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Executives

Mark K. Pogharian - Director of Investor Relations

John P. Bilbrey - Chief Executive Officer and President

Humberto P. Alfonso - Chief Financial Officer, Chief Administrative Officer and Executive Vice President

Analysts

Jason English - Goldman Sachs Group Inc., Research Division

Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division

Eric R. Katzman - Deutsche Bank AG, Research Division

Robert Moskow - Crédit Suisse AG, Research Division

David Driscoll - Citigroup Inc, Research Division

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

Kenneth B. Zaslow - BMO Capital Markets U.S.

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

Thilo Wrede - Jefferies & Company, Inc., Research Division

David Palmer - UBS Investment Bank, Research Division

Andrew Lazar - Barclays Capital, Research Division

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Robert Dickerson - Consumer Edge Research, LLC

Hershey (HSY) Q4 2011 Earnings Call February 1, 2012 8:30 AM ET

Operator

Good morning. My name is Laura, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hershey Fourth Quarter 2011 Results Conference Call. [Operator Instructions] Mark Pogharian, Head of Investor Relations, you may begin your conference.

Mark K. Pogharian

Thank you, Laura. Good morning, ladies and gentlemen. Welcome to the Hershey Company's Fourth Quarter 2011 Conference Call. J.P. Bilbrey, President and CEO; Bert Alfonso, Executive Vice President, CFO and Chief Administrative Officer; 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 statements because of factors such as those listed in this morning's press release and in our 10-K for 2010 filed with the SEC.

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

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

We will discuss fourth quarter results excluding net pretax charges of $27.7 million, which are primarily related to Project Next Century. Our discussion of 2011 full-year results exclude net pretax charges of $32.1 million primarily associated with Project Next Century and a gain on sale of non-core trademark licensing rights recorded in the third quarter. Our discussion of any future projections will also exclude the impact of these net charges and non-service-related pension expenses.

With that out of the way, let me turn the call over to J.P.

John P. Bilbrey

Thanks, Mark. I'm pleased with Hershey's fourth quarter and full-year financial and marketplace results, which represent a solid end to another good year. We accomplished our 2011 objectives while growing adjusted EPS 10.6%, our third consecutive year of a double-digit percentage increase. We achieved this in what was again a very challenging environment that included global economic uncertainty and difficult consumer conditions, commodities spot market price increases and volatility and the implementation and execution of a major price increase. The implementation of our March 30 price increase continues. We're analyzing conversion closely. And on the portion of the business where the shelf price reflects the increase were tracking as expected.

The speed of conversion varies by channel and is consistent with what we've experienced historically and versus our modeling. Net volume elasticity on these pack types is in line with our expectations and better than the historical staples group average.

As we look to Easter, the first season where price points will be higher, as expected, retailers are working collaboratively with our headquarter and in-store sales associates. The seasons, Easter, Halloween and holiday are important to Hershey, as well as retailers, as it brings consumers into the store.

We believe we have the right mix of seasonal-specific advertising, coupons and programming lined up to help consumers adjust to the new price points. As had been the case all year in channels measured by syndicated data, the CMG category, that's candy, mint and gum, outpaced the historical 3% to 4% category growth rate, increasing 4.5%. CMG also outpaced other snack alternatives in 2011 again such as salty snacks, cookies and crackers, which all grew less than 3%. Overall, confectionery continues to grow, driven by a balance of pricing and investment in the category in the form of both innovation and advertising. As a result, in 2012, we would expect CMG category growth will be above the historical annual growth rate of 3% to 4%.

For the full-year 2011, net sales increased 7.2% and was balanced between volume and net price realization. In the fourth quarter, net sales were primarily driven by pricing. We're especially pleased that the volume sequentially improved from last quarter, slightly greater than our expectations and increased about 0.4 points.

In terms of Hershey's marketplace performance, for the 12 and 52 weeks ending December 31, 2011, per our custom database in channels that account for over 80% of our retail business, total Hershey's CMG retail consumer takeaway was up a solid 6.5% and 7.8%. As a reminder, these channels include food, drug, mass, including Wal-Mart and convenience stores.

Within food, drug, mass and convenience or FDMxC, here, excluding Wal-Mart, the CMG category also continues to grow. For the 12 and 52 weeks ending December 31, 2011, the CMG category increased 4.4% and 4.5%. Hershey's FDMxC retail takeaway for the fourth quarter and full year was 6% and 7.5%, respectively. As a result, our market share increased by 0.4 points in the fourth quarter and 0.8 points for the full-year 2011.

For the overall Halloween and holiday seasons, as expected in Q4, FDMx total combined seasonal category retail sales were up. Specifically, Q4 seasonal category sales increased 4.2%. Hershey Q4 seasonal retail takeaway was up 5.8%, resulting in a 0.5-point market share gain. For the full-year 2011, in the food class-of-trade, the CMG category grew 3.2%. Hershey retail takeaway for the year was up 4%, generating a share gain in this channel of 0.2 points. Fourth quarter food class-of-trade CMG category growth was 2.5%, less than the category's historical growth rate. This was primarily due to continued weakness in the gum category, which was down 5.1% in this channel. Hershey food channel CMG retail takeaway in the fourth quarter was up 3.1%, driven by solid non-chocolate candies.

Turning now to the C-store class-of-trade, where Hershey continues to leverage its customer relationships and the only coast-to-coast in-store sales force in the category. In Q4, Hershey C-store takeaway was up again and has increased for 15 consecutive quarters. Specifically, for the 12 and 52 weeks ended December 31, Hershey retail takeaway was up 11.9% and 11.1%, respectively, resulting in a market gain of 1 full point in the quarter and 1.4 points for the full year. Similar to last quarter, these gains were driven by price realization, net volume gains due to king size growth and strong in-store merchandising.

In Q4, Hershey C-store chocolate and non-chocolate takeaway was up 12% and 15.5%, respectively. These gains were driven by pricing, core brand advertising, in-store merchandising and programming, including the Reese's NCAA Football Perfect Seat and the Ice Breakers Frost New Year's Eve in Las Vegas promotions.

In the drug class-of-trade, Hershey CMG retail takeaway was up 3.4% for the quarter, resulting in a share gain of 0.2 points. Similar to last quarter, our drug channel retail takeaway increased in every segment. Our non-chocolate candy, mint and gum performance was especially strong. The Ice Breakers mint platform, particularly Ice Breakers Frost products, continues to do well and helped drive a mint share gain within the drug class-of-trade of 2.3 points. Ice Breaker ice cubes bottle packs also had another good quarter in drugstores. As a result, we gained gum market share in the drug channel in the fourth quarter and for the full year.

