好時 (HSY) 2013 Q4 法說會逐字稿

Good morning.

My name is Bonnie and I will be your conference operator today.

At this time, I would like to welcome everyone to the Hershey Company's fourth quarter 2013 results conference call.

(Operator Instructions)

I would now like to turn the call over to Mr. Mark Pogharian.

You may begin, sir.

Thank you, Bonnie.

Good morning, ladies and gentlemen.

Welcome to the Hershey Company's fourth quarter 2013 conference call.

J.P. Bilbrey, President and CEO, Dave Tacka, Senior Vice President and CFO, and I will represent Hershey on this morning's conference call.

We welcome those of you listening via the webcast.

Let me remind everyone listening that today's conference call may contain statements which are forward-looking.

These statements are based on current expectations, which are subject to risk and uncertainty.

Actual results may vary materially from those contained in the forward-looking statements because of factors such as those listed in this morning's press release and in our 10K for 2012 filed with the SEC.

If you have not seen the press release, a copy is posted on our corporate website in the investor relations section.

Included in the press release is a consolidated balance sheet and a summary of consolidated statements of income prepared in accordance with GAAP.

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

The Company uses these non-GAAP measures as key metrics for evaluating performance internally.

These non-GAAP measures are not intended to replace the presentation of financial results in accordance with GAAP.

Rather, the Company believes the presentation of earnings, excluding certain items, provides additional information to investors to facilitate the comparison of past and present operations.

As a result, we will discuss 2013 fourth-quarter results, excluding net pretax charges of $10.9 million or $0.04 per share diluted, related to costs associated with the Project Next Century, non-service related pension expense, and acquisition and integration costs.

Our discussion of any future projections will also exclude the impact of these net charges.

With that out of the way, let me turn the call over to J.P. Bilbrey.

Thanks, Mark, and good morning to everyone on the phone and webcast.

I'm very pleased with Hershey's fourth-quarter and full-year financial and marketplace results, which represent a solid end to another good year.

Net sales for the full year increased 7.6%.

This was our fourth consecutive year of the least 7% sales growth, which has been driven by a combination of net price realization, core brand volume, growth in US and international markets, and innovation.

In the fourth quarter, net sales increased 11.7%, slightly better than our expectations, driven primarily by volume.

And this is translated into solid gross margin, EBIT margin and EPS growth.

In 2013, adjusted EPS diluted growth was 14.8%, our fifth consecutive year of double-digit percentage increases.

The category is performing well, and our business model is working.

However, we are not content.

Using history as a guide, we recognize that consumer needs and behavior continuously evolve.

We have been building and our proprietary IDP platform and look to leverage the vast amounts of available data related to consumer patterns around everyday events, and how they tie into shopping, purchasing decisions, consumption, et cetera.

This initial work has resulted in accelerated, profitable, organic sales growth and enabled Hershey to reclaim its CMG category leadership position in the US with a 31.1% share of the market.

We are also pleased with the continued progression of our international businesses outside of US and Canada.

For the full year, our international net sales increased about 16%, including the impact of foreign currency exchange rates, and we're on track to achieve close to $1 billion in net sales in these markets by the end of 2014.

And I'm excited about our recently announced agreement with Shanghai Golden Monkey.

The strength of Shanghai Golden Monkey's confectionary portfolio, manufacturing expertise and overall distribution capabilities, especially within the traditional trade, is an opportunity for us to leverage scale to make the iconic brands of both our companies even more powerful.

We believe the investments we are making across our businesses position us for future growth.

Furthermore, the dynamics of the confectionary category, impulsivity, conversion rate at checkout, seasons, multiple pack types and so on, are an advantage for all category participants.

As has been the case for the last few years, we continue to expect solid brand building investments in the form of innovation and advertising by many category participants.

As a result, in 2014, we anticipate candy and mint category growth to be in the 3.5% to 4.5% range.

Although note that you will see some lumpiness in category and Hershey performance in the March and April time frames, given the timing impacts of Easter this year versus the previous year.

Now, for an overview of the US candy, mint and gum category.

For the full year, in the xAOC plus C-store channels -- and as a reminder, this data consists of the food, drug, mass X and C-store channels, plus the inclusion of Walmart, Partial Dollar, club and military channels -- growth was solid in the chocolate, non-chocolate, and mint categories, which increased a combined plus 3.9%, well within the 3% to 4% historical growth rate.

The increase in candy and mints outpaced other snack alternatives such as salty snacks, snack nuts, cookies and crackers.

As has been the case for the last few years, the gum category has been challenged and weighed on overall CMG -- that's candy, mint, and gum -- results.

Therefore, including the full-year decline of 5.6% for the gum category, CMG growth was 2.5%.

CMG fourth-quarter category growth in the xAOC plus C channels was up 2.5%.

As I mentioned earlier, gum continues to be a drag.

And excluding it, the chocolate, non-chocolate, and mint categories increased a combined 3.5%.

Before I get into our segment marketplace discussion, let me summarize our successful Q4 seasonal performance.

For the combined Halloween and holiday seasons, Hershey retail takeaway was up 4.2%.

Importantly, our seasonal sell-through was on target, and we gained 0.6 share points in Halloween and 1.4 points in the holiday season.

This was our third and fourth consecutive years of Halloween and holiday market share growth.

