The Hershey Company (HSY) Q2 2016 Earnings Report, Transcript and Summary

Good morning, everyone and welcome to the Hershey Company’s Second Quarter 2016 Results Conference Call. My name is Keith and I will be your conference operator today. [Operator Instructions] Please note this call maybe recorded. Thank you. It is now my pleasure to turn the program over to Mr. Mark Pogharian. Please go ahead, sir.

Thank you, Keith. Good morning, ladies and gentlemen. Welcome to The Hershey Company’s second quarter 2016 conference call. J.P. Bilbrey, Chairman, President and CEO and Patricia Little, Senior Vice President and CFO will provide you with an overview of results, which will then be followed by a Q&A session. Let me remind everyone listening that today’s conference call may contain statements which are forward-looking. These statements are based on our 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 10-K for 2015 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 the summary of consolidated statements of income prepared in accordance within 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 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 second quarter results excluding net pre-tax charges of $13.9 million or $0.17 per share diluted which are primarily related to derivative mark-to-market losses and business realignment charges. These charges are defined in the appendix of this morning’s earnings release, which is available on our website at www.thehersheycompany.com. Our discussion of any future projections will also exclude the impact of these items. 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. Second quarter sales and earnings performance was slightly better than our expectations primarily due to timing in the U.S. International and Other segment operating and marketplace performance was a bit greater than our expectations, and we’re making progress against our strategic initiatives. The integration related to the barkTHINS acquisition is well under way, and we’re excited about the opportunity here and how it fits into our broader Snackfection strategy. Work continues on the snacking insights and consumer market segmentation that I mentioned last quarter. We are making progress and I look forward to sharing what we have learned in the near future as it will be a catalyst of our go-to-market confectionery and Snackfection strategy over the upcoming strategic planning cycle. The feedback we have received from consumers to date is that sweet snacking, think chocolate and textural ingredients, as well as other food value inclusions, such as nuts, seeds, cookie pieces, berries, etcetera, are high value components that are a gateway to permissible indulgence and sweet snacking throughout the day. In fact, some of the initial work done here has resulted in an exciting Snackfection item that we will be launching late in the fourth quarter. Looking at U.S. marketplace performance, total Hershey U.S. retail takeaway for the 12 weeks ending July 9, 2016 within the xAOC+C channels increased 0.5%, with market share off 0.1 points. This represents all Hershey manufactured products sold at retail, such as candy, mint, gum, salty snacks, Krave, chocolate syrup and snack bars. For the year-to-date period ending July 9, 2016, candy, mint and gum, or CMG, category growth was 0.8% and was impacted by a shorter Easter season. Non-seasonal CMG category growth progressed in the second quarter. However, it was less than estimated as we anticipated better results given both competitive and Hershey activity in the marketplace. For the 12 weeks ending July 9, 2016, CMG category growth was plus 1.2%. Hershey’s U.S. CMG market share in the second quarter was 30.8%, off 0.7 points versus the same period last year. We believe the initiatives that we are executing against in the second half of the year and into 2017 will result in improved marketplace performance. Our number one priority is to restore Hershey’s marketplace momentum within the very profitable U.S. market, where we have combined solid execution that leverages our scale with strong innovation and investment, our business is responding, more on this in a bit. Our response in go-to-market strategy to fast changing retail and consumer trends over the last year or so has not been sufficient to deliver consistent top line growth that we expect from our business. To overcome the current low growth environment that’s impacting much of the center of the store, we’re focusing on 3 important areas of our business model. That’s innovation, our marketing mix modeling and our cost structure. Innovation is a big opportunity for us. Over the last 4 to 5 years, we had good confectionery success. Some products over-delivered versus our expectations and are still doing well today. And some of the new items from last year have under-delivered with lower volumes than we modeled. While innovation is hard work, our best innovation has been tied to consumer insights coming from our demand landscape work and leveraged across big brands and platforms and driven by our go-to-market capability. Combining this work under the leadership of Michele Buck as COO will add both focus and speed to the process. As consumers’ relationship with food and shopping habits, have evolved we have tested different concepts of our marketing mix modeling. There continues to be a lot to learn with regard to efficiency and effectiveness as we balance our efforts across levers like direct trade, advertising, digital communications and consumer promotion. Technology will also play a role as we leverage predictive analytics and new tools that indicate the optimal ratio related to promotional spending and long-term brand-building initiatives. As I have said many times, we are a consumer-centric, brand-building company and we will invest in our brands and people. To do this and deliver on our financial commitments, we continue to examine our cost structure. We will deliver approximately $135 million in cost savings this year and at least $100 million per year from 2017 through 2019. Furthermore, we have intensified our focus on analysis of our global cost structure and business model to determine additional cost savings opportunities that we believe exist. While