As we look to 2012, we have many exciting products, promotions, programs and merchandising in place across all channels, including various NCAA basketball and football promotions, a Reese's and Coca-Cola promotion, sponsorship of the upcoming Avengers and Spiderman movies and the launch of many new products to include Hershey's Milk Chocolate with Almond Pieces, Jolly Rancher Crunch 'N Chew, Rolo Minis, Ice Breakers Duo mints in both strawberry and raspberry flavors and Hershey's Bliss produced with cocoa that is certified by the Rainforest Alliance.

Additionally, full-year advertising expense for the total company will increase low double digits on a percentage basis versus last year, supporting these new product launches and core brands in both the U.S. and our international markets and new advertising campaigns on Jolly Rancher and the Rolo brands.

I'm also excited about our acquisition of Brookside Foods. This was an opportunistic bolt-on that allows us to expand our portfolio and capabilities into the subsegment of chocolate-covered fruit juice pieces. Specifically, Brookside pairs dark chocolate with exotic fruit juice centers, such as goji, acai, blueberry and pomegranate that deliver the benefits of flavanols and antioxidants. Brookside has increased sales at a compound annual growth rate over the last 3 years of about 20%. As a result, they're approaching the limits of our manufacturing capability. Therefore, in 2012, we'll be adding additional manufacturing capabilities that we're targeting to have up and running by the end of the year. We look forward to building the Brookside brand in the U.S. and Canada and leveraging Hershey's scale at retail.

As we entered 2012, we remain focused on our core U.S. business where we continue to bring news, variety and excitement to the category. Our U.S. new product launches will be supported with in-store promos and merchandising, as well as advertising, which will increase meaningfully year-over-year. Our solid position in the U.S. marketplace continues to give us the flexibility to invest in key international markets where we're gaining momentum. In 2011, outside of the U.S. and Canada, we invested in our go-to-market capabilities and increased advertising 20% to 25% on a percentage basis versus last year. We expect international advertising to increase about the same amount in 2012. Our businesses in the focus markets of Mexico, China, Brazil and India had a good 2011. Combined, reported sales growth in these countries was about 25% in 2011.

As we enter 2012, we have a solid plan that will enable us to maintain our momentum in China. And in China, we'll increase the launch select sugar confectionery products that will leverage our in-market capabilities, and we expect our R&D facility to be operational in Q4. In Mexico, we'll continue our approach of gaining further distribution within the traditional trade. And in Brazil, we'll benefit from expansion with our partner, Bauducco. Therefore, if our business outside the U.S. and Canada continues to grow at the current organic rates, we'll achieve our target of $1 billion in sales by the year-end 2014. This would be about a year earlier than our original 2015 objective.

We have a solid balance sheet that enables us to pursue potential acquisition targets while also investing in organic opportunities. We remain focused on all of our markets, and we'll continue to make the necessary investments to ensure that we're positioned to grow our brands and manage challenges. The power of our brands and our ability to execute in the marketplace gives us confidence that the Hershey Company will be able to deliver achievable, predictable and consistent earnings and cash flow growth. As such, I'm happy to announce that we increased our dividend 10%. As we look to the future, our financial position allows us to be flexible in our approach to creating value for all of our Hershey shareholders.

Now to wrap up. I'm pleased with the way the confectionery category, our retail partners and Hershey continue to perform. In 2012, new products, advertising and in-store merchandising and programming put us in a position to deliver another strong year of net sales and earnings growth. Therefore, excluding the Brookside acquisition, we expect volume to be up for the full-year 2012, resulting in net sales growth of about 5% to 7%. We have good visibility into our full-year cost structure. And despite higher input costs in 2012, we expect adjusted gross margin to increase about 75 basis points driven by productivity and cost savings, as well as net price realization. Therefore, we've increased our full-year adjusted earnings per share diluted outlook, and including the change in the reporting of pension costs, we expect adjusted EPS to increase 9% to 11%.

I'll now turn it over to Bert, who will provide some additional financial detail.

Humberto P. Alfonso

Thank you, J.P., and good morning, everyone. Net sales and adjusted earnings per share diluted from operations for the full-year 2011 exceeded the initial ranges we communicated at the beginning of last year. Solid efforts by sales, marketing, operations and finance resulted in a good retail execution and another year of market share gains. Overall, we're pleased with our financial results and U.S. marketplace performance, as well as the progress we've made in key international markets.

Fourth quarter consolidated net sales of $1.57 billion increased 5.7% versus the prior year. As expected, the increase was driven primarily by net price realization benefit of 5.9%. In addition, volume sequentially improved 0.4 points from last quarter, slightly greater than our expectations. New product introductions in the U.S. and international markets, along with seasonal volume gains, were partially offset by core volume declines in line with our price elasticity models. The impact of unfavorable foreign currency exchange rates in the quarter was about 0.6 points.

Fourth quarter adjusted earnings per share diluted of $0.70 increased 15%, primarily due to price realization, supply chain productivity and lower advertising, which more than offset the impact of higher input costs and additional marketing-related investments.

For the full year, net sales increased 7.2% or 6.9% on a constant currency basis. And we're balanced between volume and net price realization, leading to adjusted earnings per share of $2.82, an increase of 10.6% versus last year.

J.P. already provided details related to our marketplace performance. So I will focus on a review of P&L and balance sheet, starting with gross margin. During the fourth quarter, adjusted gross margin was 41.7%. While we achieved our productivity and cost savings goals in the quarter, adjusted gross margin decreased 50 basis points, as productivity and net price realization were more than offset by higher input and supply chain costs. This is a greater decline than previously expected.

Specifically, greater-than-expected fourth quarter volume requirements resulted in higher commodity costs than we had forecasted. For the fourth quarter and full year, total input costs were unfavorable, about $45 million and $150 million. In addition, the impacts from year-end LIFO inventory and higher discounts and allowances were greater than our previous estimates. The higher discounts and allowances primarily reflected a packaging change in our full chocolate packaged candy presentation as we swapped out harvesting, packaging and substituted with additional Halloween-focused packaging, which did not resonate as well with consumers.

For the full-year 2011, adjusted gross margin was 42.4% versus 42.8% in 2010, a decline of 40 basis points. Higher net price realization and productivity gains were more than offset by higher input costs. Fourth quarter adjusted EBIT increased 8.9%, resulting in an adjusted EBIT margin of 16.4%, a 50-basis-point improvement versus last year as lower advertising expense more than offset go-to-market and other employee-related costs.

In Q4, advertising declined 13% versus last year. However, our on-air presence was strong as the fourth quarter of 2010 included a significant step-up investment. The decline was slightly greater than our earlier estimate as we shifted spending to invest in global selling capabilities and our Insights Driven Performance initiative. As a result, advertising expense for the full year increased about 6%.

Adjusted EBIT for the year increased 8.3%, with adjusted EBIT margin up 20 basis points to 17.9% from 17.7%. The increase was driven by solid net sales growth, partially offset by higher input and supply chain costs and investments in SM&A.