Our key categories did well and Hershey outperformed.

Specifically, Hershey CMG retail takeaway for the 12 weeks ending December 28, 2013 in the xAOC plus C channels that account for about 90% of our US retail business was up 5.2%, resulting in a 0.8 point market share gain.

For the full year, Hershey US retail takeaway and market share was up 6.3% and 1.1 points, respectively.

We are proud of our US marketplace performance, as we have gained market share in every channel that we compete for the third consecutive year.

Fourth quarter chocolate candy xAOC plus C category growth was up plus 4.3%.

Hershey Q4 chocolate retail takeaway was 5.3%, resulting in a gain of 0.4 points of chocolate market share.

Core brands such as Reese's, Kit Kat, and Rollo, as well as Brookside, all gained share.

For the full year, our chocolate retail takeaway and market share was up 6.6% and 0.9 points, respectively.

Fourth-quarter and full-year non-chocolate candy, xAOC plus C category growth, was plus 1.2% and 2.6% versus the year-ago periods.

In 2013, our innovation was primarily focused on chocolate.

Additionally, throughout the year, we were lapping very successful year-ago non-chocolate candy innovation and in-store programming.

As a result, in 2013, we lost 0.2 points of NCC market share.

We are making solid investments here in 2014, with some innovative new products that we believe will result in non-chocolate candy gain.

More on this later.

While not as large as chocolate and NCC, I would be remiss if I didn't mention the success of our gum and mint business.

In 2013, our gum and mint retail takeaway was up 27% and 11%, respectively.

As a result, our gum market share increased 1 full point, and we now have a 4% share of the market.

Our mint market share increased 1.2 points, and our segment-leading market share is 38.9%.

Looking at key channels, I am very pleased with out business in the traditional FDMx channels, where our performance has been solid.

For the 12 and 52 weeks ended December 28, our CMG retail takeaway was up 3.4% and 4.4%.

We gained 0.8 share points here for the full year, driven by the food and drug classes of trade.

In the C-store channel, CMG fourth-quarter and full-year category growth in both periods was up 3.3% and impacted by a mid-single-digit percentage decline in the gum category.

Excluding gum for the fourth quarter and full year, C-store combined candy and mint retail growth was 5.8% and 5.9%.

Total Hershey C-store performance was solid, with Q4 in 2013 retail takeaway of 5.5% and 7.5%, resulting in market share gain of 0.7 points and 1.3 points.

As we look to 2014, we have many exciting products, promotions, programs and merchandising in place across all channels, including our annual Reese's NCAA basketball and football programs, in-store merchandising and programming of Hershey S'mores, and the launch of many new products such as Hershey spreads in a 13 ounce jar, as well as on-the-go pack type with graham cracker sticks, Lancaster Soft Cremes Caramels, York Minis, the continued rollout of 3 ounce Brookside instant consumable pack type, the Q4 that launch of Brookside Crunchy Clusters, Jolly Rancher and Twizzlers Bites and stand-up take-home pouches and our innovative instant consumable flex pack that fits in a cup holder, and a yet to be announced new product that we are very excited about.

We are proud of the gains that we have made in the US, so now I will provide some color on the solid progress we have made in other markets, starting with Canada.

Looking North, our business in Canada had a good year on all metrics.

Net sales increased 5% versus the prior year, resulting in solid gross margin and operating income improvement.

A portion of these gains were in advertising and consumer promotion that mid-single-digit growth in retail takeaway.

Our combined candy and mints market share was up 0.3 points for the year, enabling us to become the market leader in Canada with a 16.6% share of the market.

Growth was fueled by Hershey, Brookside, and Icebreakers.

As expected, outside the US and Canada, net sales accelerated in the fourth quarter, up 27%, slightly greater than our expectations.

For the full year, international sales of $807 million increased 16%, including the impact of foreign currency exchange rates.

In China, Brazil, and Mexico, we made solid progress in 2013, with net sales up a combined 25% in these markets.

In our key markets, our brands are gaining distribution, trial and more importantly, repeat purchases.

On-shelf velocity of Kisses and Hershey's branded products is increasing, and we will build on our momentum in 2014.

Additionally, we will look to accelerate the testing and launch of our other global brands, Reese's, Icebreakers, and Jolly Ranchers, in key markets.

Therefore, in 2014, based on current exchange rates, we expect net sales outside the US and Canada to increase towards the top end of our 15% to 20% target, which would put us close to our $1 billion goal.

By country, our business in China had a solid quarter and ended the year strong.

Chocolate category growth in Q4 was up low double digits, and for the year, increased about 14%.

In 2013, Hershey was the fastest-growing chocolate company in China, as consumers responded to Hershey's advertising and innovation, such as Hershey's Drops and Kisses Deluxe.

As a result, China was our best performing international market, with full-year retail takeaway up about 45%.

Importantly in November, we crossed a major milestone and reached a 10.2% share of the China chocolate market.

Our momentum gives us confidence that the investments we have made, and will continue to make, in consumer insights and route to market, will benefit our business in the near and the long term.

In Mexico, our chocolate business, driven primarily by the Hershey's, Hershey's Bites, and Kisses, had a solid year.

In 2013, our modern trade chocolate retail takeaway was about double the category growth rate, resulting in a market share gain of 2 points.

