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The Hershey Company (HSY)

Q4 2008 Earnings Call

January 27, 2009 08:30 am ET

Executives

David J. West - President and Chief Executive Officer

Humberto P. Alfonso - Senior Vice President, Chief Financial Officer

Analysts

Judy Hong - Goldman Sachs

Jonathan Feeney - Janney, Montgomery, Scott, LLC

Eric Katzman - Deutsche Bank

David Driscoll - Citi Investment Research

Chris Growe - Stifel Nicolaus

Ken Zaslow - BMO Capital Markets

Rob Moskow - Credit Suisse First Boston
Terry Bivens - J.P. Morgan Securities

(Virgil Leech) - TIAA-CREF

Ed Roche - Salile Securities
Andrew Lazar - Barclay's Capital

Kevin Dreyer - Dobell and Company

Vincent Andrews - Morgan Stanley

Eric Katzman - Deutsche Bank Securities

Thomas Russo - Gartner Russo Gartner

Presentation

Operator

Good morning, my name is Phyllis and I will be your conference operator today. At this time, I would like to welcome everyone to The Hershey Company fourth quarter 2008 results conference call. (Operator Instructions)

Mr. Pogharian, you may begin your conference.

Mark Pogharian

Thank you, Phyllis, and good morning, ladies and gentlemen. Welcome to the Hershey Company fourth quarter and full year 2008 conference call. David J. West , President and CEO; Burt Alfonso, Senior Vice President and CFO; and I will represent Hershey on this morning’s call. We welcome those of you listening via the webcast.

Let me remind everyone listening that today’s conference call may contain statements which are forward looking. These statements are based on current expectations which are subject to risk and uncertainty. Actual results may vary materially from those contained in the forward-looking statement because of factors such as those listed in this morning’s press release and in our 10-K filed with the SEC.

If you have not seen the press release, a copy is posted on our corporate website www.hersheys.com in the investor relations section. Included in the press release are consolidated balance sheets and the summary of consolidated statements of income prepared in according with GAAP as well as our pro forma summary of consolidated statement of income quantitatively reconciled to GAAP.

As we’ve said in the press release, the company uses these non-GAAP measures as key metrics for evaluating performance internally. These non-GAAP measures are not intended to replace the presentation of financial results in accordance with GAAP. Rather, the company believes the presentations of earnings excluding certain items provides additional information to investors to facilitate the comparison of past and present operations.

We will discuss our fourth quarter and full results, excluding the net pre-tax charges associated with the Global Supply Chain Transformation Program and business realignment and impairment charges recorded in 2007 and 2008. These net pre-tax charges were $79.7 million in the fourth quarter of 2008 and $95.9 million in the fourth quarter of 2007. For the full year 2008 and 2007, these net pre-tax charges were $180.7 million and $412.6 million respective.

Our discussion of year to date results and the future projections will also exclude the impact of net charges related to these business realignment initiatives. With that, let me turn the call over to Dave West .

David J. West

Thanks, Mark, and good morning everyone. 2008 was a year of challenge for businesses in every sector. The food and consumer package goods industry faced unprecedented input cost volatility and worsening macro economic trends. These conditions were difficult for Hershey, our retail customers, and certainly our consumers. Against this backdrop, we implemented the Global Supply Chain Transformation Program, one of the largest and most complex projects the company has ever undertaken.

We also initiated an in-depth strategic review, including new market structure work and a category and portfolio review to determine a new marketplace strategy and an approach to price realization and brand investments. We also upgraded capabilities and added talent where needed.

I’m proud of the way our associates rose to the occasion during these times to ensure the success of these initiatives. As a result of their hard work, we exited the year with positive marketplace momentum. Our core business is currently performing well in the marketplace and we believe we have the right initiatives in place to continue to deliver solid 2009 market share performance.

Let me give you some details. Results for the fourth quarter were strong and we are pleased with the progress we continue to make. Our core brands continue to respond to investments. Net sales increased 2.6% in Q4, driven primarily by net price realization, offset by shipment timing and volume elasticity related to the August price increased, as well as the impact of foreign currency exchange rates. Burt will have further details on the sales numbers later.

Fourth quarter net sales were in line with retail takeaway after adjusting for the two points of volume related to the August price increase, which shipped in Q3 instead of Q4. Consumer takeaway for the 12 weeks ending December 28th, in channels that account for over 80% of our retail business increased by 5.2%, driven by core brands.

Specifically, the Reese’s and Hershey’s, and Hershey’s here excluding Bliss, Kit Kat and Twizzlers franchises, were up mid single digits. When including Hershey’s Bliss and the Hershey’s franchise retail takeaway, the total franchises were up high single digits. These gains were offset by sauces and snacks, refreshment and a mid single digit decline in Kisses. This Kisses’ decline is moderating, but this is not acceptable. I’ll have more on Kisses in a bit.

For the full year, consumer take away in channels that account for over 80% of our retail business increased by 3.2%. Our marketplace performance improved sequentially throughout the year and benefitted from the investment we made in our core brands. This is evident when you look at our first half versus second half marketplace performance.

Specifically, year to date through June 15, 2008, our retail takeaway was +1.6%. In the second half of the year, Hershey’s retail takeaway accelerated, increasing +4.6% in the second half. This gain was driven by core brand performance resulting from more advertising, improved merchandising and retail coverage, and good seasonal execution.

In 2009, we’ll continue to invest behind our most responsive brands and further build our selling capabilities.

The gains in Q4 were broadbased, as the category has held up reasonably well despite economic difficulties. For the 12 weeks ended December 28th, in the channels measured by syndicated data, that’s food, drug, mass – excluding Walmart and convenience – total candy, mint and gum or CMG growth was 3.3%. With Hershey retail takeaway increasing 5.2%, resulting in a market share gain of 0.5 points.

For the second consecutive quarter, Hershey retail takeaway was up in all classes of trade, albeit versus a somewhat poor performance in the year ago period. Hershey did particularly well in the food and convenience classes of trade. In the food channel, the category grew by 2% in the fourth quarter. Hershey retail takeaway increased 3.9%, resulting in a 0.6 point market share gain.

Our chocolate performance in the food class of trade was particularly strong. The chocolate segment was up 1.6%, while Hershey’s takeaway increased 3.6%, resulting in a 0.9 point market share gain in chocolate. This was driven by higher levels of advertising across many core brands including Reese’s, Hershey’s and Kit Kat, as well as by Hershey’s Bliss. Hershey’s Bliss continues to perform well in the marketplace, as sales, ACV and repeat rates exceeded our expectations.

During the fourth quarter, we continued on-air advertising and in-store merchandising. The sell through of Hershey’s Bliss Crème De Menthe an in and out holiday item was also solid. Hershey’s Bliss will continue to anchor Hershey’s commitment to the trade up segment in 2009.

Overall for Q4, the trade up segment when in the category was off slightly. We saw good gains in trade up packaged chocolates, where Hershey’s Bliss is positioned. This was offset by declines in trade up gifts and novelties. We will support Bliss throughout 2009 with strong year two advertising, year-long sampling and merchandising and continued promotion to further drive trial generation. This investment will ensure the brand grows in 2009 and beyond.

Starting out the Halloween and holiday seasons, as expected in Q4, total seasonal category retail sales in food, drug and mass ex Walmart declined versus year ago. Clearly, channel shifting towards value-oriented retailers impacts the FDMX growth rate. Specifically in FDMX, Halloween was down 2.7% and holiday down 7%, driven by a decline in gifting and a slowdown in premium items, most likely attributable to current macroeconomic challenges. Hershey performed better than the category with flattish takeaway, resulting in FDMX market share gains in both the Halloween and holiday seasons, +0.9 points and .1.4 points respectively.

In line with the slow down and higher price point seasonal items, the Starbucks chocolates portfolio was mixed. In 2008, premium represented 6% of the total FDMXC category sales, with growth of about 9% for the full year, but with an even more noticeable slow down in Q4. In Q4, the premium segment was about flat versus a year ago.

Looking ahead, we expect to see premium segment growth continue to be moderated by the softer economy. Also, this segment is reaching its saturation point in terms of retail shelf productivity. Distribution of premium items has been growing faster than velocity. We believe in 2009 retailers will begin reallocating premium space back to core brand offerings.

Over the past few years, we have gained considerable earning from our participation in premium chocolate. Highly crafted items, such as Starbucks Truffles, will continue to offer an exceptional experience for discerning consumers.

