The Hershey Company (HSY) Q3 2016 Earnings Report, Transcript and Summary

Good morning, everyone and welcome to The Hershey Company’s Third Quarter 2016 Results Conference Call. My name is Roxanna and I will be your conference operator today. [Operator Instructions] This call is scheduled to end at about 9:30 a.m. So, please limit yourself to one question till we can get to as many of you as possible. Please note this call maybe recorded. Thank you. Mr. Mark Pogharian, you may begin your conference.

Thank you, Roxanna. Good morning, ladies and gentlemen. Welcome to The Hershey Company’s third 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 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 summary of consolidated statements of income prepared in accordance with GAAP. Within the Note 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 provide additional information to investors to facilitate the comparison of past and present operations. As a result, we will discuss third quarter results, excluding net pre-tax charges of $72.4 million or $0.23 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 net charges. And 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. Before we discuss the details of our third quarter results, I’d like to add some context to the press release we issued on October 14. It’s been an honor and a privilege to be the 11th CEO of The Hershey Company. I’m proud of all that we’ve accomplished as a team over the last 5 to 6 years and plan to be fully engaged on a day-to-day basis as CEO over the next 8 months or so as we drive the business forward and regain momentum. I will also continue to work closely with my management team as we review our global go-to-market approach that we discussed in July. We are making progress and expect to discuss these value-creation strategies with you in early 2017. Importantly, we believe that The Hershey Company will continue to be successful in the marketplace. We have a solid framework in place related to customer capabilities and consumer insights, especially in the North American segment that should enable us to execute against the demand landscape work that we’ve been updating. This is in conjunction with the progress that we’ve made in our R&D pipeline and faster innovation cycle in our core CMG business and snackfection initiatives. As part of our overall commitment to research and development, we are very pleased to announce our participation in the new University of Pennsylvania’s Pennovation Center, whose grand opening is today. The Pennovation Center is a bridge that brings together corporations with the need, curious educators and student scientists in the university’s new hub for innovation that will focus on research, development and entrepreneurialism. Let me add some perspective to our international operations. We have experienced macroeconomic challenges and slowdown in some of our key development markets. With this said, under the right conditions, we know our brands can be successful, as evidenced by the market share gain that we’ve attained, where we focused on our core brand-building efforts. However, given an uncertain outlook in these markets over the near term, we will continue to assess our investment mix across the enterprise to align with both our long-term strategic intent and best growth and margin-enhancing activities. We believe that it’s appropriate to continuously assess market opportunities and evolve the best approach to meet our growth and profit focus. We simply see this as part of our ongoing operating philosophy. We plan to share further details with you at our investor event early in the year. For now, I can tell you that we are striving for an organization that’s more agile, flexible and focused on the consumer, brand-building and cost efficiency across our entire business. This will drive improved gross margin and EBIT margin. Our commitment to growth and cost control will enable us to continue to deliver strong cash flow growth and generate value for all shareholders. As it relates to 2017, it’s a bit early to discuss specifics, but we think there is a setup to deliver top quartile performance versus the peer group. A longer Easter season and planned innovation driven by Hershey’s Cookie Layer Crunch and barkTHINS’ acceleration should benefit top line growth. We have visibility into our cost structure and $100 million in productivity savings that we discussed earlier in the year that should lead to EBIT margin expansion in 2017. Third quarter sales, marketplace performance and operating income were relatively in line with expectations. Earnings per share exceeded our forecasts, driven by a lower tax rate, and Patricia will have more on this in a bit. As we anticipated, U.S. marketplace performance sequentially improved versus last quarter and was within our targeted range. Total Hershey U.S. retail takeaway for the 12 weeks ended October 8, 2016, within the xAOC+C channels increased 0.6%, with market share the same as the year-ago period. This represents all Hershey manufactured products sold at retail, such as candy, mint, gum, salty snacks, Krave, chocolate syrup and snack bars. Importantly, trends in our chocolate business improved due to a shorter Easter and the timing of innovation, chocolate retail takeaway was off about 0.5% in the first half of the year and was up 0.6% in the third quarter, resulting in a market share gain of 0.5 points. We expect that the fourth quarter total Hershey and CMG performance will continue to sequentially improve. Our brands responded positively to the investments we discussed last quarter. Specifically, marketplace results in the quarter were driven by our performance in August as in-store merchandising and display activity and on-air advertising GRPs were solid, supporting U.S. Olympics programming and the launch of Reese’s Pieces Cups. Our marketing mix for these programs was balanced between direct trade in both TV and digital advertising. You will see more of this next year as we look to optimize our marketing mix model. Innovation in targeted 360 degree programs, where we got our marketing mix right, has worked for us so far in 