Now let me provide a brief update on our international business. Our international markets outside of the U.S. and Canada generated more meaningful sales growth during the quarter. Excluding Canada, international fourth quarter reported net sales increased double digits on a percentage basis versus last year, driven by our focus markets, Mexico, China, Brazil and India. On a constant currency basis, partially driven by seasonality in gifting, fourth quarter net sales in Brazil increased more than 40%, about 30% in China and 15% in Mexico. For the full-year 2011, net sales in our businesses outside of the U.S. and Canada increased close to 25%. Our commitment to investing in these markets continues to drive solid top line growth, enabling our brands to gain momentum and greater recognition among consumers.

Fourth quarter interest expense decreased, coming in at $21.3 million versus $27.6 million in the prior period, reflecting the bond tender offer costs in the fourth quarter of 2010. For the year, interest expense was in line with expectations, totaling $92.2 million versus $96.4 million a year ago. In 2012, we expect higher interest expense of approximately $95 million to $105 million, primarily due to higher interest rates in some of our international businesses and increases in the company's finance lease obligations.

The adjusted tax rate for the fourth quarter was 32.2%, down 40 basis points versus year ago due to an increase in domestic production, as well as a mix of income among our various U.S. and international businesses. For the full year, the tax rate was 34.8%, down 40 basis points versus a year ago and within the range of our previous estimate.

In 2012, we expect the tax rate to be about the same as the 2011 annual rate. However, the rate will be about 36% in Q1 and 2 and about 34% in Q3 and Q4. In the fourth quarter of 2011, weighted average shares outstanding on a diluted basis were 229.1 million versus 230.8 million shares in 2010, leading to adjusted EPS of $0.70 per share diluted from operations, an increase of 14.8% versus year ago. For the year, shares outstanding were 229.9 million versus approximately 230.3 million shares in 2010. Adjusted EPS diluted for the year was $2.82, an increase of 10.6%.

Before moving on to the balance sheet and cash flow, I'd like to share some details regarding a change in our pension cost disclosures in 2012. Similar to a number of other S&P 500 companies, we're going to exclude non-service-related pension expenses in our defined benefit pension plans from adjusted earnings. These non-service-related expenses include the amortization of actuarial gains and losses and interest on participants' balances, which are offset by expected earnings on pension assets. Such expenses can vary significantly from year-to-year based on actuarial assumptions, asset performance and interest rates. We believe that excluding these costs and including only service-related costs better reflects the ongoing operating costs to our business, given the well-funded status of our plans that have been closed to new entrants since 2008. As a result, we'll exclude them from adjusted earnings beginning in 2012. On this basis, 2011 and 2010 full-year adjusted earnings per share would have been $0.01 and $0.02 higher, respectively.

In 2011, the actual return on pension plan assets was below our assumptions, and interest rates declined, resulting in higher non-service-related pension expenses in 2012. Therefore, our reported outlook reflects non-service-related pension expenses of $19 million or $0.05 per share diluted. This amount is excluded from our 2012 adjusted earnings outlook. For your modeling purposes, details reflecting this change from 2006 to 2011 are available on the company's website within the Investor Relations section.

Let me also note that going forward, the company will exclude the impact of M&A-related deal costs from its adjusted earnings per share diluted. We believe excluding these will provide investors a better understanding of the underlying profitability of the business. Therefore, our reported outlook of $2.79 to $2.89 per share diluted for 2012 includes nonrecurring acquisition, closing and integration costs related to the Brookside acquisition of $0.04 to $0.05 per share diluted.

Now turning to the balance sheet and the cash flow. At the end of the year, net trading capital increased $115 million versus last year due to an increase in inventory of $115 million, resulting primarily from Project Next Century production transition. Accounts receivable was up $9 million and remains very current. Accounts payable also increased about $9 million. In terms of other specific cash flow items, total company capital expenditures, including software, were $82 million in Q4 and $348 million for the full year. These include Project Next Century capital expenditures of $24 million in Q4 and $179 million for the full year. In 2012, we expect ongoing CapEx to be $215 million to $225 million, excluding Project Next Century capital additions that are expected to be an additional $65 million to $70 million. Therefore, the total CapEx estimate for the company is $280 million to $295 million in 2012.

Depreciation and amortization was $58 million in the fourth quarter. This includes accelerated depreciation related to Product Next Century of approximately $12 million. Adjusted operating depreciation and amortization was $47 million in the fourth quarter. For the full-year 2011, depreciation and amortization expense was $216 million, of which accelerated depreciation and amortization was $33 million. Therefore, adjusted operating depreciation and amortization was $183 million. In 2012, we are forecasting total adjusted operating depreciation and amortization of about $195 million to $205 million.

Dividends paid during the quarter were $76 million, bringing the full-year total to $304 million. During the fourth quarter, approximately $27 million of our common shares were repurchased to replace shares issued in connection with stock option exercise. We did not acquire any stock in the fourth quarter related to the $250 million outstanding repurchase program. Cash on hand at year-end was $694 million, down $191 million versus year ago due primarily to the aforementioned inventory increase, along with higher capital expenditures and stock option repurchases. As we exit 2011, we are well-positioned to manage the capital needs of the business.

Now let me update on Project Next Century program. We are pleased with the progress we're making on the West Hershey plant expansion, which remains on track. The building is essentially complete with the majority of equipment now installed. The startup of multiple production lines began during the fourth quarter and continues to roll out and implement [indiscernible] as expected throughout 2012. The forecast for total project pretax debt charges and nonrecurring project implementation costs is $150 million to $160 million. By 2014, we expect ongoing annual savings to be approximately $65 million to $80 million. These figures are essentially the same as previously communicated. Please see the note in Appendix 1 in today's press release for further details.

Let me close by providing some context on our 2012 outlook, starting with some details on the Brookside Foods acquisition. On January 19, 2012, we successfully completed the acquisition and established a project management office to facilitate the integration of the business. If you’ve tasted the Brookside products, I'm sure you'll agree they’re great-tasting snacks with a strong – and a strong addition to the Hershey's portfolio. Hershey will invest to grow the brand in the U.S. and Canada, as well as international markets. In 2012, we'll focus on integration, adding additional manufacturing capacity and market research. Therefore, in 2012, we expect Brookside to generate sales of approximately $90 million at current exchange rates and be neutral to our adjusted earnings.

