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Hershey Co. (NYSE:HSY)

Q4 2007 Earnings Call

January 24, 2008 8:30 am

Executives

Mark Pogharian – VP Investor Relations

David West – CEO and President

Bert Alfonso – Sr. VP and CFO

Analysts

Jonathan Feeney – Wachovia Securities

Terry Bivens – Bear Stearns

Christen McCracken – Cleveland Research

David Driscoll – Citi Investment

Dave Powers-Edward Jones

Robert Moskow – Credit Suisse

Alexia Howard – Sanford Bernstein

Kenneth Zaslow – BMO Capital Markets

Vincent Andrews – Morgan Stanley

Eric Katzman – Deutsche Bank Securities

Andrew Lazar – Lehman Brothers

David Palmer – UBS

Pablo Zuanic – JP Morgan

Eric Serotta – Merrill Lynch

Operator

I will be your conference operator today.  At this time, I would like to welcome everyone to the Hershey Company Fourth Quarter 2007 Results Conference Call.

(Operator Instructions)

I would now like to turn the conference over to Mark Pogharian, Vice President of Investor Relations.

Mark Pogharian

Welcome to the Hershey Company’s Fourth Quarter and Full Year 2007 Conference Call.  Dave West, President and CEO; Bert 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 statements because the factors such as those lifted in this morning’s press release and in our 10-K for 2006 File with the SEC.

If you have not seen the press release, a copy is posted on our corporate web-site, www.hersheys.com in the Investor Relation section.  Included in the press release are consolidated balance sheets and the summary of consolidated statements of income prepared in accordance with GAAP as well as our performance summary of consolidated statements of income quantitative reconciled to GAAP.

As we have 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 presentation of earnings excluding certain items provide additional information to investors to facilitate the comparison of past and present operations.

We will discuss our Fourth Quarter and Full Year results excluding the net pre-tax charges associated with the Global Supply Transformation Program and Business Realignment and Impairment Charges in Brazil recorded in 2007 and the 2005 Business Initiative recorded in 2005 and 2006.  These net-free tax charges were $95.9 million in the Fourth Quarter 2007 and $5.6 million in the Fourth Quarter of 2006.  Our discussion of the year’s date results and any future projections will also exclude the impact of net charges related to these business realignment and initiative.

With that, let me turn the call over to Bert Alfonso.

Bert Alfonso

The net sales in earnings per share results for the Full Year 2007 were in line with the outlook we provided during the last conference call.  Specifically, consolidated net sales in the Fourth Quarter of $1.34 billion increased 0.4% versus the prior year.  Diluted EPS from operations of $0.54 declined at 19% primarily due to higher commodity costs, increased consumer investment spending on favorable mix and higher SG&A costs related to our international expansion.

This brings full year performance to a 0.1% increase in net sales and a 12% decline in EPS diluted from operations.  Net sales for the quarter excluding the benefit of the Godrich Hershey Business in India were down at 1.1%.  This primarily reflects a net decline in US volumes which are more than offset gains in Artisan and International businesses.

Outside the US, our businesses grew at 39% in the quarter including Godrich.  As anticipated during the Third Quarter Conference Call, shipments to key distributors were soft in the Fourth Quarter which impacted our results.

Importantly, as we exited the year, inventory levels are key distributors had declined.  This should lead the shipments and retail takeaway patterns that are more closely aligned in 2008.  For the Full Year, net sales were even with 2006 and excluding Godrich Hershey Business, sales decreased about 1%.

Turning now to Market Place Performance, Hershey’s US retail takeaway in the quarter was ahead of shipments.  Consumer takeaway for the 12 weeks ending December 30th and channels that account for over 80% of our retail business was up to 0.9%.  As a reminder, these channels include food, drug, mass, including Wal-Mart and convenient stores.

In the FDMxC classes of trade retail takeaway declined 2.1% resulting in a share loss of 1.4 points in the latest 12 weeks.  Takeaway within our core chocolate franchises, Reese’s, Hershey’s, Kisses and KitKat was negatively impacted by a lower than expected by performance on Kisses.  Excluding Kisses, retail takeaway and FDMxC increased 2.1% during the quarter driven by the launch of Reese’s Whipps, cacao reserve, holiday gift box offerings and the KitKat Coffee promotion at selected C-stores.

Kisses takeaway, declined 7.1% in the quarter due to the competitive activity in chocolate packaged candy.  For the Full Year, retail takeaway in FDMxC was up 1.3%.  strong gains by Hershey’s and Reese’s both up mid-single digits was offset by challenges in refreshment and lower velocity is of some previously introduced new items.  Importantly the category remains healthy and grew by 3.5% in 2007 in the FDMxC classes of trade.

In these channels, Hershey’s takeaway declined by 1% and resulted in a share loss of 1.3 points.  In the Fourth Quarter and full year, our C-Store takeaway declined 3.4% and 1.2% driven by softness within refreshment.  Competitive new product activity has impacted our refreshment business in 2007 and accounted for about half of our total company share loss of 1.2 share points in the C-Store channel.

Hershey chocolate takeaway in C-Store for the full year was up 1.3%.  We expect our share performance to improve in 2008 as we continued to increase core brand investment and launch new products, Hershey’s Bliss, Starbucks and the signatures line to compete more effectively in the on-trend premium and trade-up segments.

In 2008, we will also have the full year benefit of increased levels of retail coverage that were mostly added in the Fourth Quarter of 2007.  With respect to gross margins, during the Fourth Quarter, gross margin was down 240 basis points compared with year-ago levels, primarily due to higher commodity costs, prior trade promotion spending and unfavorable mix.  Specifically, dairy costs were up markedly year-over-year and track slightly higher than the internal forecast we established at midyear.

We believe that dairy stock spot prices will continue to subside somewhat as we make our way through 2008.  However, we expect that dairy will have a negative impact on our First Quarter of 2008 because of the timing of increases in 2007.  Total productivity initiatives in the quarter exceeded our initial plans and helped to offset a portion of the previously mentioned higher import cost and unfavorable mix.

Net obsolescence costs were at normal rates in the quarter and were favorable year-over-year.  Outside the US, the Godrich Hershey Business generated lower than company average gross margin and modestly impacted our gross margin in the quarter.  For the full year 2007, gross margin was 35.5% versus 37.7% in 2006, down 220 basis points primarily due to increased input costs.  Productivity initiatives exclusive of the Global Supply Chain Transformation exceeded our initial estimates and helped offset the total year commodity cost impact.

EBIT margin for the quarter was down 450 basis points as selling, marketing and administrative costs increased about 14.4% or 210 basis points as the percentage of sales versus the prior year.  While consumer promotion expenses were lower, they were more than offset by higher advertising and selling expense.  EBIT margin was also affected by the cost of added retail coverage that began in Q3 will benefit 2008 as well as higher employer related costs from our international expansion.

Advertising was up 21% in the Fourth Quarter to support Reese’s and other core brands.  We also shifted some spending from consumer promotion to trial driving coupons, which are accounted for its trade promotion between gross and net sales.  So the brand spending for the quarter, advertising, consumer promotion and trade promotion was up 10% versus the prior year.

For the Full Year 2007, advertising increased to 18% with total brand spending up 9%.  EBIT from operations for the year declined 13% with EBIT margin down 270 basis points to 17.6% from 20.3% driven by lower gross margin and higher advertising, selling and administrative expenses.

Moving down to P&L, for the quarter interest expense decreased coming in at $28 million versus $31.5 million in the prior period.  This is driven by lower year-over-year rates on our commercial paper.  For the year, interest expense was $119 million up to $2.5 million from last year, reflecting slightly higher levels of debt.  In 2008, we expect interest expense to be up slightly.

