, Analyst at Barclays]

Excellent. That's it. Thank you so much.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Thanks, Andrew.

[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 and congrats everyone for such a great year. I wanted to know the guidance for '23 is more aggressive than normal, like you normally start the year rather conservative. But this year, you're guiding above your normal algorithm. And I wanted to know if you could kind of isolate what the key drivers are and why you've raised it compared to three months ago? Maybe drilling down. It looks like gross margin is coming in better than you thought, maybe you could explain why? And then also on market share, are you expecting market share gains in confectionery in '23? Thanks.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Sure. Let me start out?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes, go ahead, Steve.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. So just on the big movers on the top line, obviously, price driven, and we have good visibility into that. We saw that effect be part of the driver for the fourth quarter performance. But we see that carrying forward, especially through the first three quarters of next year. And we do have elasticity factoring, as Michele said in the last question, our planning isn't quite down to the levels of historic elasticity, but something looks more like last year as you sort of drop further through the P&L, we do see some benefit from the gross margin side as we see more stabilization in the pricing coming down and some cost efficiencies and a return to more historic levels of productivity.

Now we still have aspiration for more productivity. But at least this year, we're starting to see something that we haven't seen in the last two years. So those are some drivers through the P&L that far. On the market share side, yes, we do expect to have a positive market share next year. I think that's one that we're disappointed about this year and want to see turn the other direction next year.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes. And some of that market share will be helped by the incremental marketing investment as we've taken that up as we have additional capacity online and certainly the additional capacity as well. As we think about the pacing of the market share, you should think about it relative to the beginning part of the year will be slower, and we won't see those declines probably until we get into the spring, but once we hit the spring that will really kick into gear. We know that we had some lost opportunity this year around season that we weren't able to fulfill totally all of the orders and then also a little bit of a mix impact from refreshment being a rebound given social behaviors, but we think that will neutralize going forward.

[Robert Moskow, Analyst at Credit Suisse Group]

Okay. It makes sense. And just one follow-up. On the gross margin side, are your costs like inflation costs coming in better than you thought or is this really just productivity is accelerating more than you thought?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. Probably more on the productivity side. We have pretty good visibility into the COGS costs with the hedging program and so forth, particularly on commodities. And we're still expecting high single-digit year-over-year inflation through commodities and a lot of the material items and mid single-digits on things like labor and logistics and other supply chain costs. I don't think that those assumptions have changed much from our outlook, but probably a little bit more productivity.

[Robert Moskow, Analyst at Credit Suisse Group]

Great. Thank you.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Thanks.

[Operator]

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

[Kenneth Goldman, Analyst at JPMorgan Chase & Co.]

Hi, thanks. You're guiding to a gross margin of around 44.5% next year. I'm just curious for this coming year, what do you see as a, I guess, "normal level" if there is such a thing in this kind of environment? And I guess, more specifically, if you can grow your gross margin by a healthy amount in an inflationary environment, is there any reason it can't ultimately get back to 45% or above?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Sure. Yes, I mean our model is growing gross margin every year, that would be the goal. That's really part of the growth algorithm. And so we've had two years where that's been a challenge. We see that now turning for 2023 and really getting back on the algorithm, and so I would like to say it's price and inflation agnostic in terms of the strategy. How we get there will change based on the external environment. But yes, we do see restoring to gross margins that we had in the past and frankly, continuing to drive that forward.

[Kenneth Goldman, Analyst at JPMorgan Chase & Co.]

And then how do we think about the breakdown of sales growth and operating margins by segment in 2023? You give a little bit there, but are there any unusual items we should be aware of for either of these segments just as we consider our models, maybe drivers that aren't necessarily apparent at first glance?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. The only things that are unusual or different if I kind of go to and we mentioned some of this in the remarks, is going to have a strong top line. We're expecting that. We're also expecting to see gross margin improvement year-over-year. We saw some of that in the fourth quarter finally seeing pricing catch up in that business a little bit to inflation, but still some room to grow. But we'll see some reinvestment below that. And so we're going to activate more against the brands next year. We're going to do some capability investments between the lines to really scale up the infrastructure and part of that infrastructure is the ERP transition that we talked about in the prepared remarks.