early, the initial work under way indicates that there are bigger opportunities to unlock these cost savings. Our overall goal in all of this is to create a streamlined structure that enables us to invest for growth and serve our retail customers and consumers in the most efficient and effective way possible while increasing our margins and profitability. Looking at some of our 2016 innovation and advertising successes, I am pleased with the early results related to the launch of Kit Kat Big Kat, Reese’s Snack Mix and Hershey’s Snack Bites as new products. Performance of our Reese’s Snack Mix and Hershey’s Snack Bites products has been strong and recent data indicates an acceleration behind TV activation. Additional gains are expected in the third quarter as canister merchandising constraints were lifted and we have more capacity that’s come online to meet demand. The Kit Kat Big Kat is an example of an instant consumable-focused launch combined with new core branch advertising, which is driving growth of the entire franchise. Big Kat is the number one new item at some of our largest customers and in the C-store channel it’s exceeding our expectations. And we are also excited about the Reese’s Pieces Cup, which will only be available as an instant consumable item. Demand from retailers has been double our planning. Product began shipping earlier this month and is available in stores now. As it relates to the second half of the year, we believe we will see a sequential improvement in our marketplace results over the remainder of the year, driven by new advertising copy, innovation and higher levels of in-store merchandising and display, starting in July with the Summer Olympics in Rio. Our company, for the first time ever, is an official sponsor of the U.S. Olympic and Paralympic teams. Packaging that proudly displays patriotic coloring such as red, white and blue lettering on our iconic Hershey’s Milk Chocolate bar began in the second quarter. And our namesake brand, Hershey’s, recently launched its first ever team USA named advertising campaign, Hello From Home, which is an extension of our Hello Happy Hershey mega brand campaign that we discussed last quarter. For this campaign, we have a trio of team USA athletes that includes gymnast Simone Biles; gold-medal wrestler, Jordan Burroughs; and 2012 U.S. Paralympic gold medalist, Mallory Weggemann. Reese’s is also participating in the Olympics with a new ad campaign featuring Winter Olympics gold medalist, Lindsey Vaughn, trying out various summer sports. To do summer like a winter Olympian added a lighthearted humorous campaign that shows Miss Vaughn attempting event including archery, dressage, fencing and rhythmic gymnastics, with just a bit of humor and spoof. Some of the other Olympic related activity that we are excited about includes our Krave Meat Snack adding swimmer, Michael Phelps and soccer player, Carli Lloyd, to its promotional team. Sponsorship of the U.S. Women’s National Field Hockey team in his bid to compete in Rio and to celebrate the success of team USA, we are providing fans with once-in-a-lifetime experience to congratulate the athletes upon their return from Rio during the special visit to the U.S. Olympic Training Center. This is a just a brief summary of some of the activity we have planned in North America that we believe will result in improved retail takeaway trends over the remainder of the year. Now for an update on our international business, where second quarter net sales growth was slightly better than planned and up about 14% versus last year. Excluding China, whose gains were driven by lower levels of direct trade and returns, discounts and allowances as well as the discontinued India oil business, constant currency net sales increased about 2%. I was particularly pleased with Mexico and Brazil, where combined constant currency second quarter net sales increased about 13%. And in both markets, year-to-date chocolate category growth is solid, up mid single-digits. In Mexico, our market share is off versus last year as we look to optimize product mix with a focus on global chocolate brands that will deliver sales, better profitability and market share growth over the long-term. In Brazil, market share was up slightly for the year driven by our focus on the Hershey mega brand and our differentiated portfolio that includes milk chocolate, Cookies ‘n’ Creme as a consumable and tablet bars and Hershey’s Mais wafer products. Net sales in India declined versus a year ago product due to the discontinuance of the edible oil business. The media invested brands Jolly Rancher, SOFIT and Hershey’s syrup, where we are focusing our efforts and investments, were up and continue to do well in the marketplace. In China, gross sales declined in line with our estimate. The summer months are typically the low season for chocolate consumption. China chocolate category performance in the second quarter sequentially improved versus the second half of 2015 and the first quarter of 2016. In fact, the category was fractionally higher in June and we are cautiously optimistic that it gets better from here. We are executing against our plans to bring variety, news and excitement to the Hershey’s Milk Chocolates, Hershey’s Kisses and Golden Monkey and Munching Monkey candy and snacks brands as we expect will drive solid growth and net sales growth in the second half of the year. Over the long-term, we expect global economies and category trends to improve and that the investments in our international business will continue about and contribute 1 point of our overall long-term sales algorithm. Now to wrap up, we are a consumer centric, brand building company focused on innovation and growth in every category where we participate to satisfy the needs of our retail customers and consumers. As I mentioned earlier, we continue to analyze our cost structure as we look for additional margin enhancing opportunities that give us the flexibility to offset higher input costs and invest in our brand. We take a long-term focus and believe that investing in our business will benefit the company this year and well into the future. Now I will turn it over to Patricia, who will provide you with details on our financial results.

