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The Hershey Co  (NYSE:HSY)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, everyone, and welcome to The Hershey Company's Third Quarter 2018 Results Conference Call. My name is David, and I'll 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. (Operator Instructions) This call is scheduled to end at 9.30 AM so please limit yourself to one question, so that we can get to as many as possible. Please note that this call may be recorded.

Thank you. Well, it's now my pleasure to turn today's conference over to Ms. Melissa Poole. You may begin your conference.

Melissa Poole -- Senior Director, Investor Relations

Thank you, David. Good morning, everyone. We appreciate you joining us for The Hershey Company's third quarter 2018 earnings conference call and webcast. Michele Buck, President and CEO; and Patricia Little, Senior Vice President and CFO, will provide you with an overview of our results followed by Q&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 and involve risks and uncertainties that could differ materially from actual events and those described in these forward-looking statements contained in our 2017 10-K filled with the SEC and today's 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 our investors. Presentation of this information is not intended to be considered in isolation or as a 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 would like to turn the call over to Michele.

Michele Buck -- President, Chief Executive Officer

Good morning, everyone and thank you for joining us. Before we get started this morning, I'd like to take a minute to recognize and thank Patricia. As I'm sure you're aware, Patricia has announced her intention to retire in the spring of 2019. She has been a valued leader, as we have created a more profitable and sustainable international business model and still the more disciplined cost management model across the enterprise and upgraded the company's financial systems and important piece of our ERP transformation. Patricia, and I will continue to work closely together over the next several months, as we search for and transition to a new CFO.

Overall, I'm pleased with the progress we are making against our key strategic focus areas. Our third quarter results were in line with expectations and we remain on track to achieve the financial targets we shared earlier this year. Our US core confection retail takeaway and share trends are sequentially improving in line with our expectations, driven by strong Halloween results and distribution gains on core items. The addition of Pirate Brands strengthened our brand portfolio and marks our second high-growth, high-margin acquisition this year to capture incremental snacking occasions.

Our International business continues to deliver profitability improvements while driving strong constant currency organic sales growth. Importantly, we are achieving these results while staying true to our values and purpose, as evidenced by being named to the Dow Jones Sustainability World Index for the sixth consecutive year. Constant currency net sales increased 3% in the third quarter, including a net benefit from acquisitions and divestitures of 2.5 points. Foreign currency exchange with a 0.7 point headwind. Adjusted earnings per share diluted of $1.55 increased 20% compared to the third quarter last year.

In US, we are focused on executing a strong finish to the Halloween season, both in-store and online. Some core innovation and occasions programming to strong sell-in with more than 500 employees volunteering at retail. We are outperforming the category and on track to deliver our first ever $600 million season. The power of our core brands and breadth of our product lineup enable us to deliver great assortments for trick-or-treating and Halloween parties. Our focus on optimizing nexus, piece counts and price points has driven strong mid-single digit growth this year enabled by some of the core capacity investment and expansion we did earlier in the year.

We also have exciting Glow in the Dark packaging on select of Hershey's Reese's and Kit Kat products to add some additional magic to the season. We're seeing great engagement and ideas from consumers on social media for these new products. For those who were able to join us in late August for our digital update, the designed for online assortment bag we featured may BuzzFeed's top 10 best things to buy on Amazon list earlier this month. If you haven't gotten your candy yet there is still time. As expected this Halloween strength and other key initiatives are driving sequentially improved retail takeaway and market share performance on our core confection business.

In measured channels for the last 12 weeks ending October 14th, Hershey CMG takeaway increased 0.4% versus the prior year period, resulting in flat market share. In the latest four weeks Hershey CMG takeaway grew 2.5% resulting in a market share gain of 22 basis points with improvements across classes of trade. This enhanced performance is driven primarily by our chocolate brands, which grew 3.2% in the latest four weeks, resulting in a market share gain of 24 basis points. In addition to Halloween, distribution gains on core SKUs and new campaigns are driving better results.

On September 13th, Milton Hershey's birthday, we activated our new Hershey's Heartwarming campaign. The inspiration for this campaign came not only from Milton Hershey, who believe chocolate can bring people together, but also from others who are using Hershey's Milk Chocolate Bar to create positive connection and bring individuals and communities closer together. Our mission started from the inside out, I along with hundreds of our employees from across the country took to the streets to bring a little warmth back to communities through the gift of chocolate that day.

This launch is a great example of how we are leveraging new models to make our spending more impactful and efficient. In addition to our paid media, we secured over 2,000 media placements and almost $700 million earned for non-paid media impressions from this activation. We're really excited about the early results we're seeing from this activation. In the past month since, we launched the campaign retail takeaway on our Hershey's Milk, Hershey's Almond and Hershey's Special Dark Bars, which represent almost $750 million of retail sales was up almost 7%.

Our Reese's performance is also accelerating as expected behind Halloween strength, a refreshed campaign and the national rollout of Outrageous. In the latest four weeks, Reese's retail takeaway of plus 5% resulted in a CMG share gain of 30 basis points. In addition, we are making progress against our distribution initiatives we shared in July. Since May, our team has secured over 10,000 incremental points of distribution on our core Ice Breaker mint packs in the convenience store channel alone.

These items have leading velocities and strong margins for both Hershey and our retailers. This incremental distribution has resulted in improving top line and share performance for our mints business. This is just one example of how we are leveraging analytics to drive space optimization with our retailers. While our overall points of distribution are down due to the SKU rationalization program we announced earlier this year. We believe our focus on ensuring the highest velocity items are on-shelf will pay dividends for both us and our retailers going forward.