2016. Variety and news on the Reese’s franchise, driven by our NCAA relationship, which has been extended to the fall football season, and the launch of Reese’s Pieces Cup, has resulted in the Reese’s brands retail takeaway of close to 8% in the third quarter. End results were similar for the Kit Kat franchise, given the success of the Big Kat new product launch. And Hershey’s Kisses, up 7.2% in the recent 12-week period, is also quietly having a good year, driven by birthday-themed packaging and programming. We are getting incremental quality merchandising in other parts of the store, where wrapping paper and birthday cards can be found leveraging the emotional connectivity the brand has with consumers. And our Reese’s Snack Mix and Hershey’s Snack Bites continue to do well and give us confidence that our close-in snack strategy will gain traction over time. The same successful principles will be applied to Hershey’s chocolate, where current brand performance isn’t where we really want it to be. We believe the launch and related support of Hershey’s Cookie Layer Crunch will reenergize and make the brand fresh. Consumer demand for multi-textural eating experiences across varying snacking occasions is increasing and this product fills whitespace opportunity and should partially source volume from the cookie category. We are leveraging our iconic Hershey chocolate bar and pairing it with layers of cookie – crunchy cookie bits and decadent fillings to offer an indulgent textured snacking experience, easy for me to say. This is one of the most anticipated innovations from the iconic Hershey’s brand in many years. Based on pre-launch testing, Hershey’s Cookie Layer Crunch earned some of the highest consumer scores of any product ever launched by the company and will come in three flavors: caramel, vanilla cream and mint. Each piece is perfectly portion controlled at 90 to 100 calories and will be available at select retailers starting in December. So, we are making progress, but there is still a lot of work to do as we enter the fourth quarter and look to 2017, where our priority is to restore Hershey’s marketplace momentum with the very profitable U.S. market. We believe these initiatives and ones that we have yet to disclose will result in improved and consistent marketplace performance over this strategic planning cycle. As such, we believe the candy, mint and gum is an attractive category capable of solid growth over the long term when supported with the right mix of customer and consumer marketing. Net sales in India declined versus the year ago period due to the discontinuance of the edible oil business. The media-invested brands, Jolly Rancher, SoFit and Hershey’s Syrup and Spreads, where we are focusing our efforts and investments, increased about 20%. In China, the modern trade hypermarket environment continues to be challenging across many categories. Our gross sales in China declined in line with our estimate, with net sales up about 15% on a constant currency basis. Chocolate category performance in the third quarter was sluggish and down about 4%. Our marketplace performance was in line with our expectation, with market share off about 1 point. We’re executing against our plan and over the remainder of the year, have a balanced consumer proposition of variety, news and marketing across the Hershey’s Milk Chocolate, Hershey’s Kisses and Golden Monkey candy and snack brands. Our China e-commerce business has been relatively consistent and continues to post solid results, albeit off a smaller base. We estimate that our e-commerce business has about a 10 share of the market in China and look to build on that over the remainder of the year, driven by Singles Day in November. Now, to wrap up, despite the macroeconomic challenges facing the consumer, the broader snacks category, including indulgent snacks, continues to grow across retail channels. We are committed to our marketing mix modeling, trade, TV advertising and digital media as well as investments related to innovation, consumer marketing and insights that we believe will enable Hershey to deliver consistent and predictable top and bottom line growth. As I stated earlier, we feel good about our preliminary 2017 plans that are still taking shape. We’re a growth and EBIT margin-focused company with a goal of increasing margins on an annual basis via both cost control and importantly, top line growth. Hershey has many opportunities to leverage its global brands in U.S. scale. We are optimistic about our future and focused on what we need to do to succeed. Our balance sheet and cash flows remain strong, and our executive management team and the Board of Directors are confident that we’ll continue to build value for all Hershey’s shareholders. 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. Third quarter net sales of $2 billion increased 2.2%, in line with our forecast. Adjusted earnings per share diluted came in at $1.29, an increased of about 10% versus last year, greater than our estimate due to shift of advertising and related consumer marketing expense to the fourth quarter and the 280 basis point decline in the adjusted tax rate that was greater than anticipated, more on both of these in a bit. Excluding the negative impact from foreign currency exchange rates of 20 basis points, net sales increased 2.4%. As expected, net price realization was relatively in line with our estimates and a 70 basis point benefit primarily due to lower international and other segment direct trade and returns, discounts and allowances as we lap the year ago challenges in China. Volume was a 1 point contribution to net sales growth, driven by our performance in the U.S. Acquisitions were a 70 basis point benefit due to barkTHINS, which we acquired in the second quarter. By segment, third quarter North America net sales increased 1.8%. Volume was a 1.1 point benefit and driven by the U.S. business, where volume was up 1.7 points. Canada net sales and volume were off as planned as solid new product performance was more than offset by select SKU rationalization. Acquisitions were an 80 point – 80 basis point benefit and net price realization, a 