Our overall chocolate market share in the modern trade is about 21%, and we expect to build on our momentum in 2014 with an expansion of the Reese's test market that has been underway for the last six months, primarily in the C-store channel.

Our Mexico NCC business lost 0.2 points this year.

However, it sequentially improved versus last quarter, driven by the launch of Jolly Rancher filled lollipops and take-home pack types of Pelon and Pelonetes items.

In Brazil, our chocolate business grew about double the category.

Market share was up 0.2 points, driven by Hershey's Bars and Hershey's Mice, which has quickly established a one-eighth share of the sub-segment of chocolate covered wafer products.

Reese's was introduced at a major customer earlier this year, and has gained traction, becoming a top five SKU at this retailer.

In 2014, we will continue with the Reese's expansion and the testing of other global brands.

Now to wrap up.

I'm pleased with the way the confectionary category and Hershey continue to perform.

We have a solid position in the marketplace, and we are responding to retail customer needs to drive overall category growth.

We have consumer driven plans in 2014, and expect to drive top line volume growth by a combination of core brand growth and innovation.

Dave Tacka will provide further details, but expected gross margin gains in 2014 should give us the financial flexibility to make SM&A investments, including advertising and related consumer marketing, which we estimate will increase mid to high single-digits on a percentage basis versus last year.

As a result, we expect full year 2014 net sales and adjusted earnings per share diluted growth to be within the Company's long-term 5% to 7% and 9% to 11% objectives.

I will now turn it over to Dave, who will provide some additional detail on our financial results.

Thank you, J.P., and good morning everyone.

Hershey posted another quarter of solid results, with consolidated net sales of $1.96 billion, up 11.7% versus last year, generating adjusted earnings per share diluted of $0.86 per share, up16.2% versus last year.

The sales increase was slightly greater than our expectations, due to a solid US holiday season and stronger than anticipated international growth.

Nonetheless, the profile of organic net sales growth was relatively on target, with North America contributing about two-thirds, or 8.7 points, of the growth and international about one-third, or 3.5 points.

The impact from foreign currency exchange rates was 0.5 points unfavorable.

The Brookside business continued to do well, contributing 1.2 points to overall Q4 net sales growth.

For the full year, Brookside net sales increased 74%, in line with our target.

In 2014, we would expect Brookside net sales growth to increase greater than the Company's long-term target, although not at the level achieved in 2013.

Turning to margins, in the fourth quarter, adjusted gross margin increased 80 basis points.

This improvement was lower than our estimate, primarily because greater than expected Q4 volume required purchases of certain raw materials at higher prices and year-end LIFO and related inventory calculations resulted in slightly higher costs than our forecasts.

For the full-year, adjusted gross margin expanded 220 basis points, a truly excellent performance.

Input costs deflation of approximately $122 million provided about 160 basis points of the improvement.

The remaining 60 basis points resulted from supply-chain productivity, sales mix improvements, and fixed cost absorption, driven by the strong sales volume gains.

In 2014, we expect a gross margin improvement around 80 -- or I'm sorry, around 50 basis points, driven by supply-chain productivity, sales mix, and fixed cost absorption.

Despite volatility in the commodity markets, we have good visibility into our 2014 input costs, with the exception of dairy, as there's not a developed futures market.

We do not expect commodity costs deflation in 2014.

Adjusted EBIT in the quarter increased 15.3% versus last year, generating adjusted EBIT margin of 16.3%, a 50 basis point improvement.

The increase was driven by the adjusted gross margin improvement.

Adjusted SM&A expenses increased 12.8% versus last year, driven by increased advertising and SG&A spending.

Advertising expense in the fourth quarter and full year increased 20% and 21% respectively versus the year ago periods.

We continue to believe that on-air and digital advertising activities are a key factor contributing to our US sales growth and our momentums in key international markets.

We believe that we are now approaching continuity of advertising support levels in North America.

In 2014, we expect advertising and related consumer marketing to increase mid to high single digits on a percentage basis versus the prior year.

In the fourth quarter, adjusted SG&A, excluding advertising, increased 10.1% versus last year, in line with our estimate.

This increase reflects continued investments in knowledge-based consumer insights, non-advertising brand building, and route to market capabilities in both the US and international markets, which will benefit the Company in the near and long term.

In 2014, we will continue to invest in our knowledge and capabilities.

However, given our strong sales growth, we expect that we will begin to see some leverage on this line item.

Now let me provide a brief update on our international business.

As expected, net sales outside the US and Canada accelerated in the fourth quarter, increasing by 27.1%, driven by gains in China, Brazil, and our export businesses.

International net sales trends sequentially improved every quarter throughout the year, and we expect to carry our momentum into 2014.

Total international gross margin improved 200 basis points for the year, although operating income declined versus last year, given our investments in route to market, brand building initiatives, and full-year ownership of our India business.

We remain committed to these markets, and will continue to make the necessary investments to build brand equity, drive trial and repeat purchases.

As J.P. stated, we expect solid international sales growth in 2014, which will put us close to our goal of $1 billion in net sales outside the US and Canada.

This estimate excludes the Shanghai Golden Monkey business, which we are hopeful will close by the end of the second quarter.

Moving down the P&L, fourth-quarter interest expense of $21.9 million declined $0.8 million versus $22.7 million last year.