The tax rate for the Fourth Quarter was 36.4% 90 basis points lower than the previous year.  For the full year, the tax rate was 36%.  Note that on a quarter and year-to-date basis, the reported tax rate is higher than the pro forma rate to the effective tax rates applicable to business realignment and impairment charges.

For 2008, we expect full year tax rate to be unchanged at approximately 36%.  In the Fourth Quarter of 2007 weighted average shares is outstanding on a diluted basis for 230 million versus 235 million shares in 2006, leading to an EPS of $0.54 per share diluted from operations down 19% versus a year ago.

For the year, shares outstanding were 231 million versus 239 million last year.  EPS diluted from operations for the full year was $2.08 down 12%.  Turing to the balance sheet and cash flow, in 2007, net trading capital decreased versus last year, resulting in an improvement of $152 million.  Accounts receivable decreased $35 million and remains extremely current and of high quality.  Inventory was lower by $49 million and accounts payable increased by $68 million.

The reduction in working capital reflects 2007 programs to improve our sales and operations planning process and to manage our Days Payable.  We expect working capital to improve in 2008, primarily driven by inventory reduction in the second half of the year but not at the same improvement rates as we achieved in 2007.

In terms of other specific cash flow items, during the quarter, capital additions including software were $76 million and $204 million for the full year.  As previously mentioned in the Third Quarter Conference Call, capital spending came in below our initial estimate of 250 to 300 million due to the timing of projects related to the global supply chain transformation.

For 2008, we are targeting total capital additions to be in the range of 300 to 325 million, driven by the year on your shift in our global supply change transformation program.  Depreciation and amortization was 83 million in the quarter.  This includes accelerated depreciation related to the global supply change transformation program of $33 million.  So operating depreciation and amortization was about $50 million in the quarter.

For the Full Year 2007, depreciation and amortization was $311 million of which accelerates depreciation and amortization was $109 million and operating was $202 million.  In 2008, we are forecasting total depreciation and amortization of about $250 million including accelerated depreciation and amortization of approximately $60 million.

Dividends paid during the quarter was $66 million, bringing the full year to $252 million.  We did not acquire any stock in the Fourth Quarter related to the current repurchased program.  There is $100 million outstanding on the current authorization that the board approved in December of 2006.  During the quarter we did repurchase 7.8 million of our common shares in the open market to replace shares issued in connection with the employees exercising the stock auctions.  Our goal is to repurchase all such shares.

The Godrich Hershey Business India and the manufacturing joint venture in China with Lotte are progressing as planned.  In India, we achieved our 2007 sales target and invested in our sugar perfection brands and the launch of Hershey’s Milk Mix.  In the near term, we will continue to enhance our relevance in India and extend our reach and distribution.  While the Godrich Hershey Business will have a positive impact on net sales, we do not expect any meaningful contribution to earnings given our plans to re-invest and build that business.

In China, we made significant progress in 2007 and we established the joint venture with Lotte began local manufacturing and developed and launched a new portfolio.  We look to increase our relevance in 2008 with focused marketing investment to grow that business.

Now for an update on the Global Supply Chain Transformation that was announced back in February of 2007.  During the quarter we recorded total global supply chain realignment charges of $83 million pretax.  This reduced reported earnings per share by $0.25 for the quarter.  We recorded $35 million in cost of sales, consisting accelerated depreciation and ride offs.

The $4 million recorded in selling, marketing and administrator expenses, reflects program management costs.  An additional $45 million was recorded as restructuring in the P&L including 32 million related to employee costs and $13 million in asset ride offs and contract terminations.

For the year, pretax expenses related to the Global Supply Chain Transformation totaled $400 million or $1.10 per share diluted on a reported basis.  As we previously communicated in the Third Quarter conference call, we increased our full year 2007 estimate related to the Global Supply Chain Transformation to $380 to $400 million versus the initial estimate of $270 to $300 million.  This was primarily due to greater and anticipated number of impact in employees, volunteering for the early retirement package.

While these employees will be working through the first half of 2008, generally accepted accounting principles requires that we recognize the expense when the employee commits to the retirement date.  This is an accounting timing change and has no impact on our plans, cash flow or the total cost of the transformation program.  Our estimate of total pretax charges and non recurring project implementation costs remain at $525 to $575 million inclusive of project management and start-up costs of $50 million.

For 2008, our estimate of total pretax charges and non recurring project implementation costs are $140 to $150 million and total three-year statements remain at $170 to $190 million with a significant savings increase in 2008 compared to 2007.  To improve our competitive position in Brazil, we have undertaken a restructuring and recorded a pretax business realignment and impairment charge of $12.6 million.

It should be noted that this is not part of the Global Supply Chain Transformation Program.  Specifically, we have entered into a joint venture agreement with, Bauducco, baked goods manufacturer and will leverage their strong selling and distribution capabilities throughout the country to enhance profitable growth.  We also expect operating margins to improve as we reduce overall headcount and fixed costs in the coming months.  Hershey will retain a majority control of the joint venture.

Let me now talk about 2008, for our primary goal is to stabilize US market place performance.  We will continue to invest in our brands and businesses in both the US and international markets.  Investment spending will support consumer and customer merchandising programs for core brands as well as launch of new products, especially, Hershey’s Bliss and Starbucks.  Combined with the benefit of a full 12 months of increased retail coverage, we expect net sales to grow by 3% to 4% in 2008 including India and China.

At this point, we have a good assessment of our 2008 cost basket, while dairy costs have moderated recently a broad range of increase have accelerated over the last 12 months and the outlook is for input cost remain above historical averages in 2008.  Therefore, we expect the input cost to increase at roughly similar levels in 2008 as they did in 2007.

Savings from the global supply chain transformation program and the aggressive pursuit of additional based productivity will help moderate the impact of these increases.  In 2008, EBIT margin will be down as we invest in our businesses.  Specifically, advertising, consumer promotion and coupons will increase.

Selling expense will be higher due to the retail sales associates brought on board over the last four or five months of 2007.  In addition, employee related cost and investment and in our international businesses will also increase.  As such, we expect 2008 EPS diluted from operations to be in $1.85 to $1.90 range. Despite the inflationary cost environment that is pressuring margins, we are committed to investing behind our brands and expect to stabilize our US Market place trends in 2008.  Given the year-over-year input cost comparisons and investment plans, we expect quarterly performance to improve as the year progresses.

Dave will now provide some specific insights regarding our business.

Dave West

2007 certainly was a difficult year, to sum it up, accelerating commodity costs primarily dairy, was one of the toughest issues we faced.  While we expected dairy costs to be higher year-over-year, the rate at which it accelerated within the Second Quarter surprised both the market and us.

Beyond dairy, the market is rather on materials increased significantly later in 2007 and will result in significant increases again in 2008.  Increases of this magnitude in back to back years represent a challenging operating environment.  Our global supply chain transformation program, which we instituted and announced in February 2007 prior to the run up in commodity cost is on track.

The savings from this program as we initially indicated represent the fuel for reinvestment to drive program growth.  Despite the unprecedented increase within our input cost basket, we remained committed to this investment spending.  This decision will obviously impact the bottom line in 2008, but it is the right decision for the long-term part of the business.  Throughout 2007, competitive activity intensified in the form of both innovation and spending.  The activity was strongest in refreshment in the premium and trade up chocolate segments.  This came at the time when we were transitioning our portfolio with less than normal levels of innovation and higher amounts of discontinued items.

As 2008 begins, we are operating under the assumption that competitive activity will remain at current level.  So, overall we are not pleased with Full Year 2007 market place performance and financial results.  However, we did make progress in areas that will benefit Hershey in the long term.  Specifically, the global supply chain transformation is well under way.

