Hershey Co. Q2 2007 Earnings Call Transcript

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Hershey Co. (NYSE:HSY) Q2 2007 Earnings Call July 19, 2007 8:30 AM ET

Wall Street Breakfast


Mark Pogharian - IR

Rick Lenny - Chairman, President, CEO

Dave West – EVP, COO

Bert Alfonso – SVP, CFO


Eric Serotta – Merrill Lynch

Jon Feeney – Wachovia

Terry Bivens - Bear Stearns

Robert Moskow - Credit Suisse

Eric Katzman - Deutsche Bank

Christine McCracken - Cleveland Research Company

David Eddelman - Morgan Stanley

Eric Larson - Piper Jaffray

Todd Dubick - Banc of America

Alexia Howard - Sanford Bernstein

David Driscoll - Citigroup

Steven Kron - Goldman Sachs

Pablo Zuanic - J.P. Morgan


At this time, I would like to welcome everyone to the Hershey Company second quarter 2007 results conference call. (Operator Instructions) Mr. Pogharian, you may begin your conference.

Mark Pogharian

Thank you and good morning, ladies and gentlemen. Welcome to the Hershey Company second quarter conference call. Rick Lenny, Chairman, President, and CEO; Dave West, EVP and COO; Bert Alfonso, SVP 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 of factors such as those listed in this morning’s press release and in our 10-K for 2006 filed with the SEC.

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

As we 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 provides additional information to investors to facilitate the comparison of past and present operations.

We will discuss our second quarter results for 2007 and 2006 excluding net pretax charges associated with our previously announced business realignment initiatives to advance the company's value enhancing strategy. These net pretax charges were $124.4 million in the second quarter 2007 and $2.6 million in the second quarter 2006.

Our discussion of year to date results and any future projections will also exclude the impact of net charges related to these business realignment initiatives.

With that, let me turn the call over to Rick Lenny.

Rick Lenny

Thanks, Mark. Results for the second quarter were in line with the expectations communicated in May. Improvement in the U.S. business has been slower than anticipated and higher dairy prices adversely impacted results for the quarter.

Importantly, increased investment in our core brands proved beneficial. Reese's, Hershey's and Kisses achieved a combined 4% increase in retail takeaway during the quarter. This performance was more than offset by lower velocities of some previously introduced items and heightened competitive activity within the refreshment segment. Therefore, retail takeaway in total was down slightly, off 0.4% resulting in a share loss for the quarter.

Solid progress was made on Hershey's long-term strategic priorities. The global supply chain transformation is on schedule, and the joint ventures in China and India are on track. These initiatives will enable Hershey to compete more broadly in the explosive growth within emerging markets.

Dave will discuss the second quarter in detail. I will then provide a summary of our key plans for the second half of the year. Most important, we're taking the necessary steps to regain momentum and better position Hershey as we enter 2008.

Now here's Dave.

Dave West

Good morning, everyone. As Rick highlighted, our Q2 results were in line with expectations previously communicated in May. Consolidated net sales in the second quarter of $1.1 billion were flat versus the year ago period. Diluted EPS from operations of $0.35 declined 17%, primarily due to an increase in dairy costs and a slower improvement in U.S. retail trends.

For some detail on net sales, which versus prior year were flat for the quarter, excluding the benefit of the Godrej acquisition and JV they were down 0.7%. This reflects essentially flat corporate-wide volumes and negative price realization of around 1 point.

The pricing action we announced in the U.S. in April had little impact in the quarter as we protected previously agreed to promotional price points. In addition, we increased trade promotion in the quarter behind coupons to generate trial of selected new items, notably Cacao Reserve, as well as couponing behind big merchandising events such as S’Mores and our Reese’s and Coke promotion in convenience stores.

The flat overall volume reflects some gains in our international businesses, offset by a slight decline in the U.S. U.S.A. growth in core brand shipments on Kisses, Reese’s and Hershey’s, growth on selected new items such as Reese’s Crispy Crunchy and IB Sours gum, and in premium and dark chocolate with Cacao Reserve and Special Dark, were unable to overcome continued declines in limited editions, a slowdown in items launched over the past few years, such as Take 5 and Kissables, and in discontinued items such as Bites; and particularly, in discontinued gum brands such as Coolers and Carefree.