As J.P. outlined, we have initiatives in place that we believe will drive net sales growth across our businesses in 2012. We have planned merchandising and programming events throughout the year and plan to work closely with retail customers and monitor brand performance, given the higher price points for seasonal products. We expect 2012 advertising to increase low double digits on a percentage basis versus the prior year, supporting new product launches in core brands in both the U.S. and in international markets. We'll also invest in new advertising campaigns for the Jolly Rancher and Rolo brands. We're confident of our plans, and excluding Brookside, expect volume to be up for the year, resulting in net sales growth of 5% to 7%, including the impact of foreign currency exchange rates. We have good visibility at this time into our full cost structure, and despite higher input costs in 2012, expect adjusted gross margin to increase about 75 basis points, driven by productivity and cost savings, as well as net price realization. Therefore, we have increased our full-year adjusted earnings per share diluted outlook and including the aforementioned change in pension cost disclosure, expect it to increase 9% to 11%.

Before we open up to Q&A, as you work your models, note that due to the timing and full implementation of the price increases, we would expect volume to decline in the first quarter and then improve to be up in the second quarter and for the full year. Despite higher seasonal pricing in Q1, based on investments and merchandising plans, we expect a good start to the year.

Thank you for your time this morning, and we will now open it up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jason English from Goldman Sachs.

Jason English - Goldman Sachs Group Inc., Research Division

Two quick questions for you. First, can you update us on the progress you're making with the Ferrero partnership?

John P. Bilbrey

Well, I think that as we talked about earlier, we're doing the distribution center agreement with them in Canada. Progress -- that project is progressing, and so I think that we're on track. There's nothing new in terms of the context of that relationship beyond that.

Jason English - Goldman Sachs Group Inc., Research Division

One of your -- there was a press report out earlier this week with one of your sales directors quoted in it, talking about having conversations for distribution expansion in Europe. Is that something that you guys are seriously exploring right now?

John P. Bilbrey

Yes. Let me add a proper context to that. So ISM was this week and one of our sales directors had talked about distributors that they were talking to really around our export business. So I think it was easy to maybe take that out of context. So in terms of our overall strategic direction, focusing on the core markets that we've talked about, nothing has changed there. So I think as you read that, it might have been misleading, and that was really nothing more than our continuing export business discussions.

Jason English - Goldman Sachs Group Inc., Research Division

One more housekeeping and then I'll pass it on. That 25% rest of the world growth, was that constant currency or with FX?

Humberto P. Alfonso

That was with FX.

Operator

Your next question comes from the line of Jonathan Feeney from Janney Capital Markets.

Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division

When you talk about the retail takeaway, the 6.5% for the fourth quarter, can you give us a sense what kind of volume is associated with that? Because I just -- I think the biggest point of contrast with your business and some of the other businesses out there right now is the volume. And I just want to know how you -- what you can tell us about that, and what you're thinking for maybe category volume trends over the course of the year.

John P. Bilbrey

Well, first of all, if you were to -- I'll start with, if you look at the FDMxCW takeaway in Q4, it was up about 6.5%. If we were to look at our net sales in the quarter, it was just slightly below that, but really, almost the same. So from the metric of what you're selling and what's being taken away, we felt pretty good. Most of that would have been price.

Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division

But volumes were up on a takeaway basis, you would say?

John P. Bilbrey

Seasonal volumes, which is an important part of the Q4 volume, were all up. But I think as we talk about the combination of price and volume and as we do price conversion, I think, Jonathan, what you'll remember is, is we said about 60% of that will occur in 2012. The balance is happening in 2011. The modeling shows that we're really on track. And we think that as we get to 2012, unit volume in 2012 will be back to flat...

Humberto P. Alfonso

'13.

John P. Bilbrey

Or '13, I'm sorry, when we get to 2013, we'll be flat again, and that's right on the modeling.

Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division

Okay. Great. And just I want to -- when you think about the risks to the category, it seems like you've got a number -- you've got a top competitor who's also been very aggressive with pricing and aggressive with spending back against the category to drive value. I mean, have you seen any uptick in sort of intrusion, if you will, from other categories like salty snacks or nuts or anything else that's adjacent to candy that -- as these prices come up?

John P. Bilbrey

I don't think so. We continue to outperform, as I mentioned in my remarks, salty snacks and cookies and so forth. So the consumer continues to participate in our category. I think it's good news for us and the retailers. So we really haven't seen anything that would be different than what we've been experiencing.

Operator

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

Eric R. Katzman - Deutsche Bank AG, Research Division

I got a follow-up, I guess, on Jonathan's question. So -- and I may have touched on this last time, but so international, which is mostly volume and is probably 8% of the total of the business today, maybe a little bit more since it's growing so much, was up 20% or more. Seasonal volume was up. So that has to mean that your non-seasonal everyday business, volumes were down pretty materially? Can you talk a little bit about that? And then as a follow-up or related to that, I heard that Mars was having some difficulty in terms of their seasonal shipments. So assuming that they correct that, wouldn't that mean that your volumes could actually struggle a bit?

Humberto P. Alfonso

Yes. What I would say, Eric, is with respect to that combination of international and U.S., and we have talked about it, we have taken a little pricing in some of the international markets. But volume certainly was up, and we saw a sequential improvement. You're quite right, seasonal volume in the U.S. was up in the quarter. And from what we're seeing, we continue to see the progression of volume recovery, as the models would indicate. While we did mention that in the first quarter, given the new pricing on the Easter season, that we would expect volume to be down in first quarter '12 and then sequentially improve. And then J.P. sort of went a little beyond that and said we think we'd be back to pre-price increased volumes around end of year first quarter. But no, we've seen improvements across volume. And to get to your second part of your question, I'm not familiar with any distribution or shipping issues, but that's not something that we've seen.

Eric R. Katzman - Deutsche Bank AG, Research Division

Okay. All right. And then on the -- just to clarify and understand a little bit more, Mark and I talked about it offline earlier. But on this pension expense, I guess McCormick reported last week, it seems like it's the same issue, but they're including it in their GAAP or their adjusted or whatever earnings outlook with the way most analysts were kind of, I guess, taking that in and putting it into their models. So I'm not exactly sure why you're trying to exclude the volatile component. And then I'm also, given how U.S.-based the company is, why would you not move away from FASB and take an IFRS accounting approach?

Humberto P. Alfonso

Yes. Actually, your latter point is a very good one. In fact, the methodology that we're following or that we've changed to is far closer to IFRS than GAAP reporting. And so what we've chosen to do, given the fact that we have a well-funded plan, and I'm speaking primarily U.S. plan, which is by far the largest if you read the K, we've not had any significant contributions to the plan because of its funded status, it's been closed to new entrants. And so the service cost, which is the cost or the liability of the members that are in the plan, and again, there are no new entrants into the plan, is quite consistent year-on-year. And we believe it's a better measure of the underlying operating performance of the company. The other measures are quite volatile. I mentioned that in '10, '11, they actually added to earnings. And then we've shown the reconciliation of the $0.05 impact. And so a number of companies have gone in the same direction with slightly different techniques. We think ours is pretty clean in terms of it's in the GAAP numbers, and we show exactly what it is coming out. But again, what we wanted to get away from the some years positive, some years negative aspect of it. And IFRS is part of our thinking. It is much closer to that -- those reporting requirements.