10 basis point headwind. Total international and other segment net sales for the third quarter increased 5.3% versus last year. Foreign currency exchange rates were unfavorable by 2.2 points. International and other segment volume was up 10 basis points, as solid Latin America and select export market performance was partially offset by lower sales in China, the discontinuance of the edible oil business in India and a little softness in the global retail and licensing business. Net price realization was a 7.4 point benefit as direct trade and returns, discounts and allowances in China were lower. Turning now to margins, adjusted gross margin declined by 40 basis points in the third quarter as productivity and cost savings were offset by unfavorable sales mix from excess packaging and higher supply chain costs, driven by initial year absorption of overhead related to the Malaysia manufacturing facility. For the full year, we continue to expect that gross margin will be slightly down versus a year ago. As J.P. mentioned, we remain focused on our cost structure. The productivity initiatives we have discussed this year are on track and we plan to deliver approximately $135 million in cost savings this year and at least $100 million per year from 2017 through 2019. Adjusted operating profit in the third quarter increased 7.6%, resulting in adjusted operating profit margin of 22.3% versus 21.2% last year. The increase in adjusted operating profit was driven by an increase in gross profit and lower marketing expense. As expected, total advertising and related consumer marketing expense declined about 9.6% in the third quarter. This is partially due to timing. Recall, advertising and related consumer marketing expense increased about 5% in the second quarter and we expect that it will increase in the fourth quarter as well. North America and international and other segment, SM&A, excluding advertising in the barkTHINS acquisition, declined 5.5%, driven by savings from the previously discussed business productivity programs. Unallocated corporate expense increased 3.5% or $4 million as efficiency and cost savings initiatives were offset by higher employee-related costs, an increase in corporate depreciation and amortization and JV minority interest expense. Now, let me provide a brief update on our international and other segment. I am pleased that our total international business delivered on their Q3 plans. As J.P. stated, we are executing against our plans in the key markets of China, Mexico, Brazil and India. Adding to his commentary on China, chocolate category performance in brick-and-mortar continues to be choppy. Consumer spending still appears to be mixed within the modern trade box. China gross sales are forecasted to decline in 2016. However, net sales are expected to increase as we don’t anticipate the same level of direct trade, returns, discounts and allowances as last year. Constant currency net sales in Mexico and Brazil increased nicely. International and other segment operating profit increased meaningfully and I am pleased with the progression. As J.P. said, we are committed to profitability in this segment. Moving down the P&L, interest expense of $24.4 million increased $5.7 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 third quarter was 30.7%, lower than our estimate as R&D tax credits were greater than anticipated. As expected, the other income and expense line item includes the book expense related to corresponding tax credits that we mentioned last quarter. For the full year, we expect the tax rate to be about 100 basis points lower than last year. For the third quarter of 2016, weighted average shares outstanding on a diluted basis were approximately 215.2 million shares, down 4.9 million versus last year resulting in adjusted earnings per share diluted of $1.29 or an increase of about 10.3% versus a year ago. Turning now to the balance sheet and cash flow, at the end of the third quarter, net trading capital increased versus last year’s third quarter by $20 million. Accounts receivable was lower by $1 million and remains extremely current. Inventory was higher by $30 million and accounts payable increased by $9 million. Total capital additions, including software, were $64.1 million in the third quarter. For the full year, we expect CapEx to be at the low end of our $265 million to $275 million range. During the third quarter, adjusted depreciation and amortization was $61.5 million and dividends paid were $128.6 million. In the third quarter, the company did not repurchase any 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 did not repurchase any common shares in the third quarter to replace shares issued in connection with the exercise of stock options. Cash on hand at the end of the quarter was $333 million slightly lower than a year ago. As J.P. summarized, over the remainder of the year and into 2017, we have a lot of innovation, variety and seasonal merchandising and programming in the marketplace. We have good visibility in the holiday orders and demand related to the upcoming launch of Hershey’s Cookie Layer Crunch. We feel good about our marketing mix modeling investments and believe that we have the right balance of spend over the remainder of the year as total trade and advertising is higher in the fourth quarter versus last year. We believe these investments should result in a continued sequential improvement in U.S. retail takeaway. For the 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 75 basis points. We continue to expect that gross margin will be slightly below last year due primarily to unfavorable sales mix. Business productivity and cost savings programs are on track with our targets. And as we discussed earlier, the tax rate is expected to be slightly favorable versus our previous expectations. As a result, the company expects adjusted earnings per share diluted for 2016 to increase 4% to 5%, including barkTHINS’ dilution of $0.5 to $0.06 per share and be in the $4.28 to $4.32 range versus the previous estimate of $4.24 to $4.28. Thank you for your time this morning and we will now take any questions that you have.