The program will generate the savings anticipated, enabling us to reinvestment in our business.  It will also give us a manufacturing flexibility that will allow it to come to market with products and packaging that we could not previously make in a cost effective manner.  We have also made good progress within our International markets.  Sales there continued to increase and we are making necessary investments to improve profitability over the long term.  As I mentioned a moment ago within the US business, results were poor.  However, there were some bright spots we will replicate and expand upon in 2008.

Let me give you some specifics, from a customer’s view, this is one of our largest customers who was on track and increased meaningfully in 2007, driven by increase retail coverage and net gains by our core chocolate brands.  This led the Fourth Quarter and Full Year retail takeaway of 0.9% and 1.3% in the food, drug, mass, including Wal-Mart and convenient universe.  This is higher than our shipments, measured takeaway, and reflects shipments and consumption will be more in line as we head in 2008.

The Reese’s franchise takeaway in 2007 increased by over 4% behind closed in news and variety, which Reese’s Crispy Crunchy, Reese’s Elvis Peanut Butter and Banana and Fourth Quarter launch of Reese’s Whipps.  We also made progress within the Hershey’s franchise in 2007, where retail takeaway increased of 6%.  A number of brands and initiative did well, including Hershey’s Milk Chocolate six-packs, driven by this (inaudible) merchandising program and Hershey’s Special Dark, Extra Dark and Cocoa Reserve benefiting from the growth in dark chocolate and trade-up segments.

So, as you can see, where we align our investment, from a customer and brand perspective, the results were positive.  We will expand this type of support in 2008 across more of our portfolio brands and customers with increased levels of advertising, retail coverage, merchandising events and new products.  This necessary level of investment should allow us to be more competitive, beginning to stabilize US market place performance, especially within our core chocolate brand.

In total, advertising, consumer promotion in coupons will rise nearly 20% in 2008.  The biggest portion of the increase on a percentage basis will be in advertising.  Among the most exciting 2008 initiatives that will launch at the Hershey’s Bliss in Startbucks product lines, late in Q1.  In addition, to enhance our premium, trade-up portfolio, and will enable Hershey to build scale in these growing sub-segments.  Appropriate brands support will ensure that these products get off to a strong start.

Additionally, the launch does include dedicated merchandising fixtures and an in-aisle shelf attachment that call out the product.  We will further expand in the trade up segment later in the year with the introduction of a signatures line that will leverage Hershey’s existing mainstream brands, including Hershey’s Extra Dark and a new Reese’s Select Clusters, combined with the Cacao Reserve, Scharffen Berger, Joseph Schmidt and Dagoba.

Hershey will have a broad portfolio of premium and trade-up chocolate products.  This portfolio approach leverages are scaled as we bring our category management techniques to the premium and trade up parts of the aisle.  Our core brands will also enjoy increase brand support, especially Reese’s.  We will be more on air more frequently in 2008 and will benefit from increase retail coverage as to nearly 20% more sales associates we hired in Q4 2007 execute merchandising events across all channels.  This included Hershey’s and Kit Kat deal in our collector’s series at the start of the raising season in Q1.

This will be followed by the S’more Brad Paisley promotion and the Reese’s sponsorship of the upcoming Batman Movie event, “The Dark Night” in Q2 and then, in Q3, sponsorship of the US Summer Olympic team.  Overall we will increase merchandising versus 2007.  These actions will ensure that new product launches get off to a successful start and that core brand performance improves.  We do have parts of our portfolio that are under performing and we are working to address them.

Through the middle of 2007, Kisses franchise retail takeaway was growing, driven by the 100th Anniversary Program.  However, in the Fourth Quarter those trends reversed dramatically, resulting in retail takeaway decline of 3.6% for the year.  A disappointing holiday season with increase competitive activity within package candy and trading up were major drivers.  Kisses continues to have an extremely high level of brand awareness and loyalty, upon with which we need to capitalize.  However, our package candy line-up, which includes Kisses, as well as Hershey’s Miniatures and Hershey Nuggets has changed little over many years.  The lay-down back, merchandising and purchasing queues have not kept pace with the merging consumer trends and demand.

As a result, we need to address our consumer proposition within this segment.  This is also true to a lesser extent on our loose part business.  We need to upgrade our benefit perception with consumers.  By mentioning this on the October call, some residents have a reduction of price points.  That is not the case, we need to contemporize these businesses with pride and packaging improvements to meet current and unmet needs and provide new benefits to consumers.  Work is well underway on this front and will have more to share with you, later in the year.  We also need to continue to evolve our refreshment business.

In 2007 competitive activity and innovation on this segment were at the highest levels in search of purchase the business in 2001.  Ice Breakers brand retail takeaway was down to 10% for the year.  Distribution gains on new product launches including Ice Breakers, Ice Cube gum, Ice Breakers walnuts mints gum and York Mint Tins, improved in the late second half of 2007 as additional retail coverage came on line.

We will build on these gains in 2008.   However, the business did suffer as we transitioned away from carefree, stick-free and rolled mint items.  We do have news in 2008, as we launch Ice Breakers Ice Cube pack, a 40-count travel container and Ice Breakers Chewy Sours.  However, we will have a tougher start and anticipated the refreshment business in early 2008.

You may recall that late in Fourth Quarter of 2007 we launched Ice Breakers Packs.  A unique product that delivers the birth of cooling sensation by coupling breath strips in a pouch filled with Xylitol.  The launch in Q4 was landed to a few customers and the product was not in broad distribution.  Consumers, whose tested and purchased Ice Breakers Packs are very satisfied with fun and innovative product.  However, some community and law enforcement leaders have expressed concern about the shape of the pouch in Xylitol form and the possibilities that it could be mistaken for elicit items.  We are sensitive to these viewpoints and thus have the decision that we will no longer manufacture Ice Breakers Packs.  The product on the shelf of retail will sell through in Q1.

With the 2007 results and 2008 financial outlook that Bert discussed earlier, includes an assumption for the unwinding of cost related to this discontinuance.  As we have planned to support behind this item early in the year, we are now realigning our profession plans, to make sure we stay on track.  Additionally, our R&D group is working on exciting ideas that are unique, innovative and deliver consumer benefits that can leverage Hershey’s retail and technology scales and refreshments.  I hope to share these with you soon.

We will turn for a minute with the International, as we look at 2008 and beyond, we will continue to employ the discipline focus on key emerging markets for confectionary growth is strong.  We are pleased with the progress being made, especially in Mexico, Philippines, China and India.  The integration of the Gobrich in India is nearly complete and resources will now be focusing on growth.  We are developing go-to-market trade capabilities that will allow us to keep up to the expansion in a modern trade and at the same time, allowing us to go distribution and other Regions and Channels in the country.  While the Gobrich Hershey joint venture will have a positive impact on that sales.  We do not expect the meaningful contribution to earnings as we invest in building distribution and in consumer efforts.

In China, we made a significant products in 2007 as we established our manufacturing J.B. Flotte and developed and launched our business in to the market in Q4.  As we looked at 2008, we will continue to invest and build our brands, capabilities and distribution in key outlet in cities.  Specifically, plans calls for both advertising and consumers sampling.  We will also open a retail store, Hershey Shanghai Chocolate World, prior to the start of the Olympic Games.  We expect China sales to be up, year-over-year with operating margins pressured due to investment that will ensure that the business prospers over the long term.

Turning now a bit closer to home, Brazil.  The company purchased a small business near in 2001, each country sales have increased year-over-year.  However, our limited scale, reach and distribution have led to a disadvantage position and unfavorable margin structure.  Increasing distribution throughout the country is an essential element to improving our competitive profile.

Hence, we have announced the restructuring of the business and entered into a joint venture agreement with Bauducco, a leading bake good manufacturer.  We will have the controlling interest in the joint venture and be responsible for manufacturing and creation of the marketing plans, related to the Hershey products.  Bauducco was responsible for selling and distribution of Hershey’s brands throughout Brazil.  After we complete the integration in 2008, we expect profitability trends in Brazil to improve into the future.

