Good morning, everyone. Thank you for joining us today for The Hershey Company's second 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 pre-recorded remarks. At the conclusion of today's live Q&A session, we will also locate 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.

Thank you. We will now begin the question-and-answer session. Thank you. Our first question is from Andrew Lazar with Barclays. Please go ahead with your question.

Great. Thanks so much. Good morning everybody. As you discussed in the prepared remarks, inventory refill has certainly been nicely additive to volume growth through the first half of the year. Where do you think retailers are at this stage? And how much more of a benefit, I guess, can this be in the second half from the prepared remarks, if I'm reading it right, it seems to suggest maybe the bulk of that inventory refill is behind you at this point and maybe no longer enough to necessarily offset what volume elasticity you are seeing? So just some clarity there would be helpful.

Good morning. Yeah, absolutely. As we have always talked about our investment model or our model and running the businesses, we strongly believe in investing to drive the top line and with our strong margins that enable us on the bottom line. So we always want to be spending to the consumer, advertising our brands, having the right levels of promotion, the right levels of innovation. And as we mentioned earlier, given some of those supply constraints, we did have to pull off on that a bit just because it didn't make sense to make those investments given some of those constraints. But we very much look forward to re-upping the investments as we look at the second half. We have always planned an increase both in DMEs as well as incremental merchandising coming back online.

Yeah, that's exactly right, Andrew. We saw a pretty strong inventory replenishment in the second quarter as we commented. A portion of that was a pull-forward from the second half, so really a timing move. So as we look at the back half, we're really not seeing any additional meaningful inventory replenishment in the second half guidance.

Right. And then sort of following on that, I guess, as you and others slowly start to get back to a better inventory position and some of the supply constraints slowly ease. I guess, not surprisingly, we're starting to hear from, I think from Hershey and others that they'll be in a better position, maybe for the first time in a while, right, to begin to kind of ramp back up merchandising activity to drive volume and traffic. And I can understand why in this environment, some might simply see that as retailer concessions, given all the pricing that's come through in the industry and with commodities starting to roll over. I assume you see this as more getting back to maybe a more normal cadence of spending and really looking just to drive volumes and traffic and protect elasticities that I still think can be, in many cases, incremental to the business, but I was hoping, Michele, you could kind of comment a little bit on that, if you could. Thank you so much.

India is still relatively very small for us, growing high double digits. But back when we really made our decisions on China and India, for me, the key difference in India is the cost of doing business in that market is very different. So media costs, labor costs. And so in both markets, we thought we had the potential to drive top line. But as we really did assessment and looked at the NPV of our investment, India is a market that we feel good about our prospects of getting to profitable growth. Frankly, we're already in a place that we like relative to where gross margins are on that business, very different than where we ever were in China.

The only addition I would make is that we are beginning to notice more costs coming from third parties, such as co-packers and co-manufacturers. Many of these are under contract, and the costs are influenced by contract renewals. They are also experiencing the same cost pressures and disruptions that we are. As a result, we are starting to see a greater impact on our profit and loss statements.

I guess I'd also just add, we have made significant progress in investments in capacity, significant investments. And so part of our short-term pain was once you make those investments, it takes some time to get them up and running to get to the lines actually in place. And so part of some of the relief we're seeing is the gradual coming online of those capabilities as well, which is helpful.

Good morning, everyone. Can I ask about the general supply chain disruption that you're still experiencing? Can you discuss the specific pain points? I'm thinking about raw materials, packaging, and labor. What challenges are you currently facing? Are you beginning to see some improvement? It seems like conditions might be getting a bit easier. I also have a follow-up question.

I mean I'd say, generally, we continue to see struggles across the supply chain. How I'd characterize it is what those are have evolved. So where we are now, I would say, early on, it was some of the basic logistics issues largely driven by labor. And as we've evolved, I'd say, we're now starting to see bigger concerns relative to scarcity of ingredients, needing to leverage different suppliers at higher costs and price points in order to secure production and then also the geopolitical environment has put certain strains on the business. Certainly, the Ukraine-Russia issue created some scarcity and issue with ingredients. And more recently, there have been additional restrictions from Russia on the EU relative to natural gas. Germany will be impacted. That's an area where we source a lot of equipment, supplies, as do many of our suppliers. So I would say that that's kind of evolved.

We're beginning to notice an increase in costs from third parties, including co-packers and co-manufacturers, many of whom are under contract. This tends to occur as contracts are renewed, but they are experiencing the same cost pressures and disruptions as we are. Consequently, we're starting to see more of that reflected in our profit and loss statements as well.

