Q2 2019 Earnings Call

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[laughter].

Good morning, everyone and welcome to the Hershey Company second quarter 2019 results Conference call. My name is Catherine and I will be your conference. Operator today, all participants have been placed in a listen only mode. After the speakers remarks, there will be a question and answer session. You may have registered to ask a question at any time by pressing the star and one on your Touchtone phone. This call is scheduled to end at about 930 am. So please limit yourself to one question. So we can get to as many of you as possible. Please note. This call may be recorded thank you.

I would now like to turn the call over to Melissa pool, Vice President of Investor Relations Ms. pool, you may begin your conference.

Thank you Catherine good morning, everyone. We appreciate you joining us for the Hershey Company second quarter 2019 earnings conference call and webcast, Michele Buck President and CEO and Siegel Senior Vice President and CFO will provide you with an overview of our results followed by Q and a session.

Before we begin please remember that during the course of this call. We may make forward looking statements within the meaning of the federal Securities laws. These statements are based on our current expectations that involve risks and uncertainties that could differ materially from actual events and those described in these forward looking statements contained in our 2018 10-K filed with the SEC and todays press release.

Finally, please note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information for investors. The presentation of this information is not intended to be considered in isolation worthy substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP with that I'd like to turn the call over to Michelle.

Thanks, Melissa and good morning to all of you on the phone and webcast.

First I'd like to start by giving a special welcome to Steve.

He joined the company following our last call and he's been a great addition to the executive leadership team.

Some of you have already had the chance to meet Steve and he and I look forward to visiting with more of you in the coming months.

Now onto business.

We are pleased with our second quarter results and the momentum we are seeing behind our key initiatives for this year.

Our balanced plan and capability investments are enabling us to deliver accelerated sales growth and differentiated earnings performance.

We are maintaining our market share leadership in our profitable U.S. confection business and driving incremental profitable sales with our snacking and international portfolios, both of which continue to perform well.

[noise]. These happen they continue to be the strategic priorities, our business and I'd like to take a minute to thank my colleagues across the business for their contributions to the strong quarter.

As we look to the back half of the year, we remain confident in our ability to deliver our financial commitments for the year.

In the second quarter net sales increased 0.9% in line with our expectations.

Organic constant currency net sales growth of approximately 1.8% was driven by pricing and the launch of key innovation, including resistance and Reese's lovers as well as our new package candy bags.

The net impact of acquisitions and divestitures was a 60 basis point headwind as the tiro and Shanghai Golden Monkey divestitures, offset or Pirates brand acquisition.

The majority of the impact of these divestitures has been realized and we expect the net impact of M&A to be a benefit for the remainder of the year.

Foreign currency exchange was a 30 basis point headwind in the second quarter.

We had another strong quarter of gross margin expansion, which enabled brand and capability investment as well as robust earnings growth.

Well some of our second quarter margin and earnings games were timing related the underlying trends remain solid.

This strong gross margin expansion of almost 200 basis points drove second quarter adjusted EPS growth of 14.9%.

Steve will share more details around second quarter gross margin performance as well as our expectations for the rest of the year.

As we've previously discussed price realization is a strategic focus area for us.

The price increase we announced last summer remains on track and the final portion is implementing now as we execute our Halloween program.

Additionally, last week, we announced a new price increase on our confection instant consumables business.

These products represent roughly one third of our overall sales and they were priced high single digits contributing to an estimated two points of pricing to our overall portfolio.

Consistent with previous practices, we will have a transition period for our retailers to adjust to these new prices and we do not expect cereal sales or earnings impact in 2019 from this pricing action.

We anticipate category retail prices for these impulse items to begin to increase in the second half of the year.

These actions reinforce our commitment to a more agile approach to pricing strategy that protects our advantage margin structure, while enabling continued investments in our brands and capabilities to drive category growth.

Other key initiatives on our U.S. confection business are also progressing well and on track retail takeaway was slightly ahead of our expectations coming out of Easter due to accelerated activation of our reese's lovers in and out promotion.

Per IRA Hershey Candy Mint and gum retail sales increased 1.9% versus prior year since the Easter season ended this was in line with overall category growth of 1.9%, resulting in flat share.

This growth was led by our powerful Reese's franchise, which grew 12% during the time period behind our new package candy bags or resistance innovation, and our Reese's lovers instant consumable promotion.

We are also excited by the response, we are seeing from increased media on some of our smaller iconic brands.

These profitable brands or a tremendous asset for us that deliver unique consumer proposition and incrementality to our portfolio.

We are leveraging our new media capabilities, both for content as well as targeting and increased investment to drive growth on many of these brands.

