好時 (HSY) 2014 Q2 法說會逐字稿

Good morning.

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

At the time, I would like to welcome everyone to The Hershey Company's second-quarter 2014 results conference call.

(Operator Instructions)

Mr. Mark Pogharian, you may begin your conference.

Thank you, Phyllis.

Good morning, ladies and gentlemen.

Welcome to The Hershey Company's second-quarter 2014 conference call.

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

We also 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 2013 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 pro forma reconciliations of select income statement line items quantitatively reconciled to GAAP.

The Company uses these non-GAAP measures as key metrics for evaluative 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 2014 second quarter results excluding net pretax charges of $2 million, or $0.01 per share diluted, related to net acquisition and transaction costs primarily associated with Shanghai Golden Monkey, Project Next Century charges, as well as nonservice-related pension income.

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 JP Bilbrey.

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

Net sales sequentially improved versus the first quarter, and we continue to make progress against the initiatives that will drive improved performance over the remainder of the year.

In the second half of the year, seasonal growth will be solid, new products will launch, and we will have new initiatives that should enable us to deliver on our objectives.

Driven by a late and solid Easter season, second quarter CMG category growth was 6.8%.

Hershey marketplace results were also strong, with Q2 retail takeaway of 7.5%, resulting in a 0.2 point market share gain, offsetting the decline we experienced in the first quarter.

Our Easter sell-through was very good, and we gained 1.1 market share points in this important season.

On a quarterly and year-to-date basis chocolate is driving category growth, and as we stated earlier this year we expect our net sales and marketplace performance to be driven by strong second-half activity that we have planned.

But our first half results have been below our expectations.

In-store activity and trends were difficult to interpret over the first few months of the year, given abnormal shopping patterns, a late Easter, and a continued challenging macro environment, especially related to the consumer who has not participated in the economic recovery.

However, we've now been able to discern that across the broader snacking continuum, especially as it relates to the instant consumable pack type, we're encountering greater levels of competitive in-store merchandising and programming.

As a result, over the remainder of the year in addition to solid seasonal growth and previously mentioned new product launches, we have a few more initiatives than we initially planned.

A couple examples of those include a King of Summer program, which is a major effort within the C store channel to increase king-sized displays.

A new limited edition instant consumable product to drive excitement, variety, news, and more importantly, merchandising and programming.

A new Brookside product launch in December, in addition to the Brookside crunchy clusters.

And incremental shelf space gains in the C store channel as a result of favorable shelf sets.

We feel good about the plans that we have in place, our business model, and the opportunities that lie ahead.

We continue to believe that over the long term the candy and mint category grows in the 3% to 4% range.

Although given year-to-date results and the aforementioned challenges, category growth will most likely be around 3% in 2014.

Before we get into the details of the second quarter, I'd like to spend a moment on the pricing action announced on July 15.

As you are all aware, commodity prices have been volatile.

Prices for many of the primary and secondary commodities that we use in our products have increased year over year.

Given category dynamics related to pricing flow-through and the view of our future cost profile, a price increase was necessary to protect our margins.

This action was effective immediately on July 15.

However, during the four-week period ending August 12, existing customers can, based on their historical order patterns, order up to eight weeks of inventory at the previous price if delivery occurs by September 7.

On everyday items consumers will start to see higher prices, primarily on instant consumables and on in-aisle non-merchandise take-home items.

As such, we expect initial price elasticity impact to result in a lower volume over the remainder of the year, primarily in the fourth quarter and into 2015.

We do not expect this action to materially impact our financial results this year.

While it is a bit early to measure consumer reaction and response to pricing, we feel that our brand support, innovation, consumer spending, and investment in go-to-market capabilities should enable us to deliver on our long-term targets.

Now for some marketplace performance.

Nielsen's second-quarter measures do not encompass the entire Easter season in both the year-ago and current periods.

Therefore, the majority of my remarks today will refer to year-to-date marketplace performance for the 24 weeks ended June 14, 2014.

Year-to-date CMG, that's candy, mint, and gum, category growth in the xAOC plus C channels was up 2.1%.

However, gum continues to be a drag on total CMG performance, and if you exclude it, the category was up 3%.

Total Hershey's CMG retail takeaway for the year-to-date period through June 14, 2014 in channels that account for about 90% of our US retail business was up 2.2%, in line with overall category growth, with market share of 31.1%, flat versus the previous period.

As a reminder, this represents xAOC plus C store data, consisting of food, drug, mass x and C store channels, plus the inclusion of Walmart and partial dollar, club, and military channels.

Year-to-date xAOC plus C chocolate category growth was plus 3.5%, and in the range we expected given the level of activity in the category.

Hershey's xAOC plus C chocolate retail takeaway was 2%, resulting in a loss of 0.7 chocolate market share points.

We expect our performance in the back half of the year to be better, given the launch of York minis and Brookside crunchy clusters.

Retail takeaway from Reese's, Kit Kat, and Brookside was solid, resulting in market share gains for all three brands.

Year-to-date non-chocolate candy, or NCC, xAOC plus C category growth was plus 1.6%.

It has lagged chocolate category growth, given the industry focus on chocolate.