For the full year, interest expense was $88.4 million, slightly less than our estimate.

In 2014, we expect interest expense to be in the $80 million to $85 million range.

The adjusted tax rate for the fourth quarter was 34.2%, greater than the year-ago period, resulting in a full-year tax rate of 34.3%, which was relatively in line with our estimate.

In 2014, we expect the adjusted tax rate, again, to be about 34.5%.

But note that in the first quarter, we expect the tax rate to be closer to 35%.

For the fourth quarter of 2013, weighted average shares outstanding on a diluted basis were approximately 227 million shares, leading to adjusted earnings per share diluted of $0.86, an increase of 16.2% versus year ago.

Our full-year results were very strong.

Full-year net sales increased 7.6%.

Adjusted EBIT increased 11.8%, resulting in adjusted EBIT margin of 19.2%, up 70 basis points versus last year.

Advertising increased 21% for the year, relatively in line with our estimate.

Gross margin was 46% versus 43.8% last year, a 220 basis point gain.

And adjusted earnings per share diluted increased 14.8% to $3.72.

Turning now to the balance sheet and cash flow, year-end net trading capital increased by $23 million.

Accounts Receivable was higher by $17 million as a result of increased sales, and remains extremely current.

Inventory was higher by $26 million, primarily in finished goods, and Accounts Payable increased by $20 million.

In terms of other specific cash flow items, total capital additions, including software, were $123 million in the fourth quarter and $351 million for the full year.

This spending is about $30 million higher than our previous estimate, primarily because of extra -- of acceleration of spending on certain projects.

Construction has begun on the manufacturing facility we are building in Johor, Malaysia, and timing is on track.

In 2014, we expect total capital expenditures to be about $355 million to $375 million, including capital related to the Johor project, of $120 million to $130 million.

The total capital project is about a $240 million investment.

Depreciation and amortization was $50 million in the fourth quarter and $201 million for the full year of 2013, in line with our estimates.

Dividends paid during the quarter were $106 million, and $394 million for the full year.

Cash on hand at the end of the fourth quarter was $1.1 billion.

We did not acquire any stock in the fourth quarter.

Let me close by providing some context on our 2014 outlook.

As J.P. outlined, we have initiatives in place that we believe will continue to drive net sales growth across our business.

We're confident in our plans, and we expect 2014 net sales growth of about 5% to 7%, including the impact of foreign currency exchange rates.

We expect our net sales gains to be driven by core brand volume growth and innovation in the US and international markets, complemented by in-store merchandising, programming and advertising.

We expect first-quarter net sales growth rates to be tempered versus the strong distribution gains of Brookside in the first quarter of last year.

We also expect foreign currency headwinds, given recent volatility, particularly for Canada and Brazil.

We have good visibility into our full-year cost structure, with the exception of dairy costs.

We expect our gross margin to improve around 50 basis points, driven by productivity and the final Project Next Century cost savings.

We also expect a favorable sales mix.

We do not expect input costs deflation in 2014.

Advertising and related consumer marketing is expected to increase mid to high single digits on a percentage basis versus last year.

SG&A expenses, excluding advertising, are expected to increase at a more modest level in 2014, as we build on the investments and go to market capabilities established over the last few years, as well as consumer knowledge-based projects related to our insights-driven performance work.

In the first quarter, we expect SG&A cost increases of low double digits versus last year, reflecting the new hires and initiatives brought on in the second half of 2013.

We expect full-year adjusted earnings per share diluted to increase within our long-term growth rate of 9% to 11%.

Note that this outlook excludes operating results related to Shanghai Golden Monkey.

Excluding acquisitions and transaction costs, we expect the acquisition to be slightly accretive on an adjusted basis in 2014.

I will now turn it back to Mark to go to Q&A.

Okay.

Before we go to Q&A, J.P., Dave and I will answer your business questions.

Note that Bert Alfonso, President International, is also with us, and will answer any questions you may have related to Shanghai Golden Monkey.

Given that we are in regulatory review, commentary here will be limited.

In the interest of time, please limit yourself to one question and direct all business-related inquiries to J.P. and Dave.

Operator, can you please set up the first question, please?

Our first question comes from Ken Goldman of JPMorgan.

Good morning.

Bert, I thought we got rid of you.

(laughter)

Fortunately, that's not the case.

All right.

Dave, can you talk about what you're seeing in the Cocoa market?

The near term contracts and spiking again?

When you and I last spoke, you weren't overly concerned by fundamentals.

I was hoping for an update of your thoughts.

I guess I'm not going to comment on our views and coverage with respect to specific markets beyond what I have said about that, that we have good visibility into our cost structure except for dairy.

And so I'm not going to comment beyond that.

Can you maybe add some comment on what you're seeing on the fundamentals?

Do you think there's enough supply out there, given demand?

Well, the Cocoa market has been volatile, and -- but arrivals at the port were a little past midway in the harvest.

And arrivals at this point at the port have been very, very strong.

And so the estimates of supply and demand have been growing more balanced as that has arrived.

So I think that's the thing that you're seeing that the analysts are doing.

We are very confident that we will have solid supplies and that there's enough supply to meet manufacturing needs.

Thanks.

I'll get back in the queue.