[Operator Instructions] Your first question comes from the line of Jonathan Feeney with Consumer Edge Research. Please go ahead.

Thanks very much.

Good morning, Jonathan.

I wanted to ask a little bit about the Q4 and maybe some thoughts going forward. Obviously, I mean, you mentioned a little bit in the script there are some timing issues with the reductions to SG&A. So, I’d first like you to maybe parse how much of that is kind of reduction in advertising versus maybe structural SG&A that’s just going to be lower? And when you think about Q4 and 2017, are there things going on? Can you give us a sense of like what your – what’s the right level of relative advertising for the business right now, because obviously, you spend well ahead of your peers? You have a launch going on. But on the flipside, a lot of people are maybe looking more critical with the kind of investments that they are making and there is other ways to push it and promote right now. Thank you.

Yes. Sure, Jonathan. Thanks. What I am going to do is ask Patricia and Michele Buck, who, as you know, is our Chief Operating Officer, is also with us. So, I will ask the two of them to talk about the fourth quarter, because I think that will be something that comes up for several of you. Thanks.

Thanks. Let me start off by talking first about SG&A, excluding advertising and related marketing. You could see that it was down and has been down since we have gone through the year both on a divisional level and on a year-to-date level in corporate. When – we did have a little bit of an uptick compared to prior year in the third quarter. That really had more to do with some timing issues that we had last year’s third quarter than any change in our fundamental run-rate. And I expect to see this focus on cost in our SG&A, excluding marketing and related advertising expense to continue. In terms of the advertising and related marketing expense, we – as I said in my remarks, we have been running above in the second quarter. We dipped below a little bit in the third quarter, but we expect to have that backup again in the fourth quarter. And that, combined with added investments in trade promotion, we believe will continue to drive momentum in the marketplace. And I will turn it over to Michele to talk a little bit more about that.

Yes. So, I would say we continue to believe in investing with the consumer and focusing on getting that right balance between advertising and trade that lets us really deliver in the marketplace. If you think about Q4 overall, we have very good visibility into our holiday orders as those are already sold into customers. We will be shipping Hershey’s Cookie Layer Crunch and that will be a bigger benefit to net sales than it will be takeaway. You will see more of the takeaway towards the end of the quarter and into 2017 and you can think about that as being roughly 1 to 2 points growth for us in Q4. And then lastly, the balance of our growth will really come from overall takeaway across our international and U.S. business. And we believe that we will continue to see some sequential improvement in Q4 behind the investments that we are making.

Thank you very much.

And we will take our next question from the line of Ken Goldman with JPMorgan. Please go ahead.

Hi, good morning everyone.

Hi, Ken.

J.P., I know it’s early. I know you are not ready to give an exact number yet. But just in terms of you talked about some potential margin growth coming from some of the unique activities you maybe undertaking in the next year or two, people are speculating anywhere from 50 basis points to 400 or 500 basis points. Is there any help you can give us just sort of bracketing what the opportunity might be? I am sure you are not going to go full 3G on us, but any thoughts about the opportunity and how we should think about that would helpful at this point?

Yes. I think there is a couple of things, Ken, that I would say is that you are going to continue to see us talk about the importance of being both growth and EBIT margin-focused. And so we have got to have the right balance there. We continue to be optimistic about the category. And the things that we have talked about so far, I think we have been transparent about, but what you will really hear more with greater specificity is when we get together on March 1 at our meeting. So, a lot of this work is still in process, I would say. But the way we think about it, Ken, is we really have more of a business model philosophy around how we want to have that right balance. But we also believe that if you noticed in my remarks, I have talked about getting the right mix of growth opportunities and where we invest. And I think it’s just basic that we always have to revisit some of those. And given some of the macroeconomic challenges, I think you will see us try to get those right going forward. And then again the greater specificity will come in March. So, if you work with us on that, I appreciate it.

No, I appreciate that. Mark, if you don’t mind, if I can ask a quick second question.

Sure, go ahead.

J.P., I think you mentioned that you are looking for both top quartile performance in 2017 as just sort of an early outlook into next year. One, I wanted to make sure that, that was EPS that you were talking about just in case I missed it. And two, what are you looking at when you are looking at performance? Are you basing that versus 2016? What are you thinking about performance? What will that be on average? Just trying to get a sense of – I guess it’s my job, this entire call, trying to get numbers out of you, but trying to figure out what those numbers might be a little more specifically?

Yes. So I think you have to think about that as both from a growth standpoint and then also from an EBIT margin standpoint that will be a significant focus for us going forward.

Alright, thank you.

You bet. Thanks, Ken.

The next question comes from the line of Rob Moskow with Credit Suisse. Please go ahead.

Thank you. As a follow-up I think to Ken’s question, you will probably get questions about the sustainability of your gross margin, which is at – still at a – close to a peak. And I guess I can see a lot of room for SG&A kind of efficiencies, but I’m still curious as to what you think gross margin can do and if there’s expansion from here given that you are expanding into snacks, which I believe are lower margin. And I think commodities were probably about as low as they can go. They probably can’t get much lower. So – but what are you looking at in that regard?

Hi, Rob. It’s Patricia. Let me take a crack at that. I think you have laid out some of the parts to our gross margin that we are very focused on. I agree with you that the snacks and some of the international margin – gross margins are lower than they are. In our core U.S. chocolate business, there is not much that does better than core U.S. chocolate in terms of margin. And you see some of that mix impact in terms of what’s in the base right now. You have mentioned commodities. Commodities will go up and they will go down and we keep our eye on them. And we always look to have some visibility going forward in our commodity expenses so that we can price accordingly and respond accordingly. But I don’t subscribe to the fact that there aren’t improvements we can make in our gross margin. And I want to call out one of the things that our U.S. plants are doing here in terms of the methodology we call lean, which is really wringing even more costs out of the production process and that’s something that we are in the process right now of – we have in several of our plants and were rolling out to more plants. Another thing that we can look at is really on our SKUs and making sure that we have the best, most optimal SKU mix in our portfolio. So, while I agree with you there is a little bit of a headwind in terms of the portfolio evolution, I think that we wouldn’t want to say that there is nothing that we can do about it. We need to remain enormously focused on gross margin.