Over the past year and a half we've increased support on our Almond Joy Mounds York Payday and Whistler brands.

Our strong gross margin performance has enabled us to support additional brands Heath and rollover in the second quarter.

Early results are encouraging with our he's brands growing 37% and our role of brands growing over 7% over the last four weeks.

Well not all of this growth is incremental having more brands in our portfolio stay relevant with our consumers and growing is critical to our overall category leadership.

Our E Commerce business continues to perform well with second quarter net sales growth of over 60%.

Customer specific data as well as industry reports indicate that our growth is consistently outpacing competition by 10 to 15 basis points in 2019.

As we look to the second half of 2019, we expect to build on last year's seasonal success with solid performance in Halloween and holiday.

Additional kit Kat capacity is further enhancing our assortment bags for Halloween and enabling our kit Kat Mint Dualos innovation that will launch towards the end of the year.

Now for an update on our amplify and pirate brands acquisitions.

Her ire ice skinny pop ready to eat popcorn grew approximately 10% in the second quarter, resulting in a share gain of over 100 basis points.

We continue to focus on expanding distribution and optimizing our shelf placement, which is leading to consistent gains in household penetration.

As we discussed on our April call Pirates Booty sales performance has declined recently due to distribution losses at a few key retailers and the lapping of some significant promotional activity from prior year.

The distribution of losses occurred during to sales transition, but we remain confident that trends will improve in the second half.

As planet grams, reset and year over year promotional activity normalizes.

Retail sales trends for the latest four weeks are already improving versus the least the last 12 weeks and we expect that that will continue to improve.

Now for an update on our international business.

Constant currency organic sales grew 8.3% in the second quarter and we continued to demonstrate disciplined investment resulting in segment operating income growth of 32% versus prior year.

In Mexico, we grew our net sales high single digits in the second quarter behind continued strength in our core chocolate business and the launch of a new pedal Pelo Rico flavor.

In Canada, our Reese's brand eclipsed kit Kat and is now the number one brand.

Reese's brand is also seeing great momentum in the UK recently, receiving the gold IP I'm Award for best New product launch for our Easter Reese's Cream AG.

We will continue to focus on our core brand equities to drive profitable sales growth in the second half and beyond.

To wrap up we have good momentum across all of our key strategies with strong financial results in the second quarter.

We will continue to invest in our brands and our capabilities to take this business to the next level and drive sustainable top and bottom line growth.

I'll now turn it over to Steve who will provide you with details on our financial results.

Thank you Michelle good morning, everyone.

Before I get started I'd like to take a few minutes to say how excited I am to be part of the Hershey.

Hershey is a great company with strong brands, leading market positions in a balanced approach to profitable growth.

I've been energized by the talented team here and their passion for innovation growth and transformation.

I look forward to partnering with Michelle our board and the whole team to achieve our strategic vision and deliver strong sustainable shareholder returns.

Now onto the financial results.

Second quarter net sales of $1.8 billion increased 0.9% versus the same period last year.

Organic constant currency net sales growth of 1.8% was driven by net price realization of 1.2 points.

And volume growth of 60 basis points.

The net impact of acquisitions and divestitures was a 60 basis point headwind and foreign currency translation was a 30 basis point headwind.

These results were all in line with expectations.

Adjusted earnings per share diluted were $1.31, an increase of 14.9% versus the same period last year.

This was driven primarily by gross margin expansion and was ahead of expectations driven by two key factors related to the price increase we announced last week.

First a few select customers increased inventory on our most profitable items in anticipation of a price increase.

While total retail inventory levels were not up significantly from prior year, we benefited from positive mix for the quarter.

Second we increased internal inventory levels to support more demand from our retailers in the coming weeks as we transition to the new prices, which resulted in favorable fixed cost absorption.

About 90 basis points of our growth margin expansion in the second quarter can be attributed to these two factors and is expected to be offset in the second half primarily Q3 as internal and external inventory levels normalize.

We are pleased with underlying momentum against our margin expansion initiatives.

The business reinvestment and is enabling and a balanced top and bottom line growth it is driving.

By segment North America, net sales increased 8.5% versus the same period last year, driven by pricing, which contributed 1.5 points of growth in the quarter.

Volume was a 50 basis point headwind the net impact of acquisitions and divestitures was a 30 basis point headwind.

In foreign currency exchange rates were a 20 basis point headwind.

These results were in line with expectations.

North America gross margins expanded 180 basis points in the second quarter.

As I mentioned about half of this was driven by favorable product mix and fixed cost absorption related to the price increase we announced last week and is expected to reverse in the second half primarily Q3.