We will also continue to develop high-end specialty brands like Dagoba and Scharfen Berger, based on the learning that we are gain as we continue to participate in space. The critical component in premium will be ensuring that we have fully qualified, unique and meaningful consumer positioning for these brands.

Let’s turn from take home and seasonal usage and look more at impulse occasions. In the C-store class of trade, the category was up 6.7% for the 12 weeks ended December 28th, more the double the growth achieved through the first nine months of the year, up 3.1%. Total Hershey’s C-store takeaway increased for the third consecutive quarter and was up 9.4%, resulting in a share gain of 0.7 points in the convenience channel.

Hershey chocolate and non-chocolate takeaway in this channel during the quarter was up 9.4% and 16.4% respectively, driven by price realization and select distribution gains. Our refreshment performance stabilized somewhat, with takeaway up 0.5% as gains in gum were partially offset by softness in mints. As a category in C-stores and FDMX, mints are underperforming the total confections category and are down about mid single digits for the quarter and double digits for the year.

The core brands that we are supporting did well in C-stores, outpacing our total results. Increased retail coverage is paying off here as we emphasize our core brands on shelf at retail. Lower gas prices also appear to be having a positive effect in this channel.

So for the full year 2008, in the channels measured by syndicated data, that’s FDMXC, total CMG growth was 2.6%, with Hershey retail takeaway increasing 1.8%, resulting in a market share loss of 0.2 points. Again, this is a tale of two halves, as our performance in the second half of the year far outpaced the first half.

Specifically, our retail takeaway in the second half of 2008 was up 4%, resulting in a 0.3 point share gain, versus the first half of the year where we lost share points. So we exit 2008 with reasonable momentum and decent takeaway in share performance.

As we look to 2009, we’ll continue to focus on core brand growth. We’ll add advertising GRPs on Reese’s and Hershey’s to ensure continuity programming of the already-successful campaigns launched in 2008. We’ll support Hershey’s Bliss as well. And we’ll expand our approach to core brand insights behind markedly increased support of both Twizzler’s and Kisses.

I’m happy to report that our initial work on Hershey’s Kisses is complete. Packaging graphics have been updated with a more contemporary look and we’ll streamline our product offerings to focus on five core Kisses items. Last week, we began airing new copy with a significance increase in weight that will be on air for the balance of the year. We are pleased with the advertising and believe it should generate a significant increase in retail velocity. Hershey’s Kisses is also the lead brand anchoring our summer Night at the Museum promotion. In Q2, we’ll run an interactive promotion in conjunction with our sponsorship of the Night at the Museum Battle at the Smithsonian movie starring Ben Stiller.

We’ll have other targeted merchandising events throughout the year aimed at driving continuity. They include in Q1, Hershey’s March Madness, capitalizing on the NCA tournament craze where consumers collect wrappers depicting the correct region and seed numbers matching the 2009 Men’s Final Four matchup. Consumers then win a trip to the 2010 Final Four. The promotion will be featured on packs of Hershey’s, Reese’s, Kit Kat and Payday brands.

In Q3, we’ll focus on back to school and an even bigger S’mores summer promotion featuring Rascal Flatts. In Q4, we’ll add the Halloween and holiday, with the focus on the fall and holiday baking seasons, reaching consumers resurgent eating at home trends. Importantly, the first half of the year will be anchored in-store by Valentine and Easter seasonal programs.

So with continuity ad spending on Kisses, Reese’s and Hershey’s, strong seasonal programming, and a good merchandising calendar, we believe we will continue to hold our own and maintain our market share performance. Focus on core brands and our strong executional capabilities are the right formula for 2009. Consumers and customers are looking for tried and true brands and products and we are well positioned to deliver.

To date, the category has proven to be resilient in these difficult economic times. This has historically been the case. Q4 activity was driven largely by Halloween and holiday programming. In Q1, Valentines and Easter are key drivers. These events were sold in prior to the August 2008 price increase.

Outside of the seasons, the consumer has begun to see higher everyday prices. In C-stores, notwithstanding the expected unit declines, we have experienced good growth in dollars and overall category buoyancy. As we move through 2009, primarily after Valentine’s and Easter, consumers will see higher everyday and promotional price points across all channels. Consumer sentiment, channel shifting, and other macro factors are difficult to predict. We will make the needed investments in our core brands and capabilities to win in the market.

The pricing actions we have taken are dramatic, but they are necessary. In 2009, our commodity cost basket up markedly. When we announced our price in August of 2008, we were anticipating a $225 million increase in our commodity input costs in 2009. This has mitigated somewhat as we now anticipate the increase to be about $175 million.

However, the factors which drove commodities down also took pension plan asset values down as well. We now see higher 2009 pension expense of $70 million. And while we’ll see good local currency growth, for-ex will negatively impact our international businesses on both the top and bottom lines.

Between price realization and global supply chain savings, we believe we have taken the appropriate steps to create the affordability to invest in brands and capabilities as well as to ensure an appropriate future margin structure for our business.

Advertising will increase 20 to 25% in 2009. And, we’ll forge ahead with expansion in India, China and Brazil. We will continue to execute in the market and attempt to maintain share momentum. Overall, we expect to 2 to 3% sales growth in 2009, including the impact of foreign exchange, which we anticipate to be a major drag on our sales growth.

We continue to expect earnings per share diluted from operations in 2009 to increase; however, at a rate below our long-term objective of 6 to 8% growth. This is consistent with our statements last June and throughout the balance of 2008. I’ll now turn it over to Burt, who will provide some additional financial detail.

Humberto P. Alfonso

Thanks, Dave, and good morning everyone. Net sales and earnings per share diluted from operations for the full year 2008 were at the high end of the initial ranges we communicated at the beginning of last year. Overall, we are pleased with our financial and marketplace performance in 2008 given the volatile environment in both commodity and financial markets. For the full year, we achieved our financial objectives and stabilized our marketplace performance.

Fourth quarter consolidated net sales of $1.377 billion increased 2.6% versus the prior year. EPS diluted from operations of 59 cents increased 9%, primarily due to price realization and supply chain savings. For the full year, net sales increased 3.8% and earnings per share diluted from operations were $1.88, a decline of about 10%.

In the fourth quarter, sales gains were driven by net price realization, positive mix, and international growth. Offsetting these gains was a lower volume elasticity related to our 2008 pricing actions as well as about 2 ½ points due to foreign currency exchange.

Dave provided details related to our marketplace performance all focused on review of the P&L and balance sheet starting with gross margin. During the fourth quarter, operating gross margin increased 370 basis points as net price realization, supply chain savings from the transformation program which were higher in Q4, lower asset disposals and the timing of favorable material price purchase variances more than offset higher commodities of about 200 basis points.

For the full year 2008, gross margin was 35.8% versus 35.5% in 2007, up 30 basis points. Pricing and productivity initiatives, inclusive of the Global Supply Chain Transformation, offset 240 basis points of unfavorable input costs.

EBIT margin increased 30 basis points in the fourth quarter, as pricing and higher gross margin more than offset higher advertising, marketing and selling expenses, employee-related costs and expenses in selected international markets.

Advertising expense was up 23% in the quarter, supporting the ongoing Hershey’s Pure and Reese’s Perfect campaigns, as well as Hershey’s Bliss and brand-building initiatives in international markets. For the year, advertising increased 26% to $161 million. Selling, marketing and admin expenses in the fourth quarter, excluding advertising increased due to higher international infrastructure investments, strategic portfolio work related to our ongoing market structure and segmentation studies, higher employee costs related to incentives and capability development, as well as hiring of executive talent to fill open positions.

EBIT from operations for the year declined 11.6% with EBIT margin down 260 basis points to 15% from 17.6%. The decline was driven by higher advertising, employee-related costs, and the investment in retail coverage that began toward the end of the third quarter in 2007.

Now, let me provide a brief update of our international businesses. In 2008, we completed the integration of the (inaudible) business in India, the Lotte Hershey Manufacturing joint venture in China, including the implementation of S&P in both China and India and the JV in Brazil with Bauducco. These businesses met expectations in 2008 on a constant currency basis. On the US dollar basis, significant appreciation of the US dollar in the fourth quarter did impact our international business results. We expect foreign currency exchange rates to be a headwind in 2009, compared with the full year 2008.

We will continue to invest in our strategic international markets to increase our presence in chocolate, increase brand awareness, and further develop go to market capabilities. While these investments will not contribute to near term margin improvement, we are committed to these strategic markets to ensure the company’s continued long-term success.