Eric R. Katzman - Deutsche Bank AG, Research Division

And I guess we'll just see how the rest of the industry does it.

Operator

Your next question comes from the line of Rob Moskow from Crédit Suisse.

Robert Moskow - Crédit Suisse AG, Research Division

Two questions. On the gross margin, it was pretty far below our expectation for fourth quarter. You mentioned some Halloween issues. And I think offline, I heard that there were some obsolescence issues also. Can you kind of break apart the gross margin miss? How material was the allowances you had to give to the retailers and the obsolescent charges compared to just higher commodity costs? And then secondly, can you give us some commodity cost guidance for 2012? Will the cost hit be higher than it was in '11?

Humberto P. Alfonso

Yes. Let me put it in context on the gross margin. And as I mentioned, we expected sequential improvement, so the decline was higher than our expectations as you would have heard in the third quarter. There really was a multitude of factors. I mentioned the more significant one, so there wasn't 1 significant factor that really impacted the most. We did have some higher volumes particularly in the U.S. And so we procured at closer to spot prices for that volume. So that had a commodity impact. As we chewed up our LIFO calculation at year-end, that charge also impacted our costs. And the obsolescence and Halloween issue are actually the same issue. We made some changes. In prior years, we’d had harvest packaging, which was included if you look at the syndicated data in the Halloween numbers. And frankly, what we found was that moving away from harvest and having more Halloween packaging was actually less -- resonated less with consumers. So as we changed out of that packaging, we did provide some cover for the retailers. So it really was a multitude of those items. There really wasn't one in particular that I would say was the predominant one. In terms of 2012, really, nothing has changed versus what we said in the past. We do expect higher commodity costs, but we haven't given specific guidance on the inflation factor. But at this stage, those commodity costs, we think, will be significantly mitigated by our productivity programs, which remain on track and including Next Century, as well as J.P. already mentioned about 60% of our price realization comes in 2012. The one bit of information that we have added that we haven't spoken to in the past was that we said we think we'd be up about 75 basis points on gross margin. If you think of all those factors, commodities offset by price realization and savings, and so that gives you some indication of where we think gross margins will be next year.

Robert Moskow - Crédit Suisse AG, Research Division

Okay. So Bert, you don't want to give us an absolute dollar number for commodity costs for '12?

Humberto P. Alfonso

No, we're not providing that at this stage.

Robert Moskow - Crédit Suisse AG, Research Division

Okay. And just this might be nitpicking, but if seasonal sales were actually pretty good, I think you gained share, why was there an issue related to the packaging? Why do you think that didn't resonate well? Is it possible you just over shipped and overestimated how much they would want…

John P. Bilbrey

Well, yes, first of all, we felt good about the volumes that went into Halloween. The total category was up. I mean, essentially, with a bit of humility here, we underestimated the value that the consumer had in the harvest packaging in previous years. They use it for decoration, and it actually kind of broadened the season, if you will, in terms of packs that the consumer was used to seeing. We also had fewer items in our total Halloween offering this year. We had a higher percentage of sales in the large bags, which were $20 bags, which obviously you sell fewer units when you get into those larger dollar range, et cetera. So there were a couple of things that, while the latter one was good, I think that what we would do is return to the harvest packaging in subsequent years. And I think this is one where we have some learnings. But overall, it's a very positive quarter for overall seasonal sales. And I think in Halloween, while we feel good about the total Halloween program, there are some things we're going to need to do to improve and take these learnings on board.

Operator

Your next question comes from David Driscoll of Citi Investment.

David Driscoll - Citigroup Inc, Research Division

Just to build on Eric Katzman's comment on the pensions. I would just kind of add to you guys that I appreciate the disclosure, but these non-service pension costs are -- I believe that they really are ultimately real financial impacts to the company. So while I understand your desire to want to exclude them from maybe a current period in time, it does appear that at some point in time, they probably should run through the P&L. And then I think that we come down to kind of imperfect plans on this, which is why they do run-through on a current basis. But I go to what Eric said. He mentioned McCormick, but I think you could go on a lot of companies. Just to put this on an apples-to-apples basis, it seems like the first call estimates have to continue to include these things unless we see broad agreement across the sector that all these things need to be excluded. Still, I think the strongest argument would be if these were not truly real costs that were never materialized. But I don't think you guys are actually making that argument right now. If you are, I'd love to hear it. So that's just maybe a personal statement there. And then getting into just kind of some key questions, what is your confidence that you have in, for 2012, that the pricing will hold, i.e., can you talk about the stickiness of pricing in comparison to the desire to want to be promotional?

John P. Bilbrey

Well, David, I think that the best barometer that I always look at is what's happening in convenience because it's the one where you see it first. And so if you look at the growth and the offtake in convenience, it would lead you to believe that it's fully cycled. The pricing at this point and king size continues to grow very nicely and contribute importantly. Obviously, that's at the upper end of the price range. So I think in that example, the pricing has been 100% sticky, right? So that's pretty encouraging. And then as we look at the channels, and there's a lot of noise in the timeframe by which these different channels convert just because of the different dynamics, but we're seeing that the conversion is right on or slightly better than how we've modeled it. And so for everything we know at this point, I think we feel good. And as you can imagine, we are all over this in terms of monitoring how it goes. Easter will be the first season where we're at the new pricing. And so far, what we're seeing is, we've got really solid programming, and volume looks very good. And so all indications are in terms of all of those things you would be executing against as we go through the year. We feel good.

David Driscoll - Citigroup Inc, Research Division

When you talk about advertising, last year, at this time, you made the comments that advertising would run at a much more normalized rate of increase. But now, in your 2012 guidance, you're talking about double-digit increases. So can you discuss this a little bit? I thought kind of last year, you proved that the advertising budget was really in the right place, but now you're really kind of going a different direction and it's going to be a very big increase in 2012.

John P. Bilbrey

Well, actually, let's think about it in 2 parts. So if you look at the core brands in the advertising levels that we have planned, they would look very similar to where we're at this year. In the U.S., we're adding Jolly Rancher advertising, we're adding Rolo advertising. And so we're actually extending advertising further across the portfolio versus increasing it necessarily on existing brands. So on brands like Reese's and Hershey's, we believe we're sustaining investment levels. And so the marginal benefit of that extra dollars spend would be less on those kinds of brands. So we're really extending across the portfolio. And then importantly, in our international businesses, we continue to be investing there to build brands and grow penetration, and so some of that investment importantly is up against those businesses. If you look at it on a total basis, and part of it is remember where we're coming from, in 2008, '07 and '08, we were spending about 2.5% of net sales in advertising, which was significantly below any brand building levels. And then today, we ended up 2011 probably 6.8%, 6.9% of net sales in our advertising spend and we’ll be slightly above that in sort of, call it, the 7% to 7.5% range. That would be very, very normal CPG brand-oriented company spend level. So we really feel good where we're at and that we're executing against our long-term strategy.