Thank you, J.P. Good morning to everyone on the phone and on the webcast. Second quarter net sales of $1.64 billion increased 3.7% versus last year, slightly greater than our estimate due to timing in the U.S. and better international performance. Adjusted earnings per share diluted came in at $0.85, an increase of about 9% versus last year, greater than our estimate due to the timing of investment tax credits, more on this in a bit, sales that were slightly great than forecast and lower advertising expense versus our previous estimate. Excluding the negative impact from foreign currency exchange rates of 80 basis points, net sales increased 4.5%. Net price realization was relatively in line with our estimates and a 90 basis point benefit. Lower International and Other segment direct trade and returns, discounts and allowances, as we lap year ago challenges in China, more than offset higher North America direct trade supporting in-store merchandising and display and related promotional price points. Volume was a 3.1 point contribution in net sales growth driven by North American performance. Acquisitions were worth 50 basis points due primarily to barkTHINS. By segment, second quarter North America net sales increased 3.2%. Excluding the 30 basis point impact of unfavorable foreign exchange rates in Canada, North America net sales increased 3.5% versus the year ago period. Volume was a 4.5 point contribution to sales growth and slightly benefited from the timing of select merchandising program net sales that occurred in the second quarter that were expected to ship in the third quarter. Increased levels of direct trade supporting greater levels of in-store merchandising and display resulted in net price realization headwind of 1.6 points. Acquisitions were 60 basis point benefit. Total International and Other segment net sales for the second quarter increased 7.6% versus last year and were better than our estimate. Foreign currency exchange rates were unfavorable by 5.5 points. International and Other segment volume was off 7.2 points due primarily to lower sales in China and the discontinuance of the edible oil business in India. Net price realization was a 20.3 point benefit as direct trade and returns, discounts and allowances in China were meaningfully lower as we lap the year ago challenges. Turning now to margins, adjusted gross margin declined by 120 basis points in the second quarter as productivity and cost savings were offset by higher commodity costs, including a favorable purchase price variance versus standard in the year ago period, unfavorable sales mix and higher supply chain cost related to the startup of the Malaysia manufacturing facility. For the full year, we continue to expect the gross margin will be slightly down versus a year ago. We remain focused on our cost structure. The productivity initiatives we have discussed over the last year are on track and delivering the targeted savings. Our efforts here are yielding further opportunities, as evidenced by our full year savings of about $135 million, which is now more than our previous estimate. Adjusted operating profit in the second quarter increased 2.1%, resulting in adjusted operating profit margin of 18.1% versus 18.3%. The decline in adjusted operating profit margin was driven by our lower gross margins. Total advertising and related consumer marketing expense increased about 5%, less than our previous estimate as we continue to analyze the components of our marketing mix modeling to determine the right level of direct trade, TV advertising, digital marketing and consumer promotion. North America advertising and related consumer marketing expense was up meaningfully in the second quarter and is at healthy levels in the second half of the year to drive net sales and retail takeaway growth. SM&A, excluding advertising and the barkTHINS acquisition, declined 2.6%, while unallocated corporate expense was lower by $200,000 versus last year. Savings from the business productivity programs and the focus on efficiency and cost savings initiatives that we outlined last quarter drove the declines although this was partially offset by the timing of employee-related costs and unexpected corporate fees that were about a $0.02 headwind in the second quarter. Now, let me provide a brief update on our International and Other segment. I am pleased that our total international business delivered on their Q2 plans. Adding to J.P.’s commentary on China, chocolate category performance in Q2 was in line with our forecast. We remain optimistic about the long-term outlook in China and for our brands. However, consumer spending still appears to be mixed. Therefore, our full year sales outlook in China is slightly lower than our previous estimate. Specifically, China gross sales are forecasted to decline in 2016. However, net sales are expected to increase 10% to 20% as we don’t anticipate the same level of direct trade, returns, discounts and allowances as last year. Constant currency net sales growth of core brands in Mexico and Brazil increased nicely. Excluding China, International and Other segment operating profit increased about 5%. Moving down the P&L, second quarter interest expense of $21 million increased $2.4 million versus last year. For the full year, we continue to expect interest expense to be in the $90 million to $95 million range. The adjusted tax rate for the second quarter was 31.4%, relatively in line with our estimate and lower than the prior period – year ago period of 35.3%, largely as a result of investment tax credits. However, due to timing differences, the corresponding book expense for a portion of the credit investments, which is recorded in the other income and expense line, will not be recognized until the second half of the year. We estimate this was about a $0.03 benefit in Q2, but this is just timing. And for the full year, we expect to purchase about $50 million of investment tax credits, which should result in an adjusted tax rate that’s slightly lower than 2015. In the second half of the year, we expect the tax rate to be about 32% and other income and expense of about $35 million related to the corresponding book expense for the purchase of tax credits. For the second quarter of 2016, weighted average shares outstanding on a diluted basis were approximately 214.5 million shares, down 5.1 million versus last year, resulting in adjusted earnings per share diluted of $0.85 or an increase of about 9.1% versus a year ago. 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 $5 million. Accounts receivable was higher by $40 million and remains extremely current. Inventory was lower by $3 million and accounts payable increased by $32 million. Total capital additions, including software, were $62.7 million in the second quarter. For the full year, we expect CapEx to be in the $265 million to $275 million range, about $20 million less than our previous estimate. During the second quarter, depreciation and amortization was $97 million and dividends paid were $121 million. In the second quarter, the company repurchased $117 million of common shares against the $500 million share repurchase authorization approved in January 2016. There is $100 million remaining on this authorization. In addition, the company repurchased $32 million of common shares in the second quarter to replace shares issued in connection with the exercise of stock options. Cash on hand at the end of the quarter was $250 million, slightly lower than the year ago. As J.P. summarized, over the remainder of the year, we have a lot of innovation, variety, news and in-store merchandising and programming in the marketplace. And we continue to refine our marketing mix modeling to ensure we have the optimal level of direct trade, advertising and consumer promotion supporting our brands. Advertising and related consumer marketing expense is lower versus our previous estimate. We feel good about our marketing mix modeling investments in 2016 and believe we have the right balance of spend in second half of the year that will result in a sequential improvement in marketplace performance. The company estimates that full year 2016 net sales will increase around 1%, including a net benefit from acquisitions and divestitures of about 50 basis points and the impact of unfavorable foreign currency exchange rates of 1 point. Constant currency net sales growth of around 2% is less than the previous estimate of about 2.5%, primarily due to our expectation of lower U.S. CMG category growth over the remainder of the year and macroeconomic challenges in China impacting purchasing behavior. The business productivity initiative announced last year in June and the incremental cost savings we discussed in April and today are on track. As a result, we continue to expect that adjusted earnings per share diluted will increase 3% to 4%, including dilution from acquisitions of $0.05 to $0.06 per share and be in the $4.24 to $4.28 range. Thank you for your time this morning. And I will now turn it over to Mark.