And so that's probably the one area we rise strong sales growth, some gross margin improvement, less drop through to op margin than we might see in a normal year on the back of those capability investments. Other than that, I think the other segments are probably pretty traditional in terms of the growth characteristics.

[Kenneth Goldman, Analyst at JPMorgan Chase & Co.]

Thank you.

[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]

Thanks, operator. Good morning, everyone. My question is just around the advertising and consumer spend investments. And I guess, I had two questions. One, in the prepared remarks one of the things you talked about investing in is workforce. So I wanted to just understand, is that like more merchandisers and people in the field or something else? And then -- maybe I'll start with that and then one other follow-up.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes. I mean as we look at some of the investments that we're making in our employee base, clearly, one of our key strategic goals this year is really to integrate scale our salt business. And so we are adding some incremental talent there to really make sure that we have the right skill sets and that we have all the employee base and talent needed to do that heavy lifting in the work. Some of that also around improving our planning systems. Some of the things that when you buy a smaller company, we need some more sophisticated capabilities then obviously, given a lot of the work across the business on supply chain, where we are continuing to invest to build capacity and resilience in the network, we have made investments in supply chain talent as well.

[Bryan Spillane, Analyst at Bank of America]

Okay. But it's not specifically adding merchandisers or like more people, frontline salespeople?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

No.

[Bryan Spillane, Analyst at Bank of America]

Okay. And then the second, just was related to the kind of the thinking behind the double-digit increase in advertising and consumer spend, is that partly a sort of a function of just inflation has been so persistent? Not -- obviously, you've got price increases on your own product lines, but consumers are just seeing -- have seen a lot of inflation across a lot of consumables. And is it -- if you're going to have that level of pricing, you really need to advertise in order to sort of make sure consumers stay engaged because you're going to have to start making some choices? Or was there something else that kind of drove the decision or the need to increase advertising at that rate?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes. Absolutely. So you know our long-term model, we believe, in advertising. We've seen the impact and the returns that we get on advertising in terms of having very strong ROIs. So we take a very data-based approach to media spending, and we invest where we see that incremental profitable growth. Over time, we do know that, that advertising builds consumer connectivity, and we know that, that consumer connectivity is what -- part of what helps us to have the elasticities that we do. People are connected to our brands. And during the tough times, we know that, that connectivity leads to them continuing to buy.

So yes, it is important during an inflationary time, and we've done statistics over that analysis to validate that. And then as you know, we reduced spend last year really due to capacity constraints. And we did see an impact in demand on several of our brands. And so those are really the priorities where we are reinvesting this year. And we're also investing in some of our white space opportunities like gummies and better-for-you to strengthen the business as well as our brands, where we're really in a major growth mode, gaining household penetration, gaining market share, and we want to continue that momentum.

[Bryan Spillane, Analyst at Bank of America]

All right. Thanks, Michele.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Sure.

[Operator]

Thank you. 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.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Good morning.

[Michael Lavery, Analyst at Piper Sandler Companies]

I just want to start by following up on the spending. Could you give us a sense -- I recognize last year, your adjusted spending to match better aligned with the capacity limitations. But would this year be restored levels to sort of the optimal targets or do you still see that ramping into next year as well? Just trying to understand a sense of if you'll be back on your sort of steady run rate or kind of ideal level or if we're not even quite going to be there yet until maybe 2024?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes. I mean we are always looking at the returns that we're getting on our spending and making decisions as we go forward based on that. So we think that we're in a reasonable ZIP code. I think we've said before that we don't think we have to go back up to the very highest levels that we were at historically. We've done a great job over time. Getting a lot of efficiency, getting very tight in our targeting so that we're getting even greater returns. But I wouldn't also commit that this is the high mark above which we're not going to move above. We're still probably not quite back to exactly the point we want to be.