Yes, I would build on that. I think we also believe we have some opportunity relative to the work that we are doing on revenue management and optimizing trade as well as price mix that could help us as well.

Okay, J.P., congrats on your retirement. Looking forward to March 1. Thank you.

Thanks a lot. Look forward to seeing you as well.

Your next question comes from the line of David Driscoll with Citi. Please go ahead.

Great, thank you and good morning. I wanted to ask a little bit about the Cookie Layer Crunch, you gave some nice comments in the opening, but can you discuss just kind of why this product is so important? And how incremental do you expect it to be to Hershey and the category? So let me just start there and a follow-up, if I may.

Sure, David. It’s Michele. I will take that one. As we have talked a bit before, we really view our competitive landscape as being that whole snacking world. We know that snacking is growing faster than the total food market. And within that, we are seeing a lot of growth in indulgent snacking and we think it’s a real opportunity for us to leverage our trademarks and play as broadly as we can. And what we have seen is a strategic opportunity to source revenue more broadly and also to provide some incremental texture that we are seeing based on our consumer demand landscape that certain consumers are looking for so that it really expands the footprint of our Hershey trademark. So as we had mentioned, this is an area where we do a lot of testing. We did the BASES test that looked at concept, product delivery as well as our marketing investments behind the proposition. And all signals have indicated that it is a big nice kind of scale platform opportunity for us and that’s why it’s really important. It’s going to help us to refresh the Hershey brand to bring relevant news and capture new snacking occasions.

Can I just follow up with a question that’s a little bit bigger picture? When you guys look over the last couple of years on innovation within the U.S. chocolate category, kind of how do you grade it? And how do you consider that to be the primary culprit in – resulting in the much lower and slower category growth that we have seen? And then is Cookie Layer Crunch one of the key components to reaccelerating the category for Hershey?

So David, I would say, as we think about the key priorities that are necessary for us to drive the business and maximize our results, they really focus on portfolio, which does have a lot to do with innovation. On marketing mix, we have talked about this category as very responsive category, so getting the right balance between advertising and trade and also within advertising, how we spend our dollars and then, of course, cost control, where we are – have always been focused and as you know are focused on some additional platform work going forward there. So, I would say that innovation is absolutely key. Scale platform innovation has proven to be one of the greatest drivers for our category. I am encouraged about some of the innovation that we had this past year and I think that we have seen the results of that in the marketplace. And a lot that didn’t launch until the second half, but Big Kat, Reese’s Pieces Cup has done incredibly well. And Snack Mix was also a great innovation that drove incrementality. Of course, it wasn’t shared to the confection category. It’s actually health and salty snacks. So, it is a key lever. And having that sustainable big platform innovation gives us sustaining innovation over a multiyear period of time and that’s one of the biggest focuses for us is making sure that we have sticky innovations, so that it doesn’t just launch and come out. But I agree with you that as we look to next year, both in terms of our business as well as the category, we think that the level of innovation is really going to help to drive CMG category growth and bring consumers to our category. So we are really excited about that.

Well, I really appreciate the answer. Thank you so much.

Your next question comes from the line of Matthew Grainger with Morgan Stanley. Please go ahead.

Good morning. Thanks, everyone. I wanted to ask about the margins in the international segment. I think it’s the first quarter in about 2 years, you have been profitable there. And I don’t expect you to comment on longer term targets for where you see that at the moment, but just if you could walk a bit more through what contributed to the improvement and the profits turning positive in that segment. And do you feel you have turned the corner and are now at the point where you can sustain positive margins, positive operating profit in international over the next few quarters?

Yes, I will take a crack at that. And let me start by saying that you may recall last year, we had a lot of issues in China with trade, where we really had to readjust our inventory out in the trade to market conditions. And so what you are seeing – a lot of what you are seeing is the non-recurrence of that. We have some great results in our Mexico and Brazil operations that I feel really good about. In Brazil, we are having a very good year as we have taken over from our Bauducco JV and have now control of our – over our distribution and are seeing great results from that even given the difficult operating environment in Brazil, so great job from the Brazil team. In Mexico, we have increased distribution opportunities using our Sigma distribution partner, so great result there. India has been taking care of some products that are lower profitability and you can really see that helping our margin and we need to continue to do that going forward. I think China will continue to be a work in progress as we assess our opportunities against the marketplace that we have there, whether that’s in chocolate, which has been a little bit weak or in the more traditional candies that we have with our Golden and Munching Monkey brands. So, we are focused on gross margin there. And getting to healthy gross margin is a big part of the story of returning that whole segment to profitability.

Okay. And the restructuring that’s going on in China, is that – are we seeing the impact of that flowing through or is that being largely offset by some of the category challenges still?

It’s – I am sorry – go ahead.