Turning now to marketplace performance, Hershey's retail takeaway in the quarter was roughly in line with shipments. Consumer take away for the 12 weeks ending January 17th in channels that account for over 80% of our retail business was down 0.4%. As a reminder, these channels include food, drug, mass including Wal-Mart, and convenience stores.

Our core chocolate franchises, Hershey's, Reese's, and Kisses were up as programs behind the Kisses 100th anniversary and the Hershey’s S'Mores, as well as increased advertising spend on the core, drove takeaway on these brands up 4%. However, we did not keep pace with the category growth in refreshment or in the premium trade-up segment of chocolate, losing share in these areas.

The premium segment was a major driver of share loss in the drug and mass classes of trade. Our new Cacao Reserve product has performed reasonably well, but has not kept pace with the stronger growth of competitive premium entries. Additionally, lack of news, in combination with fewer limited editions and the impact of discontinued items, led to reductions in merchandising quality, particularly in the C store channel where our takeaway was down 1.9 % and we lost 1.3 share points.

Overall, we lost 1.5 share points in the latest 12 weeks in SDMXC. Notably, we are pleased with our performance in other non-measured, non-reportable channels such as club stores and importantly at Wal-Mart. We expect our overall takeaway and share performance to sequentially improve as we continue to reinvest in core brand growth and support our new platforms with enhanced customer and consumer activity in the second half of 2007. Going forward, our retail coverage initiatives should also improve merchandising. Rick will give you further detail on these actions shortly.

Turning now to gross margins, during the second quarter gross margin was down 340 basis points. This is due to overall input costs which were higher year over year. In particular, dairy costs are up markedly. The dairy markets are not as developed as many of the other commodity markets and therefore it is more difficult to take forward positions to cover ourselves over an extended period of time. In the second quarter, total net commodity costs negatively impacted gross margin by about 350 basis points.

Obsolescence costs in the quarter were at relatively normal rates and in line with the first quarter. The softness in single serve did have a negative product impact on margins in the quarter. Offsetting a portion of these declines were favorable manufacturing variances and productivity. Our India joint venture closed late in the second quarter and did not have a material impact on gross or EBIT margins.

EBIT margin for the quarter was down 270 basis points as SM&A was about 3% below last year. The majority of this decline was driven by lower G&A, primarily incentive and benefit costs.

Advertising increased in the quarter, up over 25%. Consumer promotion declined as these dollars were shifted to trade promotion in the form of trial-driving coupons. Total brand spending for the quarter -- that is advertising, consumer promotion and trade promotion -- was up 12% versus prior year. Our ad spending was focused on core brands such as Reese's, Kisses, as well as on some new platforms, primarily in dark chocolate Cacao Reserve.

Going down the P&L, moving to interest expense for the quarter, interest expense increased, coming in at $29.2 million versus $27.5 million in last year's second quarter, reflective of higher short-term borrowings to fund the $250 million share repurchase program initiated earlier in the year and the $500 million share repurchase program completed in 2006.

The tax rate for the second quarter was 36.2%, slightly lower than the prior year but in line with the 36.0% rate we are projecting for the full year. Note that on a quarterly and year to date basis, the reported tax rate is significantly lower than the pro forma due to the higher tax rate applicable to the supply chain realignment charges.

Weighted average shares outstanding on a diluted basis for the quarter were 232 million versus 240.1 million shares for the second quarter of 2006, leading to EPS of $0.35 per share diluted from operations, down 17% versus year ago.

A quick recap of year to date pro forma results: net sales increased about 0.6% in the first half or 0.3% excluding Godrej Hershey in India. EBIT from operations declined 8% with EBIT margin down 150 basis points to 16.7% from 18.2%. Higher advertising was offset by tight cost control and lower incentive compensation expense. Gross margin was 36% year to date versus 38.2% last year, due primarily to increased input costs. EPS diluted from operations in the first half declined 6.5% to $0.86 per share.