[Michael Lavery, Analyst at Piper Sandler Companies]

Okay. That's really helpful. And just want to unpack a little bit more, if we can, a comment you made in the prepared remarks about Seasons being a growth driver. You set it off to a great start. Obviously, last year went really well as well. And so I just would love to understand a little bit better how that unfolds and how to be thinking about that?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes. We continue to anticipate very strong growth in the Seasons. We've continued to see that in the category. Consumers, during the past several years, have even dialed up their interest in Seasons. So it is a strong part of our portfolio. It's a place where we do very well. It's a place where there's a lot of emotional connectivity. There's an anchor event. People want to participate in those anchor events with the brands that they love. And so we think that there's opportunity. We had some missed demand that we weren't able to fully fulfill because of capacity, and we're going to be in a much better position this year to be able to more fully capture that opportunity. And now, the first part of the year, as I mentioned earlier, from a share perspective, we won't be as strong as we anticipate that we will be for the Seasons towards the back part of the year.

[Michael Lavery, Analyst at Piper Sandler Companies]

Okay. Great. Thanks so much.

[Operator]

Thank you. Our next question comes from the line of Cody Ross with UBS. Please proceed with your question.

[Cody Ross, Analyst at UBS Group]

Good morning. Thank you for taking our questions. I just want to go back to the last question on volume and perhaps unpack cadence throughout the year. You have increased capacity for Seasons coming on, but you're also lapping the over-shipment in the first half this year. Can you just unpack a little bit how you expect volume to progress throughout the year, understanding that you expect for the full year to be flat to slightly down? That's my first question. Thank you.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Steve, can you talk to that?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. Going into the first part of the year, the Seasons, we've got already identified the volume and shipments there. So as Michele said, we still -- we're dealing with some capacity constraints leading into the Seasons in the front part of the year. When you look at the year overall, we're not expecting any big material differences by quarter for volume.

[Cody Ross, Analyst at UBS Group]

Okay. That's helpful. And then just one last question on capital allocation here. You're at the low end of your leverage target over the long-term. Are you beginning to look at making additional acquisitions or perhaps return more cash to shareholders in the upcoming years? Thank you.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Well, I'd just say job one right now for us is integrating the amazing acquisitions that we bought SkinnyPop, Pirate's and Dot's. And we're investing to leverage their full potential. However, we do always continue to be in the market looking at assets that can continue to advance our strategies, expand our portfolio appropriately into high-growth consumer demand segments, and we certainly do have a lot of balance sheet flexibility to be able to do the right M&A, if it becomes available.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

That's right. And I would say, more broadly, from a capital allocation standpoint, no major changes. We definitely want to be giving back cash and repurchasing shares as part of our strategy that puts good tension on the internal investments and M&A to make sure we're getting the best return. And so that's an area we'll continue to monitor. We've got a lot of capex this year, and so that's one thing that we're taking into consideration as we look at the overall balance of capital allocation.

[Operator]

Thank you. Our next question comes from the line of Chris Growe with Stifel. Please proceed with your question.

[Chris Growe, Analyst at Stifel Nicolaus]

Hi, good morning.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Good morning.

[Chris Growe, Analyst at Stifel Nicolaus]

Hi. I just had a question first, if I could, a bit of a follow-on to an earlier question, but in particular, in the Salty Snacks division, with the margin being so strong in the fourth quarter and reaching over 20%. Was there anything unique to the quarter? And then I certainly heard about investments you want to make, both internally and advertising throughout 2023, I guess I just want to understand how you expect the margin to fair throughout the year, as margins expand, but just not to the level which it did here in the fourth quarter?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. We're really pleased with the fourth quarter finished and probably two things drove that. One, we did have easier laps in the fourth quarter. And then second, we maybe said earlier, we are seeing pricing catching up a little bit more to some of the inflation that we saw over the course of the year. So we've got a little bit of a benefit of that as well.

As we look to margins for that business going forward and into next year, we want to -- again, on the gross margin, I expect to see some continued advancement. We've got a lot of plans still to optimize that business and we've talked before about streamlining the back office, streamlining the supply chain network, better integrating all of that with our existing Hershey systems and so forth.

And so in fact, we'll talk more about that when we get to our March investor conference and spend some time on that, but have aspirations to continue to see that profile up over the course of the year. But as Michele said, we are going to reinvest some of that back between the lines to accelerate the top line to invest behind the brands and then on the capability investments like ERP, but I would say the key takeaway is we have still high margin aspirations for that business as we look forward over the next couple of years.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

And most of those will occur over the longer-term. We don't expect significant margin expansion or margin expansion in '23.