Kenneth Zaslow, BMO Capital Markets

I just want to ask you, your decision to launch a new brand -- a lot of companies trying to do launching of new brands, and they don't tend to be successful; there are a lot of costs associated.

If anybody can do it, let me tell you, it's definitely Hershey.

But I guess my question is, what went into the decision of trying to launch a new brand in the US?

What are the costs associated with it?

And how do you measure the success?

I think that -- you know what?

You have probably heard us talk a lot about it.

We are doing fewer -- what we would call fewer, bigger better.

And we believe we are far more consumer-centric than we have been as we look at our demand landscapes and where there's opportunity.

So while obviously a market the size of the US has different cost implications to some market, it also has the magic elixir of volume as well.

So when we look at something like our spreads launch, which is currently underway, what we saw is that this is a $3.4 billion category in spreads.

And so spreads includes peanut butter, marmalades, and other kinds of things.

And then the fastest-growing sub-segment of that are really chocolate spreads.

So we looked for unmet needs.

And one of the unmet needs, not only in the fast-growing category, was that it was primarily a breakfast occasion.

And as we believe we can bring great chocolate credentials to that space, we are also looking at variety and day parts that are different than what was happening.

So these could be used on apples, bananas, fruits.

It's almost endless.

Strawberries, it could be on traditional brand at breakfast occasions; but it makes for a great tasting and a way to get also healthy snacking throughout the day.

All of those kind of things go into that decision.

And what is great for us is this is really incremental.

It's not cannibalistic to what we do already.

That's an -- I wanted to give you a hard example of how we might look at a demand landscape and then try to understand if we should participate there or not.

And this is one that we are quite enthusiastic about.

The other example that has worked terrific for us is really Brookside.

Brookside is a dark chocolate.

It satisfies a need that really wasn't there.

It has a package that lends itself to portion control, as well as on-the-go and hand-to-mouth.

So we look at all of those different things.

And if you look at our results this year, our innovation has been terrific over the last -- in fact, really, over the last several years.

So we talk about wanting 1 point of our growth coming from innovation, but we have done significantly better than that.

So it's really not the frequency of innovation; it's really the quality of the innovation.

The same logic goes for Lancaster?

Yes.

Great.

Thank you.

Jonathan Feeney, Janney

I wanted to understand the Chinese market a little bit better.

You mentioned you reached about a 10-share.

Maybe if you could give us a sense of what the structure of that market looks like competitively?

How that looks post the closing of Golden Monkey?

And what are some, if you have them, realistic goals for 5 or 10 years for the Hershey company in China?

To the extent that you can provide detail around that, I would appreciate it.

Thanks.

First of all, our business in China today is largely a modern trade business.

It is focused across major metropolitan areas.

We are in 130, 150 cities in total.

But the way we think about it is really, how can we execute our business model?

So how do we build our brand for portfolio?

How we build consumer awareness around that?

So if you think about concentric circles and economic density, we really want to build those out.

China is such a vast place that really talking about being national may be the wrong way to think about it.

So we're quite patient.

What we really want to do is make sure our businesses are solid and that they are funded well, and that we can build out our portfolio.

Our portfolio in China today is still young, so we have a lot of opportunity there.

And then, as you will probably hear from Bert at some point, the acquisition that we have made gives us the ability to have broader reach in tier 2- and 3-type cities, with a portfolio that is broad and is also different than the portfolio we have there today.

So those are all things that we look at.

And one another exciting thing about China is when you see the convenience channel developing there, and instant consumable being one of our real core competencies, we see that as a tremendous opportunity as well.

And J.P., just a clarification.

You said the modern trade.

Can you give us a sense, over the candy, mint and gum market in China, what piece would you estimate that the modern trade comprises presently?

Half of it, 20% of it?

A ballpark would be fine.

It's -- this is Bert.

It's quite different, chocolate versus non-chocolate.

And so it's a large portion.

I wouldn't have the exact number.

I would say more than 50% in the modern trade.

Very ace, tier-1-city oriented.

And we estimate the retail level to be at about $1.5 billion.

The non-chocolate, which is much less concentrated in the modern trade, would be about $5 billion to $6 billion.

And again, it moves further down the chain in terms of as J.P. already mentioned, it is in modern -- in tier 1 cities, but you find a lot more in tier 2 and tier 3.

The one other thing I would just add to that is that we believe about 300 million to 400 million people participate in the chocolate category today with some frequency.

So that also begins to be another dimension to how to think about the size and scale versus the potential.

Great.

Thank you very much.

Eric Katzman, Deutsche Bank.

My question has to do a little bit with the fourth quarter.

I think you said the US business, including the holidays shipments, were up 8% or 9% or so; but I think you said your off-take was up 5% or 6%.

What accounts for the difference?

Yes, there are a couple of things, Eric, that we believe is going on there, if you look at the data.

We had very good holiday execution.

We felt good about that.

But the quad ending December 28 is missing a full week of data.

And one of the things that we see happening is, especially around some of the seasonal events, is a higher percentage of volume is going into those last couple of weeks.

So that's part of it.

And then if you look at the Wall Street data, while I haven't been through it in detail, I think what you see is that you have -- I think we're up about 8% or so with that data, which goes through, I think, the first two or three weeks of January.

So it really shows that it starts to pick up some of that.

And then the other thing that was happening that's in that number is, is that we had gotten to very low inventories.

