Hershey Company (The) (HSY)

HSY 
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Hershey (HSY)

Q1 2011 Earnings Call

April 26, 2011 8:30 am ET

Executives

Humberto Alfonso - Chief Financial Officer and Senior Vice President

John Bilbrey - Chief Operating Officer and Executive Vice President

David West - Chief Executive Officer, President, Director and President of North American Commercial Group

Mark Pogharian - Director of Investor Relations

Analysts

Erin Lash - Morningstar Inc.

Andrew Lazar - Barclays Capital

Judy Hong - Goldman Sachs Group Inc.

Alexia Howard - Sanford C. Bernstein & Co., Inc.

Vincent Andrews - Morgan Stanley

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Terry Bivens - JP Morgan Chase & Co

Eric Katzman - Deutsche Bank AG

Robert Moskow - Crédit Suisse AG

Kenneth Zaslow - BMO Capital Markets U.S.

Bryan Spillane - BofA Merrill Lynch

David Driscoll - Citigroup Inc

David Palmer - UBS Investment Bank

Presentation

Operator

Good morning. My name is Angie, and I will be your conference operator today. At this time, I would like to welcome everyone to The Hershey Company First Quarter 2011 Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. Pogharian. Please go ahead, sir.

Mark Pogharian

Thank you, Angie. Good morning, ladies and gentlemen. Welcome to those of you on the line and on the webcast to The Hershey Company's First Quarter 2011 Conference Call. Dave West, President and CEO; and Bert Alfonso, Senior Vice President and CFO, will provide prepared remarks. And then both of them, along with J.P. Bilbrey, COO, and myself will answer any questions you may have during the Q&A session.

Let me remind everyone 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 2010 filed with the SEC.

If you have not seen the press release, a copy is posted on our corporate website, www.thehersheycompany.com, in the Investor Relations section. Included in the press release is a consolidated balance sheet and a summary of consolidated statements of income prepared in accordance with GAAP. Within the Notes section of the press release, we have provided adjusted pro forma reconciliations of select income statement line items quantitatively reconciled to GAAP.

As we've said within the Notes, 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.

We will discuss our first quarter 2011 results, excluding net pretax charges that are related to the Project Next Century program. In the first quarter of 2011, these pretax charges were $9.7 million. Our discussion of any future projections will also exclude the impact of these net charges. Lastly, there are broader peers [ph] reporting this morning, and out to respect to them, as well as to the analysts and investors who want to participate in those calls, we ask that you limit yourself to 1 question. With that out of the way, let me now turn the call over to Dave West.

David West

Thanks, Mark. Good morning, everyone.

Hershey's first quarter results were strong and I'm pleased with our performance. The investments we've made in our business over the last 2 years continue paying dividends, as core brands continue to perform well in the marketplace. Our advertising continues to resonate with consumers, and we are getting solid lift from our in-store selling, merchandising and programming. Our marketplace performance and strong start to the year give us confidence that we'll deliver on our 2011 financial objectives.

I'd like to start by spending a moment on the pricing action announced on March 30. As you're all are aware, commodities market prices have been volatile, and we expect that volatility to continue in the coming months and quarters. Prices for many of the primary and secondary commodities we use in our products have increased year-over-year and since our last conference call. While we can hedge our future needs on most of our primary inputs, there are numerous secondary inputs where there is not a developed futures market. Given category dynamics related to the pricing flow-through and the view of our future cost profile, a price increase was necessary to protect our margins. This action was effective immediately on March 30. However, during the 4-week period ending April 22, existing customers were allowed, based on historic order patterns, to order up to 8 weeks of inventory at the previous price, if delivery occurs by May 20. As expected, some of our retail customers have ordered product under this scenario.

Prior to the increase as Q1 progressed, we saw a shift in order patterns by some customers, who chose to carry slightly greater levels of inventory in the first quarter. Given broad-based upward inflationary pressure in many food and packaged goods categories, we suspect they were carrying additional inventory in anticipation of a potential price increase. We estimate that about 1.5 points of net sales growth in the first quarter was attributable to volume, which normally would have shipped in the second quarter. Given the relative sizes of Q1 and Q2, that will likely result in about 1.5% less revenue in Q2 as inventories normalize. Also recall that we do not expect seasonal net price realization until Easter 2012. Additionally, the majority of nonseasonal merchandising will be offered at previous promoted prices through much of the third quarter of 2011. We therefore expect a higher Q2 trade promotion rate, which will further dampen revenue.

Consumers are starting to see higher everyday prices, primarily on instant consumables and on in-aisle, nonmerchandised take-home items. As such, we expect an initial price elasticity impact to result in lower volumes over the remainder of the year and into 2012. Therefore, we do not expect this action to materially impact our financial results this year. While it's a bit early to measure consumer reaction in response to the pricing action, we feel that our brand support, innovation, consumer spending and investment and go-to-market capabilities will enable us to deliver on our full year net sales objectives, which remains around the top of our long-term 3% to 5% range. Overall, the confectionery category continues to perform well, as recent gains have been within the category's historical growth rate. Investments in the category in the form of advertising and innovation are present for most major manufacturers.

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