No. I mean, I was going to say we have done some initial integration work with Monkey. I don’t think there is – we didn’t say anything about any restructure work underway, so I don’t know if that’s what you are referring to. I mean, there is again a broader assessment going on right now. As J.P. referenced around what – it’s really a global review across all functions in all geographies. So, we will come back to you with further details on the where and the how.

Okay, great. Thanks.

Your next question comes from the line of Bryan Spillane with Bank of America. Please go ahead.

Hey, good morning everyone.

Good morning, Bryan.

A question for Michele. Can you just give us a little bit of color in terms of how business is performing in the U.S., instant consumable versus future consumption? And I know the instant consumable has been a bit of a drag over the last, I guess, year or so, but it sounds like some of the innovation or some of the work you have got going into the market next year is going to address that. But if you can give us some color of kind of the difference between the two would be helpful? Thanks.

Sure. So, instant consumables is always a priority for us, given its strong profitability and so as we look at the past couple of years, we are really focused going forward and how we can continue to drive instant consumable a little bit harder. There has been a bit more competition in that area from some healthy instant consumable offerings. But where we feel good about where we are making progress is the results we have seen from some of the innovation that was instant consumable focused, both in terms of our Ice Breakers gum, capacity expansion and then the Reese’s Pieces Cup and Big Kat. And then you will see that with Cookie Layer Crunch as well and some other offerings into next year. We have also focused on optimizing some of our merchandising strategies in a way that we think will continue to drive instant consumable a bit harder. So it’s certainly a key focus for us.

And just in terms of how it’s trending right now, is it still lagging your future consumption business?

No, it’s not.

Okay. Thank you.

Absolutely.

Your next question comes from the line of Jason English with Goldman Sachs. Go ahead.

Hey. Good morning folks. Thank you for the question. You mentioned earlier about innovation to try to rejuvenate next year so – and the platform optionality. Tactically, I was hoping you could elaborate a bit more on this Crunchers product and how it fits in, in terms of that and maybe some specificity about when and what is coming on that. And then stepping up beyond innovation, we crunched some of the numbers over here, it looks like another big source, so the category weakness has been just a crowd-out in terms of merchandising, display – and display space, quality merchandising space within retail, if you can elaborate a little more, what do you think is driving that and what do you think can try to reverse the course of that one, I appreciate it? Thank you.

Sure. So I will address both of those. So first of all we will look at Crunchers, this fits right in the strategy. We have spoken to you a bit about around snackfection, which is thinking broadly about where our core confectionery trademarks, which are so powerful, can play to bring in new users and be utilized across even more snacking occasions with consumers. So if you look at Crunchers, you can see the product has our great trademarks and great chocolate, but very different eating experience, which is much more of a munchable crunchy product, which will put those propositions in a whole different consumer use education. So it really fits in that strategy of expanding snacking occasions across the broader marketplace. And you will see that in the marketplace sometime mid first half of the year. But we are really excited about that. Relative to your broader question on some of the other factors at play in the category, one that I would bring up is just the timing of Easter is always a key factor for the category. And certainly, some years that’s a benefit. And some years, it’s not. This year is one of the shortest Easters. Next year, we have that going in our favor, so we are excited about that. And relative to display, there has been some pressure on the category as some of the biggest retailers have gone to clean floor policies. And given how much floor space confection has received. I think this category has taken a little bit of a bigger hit than some other categories potentially. We believe that we are now behind us with lapping a good piece of that and we believe that having great innovation is one of the best ways to gain display and space. And we are feeling good about some of the initiatives that we have put in place for holiday, where we are seeing share gains and also the share gains that we saw in Q3. And display has been a piece of that.

Thank you very much. I will pass it on.

Your next question comes from the line of Andrew Lazar with Barclays. Please go ahead.

Happy National Chocolate Day, everybody.

Thank you, Andrew.

I must have made I was not aware that was a thing, but I just figure that out today, so that’s good. So J.P., just a quick one, I am curious on, I guess your thoughts on all the activity in the space this coming year. We have got a new chocolate launch in the U.S. by Mondelez, you have got margin rate we are now better able in theory to kind of integrate their efforts, I guess more fully in a category that remains relatively slower versus historical run rate, so I am trying to get a sense if you think all of that is enough to accelerate the category growth rate in ‘17. And obviously, if what Hershey has planned both what we know and don’t yet know is enough to either hold or gain share in that sort of a more active environment?

Yes, sure. So we – as we look at 2017, we believe the category has indicators that it will continue to expand. I wouldn’t describe that as a planning stance that says it’s a hockey stick, but I think we can see that there is firming in the category. Consumers are in stores. And I just think overall, at the macro level, we think people are across all income cohorts beginning to spend a little bit more confidently than they have before. What I think of that I am very optimistic about is if you just look at the total snack wheel, snacking continues to progress. I think it’s largely driven by occasions. So we have to compete and do well against those new occasions that exist in the market. But I think innovation will be an important driver. It’s good for the category if you think about it within the total snack wheel that we have great competitors. And so frankly, as there is good innovation, I think it just reminds consumers the relevance of CMG in total and so I think that’s good for all of us. And then we of course have to win as well. So what I think you will hear from us as we get more specific about 2017 is we are optimistic about some improvement in the category growth rate as relative to snack wheel. We think occasions certainly benefit us as well and then we have to win market share. And that’s why we are focused against an overall business model that helps us win as a part of the top quartile of our peer group. And then we also want to win market share, obviously within our specific categories. So I am pretty optimistic about 2017 and those are some of the reasons why. Michele importantly talked about the competitiveness in-store. That was all true. But listen, we are all in the business of growth and meeting the wants and needs of consumers. So we are going to be really focused against executing. We are going to win every day from a market share standpoint and then the category growth rate should take care of itself.