As the retail environment continues to change, our category management teams have also identified several opportunities to secure incremental space for the category at select retailers. The velocities and margins of confection items, particularly for iconic brands are still some of the best in the store. So we are excited to capture these opportunities and keep the momentum going as we exit 2018 and head into 2019. This year's innovation Hershey's Gold and Reese's Outrageous are continuing to perform well and are in line with our expectations. We will continue to support both launches in the fourth quarter with consumer promotions and merchandising to not only drive trial, but also support our core portfolio as well.

In December, we are launching the first ever mash-up of our two most iconic brands Hershey's with Reese's Pieces will be available in a bar format. We also have our first new Holiday flavored Kisses in almost a decade this holiday season. Kisses Hot Cocoa chocolates combined marshmallow flavored cream and classically delicious Hershey's Milk chocolate, recreating the experiences of drinking a cup of hot cocoa. Similar to innovation earlier this year, these new products will leverage our iconic brands to drive merchandising and consumer insight -- consumer excitement in a very cost effective way.

We are also on track to roll out new, improved packaging on our take-home bars next spring. This change affects more than $0.5 billion of sales and we believe will improve branding, shelf-appeal and improved consumer experience. Let me just correct that, it's on our take-home bags, excuse me. This is a great example of non-product innovation that can drive core brand and category growth. And finally, I couldn't be more excited about another upcoming innovation that will launch in March of 2019.

Consumers love Reese's in all shapes and sizes and now, they will have a new experience with a new benefit with our launch of Reese's Thins. This product is about 40% thinner than the original cup, and it appeals to those consumers who want something sweet with more permissibility. They will be available in individually wrapped pieces in both milk and dark chocolate varieties in our newly redesigned take-home bags. This product truly provides a differentiated benefit, and we've seen this Thins concept play well in other categories. For 2019, we have a balanced approach, a combination of news, packaging innovation, as well as unique offerings that we believe will drive core brand growth.

Now, for an update on Amplify, SkinnyPop continues to show strong growth in the marketplace, driven by both distribution and velocity gains. In measured channels, retail takeaway grew 10.3% in the latest 12 weeks ending October 7th. This was driven by core SkinnyPop ready-to-eat popcorn, which grew over 8%, resulting in a category share gain of one full point. As we shared earlier this year, our goal has been to maintain the entrepreneurial spirit of the team in Austin, while leveraging Hershey's capabilities to capture new occasions and sales opportunities. The biggest example of this is our category management and shopper insights expertise.

The Austin team has spent a considerable amount of time learning from and developing relationships with our Hershey team to ensure they are fully leveraging our vast data, tools, and insights. This has enabled them to elevate conversations with retailers and secure incremental distribution and better placement for SkinnyPop, as well as provide strategic counsel to retailers on optimizing overall aisle efficiency. These skills and relationships will be critical as we continue to expand our footprint more broadly within snacking.

Last week, we closed on our acquisition of Pirate Brands. Pirate's Booty, the principal brand in the portfolio is a sizable fast growing cheese puff brand with on trend, better for you attributes and high margins. We expect the full Pirate Brands portfolio to be a great fit for Hershey's growing portfolio of snacking brands, which is targeted toward consumers who are looking for great tasting snacks without compromise. As with Amplify, we believe this acquisition is a terrific business model fit with our core capabilities. We are best at driving great brands with scale and high margins in expandable consumption categories.

We have a deep understanding of consumer snacking behaviors best-in-class category management expertise, a growing digital commerce capability and strong retailer relationships across formats. We believe that all of these will be key assets to expand and grow our full snacking portfolio in the future. Pirate's Booty can be found in grocery and club stores. And we believe there is an opportunity to leverage our category management and insights to work to unlock additional growth, particularly in the mass and convenience classes of trade.

Year-to-date, the brand has consistently grown high-single digits in measured channels with growth over 7% in the latest four and 12 week periods. Importantly, the growth has been balanced across both distribution and velocity gains on core SKUs, a key indicator of healthy and sustainable expansion. I hope many of you were able to join our webcast focused on digital commerce at the end of August. We believe the competitive advantages we have in traditional brick-and-mortar stores translate to the digital world for our entire portfolio, beloved brands, deep customer relationships and category management expertise, strength in media, and strong margins.

Our initiatives are paying off in 2018. We are increasing trips online. We are trading consumers up to higher price points. And we are driving larger basket sizes while maintaining our margin profile. Our digital commerce net sales for the quarter were up over 60%. And our market share increased 180 basis points. We believe we have the right strategy, organizational focus, talent, and technology to accelerate growth as industry infrastructure continues to expand. Our investments in US manufacturing capacity expansion are on track.

Over the last year, we have invested more than $150 million in US supply chain advancements. The Kit Kat line in Hazleton, PA, announced earlier this spring is expected to be completed by year end, and will start benefiting us in Q1, 2019. Additionally, our expansion on Ice Breakers gum and our Midwest Distribution Center are also on track and expected to be complete in the next three months to six months.

Now for an update on our International and Other segment. We continue to make great progress on our transformation, with profitability improving meaningfully again in the quarter, while driving top line growth. Combined constant currency net sales growth in Mexico, Brazil, and India was approximately 10%. In China, our constant currency organic sales were up double-digits, driven by focus on our core Hershey's portfolio. Year-to-date, our operating profit is $65 million, already $20 million ahead of our previous full year segment high in 2012.