Thank you, Patricia. Before we get into the Q&A, I want to remind everyone that we are here to discuss our financial and operational results for the second quarter and our outlook going forward. We know there has been a lot of market chatter surrounding Mondelez’s preliminary nonbinding indication of interest. As we stated on June 30, our Board of Directors unanimously rejected the indication of interest. We are not going to comment further on this matter. We appreciate you keeping your questions focused on our operations and our financial results. J.P., Patricia, Michele Buck and myself, are now ready to take any questions you may have.

[Operator Instructions] Thank you. We will take our first question from Andrew Lazar with Barclays. Please go ahead.

Good morning, everybody.

Good morning.

J.P., can you talk a little bit about just where inventory levels might be, just given I think you had received a benefit in shipment timing versus consumption both in the first quarter and then also in the second quarter as you have talked about? And then what’s driving the expectation of incrementally lower CMG category growth at this point? I know you were more cautious coming into the quarter already. And I guess what are you seeing now that has you more concerned?

Yes, Andrew. Michele and I will take a whack at that. Michele, you want to talk first about the category?

Sure, absolutely. Andrew, as you know, as we look at the total box, both the total box and center of store were really soft as we got into the year and certainly in Q2 as well. We are encouraged that snack wheel continues to grow ahead of the total box and certainly that’s really – the marketplace in which we compete is that broad snack wheel. So you really need to look at our – kind of look at year-to-date snack wheel performance as the opportunity for us. We know that the shorter Easter-impacted the category this year. That’s really a – more of a one-time or every couple year impact. We have seen some more activity in some of the indulgent categories in the second quarter. And frankly, there was a little bit greater interaction with some of those categories than we had anticipated. And we do believe we have some opportunities to further optimize our marketing mix modeling, as J.P. discussed. But over the long-term, I guess as we look at the category, clearly over the past several years, the category has been running at about that 2.5% growth rate and we continue to believe that, that will be the outlook going forward.

Yes. Andrew, if you look at inventories, we align, obviously, with our customers on where inventory should be. There is nothing different about that. And if you look at the first half in terms of takeaway as well as net sales, I mean, it’s largely in line. So, we don’t think there is anything there that would be different than what we would expect or what we planned for.

Thank you.

Our next question will come from David Driscoll with Citi. Please go ahead.

Great, thank you and good morning.

Good morning, David.

So, Mark, sorry, I got two things I wanted to ask. The second one is super short I promise. The big picture question, J.P., is given that you have a formal bid can you provide some commentary on the margin potential of the business? So, it’s not a big question, but it does relate to these kinds of things. The question here is kind of what’s the upside to operating margins over time? And this really aids investors at moments like this in understanding what do they actually own and how to frame any and all offers when you are kind of – investors are put into that situation? That’s the big question. And then just a little one on the International segment, can you give us some thoughts on how profits flow going forward on International? Thank you.