As you can see, 2008 in both US and International businesses is an investment year and that is within our brands, people and process as it is the right thing to do for the long term health of the business.  As I stated earlier, it was our intent that the Global Supply Chain Transformation Program announced in February 2007, before the unprecedented escalation of input cost would provide the necessary funding.  We will make this investment in spite increasing commodity cost.  With this investment we expect market place trends to improve and we will make our way to 2008.

This will begin after the First Quarter, which includes a shorter Easter season as we roll out our Hershey’s Bliss in Starbucks.  Based on our new products plans, global growth and the increase investment to stabilize US market place performance in 2008, we anticipate net sales growth to be in to 3% to 4% range.  We expect overall commodity and energy costs to again increase in 2008 at levels similar to that encountered in 2007.  Gross margin will be under extremely severe pressure in the First Quarter due to year-over-year comparisons of dairy, as well as other input costs and will then sequentially improve as savings from the Global Supply Chain Program and Annual productivity help modern idea impact of rising input cost.

Given the increase in spending against in keep growth initiative and the difficult cost environment, we anticipate EBIT to decline in 2008, thus, resulting an earnings per share diluted from operations of $1.85 to $1.90.  We are confident that the strategic initiative that is highlighted today will enable us to achieve these goals.

As we look in the long term, Hershey has many opportunities to leverage its Global brand in US scale.  Work is already on their way as we evaluate our approach to consumer insights and innovation and further develop a consumer driven approach to the portfolio.  Additionally, we are setting up our margin structure, every line item within the P&L, giving the continued escalation of operating cost.

We will complete this work in the coming months and in the Second Quarter of 2008, provide greater details of our assessment, including innovation plans, core brand building initiative, International growth objectives, portfolio strategy, capital structure and long-term net sales and earnings per share goals.

Throughout this review and analysis our commitment to get back on track and deliver persistent financial performance that will reward share holders over the long term.  This long terms view is shared by the Board of Directors of the Company.  They have been supportive of me and my Senior Management team.

We will do the right things in the short term that will benefit the business over the long term, putting the Hershey in the position to deliver consistently upon its net sales and earnings per share expectations so that, all share holders are rewarded as the company succeeds.

Thank you and we will now take your questions.

Question and Answer Session

Operator

(Operator Instructions)

Your first question comes from Jonathan Feeney with Wachovia Securities.

Jonathan Feeney – Wachovia Securities

Dave, with all your general environment of inflation out there, I know you have mentioned some items on your cost basket, but how are others in the industry – your  pricing, because it seems like most food items are pricing up pretty dramatically and even if I was at the measures data through chocolate pricing in the categories up strong in there, are you having those conversations with retailers and if there is any thought of …and because you have these pervasive costs that are actually covered with less severe for maybe your company and then, some of the other more brand-based company that is out there.  You can get some of room in marching back there?

David West

John I cannot comment specifically on any price-related issues.  The category remains competitive as I mentioned in my remarks, particularly innovation and spending and merchandising and it is a tough market, but I am not going to give you specifics about pricing.

Jonathan Feeney – Wachovia Securities

The convenience channel you have mentioned, that seem to be particularly competitive.  Is there any thing that was done in the past, particularly, through that channel or certain excuse through that channel that have made that difficult, that may have bottomed and make it easier for the company to grow next year?

David West

I think there a couple of things in the convenience channel, we certainly are deploying two for 2008.  First is retail coverage, we certainly have expanded our retail coverage with part time sales merchandises that are going to be focused on the convenience channel.  We will be much more active in making sure that we get core distribution in all our items in the right places and we have a much better merchandising program of key events in 2008.

In 2007 we still have an impact of some of discontinued items and we did not participate fully in the refreshment growth that occurred in the category, but as we go forward, we are really focused on execution at the convenience store shelf.

Jonathan Feeney – Wachovia Securities

Finally, in your balance sheets, they are extremely strong right now, I was little surprised to hear that there was not much stock or purchase activity in the Fourth Quarter.  Is there something you are saving enough money for or is that something, I presume more aggressively through the course of 2008?

David West

John in the Fourth Quarter as you are aware, we had a few news items going on, so we will pretty much watch out on that so we were not active to participants in the market in Fourth Quarter.  We still have a $100 million left on the share repurchased that we had out there.  Obviously, this is a topic for Board level discussion, we are engaged with the new board and the conversation around the capital structure and that conversation is ongoing.

Operator

Your next question comes from Terry Bivens with Bear Stearns.

Terry Bivens - Bear Stearns

Dave, question on marketing.  I was not a marketing major but it seems to me, one of the disappointments that Hershey has experienced over the past couple of years is you have had this really rapid growth in Dark Chocolate, and the company was not able to forge the market share there that you had in the general market.  Looking back, why do you think that was?  Did you underestimate how hard the competitors would come in, and most importantly how do you think that gets kind a back on track?

David West

Well, Terry that is very interesting.  I think that we do have a very good share of solid dark chocolate.  The normal Hershey’s special dark bar, extra dark products have done very well.  I think what is happening and there is a blurring obviously of premium and trade up.  Some of those products are dark or richer and more indulgent, that is the area where we have not played, as well as, a consumer looks to trade up from the experience standpoint of Cacao Reserve last year was an entry that we made into that area.

We feel good about the progress that we made on Cacao Reserve but we just do not have the skill in that segment and that was Hershey’s Bliss and the Starbucks launch that we have coming this year.  It gives us scale and the ability to play towards our strengths, which is retail coverage, category management, and we do believe that the Hershey brand with Hershey’s Bliss can play in that space.  We are very excited about the product offering.

Operator

Your next question comes from Christine McCracken with Cleveland Research.

Christen McCracken – Cleveland Research

I guess to your last comment on “on the Bliss and Starbucks.”  Do you feel that with those editions that you are actually going to get to a size that gives you the capability to get more involved in the category management because the sounds at least from the retail community is that they are actually maybe changing the way they handle managing the category.  What gives you the insight or have you had those discussions that you get more involved in managing, kind of that premium and super premium effort at retail, maybe you can give us a little more color around that.

David West

Well Christine, we are the category of captain in just about every major account in the aisle in confectionary.  So we are involved in those conversations, although, it is very difficult to be involved in actively managing that part of the category, when we frankly do not have a lot, we do not have a lot of items or scale.

But those items or scale, obviously, we will continue to category captain and we have been involved in the dialogue all along.  We just have more breath and portfolio scale bringing into the market place right now.

Christen McCracken-Cleveland Research

Then just on Cacao Reserve, you have mentioned that you made a lot of progress there, but it seems there is a lot of discounting on that product lately.  Is that part of the strategy maybe to develop the brands to get more awareness, I mean, how are you managing that branch to solidify your presence in premium and super premium?

David West

Actually, we are very pleased with the household trial penetration that we got and the repeat rate has been very good on some of the new Cacao Reserve items, we are the number one dark chocolate in consumer ports under the Cacao Reserve brand.  So, we are please with the product that we have made from a consumer standpoint.

I think what you maybe thinking in the market place from a discounting standpoint is likely going to be -- as we rotate to the portfolio, we launched the number of items in 2007, and some of them were very well received by the consumers.  And there are couple of forms where we launched that were not, and those were rotating through the system right now and getting them out of the shelf when we come back in with truffles and anything squares that are a little bit more align with what the consumer and that segment wants.

So, we did learn a lot as we went through 2007 on Cacao Reserve.  Portfolio will change, somewhat, it is will be more in line, I think, with what consumers are playing back to us that they want and we are excited about going forward and it now has… as you bring Bliss, as trading up on Hershey’s signatures into the category.