That's very helpful. Thank you for all the information. As a follow-up, how significant is India currently? You mentioned it in the prepared remarks, but I haven't seen much news from India lately. I'm curious about how you plan to avoid the issues you experienced in China a few years ago. I understand you've shifted your approach in China to being more hands-off; what makes India a different market? Why do you believe it can succeed in the long run? Thank you, and I'll pass it on.

India is still relatively very small for us, growing high double digits. But back when we really made our decisions on China and India, for me, the key difference in India is the cost of doing business in that market is very different. So media costs, labor costs. And so in both markets, we thought we had the potential to drive top line. But as we really did assessment and looked at the NPV of our investment, India is a market that we feel good about our prospects of getting to profitable growth. Frankly, we're already in a place that we like relative to where gross margins are on that business, very different than where we ever were in China.

Thank you. Our next question is from Robert Moskow with Credit Suisse. Please proceed with your question.

Hi, Michele. Hi, Steve. Good morning. I found your comments about 2023 quite encouraging, even though it is still early. You mentioned that you anticipate your pricing changes will be somewhat countered by high single-digit inflation and that you also have productivity improvements. Do you believe that the pricing adjustments will balance out the cost inflation in 2023, considering the delays experienced in 2022? That seems like a positive sign. Additionally, could you elaborate on the increase in advertising that you are planning? How much of that is simply to recover what has been lost so far, and what level of investment do you think is necessary?

For 2023, we're still discussing things at a general level. We'll refine our approach as we progress through the third quarter and gain clearer insights for the next year. We expect high single-digit price increases to materialize. We'll monitor consumer behavior to understand elasticities better as we exit this year. Overall, inflation remains in the high single digits. If we look deeper into this, I anticipate some commodity impact as we transition from more favorable hedges to ones based on current pricing trends. We also continue to face logistical and third-party cost challenges. It’s premature to determine whether our pricing will completely counter these inflationary effects, but we’ll have more clarity as we approach the end of the year. We plan to increase our advertising, which we mentioned before, and we expect that to grow faster than our sales rate. As Michele pointed out earlier, our goal is to consistently reinvest in our brands and consumers, ensuring a healthy level of investment when we have the capability to do so.

Okay. Did you say that, Steve, that you expect your pricing to be up high single digit next year because of the flow-through?

That's correct.

You bet.

Hi, thank you. One quick one and then a longer one on Halloween. I just wanted to get a sense, if possible, for the North America salty snacks business, the margin going forward. We've seen some volatility there. Just wanted to kind of get a sense for how to model that in the next couple of quarters, given some of the cloudiness we have in our model or at least our model on that one?

Sure. I'd be happy to take that one. So as you saw in Q2 looks a lot like Q1. We continue to see higher raw material costs and logistics costs that for these two quarters are more than offsetting the price that we've taken so far. That said, we've announced more price increase in the second quarter. So as we roll forward through the next two quarters, we do expect to see some stability and relief there. We're also going to begin to lap in the back half some of the higher logistics costs that we've been talking about. And so that will provide a little bit of relief there as well. And then longer term, as we talked about on last quarter's call, we continue to advance the structural changes that we need to do for that division. So things like setting up or formalizing the supply chain, some of the back-office efficiencies that we need to put in place. And longer term, that will drive more structural improvement. But right now, it's kind of fighting the balance between pricing and inflation and commodities costs.

Thank you for that. I wanted to ask about Halloween. It's early to be precise, but you mentioned expecting high single-digit sales growth. You also indicated that part of the reason for this is capacity constraints, which made me curious about why the guidance isn't higher. Perhaps it's due to a tough comparison from last year or a cautious approach because it's still early. I would have anticipated that capacity issues would be less significant considering the importance of the holiday and that efforts would be made to produce as much seasonal candy as possible. However, I might be oversimplifying your supply chain challenges. I am just curious why the guidance isn't a bit higher.

So Ken, as we look at the business, we had a strategy of prioritizing every day on-shelf availability. It was a tough decision to balance that with the seasons, but we thought that was really important. And so that was a choice that we needed to make. We had opportunity to deliver more Halloween, but we weren't able to supply that. And we were really producing. We began producing Halloween back in the spring. And that's really when we needed to make these key decisions on what we were going to produce, so tough trade out to make. We feel really good about having high single-digit growth, but we also feel good about as we get into the future being able to have more capacity to really fulfill more of the demand that we see during the season.

It's definitely all hands on deck.