Moving down the P&L. For the quarter, interest expense decreased, coming in at $25 million versus $28 million in the prior period. For the year, interest expense was $98 million versus $109 million a year ago. The fourth quarter and full year both benefitted from lower short term rates on a commercial paper and improvements in working capital. In 2009, we expect interest expense to be about flat versus 2008.

The tax rate in the fourth quarter was 35.7%, down slightly versus year ago. For the full year, the tax rate was 36% as anticipated. Note that on a quarter and year to date basis, the reported tax rate is higher than the pro forma rate due to the effective tax rates applicable to the business realignment and impairment charges.

For 2009, we expect the full year tax rate to be up about 36%. However, due to the timing of certain tax events and related accounting, the quarterly tax rate will be uneven next year, particularly in the first half.

As such, we estimate that the tax rate in the first quarter of 2009 will be roughly 40% and 30% in the second quarter. In the fourth quarter of 2008, weighted average shares outstanding on a diluted basis were approximately 228 million versus 230 million in 2007, leading to EPS of 0.59 per share diluted from operations, up 9% versus year ago.

For the year, shares outstanding were approximately 229 million versus 231 million in 2007. EPS diluted from operations for the full year was $1.88, down about 10%.

Turning the balance sheet and cash flow. At the end of the year, net trading capital decreased versus last year, resulting in a cash flow benefit of $66 million. Accounts receivable were down $32 million and remain extremely current and of high quality.

Year-over-year, accounts receivable sales outstanding improved by 1.5 days. Additionally, we continuously monitor our accounts receivable aging and despite current conditions in the financial markets, we have not seen an impact on our customers’ payment patterns to date.

Inventory declined by $8 million and accounts payable increased by $26 million. We expect working capital to further improve in 2009, but not by the same magnitude as we achieved in 2008.

In terms of other specific cash flow items, capital additions including software were $72 million for the quarter and $283 million for the full year. This was slightly less than our $300 million forecast for 2008 due to the timing of projects related to the Global Supply Chain Transformation Program.

For 2009, we are targeting total capital additions to be in the $175 to $185 million range. About $40 to $50 million of that spend is related to the Global Supply Chain Transformation Program.

Depreciation and amortization was $59 million in the quarter. This includes accelerated depreciation related to the Global Supply Chain Transformation Program of $12 million and operating depreciation and amortization of $47 million in the quarter.

For the full year 2008, depreciation and amortization was $250 million, of which accelerated depreciation and amortization was $60 million. In 2009, we are forecasting total depreciation and amortization of about $190 million, including accelerated depreciation and amortization of approximately $10 million.

Dividends paid during the quarter were $66 million, bringing the full year to $263 million. We did not acquire any stock in the fourth quarter related to the current repurchase program. And there is $100 million outstanding on the current authorization that the board approved in December of 2006.

During the quarter, we did repurchase five million of our common shares on the open market and to replace shares issued in connection with employee exercises of stock options. Our goal is to repurchase all such shares.

As it relates to our short-term cash needs, the company is currently well positioned. While the credit markets are volatile, market conditions have not had an impact on Hershey’s day-to-day operations, liquidity or longer-term planning.

Our cash flow continues to be strong and will improve as the Global Supply Chain Transformation is completed. Our capital structure is on target, with three-quarters of our debt or $1.5 billion in fixed rate notes with maturities starting in 2011.

We have not encountered any difficulties in our short-term promotional paper funding and have been able to place our CP at attractive rates. Our cash balance will vary during the year due to seasonality of our business. Cash on hand at year end was $37 million, down versus a year ago as our strategy this year has been to pay down short-term debt with excess cash whenever possible.

I stated in the press release the decline in the financial markets in 2008 will result in a 2009 pension expense of approximately $70 million or $0.20 per share diluted. Note that on a quarterly basis in 2009, pension expense will be about $0.05 per share diluted. This has also impacted our deferred income tax liability and other assets on the balance as of December 31, 2008.

While a decline in financial markets has impacted the value of our pension assets, as of the end of 2008 our pension plans remained well funded based on our projected obligations. As a result, minimal cash contributions of about $3 million are required in 2009.

Let me know provide an update of the Global Supply Chain transformation program. Construction of Monterrey, Mexico, facility continues and about two-thirds of client manufacturing lines are installed and producing product. Progress continues essentially in line with our implementation schedule.

During December, the scope of the Global Supply Chain transformation program was expanded to modestly include the closure of two subscale manufacturing facilities of the Artisan Confections Company, a wholly owned subsidiary. Consolidation of associated production lines into US facilities along with associated and rationalization select portfolio items. The affected facilities are located in Berkeley and San Francisco, California.

This change will enable us to leverage the scale of our high quality bean to bar operation in our Robinson, Illinois, facility where the majority of (inaudible) items are currently produced. The unique technology and creative production techniques of Joseph Schmidt have been incorporated into the company’s manufacturing network and applied to other product lines.

The total cost of these actions which includes severance for approximately 150 impacted employees is expected to be $25 million and will be recorded in 2009. Ongoing annual savings from these initiatives are expected to be $5 million.

Cumulative savings from the Global Supply Chain transformation program are $81 million, in-line with our original forecast and the estimate for total ongoing initial savings by 2010 was increased by the previously mentioned $5 million and is now $175 to $195 million. During the quarter, we recorded Global Supply Chain realignment charges of $34 pre-tax including $12 million of accelerated depreciation, $5 million of project start-up, and $2 million of SM&A expenses reflecting program management costs.

In addition, the company recorded non-cash impairment charges of $46 million related primarily to the Mauna Loa trademark. The total of these charges reduced earnings per share diluted by $0.23.

For the full year 2008, the company recorded one-time charges of $181 million. The majority of these charges, $135 million, are associated with the Global Supply Chain transformation and the previously mentioned $46 million impairment charge. The total of these charges reduced 2008 earnings per share by $0.52.

The forecast for the total project charges related to the initial program remains the same at $550 to $575 million; although we are currently forecasting to be toward the upper end of that range. Adding the previously mentioned increase in project scope, we now estimate total pre-tax charges and non-recurring project implementation costs at the upper end of $575 to $600 million. This cost range excludes possible pension settlement charges in 2009 and 2010 as discussed in Appendix A of our press release.

Total charges do include project management and start-up costs of approximately $60 million. In 2009, the company expects to record GAAP charges of about $45 to $70 million or $0.13 to $0.20 per share diluted primarily related to the Global Supply Chain transformation program excluding possible pension settlement charges.

Let me close by providing some context on our 2009 outlook. In 2009, our goal is to sustain our marketplace momentum that we achieved during the second half of 2008. This could be challenging based on the economic backdrop and consumer sentiment. Over the last few weeks the news has been full of retail sales declines across many industries including food, drug, convenience, and select mass channels. We will continue to invest in our branch and businesses in both the U.S. and international markets bringing strong programming to a (inaudible) via advertising and merchandising will help to ensure confection remains a destination category.

While commodity stock prices have moderated, a broad range of ingredients are up year over year in 2008. We expect costs of our key inputs to remain volatile and above historical averages on a spot basis. Last August, we estimated that our 2009 commodity cost basket would increase by $225 million. As the year progressed, commodity costs declined somewhat reducing this projection to an increase of $175 million.

However, this decline has been more than offset by the increase in pension expense of approximately $7 million resulting from the decline in financial markets. As a result, we now estimate the 2009 cost structure will increase approximately $245 million or $0.70 per share diluted. Our business investment expenses will also be higher in 2009 to support consumer and customer merchandising programs for core brands as well as Hershey’s Bliss.

Specifically advertising’s suspected to increase $30 to $35 million or about $0.08 to $0.10 per share diluted in 2009. These cost increases will be more than offset by higher net pricing, ongoing operating productivity improvements, and savings from the Global Supply Chain transformation program. As such, 2009, we expect net sales growth of 2 to 3% as pricing action as well as core market growth will be partially offset by lower volumes and the impact of unfavorable foreign currency and exchange rates.

As we’ve stated since mid-year 2008, current year 2009 earnings per share diluted from operations is expected to increase; however, due to the affirmation to items, growth will be at a rate below our long-term objective of 6 to 8%.

As you work on your models, I remind you that in the first quarter, we will begin to recognize higher commodity costs but will not yet fully benefit from the incremental supply chain savings and higher pricing as we’ve honored pre-August 2008 negotiated price points on Valentine and Easter promotions.

Additionally, advertising essentially much higher in the first quarter versus the year ago period as well we’re incur costs related to Kisses relaunch and Hershey’s pure campaign that begin late in the second quarter of 2008. Now, let me open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Judy Hong with Goldman Sachs.