Now let me turn to the balance sheet and cash flow. At the end of the second quarter, net trading capital decreased from the end of last year's second quarter resulting in an improvement of $104 million. Accounts receivable increased $51 million and remains extremely current and of high quality. Inventories were lower by $64 million compared to the second quarter last year and accounts payable increased by $92 million in the quarter.

The improvement in working capital reflects 2007 planned programs to improve our sales and operations planning process and to stretch our days payable. This has resulted in an improvement in net cash from operating activities that is running about $150 million ahead of last year.

Some other cash flow items. During the quarter, capital additions, including cap software, were $41.4 million. For 2007, we continue to target total capital additions to be in the range of $250 million to $300 million, driven by our global supply chain transformation initiative. Depreciation and amortization was $83.9 million in the quarter. This includes accelerated depreciation related to the global supply chain transformation plan of $33 million. So operating depreciation and amortization totaled $50.7 million in the quarter and should be in the $200 million to $210 million range for the full year.

Dividends paid during the second quarter were $60.1 million. We did not acquire any stock in the second quarter related to the current repurchase program. There is $150 million outstanding on the current authorization that the board approved in December 2006.

During the quarter, we did repurchase $47 million of our common stock shares in the open market to replace shares issued in connection with employees exercising stock options. Our goal is to repurchase all such shares. Lastly, we made $77 million in investments in Godrej Hershey in India and with the Lotte joint venture in China.

Let me quickly give you an update on the impact of the global supply chain transformation initiative which we announced back in February. Plant closures have been announced, six in total. During the quarter, total business realignment charges of $124.4 million pretax were recorded. This reduced EPS by $0.34 for the quarter. We recorded $41.3 million in cost of sales consisting of accelerated depreciation and inventory reductions.

The $3.3 million recorded in SM&A related to the program reflect program management costs. The $79.7 million on the restructuring line in the P&L includes $53 million related to employee costs and $27 million related to asset write-offs and contract terminations. Overall, projections for the project remain in line with what was announced in February. On a year-to-date basis, the pretax expenses related to this program total $164.8 million or $0.44 per share diluted on reported basis.

To date, our plans are on track for the global supply chain project and we expect to recognize $15 million in savings from the realignment by the end of the year. Construction of the new facility in Monterey is on track and we will begin production there in 2008.

Let me close by talking about 2007 and the remainder of the year. Increased investment spending and trade promotion, advertising, and retail resources will continue for the remainder of the year and should lead to improving marketplace performance as we work our way through the rest of 2007.

Specifically, we should see an improvement in trend in the U.S. business versus the first half behind improving core brands, seasonal offerings, and artist and confections programming. Our Canadian business will cycle last year's recall in Q4 and we'll also relaunch our business in China in the back half. Therefore, for the year we anticipate organic net sales growth to be in the low single-digits. Benefits from the India joint venture will be additive to this number.

With respect to gross margin, we would expect a moderation in the gross margin decline in the second half. Dairy costs escalation has slowed a bit in recent weeks, however, the market remains volatile. As we mentioned earlier in the year, our productivity program is stronger in the second half, and we will incur more normalized levels of obsolescence expense versus prior year. These benefits won't be sufficient to offset the entire overall increase of input costs.

So the top line and margin outlook and our commitment to continue to spend behind our brands leads us to expect 2007 diluted earnings per share from operations to be down mid single-digits for the year, as we continue to do what is needed to reestablish marketplace momentum.

Now Rick will provide some specifics.

Rick Lenny

It's obvious that Hershey didn't perform up to expectations during the first half. Although progress was made in many areas, we have yet to experience the broad-based gains that are reflective of a very attractive category, and Hershey’s competitive advantages.

As we enter the second half, our number one priority is to restore Hershey's marketplace momentum within the U.S. where we have combined solid execution that leverages our scale with strong innovation and investment; our business has responded. We fully intend to do what's necessary to create this combination through the balance of 2007 and beyond.