Cacao reserve does not stand-alone.  It becomes something that we now have the ability to do in broader scale, and the global supply chain transformation, as we get further down the road with our facility monitoring Mexico.  We have the ability to make items that I think that are a little bit more unique and in different packaging than we have made before.

Christen McCracken-Cleveland Research

And finally on these competitive activity and kind of a general everyday business, I am wondering.  Do you see any change to that?  Has there been any shift from a competitive stand point from your competitors, I guess, and in terms of their plans or their level of discounting, or is it just this constant ongoing struggle that you are going to have in that largest part of your business?  Why are you kind a hurting yourself?  Why does not that the category get more disciplined?

David West

Christine, I think is that the category traditionally is one that really drives around innovation and merchandising, and frankly, we did not have any particularly good merchandizing program because we do not have the type of innovation that we needed in 2007.  So, we are very focused as we spoke of forwarding 2008 around the innovation that we have, particularly in trade up and in premium.  But also importantly, in terms of the retail investment, we have made to improve our merchandising, and a better merchandising calendar that is really what is going to drive the change, I think, in terms of our share of merchandising, and it is really left around the anything round the promotion.  It is really more of a “Do you have something to promote?”.

Operator

For our next question, comes from David Driscoll-Citi Investment

David Driscoll – Citi Investment

These is really going to go down here as a quite a disaster for Hershey.  In 2007, you lose 270 basis points of operating margins in 2008, and another 200 basis points, in two years we are going to be down almost 500 basis points.  Dave, I got to go back to the pricing side, this seems to be an unprecedented period of gross inflation, your margins are getting absolutely hammered and we are not hearing anything out of you guys on pricing.  Can the category.  I understand you do not want to announce future price increases before they come, but historically this category has been extremely good about getting price increases because of the inelasticity of demand.  Has something changed here?  Is there some reason why we should believe that it is not possible to get pricing?

David West

David I am not going to comment specifically on pricing.  It is an unprecedented run up and cross over the couple of years.  We are working very hard at getting our gross margins in line.  Any number of letters, the global supply chain transformation based productivity but I am not going to comment on anything about pricing policy.

David Driscoll – Citi Investment

Even for the category or just the historical perspective.  I mean, has anything changed in there that you would want to call out for us?

David West

I am not going to comment again on pricing David, it is not appropriate for me to do that, but the category growth rate last year was again 3.5% and that has been—historically the category is growing in that 2.5% to 3.5% range.

The biggest difference for us in 2007 is that we did not drive the growth.  And we have to get our programs and our people align to drive, to grow in the category, and that growth came in premium, and it came in trade up, and it came in refreshment where we did not just participate as we should, and that is really where we are focus on.  Making sure we have the appropriate programs to participate in the category growth.

So, the fundamental growth rate in the category remains pretty good and for us, it is a matter of gaining share rather than loosing share.

David Driscoll – Citi Investment

Just a final question, you for a long time defended the long term growth model of the business at 3% to 4% top line and 9% to 11% at the bottom line, so it is going to be a tough day for share holders of the company.  You have only given perspective on 2008, can you give us some thoughts as to what you believe the long-term model can and should be.

David West

David I had mentioned back in October that is currently under review.  It is certainly is a board level conversation that is already underway.  The management team of the company has already had those conversations.  They are on their way with the board.  We will communicate something to you out here in second quarter on a long-term outlook, obviously given the investment required in the business that we feel from a consumer’s standpoint as well as the current cost environment.  We are looking very closely at that growth algorithm.

Operator

Your next question comes from Dave Powers with Edward Jones

Dave Powers – Edward Jones

Couple of questions for you Dave, regarding your operation and improving initiative, what are you guys doing to improve on those in terms of being -- How do you see the benefits impacting the company?

David West

In terms of the productivity programs that we have underway, they are really too full and I think we have talked to them on the earlier comments.  The supply change transformation is very focused on a flexibility of our plans and the concentration of our manufacturing resources that will provide not only greater product and package capabilities but also lower costs.

We do have a full program of base productivity where we look at all of the other parts of our business, and are more focused on those than ever, given the cost environment.  In terms of six months specifically we do look at (inaudible) in our business and use it as a tool the same as we would, any of the productivity tools that we use.

Dave Powers – Edward Jones

Are you guys using or to measure result in terms of like, OEE or -- what is important to you, so you see how your core business is running?

Bert Alfonso

We do not comment specifically on the metrics that we use and within our supply chain, we do have a set of metrics that we measure ourselves against to make sure that we are achieving the savings and the productivity targets that we have for ourselves internally.

Dave Powers – Edward Jones

And going forward regarding your operation initiative, what system of solutions are you putting in place to accelerate this initiative?

Bert Alfonso

In terms of initiatives, we are continuing with the plans that we have put in place.  We are making the progress that we expect.  I had mentioned that all of the savings targets over the next couple of years that we put out in the market place.  We believe are achievable at this stage and the rangers remain exactly as we had anticipated when we started the project.  We are making the progress and moving forward on that regard.

Dave Powers – Edward Jones

You have been telling this after quite sometimes and over the last two years your stock is down 80% minimum, I mean, you talked about what metrics are measuring it, everything is very vague.  The shareholders on this call want to hear what you, David West, are going to be doing in terms of “how do you measure yourself?”  And that is very critical to investors who want to buy you stock.  Return on those assets is very important to most CEO, OEE is extremely most important to CEO’s, how are you guys measuring yourself so we know whether you are doing the right job?

Bert Alfonso

This is Bert Alfonso, it was not David, and I just did not want cause confusion for you.  We hold ourselves to the measures that are common within the market place.  Certainly all the financial measure that we talked about in our press release are critical measures for us and on the operating side, we use a different set of measures, more margin related and cost per production related.

Dave Powers-Edward Jones

Cost per production, okay.  How do you see those benefits impacting your bottom line?

Bert Alfonso

They benefit us in terms of how much we can offset the rising cost within our business.  I had already mentioned previously in the comments, our savings from the supply chain transformation are targeted to achieve $172,190 million of savings between now and 2010.  We believe that we are firmly on track to achieve those, and as already said, we do look for productivity across the business not just in the supply chain.

Dave Powers-Edward Jones

Okay, and going forward to my final question.  What is your number one goal to accomplish this year in terms of reducing cost improving throughput through out all your plans?  How do you plan throughput throw all your plans to make sure you are getting the right product, to the right costumers at the right time at the right price?

Bert Alfonso

In terms of the number one objective, obviously is to achieve the cost that we have planed for 2008, but there are number of variables that affect that.  You are talking throughput that is more about our marketing programs and our ability to increase our sales, so obviously there are some relationships, but purely from an operational view.

Dave Powers-Edward Jones

You know, when I say throughput, I am not talking about marketing and sales.  I am talking about throughput to your plans.  How you are improving, that is why I was asking about OEE earlier throughput to your plans to make sure you are maximizing your assets and making sure you are getting the right return on in all your internal investments.

Bert Alfonso

Clearly, we are focus on having the best cost profile that we can.  Honestly!  I am not sure where are you going in terms of trying to pin us down to one measure?

David West

We gave a lot of detail back in February about metrics related and passing the utilization and you and I can follow up after the call on that.

Operator

Your next question comes from Robert Moskow with Credit Suisse

Robert Moskow – Credit Suisse

Dave, I wanted to know, are you comfortable with the management team and the restructuring that you have done over the past couple of months.  Do you feel like you have the right people in place or are you going outside and trying to bring more spaces in at top levels, and if so, if you are doing any hiring, are you having any trouble persuading people to come to Hershey in the midst of this challenging time for the company?

David West

Rob, I am very pleased to the management team that we have in place.  We use our internal succession management plan to fill 40 roles in the latter part of the last year. The CFO role, the global chief marketing officer as well, the head of International North American commercial group, we have made some changes in early December to the way we are working through global marketing and innovation, and some of the branding work.