In the xAOC plus C channels, Hershey's non-chocolate candy retail sales declined 1%, resulting in a market share loss of minus 0.4 points.

However, post-Easter our NCC trends improved, and we've outpaced the category, driven by the Lancaster brand.

Lancaster continues to show very positive results.

Trial and repeat is in line with expectations and it is revitalizing the caramel category.

Distribution is an our targeted range, with plans in place to increase distribution in the back half of the year.

While not as large as chocolate and NCC, we continue to do well within the gum and mint categories.

Specifically, our year-to-date gum and mint retail takeaway within the xAOC plus C universe was up 29% and 7% respectively.

As a result, our gum market share increased 1.2 points and we now have a 4.9 and share of the market.

Our mint market share increased 0.7 points, expanding our segment leading position to 39.8%.

In the C store class of trade, Easter impacts are minimal.

Here for the 12 weeks into June 14, the CMG category was up 1.9%.

Excluding gum, and despite trips being down again in this channel, C store candy and mint 12-week category growth was up a combined 3.1%.

Hershey's Q2 C store performance was less than our expectations.

Our total C store retail takeaway increased 1.3%, driven by our mint business which posted growth of 7.2%.

However, we underperformed in chocolate, resulting in Q2 C store CMG market share loss of 0.2 points.

Overall C store trends were mixed.

In Q1, C chocolate category growth was about 6% due to introductory price points of new competitive products.

With the inclusion of this promotion, Q2 C store chocolate category growth slowed to about 3%.

Hershey's Q2's C store chocolate retail takeaway was up only 1.1%.

Our C store performance was soft in the first half of the year, given that more of our innovation was in take-home versus instant consumable pack types.

As I mentioned earlier, we are seeing more in-store activity across the border snack categories.

Combined with lower trips and economically challenged consumers, our merchandising and programming was not as effective.

From my earlier comments, we're making changes and updates to our merchandising, programming, innovation, and consumer investment over the remainder of the year and into 2015 to improve our performance.

I'd also like to provide you with an update on our grocery segment whose marketplace performance is excluded from the CMG Nielsen database.

The Hershey Spreads launch has gotten off to a good start.

We are on track with our plans related to the jar and the instant consumable pack types.

Given the mid-May launch of the IC item and repeat jar purchases, the contribution of Hershey Spreads net sales will be greater in the second half of the year versus the first half.

Our ACV target for the Spreads jar was reached in the Q2, and instant consumable ACV is off to a good start and will build over the remainder of the year.

Additionally, in the fourth quarter we will launch Reese's Spreads, a peanut butter chocolate spread, and my personal favorite, which has tested very positively.

Additionally, we've partnered with Pizza Hut on desserts portfolio featuring Hershey's chocolate chips.

We believe this will have a halo effect on our baking chips business just in time for the upcoming holiday baking season.

Moving now to international.

Net sales were in line with the outlook we provided last quarter.

We anticipated a profile similar to last year.

Despite slightly greater foreign currency headwinds, international net sales were in line with expectations, up 7%.

China continues to do very well.

Our sales increased double digits, and Hershey continues to be one of the fastest-growing international chocolate companies in China.

For the three months into June 14, chocolate category growth was around 7.7%, less than last quarter and typical of the trend post the Chinese New Year.

But our chocolate retail takeaway of about 30% was almost four times the category growth rate, and we're poised to have another solid year.

We are on track to achieve distribution gains in the second half of the year and begin a phase launch of Reese's in the fourth quarter.

In Mexico, the overall economic environment remains sluggish.

As expected, our business sequentially improved from the first quarter with net sales flat on a local currency basis versus last year.

Modern trade chocolate category growth resumed in Q2 and was up about 4%.

Hershey retail takeaway of 11% resulted in a market share gain of 0.8 points.

Given the economic challenges facing traditional trade consumers in Q2, our nonchocolate business underperformed the category.

We expected a tough operating environment in Mexico over the remainder of the year, with a sales profile similar to the second quarter.

After being down in the first quarter, Brazil Q2 net results increased double digits versus last year, reflecting April shipments related to a late Easter.

Importantly, chocolate category growth resumed in the second quarter, albeit helped by a late Easter.

On a year-to-date basis, the Brazil chocolate category is up about 2.3%, while Hershey has increased about 2.9%.

We now have a 4.8% share in this important market.

Given the challenging macroeconomic environment, we would expect category and Hershey growth to be slightly below last year.

We're focused on the long term and not concerned about the impact of foreign currency exchange rates or near-term challenges facing consumers.

We remain very optimistic about our businesses in these key international markets, and expect international net sales growth of around 15% in 2014.

Dave will provide you with additional financial details of our Q2 results and our full-year outlook.

So let me now provide you with some closing thoughts.

Over the remainder of the year, we will have greater levels of merchandising, programming, and innovation in the marketplace.

Advertising GRPs, or impressions, will be up mid-single digits on a percentage basis for the full year versus 2013.

Advertising GRPs are able to increase greater than advertising dollars this year, due to a new global media planning and a buying process that is leveraging our scale.