The remaining 90 basis point expansion was consistent with expectations and was driven by favorable commodities price realization from our July 2018 price increase.

And improved waste as we continue to execute our SK you rationalization program.

These factors are expected to continue contributing to solid underlying growth margin expansion in the second half, though will be partially offset by the reversal of Q2 gains from product mix and fixed cost absorption as well as some additional supply chain costs associated with fully integrating pirate brands into our operations.

North America advertising and related consumer marketing spend decreased 2.7% in the quarter driven primarily by advertising.

We expect dollar investment to continue to accelerate as we move through the year due to the lapping of last year's media efficiency gains and increased investment in our confection brands.

Second quarter total international and other segment net sales increased 3.9% driven by volume gains of 960 basis points.

This was partially offset by a 320 basis point headwind from divestitures.

A 130 basis point headwind from net price realization.

And a 120 basis point foreign currency exchange headwind.

International and other advertising and related consumer marketing increased 38% versus prior year.

Most of this increase is driven by increased investment to support Ramadan in EMEA.

Our India kisses launch and timing of consumer marketing spending.

Total Hershey adjusted gross profit increased 5.3%, resulting in an adjusted gross margin of 46.5% an increase of 200 basis points versus the second quarter of 2018.

As mentioned approximately half of this expansion was driven by favorable product mix and fixed cost absorption that are expected to reverse in the second half.

The remainder was driven by favorable commodity price realization from our July 2018 price increase.

Inefficiencies from our SG you rationalization initiative.

Given the progress we have made year to date and our visibility into the second half. We now expect full year gross margin to increase approximately 100 basis points.

Second quarter adjusted operating profit of $370 million resulted in operating profit margin of 20.9% an increase of 150 basis points versus the second quarter of 2018.

Gross margin gains and continued SGN, a discipline were partially offset by incremental advertising on our confection brands.

Moving down the piano.

Interest expense of $34 million decreased $1 million versus Q2 last year.

Full year 2019 interest expense is now expected to be in the $140 million to $145 million range due to lower interest rates.

The adjusted tax rate for the second quarter was 14.8% versus 16% in the year ago period.

These declines were driven primarily by a valuation allowance releases.

And excess tax benefits from stock based compensation.

Partially offset by fewer tax credit investments.

Second quarter other expense was $13 million, a decrease of $8 million versus prior year due to fewer tax credit investments.

We now expect our full year 2019 tax rate to be approximately 18% versus our previous estimate of 17%.

However, we also expect our full year other expense to decline to $80 million to $90 million as we expect fewer tax credit investments.

The net impact up to the full year of these two changes is expected to be negligible versus our previous estimate.

For the second quarter of 2019 weighted average shares outstanding on a diluted basis were approximately $211 million.

This is a slight increase versus the first quarter due to an increased number of stock option exercises in the quarter.

The company did not repurchase any shares in the second quarter against our July 2018 $500 million authorization.

And $410 million remain.

The company repurchased $56 million of common shares in the second quarter in connection with the exercise of stock options.

Total capital additions, including software were $176 million in the second quarter.

For the full year 2019, we estimate capex to be towards the high end of our $330 million to $350 million range.

As a percent of net sales this remain slightly higher than our long term target as we continue to implement our new ERP system and invest in core capacity.

We continue to return cash to our shareholders with second quarter dividends of $149 million.

This was our 350 eightth consecutive quarterly dividend on the common stock.

Additionally, this morning, we announced a 7% dividend increase a testament to our solid balance sheet and strong cash flow generation.

To summarize for the full year, we expect full year reported net sales to grow around 2% the midpoint of our previously communicated range. We continue to anticipate approximately a half point net benefit from acquisitions and divestitures.

And the full year FX impact to be negligible based on current exchange rates.

Full year reported earnings per share diluted are expected to be around $5.58 comparable to prior year.

We expect full year adjusted earnings per share diluted growth of around 6% to 7% the top half of our previous range.

As we look to the second half we want to highlight a few areas, where we expect trends to vary versus the first half.

Advertising and related consumer marketing expense is expected to grow more in the second half than the first half as we lap media efficiency from last year as well as increased support on our core confection brands.

Given current sales and EPS guidance compensation is anticipated to be a headwind in the second half of 2019 versus the second half of 2018.

Due to timing of tax strategies, we expect the second half net tax impact to be unfavorable versus prior year.

For the full year, we continue to expect a slight benefit to EPS from tax.

That concludes my financial discussion and ill now turn it back to Michelle.

We have a portfolio of 11 brands and amazing team of individuals that are excited and proud to come to work every day.