Importantly, each country is contributing to the profit and top line improvements as we shift the mix to more profitable core and right size our investments. Last week, we launched our iconic Hershey Kisses brand in India. Over the past decade, we have introduced a range of Hershey's products that are loved by families across India, from Hershey's syrup to cocoa, to milkshakes, to chocolate spreads. And Hershey's is a leading brand in each of these categories. We believe the launch of Hershey Kisses will further fuel our growth in this strategic market.

In summary, we delivered solid top and bottom line performance and we are seeing sequential improvement in retail takeaway trends, CMG market share, and gross margin in line with expectations. We have a great holiday program ahead of us, and continued distribution gains to keep the momentum going through Q4 and into 2019 on our core US confection business. And our International business and broader snacking portfolio continue to perform well and remain on track to deliver additional sales and profit growth for the company.

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

Patricia Little -- Senior Vice President, Chief Financial Officer

Thank you, Michele, and thank you for the kind words. Good morning, everyone. Third quarter net sales of $2.08 billion increased 2.3% versus the same period last year. Constant currency net sales increased 3% with foreign currency exchange 70 basis points headwind. The net impact of acquisitions and divestitures was a 2.5 point benefit to net sales growth. As a reminder, M&A contribution to overall growth in Q3 was less than in the first half of the year due to our Tyrrells and Shanghai Golden Monkey divestitures. The Q3 contribution from the North American Amplify business was comparable to Q2. Volume was a 1.7 point benefit in Q3, which was partially offset by negative net price realization of 1.2 points.

Adjusted earnings per share diluted of $1.55 was an increase of 20.2% versus the same period last year. Income from a more favorable tax rate, SM&A declines, acquisition and volume growth were partially offset by gross margin declines. We are reaffirming our full year net sales and adjusted EPS outlook. We expect reported net sales to be at the low end of the 3.5% to 5.5% range, with approximately a 3.5 point net benefit from acquisitions and divestitures. We continue to expect organic net sales growth to be slightly up versus prior year.

Full year adjusted earnings per share diluted are expected to be in the $5.33 to $5.43 range, an increase of 14% to 16%. We anticipate the top and bottom line impact from our recent acquisition of Pirate Brands to be minimal in 2018. By segment, North America net sales increased 2.9% versus the same period last year. The Amplify acquisition added 3.7 points and volume gains contributed 90 basis points. Net price realization and foreign currency exchange rates were a 150 basis point and a 20 basis point headwind, respectively.

The negative price realization was in line with expectations, driven by slightly higher levels of planned promotional support as well as true up of trade accruals and other accounting impacts. These trade rate increases are not resulting in deflationary retail prices on our confection brands. Per IRI on average, our retail price per pound is relatively flat to prior year. Therefore, we remain confident in our ability to execute the price increase we announced in July.

As a reminder, this pricing action of approximately 2.5% had several components and will predominantly impact 2019. While some of the price increase will take place in January, the redesign of our packaged candy portfolio will flow through in early Q2 and seasons will begin realizing price in Q3 with Halloween. With the multiple levers we are employing with this action, we expect retail shelf prices to increase on approximately 20% of the portfolio. Given our targeted approach and continued investment in the category, we expect solid conversion, similar to previous actions. North America advertising related consumer marketing spend declined 18.5% in the quarter.

I want to spend a couple of minutes providing some important details and context here. Media spend for our strategic scale brands was in line with prior year for the quarter. We are leveraging analytic tools to improve effectiveness of this spend to get more reach and impressions for the same amount of dollars. So far this year, we have achieved double-digit ROI increases in four of our top five brands. We are also focused on expanding our reach through earned media by having authentic and appropriate content in the right channels. Our Heartwarming campaign is a great example of this.

As we work through new models, we are also taking advantage of cost savings in agency and production fees, as we leverage the appropriate production for different channels. An example of this is the creation of our own in-house production studio that went live earlier this year. This is enabling us not only to take advantage of our great employee creativity, but also to be faster and more cost effective. We have also continued to right size our investments in our smaller emerging brands in line with our previously stated strategy. We remain committed to supporting our portfolio and will continue to invest at levels significantly above industry average.

Now for an update on Amplify. As Michele mentioned, sales growth remained strong, with core SkinnyPop ready-to-eat popcorn continuing to grow high-single digits. We are on track to deliver our acquisition model for both the top and bottom line in 2018 and anticipate approximately $0.08 EPS accretion this year. Third quarter total International and Other segment net sales decreased 1.9%, including a 6.4 point impact from divestitures and a 4 point headwind from unfavorable foreign currency exchange.

Volume and net price realization were 780 and 70 basis point benefit, respectively. Mexico, Brazil, and India strength continued with combined constant currency net sales growth of approximately 10% and the transformation of our China business is ahead of our expectations. International and Other advertising and related consumer marketing declined 1.7% in line with our expectations as we right size our investments to drive more profitable growth.

Now turning to gross margin. Adjusted gross profit of $916 million declined 0.6% resulting in an adjusted gross margin of 44%, a decline of 130 basis points versus the third quarter of last year. This is in line with our expectations for the quarter and was driven by higher year-over-year freight and logistics costs, as well as incremental investments in trade and packaging. As we had shared earlier this year, we expect continued sequential improvement in year-over-year change in Q4 given the pattern of last year's inflationary pressures.

