Greetings and welcome to The Hershey Company’s Third Quarter 2021 question-and-answer session. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. I would now like to turn this call over to your host, Ms. Melissa Poole, Vice President of Investor Relations for The Hershey Company. Thank you. You may begin.

Good morning, everyone. Thank you for joining us today for The Hershey Company’s third quarter 2021 earnings Q&A session. I hope everyone has had the chance to read our press release and listen to our pre-recorded management discussion, both of which are available on our website. In addition, we have posted a transcript of the pre-recorded remarks. At the conclusion of today's live Q&A session, we will also post the transcript and audio replay of this call. Please note that during today's Q&A session, we may make forward-looking statements that are subject to various 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 Chairman and CEO, Michele Buck, and Hershey Senior Vice President and CFO, Steve Voskuil. With that, I will turn it over to the Operator for the first question.

At this time, we'll be conducting a question-and-answer session. Please limit yourself to one question and one follow-up. One moment while we poll for questions. Our first question comes from the line of Jason English with Goldman Sachs. You may proceed with your question.

Good morning, folks. Thanks for bringing me in. Congrats on a strong quarter, particularly given the strength that you're cycling in the prior year. But despite the strength, I can't help but remember that Shivery snacks have lost some of their sweetness pre-COVID, with little, if any, volumetric growth. COVID has clearly rejuvenated demand. Your capacity expansion effort seems to suggest that you believe that demand is going to stick. So, my question for you is why? Why shouldn't we believe that that demand is going to leak back out in the next year or two?

As we examine the growth we’ve experienced, it has been quite widespread. It spans various regions and consumer groups. From our conversations with consumers, it's apparent that some of the behaviors and routines adopted during COVID will persist. While not all will remain, and perhaps not to the same extent as when people were advised to stay home, we do anticipate that some will stick around based on our observations and feedback. We also notice continued strength as people are increasingly active and mobile, indicating a healthy balance. Additionally, we've frequently heard from consumers about the emotional connection this category has with positive moments. With more happy moments on the horizon, as people feel a sense of progress in overcoming the pandemic, we expect those joyful experiences to continue. Overall, we believe that many of these routines will remain going forward. However, we acknowledge that there are uncertainties ahead. None of us anticipated the events that unfolded, making it impossible to predict the future with certainty. In managing capacity, we’ve taken a careful approach to our investment strategy. We’ve learned from brands that demonstrate consistent growth over time, and there are clear indications that investing in capacity will yield returns, as exemplified by Reese's. There are also a few other areas where demand was initially high, but we chose to wait before increasing capacity until we felt confident in a promising return on investment. It is a delicate balancing act, but at this time, we are optimistic about the future.

That's helpful context. Thank you. And I too like happy moments. One more question, then I'll pass it on. In your prepared remarks, you touched on your collaborative space planning with retailers and resulting acceleration growth for both you and your categories. Can you elaborate on that? What's going on with the initiative and maybe provide some specifics on the changes that are being enacted by the retailers? Thank you. And I'll pass it on.

I'm sorry, can you just repeat the very first part of the question? I missed.

Well, your collaborative space planning for retailers.

Yes, okay. You were talking about it in your prepared remarks. Give us more specifically. What is it, what's happened, what are the changes that are being enacted on the back end of it? Yes, absolutely. So, I would say over time, given that strong partnership we've had with retailers and particularly a lot of our category management expertise around analytics, we've always partnered with retailers in terms of how to think about the placement of confection in their stores and ways to optimize category growth. Whether that's looking at heat maps with how people travel through convenience stores or years back when we found underutilized space under the checkout counter in convenience stores, and we put the category there. Recently, a lot of the focus from our retailers, or there's been a big focus around the labor shortage and thus, a push for even more presence of self-checkout. And so, we've partnered really closely with those retailers to increase the presence of the category at self-checkout and to maximize the presence in those queuing lines leading up to checkout and particularly self-checkout. I mean it's a perfect fit with some of the struggles they're having around labor and a great opportunity to get the category out there and make sure that people don't miss that chance to have that last impulse purchase. So, I think our retailers are always focused on what's going on in the environment that they need to address in terms of their store layout. And fortunately, we've been able to help them with some of that.

Makes a lot of sense. Thank you.

Our next question comes from the line of Andrew Lazar with Barclays. You may proceed with your question.

Great. Thanks so much. Maybe just first off, I was hoping you could talk a little bit about what you're seeing in terms of competitive response with respect to the pricing moves that you've announced and how that impacts your expectations on elasticity because obviously thus far while early, it would seem like volume trends have held up remarkably well in response to the pricing that you've taken.