And we remain focused on achieving balanced sales and earnings growth to continue delivering peer leading shareholder returns.

Steve Melissa and I are now available to take your questions.

And that is star and one if you would like to ask a question today. Our first question will come from Andrew Lazaro with Barclays. Please go ahead.

Good morning, everybody and welcome Steve.

Thank you Andrew good morning.

Hi.

As you noted consumption in North America was a bit above above shipments organic growth and I assume some of that was there's certain things like SKU rationalization and such but I guess with a SKU rationalization I think expected to moderate some in the second half and pricing expected to build and certainly a greater level of innovation.

That will help as well.

And then just I may have missed it but the incremental pricing that you've announced is that all this pricing or similar to last year's pricing, where it was a mix of all the various revenue management levers. Thank you.

Thanks, Andrew its Michel hate So let me do your first one your second part of your question first the incremental pricing is indeed oil list pricing. So that's a pretty simple and as we look at our consumption and our sales let me start with as we told you in the past on a full year basis, we always expect our net sales and our takeaway to be relatively in line, but we continue as we havent had in the past again this year to have some volatility from a quarter to quarter basis.

I guess, the easiest way that I would.

Advise you to think about it is if you look at our takeaway trends first half second half.

And you see that basically on our CMG business, we were up first half about 2.6%, but we all know that about a point to that was driven by Easter. If you take the first half minus the the Easter bump we expect that same underlying trend to continue in the back part of the year. So we think we're going to have continued have pretty solid takeaway on a full year basis.

There are several puts and takes as you look at the net sales piece relative to.

A little bit less SK you ramp in the second half, but at the same time, we are we have a bit of a harder lap as we.

Lap some of those seasons and as you recall, how strong seasons were in the back half of the year last year.

Some inventory related things in the second quarter, but by a full year end, we think it will it will level out as it has in the past.

Great. Thanks very much.

We'll now go to Ken Goldman with Jpmorgan. Please go ahead.

Hi, good morning.

Hi, Ken.

You said you don't expect a material sales impact from the new pricing action. This year, but I think are also heard you say that.

Category retail retail prices for these impulse items will increase in the second half of the year. So I wanted to reconcile this a little bit if I could.

On your customers taking up their pricing before you are.

So why are you protecting your pricing I just wanted to clarify when you expect wholesale and retail net prices to rise and if they're in synchronicity with each other.

So we do expect that we will see some impact at retail on the everyday business.

Particularly in the fourth quarter, but as you know as you look at the back half of our year. We are heavily weighted towards season. So seasons is a much bigger piece of the portfolio than the everyday piece. So we expect we'll see some there but we also do some price promotion protecting so many of our retailers have price promotions trade promotions that they have booked that we've committed to six months out sometimes slightly more and we do price protect those promotions.

When we go out with our pricing actions. So thats why you don't see the full impact.

And again, we believe the impact will will not be material to us.

We will be increased retail prices and maybe you are saying that there really won't be because it will be built back sorry, I just want to understand will that potentially lead to a situation, where you're not getting the pricing yet.

Retail prices are going up and therefore, your volume could get hurt because of some of our specific trends I guess I just want to make sure im understanding all the puts and takes here from a net pricing perspective.

There is a little bit of of impact there, but it's it's minimal and all the pricing is baked into the guidance.

Okay I'll, let it go thanks, so much.

And we'll now go to David Driscoll with Citi. Please go ahead.

Okay. Thank you and good morning, and welcome Steve So nice to have you on the call nice quarter joined the company.

[laughter].

Yeah I'd pick it too can you can you talk a little bit about the pricing and the impact on the king size bars, I think as we understand it the king size bars World will break the $2 price point to little over $2 and this may cause some downtrading. So just kind of building on Ken's question, just trying to understand the impact of the price increase here in and how it affects the lose bar portfolio is this something where you can you just walk us through these impacts as I find it kind of complicated king size was always such an important component of your loose bar business. So profitable. So if it forces some downtrading the standard bar.

You'll walk me through the the impact on on how you see the price increase playing through on this issue.

So David.

We have a pretty sophisticated price elasticity modeling that we do whenever we take any price action, including this one that model takes a look at the impact of pricing of crossing key price thresholds and also takes a look at the relationship between regular count the single bar and the King size because there is an impact there you know it looks at other competitive items in the marketplace and any impacts there. So all of that is taken into account as we do those legacy models that help us to predict the conversion curve and then we also take a look at that and in some cases. If there is an area, where we think we need it part of our total pricing action could include some level of reinvestment in trade on specific areas to either maintain the current price point, we certainly also reinvest in advertising because we know back from the past if we take pricing and at the same time reinvest that Thats also help.