So, I will take the first part of that and Patricia and I can talk about your short one, but Andrew [ph], we are just not going to speculate around things that we would have to do with hypotheticals there. So I mean over time, we can talk about how we continue to be margin focused. You have heard us talk about our focus against the cost of our operations coming up. We talked about the $135 million we want to deliver this year. So I would just come back and say, as you know, we are a margin focused company. We want to make sure that our opportunities and our costs are well aligned and we want to continue to be able to invest in our brands and our people as we go forward. But as it might relate to something hypothetical, I just can’t comment on something like that.

On the international piece, first I really want to call out that, as I said at the beginning, a piece of our over-performance on EPS was driven by great results internationally. We are very focused especially on China right now as they continue to sequentially improve their business. They also have a lot of focus on making sure that we have the right cost structure aligned to the opportunities in that market and they are doing a lot of work on that. So we continue to expect improved results internationally over time.

Hey David, I am sorry that I said Andrew. They have told me here, so I apologize for that. Trust me I had your face in my mind perfectly.

Not a worry at all. Thanks so much for the thoughts. Thank you.

And we will take our next question from David Palmer with RBC Capital Markets.

Thanks. Good morning.

Hi David.

You released – you had mentioned marketing to authenticity and simplicity of ingredients, are consumers telling you that this is a friction point for your brands and for the category, are you solving that perception issue and do you intend to do a renovation of any of your products associated with this message?

So for certain consumers in the marketplace, certainty authenticity and simple ingredients is clearly something that they are looking for And so our approach is really to think about our – the holistic portfolio that we have and make sure that we have choices for everyone along the spectrum, so certainly barkTHINS, clean label, simple ingredients and that appeals to that consumer. And as I believe you are aware, we evolved our Hershey product, which was very close to simple ingredients, took it all the way there and we are actually going to begin advertising on that in the third quarter. So we believe that certain products of ours, certainly like a Jolly Rancher, are never going to be simple ingredients. So we will have a full portfolio that gives consumers meaningful other choices.

And just a follow-up, is the Snackfection innovation that you are talking about for later in the year, is that an extension of the confectionery brand into healthier snacking and if so, do you feel like indulgent brands can move into better for you?

So I would say that it is – the innovation that’s coming up is really what I would call Snackfection in terms of blurring – the blurring that’s occurring between various snack categories. Think salty snacks and confection or other categories, cookies and confection, etcetera. So it’s really leveraging the fact that consumers are looking for more of those complex eats and opportunities to play at the seams between categories. I think there – that largely our confection or hardcore mainstream confection brands will continue to offer primarily indulgent benefits. But there are some places where I think there is a little bit of crossover. For example, Snack Mix certainly has nuts, pretzels, etcetera and consumers are seeing that a little closer to having some food value than a straight chocolate.

Thank you.

And our next question comes from Bryan Spillane with Bank of America. Please go ahead.

Hi, good morning everyone. I guess the question I mean just following-up on Andrew Lazar’s question, Michele can you just tease out for us how much of the category weakness or the category being sort of softer than it had been historically is coming from immediate consumption versus at-home consumption, I mean I guess the idea being it just seems like there is a vast amount of choice as a consumer goes to the front end with a lot of products that are near or somewhat close to what your base products are, so just trying to get a sense for how much of the work you need to do is really in getting immediate consumption changed or is it really equal, both at-home and immediate consumption? Thanks.

Yes. I mean I don’t think that we are seeing a strong skew to one type of consumption versus the other. So as we look at our instant consumable business, it’s relatively flat. So a lot of that can be skewed by the support that goes behind the business relative to merchandising. And certainly, the clean floor policies have probably impacted the take-home side of the business a bit more. So we continue to focus on big scale events, focus on our core brands and core pack types, both in terms of take-home as well as instant consumables, but we aren’t really seeing a dramatic trend one way or the other on that front.

Okay, thank you.

And our next question comes from Alexia Howard with Bernstein. Please go ahead.

Good morning everyone. Can I ask about the recent CVS announcement that they are going to be putting quite a lot more better-for-you snacking in the front area of the store, I think they talked about replacing about 25% of the area that was previously targeted at candy, I guess what – how do you react to an announcement like that, is there a risk that those kinds of moves might spread elsewhere in the industry? Thank you very much.

So first of all, we partner with our retail customers very closely, so announcements like that aren’t surprises to us. They actually look to us to help them to optimize their total box and their total sales across snacking. If you look at that CVS example, that – you might be surprised to learn that, on that one, for example, we are netting out in a neutral position from an SKU perspective. So as we have broadened our portfolio to have offerings like barkTHINS, Krave meat bars, think about refreshment portfolio, those are actually allowing us to remain neutral on an SKU basis and really just offering consumers broader choice, both for across the CVS portfolio, but also the Hershey portfolio. So certainly, it’s something that we are focused on. I wouldn’t tell you that it’s not something that we are – that we have an eye on. But we are really thinking about the fact that, that is out there and making sure that we have the right plans in place to continue to drive our confectionery and broader snacking portfolio.

Thank you very much. I will pass it on.

Our next question is from John Baumgartner with Wells Fargo.