Sure. As we have always seen in this category, it tends to be a very rational category relative to pricing. Our most recent pricing actions are on track, and we have seen several competitors take pricing actions this year, including over the past several weeks and we don't really expect that we'll see any material changes in pricing on shelf versus the competition, any changes in GAAP, etc.

Great. I understand the complexities of the current supply chain, which makes it difficult to be very specific about 2022. However, if we look at the overall picture, consumption trends remain strong, Hershey is implementing more pricing, and inventories have been low for nearly two consecutive years. All these factors suggest a reasonable outlook for sales in 2022. Again, please correct me if I'm wrong. Regarding profitability next year, I know there will be supply chain challenges at least through the first half of the year. My question is whether you anticipate that gross margin pressure will improve sequentially in the first half as pricing adjustments take effect and supply chain efficiencies are achieved, or do you expect the gross margin pressures in the first half to be just as significant as what you are experiencing in the latter half of this year?

Sure. I agree with your observation about the top line. Currently, it's difficult to identify any indicators suggesting a lack of momentum or performance. As we transition into next year with a longer Easter, pricing will be more significant compared to this year, and we are optimistic about potential capacity improvements that could provide some benefits. At some point, we expect inventory levels to be replenished, although it's challenging to predict exactly when that will occur. Despite the volatility, I concur with your initial point. Regarding gross margin, there are still numerous factors at play. Pricing changes will positively impact gross margin when considering raw materials. This year, raw material inflation was not a major concern for us, but we anticipate it will have a greater impact next year. We don't foresee any relief from logistics inflation in the first half of next year. We'll have reduced spot market activity as we are better positioned to meet stronger consumer demand than we were in the third quarter. We still anticipate some labor inflation, and as noted earlier, we've increased our workforce to address rising demand. Packaging inflation in resins has shown some moderation but has not returned to previous lower levels, which will likely continue to exert pressure at least through the first half of the year. Furthermore, the challenges in logistics, trucks, warehousing, and labor will continue to affect us. Taking all of this into account, the gross margin outlook remains complex. We will provide more clarity during our February guidance update. For now, particularly in the first half of the year, we expect to face significant cost pressures.

Great. Thanks so much.

Our next question comes from the line of Robert Moskow with Credit Suisse. You may proceed with your question.

Hi. Michele, I wanted to ask about the decision to reduce advertising for the year. I guess it makes sense in the context of supply chain challenges and if you can't get the inventory where you want, why advertise? But the stock's done well and your sales have done well because of the market share gains. And I just wanted to know if you think there's risk to market share erosion from this decision. Do you think your competitors are doing the same thing, so it won't matter? How did you evaluate the risk and reward of that?

Yes. So, first of all, I would say there is not a strategic change to our business model. We remain committed to investing in brands at some of the highest levels in our industry across the peer group. So, there's nothing that has changed about the strategy, so I want to be clear about that. As we looked at the decision, it really was driven by the fact that we have such elevated demand. And given that the supply chain challenges just wouldn't enable us to be able to meet the further demand that we would create through our very impactful advertising, that it just didn't make sense. It put more pressure on the supply chain. And also, we probably wouldn't get a good ROI because we wouldn't be able to fulfill that incremental demand. If we look at our market share right now, we don't think that the advertising cuts that we had executed impacted our share in Q3. And we're not the only ones having supply chain challenges and issues. So overall, I think across the board, even in the industry, we're seeing a lot of people manage advertising to supply as a challenge. We'll continue to focus on optimizing it. We will invest as much as we can, as much as we think we can sell. Certainly, we're investing in capacity going forward and we are very agile in how we're handling support behind our brands.

Okay. And can you give us any update on Halloween? Will Halloween just blow right through inventory or were you also challenged to fulfill demand for Halloween just like other products?

Yes. It is a very strong Halloween season, the biggest that we've ever had, with very strong double-digit growth on top of the strengths that we had last year. We have done our very best to get as much product out there as possible. Certainly, I would say supply pressures hit every aspect of the business, so tallying season would be a piece of that. But we're really excited about the growth that we've seen year-to-date, both in the category, as well as our own business, and I'm seeing lots of very picked-over products out there as I'm out in stores because it'd be a good trick-or-treat, they send everything we've purchased from consumers as well as the people really flock back to that behavior.

Our next question comes from the line of Ken Goldman with JP Morgan. You may proceed with your question.

Hi, thanks so much. I wanted to start by asking about your perception of your labor relations right now. We've had a couple of strikes obviously in the food-at-home industry. So, I'm just curious for any updates on how you see the risks there and so forth.