To accelerate the conversion curve. So we believe all that is taken into accounts as we do the analysis and you're right that on some of those businesses some of those.

You do hit some of those issues, but we think thats fully taken into account in our plans for the marketplace.

One quick follow up on your comment on the Reese's. We also understand that the recent lovers promotions was was very successful, but ironically the criticism that I heard was that it was such a good product people were disappointed the retailers are disappointed they couldn't reorder. It can you give us some thoughts as to what you do with something like this that's that's gone. This well is there any thought to making any part of that that promotion of an everyday part of the lineup or do you just repeat the promotion sometime in the future. How do you think about that.

So David it's certainly a great problem to have and we will evaluate all of those things interestingly. There is sometimes a good thing to have something consumers love and they look forward to seeing it returned to the marketplace and I think frequently we found that thats a really good strategy to employ it was a great in and out promotion and we could do it.

Again in the future. So we'll be evaluating those options are all options to determine whether something like that should become permanent or we just leverage it to keep news and excitement which is key in this category.

Thank you so much I will pass it along thanks.

As a reminder, that is the star and one keys to ask a question today. Our next question comes from Jason English with Goldman Sachs. Please go ahead.

Hey, good morning folks.

Thank you for for Simon.

I guess I want to come back to the price increases as well and focus a little bit more on what's different this time.

Looking back at some of the go last time for the last pricing cycles, particularly in single serve.

Arguably they were all cost justified and we'll certainly see kind of what the cost justification is for this magnitude of price and single serve. So question number. One is are we missing some sort of cost pressure out there that necessitates this price and if not.

Without the cost pressure how might this be different do you expect to have to deal back more to reinvest more.

To keep retailers happy or.

Or do you expect the relationship for retailers to be very similar to what we've seen in past cycles.

So thank you for the question.

You know as we shared we've evolved our pricing approach from one in the past that was very much a much more cost and commodity driven to much more of a strategic pricing capability, where we think strategically across the portfolio at where we have opportunity.

On an ongoing basis more than versus that kind of episodic approach, but we approach. It in much the same way as we have in the past in terms of how that how it gets impacted in executed through retail and I wouldn't anticipate that we would see any type of different scenario versus other times when we've priced instant consumables in the marketplace. We have a price that part of the portfolio for probably more than five years and we expect to see similar results based on what we've seen in our last 50 models.

That's helpful. Thank you and and looking back to the 2014 hike or the or even the 2011.

The buy in period.

Protection period was eight weeks in duration for both of those cycles and it effectively caused a deferral of the.

Flow through benefit by one quarter. So you announced in July last time by the fourth quarter, we actually saw material flow through of price benefit youre, suggesting this time will be different.

But at the same time, we're seeing it's kind of consistent so what's the disconnect. There why shouldn't we be expecting a more material benefit coming in the fourth quarter.

I mean, we expect that we will see some impact in Q4, but we don't view that impact to be material and I think some of that will be associated with.

What some of them varies on how much we see relative to what kind of inventory position people are carrying and you know how that kind of flows through yeah. Jason is the less I mean, I think the one piece that we that we did talk through that was a little different than the last time is we did have retailers kind of building inventory on these pack.

Before we announced so there is a little bit more inventory in the marketplace at those old prices. So we'll take a little bit longer to cycle through that just because the speculation was out there in advance so that is a little different from the last time.

Okay very good thank you.

Thanks.

Well now go to Bryan Spillane with Bank of America. Please go ahead.

Hey, good morning, everyone.

Good morning.

So.

Just I guess a question first just about resistance.

It's been in the market now for I guess, almost two months and so any.

Sort of takeaways in terms of how thats performing in the market better or worse than expectations, and how you're thinking about that for the balance of the year.

So resistance is performing well it is exactly in line with our expectations and we are feeling good about not only the trial, but also the repeat which is strong and building.

And we believe that based on what we're seeing to date it will be a sustainable item for us and that we may be able to expand extend further off that platform.

So I guess following up on that just in terms of extending off of that platform is that possible to go within across some other brands, maybe as we look into next year.

Yeah, well, we don't want to make any firm commitments on our future innovation plans I think we clearly look at a platform a an idea like that is something that really can be a platform that can be expanded and if you look at how we've run platforms in the past many times. It is a basic idea that we take across brands and just allows us to get scale for merchandising et cetera.

Okay, great. Thank you.

You're welcome.

Our next question comes from Alexia Howard with Bernstein. Your line is open.

Good morning, everyone, Hi, Alexia Hi, there.

Ask about you made a couple of comments about the the popcorn brand belyea.