[Chris Growe, Analyst at Stifel Nicolaus]

Okay. That's helpful. Thank you. And then just a quick follow-up, if I could, on to understand how inventory will fare through the year. You talked about depleting some inventory late in the year as you convert -- or move to the new ERP system. Should inventory grow through the year and then you deplete it or does it hold this level then it just goes lower as you kind of move that inventory out? Have you built it already, I guess, is the question or do you expect to build more?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. We haven't built it all already. I mean there will probably be some build, not that material. I mean there's a limit to how much salty inventory we can build. But as we said, when we get to the fourth quarter, we expect a pretty significant depletion and that's really just to allow the cutover between systems. And so on a net-net basis, that will look like a negative for the year for that business. We would expect to see that come back next year, probably with a strong start to the year.

[Chris Growe, Analyst at Stifel Nicolaus]

Okay. Thanks so much for your time.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Sure.

[Operator]

Thank you. Our next question comes from the line of Nik Modi with RBC Capital Markets. Please proceed with your question.

[Nik Modi, Analyst at RBC Capital Markets]

Yes. Thank you. Good morning, everyone.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Hi.

[Nik Modi, Analyst at RBC Capital Markets]

Michele, I was hoping you could just comment on fill rates, kind of where you guys are now versus kind of where you'd like to be? And I know things are below where they have been historically, just curious, is that just a function of capacity. There's also a labor component to that? And then I had a bigger-picture question.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes. So I would say our fill rates are much better than where they were. There's been some significant improvement versus last year as we've been able to invest in capital and get additional capacity on the ground. So -- and really, there's minimal impact from labor. It was really largely very much tied to capacity. Now we did staff up in labor to enable us to be able to obviously execute against the capacity and the incremental lines. But we're seeing less network disruption than we've seen in the past, not all the way back to the perfect situation it was before the pandemic, but it certainly improved.

[Nik Modi, Analyst at RBC Capital Markets]

Great. Thanks for that color. And then just the bigger-picture question is, look, these categories, especially on the chocolate and confectionery side, I think clearly, we can see a renaissance and maybe we can attribute some of it to COVID. But I'm just curious, like what does your research -- internal research say about what's actually going on with the consumer and these categories? Because I think we can all agree the underlying trend rate has been much better than I think anyone would have expected a couple of years ago?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Well, certainly, we know that snacking has been on the rise, has continued to be on the rise as the consumer behavior, pre-pandemic and also post-pandemic, we know that they're still is a bit more at-home behavior versus folks cutting back on going to restaurants. And certainly, that's a benefit across packaged goods snacking. We also know, based on our insight, that consumers are interested in snacking in particularly in confection and chocolate on two diametrically kind of opposed parts of their emotional state.

One is when they are incredibly happy, and it's a treat time, and they want to treat themselves. And the other is when there are downtimes and they want a bright spot, but they do view these categories and especially chocolate as a part of kind of emotional wellness, what it does and how it makes them feel.

And then, of course, I think the more that we interact with consumers, and this really hasn't changed over time, consumers emotional connectivity to our brands. Our brands are more about the -- more than just about the products. They are about the moments of connection. Many of them are used in special times, and we get letters all the time with people talking about the special role that some products played in their life. They remember when they were with a friend experiencing it or with their kids at a season. And I think that continues to be timeless and perhaps has even dialed up a bit since the pandemic.

[Nik Modi, Analyst at RBC Capital Markets]

Great. Thanks for that color.

[Operator]

Thank you. Our next question comes from the line of Jason English with Goldman Sachs. Please proceed with your question.

[Jason English, Analyst at The Goldman Sachs Group]

Hey, good morning folks. Thanks for hopping me in. My apologies, I didn't get a chance to go through all the prepared remarks. We got a lot going on this morning. Apologize in advance for asking too many questions, but two quick things. First, the capacity expansion. You gave some quantification for the year. What's the cadence? When should we expect to see that capacity coming online?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. It's going to be coming online throughout the year. And again, this sort of fits into a broader discussion we've had on capacity expansion. I think we've talked in the past. And if you look at the 2020 to 2024 period, we're looking for a 15%-ish increase in capacity of the network. And so that goal. And I would kind of think about it coming in ratably over the course of the year.