Yes. Absolutely. We are very focused on our labor and the first and foremost, I would just want to again, publicly acknowledge and thank our manufacturing employees. We have folks in our plants who have been with the Company for 20 years, 30 years, 40 years. And it's really their focus, their dedication from the very beginning, that has enabled us to demonstrate and deliver the growth that we've been able to during this very dynamic environment. So, we have very long focus and believed and operated in a way that we believe we have the best advocate for advocates for the needs of our people. We are in constant communication with our employees, and we're really focused on our total employee value proposition with those employees. We know that we have highly competitive wage rates, we have excellent benefits, and then we routinely benchmark all of that. But we're also very focused on the softer factors that are very important to our employees. And that includes, especially during these times of global supply chain challenge, work-life balance, stress management, flexibility in hours, being able to get time off. And so, we have enacted a lot of strategies to really try and help with that. We have an always on recruiting approach and we have really amplified our recruiting efforts this year to be able to successfully manage through the challenges and increase our net headcount. We've also leveraged the analytics to, as I said, understand some of the things most important to our workforce. So, we're very focused on that. We are very focused on prioritizing the needs of that group and continuing to look at ways that we can optimize the situation in terms of supply and demand. So, we feel pretty good about that.

Great. Thank you for that. And then a quick one for Steve. Steve, year-to-date, your corporate other expense line has been up fairly meaningfully from both 2020 and 2019. I realized that grows somewhat in line with sales. But I'm curious how we should think about when an ongoing annual number for that corporate line is, especially as we think about modeling 2022. Are there any potential one-time headwinds we should be thinking about that maybe go away next year or is this kind of a good runway to think about?

You'll see incentive compensation is one of the big pieces in there, and as we turn the page to next year, that'll be one item that resets. Otherwise, there's not as much change. We talked about this year we had some planned investments in ERP and digital. We'll have some of those kinds of investments I expect next year. We also had a little bit heavier medical claims and benefits impacts this year coming off of COVID. So that may or may not continue next year, but probably the incentive reset will be the biggest year-over-year change as we start the next year.

Thank you.

Our next question comes from the line of Bryan Spillane with Bank of America. You may proceed with your question.

Hi. Good morning, everybody.

Good morning.

So, to wrap up 2022, Steve, I wanted to mention that this year we benefited from lower interest expenses. As we look ahead to next year and analyze our models below the operating profit line, is there anything specific we should consider regarding potential changes?

Yeah. Nothing major. I think if I was to look at tax this year has been lumpy, but if I look at where we set the final guidance for the year from a tax standpoint and I look to next year, I'd expect a relatively similar level for next year. We had some one-timers this year that will not recur next year. We talked about it in the second quarter and to some extent, this quarter as well. So, I can't take those out. And I look at the finishing tax position I see the same interest expense. I don't expect a lot of change, but flat year-over-year. So, I hope that helps. Not much movement year-over-year, other than the one-timers.

Yeah. No, that's helpful. And then just a follow-up on the capacity expansion. I guess two questions related to that. One is, what type of investment is it? Meaning is it actual physical product production lines, or is it investments in further down the manufacturing, like packaging capacity? Just trying to get a sense of actually what type of capacity you're adding.

Yes, we're adding capacity on both. Both, in terms of product production, as well as packaging across multiple brands. I think we spoke before about building our agile fulfillment center. That is up and coming online. So, it's really across the board.

Can you provide an update on your current capacity and utilization? I'm trying to understand if the recent increases in capital expenditures will result in a sustained elevated cycle, or if you anticipate having more capacity flexibility soon.

I'd start by saying capacity utilization varies by brand and piece of the business, so each brand is in a slightly different position. We certainly have invested several hundred million dollars to install at least 9 new lines since the pandemic began, and we do have more planned for '23 and for '24. But Steve, do you want to talk a little bit more about where we are in that total investment?

Yeah. If you look back really the last 2 years and this year, we have done a lot of infrastructure spending. So, we talked about the agile fulfillment center. We've got a Canadian DC that's in process, and of course, the ERP transformation, which is a big component as well. Now, I'd say we have to finish those projects before pivoting more towards the capacity side. So, I think like we talked about machines packaging. So far, we haven't had the need to build buildings and infrastructure of that sort. But as we look at the total, next year, as we talked about a slight increase versus this year from a CapEx standpoint, really due to project timing this year more than anything else. And then, as we look further, I know we get more guidance on that, as we get into next year.

Okay. Thanks. I'll leave it there. Thanks, everyone.

Our next question comes from the line of Nick Modi with RBC Capital Markets. You may proceed with your question.