I'm curious about the pricing on the skinny pulp line it seems to have come down fairly sharply.

In the last.

Okay I guess.

Three quarters also.

The rest of the category doesn't seem to have followed I'm wondering if there is.

Well the competitive dynamics, what the what the thinking behind that was and.

Whether you anticipate needing to continue with that those kind of pricing strategies going forward. Thank you.

So one of the things we love about Skinny pop and believe is a key part of the business prop is the premium pricing that we have on that brand.

We are delighted that we're continuing to see really strong growth overall strong retail growth in the double digit range, which to us would suggest that the price volume piece is working though this is a brand where given the channel dynamics, we can see bigger swings on promotional pricing impact in the marketplace just given.

How that product skews by class of trade. For example, there is a bigger club business on skinny pop than we're used to seeing on the rest of our portfolio and that can drive bigger swings there.

So I wouldn't be concerned about it relative to that that we are looking to change the pricing strategy on that brand.

Okay. Thank you and and just as a quick follow up I mean, you've made a number of diversifying snacking acquisitions of late are you still very actively looking for more opportunities to do that thank you and I'll pass it on.

Yes.

I believe that.

M&A is a key component of our growth algorithm and of our strategic vision for the company and we continue to stay very active in the market investigating.

Categories and assets as you know, it's all about finding the right one but you can expect to continue to see us be focused on further expanding the portfolio.

Thank you very much I'll pass it on.

And as a reminder, that star in one to ask a question today. Our next question comes from Robert Moskow with Credit Suisse. Please go ahead.

Hi, Thanks for the question.

Steve I hate to be the one to greet you with an accounting question, but [laughter] CFO . So.

The benefit you had in second quarter from the inventory build.

As it relates to inventory in your your own inventory write it hasn't shipped out the door yet.

Yes, there is two parts that we talked about on the call. The one is.

Retailers.

Distributor built some inventory and that some of that doesnt benefit us from fixed cost, but the mix that they built it and gave us a favorable mix impact.

And then we built a bit of our own inventory because we build our inventory this time of year anyway for Halloween, but beyond that we built some more in anticipation of the price increase and thats. The portion that drives a fixed cost absorption benefit busy put those costs and inventory until it bleeds out in the third quarter.

Okay. So.

Sure I understand like your volume was down in North America in the quarter, but but retailers were building up inventory does that mean it would have been worse, if they hadn't been building up inventory.

In total inventories for retailers didn't build that they've built if they build some in anticipation of the price increase in if they are more profitable brands that we touched on in total they weren't up and so I don't know if that ends around the IB accounting impact has more to do with our internal inventory than external inventories right.

Okay, well and then the next question is if it hasn't been shipped yet how do you accrue for for inventory benefits on that kind of volume is it like you just get better.

Rates on your labor or better rates on your.

On your current commodities like.

It seems to be you would you would enjoy that benefit until it actually shipped to a customer, but maybe I just don't understand the accounting.

Yes, if you're getting more efficiency in your plants by running more volume and then it goes into the inventory so off the piano into the inventory until it comes back when you do the sale. Okay. All right. Thank you.

Our next question comes from Chris Growe with Stifel. Your line is open.

Hi, good morning.

Good morning, Hi, I just had a question for you in relation to the price increase obviously, it's well validated by competitors taking prices up too.

I guess I'm, just curious with input costs down are you getting much pushback say from retailers on this pricing strategy, especially at this time when input costs are more favorable.

So our retailer conversations around pricing have gone well so far.

You know the retailers know and appreciate that we continue to invest in our brands that we provide a lot of investment to drive category growth in terms of our category management and other investments with the customer and we really jointly work together to drive revenue growth and profitable growth, which which benefits all of us. So at this point in time, we're feeling good as you know the category has price. So it's been a category initiative.

And we're feeling good at this point.

Okay and then just a question for you you talked about a second half North American sales growth rate.

Largely in line with the first half of the next Easter benefit and if I understand that right you're going to have pricing coming through at least at that at that level.

You got marketing up in new product pipeline looks pretty solid it would seem volumes could grow in the second half of the year, Although I've only that's what you were implying so im just trying understand those that factor and how that could affect your second half growth rate.

Sure so.

As we think about the back pad as part of the year I did mentioned that some of the lapse or a little bit tougher for us as we look at the back half given the strength we had in season.

There's also a bit of a pipeline.