Good morning. Thanks for the question. Maybe to ask the U.S. consumption question a different way, just going back to your consumer analytics around segmenting out into various buckets, the loyalists, occasionalists and so on, of the categories’ deceleration, can you pinpoint where on that spectrum the pressure has really emerged, maybe as the first pass. And then as a follow-up, in terms of the course correction from here, how should we think about the need to maybe spend more back against the brands, either promo or advertising, given the substitute pressure coming into your – the snacking categories?

Yes. So I would say I mean relative to the marketing mix, as J.P. mentioned I think we are really still working through with evolving consumer choices and the evolving retailer landscape, just really optimizing that mix. So I would tell you that we continue to learn every quarter. We have gotten more sophisticated models in place to help us to better understand the interaction between all of that. But that’s an area we will continue to work on and I think make some continuous improvement going forward.

So one thing that I would add to that is that as we have seen innovation across the snack wheel, so remember what we said earlier is the box is up about 1.8%. Snack wheel is actually running ahead of that. And then there is parts of the snack wheel that are obviously outperforming others. And what you could link that to in almost every instance is the quality of the innovation. So I would actually say that has been a more critical element in a more competitive and space constrained world that that’s giving certain brands and categories an opportunity to be available and consumers are responding to that. But for me, the really good news is that the snack wheel continues to do well. We just have to make sure that we are working hard and winning our part of it.

Okay, thank you.

We will go next to Mario Contreras with Deutsche Bank. Please go ahead.

Good morning Mario.

Good morning. So I wanted to ask, with respect to China, can you give us an update on how you stand with your current distributors, are you satisfied with the setup that you have, are they meeting expectations. And then beyond that, given the recent Mondelez announcement about their entry into that market, do you anticipate any changes to your strategy or to overall category dynamics in the upcoming quarters?

Well, first of all, in terms of any entrants into the category, the China market is still a young market relative to consumption per capita. So really, as long as we are all working hard on category development, that’s probably a good thing. So frankly, that’s how we think about it. In terms of our acquisition and integration work there, I would tell you that we are making really good progress against the integration. Some of that work is still continuing obviously, but we have really gone through and done the sales organization work and combined those. That’s gone well. We have taken what was the Hershey piece and the Golden Monkey piece and really tried to consolidate those distributors. So, it’s a bit blended from where we started with Golden Monkey and Hershey, but we really feel as though our go-to-market position is in the best shape that it’s been. We are selling things. So, as I like to think about it kind of in a simple way, are we making stuff, shipping it, selling it and collecting money? And all of those things are working for us. So, I think that the market in China, as you have heard from a lot of companies, is pressured. I think we would align with that. The consumer obviously has to show up, but we feel good about where we are at. And we will continue though I would say to as I have said before, make sure we are rightsizing all of our businesses to the opportunities. And certainly, we will continue to focus against that. And then as you think about the overall P&L, the impact of China restructure on our P&L this year is really relatively limited. So, we think that will continue to also help us as we go forward.

Okay, thank you.

Our next question is from Jonathan Feeney from Consumer Edge Research. Please go ahead.

Thanks very much. J.P., I wanted to circle back for a second on your answer to Andrew Lazar’s question on inventory, even though I am picturing David Driscoll in my mind. The – like you, I just – like you, J.P., I just can’t stop picturing him, but the – what kind of – when we look at like both the category and your takeaway, what sort of consumer takeaway in North America for the third quarter, fourth quarter, maybe into next year, do you have in mind when you think about the kind of – this kind of shipment growth going in? I am just trying to get – and what does that mean for kind of market share and what would be sort of good success metrics for you going forward for the next 6, 12 months there?

Yes. If you think about the second half of the year and first of all, the inventory perspective I gave you, I am not sure I can add a lot to that. That’s certainly how it is. If you think about the second half of the year, with Halloween and seasons, we have very good visibility to that. We know what that’s going to look like. Same thing would be with holiday. And then also remember, as we have talked about a significant innovation in Q4, we benefit from the volume of that as we begin to build distribution and of course, the merchandising activity is after that. So, as we move through the year, you have the benefit of that volume that won’t necessarily be a piece of the takeaway, so you might have a bit of a disconnect there in the second half. It shouldn’t be significant. But as we have talked about our expectations in terms of the balance of the year, it does take into consideration the first half of the year and where we have seen the category growth be and that’s probably where you also have seen some of the moderation on the outlook and expectation there. I don’t know if anyone else wants to add something to that.

Yes. I mean, I would just say we expect to continue to see kind of a slow sequential build in takeaway as we move further into the year.

Yes. I think the fourth quarter will be better than the third obviously just because of our strength in seasons. And then to J.P.’s point, net sales, intuitively, should be a little bit better than takeaway because of the big launch that we have late in the year that we are getting to later.

Great. Well, thanks very much everybody.

You bet. Thank you.

We will go next to Matthew Grainger with Morgan Stanley.