Great. And as it relates to in-store competitiveness, you may get into this more at your meeting in March, but where you do think Hershey stands now at the sort of the in-store effort or the feet on the street, you made a lot of investment there over the last couple of years, is that in the right place or does there need to be some maybe some additions and further investment on that part of it?

Well, in my comments, I talked about being flexible and agile. And that’s something that we look at all the time. And so we are constantly reviewing where we think the opportunities are with our organization. We believe strongly in the resource that we have and the effectiveness of our sales organization, our overall go-to-market effort. So you would continue to see that as something we just view as really important to winning every day.

Thank you.

Your next question comes from the line of Alexia Howard with Bernstein. Please go ahead.

Good morning everyone.

Good morning Alexia.

Hi, can I ask about how you are thinking about the acquisition strategy from here, I would love to hear what your sort of views, historically on the Brookside acquisition and then Krave were. And I am focusing on North America here, as you think forward, are you thinking about larger scale opportunities and how are you thinking about diversification maybe in the direction of Krave and more into the non-sweet snacks area or is it going to be more of the bolt-on box and Brookside type of activity?

Yes. So Michele and I will both talk about that. Let me take the more macro piece of that. So we believe that we want to grow and we look at acquisition as an important piece of that. Obviously, if we can find large, meaningful assets that align with the categories that we are in, we are very open to that. As we have talked about before, we are very aware of all of the different things that exist. We look at a lot of things. At the same time, we believe we have a great business model and we don’t want to do anything that doesn’t really help us build there. I think that when you would see us do smaller things, it’s because we believe they fit within a larger platform or have a brand positioning that we can really build around. I don’t think we are going to be in the business of just getting a lot of disconnected small things that we can’t figure out how to knit together. So, we are very thoughtful about how we think the emerging consumer trends are and does that help us get into some of these different places. So, M&A is an important thing for us. At the same time, we want to be very, very thoughtful about how we approach that. I will let Michele talk a bit more about Krave and Brookside and some of her thoughts there.

Sure. So, we feel good about each of those acquisitions if I look to Brookside, Krave as well as barkTHINS though that one obviously is early. And really, our strategy there is looking at how we can expand our portfolio to either bring in new users or new usage occasions, something that we perhaps aren’t able to do with our current existing portfolio of brands. So, we really think about buying a brand and a full proposition. As I look at Brookside, we have been really pleased with how we have delivered against that acquisition model over the years. We certainly have grown the business. It continues to be important strategically in terms of delivering and getting us more into the mass premium space. And right now, we are focused on consumers love the products. We have great repeat. And our next wave of growth there needs to be to continue to drive incremental trial and bring in additional users to that product that folks love. Krave, we are feeling good about. And if you look at all three of these acquisitions, as we create value, we certainly start by creating value by expanding distribution and that’s been the clear first piece of the model by achieving cost synergy and then third, by unleashing and expanding the brand and that’s really the model we think about each one. Krave, we have nearly doubled the sales on that, likewise, nearly doubled distribution and are feeling good about where our velocities are in the marketplace and the innovation pipeline we have behind that. And we are seeing similar results that would certainly again allow on barkTHINS. So, we feel like we have got a model that is helping us to continue to have a portfolio that meets the growing, expanding needs of consumers.

Thank you very much. I will pass it on.

Your next question comes from the line of David Palmer with RBC Capital Markets. Please go ahead.

Thanks. Good morning everyone and congratulations, J.P.

Hey, thank you.

As a follow-up on an earlier question, how would you compare the new cookie fused products to past innovation maybe in your consumer testing or the trade buzz, it can be compared against the platforms like Minis, Pieces or Reese’s Stuffed with Pieces or Hershey caramel? And I have a quick follow-up.

Well, first of all, all of the different things that we look at there, we believe they are consumer tested and we want to make sure that they are meeting a need. We have done a lot of demand landscape work that helps us think about where these products belong. And I think we are – I would tell you that I think the rigor we have and the new demand landscape work that we are doing is pretty exciting and it gives us some real insights into some of the things we are doing in our R&D work. So I would tell you we are very confident about the things that you will see us working on as we go forward. And I am sure that in March, we will reveal a little bit more of our demand landscape work and you will see where we are positioning some of these products. So obviously we have always been thoughtful and we are always optimistic, but we just try to get better every year. And we are pretty excited about the things we have in front of us.