Phil that we had in the second quarter from our new products. If you think about the new products, we had going in the marketplace. We have the new package candy bags. We had recent stands we had reached lovers rich levers actually hit the market a little sooner than we had anticipated that hit in Q2, we thought more of it was going to hit in Q3, and so those things come out of our numbers in the back half of the year and then if you think overall about the business. We are increasing our DNA spend and we will have impressions up similarly to the first half of the year, but it's going to cost us a little bit more on that just because we're lapping some of the efficiencies that we realized as we brought some of our creative production in house year ago Hope that helps.

It does yes, thanks, so much for that.

Our next question comes from David Palmer with Evercore. Please go ahead.

Hi, Thanks, just a little bit of a follow up on Chris' question on volume and your return on advertising.

This summer.

Is the summer of Reese's and you've already been spending back in the quarter on advertising. It it sounds like it's going to be doing even more in the next quarter or two with the benefit of pricing behind you.

So I guess the question is about volume and it's been tough to grow for a lot of players in the instant consumables area.

What makes you think or how confident are you that you are going to get a volume response from this advertising in the second half and.

And I guess, it's it doesn't seem like that's baked into the into the numbers. So how how are you going to be judging this return on investment. Thanks.

So generally as we price we expect to see a dip in volume that's just how the the conversion works so.

Ah the first year of pricing you take a drop in your volume and then the consumer kinda converts and get used to it certainly we try to accelerate that conversion curve by spending into advertising, which we have found to help really drive that conversion curve to be a bit stronger than it otherwise would so that's really.

That's really what's occurring when you think about that because our last year price impact is really whats.

Hitting the marketplace. This year just as this year's price impact primarily comes into the marketplace in 2020.

Yes, so perhaps safer to say that you would be hoping to see a high volume.

Response, as the year progresses, and perhaps that exit rate on volume is going to be how you judge this advertising push.

Yeah, I would say that yes that progressive getting better.

Peace towards the end would be how we judge it yet.

Okay. Thank you very much.

Well take our next question from John Baumgartner with Wells Fargo go ahead.

Good morning, Thanks for the question.

So just wanted to touch on the international business focused markets are growing mid singles, but thats, a slowdown from last year, especially in Lat am in India. So I mean, how much of that D. So would you say is just harder comps relative to anything incremental on the competitive front or on the consumer side and then I guess secondly, the non focused markets or I guess the export markets. I mean, those are still an appreciable part of the business and your growth seems to be accelerating so that's what's driving that picked up and how do you think about the export business is fitting strategically over the longer term for you.

Yeah, absolutely. So so if you think about our international strategy certainly we believe international the important part of our business model and we will be continuing to focus on profitable growth across the key markets.

The way, we think about that business, we have scaled businesses in Canada, Mexico and Brazil.

We have a very highly profitable export business, just because we don't have those fixed costs of your feet on the ground as we export but we found that to be a very viable piece of our business model and actually growing increasingly across the board, particularly we've seen a lot of strength from the Reese's brand in the UK with very limited investment on our part and then the place that we're really placing bigger bets for the future are in China, and India. The big emerging markets that you don't have so much potential growth and we're excited about those opportunities. So yeah, I would say the slowdown in the topline growth is really a factor of.

As we build scale you know that same kind of growth just off a bigger base starts to drop down, but we're feeling really good about the performance in across all those markets they've been hitting expectations, India. We launched kisses feel good about what we're seeing there and about expanding that opportunity. So.

Yeah, we're feeling good about that piece.

Great and just a follow up on the pricing just just to be clear I mean, it sounds like the second round the pricing you're taking is going to be in excess of commodity inflation. So should we be thinking about a benefit net of net of 'em inflation for next year and your margins or you are you gonna send that back elsewhere in the in the business just to be clear on that.

So we definitely are run our business model in a way that we try and make sure that we are balancing.

Pricing or margin expansion overall through smart cost management to enable reinvestment back into the brand. So you know that we have a pretty active commodity management hedging program. You know, we try and look at what that outlook looks like look at all the other cost factors and cost elements into cost bucket and just keep trying to net ahead in terms of pricing, where we think it makes sense of whether is realized realization opportunities smart cost management and end up investing back in so it's really kind of a it's a holistic approach to looking at the PNM versus just zeroing in on any one line yeah. I'd say the key is you know the proactive posture. So we're not ready to talk about 2020, yet, but certainly having the pricing in place will be a good way to start the year.

Great. Thanks, a lot for your time.

Well now go to Ken Zaslow with BMO. Please go ahead.

Hi, good morning, everyone.

Hi, good morning.

Just two questions first is on the smaller brands like the role as the heat.

What did you done differently with them as it just activating marketing what other brands have you not touched yet that maybe in the potential and then I've a follow up.