Third quarter adjusted operating profit of $471 million increased 5.1% versus the third quarter of 2017. This resulted in an adjusted operating profit margin of 22.6%, an increase of 60 basis points, driven by lower selling, marketing, and administrative expenses. As Michele mentioned, we are really excited about the addition of Pirate Brands to our portfolio. Net sales of the business are approximately $90 million and EBITDA is between $25 million and $30 million. This acquisition was financed with short term borrowings and cash on hand. We expect minimal impact to our leverage targets, given our strong cash flow and anticipation of slight accretion in year one for the acquisition. Additionally there is no change to our credit ratings.

Moving down the P&L. Interest experience of $37 million increased $12 million versus Q3 of last year driven by the Amplify acquisition. Full year 2018 interest expense is expected to be approximately $140 million, the high end of our previous range, including the impact from our recent acquisition of Pirate Brands. The adjusted tax rate for the third quarter was 22.8% versus 30.3% in the year ago period, driven by US tax reform. We expect the full year 2018 adjusted tax rate to be approximately 19%. Third quarter other income and expense was $8.5 million, a decline of $16.7 million versus the year ago period. This year-over-year decline is driven by timing related to our investment tax credit strategy.

Our full year 2018 outlook remains the same at $65 million to $70 million. For the third quarter of 2018 weighted average shares outstanding on a diluted basis were approximately 211 million. The company did not repurchase common shares in the third quarter to replace shares issued in connection with the exercise of stock options or against the October 2019 or July 2018 share repurchase authorization. The total combined outstanding authorization is $560 million. Total capital additions including software were $105 million in the third quarter.

For the full year 2018, we expect CapEx to be in the $355 million to $375 million range in line with previous estimates. We continue to return cash to our shareholders with third quarter dividends of $147 million. This was our 355th consecutive quarterly dividend on the common stock. Our Margin for Growth program is progressing nicely and we remain on track to deliver the high end of $150 million to $175 million program savings range. We have executed a significant portion of the initiatives and now believe our restructuring costs will be slightly less than initial expectations. We now expect total estimated project costs of approximately $340 million to $355 million versus our original estimate of $375 million to $425 million.

That concludes my financial discussion. Thank you for your time this morning. I'll now turn it back over to Michele for some closing marks.

Michele Buck -- President, Chief Executive Officer

Thanks, Patricia. As we have shared consistently this year, we are focused on delivering our 2018 commitments and we are on track to do so. I'm confident in our strategies, and I'm extremely proud of our Hershey team as we build momentum in the back half of the year. I'm pleased with the momentum on our core US confection business. Our growing snack brands are performing well and we are excited about the opportunity that Pirate Brands brings to our portfolio. And our International business continues to provide meaningful top and bottom line growth.

We will continue to invest in our business as we look toward 2019. Our pricing strategy will begin to have an impact in 2019 along with strong seasonal growth, including a long Easter, core capacity expansion, solid innovation plans, new campaigns and growing digital capabilities. We will continue to do this while operating in a way that is consistent with our values and purpose and our focus remains on long term value creation.

Patricia, Melissa, and I are now available to take your questions.

Questions and Answers:

Operator

(Operator Instructions) We'll take our first question from Andrew Lazar. Please go ahead. Your line is open.

Andrew Lazar -- Barclays Bank PLC -- Analyst

Good morning, everybody.

Michele Buck -- President, Chief Executive Officer

Good morning, Andrew.

Andrew Lazar -- Barclays Bank PLC -- Analyst

Hi. I think the start of this year, you had guided consumer spend or advertising and consumer to be down slightly, with more of the focus on spending on analytics and some of the enterprise resource planning that you're doing. I guess year-to-date, it's down a bit more than that, around 10% or so. And I know your long term targets would have A&C growing more in line with sales. So I guess, I'm just trying to get a sense, if that's still the expectation longer term. And if so, would we expect some type of step-up next year to get more on that long term track?

Michele Buck -- President, Chief Executive Officer

Thanks, Andrew. We continue, as you know, to have a very heavy investment in our brands much higher than the industry average. And if we look at the investment we've had on our core brands on both in Q3 where it was flat so we had very stable investment. And on a year-to-date basis, our investment in our core brands was actually up. So what we really try and do, as we go through the year is leverage the learnings that we're getting and making sure that we are constantly putting our spend in the most effective places. And as we looked at this year and got into it, we believed that we were overspending on some of the smaller brands and we wanted to reduce that spend to ensure every dollar counts to drive business.

And also, we did have an accounting change that resulted in moving some dollars out of the consumer marketing line into trade. So as you look at the go forward, you're going to see some of that continued right sizing between now and the end of the year, but as you think about 2019, I would tell you, we are very strongly committed to investing where there are returns will have the -- will really have -- the accounting changes will have lapped the right sizing of the smaller brands. And you shouldn't expect to see declines like we've had in 2018. We think that we'll be more set in terms of our normal track of spend and moving forward.

Andrew Lazar -- Barclays Bank PLC -- Analyst

Got it. Thank you very much.

Michele Buck -- President, Chief Executive Officer

Thank you.

Operator

We'll take our next question from Bryan Spillane. Your line is open.

Bryan Spillane -- Bank of America -- Analyst

Hey. Good morning, everyone.

Michele Buck -- President, Chief Executive Officer

Good morning.

Patricia Little -- Senior Vice President, Chief Financial Officer

Good morning.