Therefore, despite the ongoing commodity cost pressure we are significantly increasing the investment in advertising, key consumer and customer promotion events, innovation and retail coverage.

Our core brands posted a 4% gain in retail takeaway in the second quarter behind increased brand investment. This investment spending will continue in the back half and I will provide specifics in a moment.

The other big opportunity for us is new product innovation. Over the past several years, we have had good success in new products, particularly limited editions and dark chocolate. However, some of our new products have experienced shorter life cycles than expected. This lower velocity has impacted retail distribution and takeaway.

In addition, the majority of the fall off has been within the single-serve pack type, thus impacting margins and our performance within convenience stores. Our new product innovation must become more sustainable. This will require sharper consumer and customer insights and a more rigorous process from idea development to end market execution. We're taking the appropriate steps in terms of resource allocation and key changes to our new product development process.

We're pursuing parallel paths for new product innovation. One is close in news that leverages our core brands, while the other is more sustainable platforms such as dark and premium chocolate. I'll start with the broader platforms.

The platform that is the most promising is dark and premium chocolate. This segment is expected to show continued strong growth. Over the next five years, we expect the segment to measure $2.5 billion at retail, representing a mid-teens compounded growth rate. Hershey's growth in this segment has not kept pace with the competition and this will change.

Through the years, Hershey has benefited from portfolio scale in mainstream chocolate. This approach will extend to premium chocolate in two key ways. First, earlier this morning we announced a strategic alliance with Starbucks, one of the most iconic brands in the world. Hershey will manufacture, distribute and market a broad range of Starbucks branded chocolate and cocoa products beginning in early 2008.

The premium segment is poised for rapid growth as consumers search for superior high end offerings and as retailers are adding sections dedicated to premium chocolate. Hershey, as category captain, will provide customers with the appropriate category management insights to fully capitalize on this opportunity.

The addition of Starbucks, when combined with Hershey's Cacao Reserve, Scharffen Berger, Joseph Schmidt and Dagoba brands, will enable consumers and customers to select from a wide portfolio of on trend, superior premium chocolate products that deliver unique benefits and satisfy numerous usage occasions.

Hershey's retail scale and merchandising expertise will be a key enabler of this strategy. It will certainly speed the development of Cacao Reserve by Hershey’s, which represented our initial entry within the mass premium segment. Consumer research, both prior to its launch and following the initial trial, confirms that the Hershey brand can participate in this emerging segment.

To ensure that we deliver the right consumer proposition during the remainder of 2007, we're evolving the Cacao Reserve portfolio. Late in the second quarter, we launched Indulgent, individually-wrapped truffles and chocolates in stand-up bags. This past weekend an FSI delivered coupon support that in conjunction with in-store merchandising should further boost consumer trial. In-market learning will help determine the power SKUs while phasing out slower moving items.

Some of the items in the line were developed in concert with Barry Callebaut, the world’s largest producer of cocoa and chocolate products. This week we announced we would further our relationship with Callebaut. We finalized an agreement enabling the two companies to partner on research and development activities with a focus on driving innovation and new chocolate taste experiences, premium chocolate, health and wellness, and ingredient research. This alliance provides Hershey with immediate access to these capabilities. To build additional scale within the premium trade-up segment, we're developing a major new entry that will be announced later this year.

Turning now to the refreshment platform, this segment is on trend from a consumer standpoint, delivers profitable growth for retailers and is highly incremental for Hershey. As such, it it's attracting a significant amount of competitive activity, particularly in new products and varieties. We experienced strong growth in 2006 but have lagged the segment this year. Although Ice Breakers is a brand that can effectively compete in refreshment, our innovation to date has not been as consistent as we need it to be.

Where we have been able to gain distribution, the velocities have been solid. This is the case with Ice Breakers Sours mints and gums and York Mint tins. However, the competitive activity mentioned previously and the lack of portfolio scale in refreshment have limited our retail space.