Thank you. Good morning, everyone. Michele, I wanted to ask about market share and get some context. A key question has been how much of the share gains Hershey has achieved over the last 12 to 18 months and what portion was taken. It appears that a significant amount was taken. Could you discuss where you see the most stability and where things have retreated? Also, discussions are currently taking place regarding shelf allocation for 2022. I would like to hear your initial thoughts on how you think you'll advance in that area.

Yeah, sure. Since the pandemic, we have been able to hold on to about 50% of the market share gains that we had realized. We see certain areas of the business where those numbers are very strong seasons in particular, as we mentioned in our remarks. We had gained 500 basis points and we held on to about 75% of that. Take-home also has been very strong in terms of our retention. So, we're pleased with what we've been able to hold onto. And as we continue to unlock more capacity and reinstate some of that advertising, we believe that we'll see some continued strength going forward.

And then just a follow-up on assortment because I know that's been a big area that retailers have been focused on, given all the supply chain challenges. So, as you engage with retailers regarding space with some of your initiatives, how are you guys thinking about your overall assortment on the shelf?

Yes. So, I would say, we know that assortment bags are really big sellers with consumers. And there's been a trend towards that, particularly during the seasons and especially during Halloween. So, we have definitely seen that part of the category tick up relative to assortment bags. If I look broadly at assortments and what is on the shelf, what we've been trying to do is to optimize our portfolio of SKU for right now based on what consumer demand is, where the demand is, and availability of capacity. And we've really prioritized a lot of our core items that the core of the core of the core items, which are the highest velocity items even to the point where we're focusing in some places, on shelf you will see double facing of those items as opposed to the presence of perhaps some second or third tier items. So, we've spent a lot of time on this, and we think we've taken a really smart approach that has enabled us to generate that very positive demand and at the same time, maximize the available output that we have on capacity and on supply.

Excellent. Thank you. I'll pass it on.

Our next question comes from the line of Michael Lavery with Piper Sandler. You may proceed with your question.

Good morning. Thank you.

Good morning.

Just wanted to come back to the trajectory of capacity relief. I know you've quantified the reload hit for this year. Just in terms of at least how you're planning for it, assuming that's all set for next year, can you give us a sense of how you expect that to unfold and just how soon you can start to see a relief and reloading retailer inventories?

Steve, you want to talk about that.

I think it’s difficult to predict exactly how that will develop over the next year. As mentioned earlier, we have capacity that has come online this year, and more is expected next year. Balancing consumer demand with our additional capacity will pose a challenge for our quarterly projections. We will have more information in February, and I should have a clearer understanding by then.

But and is the issue more the production lines or labor or is it both?

It's a bit of both. Labor only from availability. Like everyone, we've done a lot of hiring this year. We talked about it again in the prepared remarks. We've increased headcount but we've also seen more attrition than we've had in the past. So, there's a labor component, but there's also a machine capacity component.

And I'd also say there has been a logistics and shipping component, as well, although we've been able to take some actions and have seen some improvement on that.

Okay. Thanks. And you mentioned in the prepared remarks about the strength in unmeasured channels and just how your total sell-through is stronger than what we see in the measured channels. Can you give a sense of if there's any certain products or channels in particular driving that and just how sustainable it might be?

Yeah. I mean, we're seeing it up versus the pre-pandemic levels. And I think over a 2-year, it's relatively in line with what we would call normal. So, low single-digit growth is kind of what you should be thinking there.

Our next question comes from the line of Alexia Howard with Bernstein. You may proceed with your question.

Good morning, everyone.

Good morning.

Morning.

Right. 2 questions from me. Firstly, you mentioned in the prepared remarks that some of the emerging markets are still holding up well. I wonder if you could give us a quick tour of India, Brazil, and Mexico. How long do all they collectively and what are the main initiatives that are in those areas? And then I have a follow-up.

Yeah.

Steve, would you like to discuss the size and

The three markets are performing well. As I mentioned during the second quarter call, we are gaining market share in all three of these areas with our key brands. We're pleased with the progress we've made. You can expect to see an impact on the top line due to the benefits from our go-to-market strategies, including our model in China and efficiencies in the other markets. We are optimistic about how things are developing. Looking ahead to the fourth quarter, we might face some of the same capacity challenges in the U.S. and North America that could affect those markets as well. However, we are very pleased with the distribution gains and the velocity and share we've observed across these three markets.

I'd say in terms of the key initiatives, I would probably bucket them across in terms of investing in the core. So, India, we're still focused on the chocolate expansion and broadening that. In Mexico, we have both a strong chocolate portfolio as well as Pelon Pelo Rico in the sweets area and in Brazil continuing to fill out our portfolio. We launched Halloween in Brazil for the first time. We had a premium dark line that came out in Brazil a while back that's been very successful. And across all of those markets, investing to continue to build those brands and to build distribution I think are really the key priorities there.