Judy Hong - Goldman Sachs

Good morning, everyone.

David J. West

Morning, Judy.

Humberto P. Alfonso

Morning.

Judy Hong - Goldman Sachs

Dave, I’m wondering if you could share with us your thoughts in terms of what you observed as far as the volume price elasticity is concerned following the August 15 price increases. And I understand the promoter prices haven’t gone up but anything you can share with us and whether you feel the 2 to 3% number in 2009 as far as sales growth is concerned, maybe turning out to be a little bit more conservative.

David J. West

I’ll give you, just give you some thoughts on what we’ve done. Yes, the price increase in August obviously we did honor previously committed prices for Halloween, holiday, as well as Valentine’s and Easter. So in the fourth quarter, I mean roughly have the volume that moves through at retail is in that holiday and Halloween.

So, we did get obviously the list price increases which was right - roughly 10% across half the business. So you can guess it’s somewhere around mid single digits in terms of price gains in the quarter.

We did start to see a dampening effect of foreign exchange as Burt said, it was about - a little bit more than two points of growth in the fourth quarter because of lost to foreign exchange. And we had the volume shift out of the fourth quarter into the third because of the timing of the pricing. So you can kind of take that mid single digit list price gain and work it down to get the math to work.

With respect to elasticity, there are a couple of things that we did see through the quarter. Clearly most of the merchandise in the quarter is seasonal and in destination, we did gain considerable share in both Halloween and holiday. We’re very pleased with our execution there.

And we also a reasonably good mix shift in two different ways. One every day versus promoted volume, so we got decent trade promotion performance versus our expectation. And then also good channel mix especially with See’s stores being up. So overall, kind of too early to tell because the destination category effective of Halloween and holiday, the consumer really hasn’t seen it and they won’t see the full blown list pricing and promoted price increases until sometime after Easter.

So it’s really kind of early to tell. We’re pleased with what we’ve seen so far but way, way too early and frankly, every day you read the paper, you see consumer sentiment. You see job loss. So it’s kind of early to take a read and then you know we will have the foreign exchange.

Our foreign exchange - our international business is relatively small compared to a lot of other folks but it’s still a pretty big drag for us in terms of the top line. So when we look at the two to three, clearly the elasticity effect is still a little bit of an unknown and we’re going to have the foreign exchange drag next year as well.

Judy Hong - Goldman Sachs

Okay and then Burt, in the fourth quarter can you walk us through the expansion of gross margin that were seen both sequentially and on a year over year basis and some of the factors that drove it and perhaps, you can quantify those factors.

Humberto P. Alfonso

Yeah, I think the right way to think about gross margin in the period was we certainly had as Dave mentioned good net price realization and certainly so you see the pricing that we got on about half of the business which he mentioned which is in our seasonal as well as some better performance on the trade line. And that gave us good expansion.

We also had mentioned during the year that our supply chain savings were certainly more fourth quarter oriented and that’s just a sequence of the way our plants were closing and the fixed cost benefit that we were getting. So we did see in the fourth quarter as we anticipated that we would good supply chain performance in that quarter. And I would say that those were the - there were some offsets but those were the bigger drivers to a strong margin in that quarter.

Judy Hong - Goldman Sachs

Okay, thank you.

David J. West

You’re welcome.

Operator

Your next question comes from the line of Jonathan Feeney with Janney, Montgomery, Scott, LLC.

Jonathan Feeney - Janney, Montgomery, Scott, LLC

Good morning, guys.

David J. West

Good morning.

Humberto P. Alfonso

Good morning.

Jonathan Feeney - Janney, Montgomery, Scott, LLC

You guys congratulations. Dave, could I dig in a little bit more on the premium segment? Particularly Bliss but you mentioned Bliss and Starbucks. You mentioned some of the slowdown.

Could you talk a little bit more in a more granular way about what the retailers are telling you about the outlook for premium chocolate, what your outlook is and just also how much of the increase in advertising would you say has been geared towards those sort of premium products in the context of your — the expansion, I think 35 to 50 you talked about for ’09.

David J. West

Sure, let me just talk a little bit. I think essentially the consumer sentiment has shifted in such a way that in categories where the consumer can actually trade out of the category, they’ve traded out. So durables, appliances, some of those categories that consumers traded out. In food we obviously, we won’t see a trade out as consumers will continue to eat.

So we have seen though is somewhat of a trade down. So though we’ve kind of thought of the market in three kind of tiers or layers if you will; premium, trade up, and then kind of the core every day. And Bliss, Hershey’s Bliss is in that trade up kind of segment of the market and Starbucks, Sharperberg (ph ), and (inaudible) for us are more up in the premium.

We saw a significant slowdown in both premium and trade up and it shift more down toward every day in the fourth quarter to the point where both the premium and the trade up segments were pretty much flat for the fourth quarter which is a significant slowdown versus historical growth rates.

Most of that we saw was more in gifting and novelty, so the packaged chocolate components of trade up particularly where Hershey’s Bliss is playing actually grew pretty nicely in the quarter but it was more than offset by declines in gifting. Within premium, I mean the premium growth rates have been pretty high the last couple of years and we saw that even through the first part of this year. I said for the full year premium growth, the segment growth was 9% but for the fourth quarter it was basically flat.

So you can see a deceleration there. And what I think you’re seeing there again is consumers are really trading kind of down out of premium to trade up or out of trade up into every day.

And so I think what you saw mostly in the fourth quarter is the destination effect of holiday and Halloween as well. So consumers are making sure they’re making those purchases.

So I think essentially what we’ll see in the category next year is the - I think a little bit of space at retail will shift out of premium trade up as those parts slow down and are less productive. And they’ll move back into things that are every day. As we mentioned on the third quarter call, we’re relatively well-positioned in the category for that kind of a shift because of the strength of our core brands. And we did see some of that happening in the fourth quarter and we’ll think we’ll see it through the beginning of 2009 as well.

Jonathan Feeney - Janney, Montgomery, Scott, LLC

And just on the ad spending, Dave, how much of the sort of increase would you say would be represented by those trade up and premium, you have this pretty big commitments to things like the launch of Bliss you’ve made behind those products, spending versus core?

David J. West

We did spend on both Bliss and Starbucks much more so on Bliss than on Starbucks. The Starbucks advertising was very targeted and over a shorter period of time. And I’m not going to give you exact numbers but Bliss, we made a significant increase enough to get to continuity levels of coverage and we will continue to do that in 2009. We very much believe in the trade up part of the category, consumers will continue to kind of treat themselves and reward themselves in that space.

The economy will come back someday. I hope you have a better projection than I do but in fact, when that comes back we’ll see premium and trade up continue to be part of - even in today’s market what consumers are buying but we want to be well-positioned as the economy comes back and people start to trade back up.

Jonathan Feeney - Janney, Montgomery, Scott, LLC

Thanks, Dave. And just one question for Burt, when you look at the Global Supply Chain transformation specifically the Monterrey plant. As I understand, weakness in the peso should actually help your outlook for those cost saves going forward. I mean is that the case and is there any way you could quantify that?

Humberto P. Alfonso

There’s some benefit from that. I would tell you that it’s mostly on the labor side but it is a dollar functional entity because it’s a Makeela (ph), operates on the Makeela regulations.

Jonathan Feeney - Janney, Montgomery, Scott, LLC

Oh, okay.

Humberto P. Alfonso

And so it’s not the same as a fully Mexico operation as you might think. So there are some but not what you’re thinking.

Jonathan Feeney - Janney, Montgomery, Scott, LLC

Okay, thanks very much.

Operator

Your next question comes from the line of Eric Katzman with Deutsche Bank.

Eric Katzman - Deutsche Bank

Morning everybody.

Humberto P. Alfonso

Hi, Eric, how are you?

Eric Katzman - Deutsche Bank

I guess my first question, Dave, has to do with your comment about the category being up. I guess that’s in dollar terms given all the pricing that’s going on but I’m a little bit concerned with volume. It seems if volume was down this quarter that it’s been about, by my count, six or seven quarters now where volume has been down and yet, your advertising is up significantly. So can you just kind of talk about how we should think about that trade off and what that kind of means for a capacity utilization and the restructuring?

David J. West

Yes, I think that - I mean that’s a fair question in terms of the unit versus the dollar trade off. I mean when you take price increases and you look at the elasticity models, we would expect to see some unit declines. That’s how we’ve thought about it. That’s how we’ve planned it.