We had a significant growth rate in the first half.

Some of our brands were growing double the rate of the category, especially in the chocolate segment.

So if you look at the chocolate segment in particular, which has continued to remain really strong, we saw some inventory rebuilding throughout the fourth quarter.

And so there could be a couple of points as you got into December that came back in terms of inventory rebuild to more normal levels.

They are still low, but they're closer to the normal range of what we saw.

So I think those are the two biggest components.

The thing that was encouraging to me, as I looked at that data, really was the fact that it looks as though things are coming back nicely.

So whether that's an anomaly or not, I don't know.

But we continue to feel pretty good about what we think the category growth rate is going to be in 2014.

Okay.

And then if I could just -- a quick one for Dave.

Is there any reason why free cash flow shouldn't be growing basically in line with earnings this year?

I guess CapEx is up a little bit, but maybe you get a little working capital improvement towards the year end?

I think what I would say is that if you look at operating cash flow, it should be growing in line with earnings.

And we kind of gave you some outlines around the CapEx and dividends.

Okay.

I will pass it on.

Thank you.

Robert Moskow, Credit Suisse

Follow-up question on fourth quarter.

The gross margin was a little below expectations, and I guess the advertising spend was a little below expectations also.

Regarding the gross margin, is -- were you forced to buy materials on the spot markets?

And is that why your costs ended up a little higher than you thought?

And then also, if this a LIFO issue, does that mean that you have LIFO layers that are -- that you can dip into in 2014 that have maybe lower ingredient costs than what we see in the spot market?

I'm really testing my accounting knowledge here, so I'm hoping you can bail me out.

(laughter)

First of all, you're right.

The reason that we -- that the gross margin was lower than we forecasted in the fourth quarter was that we did have some higher commodity costs associated with the higher sales that we had in the fourth quarter.

And so we wound up picking up some materials at spot prices.

And in the year-end accounting, there's a number of calculations, including LIFO and things -- and it also includes things like how fixed costs go into inventory and that sort of thing.

And those things just came in with a little bit more expense than we had forecast.

I think the important thing on the gross margin is that the full-year gross margin improvement of 220 basis points was very strong, and it included solid productivity gains in sales mix improvements, which are really the things that will continue to drive our gross margin improvement as we go forward.

Okay.

And the advertising?

The advertising was basically -- it was, the spending was a little bit lower than we had forecast.

But there was nothing significant that we did that caused that.

All right.

I will follow up later.

Bryan Spillane, Bank of America

Just a question on the international business.

And I guess if we look at it, there was -- profit dollars were up about $150 million for 2013.

And in the commentary, you said that about one-third of your volume growth for the year came from the international operation.

Can you give us some idea about, if we look just the profit dollar contribution, not margins, but just how much of the profit dollar growth came from international.

Is it more than one-third of revenues?

Is it less?

I'm just trying to get a sense for how much -- now that that's becoming such a big flood of revenue, just how it is contributing to the profit growth.

And maybe -- again, not even -- if it is not specific, but try to give us some sense for, as we model 2014, what your expectations are in terms of how the international revenues will contribute to profit growth.

Essentially, what we talked about is that in the international business, we had strong gross margin improvement.

And beyond that, we continue to invest in the business.

And so I guess what I would say at this point is that we continue to be on our targets, as we're going to building the models out in the international business.

But we are continuing to invest in the advertising and those parts in the international business.

Yes Bryan, it's Mark.

Just to clarify, the 3.5 points was the fourth quarter contribution from international.

They had a very strong second half of the year, as we expected; and it will probably be a similar type of profile even in 2014, where international second half is bigger than the first half.

Okay.

I guess what I was trying to get at is, are we at a point where the -- you get leverage, really, on the SG&A spending, where it's not just that it's actually -- you're obviously having a really good contribution to the revenue growth.

But at what point -- or where are we, I guess, in terms of that evolution, where the international growth also -- you get the leverage on the operating profit line, where it's really going to be a contributor to operating profit growth?

(multiple speakers).

Yes, I think, Bryan, we are still early in the curve of our evolution there.

So you know what?

We want to make sure that the SG&A investments that we're making to continue to drive top-line growth.

Even in markets like China, our portfolio is quite limited today.

As you look around in some of these key markets, that would continue to be true as well.

So we're going to follow our business model of brand building.

Because we have good, healthy gross margins, it does give us the chance to moderate that if we chose to do it.

But right now, we continue to believe that we are building consumer awareness, we're establishing brands.

And so, I think we're going to continue to be in an investment mode for a while.

But obviously, we look at SG&A leverage in a number of different ways, and we want to be mindful that we grow into any investments that we've made if, for some reason, we were out over our skis.

Okay, great.

Thank you.

David Driscoll, Citi.

Congratulations on another strong year.

My question, I want to focus on the US a little bit.

Brookside.

I think, by the numbers you gave, I would calculate that Brookside has now got a total size of something like $200 million.

Where do you think that this can go?

And then when you talk about new product contributions of 1 point, I would assume that because Brookside has such strong momentum going into 2014, new products -- and I'm hoping I can count this as one of them, it will be more than 1 point of contribution in 2014.

So all things Brookside.

I think first of all, your estimate around where Brookside is currently at is certainly a good one.

And then to just you just give you a little bit of dimension on the full year.