Clearly, our 2007 results would bear.  It was not working to the way that we would liked to have, so we did make some changes in global marketing and innovation.  We are very please with the team that we have in place.

We have two open spots on my staff.  The Senior Vice President of HR has announced her retirement and she is obviously helping through transition until that spot is filled.  And then we also have Global Supply Chain job open, both of those are active  searches internal and external, and at this point in time I would tell you -- based on the prospects for the company, the opportunity to work with the kind of brands that we have.  We are not having any issues getting a list of candidates that we are happy with.

Robert Moskow-Credit Suisse

Okay, and lastly, when you come back to us in Second Quarter, I guess my first question is how long have you been working on this revised plan and thinking about changing your growth algorithm?  Why can’t we hear about this today?  What are you still analyzing?  And then secondly, you say you are assessing your marginal structure but the guidance already implies another 200 basis point decline in margins to 15.5.  We have not seen those kinds of levels since 2001.  So isn’t your margin structure already adjusted?

David West

Rob, I think that the answer to your question -- when we talked back in October on the call and Ricky just announced that he was going to retire, we have talked about coming back to you in January with a view to the long-term growth model.  Obviously if you think the change since then, we are in the process of finalizing some of those things at the board level and those conversations that obviously needs to happen first before we can communicate with you.

Clearly, the operating margin structure and the reduction obviously we had in 2007 is that we are calling for year 2008 reflect the needs for us to make the necessary investment in the business, in the US market place, in the core brands as well as in the trade up and premium space and also internationally.  We will have a little bit more flavor for you but I think what you need from us is that we are going to make the necessary investments in the long-term and help with the business.

The work has been underway, and we will continue to review that management and board level and be back sometime in the second quarter.

Robert Moskow-Credit Suisse

I guess my question is, do you feel like you have a good idea of what you are going to do to improve the operations of the company.  And then it is just a matter of the new board members being in place anytime they get in front of them of they time to get comfortable or do you feel like you have these plans already in place?  And now it is just a matter of getting in front of the new people that are involved, or things changing and you are still analyzing what to do?

David West

Well, we are clearly not standing still.  We have a global supply chain transformation which is a large project the company has ever undergone and that one in underway.  We have done the joint ventures in manufacturing in China and India.  We are going to invest in those businesses; we have Starbucks and Bliss, so we clearly have a number of key initiatives which are aimed at improving the results of the business.

A couple of things that I did mention today is I said for example, the Kisses brand.  There are some things in the portfolio that are not working as well as we want them to, some of them are specifically brands and others might be segments of business that were looking at, and that work as I said, back in October had already begun and as part of the long-term growth algorithm, as well as, capital structure, et cetera. When have begun those conversations with the new board and we are going to continue to work it through at that level, and that is the appropriate way for us to go about it.

Operator

Your next question comes from Alexia Howard with Sanford Bernstein

Alexia Howard – Sanford Bernstein

A couple of quick ones, can I ask about some of the non-core businesses that you have? I am thinking particularly about the Monolower(ph)  acquisition and perhaps some of the Four A’s in to more snacking categories, like cookies and so on.  Can you give us a quick updates on where those stand and what the plan is for those.  I understand that the Monolower(ph) business was a quite disappointing in margins for a while plus the acquisition and cookies, the four-A in there has been somewhat challenging and getting growth in that.  Is the idea to really focus back on the core chocolate portfolio and spend most of your investment dollars going forward on that part of the business?

Bert Alfonso

We generally do not comment or speculate on any acquisitions or divestance for that matter.  With respect to the businesses that you mentioned, we regularly look at a portfolio analysis and we are in the process of that, and it is a part of a work that we are doing that Dave had already mentioned to discuss these with the board.

The core businesses refocus strictly with in the chocolate side of the business, yes!  We are clearly putting more resources of what has been put in to chocolate against those core brands, as we focus more on reviving Hershey’s and Reese’s, Kisses and KitKat.  So I would not comment what the exact plans are for those business, although, I would say that yes!  It is a regular part of our practice to look at our portfolio breath, and have those discussions with the board

Alexia Howard-Sanford Bernstein

Just finally coming back to general sales, bouncing back to between 3% and 4% this year is quite a decent step up from working within over the last couple of years.  Given the similar levels of competition and that has clearly been an issue since late 2006, and some of the market dynamics out there, can you give us quick two or three top items of what gives you the confidence that things can be reinvigorated these year on the top line.

David West

Yes!  We are much more confident in our ability to compete in the trade up and premium space which drove a lot of the category growth last year with the Hershey’s Bliss and Starbucks launched.

We have a better merchandising program supported by retail coverage which is 20% more people than we had last year, and as we got 2008 we are shipping much more towards, the consumption pattern in the US.  Do you remember in the vital part of the year, we had some distributor inventory productions?  So that will cover the US and then globally we continue to get good growth, we have five months of – or in the acquisition, we made that in May of last year and we expect to get some good growth in China and other markets as well.

Operator

For our next question comes from Kenneth Zaslow with BMO Capital Markets

Kenneth Zaslow – BMO Capital Markets

Couple of quick ones right after that, the 3% to 4% that is internal or that is including acquisition, it sounds like it is including acquisitions?

David West

It includes the just the stab period of the -- acquisition

Kenneth Zaslow – BMO Capital Markets

Maybe I missed this but you said that the commodity increase for 2008 will be similar to 2007.  What was the commodity increase in 2007.

David West

I believe we have said in the past that -- of the margin impact, it was the majority of that around 220 basis points.

Kenneth Zaslow – BMO Capital Markets

So that is still exactly what happened in ’07?

David West

That is what happened in 2007, and similar levels in 2008.

Kenneth Zaslow – BMO Capital Markets

Okay, in terms of when you are assessing the margin structure, does that mean that ‘09 could potentially be another down year or is 2008 the bottom of the way you think EPS growth would be?

David West

Our comment about assessing the margin structure is beyond the goal of supply chain transformation.  We clearly know that we need to generate a significant amount of productivity through out the P&L given the input cost environment that we are in.  So I would not read it to anything other than us making sure that we have a full assessment of where our productivity is going to come from going forward.

Kenneth Zaslow – BMO Capital Markets

Does this mean that your margin can contract beginning ‘09 and then we haven’t reached the bottom on your margin structure yet then, is it not that the implication?

David West

I am not going to project for beyond what we already told you here on a call today, that comment, specifically, is intended for you to understand how aggressively we are looking through our P&L in our business, to make sure that we have the appropriate levels of productivity in this cost environment.

Kenneth Zaslow – BMO Capital Markets

My last question is, since 2003 Hershey has added about $ 1 billion with the sales, but your EPS is essentially the same as 2003.  How are you changing the way you look at incremental sales and how does that, because again you have created these billion dollars of incremental sales and yet, your EPS is right back to 2003 level.  What is changing in how you assess incremental sales?

David West

I think one thing that you need to focus on what is happening in the cost input between 2003 and 2008, when you talk about the incremental sales and the gross margin obviously is associated with that.  And, some of the sales that we have added has been more global, which are going to come at a lower margin.  Those would be the two factors I would ask you to think about.  When it comes to incremental sales, we would probably talk specifically that some of the US innovation was not nearly as incremental as we would have liked it to have been, but beyond that and those would be the factors that I would have you consider.

Kenneth Zaslow – BMO Capital Markets

Other package income has also experienced the higher commodities and they are not having such the divergence between sales in EPS.  And, again I am not trying to kick you way down.  I understand the commodities, but are there other internal issues that, that could be corrected and changed that would not have this issue repeat, aside from the commodity issue?

David West

I think the other issue that the only other thing I would say is that we are investing aggressively behind our brands.

Operator

Your next question comes from Vincent Andrews with Morgan Stanley.