David Driscoll - Citigroup Inc, Research Division

Very clear answer. One final question for me. Bert, Brookside, $90 million in sales. Given the low cost of funding, you say this is neutral to EPS. I'm struggling here just a little bit well on the math on this one. Are the margins on this thing really bad? Or are you guys just wanting to say that -- I mean, like I can't get to neutral unless I assume that the margins on this thing are really quite bad given the funding costs. What am I getting wrong here?

Humberto P. Alfonso

No, Dave, I wouldn't say that we're disappointed in the margins of the business. We are investing in the business in a way that will create future opportunity, particularly in the North America where it's already pretty successful and then doing research outside of that. So it really is brand investment. The business is cash flow positive. There is a certain amount of goodwill amortization that hits the P&L in the first few years as a result of the purchase, which is non-cash, as you might expect. And we're also adding some capacity to be able to expand the brand. So we're happy with the margins. Obviously, we can improve on them with some synergies in terms of our scale. But it is a sound business and one that we think is going to really pay dividends for us.

Operator

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

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

I just had a couple questions for you. The first one, I just wanted to ask about, as of last quarter, we saw some retailers pushing through pricing at a little more aggressive rate. That didn't seem so obvious this quarter given how your sales and some of the measured channel kind of lined up pretty well. Is that just because of the heavier seasonal sales in the quarter?

John P. Bilbrey

That's absolutely correct.

Humberto P. Alfonso

That's correct.

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

Okay. And then I wanted to ask about the cost savings. I know you have some Next Century savings next year. You'll have some, I assume, some ongoing productivity savings. Anything unique or can you give kind of a rough range of the cost savings coming through in 2012, particularly in relation to the gross margin being so strong?

John P. Bilbrey

Yes. The 2012 savings program from a dollar range perspective is actually pretty close to '11. So we were expecting $80 million to $90 million of savings. There's some minor differences in terms of the contributors. We always have our normal productivity within the 4 walls of the plant. Project Next Century savings actually increases from about $15 million to the $20 million to $25 million range. And then we had an active program that we've talked about the last 3 years. That was against nonmanufacturing spend, which we've captured about $100 million. And while there is savings from that program, that program is not providing as much savings as it has incrementally in the past few years. But the total program remains in that $80 million to $90 million range. And that certainly is a big contributor to the gross margin. But, again, I’d point you to the price realization based on our conversion models, where about 60% of that comes in 2012.

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

Yes, okay. And my last question is in relation to balance sheet and how we should think about it. I mean, maybe you could characterize the acquisition pipeline for the year. I would contend you could do a lot of share repurchase. So I'm just trying to understand, you've got a modest amount of share repurchase authorization available. But is there a full pipeline we should expect you to be trying to execute against, if you will?

John P. Bilbrey

When you mention pipeline, are you talking M&A?

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

Acquisitions, you got it. Yes.

John P. Bilbrey

Yes, well, we're not really going to -- we're not going to comment on specific M&A. With respect to the balance sheet, yes, we continue to be a very predictable strong cash flow performer. In 2012, we had slightly less capital but still a good amount of capital, close to $300 million as we finish up Next Century. While we didn't execute against the 250 million buyback program, we did buy back 285 million of shares in the open market against the replenishment program. And then we announced a 10% dividend increase. So we continue to have a sound balance sheet. We continue to explore opportunities for M&A, and we'll be able to finance those in appropriate manner where we find value to shareholders. So all of those are important to us, and we'll continue to focus across that range.

Operator

Your next question comes from Ken Zaslow from BMO Capital Markets.

Kenneth B. Zaslow - BMO Capital Markets U.S.

I have just 2 questions. First one, in terms of the pension costs, just to understand it, when you initially gave guidance, was that included and so it's like-for-like? Or is the increase related to the $0.05 decrease?

Humberto P. Alfonso

When we initially gave guidance, we were just really communicating within our 3 to 5, 6 to 8 long-term guidance. And so at that time, we wouldn't have given any indication around pension. We frankly hadn't finished the debate, and it's something that we talked about internally and came to what we thought was the best conclusion. Obviously, the current numbers do, and there's a reconciliation in the press release that gives you pretty good detail of what that is versus what we're currently saying, 9 to 11, which does include that adjustment on a pro forma basis.

Kenneth B. Zaslow - BMO Capital Markets U.S.

And the second question is, it seems like, obviously, your international sales growth is actually moving at a greater pace than you anticipated going forward. Can you give some sort of at least qualitative view on how you're thinking of the margin structure of each of the business? Mexico, Brazil, China, India are progressing relative to your expectations. And do you expect a quicker return on the margin or operating profit line?

John P. Bilbrey

Well, first of all, as we’ve said, our overall international businesses are profitable today. If you look at the focus markets that we have, we're in an invest mode. And so you would expect those margins to be lower, but they're certainly taken into consideration within the guidance that we're giving to you. And then the other comment I would make there is, we believe we're well-positioned for any both opportunities and challenges. At any given time, if we wanted to change our current model of investment in those markets, those markets could be profitable today. But the intent is, is that we have a commitment to grow those markets. And therefore, you would expect those key markets, which are in an invest mode, to be in a lower margin than in fact the average of the company.

Humberto P. Alfonso

Yes. And one way to think about that is depending on where you're measuring. So obviously, at a gross margin level, they're much closer to U.S. rates than operating because of that invest-growing profile.

Kenneth B. Zaslow - BMO Capital Markets U.S.

Great. And then in terms of China, specifically, there is going to be another additional sales force expansion as well there, in line with R&D. So is that a 2- to 4-year period? Is there a period of time that you actually think that you'll be established at a run rate level by 2014? Or is it going to be an investment period beyond that for China?

John P. Bilbrey

Well, Bert and I both probably will take a whack at that. On the investment in the selling capability, our business is largely along the Eastern seaboard today. We continue to move west as we think that's appropriate. And then within each of those key geographies, if you think of it as concentric circles, we increase our density there as well. So I think that we'll continue to be investing in our go-to-market capabilities in a very planful way. We don't have an idea of where we get well out over our SKUs or so far ahead of ourselves. So the great thing for our company in a country like China, and this really applies to our focus markets, is you have this dynamic market growth. But the important thing is to participate in it at attractive cost versus get out ahead of it. So it's really not about winning share at a high cost from competition as much as it is participating in the dynamic growth. And that enables you to, in a very planful way, expand the organization. So I don't think you would see us doing something that would get us out of a line with how we feel the size of the business is for us.