[Jason English, Analyst at The Goldman Sachs Group]

Okay. And the elevated capex, it sounds like this was a long slog. Should we expect this elevated level to continue into next year and the year beyond as well?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes, not at this level, but I would say, at least for the next -- for 2024, we will have some amount of elevated capital we'll still be finishing off the ERP program and still probably having some tail investment from a capacity standpoint. So those are the two things I would point to. And on the capex, as we talk about all the time, the majority of that capex is targeted on capacity expansion. If you click into that, a large portion is driven by recent fantastic growth we've had there and capacity and network capacity has improved significantly, but we still have opportunities, some on recent some and other brands to unlock more efficiency and capacity. And so that capacity expansion plus the ERP investments that will eventually drop out are the two kind of biggest components of the capex right now.

[Jason English, Analyst at The Goldman Sachs Group]

Understood. And last question for me. I've always considered your European venture to be a bit opportunistic. It's just a small tactical export business. Yet, recently, you've kind of carved it out as a standalone business where it doesn't even had. Does this signal anything in terms of your strategic intent on expansion in Europe?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

No, not at all. If that's in reference to any of the talent changes that we made they were really in the course of just normal development and expansion for people to get new opportunities. Europe continues to be small. We continue to feel that we are making great strides and seeing a lot of growth there. But there is no strategic change in our approach to that market at all.

[Jason English, Analyst at The Goldman Sachs Group]

Understood. Thank you.

[Operator]

Thank you. Our next question comes from the line of Pamela Kaufman with Morgan Stanley. Please proceed with your question.

[Pamela Kaufman, Analyst at Morgan Stanley]

Hi, good morning.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Good morning.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Good morning.

[Pamela Kaufman, Analyst at Morgan Stanley]

Can you talk about your key innovations planned for '23? And how are you thinking about the drivers of top line growth between innovation versus existing brands where you've been capacity constrained?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Sure. So innovation continues to be an important part across our portfolio. And we have several items that are launching this year that we think will generate a lot of consumer excitement and merchandising. And if we look at our core confection business, the highlights there would be Reese's stuffed with Reese's Puff. We have a limited edition, which is a Reese's Creamy and then a Reese's Crunchy product. So a line of limited editions that let consumers pick their favorite which texture they like. And then we have an exciting new Kisses flavor that is called MILKLICIOUS, which is a kiss filled with a milk chocolate filling.

On our salty business, we launched, as a limited time addition this year, a Dot sugar flavor. And so folks will see that in the market as it's been very successful. So those are probably the highlights of some of the biggest innovations. We continue with our strategy that we employed several years ago that's really helped to accelerate our top line growth, which is while innovation is important, and we will support innovation across the board for news and excitement we really don't want to stray away from a primary focus on our core. Our core, our brands that are sustainable. They have been out there for a long time. Consumers love them. the velocities on them will always be stronger than innovation. So across our entire portfolio, driving our core is job one and then using new innovation for news and excitement.

[Pamela Kaufman, Analyst at Morgan Stanley]

Great. Thank you. And just in terms of your organic growth outlook for 2023, how are you thinking about the growth between North America confectionery and salty snacks? And maybe if you could just touch on some of the key growth drivers behind the salty snacks business for '23.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

So I can talk about some of the growth drivers and then let me have Steve talk a little bit about the other part of your question. So as we look at salty snacks, we will be, as Steve mentioned, investing in marketing to really continue to expand those brands and businesses and continue our growth in household penetration. So that is clearly an investment that will drive growth. We continue to have some level of distribution upside, especially on dots. We saw distribution upside as well as increased item counts in 2022, and we'll see some of that growth continue as we go through '23.

Once we get beyond that, we think we'll then start to be going more to velocity increases and price pack architecture opportunities. So those are some of the biggest ones. Investments in SkinnyPop in advertising as well will continue to unlock growth potential. I think those are some of the biggest growth drivers across the salty business.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes, just at a very high level. From a confection standpoint, we're expecting high single-digit top line price being the primary driver there. And as we talked about earlier seasons, underneath that season and then media investment behind the brands are going to be big components of that. On the salty side, double-digit growth, which is what we should expect from that business and more price there as well, but also volume. And again, as we said, there, too, we're investing behind the brand, and we have some distribution opportunities, as Michele mentioned. On the international side, a solid mid single-digit performance on the back of distribution volume, some pricing as well and some innovation. So at a high level, those are sort of the big targets.