Halloween orders are on track, and we have the right mix of seasonal specific advertising, coupons, and programming support that sets the stage for another winning season.

So we have a lot of activity over the remainder of the year that should help us drive sales growth.

Additionally, we continue to feel good about the outlook for candy and mint category growth.

Overall, the category continues to perform well with year-to-date gains within the category's historical growth rate.

Investments in the category in the form of advertising and innovation are present from most major manufacturers.

Given high household penetration and the impulsive nature of the category, as well as affordable price points, we believe retailers and consumers will continue to value the confectionery category.

As a result, we would expect the category to continue to consistently secure key merchandising and programming space, even as price points may rise.

Thank you for your time, and let me now turn it over to Dave.

Thank you JP, and good morning to everyone on the phone and on the webcast.

Second quarter net sales of $1.58 billion increased 4.6% versus last year, generating adjusted earnings per share diluted of $0.76, an increase of 5.6% from last year.

We expected second-quarter sales to improve sequentially versus the first quarter, and they did.

However, sales growth was below our expectations, given the US mix headwinds and the increased levels of in-store activity across the broader snack continuum, as JP discussed.

Organic net sales growth of 5.3% was driven by volume.

As expected, new product launches are on track from net sales and the marketplace perspective, and were about 60% of our total volume growth.

Core brands' contribution was about 40%.

The unfavorable impact from foreign currency exchange rates was 0.7 points, and in line with our expectations.

North America sales increased 4.5%, with balanced growth in the US and Canada.

International net sales increased 7%, relatively in line with our expectations.

Turning to margins, adjusted gross margin declined by 230 basis points in the quarter, as higher input costs, primarily commodities, and unfavorable sales mix more than offset supply chain productivity and cost savings initiatives.

Dairy costs in the quarter were higher than our expectations.

As many of you know, there's not a developed futures market for dairy, which significantly limits opportunities to hedge our requirements.

While spot prices have declined slightly from the year-to-date high, US market costs remain at elevated levels.

As a result of the higher prices, we have increased our dairy costs forecast for the remainder of the year.

This increase, as well as higher trade spending, primarily for greater merchandising activities, will adversely impact gross margin, particularly in the third quarter.

Adjusted earnings before interest and taxes in the second quarter increased 1.6% versus last year, generating EBIT margin of 17.7% (sic - see Press Release "17.6%") a 60 basis point decline versus last year.

The decrease was due to the lower gross margin, partially offset by slightly lower selling, marketing, and administrative expenses.

During the quarter, advertising and related consumer marketing expense declined about 5% versus the prior period.

GRPs increased in the quarter as we continued to fully execute our on-air advertising programs for major brands and new products.

The reduced expense was primarily the result of decisions to delay new production costs and shift some funding to coupons and trade merchandising to better reflect today's consumer environment.

Selling, marketing, and administrative expenses, excluding advertising and related consumer marketing, was about the same level as the prior year, as higher selling and employee-related costs were offset by a $5.6 million foreign currency exchange gain related to the manufacturing facility under construction in Johor, Malaysia.

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

Similar to last year, we believe 2014 international sales growth will be back-half weighted, given the timing of distribution gains, new product launches, and seasonal growth.

Second quarter international net sales increased by 7%.

On a constant currency basis, they were up 10.4%.

In our focus markets, China net sales increased low double digits, and we continue to grow market share.

We are on track to achieve further distribution gains in the second half of the year, including the phased launch of Reese's in the fourth quarter.

In Mexico, second quarter net sales declined about 5% versus last year, due to foreign currency headwinds.

On a constant currency basis, sales were about flat, an improvement versus the first quarter.

We expect the operating environment in Mexico to remain sluggish over the remainder of the year, resulting in a sales profile similar to the second quarter.

In Brazil, second quarter sales increased double digits, due to the timing of Easter shipments that occurred in April.

Over the remainder of the year we expect the chocolate category in Brazil to be pressured by a soft economy and volume elasticity related to pricing.

Therefore, we expect total international net sales growth for the year of around 15%.

Note that this excludes the Shanghai Golden Monkey business, which we estimate will close before the end of the year.

Moving down the P&L, second quarter interest expense of $21 million was about the same as last year.

For the full year, we expect interest expense to be around $85 million.

The adjusted tax rate for the second quarter was 34.3%, in line with our estimate.

For the full year, we continue to expect the adjusted tax rate to be around 34.5%.

For the second quarter of 2014, weighted average shares outstanding on a diluted basis were approximately 225 million shares, leading to an adjusted earnings per share diluted of $0.76, an increase of 5.6% versus year ago.

Now let me provide a quick recap of year-to-date adjusted results.

Net sales increased 3.4% in the first half.

Adjusted EBIT increased 2.8%, resulting in an adjusted EBIT margin of 20.2%.

Year-to-date adjusted gross margin was 46.0% versus 47.1% last year, or 110 basis points lower, due to higher commodity costs.

Adjusted earnings per share diluted in the first half increased 5% to $1.90 share.

Turning now to the balance sheet and cash flow.

At the end of the second quarter, net trading capital increased versus last year's second quarter by $82 million.

Accounts receivable was higher by $57 million, primarily because of sales timing, and remains extremely current.