Hi, good morning, everyone. Thanks for the questions. J.P. and Michele, you talked about the pipeline of innovation that you have coming up in chocolate and snacking in the second half. And when we look at the CMG trends at a subcategory level, we are actually seeing some of the strongest growth in non-chocolate and your own sales there have been dramatically weaker. And I know you have been in a position of needing to be selective about where you are focusing your investments. But can you just speak to your approach toward how you are thinking about non-chocolate at the moment? Any concerns that you are starving that side of the business and losing too much market share in the short-term? Thanks.

Yes. So, I would say yes to that question. As we made prioritization choices across the portfolio, we made a decision to pull back a bit in non-chocolate and I think we are reevaluating that choice certainly as we speak. I think we pulled back at a time that some others in the marketplace actually accelerated. So as we look to next year, we are certainly adjusting our approach. We think that variety and news are absolutely key and that’s really where our focus will be to dial up efforts in combination with the strong innovation that we feel really good about on chocolate, around things like core news, like Big Kat, Reese’s Pieces Cup and then big sustainable scale innovation on chocolate, like the big one that we have coming towards the end of the year. But you will see us dial up the focus on non-chocolate next year.

Okay. And just I am not sure if it’s possible to talk more about timing there. I mean, how quickly can you replenish the innovation pipeline? Is that something that takes a few quarters or is it possible that it might – given where your efforts have been that it might take longer?

Yes. On non-chocolate, I would tell you I wouldn’t expect to see activity this year. It will be into next year. I would rather not go into the specific timing just for competitive reasons, but definitely it would be a couple of quarters. We have a pipeline in place and so it’s really a matter of dialing that up and getting it into the marketplace.

Okay, understood. Thanks.

The next question is from Jason English with Goldman Sachs. Please go ahead.

Good morning, Jason.

Hey, good morning, J.P. Thank you guys for the question. So, a couple of questions. Let me start one sort of higher level. A lot of talk on the call and I have clearly seen the data of sort of shifting growth within – I think you called it a snacking wheel. I guess I have a question on pricing within confection. Is there any concern that price gaps between alternative snacking solutions may be an issue? And any implications in terms of pricing power going forward as we certainly see a number of your key inputs, moving higher recently?

Yes. So, let me talk about the pricing piece a little bit and then we can touch again on sort of the snack wheel stuff. But I think what we have seen is that if you recall on the last call we talked about the number of new entrants that’s happened, especially in snack bars relative to the whole snacking space. And some of those entrants, I think have gotten trial not only because they are new, but I think there has also been a different pricing delta that the obstacle to trial has been lowered. And so I think the level of activity probably speaks more to what the net value to the consumer could have been across all of the different options and opportunities available to them. So I think going forward, while we are looking a lot at our whole revenue management approach and making sure that we really got that right, we’re thinking a lot about this particular question. And I do think there’s some influence there as there’s been trial in the category. And I would just come back to my other comment around innovation, is it’s is very clear that those brands and companies who have done well in innovation have gotten a disproportionate share of the consumers’ attention. And those – that’s the real quality driver, in my mind. So if you come back to what I said earlier, we are really, really focused against three things in our business model. And it’s the innovation. We are really looking at our marketing mix model, because based on the previous question, you are right, allocation and resources across different pieces of the business I think there are some things we learned there. And then of course we want to run a frugal business and invest in our brands and our people. And those are the three things I think you should take away from what we are really talking about today.

That’s helpful. One more then I will pass it on. On the innovation front, it’s been a long time since we have seen a successful new candy bar launch sustain the market, so can you talk a little about what’s differentiated about this Cookie Layer Crunch product that leads you to believe that it can really be a sustainable success?

Yes. Listen, why don’t I ask Michele to talk about that, but I think if you go back to how she talked about it within the seams of a pure confection and as you might think about other snacking opportunities, that that’s what we think is really unique about how this is positioned. We would like to see it source volume from maybe some new places that stretches us a bit from just the core, but I will let Michele speak to that.

Yes. So our most successful innovations are clearly grounded in deep consumer insights, and we have certainly gone – leveraged a lot of insights and research as we have developed this proposition and feel quite good about it. As J.P. said, it really does play between those themes in Snackfection of marrying cookie and chocolate obviously. And also it really plays on some deep insights around palate. If you think about the kind of the creamy crunchy palate, sweet and salty we see in the marketplace has demonstrated a lot of growth. And we are seeing with younger consumers in particular, there is strong interest in complex eats that this really delivers upon that will provide incremental usage versus our portfolio, which tends to be more of a – kind of a straight, creamy palate. So if you think about the textural experiences consumers are looking for and the new users that we are able to bring in, we are feeling really good about it.

I look forward to trying it. Thank you very much.

Next, we will go to Chris Growe with Stifel. Please go ahead.

Good morning.

Hi, good morning. I just had two questions if I could or just really follow-ups. I guess I want to be clear, back to an earlier question, if you quantify the effect on U.S. sales in the second quarter and like what could come out of the third quarter as you pull forward those sales. And maybe if I could add just a follow-up question to an earlier question, as you think about all these cost savings, is there a level of marketing you are trying to achieve or how should we frame at least the potential to reinvest some of these savings back into the business? Thank you.