Hi, good morning folks. Thanks for letting me in. I guess I want to start on capacity because there's a little bit of conflicting messages here. I think on one side, you've got enough capacity to be refilling retailer inventory levels. But on the other side, you don't have enough capacity to meet demand for some products. Can you help me put those two conflicting things and also give me a little bit better understanding of where the bottlenecks are, and what the pathway and timeline is to relieve those bottlenecks?

Yeah. So capacity is constrained, but obviously in certain parts of the portfolio, more than others. So there are certain places we have no constraints and there are other places that we are more constrained. We've shared previously that Reese's is one of the areas where we have seen high double-digit growth for extended periods of time. It's our very largest brand. So that's certainly been a pressure point. And then there are a few other places that have been pressure points and where we've needed to make trade-offs in order to prioritize some parts of the portfolio. So we continue to work through a capacity investment plan to address where the soft areas are and bring capacity online. So that might be part of the mixed messaging is there are certain places we're not constrained others that we are. Refreshment specifically Icebreakers Mint is one area where we had some production difficulties as we ramped production back up after the COVID softness. And so that's one place as well that we're continuing to work to get more supply available. As we address the issues, I would describe our progress as a gradual improvement. This year, we are facing significant constraints, but we expect to see steady improvement as we move through 2023. By 2024, we feel much more confident in our ability to meet demand fully. That's my perspective on the situation. Steve, do you have anything to add?

Yeah, just the color around in the last three years, we've invested on the order of $800 million on capacity mostly in the core. And so we've got 13 new lines in place coming online. We've refurbished 11 and so as Michele said, over the next year or two, we're going to start to see more significant capacity available.

If it helps. The investments that we made will result in about a 15% increase in our internal volume production capability. That should allow us to catch up but also to deliver some of that future growth.

For sure. That's helpful. I want to revisit Rob Moskow's question briefly. I was surprised that you were providing insights on 2023 this early; it's not typical for you. This raises the question of why. One way to interpret it is that you have inflation, but your prices are higher. While gross margins are currently weak, they should return to growth next year. Alternatively, your focus on increasing spending next year suggests caution regarding how much margin flow-through will directly impact the bottom line. Which of these two interpretations do you think we should focus on?

I would just say it's still pretty early. We're trying to just give some broad movements on the top line and inflation. That's really the part that we could share. I say we're learning more every month and quarter that goes by, we'll have a lot more to share as we get to the end of the year. So really not trying to get ahead of our skis just extending some of the color we see right now.

And Jason, if I would just add a little bit was just related to some of the pricing that's in the marketplace and expecting to come, trying to put that in perspective around how much 2023 factored into that choice and just trying to make sure that everybody was understanding some of the inflation that we see coming in 2023 to help put some of that pricing in perspective as well.

Thanks, operator. Good morning, everyone.

Good morning.

Hi, Bryan.

I wanted to follow up on the discussion about inflation. You mentioned earlier that some of the pressure comes from a scarcity of ingredients, which is more than just market-based issues. I'm trying to understand how much of the increase in costs of goods sold is a permanent shift and how much is still tied to the current environment, with the possibility of disinflation in the future. I'm looking to grasp how much of this is now a permanently higher base for costs or if some of it could be variable, allowing for potential disinflation later on.

Yeah. So it's a really good question, and it's hard to answer that one with precision as you look at all the moving pieces there are clearly some that we would see as temporary. The scarcity issues, hopefully, some of the commodities pressures that are being influenced by the events in Eastern Europe, things like that. On the other side, we've seen more labor inflation and other things that could prove to be more structural. And so again, as we get to the end of the year, and we get some guidance for next year, I'll probably give some more color on that. But it is a mix. Some are temporary and some at least have the potential to be longer lasting. That said, we also focus on productivity and continuous improvement every year and extend the goal of that program is to be able to more than offset over time some of those structural costs. And so that also has to continue to advance.

Thank you. Good morning.

Good morning.

Morning.

I just wanted to come back to Dot's, which obviously is up very strongly. I would love to understand a little bit more some of the dynamics there. How much is distribution driven? And maybe more importantly, how much distribution upside runway do you still have left?

Sure. So we are absolutely very pleased with Dot's performance in the marketplace and the momentum that we see. I think what we're really happy about is we continue to gain distribution, but we are maintaining our velocities as we continue to broaden reach. And that can be a challenge to do as you continue to broaden reach into sometimes some of the smaller accounts. So all the trends are in line with our expectations. Retail sales growing about 50% over the past 12 weeks, share up about 370 basis points. We are right now lapping some large distribution increases from prior year. So we do expect to see a little bit of softening in trend as we overlap that, but we do have continued distribution upside as we took over the business, the distribution was really concentrated primarily in the center of the country and the West. And we're really still filling out the East and importantly, just making sure that we have the right placement in stores and then, of course, beginning to actually market and drive consumer messaging to the brand, which we help think will further drive upside in velocities.