[Pamela Kaufman, Analyst at Morgan Stanley]

Thank you.

[Operator]

Thank you. Our next question comes from the line of Chris Carey with Wells Fargo Securities. Please proceed with your question.

[Christopher Carey, Analyst at Wells Fargo Securities]

Hi, good morning. Thanks for the question.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Good morning.

[Christopher Carey, Analyst at Wells Fargo Securities]

Steve, you gave good information on gross margin ranges for the year, a little bit on cadence with the Q1 and the impact of inflation. It's just striking to see high single-digit commodities mid-digit labor, which is this dynamic of sticky inflation that we're seeing across the staples landscape, but clearly, you have good visibility into that outlook. I guess what I'm wondering is this is going to be probably a volatile environment for inflationary drivers, namely commodities over the next year.

And I'm just trying to frame if there is a change in the commodity outlook, is that something that changes your own outlook? Or are you so locked in on costs. At this point, that is -- no, we have good visibility on the year, and we're fairly locked in, and that's really more of a consideration from a year from now or something like that. And I have a quick follow-up.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Sure. On the -- in general, we have pretty good visibility, I would say, across COGS and commodities. I'd say the hedging program gives us some of that visibility. Though the caveat is that if you look at the last two years, where we've been bitten in some cases, have been the things that we don't hedge and have been volatile, things like packaging and resins and specialty ingredients and dairy even in some. So those are ones that I think we keep an eye on and movements at some of those -- material movements can move the needle, and we saw some of those material movements in the last few years. I think our expectation is some of that will settle down and with that settling down and our visibility into the rest of COGS, I agree with you, it's still potential for volatility, but we feel we've sort of picked the guidance range to try to accommodate most of that at volatility.

[Christopher Carey, Analyst at Wells Fargo Securities]

Okay. That makes sense. One quick follow-up and perhaps something that's even better suited to the Investor Day coming up, but this sounds confident on long-term margin improvement. And then clearly, we saw an inflection in the snacks business today with positive commentary on the medium-term in that business. So when you think about that long-term margin between the confection and the snack side, do you have any sense of what would be driving that between those segments or is this just more of a holistic target for the organization over time? Thanks so much.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. That is a great one for the investor conference. And what I will say, our expectation is we want to see margin improvement across all parts of the business, all segments. And so we've seen a lot of improvement in international in recent years, but we have the same expectation that that's going to continue also. And that we're going to optimize and grow, but grow in a sustainably profitable way there. Saltly probably expectations given the capital that we've deployed in those acquisitions and the opportunity, we touched on things like private label and the impact that still has on the business as we look to the future opportunities to extract more margin out of that business and always on the confection side, we want to have a model that drives margin accretion.

[Christopher Carey, Analyst at Wells Fargo Securities]

Okay. Thanks for the answers.

[Operator]

Thank you. Our next question comes from the line of David Palmer with Evercore ISI. Please proceed with your question.

[David Palmer, Analyst at Evercore ISI]

Thanks. A question on gross margin in this latest quarter, especially versus the third quarter. The reason I'm asking for color about what might have been your biggest unlocks that fourth quarter is because on one end multi-year basis, it looks like pricing was rather similar to the third quarter, yet the year-over-year margin trend improved, and that fourth quarter was actually higher than it was in the fourth quarter of 2019. So any color about unlocks on gross margin would be helpful?

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes, I think the biggest driver that we touched on, we did have some better productivity dropping through supply chain efficiencies that had ramped up in Michele said, we're not all the way back in terms of that supply chain efficiency, but we just see an uptick in the fourth quarter. And then I'll say the volume growth on the elasticity side, helping a dropping some fixed cost absorption through the P&L as well. Those are probably, but to point just a couple of things, those are the ones I'd point to.