Inventory was higher by $76 million.

And accounts payable increased by $52 million.

Capital additions, including software, were $70 million in the second quarter.

For the year, we now expect total capital expenditures to be about $380 million to $390 million, including the capital related to the Johor, Malaysia project.

This is an increase from previous guidance, primarily as a result of including capital in the China manufacturing JV that we've now taking control of.

Depreciation and amortization was $51 million in the second quarter, in line with our estimates.

During the second quarter the Company repurchase the $125 million of outstanding shares, completing the $250 million repurchase authorization that was approved in April 2011.

Additionally, we repurchased $40 million of our common shares to replace shares issued in connection with exercises of stock options.

All $165 million of the acquired shares were repurchased in the open market.

The Company continues to generate substantial free cash and has a strong balance sheet.

As was mentioned in this morning's press release, we have increased our quarterly dividend by 10% so that we remain in line with our targeted 50% payout ratio.

This action reflects our confidence in the long-term growth potential of our business.

Additionally, we have authorization to make additional repurchases of up to $250 million, based upon cash availability within our cash use priorities.

Cash at the end of the second quarter of $563 million was relatively in line with the year-ago period.

The Company is well positioned to fund our working capital needs, capital expenditure requirements, and the Golden Monkey acquisition.

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

As JP outlined, we have initiatives in place that we believe will drive net sales growth across our businesses over the remainder of the year.

We believe these actions will result in 2014 net sales growth around the low end of our 5% to 7% long-term target, including the impact of the price increase and foreign currency exchange rates.

Due primarily to higher dairy costs, greater merchandising, and unfavorable mix, we now expect gross margin to be slightly down versus 2013.

Based on the timing of new product launches in both North America and international markets, advertising and related consumer marketing expense in the second half of the year is expected to be up mid-single digits on a percentage basis versus last year, with the biggest increase expected in the third quarter.

This will result in full-year expense being up low single digits.

As JP mentioned, the increase in GRPs will be greater than dollars this year.

We continue to expect SM&A expense, excluding advertising, to increase this year at a rate less than sales as we leveraged the investments we've made over the last few years.

As a result, we expect full-year adjusted earnings per share diluted to be around the low end of our long-term growth rate of 9% to 11%.

We continue to expect that the fourth quarter will drive second half and full year EPS growth as we begin to lap the higher commodities and SM&A cost levels.

Additionally note that this outlook excludes operating results related to Shanghai Golden Monkey, which we now expect will close by year end.

We continue to expect Golden results, excluding acquisitions and transaction costs, to be accretive in our first year of ownership.

The impact in 2014 is now expected to be minimal, given the later than expected closing date.

Thank you for your time this morning.

JP, Mark, and I will now take any questions you may have.

(Operator Instructions)

Chris Growe, Stifel.

Good morning, Chris.

Good morning how are you?

Good.

Good, thank you.

A couple questions if I could, please.

The first would be, I guess it would be to Dave, in terms of the gross margin being down slightly for the year.

Is it the pricing you are relying on in terms of the improvement sequentially in gross margin?

I know you lapped some of the input cost inflation that started late last year.

And then I guess related to that, is the, in terms of the cost savings coming through in terms of Project Next Century, that kind of thing, do those pick up in the second half of the year?

The Project Next Century savings are pretty well completed.

We've completed the project and the savings are pretty much all flowing through.

In the back half of the year, the gross margin is impacted by the higher commodity costs versus last year.

But with respect to the fourth quarter, we really just begin to lap where we started having the higher costs last year.

Okay.

And then if I could ask another question for JP.

And just in relation to, I guess as you see your investments behind the business from an advertising and promotional standpoint.

Advertising's up less than you said as of last quarter, but it sounds like you're getting more promotional as well.

As you look the pressure against the consumer, is that the [same as you thought] before, just more money moving into promotional funding?

I think there's a combination of things.

Let me point a couple of things out about the cost.

There's the GRP efficiency which we've gained, which is a piece of it, because of a change we made there in the process.

And then one of the things that you don't see is the nonworking piece, or the production cost piece, which is a meaningful number for us this year as well.

So in terms of absolute GRPs, I think that we're good there as we look at our current plan.

I think the way to think about the merchandising is that, as we look at the total snacking continuum, we've seen a significant increase in overall quality merchandising, especially in some specific channels like C store.

It's not that merchandising is necessarily at a deep discount versus where you might think it has been historically.

It's really more of a competitive environment and the range of choice that the consumer has.

So some of that snacking is being where -- I think, if you look over the last couple of years, a lot of that growth has been led by CMG.

I think what you're seeing in the current environment is that there's more on the floor and it's more competitive across total snacking.

So the choice the consumer has is broader versus absolute price being a driver.

So any limitation to Hershey getting their fair share of space, or more space?

Especially in the C store.

Is that the intention (multiple speakers).

I don't think so.

As you know, we've got great coverage in C store.

For us I think it was really about programming and what we saw with competitive programming, particularly in the first quarter and then continuing into the second quarter.

I know there's some of the things that I talked about that we're going to be responding to.