Vincent Andrews-Morgan Stanley

I just have more a philosophical question?  I guess now that most of the other questions have been answered, but it seems like your competition has really taken you by surprise over the last couple of years and you are still in a very defensive stance, trying to get back to zero on a lot of levels and what point in the -- to look beyond, just trying to defend yourself and perhaps come up with things that will in turn take your competition by surprise and really put you in a more offensive mode from a competitive perspective.

David West

I would say it is less about the competition, it is more about consumer and the way we approached innovation and insights, took us to a place that we made a choice back in 2004 and 2005 to expand our portfolio and adjacencies.  That proves to not be nearly as incremental nor to us as we would have liked.  At the same time within the category, a consumer needs more changing in their demands, we are changing with respect to premium chocolate and trading up in chocolate and we did not meet that merging consumer demand and the same with refreshment.

We did not meet some of the emerging consumer demands there, so we are much more focused on consumer demand and insights right now than we would have been in our innovation portfolio in the past.

Clearly, some of our competitors did a better job in certain areas in meeting some of that consumer needs and we did not.  It is less about what the competition has done to us it is more about what we did not do with the consumer and believe me, we have a laser-like focus on that consumer insight right now and those are some of the things we have we have talked about in terms of changing the portfolio.

Operator

Your next question comes from Eric Katzman with  Deutsche Bank.

Eric Katzman – Deutsche  Bank Securities

I cannot believe it, but I actually do have some questions.  Did you say how much the cost basket, however, you want to define that, was up in ‘07 in percentage terms?  Did I miss that?

David West

What we said was that our expectation in ’08 was that we would have a similar level of cost increase as we did in ’07.  Taking it back to the ’07 numbers, just to get you grounded, in ’07 gross margin decline was 220 basis points and the productivity was offsetting a 240 basis point commodity cost increase.

Eric Katzman - Deutsche Bank Securities

Are we then able to calculate, because most of the companies in the business have said our cost basket in ’07 was up 7% or 10%, so I am just trying to get a better feel as to what that percent increase is, kind of where you are versus the group, let as say, average.

David West

We have not talked about it; we did not talk about it that way.  We have talked about it much more in terms of the gross margin impact and you know 200 basis points of gross margin contraction, along the way and that you can convert that if you like, but we a similar amount of commodity plus pressure this year.  It might not be on the same parts of the input basket as it was in 2007, but overall, the grain complexes are up, they were up markedly in ’07 and we still have of that spill over in the First Quarter of 2008 and it fuels up, et cetera, et cetera, so maybe it is a different part of the basket, but it is pretty much the same kind of an increase.

Eric Katzman -  Deutsche Bank Securities

Just a follow up in to your last point David, which I felt was very accurate and right on point, in terms of R&D and innovations and that is in many ways were the company has stumbled.  The argument was always made there that like Americans just want a Hershey, sweet type of milk chocolate product and that they want what it is coming out of, let us say, more indulgent European-type chocolate, but the company always have the ability , in terms of R&D to make it, if they wanted to and I guess we do not get much visibility into R&D there and it is not normally something that we have to focus in on, but it seems to me that, that is a pretty critical component and I guess, I do not know if the Second Quarter, is it going to be a meeting or if it is just a conference call, but it seems to me that we have to get pretty comfortable that the R&D pipeline is really going to be resurrected.  It sounds like across most of the portfolio.

David West

Our intention is to meet live and not do a conference call, as we come forward with this Eric, but you are right on target on a number of things.  We have the ability to change the flavor profile of the chocolate.  We have not always had within our manufacturing infrastructure, the ability to change package formats and piece, sizes and shapes, et cetera.

That is one of the things that the Global Supply Chain Transformation enables us to do, which certainly will give us a lot more possibilities with meeting with consumer needs and insights, but we are clearly in our profile in’03, ‘04 and ‘05 was much more around providing variety to the consumers, varieties of the brands that we already have and that proved of not being merely as incremental or sustainable, as we have initially liked it to have been.

We are really now focusing on consumer insights and back to the consumer demand, trying to find the white spaces  and some of our brands and some of the pack that needs to be repositioned, because they have lost some of that relevance with consumers over time.

Eric Katzman -  Deutsche Bank Securities

And, that is what you are pointing to last call as supposed to a price repositioning.

David West

Correct, it is a clearly a price value repositioning.  Some of our brands, frankly the consumers have other all alternatives and they are making a choice that they are willing to pay a little more for something else.  We have got fundamentally some of the best brands in the category.  We got with Hershey’s Kisses, the Hershey brand itself Reese’s, those brands can and should play with all of the consumer needs, tapes that are out there.  We need to do a better job, be it product packaging, positioning on those core brands.  The network is under way with work with a feverish pace that you would expect it should.

Operator

Your next question comes from Andrew Lazar with Lehman Brothers.

Andrew Lazar - Lehman Brothers

I guess Dave, what I am trying to better determine is whether the investment levels you are talking about for ‘08 and the associated lower EPS year-over-year, whether those are actually enough and if so, why do you feel that is the case?  It comes down to obviously the marketing levels that you are looking to apply, even if you take the difference between where estimates, where and where they are now going to be for ‘08.  Even if all of that incremental was applied, specifically only to advertising, maybe that takes the rate of advertising as a percent of sales up, maybe to 5% or so and maybe that is enough, I do not know, but I know some of that, obviously is going to be applied to non-advertising consumer spend and maybe some of it is just to cover input cost during the year and things like that.  I guess I am trying to get a sense of what is the right level of marketing spend and do you think that ‘08 is a year where you get all the way there, or is it a wait and see and there might be more that is needed as you go on to ’09 and beyond?

David West

I rather say it is a very, very good question and the one that we continually evaluate and resolute.  When you think about what we did in 2003, 2004, 2005 at Limited Edition.  The Limited Edition was a known product, was in slightly new form.  There was not a lot of need to communicate that to the consumers, as long as you got it appropriately merchandised and as we look back on that, timeframe, we are not ingesting in the core brand, to the same extent.  We are allowing the Limited Edition to carry some of that news to market.

As we get to trade up in premium, where we need to communicate to the user, a new use education, a new precious in cue, a new packaging format, clearly that is going to cost us of more from a consumer standpoint and also, were fundamentally are back to the core, particularly, when you think about our C-Store and most or our business and we got some great core franchises.

The challenge for us is not only the level of spending, but how well we spend it.  Our Reese’s spending last year worked phenomenally well.  You could argue that our Kisses spending did it.  You look at the Kisses brand and what happen to the Kisses brand in Fourth Quarter, while we had spending, we did not get the results.  We want it, because the product is just not positioned the way it needs to be and we need to work on that.

We clearly are investing more on the brands.  We did it in ’07, we are going to do it again in ’08 and we will continue to evaluate that, but we do feel much better about ourselves, where we are from a brand spending in going into ’08.  Clearly, I loved to not have the commodity had it went to fight into, but that is the reality.  The market place, what we need to do is right to business long term, so we were back into over time, but to take a little bit more insights, in terms of how we are thinking of positioning and spending.  Right now, the guidance for ’08 is the best I can to give you.

Operator

Your next question comes from David Palmer with UBS.

David Palmer-UBS

I am curious, I guess building on some of these questions about innovation.  I wanted to focus on the C-store channel and single-serve innovation, in particular, obviously it pulled back somewhat and some of your non-chocolate categories, but I am perhaps more concerned with the closure of core innovation in single-served, perhaps has not really moved the needle, as much as you would hoped in recent years.  As well as I am thinking about Kissables and Take 5.  I am wondering, away from premium, what you are perhaps thinking and doing differently with the likes of Reese’s Whipps and future innovation that might hit this channel in single-served, that would make these more incremental and sustainable in your mind.