David Driscoll -- Citi -- Analyst

I guess I just wanted to understand a little bit more, just in the fourth quarter, it still implies a pretty wide EPS guidance range for the fourth quarter. And I guess given the visibility that you have into a lot of the seasonal stuff you're doing, just trying to understand what the variables are that might sort of drive you to the high end or the low end of that range? Just why such a wide range in the fourth quarter?

Michele Buck -- President, Chief Executive Officer

Patricia, you want to take a crack at that?

Patricia Little -- Senior Vice President, Chief Financial Officer

Yeah. As you know, we were just -- we really haven't had any major changes at all in our outlook for the full year EPS. And we just left the range where it was just to frankly, make sure that we were working right into that number.

Bryan Spillane -- Bank of America -- Analyst

Okay. So it doesn't imply that there's any potential for like you were anticipating any volatility in costs or shipment timing or anything like that?

Patricia Little -- Senior Vice President, Chief Financial Officer

No. That's correct.

Bryan Spillane -- Bank of America -- Analyst

Okay. Thank you.

Operator

We'll take our next question from Ken Goldman. Please go ahead. Your line is open.

Kenneth Goldman -- JP Morgan -- Analyst

Hi. One quick one and then a follow-up, if I can. For 2018, management had previously guided for the gross margin being down 120 basis points year-on-year and the EBIT margin being flattish year-on-year. I may have missed it, but I don't think you specifically reiterated those numbers. Can you help me out with those? And then, I have a quick follow-up, if you will allow me.

Michele Buck -- President, Chief Executive Officer

Patricia, you want to talk about gross margin?

Patricia Little -- Senior Vice President, Chief Financial Officer

Yeah. So Q3 came in right in line with our expectation. And, as we've stated before, really the change versus each quarter is heavily impacted more by the phasing that we saw last year in 2017. So we continue to expect Q4 gross margins to be in line with or slightly up from prior year because last year the fourth quarter is really when we saw the big impacts of inflationary pressures. So we're also very focused on our continuous improvement program, our Margin for Growth initiatives. In Q4, all of those are on track. I think we'll come into the full year slightly below the 125 basis points, but we continue to be very pleased with the progress that we're making there. In terms of operating margin, it remains where we expected it to be.

Kenneth Goldman -- JP Morgan -- Analyst

Okay. Thank you. And then my quick follow-up is you had also, of course, not given guidance on 2019, but you had said previously, you expect sales for 2019 at the low end of the 2% to 4% range, the gross margin up year-on-year, corporate expenses, I think down as much as $100 million. Again, these aren't officially guidance items, but just for our modeling purposes, as we sit here today are they still reasonable projections, roughly?

Michele Buck -- President, Chief Executive Officer

We really aren't going to talk about guidance until the January -- late January call. So I don't know that we want to give any other additional perspective on that right now.

Patricia Little -- Senior Vice President, Chief Financial Officer

Right. We're still working through our plans, as we speak. And we'll be back to you in the fourth quarter call with more specificity.

Kenneth Goldman -- JP Morgan -- Analyst

Okay. Thank you.

Operator

We'll take our next question from David Driscoll. Your line is open.

Michele Buck -- President, Chief Executive Officer

Hi, David.

David Driscoll -- Citi -- Analyst

Sorry, thank you. Great. Good morning, everybody. I mean Patricia, I'm not sure, if we're going to get to hear you on the January conference call, but if we don't, I really do appreciate all your help over the years. My question is just on this emerging momentum within the chocolate franchise. I believe you called out the four week data at up 3.2%, and market share up about 24 basis points. Can you just spend a little time here and talk about the competitive dynamic? Where do you see the momentum really building? Is it -- what I'm trying to get at here is it really the seasonal piece of it, so that'll carry through the fourth quarter, but then when we get to the first quarter, it's got to kind of flip to the core franchise?

Michele Buck -- President, Chief Executive Officer

Yeah. So thanks for the question, David. So we certainly are seeing a big impact from seasons, as you know, Halloween and holiday are some of our largest seasons. We had a very strong sell-in to retail. So the retailers bought then, obviously, the key is we need to see consumers buy. And we're really thrilled that we're seeing that sell-through, where consumers are buying and the season that is up. And by the way, that bodes well for the (Technical Difficulty) if we sell-through well, the buy is then very strong.

As we look to the end of the quarter, we anticipate a good holiday because again, we have a good sell-in for holiday and so we're expecting to see that as well. The other place that we are really seeing some momentum and anticipate a bit more momentum is, though most of our velocity or momentum right now is on seasons, we have distribution gains that we've shared with you in the past that we are working toward that we are starting to secure. And we do believe that we'll see more of the benefits of those distribution gains as the year progresses and into early next year.

And we've also seen some velocity increases, particularly on the variety brands where we've invested incrementally, as well as on Hershey and Reese. So we believe that -- we're seeing the kind of the green shoots of that, that we anticipate will continue. So as we look at the fourth quarter, we believe that we'll see continued takeaway strengths, we believe that 1% or perhaps greater.

David Driscoll -- Citi -- Analyst

And then, just a quick follow-up, Patricia. If you could just address North American pricing. In your script, I believe you said pricing was negative 1.5%, but that retail level pricing wasn't really changing. So if you're giving lower prices to your customers, what did you get for it? So it's not lowering the price at retail, which I would expect to have like a positive volume benefit, but if you don't get lower retail prices, what are you getting for that price investments?