And then, of course, our innovation is much more significant in the second half.

So we feel good about our stance, but it's a competitive environment.

Sure.

Okay.

Thank you for your time.

Thank you.

Bryan Spillane, Bank of America

Good morning, Bryan.

Actually just a follow-up on Chris' question.

If you look at the nonseasonal business and the instant consumable business, the snacking, the broader snacking competitors have -- there's been a lot of product, new product innovation.

Doritos has definitely, or Frito has definitely stepped up its activity on new product.

You've seen it in Nabisco.

So I guess my question is just how do you feel about your innovation pipeline?

Not so much for this year, but even into 2015?

If we assume that there is going to be a lot more of this sort of stepped-up product innovation in that snacking continuum.

Do you feel comfortable that you've got the new product pipeline to compete, in what could be a more competitive landscape?

Let me answer it in two different pieces.

First of all on the innovation front for our brands, we've got what we believe is a very strong innovation pipeline in the second half.

We've talked about some of that, and then of course we've added some incremental things.

So we think were going to be competitive there.

If you really dig into the data of what's going on, part of what we've seen, which is different than what we've seen in the past is that our everyday business didn't do as well as we would have hoped it would have in this particular timeframe.

I think the forces and factors are some of the things that we talked about.

The independent C store in CMG did not do as well, and I think you have a consumer who's more challenged than in maybe the more modern C store channel where gas is a part of the overall mix.

And then one of the unique things is, we look at our data, is remember last year Hostess, Twinkie, some of the bakery segment was not participating in the category.

This year they are.

While they haven't participated at a significant price discount, the percent of merchandising over the quarter that they had their products merchandise was very high.

So you saw meat snacks did very well, salty snacks did well, bakery did well.

And so the growth was really led there across the snacking continuum, more so than it was with CMG.

And those are some things that we have to respond to as we go forward.

So as you go forward into 2015 will you change anything about your -- the types of new products you want to roll out or make some adjustments to your pipeline?

I mean, to kind of put it succinctly, you had a new product innovation pipeline, and I guess some of it's going to be back-half loaded, but it may not be matching up as well against some of the other sort of non-chocolate and non-candy competitors.

So is there something you have to do to tweak your innovation (multiple speakers)?

I think you could say that in the first quarter as we kind of go back and keep score there, but as we look at our overall growth algorithm of getting a minimum of 1 point of our growth from innovation, and as you know we've been more in the 2-point range, what we'll do is we feel very good about our pipeline.

We will be pulling some things forward in that pipeline as it relates to the US business so we don't feel as though we don't have initiatives that can bring a lot of value to us.

And then that pipeline will also have a focus on the core.

And if you look, again just to recall from my remarks, if you look at the first and second quarter, we did well on Kit Kat, we did well on Reese's, we did well on Brookside.

And so we just need to make sure that we've got the right timing and phasing of that innovation.

All right.

Thank you, JP

You bet.

Thanks a lot.

Matthew Grainger, Morgan Stanley

Good morning, Matt.

Hi.

Just a question on the balance sheet and M&A.

You were mentioned in press reports as a potential suitor for Russell Stover, which obviously ended up going elsewhere.

I was just wondering if there was anything you could say anecdotally about how you evaluated that opportunity and why, given the strength of your balance sheet, you didn't pursue it more aggressively?

And then just on a broader level, can you remind us whether you have any specific valuation or return on capital criteria that come into play with when you are evaluating acquisitions, or is it really only about strategic fit and accretion over sort of a 1 to 2 year period?

I think in terms of how we look at the business, I think the number one thing we will look at is our strategic fit.

And so again, when we look at acquisitions we're trying to find things that will be both in our focused markets and that will add to our ability to grow or ability -- or our capabilities.

Those capabilities could be portfolio, they could be distribution, or route to market.

Those are really our key factors.

Economically we use a discounted cash flow model, and clearly look at the return.

And we use that to make sure we're disciplined in terms of the pricing.

With respect to the Russell Stover, I really don't care to comment any further on that one.

Okay, understood.

Thanks.

And just a quick sort of broader question on category trends.

Obviously there's a number of competitive and macro factors, and you've highlighted those.

But just wondering based on your segmentation work and your observations on the category, is there any evidence that broader health and wellness trends and concerns are having at this point a measurable impact on the category, even though that historically hasn't been the case?

We don't think so.

I think that there is broadly consumers you can see over time have changing relationship with food.

If you look at total snacking, snacking continues to grow as a total category.

And then one of the things that we've talked about is, if you look at the core confectionery category, people come to the category as a reward-me category.

They know it indulgent.

It's not a food group.

They tend to -- it tends to represent about 2% of total caloric intake.

So it's self-regulating in many respects.

So as we think about the future, we're thinking about the total snacking continuum.

That can be everything from indulgent to more functional.

But remember the chocolate segment in the category really continues to do well.

It's just simply in the last quarter that wasn't led as largely by us as it has been in the previous timeframes.

Okay.

Great.

Thanks, everyone.

You bet.

Andrew Lazar, Barclays

Good morning, everyone.

Good morning, Andrew.

Quick question on elasticity.