[David Palmer, Analyst at Evercore ISI]

And just a big picture question, one I've been thinking about is during this COVID era, clearly, at-home snacking did well. You guys have made your own thunder with smores and your seasons and you seem to have pretty good visibility into what you're doing each year in Seasons. And so it looks like you're going to -- you're poised to have a pretty good 2023. But I'm wondering just as you just think about the overall energy for at-home snacking as an occasion, do you have a view about whether that can sustain in terms of its growth rate I wonder about this not just for Hershey, but for other companies as well. Any comments there would be helpful? Thanks.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Sure. So let me start by saying as much as we have benefited on our take-home business with at-home snacking, our instant consumable business has also been quite strong. So we've really seen growth across all what we say all three segments of our business, even take-home and instant consumables. We don't expect that we're going to lose volume on those segments going forward. So we don't see a reversal in the trend. But we would say that growth may moderate, we would expect it to moderate a little bit versus where it's been as consumers just shake out into their normal ongoing behavior.

[David Palmer, Analyst at Evercore ISI]

Thanks.

[Operator]

Thank you. Our next question comes from the line of Steve Powers with Deutsche Bank. Please proceed with your question.

[Stephen Powers, Analyst at Deutsche Bank Aktiengesellschaft]

Yes, hi. Good morning. I wanted to go back to the two topics you talked about already, the A&P investments and the workforce investments. Just a little bit drilling beyond into those. Just any -- on the A&P side, any notable phasing of the incremental spending that you're planning? And if so, just the drivers of that phasing, if you could?

And then on the workforce side, Michele, you walked through a number of priorities, especially on the Southeast side and I think there it makes sense and they're frankly intriguing. I guess the question is, where are you with those hires? Is that something that we should anticipate you kind of have in the near-term pipeline and the investments show up early in the year and carry forward? Or is it something that builds and is more the spending progressively layers on as the year goes on? Just where you are in making those hires that you talked about earlier? Thank you.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Yes. So as we look at the investments in marketing spending, you should think about the confection investments being fairly stable throughout the year. On Salty, our investments will be more front loaded during the year towards the end of the year is when we're doing the S4 conversion. So we're really going to drive the volume harder at the beginning and those investments harder at the beginning of the year. SG&A spend, we will see that across the quarters and especially beginning in Q1.

[Stephen Powers, Analyst at Deutsche Bank Aktiengesellschaft]

Okay. Thank you very much.

[Operator]

Thank you. Our next question comes from the line of Max Gumport with BNP Paribas. Please proceed with your question.

[Max Gumport, Analyst at BNP Paribas]

Hey. Thanks for the question. Just one for me, and it's on gross margins. So you expect gross margins to be up 40 basis points to 50 basis points year-over-year in 2023, given net price realization and higher levels of productivity, which are expected to offset inflation. But it sounds like 1Q 23 gross margins will be pressured due to lapping a timing benefit related to inventory valuation last year? I'm just trying to get a sense for if you could close frame the magnitude of that 1Q '23 impact? Thanks.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. So you're exactly right. For quarter one, that will be our most pressured gross margin quarter. In fact, I expect we'll be still down year-over-year for the first quarter because of those laps. And I don't know that I did mention -- get as specific as the guidance for that. But you're exactly right, that will be our most pressured gross margin quarter.

[Max Gumport, Analyst at BNP Paribas]

Great. I'll leave it there. Thanks very much.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Thank you.

[Operator]

Thank you. Our next question comes from the line of John Baumgartner with Mizuho Securities. Please proceed with your question.

[John Baumgartner, Analyst at Mizuho Securities]

Good morning. Thanks for the question.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Good morning.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

Good morning.

[John Baumgartner, Analyst at Mizuho Securities]

First off, Michele, in confection, you're bringing more capacity online, increasing brand spending as well, but how are you thinking about in-store activation at this point? I think going back pre-COVID, there was an increased focus in the aisle with the king side and some different shelf sets. Then you move to the checkout lines, I think you had taken some shelf space for magazine and non-consumables. So if we think about 2023, and I guess even beyond at this point, what are the levers you see as most impactful from here? Where you still benefit from activation going forward?

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

So we are always looking to optimize across the entire mix of levers that we have to drive activation managing the shelf distribution, shelf space is always a priority. There were some areas, as we were lighter on capacity, where we were unable to fill some of those distribution needs. So we see some of that ahead of us as an opportunity as we have improved service. We talked a little bit earlier about the marketing spending where we had pulled back again because we were lighter on capacity. So reinstating that, we know that there's a very strong return on that.