I think what you need to continue to look at for us in the quarters leading up to the fourth quarter here. We have seen good core brand momentum in dollars and reasonably good volumes on some of those core brands. So that focus on the core is clearly paying off for us.

We are certainly more efficient and profitable by getting that core to work harder for us. And we think that that strategy is still working out. And we’ve got some things that are still kind of in the tail of our portfolio that are declining. I mean we’ve seen a decline in mints. We’ve seen a decline in some of the - kind of second and third tier brands on a unit basis.

So, I think the volume story’s a little bit more of a tale. There’s two parts to the portfolio. The core has held up reasonably well from a volume standpoint up until obviously the fourth quarter here and then the tale’s probably off a little bit more from a volume basis. And with respect to what we saw in the fourth quarter, that trade off of units and dollars, it’s early to tell but given the costs and the cost increases over the last two or three years, we really believe that the pricing is necessary and appropriate.

Eric Katzman - Deutsche Bank

Do you have any indication as to whether competition is going to follow the increase in the promoted price post Valentine’s or Easter?

David J. West

Eric, I can’t speak to what every - anybody else’s programming is. We have had our conversations with customers and done what’s right for our business and our cost structure. And from my standpoint, we’ll be appropriately priced to build the right model. It remains to be seen when we get there, how retailers and consumers react to those price points. And I don’t have anything specific to give you on those price points coming out of Easter.

Eric Katzman - Deutsche Bank

Okay and Burt, last question on the cash cost of the restructuring plus the minimal cash contribution from pension in ’09. What will that be?

Humberto P. Alfonso

In terms of the pension, I mentioned the full expense is $70 million. And as we go through the pension obligation projections, what we anticipate making in cash contributions is quite minimal. It’s in the - around $3 million which is the number that we were pretty confident in. So there’s not a lot of cash contribution requirements in terms of our funded plans.

On the Global Supply Chain side, we’re - I had mentioned that the expenses in the coming year are actually down quite a bit as you would expect because we’re down to our last couple of plant closings and a lot of the prior costs have been accrued. So I think I put the number out there somewhere between 45 and 70 and no more than about half of those would be cash related.

Eric Katzman - Deutsche Bank

So you’re going to generate maybe a buck, I guess depending upon where earnings coming out like a $1.70 plus of cash flow per share pre dividend. It would seem.

Humberto P. Alfonso

Well, we’re not - right now we’re still crushing through exactly our cash model and finalizing the balance sheet so we’re really not providing that type of guidance.

Eric Katzman - Deutsche Bank

Okay. I’ll pass on. Thanks.

Operator

Your next question comes from the line of David Driscoll with Citi Investment Research.

David Driscoll - Citi Investment Research

Thank you, good morning everyone.

David J. West

Good morning, David.

David Driscoll - Citi Investment Research

Well, congratulations on a nice ended year and regaining some momentum in the brand. Dave, I’d like to talk to you a little bit about the advertising spending. First, the $30 to $35 million, again you sort of eluded to this in your prepared remark but can you just talk a little bit about where this incremental money will be focused?

David J. West

Sure, I think David a couple of points I’d make in terms of what we saw actually in the latter part of 2008 is going to carry forward and be true in 2009. It’s become a little bit more efficient to buy media in the latter part of ’08 and into ’09. So when we looked forward to ’09, the Hershey’s Pure Campaign that we began running about middle of year last year will be continuity advertising all year.

We just started Kisses advertising. I hope you’ve seen the commercial, then started running it last week and that’ll run for the balance of the year. We’ll continue to have continuity on Reese’s and similar levels on Hershey’s Pure. We’re also looking at adding GRPs on Twizzlers and a few other places. Essentially the good news about efficiency both because of continuity and marketplace efficiency, the GRP increase is much, much higher than the actual increase in the rate of the advertising and that’s where we’ll be putting it this year.

David Driscoll - Citi Investment Research

When we focused in on Kisses, when I look our Nielsen Data Food Drug and Mass Channels, Kisses for the latest 52 weeks is down just shy of 15%. Would you say that that number is - because again that’s packaged candy so it’s more — I generally think that our data is accurate. Number one, is that about right to what you’ve seen in 2008? And then number two, talk about how you’re going to fix that franchise in 2009 and will we see strong growth here or is it the expectation just to arrest the decline?

David J. West

Well, let me try and unpack that question and I think take it in two or three different chunks. The first is about your data and not your data but the data in general. We use a custom database both from IRI and Nielsen and it does tend to differ a little bit from what you guys have in terms of growth rate and some of the segment growth rates but let’s just say it’s directional correct for sake of argument but it’s not exactly to what our data would be.

The decline you saw in Kisses, as we said, we watched that and we’re working on that throughout the year. We’re not pleased with it. It moderated some in the fourth quarter and we think that we have part of what we went through last year was a rationalization of some of the items we had proliferated into too many flavors and skus. So some of what you saw was just the slowdown and a discontinuation over time of the tale, if you will of the Kisses portfolio.

As you think about 2009, we’ve got new graphics on shelf. We got a much better representation of the core, strong items on shelf and the advertising to back it up. We’ll also - Kisses will anchor our second quarter promotion at The Night At The Museum promotion. So we have, I think, some pretty good news around Kisses for the year.

I think the challenge for modeling right now is obviously the whole question of the consumer has yet to see increase promoted prices on the packaged candy line. They won’t see that till post-Easter. So projecting forward, we feel that we can erect that decline in terms of dollars as we head into 2009 and that’s probably where I’d leave it.

David Driscoll - Citi Investment Research

Okay, one final question. Burt, can you just talk to us about how the quarterly pattern might evolve for the commodity cost; i.e., is the commodity increases - are they substantially weighted to the first half of the year and thus we would see an easing of commodities in the back half?

Humberto P. Alfonso

Well, I think after you take a look at the commodities they’re pretty evenly spread across. What’s different, in terms of how the margins will evolve, I suppose, is more related to the way our savings - again continue to be a bit more back-end oriented, I mentioned that advertising will certainly be higher early in the year specifically in Q1. I talked about the tax rate especially in the first half being a bit uneven but from a commodity perspective, there’s not a huge fluctuation across the quarters.

David Driscoll - Citi Investment Research

Great, thanks a lot everyone.

Operator

Your next question comes from the line of Chris Growe with Stifel Nicolaus.

Chris Growe - Stifel Nicolaus

I just wanted to verify in relation to some data you gave earlier. I think, Dave, you were talking about roughly 5% pricing in the quarter but that, I think, would be just related to the August price increase. There was still some pricing coming through from the January price increase as well, right?

David J. West

I think the two increases during the year. If you’ll recall, the first increase was only on the standard bar component of the portfolio. It was not a full line pricing. So there’s a little bit of that that would’ve come through obviously in the fourth quarter but only on a smaller part of the portfolio and as you look at the way the components of the fourth quarter are it’s a much more packaged candy seasonally driven quarter versus the inconsistent consumable part of the business.

Chris Growe - Stifel Nicolaus

So in terms - you haven’t given a good sales breakdown. I mean pricing was up. It sounds like a little bit over 5%. Volumes sound like they were actually not down as much as I thought they would be kind of flattish. Is that the right number to use?

David J. West

Well, I think if you think mid single digits from pricing. And then we had foreign exchange as a drag. I talked about that being a couple point drag and then the two points of shift

Chris Growe - Stifel Nicolaus

Right.

David J. West

You move to Q3 and then clearly what I would say is we had reasonably good holiday performance in the quarter and that holiday volume probably offset some of the elasticity volume losses. So if you kind of balance those two things together, the volume performance overall was not too bad in the quarter but I think it’s holiday offsetting some of the elasticity from the price increase.

Chris Growe - Stifel Nicolaus

Okay and then I just - one other question on sales. And that is just that you reported 2.5% and 2.6% increase in sales. You had the buy-in knock a couple of points off that but you also had negative foreign exchange and your retail ticker was up 5%. So was there - surprisingly I guess it looks like the retail inventory increase in the quarter given the way your sales performance was relative to take away?

David J. West

No, I think that that’s actually - if you normalize the 2.6% takeaway and you take out the international and the foreign exchange, etc. shipments were very much in-line with takeaway. And our inventories out at retail I think are in really good shape right now.

Chris Growe - Stifel Nicolaus

Okay. And then I just wandered in relation to the See store trends picking up. Would you attribute that to lower gas prices or was is - and I know you have some promotions and some programs there as well but would gas, lower gas prices be what you consider maybe the main driver of those sales?