Humberto P. Alfonso

Yes, I wouldn't add anything to that.

Operator

Your next question comes from the line of Alexia Howard from Sanford Bernstein.

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

A couple of questions. First of all, on the revenue guidance for this year, I'm assuming that, that includes the sales from the Brookside acquisition, which I think is about 1.5%. And then given that the international business is growing so rapidly, that may be adding another couple of percentage points to the total company top line. So would I be right in thinking that the U.S. sales guidance is more in the 2% to 4% kind of range? Is that the right way to think about it?

Humberto P. Alfonso

No. Let me try to give you a few more data points. First, the 5% to 7% that we've mentioned, it would be an organic growth rate and so it would not include Brookside.

Mark K. Pogharian

Although it’ll be -- Alexia, this is Mark. That 5% to 7% does include a little FX, so it's not truly organic. But...

Humberto P. Alfonso

Right, it's not constant currency, but -- and again, and we expect a little bit of a drag versus last year, particularly in the first half from currency. But it is -- think of it more as organic in terms of x Brookside and you would add Brookside to that. J.P. mentioned that the category continues to trend above historical, which we think of as 3% to 4%, and it certainly performed above that 4%. We expect a continuation of that in the U.S. market, and we expect to be able to be competitive within that range. And so I wouldn't think of the U.S. as a 2% to 3% grower, where we're saying the category grows a bit of a 4% historically and that we are very competitive within that range.

Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division

Okay, great. And then just a follow-up on the pricing situation. Just been hearing some commentary that maybe the #3 player in the chocolate market in the U.S. is pulling back a bit on the price increases that they tried to take. Are you seeing any of that? Or at the moment, is everybody following you on your price lead?

Humberto P. Alfonso

Well, we don't think of it as following or anything like that. I would say that all of the category players have taken some pricing, but we haven't seen any of -- we haven't seen retailers shy away from those. And so we think everybody's converting at some pace, and we're pretty happy with our conversion.

Mark K. Pogharian

Yes, Alexia, this is Mark. I mean, I think if you look at the IRI/Nielsen data that you guys continually to get on a quad basis, I think it indicates that there is pricing across all manufacturers.

Operator

Your next question comes from the line of Thilo Wrede from Jefferies & Company.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Just 1 quick question for you. I understand that the CMG category has different dynamics than overall packaged foods. That being said, though, some of your packaged food peers have been talking lately about going to smaller pack sizes, going to lower opening price points, yet you talk about getting growth benefits from selling more king size packages. Help me understand why the king size works in CMG and chocolate but not in other packaged food categories?

John P. Bilbrey

Well, let me give you just a couple of things to think about. First of all, it's important to remember that we're not a food group. We're less than 2% of total caloric intake for Americans. And we're an accessible indulgence. So the category has some dynamics that are probably different than some of the other categories that we were talking about. So I think that's just a fundamental element here are the differences between us and some of the other snack-type items.

Humberto P. Alfonso

Yes. The other -- the only thing I would add is, when you mentioned what we specifically call king size is in the consumable\-pack type, you may have been thinking J.P.'s referral to larger pack sizes during some of the Halloween seasonal, which in our mind isn't what we think of as king size but larger pack size in any case.

John P. Bilbrey

And I'll just add that -- a little more specifics onto that is that the value of king size is an obvious and good value to the consumer. They can do the math easily, and then therefore, again, it's at a low price point. It's accessible. And I think, again, the reason people purchase and participate in the category may be a little bit different.

Thilo Wrede - Jefferies & Company, Inc., Research Division

So even though your regular sizes show the regular price elasticity, the price sensitivity that the overall packaged food industry is talking about does not seem to apply to these king size products then.

John P. Bilbrey

I think that's correct.

Operator

Your next question comes from the line of David Palmer from UBS.

David Palmer - UBS Investment Bank, Research Division

Just a couple questions. First, a follow-up on your answer earlier. You mentioned that seasonal mix was higher. Was there a dynamic about -- in your take home packaging where the seasonal did not have pricing but some of your other packaging, sort of the lay-down packs, did, and you saw a shift in packages, in mix that might have been a little greater than expected?

John P. Bilbrey

We wouldn't have seen a shift for that reason, but you're right that we did not take pricing on the seasons. They're still under price protection, but a lot of our everyday packaged candy would have been at higher prices, yes.

David Palmer - UBS Investment Bank, Research Division

So you don't look at that as a price elasticity thing, rather, just a function of the marketing and...

John P. Bilbrey

Yes. I think it's really season-specific. And so consumers buy for the season. They don't necessarily buy more seasonal packs because they're not priced up yet versus the every day. They're just -- they're different usage occasions. So they wouldn't stock up on seasonal to avoid the everyday pack price increase.

David Palmer - UBS Investment Bank, Research Division

And second question on your C-store trends. I'm wondering if you can give some feeling about how you -- that channel may play out in 2012. I know you're not going give exact channel guidance, but perhaps some ways to think about it. As I'm thinking about it, you have strong momentum in the second half. And exiting the year, it looks like you had some fantastic growth in that channel. But you're going to be lapping some innovation. And then I just wonder about king size. It's been such wonderful lift for many years now, at least as I perceive it. Do you see that dynamic continuing to play out on a favorable way for that channel? Any thoughts would be helpful.

John P. Bilbrey

Well, I'll make a couple of comments. First, we've experienced very good trends in C-store. And so we're going to be lapping some pretty challenging comps. So it would be nice to assume that we'll continue to have those that look the same, but my guess is some of those are going to be pretty tough comps to lap. With that said, I think the momentum in the C-store channel is going to continue. I don't see anything that suggests their business model or traffic will change. So I'm pretty optimistic about the overall dynamics of the convenience store channel. With regard to king size, again, I think because of the accessibility of our category, it’ll be far more about the category performance than it will be any individual pack size. And because these products are accessible in every measure and we continue to have about 8 points of presentation or activation in the average C-store across the country, that we feel good about our programming and I'm quite optimistic about the channel.

David Palmer - UBS Investment Bank, Research Division

Is that mostly the big cup -- big pack Reese's stuff in the king size? I mean, what is really -- what are your key king size drivers?

John P. Bilbrey

Well, there's really -- over the last several years, there's really been a couple of really key drivers, I think, between our -- behind our C-store success. First of all is we had, you may remember, we used to talk about the big 33 program. So I think what happened is, is we got far better at having a very constant range across C-stores in general, and then that enabled our advertising to work harder for us. It enabled the consumer to be able to find the things that we were talking to them about. And so our distribution was really important. We also got far, far more focused around the retail programming that we had. And if you -- sometimes when we're out having visits with you guys, we'll show you some of those programming calendars. And we execute really, really well against those. And remember, we increased our selling organization coverage and size across C-store. So we're covering those with our dedicated sales force at a higher rate than we had in the past. So I think all of those things have just really helped us activate in the category, and then we have a disproportionate representation in king size. So if you were to look at the total category, our king size participation there is greater. Therefore, as this value dynamic or as the consumer looks at the category, we have gotten a disproportionate share of that growth.