Reinvesting the front end, retailers are always looking at how they optimize front-end space. And so we partner with them, and we continue to see opportunity there. And as we look at our in-store promotional spending, we do believe that getting visibility in display in store is important to our business. That said, our promotional spending is below COVID levels, and we've seen that we've continued to be able to drive the business where those promotion levels are today. So that's not a key priority to reinstate back to the past.

[John Baumgartner, Analyst at Mizuho Securities]

Okay. Thanks for that. And then -- and Steve, on the salty snacks margin, there was a lot of noise this year. You mentioned the catch-up on pricing. You had the warehousing in Q4, you had some reduced promo and advertising spending. As we think about the sequential increase in margin from Q3 to Q4, is it possible to bucket those tailwinds across the different elements? Or maybe what do you think the underlying run rate is for segment margin exiting '22? Is it mid-teens? Is it high-teens? Just trying to think about the moving pieces versus the structural improvements there thus far. Thank you.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Yes. It's a fair question. There have been a lot of movements across the quarters. I think when you think about run rate in the mid-teens. That's probably a good baseline to operate from. And as I say, there will still be movement across the quarters, probably, especially as we look to the back half of this year with that ERP transition that we talked about it. As we get further into the year, we'll give more color to some of that variability. But if you think about mid-teens, that's probably a good starting spot.

[John Baumgartner, Analyst at Mizuho Securities]

Okay. Thank you very much.

[Operator]

Thank you. Our next question comes from the line of Jonathan Feeney with Consumer Edge. Please proceed with your question.

[Jonathan Feeney, Analyst at Consumer Edge]

Good morning. Thanks very much. So -- It's been about 15 points or so over the past two years of pricing. And I was wondering if you could characterize -- I know that's data-driven. But I wonder how you could characterize how much of that was driven by this narrative about rising costs? And if costs continue to moderate or even decline, should we expect some -- just -- is the expectation from the retailer that some of that pricing goes away if costs go down? Or has this just all been a change in the conversation to let's work together to grow the category? I'm just curious about how much risk you have if costs, in fact, start to moderate and decline? Thank you.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Sure.

[Michele Buck, Chairman of the Board President and Chief Executive Officer at Hershey]

We always work together with retailers to try and maximize category growth. That is our fundamental premise, especially being leaders in all of the categories that we are in. If the category is growing, we feel really good. that we will benefit from that growth.

Historically, there hasn't really been a move in the category to execute price declines or price rollbacks. As prices have gone up, they have tended to stick in the marketplace. As a matter of principle of how the category dynamics have worked. And then what we really try to do is to leverage some of that favorability in price in our holistic model to reinvest for growth, whether that's reinvesting in capabilities to get smarter about managing the shelf with the retailer, helping them to find new points of interruption or whether that is incremental consumer investment.

[Jonathan Feeney, Analyst at Consumer Edge]

Makes sense. Thank you.

[Steve Voskuil, Senior Vice President and Chief Financial Officer at Hershey]

Thank you.

[Operator]

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the call back to Ms. Poole for any final comments.

[Melissa Poole, Vice President of Investor Relations at Hershey]

Thank you so much for joining us this morning. We will be available for any follow-up questions you have. Have a great day.

Participants

Corporate Executives

• Melissa Poole, Vice President of Investor Relations
• Michele Buck, Chairman of the Board President and Chief Executive Officer
• Steve Voskuil, Senior Vice President and Chief Financial Officer

Analysts

• Andrew Lazar, Barclays PLC
• Robert Moskow, Credit Suisse Group AG
• Kenneth Goldman, JPMorgan Chase & Co.
• Bryan Spillane, Bank of America Co.
• Michael Lavery, Piper Sandler Companies
• Cody Ross, UBS Group AG
• Chris Growe, Stifel Nicolaus
• Nik Modi, RBC Capital Markets
• Jason English, The Goldman Sachs Group, Inc.
• Pamela Kaufman, Morgan Stanley
• Christopher Carey, Wells Fargo Securities
• David Palmer, Evercore ISI
• Stephen Powers, Deutsche Bank Aktiengesellschaft
• Max Gumport, BNP Paribas
• John Baumgartner, Mizuho Securities
• Jonathan Feeney, Consumer Edge