New refreshment items must deliver a meaningful consumer benefit that can compete effectively at retail and maintain a reasonable level of ongoing sales. We believe that Wellness mints and gums do this. In May we launched two flavors of Ice Breakers Wellness gums. These offer consumers unique benefit as they include ingredients such as ginseng, vitamins and antioxidants. In September we'll introduce Ice Breakers Wellness mints. Both the gum and mints are packaged in convenient, on the go tins. In December we will introduce Ice Breakers ice packs. This unique product delivers a superior boost of cooling sensation by combining breath strips in a pouch filled with Zylatol.

A third platform involves well being. Consumers are responding to the benefit of portion control, especially 100-calorie packs. Across the food industry this segment is growing at rates better than 60%. Hershey is participating broadly in this growth with Snacksters 100 calorie packs. In addition, Hershey's 60 calorie sticks and 100 calorie bars are performing well. We're adding capacity to keep pace with full year sales growth that is expected to be up double digits.

Our approach going forward is to be more targeted in our positioning while delivering consumer benefits that can leverage Hershey's retail and technology scale. This approach will also be applied to closed and new products which brings news to our core brands and leverage their strong equities.

This has worked particularly well with Reese's. Reese's Crispy Crunchy has added a new dimension to the brand, and is the major driver of franchise growth on a year-to-date basis. Reese's Whips, which will deliver a meaningful benefit of 40% less fat will now be available in September.

The Reese's brand will also benefit from the Elvis Peanut Butter and Banana Cream limited edition. Retail sell-in was successful, and we anticipate very strong in store support. For example, at a major drugstore customer Elvis is a top five turning standard bar. Given that we had request for twice the typical number of merchandising units we expect to have more success stories such as this.

In addition to bringing news to the category ,these close and new products will benefit from the step up in second half spending behind the core brands. Whether the advertising message is specific to the new item or reinforces the existing brand equity, there's a halo effect across the franchise. Importantly, this type of innovation will be tailored to our scale and business system. We will plan our closer in innovation to anticipate a shorter lifecycle, minimize capital and product returns, and ensure that distribution is only in appropriate outlets, customers, and trade classes.

For example, the Kisses franchise performed well in the second quarter. Retail takeaway improved sequentially versus the first quarter. This gain is attributed to the custom Kisses flavor offered only to select customers to celebrate Kisses 100th anniversary. In the second half, customer programming accelerates with the end stands that include the iconic milk chocolate Kiss in addition to the custom items. Promotional materials will be prevalent in certain geographies, giving consumers an opportunity to win a trip to the sweetest place on earth, Hershey, Pennsylvania.

Our retail sales force remains a competitive advantage. One of the major enablers of our brand-building strategy is superior retail execution, whether we're winning the seasons, driving core brand growth or delivering new product innovation we must ensure the right level of resources are placed against the right customers and channels.

For example, we have utilized our in-store presence to create what we refer to as the fifth season. That's the very unique summer S'Mores program. This year we developed a fully integrated promotion with the key component being preassembled palettes of Hershey's milk chocolate bars, Honey Maid graham crackers and Kraft marshmallows. Prior to Memorial Day and continuing through the summer grilling season and Labor Day, these pallets are shipped directly to key customers. This event supported by media and couponing, has achieved strong merchandising support. Hershey's milk chocolate bars in convenient six-packs have experienced double-digit growth. We expect similar results for the balance of this promotion.

We continue to assess and refine retail coverage across all channels. To support our consumer and customer initiatives, we will be increasing retail coverage by 30%. We expect to achieve these staffing levels by September so the latter part of the second half will experience the major benefit. Convenience stores will be the recipient of the largest increase. C stores continue to be a long term source of growth for Hershey.

The recent share loss is due to lost merchandising from the previously mentioned competitive activity in refreshment, and the shorter life cycles of some new products. Increased coverage in support of stronger programming will deliver improved performance.

Within convenience stores we will be driving our core brands. The Reese's and Coca Cola promotion has been widely accepted and momentum is building. Participation in the second half will increase by 20% versus the first half. Hershey's segment leadership in king size expanded during the second quarter with takeaway up 11%. This momentum will accelerate behind the current Elvis promotion and a fourth quarter king size two for $2 merchandising event.