I'm curious what you are sort of modeling for elasticity to the price increase?

And I guess, more importantly, if it's different from kind of what you built in the last time around when I think elasticity was --frankly it ended up being a lot modest than you expected, and certainly less than kind of a one-to-one relationship?

And then as part of that, JP, you had mentioned in your prepared remarks that given the price increase, you'd expect volume to be lower in the second half of the year.

I didn't know if that meat lower year over year, or just lower than it previously would have been had you not taken pricing?

Yes.

So the answer to the second part is really versus a planning stance without pricing, is what I would say there.

Andrew, we always model a 1 to 1 ratio on all of our pricing.

You're correct in that the last couple of pricing moves we've seen with a significant increase in advertising spend in the category, which reminded consumers what they participated in the category.

We experienced something more like 0.6, 0.7 conversion rate.

And so the things that we're talking about would have the modeling of 1 to 1. Obviously, I'd like to see us do better than that.

And we will keep you posted on what that looks like.

So we would hope to see conversion with shorter timelines and faster conversion rates, but the modeling is 1 to 1.

Great, that's very helpful.

Thank you.

And then just a last one.

Typically you taken pricing with an attention to protect your gross margin percentage as opposed to just gross margin dollars.

I assume that's sort of the intent as you think out to 2015 and beyond, but I just wanted to run that by you.

You have it correct.

Great.

Thanks very much.

Our model is to protect our margin and invest in our brands.

Great.

Thanks very much.

Eric Katzman, Deutsche Bank

Hi, Eric.

I guess first is a more detailed question.

In the press release you said that the FX was, headwind was greater than you expected, and Dave you said it was in line?

So you want to clarify which is correct?

Sure.

I think where we wind up there is that, as it affects the international business it was a bit greater than what we expected, and as it related to North America, Canada was a little bit more favorable than we expected.

So you mean Canada was more favorable?

Yes, Canada was a little more favorable.

International was a little bit more unfavorable.

So on balance we were pretty close to what we expected.

Okay.

And then I guess this is kind of like what did you know and when did you know it, but when you last gave guidance, you had expected sales to still be in line with your target and gross margins, you had moderated but you still expected them to be, I guess, kind of flattish.

And now in your guidance you've included the price increase.

So obviously the price increase could be material to top line as well as your gross margin calculations.

So I guess what -- were you anticipating a price increase but didn't tell us last quarter when you gave guidance versus today?

No.

I mean our guidance as of the last quarter was basically what we expected at that time and not anticipating the price increase.

As we've said, we really don't expect the price increase to have a significant impact in 2014.

In the fourth quarter we will see some instant consumable pricing, and some of that will be offset by volume.

But again, given the elasticities, we don't the much impact.

The change in the gross margin versus the last guidance is really about the continued high pricing in dairy costs and also the mix that we saw in the second quarter.

Okay.

And then last question, and I'll pass it on.

Can you remind me, is gross margin a part of your compensation package?

Because obviously that piece is coming in well below your expectations this year.

And so my question is really geared towards your comp accrual and would a setback to normal in 2015 be a headwind we should kind of consider?

I mean I realize the year's only half over, but gross margins are obvious below plan.

I guess kind of two points.

With respect to your first one, and we do disclose our metrics in the proxy, gross margin, absolute gross margin level is not part of our comp program but it's a key part of how we get to our earnings.

And so that's how I would address that.

The second part of your question, as you're looking at 2015, we're not really ready to give 2015 guidance.

But what I would say to you is that, as we've taken the price increase, we've looked at our gross margin as part of that.

Okay.

All right.

I'll pass it on.

Thanks.

Thank you.

Robert Moskow, Credit Suisse

Hi, Rob.

Hi.

I wanted to know if Mars' price increase that they just announced, it's 7%, your's was 8%.

Have you done any math to determine whether their pricing will be a little bit below your's when it's all said and done?

And then secondly, I wanted to know if I could kind of think again about the international growth algorithm.

You're probably still mid-teens this year.

But if Brazil is -- the category seems to be growing at a very low rate.

Mexico has stagnated.

China's doing obviously very well.

But China seems to be the only real driver of growth.

So, excluding the acquisition for a second, what are you thinking -- what is your thinking about 2015?

Does the macro have to get better in Mexico and Brazil for that algorithm to work?

Well I think there's one component that you didn't talk about, and we have a meaningful export business as a part of that international business.

So it's not all about just the focus markets, but we also have a very good structured export business that continues to do very well, and that's also a really profitable business.

I think it's important to keep in perspective in Brazil that it's a relative -- we have a relatively modest-sized business there, and we continue to build distribution and presence on shelves.

So a lot of our potential there is really around increasing a portfolio size, and it's really increasing brand presence.

So those are fundamentals that we believe that, as we continue to execute against that, will continue to grow there.

So I think, while a lot of those macro things are important, we also have another lever that works well for us.

In terms of the Mexican business, we've continued to grow our chocolate share there.

There's some macro economic issues that seem to be impacting the consumer there.

So I can't really predict going forward what I see there in terms of pace of recovery in terms of the total market, but I think those markets will get better versus worse.

And then I think we will continue to do well in China.