David J. West

It’s kind of hard to tease out lower gas. I think one of the things that we’re most pleased about is retail coverage. If you remember we put retail coverage, we started a little bit later in the latter part of last year but really got it going in the first part of 2008 and the retail coverage really seems to be working. We’ve got good ACV gains on the core items out there.

Clearly, gas prices have to be helping. The decline in gas prices have to be helping traffic in and out of the store. Historically there was a point at which we didn’t see a lot of correlation between the gas prices and store traffic. We crossed the threshold obviously at some point and time when gas prices just kept skyrocketing where we did see an impact to the consumer.

And now obviously, the same has to be true on the way down. So I think the good news is that the consumer is actually in the store more and buying, so that has be helping us. And we’ll look for the correlation going forward, but with the volatility it’s kind of hard to find the correlation just yet.

Chris Growe - Stifel Nicolaus

Sure. And Bert, can you give like a cost inflation, a rough cost inflation figure for the quarter? Like the incremental increase year-over-year?

Humberto P. Alfonso

In terms of Q4?

Chris Growe - Stifel Nicolaus

Yeah, Q4 input cost inflation. Whatever dollar amount that is, or however you want to give it.

David J. West

It was about 200 basis points, Chris.

Humberto P. Alfonso

Yeah, 200 basis points. The only thing I would mention, which I didn’t mention in the past that certainly some of our costs were up as I mentioned, because we are up year-over-year. The one exception to that was dairy and I think we have mentioned that in the past, which is not as high as it was in 2007.

Chris Growe - Stifel Nicolaus

Sure, okay. Thanks a lot.

Humberto P. Alfonso

And obviously we don’t hedge dairy.

Chris Growe - Stifel Nicolaus

Absolutely. Thanks.

Operator

Your next question comes from the line of Ken Zaslow, with BMO Capital Markets.

Ken Zaslow - BMO Capital Markets

Just following up on that last comment that you just said; is in terms of the reduction of your commodity cost basket going down from 250 or 225 to 175, was it largely because of the dairy costs coming down and that is unhedgable and that’s kind of what had happened? Is that a fair assessment?

Humberto P. Alfonso

Well I think that’s one way of thinking about it, yes. If you look at the rest of the inputs in the basket, about the only two commodities that haven’t seen any kind of moderation are cocoa and sugar. Nuts haven’t been particularly as friendly either. So, dairy is one way of looking at it, but fuel came down and so we had started to take a position to get visibility.

First and foremost for us, if you think about what we think about in commodities, one, it’s certainty of supply. And then once you get the certainty of supply, it’s the visibility to understand what it’s really going to cost you on a forward basis so you can plan the business and make necessary pricing decisions.

And then the third component to that is, once you have got those two done, you’d like to beat the market. We think actually in 2008, and as we head to 2009, we did all three of those things, but clearly cocoa and sugar have not come back, so dairy has come back to a certain extent and we think we’ve done a pretty good job across all of them in terms of our performance versus the market.

But as you look at that change, unfortunately pension expense goes the other way with respect to what’s happened in the fourth quarter and kind of offsets that favorability in commodities.

Ken Zaslow - BMO Capital Markets

But the dairy is the main one that you can’t hedge? Like you can hedge full and then as you said, you were looking for certainty, that’s the only reason I thought that maybe that was reason for the major decline.

Humberto P. Alfonso

But they’re not hedging dairy, that is true.

Ken Zaslow - BMO Capital Markets

And then, in terms of just the tax, make sure I understand, you said 40%, 30%, and then what’d you say for the third and fourth quarter?

David J. West

I didn’t mention anything about a fourth quarter, I did mention that we expect the rate on an annual basis to be about the same, 36% as we came in 2008. I tried to get a little bit more color on the first half, because it is a wider range than typically across the quarters.

Ken Zaslow - BMO Capital Markets

Okay. And then the other question is: just going back to the sales growth, if you were excluding foreign currency, what would you think the sales growth would be in 2009?

Humberto P. Alfonso

Yeah, we didn’t really give anything specific, but if you look at the trend in the fourth quarter, it cost a couple of points. We’re a little bit more heavily loaded in terms of the skew of the seasonality of international sales. But we’ve already kind of taken that in the fourth quarter, so we still have three more quarters to go of something that cost us two to two and a half points in the fourth quarter. So you can kind of figure it’s costing us close to a couple of points, a point to two.

Ken Zaslow - BMO Capital Markets

So implicitly, you are actually raising your internal sales growth, relative to what you thought last quarter. Is that a fair assumption?

Humberto P. Alfonso

Well, if you think about where we’re headed in 2009 and what we’ve gone through in 2008. We kind of set long-term goals of three to four on the top and six to eight on the bottom back in June. But we said at that time that we would be less than six to eight, but growing earnings this year. When we talked about the price increase in August, we went from the three to four down to two to three. Or three to five, I’m sorry, down to two to three.

As we’ve managed through the year, there’s been an awful lot of puts-and-takes, we’re actually kind of pleased that we’ve been able to figure our way through the puts-and-takes and been able to hold the two to three despite the foreign exchange. So, I think what you can read into that is that there may be a little bit more strength in the underlying U.S. business coming out of the fourth quarter than we would have anticipated last June.

Ken Zaslow - BMO Capital Markets

That’s what I was getting at. And is part of that strength, is that because - you mentioned it, but it didn’t seem you like kind of hit home on this, is that added the retailer-ship away from the hiring chocolates to the core brands, which again it’s still your concentration that you get to pick up shares, would that be part of it as well?

David J. West

I think it’s a number of factors, I think it’s clearly in advertising it’s increased merchandising effectiveness. Those two things are key drivers for us. And then I do think that there’s a favorable movement within the category. But listen, we’ve got a lot of stuff in premium and trade-up other than Hershey’s listed that are feeling the same effects of consumers trading down.

But the good news is, in this kind of economy, both customers and consumers want to make sure that they’re buying something that they know they’re going to get value for and that they know. If they’re going to spend money, they’re going to spend on something that’s tried-and-true.

We’ve fit the bill there, so there’s a little bit of that as well, I think it’s a combination of good brand support, really good merchandising, and then just some of the dynamics out there in terms of channel shifting and the way the consumers are spending.

Ken Zaslow - BMO Capital Markets

Great, thank you very much.

Operator

Your next question comes from the line of Robert Moskow, with Credit Suisse.

Rob Moskow - Credit Suisse First Boston

Hi thanks. A couple of questions; one is on the cash flow, I mean your forecasting a big decline in CapEx in ’09. You haven’t told us what cash flow was in ’08, but should we expect some kind of a step-up in ’09? Secondly, what are you going to do with that cash? You used to have some pretty big share repurchase programs, can you update us on whether that is still in the equation or whether that reduction is the focus?

And then lastly, can you talk a little bit about just the category for chocolate in general? Do you find that it’s a relatively rational category today? I know it’s always highly competitive, but you feel like the steps that you’re taking on pricing are pretty well-matched by everyone else and do you think there’s a chance here that everyone can hold pricing, even as commodities perhaps decline?

Humberto P. Alfonso

Let me take a shot at the cash flow and sort of turn it over Dave on the pricing. You’re correct, we did talk about a sizable decline in capital expenditure in that $100 million range. We also talked about some pretty big declines in our depreciation numbers to some extent, because a large component of accelerated depreciation from the supply chain transformation becomes much smaller in ’09.

So, while that’s a non-cash item versus a cash item, in terms of the way the cash flow works, they’re somewhat offsetting. And there are other moving parts in terms of how the pensions, liabilities, and the deferred taxes work.

So, again we’re not giving guidance per say, we do think we have a strong cash flow, and we expect it to be strong again in ’09. With respect to the savings and the things that come from the cash flow from the transformation program, we think of those more in terms of how we manage the cost structure.

David J. West

I think Rob, with respect to the category, it’s trust - we need to do what’s right for our business and cost structure, and we’ve done that. I mean it’s a fairly dramatic price increase, and until we really get out in the middle of next year and see what - the biggest factor for me is really the consumer dynamic and how the consumer reacts to seeing higher promoted pricing points and higher list prices. And at this point in time, it’s uncertain as to what other folks are doing out there, with respect to their business and we have to do what’s right for ours for the long-term.

So, that’s what we think we’ve done. In this environment, your question about cash flow is the same. There’s enough uncertainty out there in terms of financial markets, et cetera. We are a good generator of cash; historically we might have been more active in share buy-backs, we weren’t particularly active in 2008.