So when we talk about 5 to 7, on the low side, that innovation would be about 1 point of the algorithm.

And on the top side, obviously, it would be closer to 2 points.

If you look at 2013, most of our volume -- literally all of the volume was volume growth.

But the beauty of it was that on those core brands, it was up about 3.8.

Volume on new products was up above 2.

And then Brookside was not considered a new product in 2013, and so it also had a significant contribution of about 1.3 points of that growth.

So if you take those numbers, you get a little bit above the 7.6 growth rate.

But then you take the FX out, and that's how you land back at 7.6.

So we have been very fortunate that these new brands that we've introduced have been quite accretive to the portfolio, and then we have been able to have quality innovation.

And nobody is going to ever have a perfect record on innovation, but we have been very fortunate that we have had quite solid innovation that has helped.

And then these brands are sticky.

They are contributing as they go forward.

And then the potential of Brookside, I don't have any problem in thinking about it as a $500 million brand.

I don't have a date on that.

None of us know going well forward into the future, but I see this as a brand that has global relevance.

And we just have to do a good job and make the most of it, but I think this is a terrific brand that will establish itself truly as a big brand.

That was really helpful, J.P. If I could just do one follow-up on the US business?

I believe that one of your competitors is going to launch a Super Bowl commercial on Butterfingers and maybe trying to grab a slice of the Reese's pie.

Do you see a lot of interaction between those brands?

And do you have to do something special to defend yourself there?

We have very solid programming on our Reese's brand.

This is a very, very big brand.

And so we take all of these things seriously.

I think anything that brings people to the category is great.

Reese's defines, largely, the sweet and salty segment.

Usually when you have a variant of a parent brand, it never becomes as large as the parent.

And so, while I'm sure that it's a great product and they will do well, we will make sure that we are fighting for our space.

And as you get into March and March Madness and college football with the NCAA programs and things, we have got terrific programming on Reese's.

¶ We will defend it at home, and we're looking to grow it globally.

So we are up for any fights that come our way.

I like it.

Thank you.

Andrew Lazar, Barclays.

With the category expected to grow, as you said at the outset, to 3.5% to 4.5% this year, so many from new products you are putting out international contribution, it certainly seems like there is, obviously, the high level of confidence in visibility in the 5% to 7% sales growth forecast for this year.

I guess partly where you fall in that range, or even if you ultimately get above it, depends on the ability to also continue to take market share as you have been doing pretty consistently.

I'm just trying to get a sense, does a combination of the marketing spending, the innovation that you've got, give you enough comfort on additional market share gains, even in light of maybe more category activity?

Yes.

I think the category activity will be good for the category in total.

It's an expandable consumption category.

So I think welcome those things, and I'm sure retailers do as well.

And then we continue to feel really good about the execution we have against our brands.

So our goals are obviously to continue to execute well.

And I think we've got a pattern, and a model, that has demonstrated our ability to grow share.

And so I think a healthy category is really fundamental to that.

But I think what you will see is quality, rational behavior in the category; and that is good for everybody.

And on the new product you talked about, when is that expected to hit the shelves this year?

And can you even comment on whether it's in the core confectionary sort of wheelhouse?

Or is it something more on the fringe, like a spread type thing?

I thought I'd give it a try.

(laughter)

Yes, we're probably not going to talk about that one quite yet, because we want to do a really good job with the release and announcement of that.

So obviously, you'll get a chance to see that.

It's later in the year.

But the things that we're currently doing, we continue to feel really good about getting off to a great start; and advertising on spreads is starting.

I think it's about February when we begin to see some other incremental advertising on some of the other things we are doing.

It's a consumable spread products, started shipping in November; but it's really building its presence now and on the front end and so on.

So we have got plenty of things to keep us busy.

And we will make sure that when we get ready with our new item later in the year that you won't miss it.

I'm certain of that.

Thank you.

David Palmer, RBC

A question on advertising.

Hershey has, obviously, over the many years that you have been getting more consumer-focused and centric in your approach, you have been going from the low end, it appears, to the high end on ad spending.

While you're continuing to ramp that, at least as high as sales, perhaps the massive increases are over.

And with that in mind, are you seeing less obvious ROI on incremental ad spending in certain areas?

Perhaps in the US market, perhaps with the New Age media and the less live TV watching, so to speak, that's going on out there?

Are you finding efficiencies in certain areas while expecting to ramp up in others?

Any sort of color about ad spending.

One question that would come up is, with less advertising ramp, does that mean less core growth?

And what would you say to that concern?

Thanks, guys.

We look at our line on our advertising very carefully.

We -- of course, the mixed moves around; so it's not always on the same things.

But when you get a brand toward the top of the curve, and it is at a sustaining level, it doesn't mean you get to a sustaining level and things begin to decline.

So you look at those things all of the time.

So we are very rigorous with our models on how we how we analyze ROI, so I feel very comfortable with that.

I think an important thing that you have mentioned is, is how does media evolve?

And are we participating in ways where we think we have our most effective media?

So one of the things that we do is where we believe we aren't getting the ROI that we would like to get, we look at how do we use alternative media types, how do you add digital to that?

We are continuously learning on our brands.

So on a big brand like Reese's, 10% of its budget is in digital; and we continue to learn there.

I wouldn't tell you that many people, and I wouldn't claim that we had mastered all of the evolution of digital.