Operator

Your next question comes from the line of Andrew Lazar from Barclays Capital.

Andrew Lazar - Barclays Capital, Research Division

I'll just keep this quick. I just -- given Hershey's sort of desire to be more aggressive from an M&A perspective in emerging markets, and it would seem like perhaps you guys are a bit disappointed that maybe you haven't been able to do more in that arena so far. And if that's the case, I'm just trying to get a sense of maybe what it is that you're seeing there that's preventing you from doing it or not seeing there that you had hoped to see. Just to try and get a sense of how we can think about that going forward. Is it just that they're opportunistic and they haven't been there? Or are there some structural things maybe that you're seeing in some of the businesses that might be available that just aren't really doing it for you?

John P. Bilbrey

Well, I think, Andrew, first of all, if we were disappointed, it hasn't caused us to be desperate. So I think that again, without being overly specific, I think that we’ve said we're actively looking at a combination of bolt-ons all the way through to larger types of events. And these things take time. You certainly want to do them well. We want to be choiceful and smart as we go. So we're actively paying attention to all the opportunities that we think could be good for our company. And as we think about making those choices, we really want to make sure that they're really good choices and that they really deliver against the company's long-term objectives.

Operator

Your next question comes from the line of Bryan Spillane of Bank of America.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Just 2 quick points of clarification. First, on the pension expenses. Just want to be clear, on the piece that you're going to be excluding, are you going to be marking to market your pension assets on a quarterly basis and so that’ll be volatile? Or are you still doing the smoothing and so people can at least allocate that $0.05 as sort of a visible cost that can be just allocated each quarter?

Humberto P. Alfonso

Yes. It's really not a mark-to-market. Some of the companies have taken that approach. As I said, as companies have taken slightly different approaches to adjusting earnings, there are some that have done that. No, ours would be smoothing. And as I said, our point on that is that they're primarily noncash -- they're noncash charges. You could – in the K, where there is an impact, if this were to go in one direction for a long time, obviously, it may have some funding implications. But [indiscernible], we haven't seen that. And the fact that we have some years up and some years down is really what led us to pull that out in terms of what's the real operating cost to the business of the service costs within our pension plan. But it is a smoothing.

Mark K. Pogharian

It's Mark. Just to be clear, I mean, similar to other restructure charges and how we show the -- we take you that reconciliation from GAAP to adjusted, I mean, we will do the same with this as well.

Humberto P. Alfonso

Yes. And the lines that predominantly get impacted are the ones you would think, right; gross margin because of our factory, employment and SG&A.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Okay. And then just 1 other point. Just in terms of the seasonal business in the quarter, did the snowstorm, the bad weather on the East Coast at all affect Halloween for you or for the industry?

John P. Bilbrey

No, absolutely not.

Humberto P. Alfonso

No, we didn't see that.

Operator

Your next question comes from the line of Rob Dickerson from Consumer.

Robert Dickerson - Consumer Edge Research, LLC

Yes, just 2 quick easy questions, hopefully. So the gross margin, I know you're guiding to 75-basis-points improvement driven by increased pricing, volumes up and productivity. But I just -- I'm curious, I mean, do you think that there's obviously

[Technical Difficulty]

I'm just curious, I mean, do you think that there's actually a little bit more upside to that? Because, I mean, we've just seen cocoa now down 30% in June year-over-year, and the class 3 is expected to be down 7% to 8% for '12. So I'm just curious, you didn't really call out lower expected commodity costs. When you talk about high expected costs, are you speaking just higher absolute levels or what? So just a little clarification on that.

Humberto P. Alfonso

Yes. We think of it as more the combination or the cost basket as we call it. And while you're quite right that we've seen some declines in cocoa and a little bit on the sugar side, we typically look at it, what's the 2-year average across that commodity basket. And you'll find that, by and large, we're above those levels, cocoa being the exception at least for the moment. And still, things like peanuts and dairy, in fact, and some of the others are still quite elevated. So we've seen a little bit of tapering, and that's good for you certainly in any case. But it really is based on the basket, not any individual commodity.

Robert Dickerson - Consumer Edge Research, LLC

Okay, perfect. And then secondly, I guess this is back to Chris's question originally, just on the buyback. I mean, I know you used to buy back shares. You haven't really bought back shares now in 5 years. So I guess a more direct question is just like, what would get you to buy back your shares or buy back more shares that would be accretive to earnings?

Humberto P. Alfonso

Yes. I mean, we did buy back some shares this year. And you're right, we haven't been as active. We certainly stayed out of the market a couple of years ago when the financial structure was a bit more up in the air. This year, we completed the '06 program that was the $100 million, and we were actually pretty active deploying cash in terms of option replenishment. As you might imagine, the shares were up nicely, and so there was more option exercising. So it's one of the elements that we look at in terms of giving back to shareholders and we discuss with our Board of Directors. So we've not done as much as you pointed out and we had in the more recent past, but it's not one that we would shy away from.

Robert Dickerson - Consumer Edge Research, LLC

Okay. And then lastly, and really just to kind of sum up all the comments that you've had in Q&A. If I think about just EPS guidance that you had in Q3, more in line with long-term targets, 6% to 8%. And now, if we look at guidance now, you're guiding 9% to 11%. You just back out the $0.05, let's say, because that's probably -- everyone else was already factoring that in. You’re at 7% to 9%. So if I look at the 6% to 8% relative to the 7% to 9%, what really was, kind of in a nutshell, what was that 100-basis-points improvement to 3 months ago?

Humberto P. Alfonso

Yes, again, in the third quarter, we traditionally don't give a lot of details around the guidance. And so your observation is accurate in terms of we're looking at sales guidance, which is above the range. And so that's different than what we talked about. We gave more detail on gross margin. Last time, we said we were focused on it. This time, we're actually telling you that we're expecting to be up, close to 75 basis points. And we're investing in the business both in the U.S. and outside of that at appropriate levels. We're pleased with the financial performance that we're projecting for the year. And really, that's the additional detail that we're providing today.

Operator

[Operator Instructions]

Mark K. Pogharian

All right. Well, if that's it, operator, we thank you, we thank everyone for joining our conference call today. And myself and Matt Miller will be available for any follow-up questions that you may have. Thank you very much.

John P. Bilbrey

Thank you very much, everybody.

Operator

This concludes today's conference call. You may now disconnect.

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