And as well as these other markets, is remember within our strategies as we talk about being focused on specific geographies.

It's also about expanding the portfolio.

In a lot of these markets, we had a very modest portfolio still at this point in time.

Again, I think the fundamentals of how we grow are very much in our favor.

And I think that's why more broadly we can feel optimistic about the continued growth across those international businesses.

And the Mars question?

You've seen what I've seen in a general marketplace.

So I can't really comment or provide any analysis on what they may or may not have done, but I'm sure that will reveal itself as time passes.

Just a follow-up.

Can you say how much your exports are up this year, and whether that's higher or lower than historical?

What I can do is I don't have the number right in front of me, but if you want to call Mark we're more than happy to provide you specifically that information.

I just don't have the number on the top of my mind.

I apologize for that.

Okay.

Thank you, JP

Ken Goldman, JPMorgan

Hey.

Good morning, everyone.

Good morning, Ken.

As we think about your price increase and the window you've given customers to perhaps buy in a little more than they usually would over next few weeks, how should we think about the cadence of your shipments the next two quarters?

I assume it's reasonable to model some 3Q sell and a reversal in 4Q.

Is that accurate, and can you help us on the magnitude of that, perhaps?

Well, I think given the timing of the price increase and how it executes, I wouldn't expect to see a big swing between the third and fourth quarter because of the buy-in period here would run into August and would ship pretty well clean out in September.

And then question for JP on advertising.

You and your predecessor, Dave West, had a really strong commitment to advertising.

For a long time it's worked.

And I guess that's what makes this year's lower ad spending as a percent of sales in terms of growth a bit confusing.

And I guess my question is this, if you believe strongly in brand-building, and it's been effective in the past, why not just say, okay this won't be the best year in our history.

Maybe we grow earnings below our long-term range.

A lot of companies are experiencing that.

But we're not going to back off our principles of innovation and marketing just to, perhaps at least from the outside it looks like, making our numbers.

So why not take hit this year, keep brand-building high, especially in this competitive environment, and really stick to your long-term philosophy?

I do believe we're sticking to our long-term philosophy.

I think part of what is going to happen is you're going to continue to see the balance over the first and second half as we support innovation.

We've also gotten a number of our brands more towards the top of the curve of our advertising efficiency.

So it doesn't require necessarily the same levels of increase.

It's really much more around the mix of where you apply some of that advertising.

So if you were to really look at where we've rebalanced some of that advertising, you would see some brand, individual brands, that have gotten some pretty significant increases in advertising.

Maybe some others that have been deemphasized or frequency has changed.

But I don't think our philosophy has changed.

And we will continue to reassess, over time, if we believe we're doing the right thing or not.

And the fact that we want to be a knowledge-based brand-building company is at the core of everything we think about and how we want to act.

So I may come to a different conclusion in the way that you're describing it, but the philosophy hasn't changed.

Okay, that's helpful.

Thank you, JP

David Driscoll, Citi.

Good morning, David.

Thanks.

Good morning, everybody.

JP, just wanted to ask a little bit about the second-half sales growth.

You made some comments here, but I want to go over this because I think this is a very fairly critical issue.

Second-half sales growth must accelerate to reach the full-year growth of about 5%.

Given the first-half performance at 3.4%, really I want to just understand, what gives you confidence in this acceleration?

And frankly, is this just a high bar, given after first quarter and a reduction in guidance here, I think you might understand that confidence on the outside is going to be a little bit low.

So your answer here I think is reasonably critical.

Yes.

Well, so there's a couple of things.

Remember that in the second half of the year, 68% of our seasonal growth occurs then.

We have visibility to what those numbers are.

And that seasonal growth is ahead of what the average Company growth would be.

So we know that we have very strong seasonal business booked for the second half of the year.

We believe that the innovation that we have is both meaningful and should be effective for us.

So those are big contributors as well.

And we continue to have, we think, in our international business where we're rolling out Reese's that that's going to continue to work hard for us.

And then the incremental advertising that we've added with the king-size event I mentioned earlier.

We have a great cross-promotion program with Coke and Reese's, and a couple of things that we haven't talked about yet.

I think, David, we're really winding up to take the things we learned in the first half, that take-to-make is over 6%.

We know that.

But we feel good about the actions that we're taking in terms of the competitiveness and understanding of some of the things that went on in the first and second quarter.

So I have confidence that we're going to get there.

Two follow up.

On international, I believe last quarter your guidance for international on a full-year basis was 15%.

You've reiterated that today.

But apologies, but it sounded like in your description of international, things were weaker.

So I'm just trying to reconcile the tone of your international comments in Mexico and Brazil versus the fact that the international guidance is unchanged.

Will I think the kind -- Dave and I can both respond to this.

I think what we're saying about Mexico and Brazil is pretty consistent with what we said last quarter.

We continue to experience good growth in China, and then the exports piece of our business, as I've mentioned to you continues to do well also.

To reiterate, I don't think there's change there.

Certainly I was very transparent in terms of some of the challenges in terms of FX and then consumer challenges in Mexico.

From a programming standpoint and a takeaway standpoint, I think the results are pretty good.