We like the credit rating that we have frankly, and the access that we’re getting to financial markets and that’s something that we’re going to kind of hold on to, to the best of our abilities as we get into the early part of ’09.

Rob Moskow - Credit Suisse First Boston

Okay. Did you say that it’s uncertain how the consumer is going to behave? Or did you say it’s uncertain how your competition’s going to behave?

Humberto P. Alfonso

Clearly, it’s uncertain how the consumer’s going to behave and realistically, we’ve set promoted price points, we agreed to them a long time ago, out through Easter. When we get out beyond that, we know what our business plan is and what our business model is and we’re going to execute against that. And again, it remains to be seen what happens in the marketplace. In this environment, April and May are an awful long time away.

Rob Moskow - Credit Suisse First Boston

Thank you both.

Operator

Your next question come from the line of Terry Bivens, from JP Morgan.

Terry Bivens - J.P. Morgan Securities

Good morning, everyone. I don’t want to get into dueling data here, but I have to say our Nielson numbers when you include the Wal-Mart panel data, which is usually pretty accurate. We’re looking at sales growth of about a half a percent for the period that equates to your fourth quarter, which is a long way from 5%. And I know there’s - it doesn’t include C-stores, but C-stores is not that huge in element. So I guess my question is, what am I missing there? What would you think accounts for the difference?

Humberto P. Alfonso

Terry, I honestly couldn’t tell you. You’re using Wal-Mart panel data, when I do (inaudible) CW, I’m using actual Wal-Mart retail Inc data. We have consumer takeaway in convenience stores at plus 9%. This is the data set we’ve used for the last however many years, so there’s no surprise here for us in terms of what we’re looking at.

I think we’re saying five-two for Hershey, obviously we gained share, so the category growth rate is a bit lower than that. But we always talk FDMXC, we don’t do FDMXCW, we only get our data, we don’t get the competitive data at Wal-Mart, so I can’t give you a category at Wal-Mart, I can only give you our data.

So, we can talk a little bit internally here, if there’s a discrepancy, but you might want to call Mark and just kind of work through some of the sub-components, but this is the dataset we’ve always used and as I said, it pretty much matches our shipments and internally is what we’re seeing.

Terry Bivens - J.P. Morgan Securities

Alright, well I’ll try to resolve that offline. I guess the other thing I wanted to ask you about is, if you look at the way Bliss has behaved, there’s some evidence out there to suggest the velocities maybe aren’t quite what you’d hope for, despite some pretty strong spending behind them.

And I’m just wondering, have over the last couple of quarters, have you kind of shifted strategy in the sense that maybe there’s going to be less emphasis on innovation like Bliss and Starbucks, and maybe kind of going back to much more support behind the core brands? Has that been a change?

Humberto P. Alfonso

I don’t think it’s a shift in strategy, I will tell you that with respect to innovation, in today’s marketplace, selling something that is pretty much proven into customers and then having consumers spend against it, it seems to be the right formula.

Bliss is a good example of how we’re thinking about innovation. Very thoughtful, a product that delivers to consumers, a targeted incrementally versus what we would have done in the past, and then certainly supported well.

As we’ve done internally, we’ve certainly have set a higher bar for ourselves with respect to innovation. What we’ve put into the marketplace, we wanted to be certainly more certain that’s incremental, and that we support it appropriately and that it delivers, with respect to our consumer segmentation work that we did last year, that it delivers either to a new set of consumers or a new benefit.

And so, as we come to market with innovation, we’re going to make sure that it’s bigger and certainly more incremental, so we are holding ourselves to a higher standard, and what we found, frankly is the responsiveness of the core brand is so good to what we’ve done so far, that in this marketplace it seems to be the right thing.

So, I’m not sure I would call it an overt shift in strategy, but it is as we look at the way we’ve done innovation and are filling our pipeline a little differently, we’ve decided to go at the core a little harder and it’s so far paid out.

Terry Bivens - J.P. Morgan Securities

Okay, thanks very much.

Operator

Your next question comes from the line of Vigil Leech, with TIAA-CREF.

Virgil Leech - TIAA-CREF

Maybe you said this but I missed it, when you look at your 2 to 3% sales growth forecast for this year, how does that break down between currency pricing and volume

David J. West

We didn’t say it, we talked a little bit about the two to the three and then that we would grow - we would certainly see growth in our international businesses on a local currency basis.

Virgil Leech - TIAA-CREF

Wait a minute, just give me the specific numbers, please. It’s not a complicated question, you guys have danced around it quite a bit.

Humberto P. Alfonso

We’re not going to give the - we’re going - as I said, we expect to see somewhere approximating a couple of points to drag on foreign exchange and with respect to underlying volume in pricing, we haven’t given that. As we continue to watch where the consumer’s going with respect to the price increase.

Virgil Leech - TIAA-CREF

Well, how can you give out such a specific sales forecast if you don’t know the components?

Humberto P. Alfonso

We know the components of we’re anticipating, but as we’re modeling through the pricing and the price elasticity, frankly that’s something that I’d rather not share that broadly, for competitive reasons, we have our own model. And if I start to share those models, I think that that might put me at a disadvantage of how we think about the category.

Virgil Leech - TIAA-CREF

But you are assuming volume will be down this year?

Humberto P. Alfonso

Yes, because if you look at the list price increase, that would imply volume is down.

Virgil Leech - TIAA-CREF

Okay, thank you.

Operator

Your next question comes from the line of Ed Roche, with Salile Securities.

Ed Roche - Salile Securities

I had a question on the fourth quarter costs. So I think the last time you mentioned the cost inflation number for ’08, it was $110 million, that was after the third quarter. So that would have implied a pretty big number in the fourth quarter like $48 million increase and it came in around $18 million.

Now, that’s if I follow your numbers correctly here, but did you really see that much favorability during the quarter?

Humberto P. Alfonso

Actually, I’m not following your particular calculation you’re suggesting that about half of the inflation came in Q4. That doesn’t line up with what we’re experiencing. The other part of your statement fully agree with in terms of the savings coming from the transformation program, we’ve been pretty consistent all year, last year, that there would be a much heavier component of that savings in Q4. Just the way the phasing of the plan closings and the much lower fixed costs that we experienced in Q4.

So, $100 million or so is correct, but perhaps you can call Mark and chat offline.

David J. West

Yeah, I can go through the quarters for the year-end with you after the call and we can marry that up.

Ed Roche - Salile Securities

Okay. Alright thanks. And then one follow up here. I was just noticing those trends where your numbers - your takeaway numbers excluding Wal-Mart - well, I should say it this way, the ones including Wal-Mart have been outperforming the ones that exclude Wal-Mart pretty consistently and year-to-date I think the average was three and half up through the first three quarters, versus two for the excluding Wal-Mart. Suggesting that you’re doing better at Wal-Mart.

And then, in the fourth quarter, they’re right on top of each other at a 5.2% increase for both data sets. Is there anything that we should read from that? Is there any kind of change in trend that that would signal?

Humberto P. Alfonso

No, I think what we did talk about was the acceleration in convenience stores clearly. And then the reality of it is in food stores, we had a particularly good seasonal period. So we picked up in retail coverage both in convenience and food, and we started to see better results there.

Ed Roche - Salile Securities

Okay, terrific. Thank you.

Operator

Your next question comes from the line of Andrew Lazar, with Baclay’s Capital.

Andrew Lazar - Barclay's Capital

Good morning. Just a quick one. In the fourth quarter, for your everyday business, you know that saw more of a full brunt of that 10% of price increase in the quarter, is there any way to get a sense of kind of how the volume on that everyday business, forgetting about the seasonal piece sort of behaved in relation to more of the full pricing?

David J. West

Yeah, I think I made two comments and I’ll come back to them and amplify them a little bit. Within convenience stores, as I mentioned, we saw very good takeaway growth for us and the category up, and that ended in dollars. As I said, we saw the kind of the anticipated unit fall off and the dollar response that we would have expected. Within the everyday business, I talked a little bit about better trade promotion efficiency in the quarter. We did see more of the everyday business moving off the base versus the incremental than we thought we would. And so, it was a minor and small to read, but as I said we were pleased with trade promotion efficiency in the quarter.

Andrew Lazar - Barclay's Capital

Alright, at least from an early perspective on the everyday piece, it wasn’t like volume all of a sudden, really started to sort of fall of a cliff, if you will. It seemed it was within the expectations or better than at least early days you’ve set out for yourself.

David J. West

Yeah, I think that’s a fair characterization.