Patricia Little -- Senior Vice President, Chief Financial Officer

Yeah. So we had a number of impacts in the third quarter and some of them are the accounting that Michele already mentioned. So some of our costs moved from our marketing expense up into trade. We also had a little bit more prior year adjustments than we've had -- or we've had more of an impact of that. So that's a piece of it. That's actually not quite half of the change. In terms of the rest of it, different promotional programs deliver different benefits. And we are always trying to mix those out so that the consumer, as well as the retailer, gets the advantage of it.

And we see different impacts, in fact, across different segments and classes of trade of our business. We just didn't want to give the impression that's we're seeing a deflationary impact on the prices. So we think that our overall trade is working hard for us. We always want to make it work harder. And we feel continue to really confident that the pricing that we talked about earlier will bear the fruit that we're expecting.

Michele Buck -- President, Chief Executive Officer

Yeah. I just also clarify and remind everyone that the pricing action we took really will impact us in 2019. If we look at some of the straight pricing in terms, we anticipate we'll see the benefit in Q1. We'll start to see some of the weight out that we took on our consumer packaged candy line in Q2. And then, as you know, we plan seasons out very far, so some of the benefits around seasons from pricing will come as late as Q3, just so that you all remember that.

David Driscoll -- Citi -- Analyst

Thank you very much.

Operator

We'll take our next question from Jonathan Feeney with Consumer Edge. Please go ahead. Your line is open.

Jonathan Feeney -- Consumer Edge -- Analyst

Good morning. Thanks very much.

Michele Buck -- President, Chief Executive Officer

Good morning.

Jonathan Feeney -- Consumer Edge -- Analyst

Just a -- what role would you say that distribution gains are playing right now with the acquired brands with SkinnyPop? And looking forward into 2019, I mean can you give us some viewpoint as to not only in the Amplify brands, but the Pirate brands that are coming up, are there opportunities to grow through distribution? And again, how much of the growth right now is distribution driven versus, same-store sales if you will or velocity? Thanks very much.

Michele Buck -- President, Chief Executive Officer

So on this piece of the portfolio, Jonathan, both distribution and velocity are opportunities. So we're certainly seeing some distribution gain benefits because one of the greatest synergy values that we can bring as a company is the category management piece, where in many places, SkinnyPop velocities were the strongest on-shelf within the category, but the distribution or the facings did not match with that velocity strength. So we're about right sizing that. We are also about expanding distribution into the classes of trade where we have the strongest presence where SkinnyPop was underdeveloped.

So it was underdeveloped at Walmart, convenience stores, et cetera. We haven't -- we're realizing some of that now, but there's more to come. But velocity is also very important and we're pleased that we're continuing to see strength in velocity on these brands as well. So you're going to see a mix of both on the entire portfolio of acquisition brands.

Jonathan Feeney -- Consumer Edge -- Analyst

Thank you.

Operator

We'll take our next question from David Palmer with RBC Capital Markets. Please go ahead.

David Palmer -- RBC Capital Markets -- Analyst

Thanks. Good morning. Just a question on organic sales, it feels like the fourth quarter might be one where you have could have shipments be even stronger than consumption. You mentioned holiday demand or seasonal demand is strong and we've heard that too. And you talked about some new products that are coming some of which that may be shipped ahead of the first quarter. So I know your organic sales guidance implies something similar for the fourth quarter as to what you have done year-to-date, but should we be thinking that the fourth quarter would be higher? Thanks.

Michele Buck -- President, Chief Executive Officer

So David, I would say the answer to that is no. As you know, we have noise between takeaway and net sales given the dynamics of our category, particularly given the fact that about a third of our business is seasonal. And we also have a promotionally driven business as well. So those things combined with the impact of SKU rationalization, and then as some of you have called out, some inventory contraction. We have some consolidation in the industry that's leading to that. We also do have some retailers who are looking to increase inventory to ensure that they can minimize out of stocks. But as we planned this year, we anticipated that net sales would be below our retail takeaway in the fourth quarter and we are -- because of some of these factors I talked about and we're continuing to believe that will be the case.

David Palmer -- RBC Capital Markets -- Analyst

Thank you.

Operator

We'll take our next question from Alexia Howard with Bernstein. Please go ahead.

Alexia Howard -- Sanford Bernstein Research -- Analyst

Good morning, everyone.

Michele Buck -- President, Chief Executive Officer

Good morning.

Alexia Howard -- Sanford Bernstein Research -- Analyst

So I know you're not giving an outlook for next year, but could you give us some commentary around the progression of the gross margin. You're obviously lapping tough comps. They're getting easier next quarter. We should get more toward the flattish area on the gross margin next quarter. You've got pricing kicking in a positive way. I'm not sure how much of a headwinds some of the other factors like freight and packaging are likely to be next year or where commodity costs are going. But will we be right in thinking that things are getting easier on the gross margin side from here on out?

Michele Buck -- President, Chief Executive Officer

So let me provide overall commentary and I'll let Patricia go a little bit deeper. So Alexia, I would say that -- I don't know, I would say things are getting easier because it feels like they never get easier, but we do believe that we will be making improvement on margins as we exit 2018 and as we go into 2019, part of that obviously, driven by pricing and the impact that we will get as our pricing hits next year. But do you want to talk a little bit about cost inputs, Patricia?