In the first quarter, I think we laid out the challenge in Mexico and also the challenge in Brazil.

And we said we would see some sequential improvement as we go through the year.

And we definitely saw that in the second quarter.

So our results there were pretty much in line with what we were expecting.

Thank you.

Just a final one.

The innovation on Ice Breakers and Brookside, am I correct that you have shifted this from the third quarter into the fourth quarter?

And if that's true, can you explain why you did that?

Well, the only thing that has had a shift on timing is Cool Blast.

It really had a couple of factors.

We continue to be finalizing, perfecting the start-up and formula.

And then the other part of it is the capacity issue to where we just want to make sure we had the right capacity in place.

It's not going to affect anything else.

And we feel good about going ahead there.

But those are some normal kinds of start-up things.

Nothing remarkable.

Thank you.

Jason English, Goldman Sachs to

Good morning, Jason.

Good morning.

Thank you for the question.

I appreciate it.

I've got two here.

I'll just rattle them off at the same time.

First, if there's some concern in the media consumption channels that consumers are swamping into other categories where promotional activity's elevated, as you raise prices, how do you make sure that that shift doesn't accelerate?

And then the second question, lower advertising, more trade promo, bringing back limited editions, this feels very deja vu mid-2000s, which obviously didn't end very well.

So can you maybe draw some parallels, or contrast of why -- what's similar, what's different and why this doesn't end as poorly as that one did?

Let's try to do everything we can to not compare the fact that we're doing a limited edition to the fact that we did a lot of limited editions back in 2005.

So in 2005, as we've discussed quite openly many times, those limited editions really became our innovation.

That's really not what we do at this point in this era.

And so -- but if you have a limited edition and it's limited, the news is not a bad thing.

It's a merchandising event.

So that's how I think you ought to probably think about characterizing that.

We know that the category has been pretty inelastic over time.

We've been able to successfully convert price to consumers, been able to convert, and again I think what we have to observe over time is what's happening with the frequency in some of those areas or channels where the consumer may not be participating in the recovery, as those at the top end of the economic pyramid.

So I think that it'll be, as we've done the past.

We expect conversion to be good.

And the phenomena that I talked about in the independent C store probably is not going to be that connected to what's happening in terms of the price, and the pricing most likely would affect the entire category and not individual brands.

So I don't think to the consumer it's going to look that different.

What I would add is, in the things that we've gone through and we've talked about in responding to the situation from the first part of the year, that there's activities that we're putting right around our base products.

And so that the limited editions have a very limited focused role, and that's just obtaining some level of merchandising and news.

And as JP said, the big difference is that we really are focused, the innovation now is really focused on more meaningful and sustainable activities.

Okay.

Thank you, guys.

I'll pass it on.

Jonathan Feeney, Athlos Research.

Good morning.

Thanks very much.

Good morning.

I wanted to dig in, get another go at this price increase, margin elasticity question going into next year.

When you took you price increase in 2011, I mean as bad as things are today, the unemployment rate was higher then.

It just wasn't a great macro environment in general in 2011.

If I remember correctly gas prices were going up at that time.

So you've talked a lot about the macro environment, but I guess what gives you -- what makes you think that the elasticity reaction consumers will have in this really tough macro environment would be any different than what they had back in 2011, particularly given that it seems your leading competitor is following suit here?

I don't think that it will have big differences than what we've seen.

As I've said before, the planning that we've always done around these is the 1 to 1 ratio.

I think your point is a good one in terms of how we should expect the category to behave this time versus other times.

And the history of the category over many decades is that it's a pretty inelastic category and it cycles pricing really effectively, and that's exactly what I would hope this time.

I don't want to -- the thing that I want you to take away from this call is, is that we think about their business, there have been a number of different things over the last 6 to 9 months, whether it's been trips, weather, all of these other things.

Likely we don't know if those are one-offs, if there's some other effect, they were real.

But what we know is, is that we have fundamental execution opportunities, planning opportunities around how we schedule the promotion and merchandising activities we have.

And so we really put a number of these other things aside.

We do know in certain parts of classes of trade, there's a consumer that continues to be challenged.

We're also seeing, in the snacking categories, some items with some pretty significant pricing that are doing very well.

I think in the end, while there may be some people, unfortunately, who are really impacted, I think the real drivers will be around the things that we know how to do best, and that's execution.

Great.

Thank you very much.

Operator, we have time for one last question.

Your final question comes from the line of Eric Larson with Janney Montgomery (sic).

(Multiple speakers) One quick follow-up question.

In your price increase that you have going forward here, and in your allowed buy-in to your customers, are you protecting the margins on your fourth-quarter seasonal sales for your customers?

Yes.

So the answer would be yes.

And if you just think about how it works, is the instant consumables tend -- those prices tend to go up almost immediately on the shelf.

Merchandising that's been scheduled tends to also -- you would agree to it be protected.

And then the seasons are protected all the way out to what will be Halloween of next year.

So the answer to your question is yes.

All right.

Thank you.

Thank you very much for joining us for today's conference call.

And we'll be available for any follow-up questions that you may have.

This concludes today's conference.

You may now disconnect.