Kit Kat will capitalize on the growth of hot beverages in convenience store with counter units placed at the high-traffic coffee stations. A recently executed Kit Kat and coffee focused radio promotion has helped drive Kit Kat takeaway in C stores by 6%.

This retail investment will support strong seasonal programming. The second half of the year is the most important from a seasonal standpoint, accounting for 60% of the full year seasonal takeaway. Hershey is the clear marketplace leader during the high consumption Halloween and holiday timeframes. Seasonal orders and committed merchandising plans are on track to deliver solid performance. The major emphasis is on our core brands such as Reese's, which will benefit from seasonally relevant TV and print support.

Our key brands respond well to in-season advertising with an ROI of over 200 during the key Halloween timeframe. As we get closer to October, we'll run FSI's promoting snack-sized bag candy including Reese's, Hershey's and Kit Kat. These three brands alone account for well over half of our Halloween retail sales.

During the holiday season, we'll support a broad range of our brands with national promotions featuring strong couponing activity. In addition, Kisses will benefit from seasonal advertising which has proven to be very impactful, with an ROI of almost two times the average. To capitalize on the gifting opportunity, Hershey will leverage several of its brands. Cacao Reserve will offer a variety of unique packaging formats ideal for gifting. These items, featured on specially created holiday gift center displays will be provided to key customers. In addition, Scharffen Berger and Joseph Schmidt will deliver high end gifts in selected retailers. Combined, these seasonal programs will drive sell-through and retail takeaway.

Now to wrap up. The company's performance during the first half is not what we've come to expect or what we're capable of delivering. We've completed a detailed assessment of what's working and what's not and are making the appropriate shifts in plans and execution. We are increasing the investment in our brands and selling capabilities while pursuing a disciplined approach to global expansion.

Based on the plans in place in the second half, we expect sequential improvement in organic net sales that will result in full year 2007 growth in the low single-digit range. Against this back drop of improving sales are higher dairy costs and stronger investment levels. Both will pressure margins. As such, we expected earnings per share diluted from operations for 2007 to decline mid single-digits.

We're committed to taking the appropriate steps to ensure that Hershey's enters 2008 with a strong foundation for delivering profitable growth both in the U.S. and within key global markets that represent attractive long-term potential. Investments made in 2007 are the essential building blocks necessary to deliver consistent net sales and earnings growth over the long term. We'll drive these fundamentals throughout the remainder of 2007 and emerge from this period a stronger company.

We will now open it up for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Eric Serotta – Merrill Lynch.

Eric Serotta – Merrill Lynch

Good morning. There was obviously a very big swing in your second half guidance. Could you give us some quantification as to how much of this is attributable to accelerating some of your investment spending to position the company for ’08 versus the weaker than expected performance in the core business and new products?

Particularly, could you comment on change in your marketing spending plans versus the guidance that you gave in early May?

Dave West

Hi Eric. Let me take a shot on that, and Rick can add some color commentary if he would like. Since May 10 when we communicated to you last, the commodity cost picture is a little worse than it was, so that is a part of what we are seeing here in our second half estimates now. We will increase our investments, particularly in the back part of the year behind consumer promotion and trade spending and some couponing to get the takeaway re-established, so you will see higher spending from us.

Probably a little bit more advertising than we would have been thinking about back in May, but even more in the way of trade promotion and FSIs and some consumer activity to get things moving again.

Then also as we look through the back half of the year, frankly the share projection that we had for ourselves in the second quarter we didn’t quite get to where we wanted to be, and so as we have projected the rest of the year, we have taken that into account that we have not seen the turnaround as quickly as we would like, and that does have both a volume and a mix impact, because the seasonal part of the second half is already sold in. So what we would expect to see a little bit less robust takeaway in would be more in instant consumables in the back half, which would have a negative mix.

Eric Serotta – Merrill Lynch

Just following up on that point, I guess we have been hearing for five quarters now about the mix drag as customers burn through the inventories on the limited editions which aren’t moving as quickly as they used to. When does this end? Could you give us some assessment as to the limited edition inventory in the pipeline in the retail channel out there, and when you see that finally at least turning neutral from being a drag?