Yes. So let me start by – we are not going to quantify the sales impact, but I think you might be thinking it might be larger than - by the nature of your question, it sounds like you might be thinking it’s a little larger than it is. On the cost savings piece, we really want to look at all the levers of our costs. I think we have done a historically good job of looking at our COG savings. We continue to focus on that and that will actually be the biggest driver. We need to extend that into other areas, including our SM&A that excludes our marketing part of our business. And then on marketing, it’s going to be a combination of continuing to want to invest as a brand building company, but doing that in an ever smarter way and making sure that every one of those dollars works for us. The world is changing pretty quickly and we are just going to need to continuously reevaluate the roles of each of our – each lever that we have in marketing.

Okay. And then just Patricia, one quick follow-up then, I think in the U.S., you had 3.5% growth and I look at your takeaway in the quarter, it’s around 0.5%, so I am trying to put those numbers together, am I looking at it the wrong way or...?

Yes. I think it’s – because of timing of some of the things, it’s probably easier to look at it on a year-to-date basis. And when you look at it on a year-to-date basis, there is actually virtually no gap between our – there is a very small gap between our takeaway and our sales.

Okay. Thank you.

We will go next to Robert Moskow with Credit Suisse. Please go ahead.

Hi. Thank you. What can we expect to hear from you folks on your Analyst Day coming up, assuming you are still going to have it, do you think you will give us a little more clarity on the cost structure reductions that you are planning and maybe even some more details on all this marketing mix modeling and I think people are going to care Michele, if this is a message that advertising and promotion or really just advertising kind of comes down a little bit, I think we all remember 2005 and 2006 when it went down too far, so will you give us more clarity in that regard also?

Hey Rob, I mean it’s Mark and I will let Michele and J.P. talk to those – to the business – some of the business drivers and investments that you referenced. As it relates to the Analyst Day, you are right there hasn’t been a date put out there. I mean there is obviously a lot of moving parts. And you know that we are absolutely focused on the business and doing all the right things for the near and long-term, as we continued to do. But as soon as we have a date, we will communicate it.

Yes. I would just very quickly talk about on the cost side, we have talked about very clearly what we expect in 2016. It’s a bit early to get into some of the specifics of the additional work that we are doing, but we are – we have a process in place and we are looking at all the costs and opportunities we have literally across the entire business, line by line. And we want to ultimately make sure that we can make up the investments in our brands, aligned with the opportunities that are in front of us. I think you will continue to hear us be very consumer and brand focused and yet at the same time, we will always be very margin focused. But we have to be able to afford those investments. But as we think it’s appropriate to build brands, I think you would see us want to be able to invest at within the kinds of ratios that we have talked about in the past. And as I always say to the team here, volume is the magic elixir. It’s a great category and we get really good returns on the investments we make versus our brands. But clearly, we have got to be driving volume to make that story look optimal.

I would say our focus is really optimization. How do we optimize and continue to be consumer centric and brand building, so not really a big change in that piece of the business model.

Okay. Thank you.

Operator, we have time for one more question.

And we can take that question from Erin Lash with Morningstar. Please go ahead, Erin.

Good morning Erin.

Hi. Good morning. Thank you for taking my question. I just wanted to follow-up. There has been a lot of discussion about innovation on the call and obviously, you have expressed a commitment to bringing new products to market to drive category growth. But I was wondering if you could speak to the pace of innovation in terms of the timing and the ability to get an idea or a product from development to shelf, it sounds like some of your competitors and some of the more, I guess smaller niche operators have been bringing new products to market in a quicker fashion and I wonder the extent to which you have thought about, is your pace of innovation timely enough to respond to consumer trends? Thank you.

Sure, thank you for the question. I think it’s more about the productivity of innovation than it is the pace of innovation. And so when you look at things like hand-to-mouth that we were very successful with and it continues to be productive for us, it’s what I always call sticky innovation. It’s innovation that lasts. It’s many times a platform and it allows you then to expand even across brands because you have identified a need state that’s really important. If you look at how we classify innovation, actually our numbers versus our innovation targets are actually pretty good this year. I mean it’s not that they are wildly different, but what you have to really achieve is that stickiness and then the thing that it gets you to the platform innovation. So we have a really good pipeline of things in front of us. And so I don’t think it’s about all of a sudden having to start focusing against innovation. It’s really making sure that we are bringing the right innovation to the market with the right investment and productivity. So that’s really how I think about it. And Michele may have something she wants to add, but that’s how I think about your question.

No, I agree. I think it’s about quality and sustainability, just making sure that we have – we stick true to our model on that front.

Thank you very much.

Thank you very much for your questions today. Investor Relations group will be around for any follow-up questions you may have.

And this will conclude today’s program. Thanks for your participation. You may now disconnect and have a great day.