Bert Alfonso

Actually, in convenience stores, our chocolate brands, our chocolate takeaway was actually up a little more a percent, during the year, so for 2007.  We did grow our chocolate business in the convenience store and Reese’s Whipps and Reese’s Crispy Crunchy are clearly good examples of that.  What we have going in 2008 in convenience is much better merchandising against our core brands.  Rather than Limited Editions being the vehicle for merchandising, it is much more on the core and having significantly more retail help, of getting the shelf right, getting the distribution levels up are the two things that in 2008 are going to certainly help us.

David Palmer-UBS

Dave when you reflect back on some of these bigger innovations, bigger steps perhaps you think back and think perhaps we should have spent more on marketing or maybe there is something on the taste profile and you are testing that you could have done differently.  Is there any learning that you can share with us about ways that you could make your bigger, riskier innovations, have a higher hit rate and more incremental?

David West

We do have a lot of learning, particularly on some of the brands that you talked about and again it comes back to positioning, consumer insight and what benefits the brand brings and what needed their meeting.  We do have some lessons learned there on some of those brands, but realistically, for us right now on 2008, we are focused on those core brands in convenience stores, because we need to do a better job on executing the against the core.  We have better programs against them and that is where we are going to win in 2008.

David Palmer-UBS

I remember Rick used to talk about, perhaps, there was a paralysis through over analysis and that you wanted to get the organization moving faster with innovation.  Is there now a thinking, perhaps, there was not enough homework done on some of the things that were pushed at the market, in some way, that you are thinking going forward?

David West

I do not think it was speed issue, in terms of getting things to the market too fast.  I do not think that clearly is not it.  I think we launched a large amount of new news and that new news does not prove to be nearly as incremental and the challenge we had that so much new news going in the market at the same time is as that new news flows, you then have to take it all back out and one of the drags that we have in 2007 and in the latter part of 2006 was really a lot of that innovations as it slowed, it came back in form of either returns or just sat on the shelves longer that we would have liked and it just locked up the system and therefore the core brands did not get the kind of attention that we would like them to have.  But, as they are going forward, our approach innovation will be very different and we will look forward to sharing that with you over time.

David Palmer-UBS

I guess I will let you have the last word, but I am just trying to figure out, what reason you would present if there is like one top on the list type reason that this core, single-served type innovations that you inevitably have, the Reese’s Whipps-type stuff.  Why should it be more incremental and sustainable than the steps we have seen in the last few years?  If you have any file comments on that, I just leave it there.

David West

I think about what we done with Reese’s brand, with Reese’s Crispy Crunchy, new form and texture of the Reese’s brand, Reese’s Whipps with a lower fat claim on that big brand.  That is a very different approach on Reese’s then, I am just going to have another line extension inside-out Reese’s couple, dark chocolate that comes in and out.  Again, having a much more targeted, focused benefit that we are bringing on those brands versus just another flavor line extension that kind of goes into the system and comes back out.  We did that on Reese’s on 2007 and we will do that on other brands as we go forward.

Operator

Your next question comes from Pablo Zuanic with JP Morgan.

Pablo Zuanic-JP Morgan

One question first for Bert and then, one for you David.  Bert, in terms of the guidance for 2008, I do not know if you told us, we usually with margins down to 200 to 250 basis points, but what is the algorithm there within gross margins and SG&A.  Are you implying that gross margins are going to be down to 200 basis points and change SG&A the sales will be flat?  What is the mix there, that you are assuming in your guidance?

Bert Alfonso

We actually did not comment exactly on gross margin and we did comment on commodity impact that we expect between net sales and gross margin.  SG&A clearly we said would be increasing and the factors that drive those are the full year impact of the retail sale force increase.  We do have more behind our sales and marketing, as well as, innovation pieces and advertising is going up, as well.  I think we mentioned what that percentage was, so a most specific comment on the movement of gross margin, other than the commodities and a lot of the off setting impact that we have from productivity and absolutely a lot more investment in SG&A.

Pablo Zuanic - JP Morgan

I guess, one for Dave, in getting to the terms and idea, I am trying to understand marketing spending, but we look at Wrigley and they spent 11% of our sales advertising and I guess the more that you are moving to single serves away from package candy and I suppose you will continue that strategy.  There is a need to move closure to Wrigley, 11% and a 2%, I know it was touched on before, but what is the big difference between chocolate and gum if you are pushing in to single serves.  I assume single serves implies more impulse purchases and as a result, on top of my mind, being needed by the consumers.  Hence, a little bit more advertising would be needed.  Can you back to that, please?

David West

Pablo, I think a single serve is a very profitable part of our business, but here we have a very large seasonal business, very large package candy business and clearly trade up and premium are going to be in the aisle, not necessarily in the ends of consumable version and so, therefore, those parts of the portfolio tend to move much more based on merchandising feature and display.  Therefore, there are more trade promotion intensive than certainly the front end would be and we still have a very large part of our portfolio in our scale is in the aisle and we need to win on that part of our business.  Therefore, the model will tend to be different versus a strictly inconsumable kind of a business.

Pablo Zuanic – JP Morgan

One last Dave, if I may, I am just trying to get a good sense, in terms of the niches of business within the premium and trade up on what you call the main stream.  Can you give as a sense, it seems if the market is still up 3%, that obviously premium and trade has cannibalized the core.  Give us a sense, in terms of what is your market share, in each of those two segments, premium trade up and where are you, in terms of core and is it fair to say that the share loss has been really mixed related.  That your share remains and has been stable, can you walked us through that?  Any caller here would help.

David West

I am not going to give you specific shares, I will tell you that the growth rates of the premium and trade up are certainly higher than the category average.  The growth that has come in premium and trade up would certainly from our competitors who took advantage, much more so, than we did.  As we looked at 2008, we need to grow in those growing segments of the category that are growing in a much more rapid pace.  The largest part of the category is still in the everyday business and that is also where I think we have the most work to do, to make sure that we are properly positioned and giving the consumers the right benefits and getting the right price value equation there.

Operator

Your next question comes from Eric Serotta  with Merrill Lynch.

Eric Serotta -  Merrill Lynch

Most of my questions have been answered.  I will just follow-up off line.

Operator

You have a follow-up question from Robert Moskow with Credit Suisse.

Robert Moskow - Credit Suisse

Hey Bert, in your topic spending for a week, how much is that spending is for the restructuring plan and how much is core?

Bert Alfonso

A larger portion is related to the restructuring and frankly, the CAPEX next year is higher, breath primarily a shift, from this year to next year.  It does not affect the progress that we are making on the supply change transformation, but it does reflects the certain decisions that we made in terms on how we paced the capital addition.  The majority is related to that and obviously, included in that is the Monetary facility, which is a sizeable investment.

Robert Moscow - Credit Suisse

You mean that the majority of the increase or the majority of the overall spending as restructuring?

Humberto Alfonso

Majority of the overall.

Operator

Your next question comes from David Driscoll of Citi Investment.

David Driscoll – Citi Investment

Can you comment on the place fixing allegations in Canada and the corresponding issue that might be arriving here in the United States.  Is there any comments that you could make to us about what is happening on this?

David West

In view of the ongoing investigation by the Competition Bureau in Canada, we cannot comment on specific allegations.  We can tell you that we continue to cooperate fully with the investigating authority in Canada.  We will cooperate fully in any active US investigations.  We have not been asked to provide information related to this matter in the US, so therefore, we do not have any details and we are really not able to provide any additional information on the US matter.

Operator

There are no further questions at this time, are there any closing remarks?

David West

Thank you for joining us with today call, Bert Alfonso and I will now be available later this morning for any follow-up questions you may have.  Thank you.

Operator

This concludes today’s the Hershey Company Fourth Quarter 2007 Result Conference Call.

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Source: Hershey Co. Q4 2007 Earnings Call Transcript
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