But we look at the ROIs on that as best as we can and feel that we're doing the right thing there as well.

So I think that with these -- you can't make assumptions that just because you get to sustaining levels means all of a sudden that means a brand is going to decline.

But it also means that you can look at that and plus and minus how you're doing that.

But it's all driven by a combination of ROI and marketplace need.

Thank you very much.

Jason English, Goldman Sachs

A couple of quick questions.

First, J.P., you gave us an outlook for the category next year of -- I think it was 3.5%, 4.0%, 4.5% type growth.

Correct.

As we think about this category growth, are you expecting pricing to be a component of it?

Or is that all volume-driven?

We don't -- when we give our guidance, we don't include anything that would be M&A or pricing oriented.

It includes what we believe FX impact will be.

So that's not in those numbers.

I'm not referring to your guidance; I'm referring to your outlook for the category.

The outlook for the category would not have pricing as a component.

Okay, that's helpful.

And now I want to turn to international.

With it becoming such an important piece of the story here, particularly from a growth perspective, I was hoping you could give us a little bit more detail on it.

Specifically, can you give us a sense of the 16% growth?

This 25% in China, Brazil and Mexico, and 45% in China -- how much of that is distribution-related versus just the core?

And also, can you give us a sense of the magnitude or scale of these three markets relative to the $807 million figure you gave overall?

I tell you what let's do -- let's advantage of Bert being here, and he can chat about that; and I will fill in if it's appropriate.

Yes, I would tell you that if you look at Mexico and Brazil with respect to distribution versus new and versus just core growth, non-distribution, it was largely all volume and not a lot on the distribution piece.

China is quite different, where we are still expanding into more cities.

And so, of the China growth, about one-third of that would be additional distribution, with the rest being velocity increases driven by advertising and some new brand activities.

J.P. already mentioned, we launched Hershey's Drops; we launched a test market for Reese's, as well as for IB mints and, toward the end of the year, Kisses Deluxe.

Any color on the size of the markets?

We're not a segment reporter, although I'm sure we will get there in due course.

But the only thing that we would continue to say is that we're shooting very close to that $1 billion mark, which we have been targeting for 2014.

Among those, I would say that China and Mexico are the bigger countries, with Mexico still being our biggest outside of US and Canada.

Although that probably will change as we get into that.

And we will give you a lot more color when we get to CAGNY, I think, with respect to the different countries.

And while Brazil grew very quickly last year, despite the FX impact, it's the smaller of the three.

Great.

I look forward to CAGNY.

Matthew Grainger, Morgan Stanley

Just a follow-up on international.

You talked about accelerating growth in your key emerging markets through the year and sustaining some of that momentum into 2014, which obviously runs a little bit counter to what we're hearing from other consumer companies or specific categories.

Does your outlook for close to 20% sales growth reflect the view that your categories aren't showing any evidence of slowing?

Or does it reflect an expectation maybe of even more robust or accelerated share growth over the next year?

Yes, I think what you're hearing about emerging markets could be different based on the categories across different CBG companies and what their maturity and development is.

Our category, and this is one of the things that I think makes it an advantaged category at this point in time in history is, is the category is still relatively modest in the number of these markets.

Consumers are participating in the category with greater frequency, and we continue to expand portfolio offerings as we go.

So again, I think they are very constructive markets, in that it's not a battle for market share in a stagnant or challenged environment.

It's really about building brands, it's building the category, it's being rational, and consumers come to the category.

So I think that's why, when you hear the players in the category talk about it, you probably hear some things that may seem to be a bit disconnected from the total.

And I'm not to say that we are immune from all things.

But I just think the category dynamics are quite different than a number of the other categories, and that's really why you hear some of these different commentary.

(multiple speakers) I think the other thing, when we talk about the 15% to 20%, that does include FX.

We continue to see very good growth in local currencies.

Okay.

Thanks.

Apologies if I missed it, but can you give us a sense of what you are expecting in terms of an FX headwind to sales for next year?

We didn't say that; but at current exchange rates, it would be about 0.5 point.

But it will be heavier in the first half of the year and a little bit less in the second half.

Okay.

So close to 5% impact on international, then?

0.5% on consolidated.

Consolidated, yes.

Okay.

Yes.

Okay, great.

Thanks.

Operator, we have time for one more question.

Alexia Howard, Sanford Bernstein.

While we have got Bert on the line, can I ask one more question related to the Shanghai Golden Monkey acquisition?

Specifically how it affects the margin trajectory in China.

I think before the acquisition was announced, it was going to be a few years before breakeven was achieved in the country.

Presumably, the acquisition puts you on a different trajectory here.

Maybe you can comment on that.

Thank you very much.

Good morning Alexia.

Yes, I think you've got it right.

We are obviously in much more of an investment mode in the chocolate side of the business, which is our current business.

And we already mentioned Shanghai Golden Monkey would be slightly accretive, if you exclude any of the one-time charges for integration post approval and post closing.

So it will help that along at a little bit quicker pace than we would have had without the acquisition.

Thank you very much.

I will pass it on.

Okay, thank you very much for participating in today's conference call.

Investor relations group will be available all day for any follow-up calls you may have, and we will see you all at CAGNY.

This concludes today's conference call.

You may now disconnect.