So yeah, I would say primarily marketing so on those smaller brands over the years, we have seen evidence where a packaging upgrade on the graphics can have a nice impact on those businesses given they don't have a lot of support when consumer goes to the shelf and you really refresh the package. So we've done that on several of the brands.

Definitely unlocking them through advertising as if you haven't talked to consumers and then they start to hear about those brands.

From an advertising perspective, we definitely we definitely see a lift there and I would say that that is the the primary activation. We have hit most of the smaller brands. There are a few that I would say there is a couple more that you know we will consider.

Investing in going forward I can think of three I don't know if I, if I want to really talk about what those are for competitive reasons, but there are there are a couple more that we would consider some minor invested but I would say, we the ones that you've seen this year, including down to Heath and rollout.

You should think about those and you know the more sizable ones for which we would see the bigger impact.

And then my follow up I think you said earlier that you lost distribution.

In some of the one of the acquisition I know, which one was that part of the.

Plan going into that and what are the plans to re gets to regain a distribution back.

So it was on Pirate's brands as part of the transition. It was one of those elements were.

Yep distribution was lost a retailer or a couple of retailers that shouldn't have been on as we took over the business. Our sales team quickly went in and got to buy and to get that district distribution back. It just takes a little time, because you can't actually get the distribution on shelf until the customer has a plan a gram reset lined up and the next planogram resets were in the fall. So September October timeframe, we expect to start to see that distribution come back we have the commitments that it will come back so it really wasn't about.

Not deserving the space it was more of an integration hiccup and we feel really good about the Blas. These were seeing where we haven't lost distribution. We are very high single digit velocity gains on pirates.

And there's more distribution gains across the U.S. HCV or or are you there and you just got to execute them.

And I'll leave it there thank you.

No I think there's more opportunity in distribution across the U.S.

Great. Thank you very much.

And we'll now go to Steve Strycula with Qbs. Please go ahead.

Hi, good morning.

Good morning.

Michelle quick clarification question for you.

The price increase the talking this year, meaning July 2018 that is going to be contribution about 1.5% for full year pricing, but on an annualized basis, it's two and a half so theres a phasing effect my understanding is from what you're saying on today's call is that to go forward price increases closer to a 2%, but with no phasing. So we should think about it being a clean 2% next year. That's that's the first part of my question.

Yes, that's generally fair way to think about it.

Okay, and then the second piece a little bit on the strategy.

The way I understand it to simplify the math is that North America breaks down a third center of store a third front of store in a third seasonal and it sounds like you took pricing across two of those pieces of the threers, meaning one third is left untouched.

Can you speak a little bit about what's happening in that portion of your business and how we think about when might be appropriate times to also kind of monetize the pricing opportunity.

So.

Yes part of seasons.

We have done some small pricing action.

So.

Generally.

Weve priced pretty broadly across the portfolio.

We haven't taken as much on the suites part of our business, but.

We have had some increase in seasons as part of our broader increases. So at this point I can't tell you that there is a you know we don't talk about or for future plans around pricing, but.

We do feel like we've taken some there and on an ongoing basis, we're just going to constantly evaluate the entire portfolio and look at when and where we think there's opportunity for greater price realization.

Okay. Thank you and congrats on the quarter.

Thank you.

Our final question today comes from Michael Lavery with Piper Jaffray. Please go ahead.

Good morning, Thank you.

Good morning.

Just back to the international business can you maybe give us a sense of the margin progression there sort of what inning. We're in obviously divesting Golden Monkey was a big help and you've done quite a bit to really improve the profile. There the trajectory of margin expansion, obviously been really strong seasonality, what's the kind of the runway ahead or the last four quarters more indicative of what we should expect or is there still some big step ups to come.

I wouldn't expect a big step up certainly we're going to continue as we do everywhere to look at every line on an item on our PNM and continue to look at opportunities to improve margin because that's just a piece of who we are as a company, but I think the really big step ups.

We have been taken to green and going back to the earlier question you had and now it also matters the mix between the export countries and the ones that we have feet on the ground and at the feet on the ground grow that'll have an impact on how that margin progress as well.

That's helpful. And then is pricing a meaningful component of what you can push there too or is really the pricing focus just north America.

So we have always had a very active.

Pricing component in those markets.

As you know there are economic volatility components in those markets that are.

Forex et cetera.

So we do continue to price and part of why our margins are where they are in some of the pricing there, but it does vary by market and given there are smaller piece. We just don't talk is overtly about that on the call.

Okay. Thank you very much.

We have no further questions at this time.

Thanks, everybody I'll be around today to answer any follow up questions you have.

This does conclude todays program. Thank you for your participation you may disconnect at anytime.

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