And then with regard to SKUs, back in 2015 I think you were talking about SKU rationalization being part of the plan. Earlier in the year, it looked like SKUs were flat. Now, they are coming back up again. Are you in a good place with the trade on SKUs and velocities or how are you thinking about that as you enter into ‘17 and have new products coming on shelf? Thanks.

So, we know that it’s a highly competitive marketplace and I think we are always trying to achieve that balance between having the right amount of news to fulfill those consumer and retailers’ needs and be competitive in the marketplace, but also balance that with being very disciplined and really making sure that we have got the right focus on profitable SKUs that allow us to deliver the best margin. So, I would tell you that we have got a lot of focus on that right now. We have continuing focus on that and we will look to continue to optimize there.

Thank you.

Your next question comes from the line of John Baumgartner with Wells Fargo. Please go ahead.

Hi, good morning. Thanks for the question.

Good morning, John.

Michele, just in keeping with the theme of generating your own growth in the U.S., how much more can you maybe lean into the seasonal businesses whether it’s in C-stores or other channels? I mean, that seems to be a reasonably incremental segment that Hershey hasn’t executed against significantly in the past?

We think very broadly about seasons and seasons are really celebratory occasions. So, we certainly look to max out each individual traditional season opportunity, but we really try and think more broadly about how we can apply that model more broadly. So for example, the S’mores occasion is a great opportunity of almost – of the S’mores season. And then more recently, we built the birthday opportunity, which we just started shipping in the marketplace in the second half of this past year. It’s one of the reasons why Kisses is doing so well, because we have now found a way to get that Kiss and some of our chocolate products into a new occasion, where we really help create and shape that occasion for consumers and the need for our product during that occasion. So, we see that as one of the big opportunities just to continue to expand on that occasion focused strategy in addition to winning the traditional seasons and continuing to uncover new insights that allow us to do that.

Thank you.

Operator, we have time for one more question.

Okay. The last question will come from Steve Strycula with UBS. Please go ahead.

Hi, good morning everyone.

Good morning, everyone.

So, two quick questions one for Michele and one for J.P. For Michele, I think I heard you say earlier in the call that Cookie Layer Crunch, which you are excited about should be about a 1 to 2 percentage point lift to baseline sales in the fourth quarter. Is that right? And if so, should we expect it to kind of endure through the first half of next year as you kind of bump up that baseline into 2017?

I don’t [indiscernible].

I don’t know if we want to get into that level of specificity yet. I mean, obviously, the fourth quarter, you are backing into it, so it’s a little bit different. But a lot of this – it’s a big brand, a big launch and we hope to get trial and repeat. And then as J.P. loves to say, repeat a repeat. We will certainly provide more color there, but I mean it’s the biggest news on the brand in a long time. So let’s put it that way.

Great. And then J.P., a quick follow-up, just wanted to see – you commented earlier on the call that you are seeing broader based spending habit pickup across the income spectrum it seems like because you said traffic seems better in the stores. And I think this time last year, you are talking down saying traffic was a little bit of a pain point in some of your occasions. So, can you kind of explain the evidence as to why you are seeing kind of like a broader based pickup in your core consumer and even the category? Thanks.

Well, first, you have to take a step back and remember, with our brands, we have very high household penetration. We have high market share. And therefore, we can see across and we have ubiquitous availability. So as we look at all of the different channels and how consumers are – put traffic into stores and then how they are spending per trip, it’s all things that we follow pretty closely. And so you are starting to see such. So imagine that some retailers probably have relatively stable traffic on a going basis than others depending who their income cohorts are. You might see a bit of a different traffic pattern. So, what’s happening is, first, you begin to see people come back into the stores and then you begin to see the basket broaden a little bit. So, I just want to be cautious that it’s not as if everybody is out high-fiving. But as we talk to some of our retailers and as we follow those metrics, there is evidence that the consumer on a more broad base is having a greater frequency in the store. And then we follow what I would simply call the breadth of the basket or the trend – or the value of the basket and we are seeing some improvement there as well. It’s different by channel and you would see some retailers having different experiences. In some retail segments, still talk a little bit about volatility that they are seeing. But again, the good news is that fairly broadly, we are seeing an uptick in trips. And then as the economy I think continues to firm a bit, there will be some confidence around the spend of those consumers. And that’s part of what makes us optimistic about 2017 is if you think about the three elements of our business, seasons, the everyday business and then, of course, instant consumable, instant consumable is very much influenced by people obviously being in the store. We are going to have our products on the floor when they are in the store. When our advertising is working hard for us, you see that everyday business, which is a wonderful margin business for both us and the retailers, do well. So, it really comes back to these elements, Michele talked about earlier for us, strong innovation, making sure we have got the right marketing mix modeling and then the business model that we have talked about. And we will explain more in – when we get together in the spring. It’s really going to be the three buckets of focus for us as a company.

Well, congratulations on a good quarter.

Thanks a lot.

Well, thank you very much for joining us today. The IR team will be available for any follow-up questions you may have.

This does conclude today’s call. You may disconnect at anytime and have a wonderful day.