Patricia Little -- Senior Vice President, Chief Financial Officer

Yeah. So we are seeing -- there's been a lot of discussion about freight and logistics, so let me start there. We started to feel the impact of that about a year ago and that has certainly continued and I don't expect that to change going forward into next year, because the structural reasons that freight costs are higher are not going to go away, in terms of some of the cost pressures that those give us. Commodities are always something we look hard at. We make sure that our hedging program is focused on really giving us cost visibility into those parts of the portfolio. And we're not expecting a huge impact from that. So, overall, I think what we will see is continued improvement as Michele said, driven by pricing and our continuous improvement program that we're always extremely focused on.

Alexia Howard -- Sanford Bernstein Research -- Analyst

Thank you very much. I'll pass it on.

Operator

We'll take our next question from John Baumgartner with Wells Fargo. Your line is open.

John Baumgartner -- Wells Fargo -- Analyst

Good morning. Thanks for the question.

Michele Buck -- President, Chief Executive Officer

Good morning, John.

John Baumgartner -- Wells Fargo -- Analyst

Michele, I wanted to come back to the A&C spend because I understand the concentration of resources and also your spend level relative to peers, but when we think about confectionery versus other snacks, I mean the share of stomach (ph) is still under pressure. So, whether it takes the form of ad spend or the other in-store expenses and I think trade pulling up in flat for about the last four years or so as it is, why doesn't absolute spend still have to be higher? I mean, is the incremental ROI on core brands leveling off at this point, I'm just trying to square the comments versus the absolute growth?

Michele Buck -- President, Chief Executive Officer

Sure. So when we think about the right investment, while certainly spend can be a benchmark. The real thing we look at are the number impressions that we're delivering and how we're delivering impressions. And so, if we can get better, more targeted, better insights, better copy, a better media approach or the addition of social media and earned impressions in the mix, that really influences our decisions about how to support each and every brand. And the other piece simply is, as we look at the portfolio, a lot of this really does come down to some of the smaller brands, where -- we spent against some of those a bit more like they were a big brand model.

And some of the more emerging brands are really driven more by an impact at retail, making the brands visible at retail, ensuring they have the right facings on shelf and mass media spend is not the right approach for some of those smaller household brands, brands that have call it, 5% household penetration, versus a brand like Reese that has 55%. So we are spending more on some of the brands like a Reese, where -- and we do testing constantly to understand where there is upside, where we think that we can spend even more and get more. But it's really all based on looking at those impressions we can deliver. Does that help?

John Baumgartner -- Wells Fargo -- Analyst

Yeah. Absolutely, thank you.

Operator

We'll take our next question from Jason English with Goldman Sachs. Please go ahead.

Jason English -- Goldman Sachs -- Analyst

Hey. Good morning, folks. Thanks for squeezing me in. I appreciate that. First, a quick housekeeping question, you started the year with a tax rate around 20% to 22%. It's now drifted to 19%. Is 19% a good number to assume for next year or is there risk that this drifts higher?

Patricia Little -- Senior Vice President, Chief Financial Officer

Yeah. Again, we haven't planned out all of the 2019 pieces of the business that allow us to hone in on the tax rate, but I think that's a reasonable planning stance.

Jason English -- Goldman Sachs -- Analyst

That's helpful. Thank you. And I want to go back to Michele's comment on some gross margin improvement as we go into 2019, with pricing playing an important role. Of the 250 basis points of price, we're getting to around 200 basis points coming from the weight out initiative on the multi-serve bags. Is that reasonable?

Michele Buck -- President, Chief Executive Officer

No.

Jason English -- Goldman Sachs -- Analyst

What do you have?

Michele Buck -- President, Chief Executive Officer

Yeah. So we had -- Jason, this is Melissa. We had said of the 2.5, about 50 basis points was the retailer terms and then of the remaining 2, it was about half and half between the straight price and the weight out, so we've called about 100 basis points of the 250.

Jason English -- Goldman Sachs -- Analyst

Okay. That's helpful. And on that weight out, you mentioned that it's being accompanied with a packaging upgrade. And we were down there in August and as we discussed, it's clearly a more expensive pack. Does the cost benefit of the weight out match the incremental cost of the packaging or do you actually get some surplus?

Michele Buck -- President, Chief Executive Officer

I won't say -- I don't know that we really want to get into the details of margins by items that we have in the portfolio. I would say that we feel good that as we add value to the consumer that we are netting out in line with a good value proposition that enables us to cover the incremental costs and still have very strong margins across the business. So I'd say, you can think about it as it's net in line. We're not losing anything. We're not realizing a windfall, but it's net in line in terms of covering the costs.

Jason English -- Goldman Sachs -- Analyst

Totally. So that kind of net's neutral. We're left with about 150 basis points that can cover the rest of the inflation in the system.

Michele Buck -- President, Chief Executive Officer

Yeah.

Patricia Little -- Senior Vice President, Chief Financial Officer

That's fair.

Jason English -- Goldman Sachs -- Analyst

Okay. Thank you. Thank you very much. I'll pass it on.

Operator

We'll take our next question from Rob Dickerson with Deutsche Bank. Please go ahead. Your line is open.

Robert Dickerson -- Deutsche Bank -- Analyst

Thank you very much. I just had a simple question on International. Obviously, there was a sizable step-up in volume performance in the quarter and then the operating margin I believe was around 13%. So I asked last call, is the low double-digit kind of run rate over the next couple years still feasible on International and the answer was yes, but we're seeing it now, not two years out from now. So the first question is just is that 13% a rational expectation going forward into 2019 and Q4 and what have you and then also just the volume performance in International, what's driving that outside of just the divestment of Golden Monkey and is that sustainable?