Great. And then as a follow-up. I didn't see any reference to the e-commerce channels in the prepared remarks this time around. Has that channel slowed down materially? Obviously, it was very elevated during the pandemic, and I'm just wondering what's happening over there and whether that's becoming maybe less of a focus this year?

Yes. So overall, I think perhaps not totally unexpectedly, from a broad consumer perspective, overall trips to stores, both brick-and-mortar and e-commerce are up both versus 2020 and 2019. In-store trips have pretty much rebounded to the pre-pandemic level. And in e-commerce, what we've seen is the trips have largely maintained versus last year. But we have seen the dollar per trip go down as many of those consumers who were more exclusively purchasing in e-commerce shift more of their spend back into bricks and mortar. Most of the e-commerce shoppers are not exclusively e-commerce; they shop omni-channel. So, we saw some of that shifting occur. Relative to our business in particular, our e-commerce retail sales are up versus last year with our omni-channel partners, despite the significant growth that we had a year ago. And also, despite the significant growth that we're seeing in bricks-and-mortar as well.

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

Our next question comes from the line of Steve Powers, with Deutsche Bank. You may proceed with your question.

Thank you. Good morning. Regarding the capacity issue, it's difficult to determine the exact timing for alleviating the pressure on brands facing capacity constraints, as you discussed with Michael. I want to revisit Rob's question to understand how long you anticipate this lower marketing run-rate might last, and how long you would feel comfortable maintaining it considering the competitive landscape.

I believe that in relation to our marketing investment, we are going to remain agile and flexible. As we bring new capacity online or make adjustments in our operations, we have focused on freeing up additional capacity by reducing changeovers and concentrating on core SKUs. Therefore, we are in a phase of continuous improvement regarding capacity investment and maximizing our current capacity. We closely monitor these factors so that when we notice increases, we can quickly reassess and adjust our spending accordingly.

Yeah. All I would add is when we talked in the past about the analytics that we have around our media investment, and we put a lot of our own investment in building out that analytics capabilities. So don't think of the media tests as sort of a peanut butter approach. It's very surgical, very precise to the areas where we have capacity constraints and very protective of the high ROI core brand advertising.

That makes sense. Could you clarify how much of the analytics and considerations are based on your internal factors versus the competitive landscape? It seems that currently, both you and your competitors are in a similar position. Therefore, as you scale back, you’re not too worried about losing your share of voice. However, if you felt you were behind in capacity compared to your competitors and saw them gaining traction, how would that impact you? Would you increase your marketing efforts ahead of capacity to maintain your share of voice, or how would you approach that?

Yes. I know our retail sales team has very strong presence to start the week. Between what's on air and what's on-shelf and what's being promoted. We have very good data coming back on what's happening from a competitive set. And all of that does feed into the decision as we think about how we're going to optimize our marketing and media spend.

Okay, great. Just one last question if I could. You called out the price increase executed recently in the U.S. and your expectation for pricing to play a bigger role in next year's growth, which makes good sense. Is there any color you can provide just in terms of the cadence of how you expect net-realized price to flow? Is it going to be relatively even throughout the year, or does it build? Just any context there would be helpful. Thank you.

Yeah. We're going to have more in the first half of '22. Think about the most recent price increase will kick in in the first quarter plus we'll have carryover from the price increases that we announced earlier this year. So, the first half will have more price relative to the back half.

Our next question comes from the line of Jonathan Feeney with Consumer Edge. You may proceed with your question.

Good morning and thank you. I have a quick question. I'm trying to understand the numbers for Q3, and I think I might be a few days off. However, I see that the pricing in the U.S. scanner channels shows 9 and 7 for Q3. This seems significant, especially since retail pricing appears to be ahead of wholesale pricing. Can you explain what might be happening here? Does this indicate what kind of pricing we should expect moving forward? Is there a chance that retailers are increasing their margins compared to what you consider standard operations? Thank you.

We're not seeing retailers margin up in a material way. What you do see is a lot of impact of mix and retail when you really got to click down to get down to pack type and see what's happening. And when you get down to that level, it's consistent. More than what you see when you look at just at the top level.

Got you. So, you say, it's more of a mix phenomenon then?

That's right.

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Ms. Melissa Poole for closing remarks.

Thanks so much for joining us this morning. We'll certainly be available throughout the day for any additional questions you may have. Have a great day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and enjoy the rest of your day.