Andrew Lazar - Barclay's Capital

Okay. And then just last one. Bert, in terms of - you’ve laid out the incremental productivity saves you’re expecting from the restructuring, how do I think about what you considered and you mentioned this earlier in your comments, kind of how to think about the incremental saves that come from your ongoing productivity plans?

Humberto P. Alfonso

Yeah, that’s a good point. We do have a pretty active, ongoing productivity program. A lot of it is related to supply chain, but it also focuses on G&A areas. And there’ll be a little bit more of that in the back three quarters, but I would say that that’s more even, certainly than the specific supply chain transformation savings.

Andrew Lazar - Barclay's Capital

And is there a rule of thumb around how to quantify that? Some companies say hey it’s 2% of cost-to-goods incremental each year or -?

Humberto P. Alfonso

I think the way we try to think about it is we certainly try to look at what the inflationary trends are, across the business and in our objectives to try to cover all or as much of that as possible.

Andrew Lazar - Barclay's Capital

Between the two? Between the ongoing, obviously, and the inflation?

Humberto P. Alfonso

Yes.

Andrew Lazar - Barclay's Capital

Okay, thanks a lot.

Operator

Your next question comes from the line of Kevin Dreyer, with Dobell and Company.

Kevin Dreyer - Dobell and Company

Hi, good morning. Curious, since the closing of the Wrigley-Mars deal, have you seen any change in the marketplace, whether in pricing or your ability to get shelf space? And are you at any sort of a competitive disadvantage due to your lack of scale and gum?

David J. West

To be clear, we have had lack of scale in gum before Mars and Wrigley came together, so I’m not sure that’s that changed any. To this point, obviously that’s a big integration and there in the early days at APCO, we haven’t seen a whole lot of changes in the marketplace, clearly it’s something we take very seriously.

I mentioned in the fourth quarter, us starting to spend - and I think Bert mentioned it against some category work and customer and consumer work that we think that we need to be fairly aggressive on in terms of making sure that we continue to maintain the thought leadership with our customers.

We are the category captain, pretty much most places; we have proprietary models. We still lead in the seasonal business, we still lead in the isle and we’ll continue to want to be the thought leader in the category, and we’re going to do what we think we have to do to preserve that. But beyond that, I would say in early days of - but while we’re extremely diligent, we haven’t seen a lot of changes yet.

Kevin Dreyer - Dobell and Company

Right, and just if the industry continues to consolidate further, it’s that something you’re looking to participate in?

David J. West

Not going to comment on M&A or industry consolidation or any of those kind of rumor speculation, that’s just not what we engage in.

Kevin Dreyer - Dobell and Company

Okay, thank you.

Operator

Your next question comes from the line of Vincent Andrews, with Morgan Stanley.

Vincent Andrews - Morgan Stanley

Thanks. We wanted to just kind of get some detail on the pension expense calculation. We had given it a shot ourselves and came up with a much lower number. So if you have any kind of data points that you could give on that, otherwise you probably want to take it offline with Mark as well, given the lateness of the hour.

Humberto P. Alfonso

No, to be honest I think it’s a pretty straightforward accounting calculation in terms of the pension obligations. The big changes in the year, I think I mentioned them, certainly our pensions assets declined. Sort of inline with where the market declines, where in fact I think we did slightly better.

But it’s nonetheless a large decline. And taken into account that that asset base that we start the year with and the new curve for pension obligation payment discounts, we do the calculation. Obviously it has a big implication how funded the plans are.

In terms of whether there is or isn’t a cash requirement, but the calculation is pretty straightforward, depending on how the assets perform and what that discount rate changes.

David J. West

Yeah, if you track back last year’s - it’s pretty explicit in the footnotes in the 10K. And if you track back from the asset values from last year and make an assumption about what market loss was and then amortize that loss through the B&L you can kind of get to the answer fairly quickly. And the discount rates change as well. So we actually obviously, we’re pretty clear about how we disclose that as required in the 10K.

Vincent Andrews - Morgan Stanley

But I think we did all this, so maybe I’ll just follow up with Mark to see what we did wrong. Unless - you just said you changed your discount rate? Can you tell me what -?

David J. West

Well, the discount rate does change and that’s really just the market rate changes. We used the Citibank pension discount rate, it’s pretty widely used. And the only implication for that is with your amortization period is, and that has a lot to with your population. So we’ll send you back to Mark for details if you need them.

Vincent Andrews - Morgan Stanley

Okay, great. Thanks so much.

Operator

Your next question comes from the line of Eric Katzman, with Deutsche Bank.

Eric Katzman - Deutsche Bank Securities

Taking the follow up, Dave I guess you were very respected when you were the CFO and you were kind of proving yourself as the CEO. But going back to your CFO days, it looks like you’re going to be generating a fair amount of cash, I assume that your cost of capital as you calculate it is probably relatively low.

So, when you do like a DCF model, I guess I’m not really sure what it would imply, but you’re not repurchasing stock, even though you have a fair amount of cash coming in. But your multiple on consensus earnings is 50% above the group, so kind of how should we think about your cost-to-capital and what is the right use of the cash that you’re going to be generating?

David J. West

See clearly, this is a board level topic and we discussed it pretty much continuously at the board. We’re in unchartered financial waters, and right now, Eric as I said earlier on the call, I think it’s really important for us to maintain access to capital in the markets. And the rating that we have today is important to us and it gets us A1P1 access to paper, and at reasonably good rates.

And we think that that’s an important thing. We’ve also had a fairly significant outflow with respect to the global supply chain transformation over the last couple of years here and we’re winding that down.

So, I think this is kind of unprecedented times, so we have made the choice to be fairly conservative right now with our cash and make sure that we keep that credit rating where it is and keep liquidity first and foremost. And hopefully the markets will ease out here in 2009 and we’ll continue to then have that conversation at the board level about does it return to shareholders, is it dividend, clearly is it in both on M&A.

All of those things are things that we are constantly looking at. But in today’s market, I think keeping the liquidity and the rating is pretty important.

Eric Katzman - Deutsche Bank Securities

Well thanks for taking the follow up, but so I guess if the credit markets remain semi-frozen, we should just basically assume kind of a cash build on the books? Beyond obviously the need to fund a dividend.

David J. West

I think as I said, that we’re very conscious of the liquidity need of the business and hopefully we see a thawing here sooner rather than later. But so for the short-term I would say it’s important for us to keep the rating and leave it at that.

Eric Katzman - Deutsche Bank Securities

Okay, thanks.

Operator

Your next question comes from the line of Thomas Russo, with Gartner Russo Gartner.

Thomas Russo - Gartner Russo Gartner

Hi. I have a question on the plant closures on the west coast. I recall the numbers you mentioned, may have been $75 million of cost to do so and $5 million of savings from this effort. Are those first of all, the right numbers and secondly what kind of return on investment for those charges does that represent?

David J. West

No, let me just clarify. The cost I mentioned was $25 million versus the 75. And you’re correct on the $5 million of annual savings.

Thomas Russo - Gartner Russo Gartner

Excellent. And then within the experience from the pension performance over the past year; have you done anything to reposition the pension fund or to reallocate or change the balance of assets?

Humberto P. Alfonso

The pension plan assets are managed within our pension committee internally. We have some advice from different advisors. We’re pretty happy with the allocation that we have and obviously as the numbers change, we are conscious of reallocating the assets back to the percentages that we want against the different investment classes.

Thomas Russo - Gartner Russo Gartner

Thank you. And this is the last question; on the commercial paper side, you mentioned that today the markets are treating you reasonably well. I’m just curious over the past six months, how extreme did your exposures get? What sort of pricing did you experience at some point? And what was the maximum stress of that?

Humberto P. Alfonso

Yeah, we’re not going to comment on specific costs of commercial paper. The only thing I would say is that we have reduced the level of commercial paper and we did that last year as we floated a long-term bond offering last January or February.

So we have reduced our exposure there, we’ve not had difficulty placing the paper, so knock on wood there. Suffice to say that the reduction in commercial paper was some of the way that we tried to manage just the difficulty of placing that paper. But we’ve not had any issues and our rating is helping us do that.

Thomas Russo - Gartner Russo Gartner

Thank you very much.

Operator

At this time, there are no further questions.

David J. West

Okay well, thank you for joining us today on the conference call. And Mark and Bert and myself will be available for any follow up questions that you may have. Thanks again.

Operator

This concludes today’s Hershey’s Company fourth quarter 2008 results conference call.

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Source: The Hershey Company Q4 2008 Earnings Call Transcript
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