Michele Buck -- President, Chief Executive Officer

So let me talk about the volume performance and then I'm going to hand it over to Patricia to talk a bit about the margin. So, I feel really good about the sustainability of the volume performance. If you look at what we've done over the past couple years here in our portfolio, we have transitioned our portfolio to highly branded higher gross margin items. Our number one focus is on the Hershey's brand and our Hershey's portfolio and we are -- what the growth we are getting is from that brand and from the other invested brands in the marketplace. So the growth looks to be very sustainable and especially, as we've divested parts of the portfolio that really were creating the biggest drag both in terms of the top line but also profit. So I'll turn it over to Patricia now to talk a bit about margin.

Patricia Little -- Senior Vice President, Chief Financial Officer

Yeah. We couldn't be more pleased with the performance of International in the third quarter. They really delivered and frankly, over delivered versus where we -- and thought they'd do at the beginning of the year. So we're pleased. The margin performance though is pretty seasonal. And fourth quarter is always the lowest margin business because we are spending against Chinese New Year that has not occurred yet. So that's always -- that's just always a low margin quarter and you'll see that again this year.

Robert Dickerson -- Deutsche Bank -- Analyst

Okay. Great. Thank you.

Operator

And we'll take our last question today from Robert Moskow with Credit Suisse. Please go ahead. Your line is open.

Robert Dickerson -- Deutsche Bank -- Analyst

Hi. Thank you.

Michele Buck -- President, Chief Executive Officer

Hi, Rob.

Robert Dickerson -- Deutsche Bank -- Analyst

Hi. So I did want to follow-up on the distribution gains and how it relates to inventory. And I do think you're doing the right thing by taking a conservative approach to forecasting inventory de-loading. But you said that your core business distribution has been expanding. When we looked at Nielsen data, I guess overall distribution is still declining this year. Do you have a number for your overall distribution and is that up or down? And then, I have a follow-up on taxes as a going away present for Patricia.

Patricia Little -- Senior Vice President, Chief Financial Officer

I'm not going to go away yet. You can hold it.

Michele Buck -- President, Chief Executive Officer

So Rob, I guess as you think about distribution, our biggest focus on driving distribution is on driving productive distribution and really taking a look at what's on the shelf and ensuring that the highest velocity items are gaining distribution. So while overall points of distribution given they're not all equal, may not be up, what we're feeling good about is that we are making some really good calls to get more productive items on the shelf.

Robert Moskow -- Credit Suisse -- Analyst

And does the SKU rationalization cause any further distribution declines just for the overall footprint?

Michele Buck -- President, Chief Executive Officer

Yeah. If you look at total points, I would say yes, because the key things we would be getting rid of, are the less productive items. And so some of that can come through, though some of the SKU rationalization is around merchandising units as well, so which it doesn't translate to a strict SKU.

Melissa Poole -- Senior Director, Investor Relations

Yeah. And Rob, this is Melissa. We had talked a little bit before when we talked about the SKU rationalization program, that you probably would see more of an impact on net sales than you would retail takeaway, as you're taking some inventory out of the system for some of those merchandising vehicles and other things that won't show up as much in retail, but you would see some inventory contraction there.

Robert Moskow -- Credit Suisse -- Analyst

Okay. And then, Patricia thanks again for all your help over the years. But for the tax rate guidance now at 19% that's a little lower than before, but it's related to your other income line because of the government tax program. So where is that line going to come in? Is that going to be around like last year at $95 million or -- because I think the original guidance was a lot lower than that?

Patricia Little -- Senior Vice President, Chief Financial Officer

Yeah. We haven't changed our guidance on that. Our full year 2018 outlook is still $65 million to $70 million for the other income and expense. It was lower in the third quarter, as you point out. And that's why you saw the flip up in the third quarter tax break.

Robert Moskow -- Credit Suisse -- Analyst

Okay. So then if your tax rate then implied for fourth quarter is like 9%, does that mean that your expectations for operating income were a little lower than -- they were three months ago or were in line?

Patricia Little -- Senior Vice President, Chief Financial Officer

So really, nothing has changed for the full year. We always have variability related to this investment tax credit program that we have. And I'll also point out that now there's pension expense in that. The non-service pension expense is in that other income line as well, so that's also creating a little bit of noise, but it's really nothing in the fundamentals has changed.

Robert Moskow -- Credit Suisse -- Analyst

Okay. All right. Thank you very much.

Melissa Poole -- Senior Director, Investor Relations

All right. Thanks, everybody for joining us this morning. We'll be available throughout the day for any follow-up questions you may have.

Operator

This does conclude today's program. Thank you for your participation and you may disconnect at anytime.

Duration: 57 minutes

Call participants:

Melissa Poole -- Senior Director, Investor Relations

Michele Buck -- President, Chief Executive Officer

Patricia Little -- Senior Vice President, Chief Financial Officer

Andrew Lazar -- Barclays Bank PLC -- Analyst

Bryan Spillane -- Bank of America -- Analyst

David Driscoll -- Citi -- Analyst

Kenneth Goldman -- JP Morgan -- Analyst

Jonathan Feeney -- Consumer Edge -- Analyst

David Palmer -- RBC Capital Markets -- Analyst

Alexia Howard -- Sanford Bernstein Research -- Analyst

John Baumgartner -- Wells Fargo -- Analyst

Jason English -- Goldman Sachs -- Analyst

Robert Dickerson -- Deutsche Bank -- Analyst

Robert Moskow -- Credit Suisse -- Analyst

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