Okay. That's helpful. Thank you. And just a quick follow-up on the pricing, I know you've said you've got at least most if maybe not all of it that's announced. Is there any of that's sort of TBD or to be negotiated, or is it all locked and loaded and just a question of on the cloud ready to go out the door?

Our recent announced pricing action is being executed. It is going as planned, and we're starting to see some of the new retails in the market already. We feel good that we really took a consumer-focused approach for the right retail price points, and we're also beginning to reset some of the promotional points. So overall, the prices are moving in line with our recommendations and our expected ranges. And we are pleased about that as we want to really move ahead with further investments in the business and capacity and consumer spending, new capabilities and the right programming, and all of this will allow us to do that to drive profitable category growth.

Thank you. Our next question is from Chris Growe with Stifel. Please proceed with your question.

Thank you. Good morning.

Good morning.

I have a question regarding the recent price increases, specifically in confectionery. I’m trying to understand why it seems like very little impact is being felt this year. It seems that some impact should be noticeable, but it’s minimal. Also, to what extent has this led you to incorporate a higher level of elasticity into your assumptions for the second half of the year? I’d like to gain a clearer understanding of this.

Sure. Yeah. I mean it's right. Most of it will impact next year. We will get a benefit in the fourth quarter. But even a portion of that benefit, we're reinvesting in – with the trade and to drive merchandising and so forth. But most of it will impact next year. In terms of elasticity assumptions, we do have in the back half in elasticity that is a little bit better than what we've seen historically, but a little bit worse than what we saw in the first half. It actually looks a lot like the second quarter, if you adjusted for the volume replenishment, that level of elasticity is the assumption for the back half. And then, of course, the range on guidance kind of goes up and down from there.

Okay. And then one related question to that would be, do you expect pricing to sequentially accelerate in the second quarter – I'm sorry, in the third quarter from the second quarter or maybe more Q4 with the confectionery pricing coming through? And then do you believe you can grow volume in the second half of the year? You've had some really strong volume trends to date.

Yeah. So we don't see sequential improvement in the third quarter. We do in the fourth quarter, and that's when we'll see the beginning effects of the price increase. And we don't expect to see volume growth. Again, with that elasticity impact defined with the pull forward of the inventory replenishment from the second half into the second quarter.

Good morning. This is Simon Negin filling in for Cody Ross. Could you give some additional detail into the delays in capacity coming online next year? Is this only impacting lease? And how much of an impact is expected?

The – so most of the capacity that will be coming online is focused on the core Reese's one significant component of that. I don't think we're going to be specific about exactly how much is coming on when, but that is the focus of the capacity.

Got you. And just one smaller question. Obviously, dots is demonstrating incredible growth largely distribution gains. Moving forward, do you expect a change in consumer's trialing new brands and products when budgets are squeezed more in this environment, perhaps sticking to what they're comfortable with?

It's a good question. I think across snacking, what we tend to see is consumers very much like their brands. So if you look across total food, as budgets are tighter, certainly, private label brands have grown share versus with across snacking, private label has not and consumers tend to like their brands. So I think that consumers will continue to try new brands, given that they have a real focus on brands within snacking. So we will closely monitor that. But at this point, we haven't seen any concerns around the slowdown in trial as a result of that.

Good morning. Thanks for taking the question. And great quarter. As far as pricing over the next 6 to 12 months, assuming we have, if we did have a moderating cost environment, how you lived through a lot of ups and downs in cost in this business. How do the – if there's been so much conversation, so much acceleration in pricing, much of that headline cost driven. How does it work – if – what changes about the conversation if costs move sharply in the other direction? Like they did in grains, for example, at least so far, off their peak? If costs moderate, how do you handle that? Do people – does it typically play out that it's increased promotion? Do you see decreased list prices, or do you see no impact in just a significant increase in gross margin?

Yeah. I mean our focus is always on driving profitable category growth and looking at how we can invest to do so. We have a deep list of investment priorities and growth driving opportunities and so we believe that this enables us to really invest to unlock whether that is in capacity, whether that is in the right consumer marketing support, whether that is in more impactful promotions, investments in innovation, technology, et cetera. So, we like to invest back in the business. And I would say that's the overall approach and strategy that we take.

Thank you.

Thank you very much for your time today. We appreciate all the questions, and I know that many of you will have follow-ups with Melissa throughout the day. So thanks.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.