Rick Lenny

We are working through the reduction in the limited editions and the year-over-year impact. I think the other one that is important is we talked in terms of our innovation, we are seeing a shorter lifecycle on some of the new items that were higher margin, single serve that we thought would have more sustainability, which is why we are being very aggressive in our two-step approach to innovation. The close in innovations, right-sized to the brand and then more broad platform innovation that can be a part of a very high-growth segment such as premium and dark chocolate. So those are really the two combining factors as to your point in terms of when is it going to turn?


Your next question comes from Jon Feeney – Wachovia.

Jon Feeney – Wachovia

Thank you and good morning. Dave, you mentioned your total consumer spending rising 12% this quarter. Is it possible you could maybe parse that out between advertising and trade, and talk a little bit about your targets for the year for those two categories of spending?

Dave West

Advertising spending, I mentioned in my remarks in the second quarter was up over 25%. We would expect to see continued double-digit increases in advertising through the second half of the year.

The reason that I am talking about consumer promotion and trade promotion together is because we made a conscious decision this year to shift some of our consumer money, which the consumer promotion is actually down below the sales line, we’ve shifted some of that up into FSIs and some couponing activity to get trial on some of the new items. It shows up as trade promotion expense between gross and net.

So it is a little hard for you to see it, but overall, when you put all of those buckets together it was up double-digit in the second quarter. We would expect similar increases going forward, and a profile that is fairly similar to what we saw in the second quarter.

Jon Feeney – Wachovia

Do you have a number in your head as a percentage of sales, what is the right number for ad spending on a consolidated basis? I mean, you are clearly growing it way ahead of sales right now.

Rick Lenny

I think the important thing, and we have talked before, given our category leadership and scale within the segment, we see very high ROIs between both trade promotion support in support of a value-added event as well as advertising, so we look at the total bucket of funds that we want to invest in our brands.

I think what is important, while we are increasing advertising, another factor is what are we advertising against? If you think about it within that increased advertising we are very much focused on core brands which we know respond extremely well, and they have been, and also new products, some of which are also a part of the core brand equity. I think not diffusing that spending across multiple parts of the business, I think we have a much greater impact.

But the important thing is we see the opportunity to leverage our total investment, given the scale of our portfolio with both consumers and customers, and that is a strategy we have been following.

The short answer is, we don’t have a specific target for a percentage of sales devoted to advertising. We really look at it on a brand-by-brand, initiative-by-initiative basis.

Jon Feeney – Wachovia

A big picture question. You have a lot going on here with the international JV and now the Starbucks co-branding. Is it possible that some of the difficulty you are seeing in the marketplace – obviously the core businesses are pretty good, but – is it somewhere between those new products in the market, the premium chocolate, are suffering from maybe a little bit of overload at the management level, like trying to do too much?

Would it make sense to maybe focus more on the core U.S. business, or would you say that is not a fair characterization.

Rick Lenny

I think there are a couple of things. Within the core U.S. business, we see the long-term profitable growth opportunities within chocolate. We have a 40-plus share of the chocolate market, the largest and most profitable chocolate market in the world. Everything we are doing is focused on how do we continue to strengthen that part of the business?

We have scaled back some of our efforts on snacks and you could say maybe that was the distraction in the U.S. But our work on the global supply chain transformation and our work on our disciplined approach to global expansion are not distractions or getting in the way. Quite simply, they are an enabler for us to collectively have a much stronger, broader-based company going forward.


Your next question comes from Terry Bivens - Bear Stearns.

Terry Bivens - Bear Stearns

There are a number of topics on this one, but one thing I want to talk about, Rick, was the premium chocolate. You mentioned there that you had lost some share there and that some of the Cacao Reserve products aren’t selling that well and you’re trimming some of the SKUs that we have out there. Is that correct? Did I hear that correctly?

Rick Lenny

I think what is important, let’s take a step back. The premium segment has shown explosive growth, which is good. It is on trend from consumers, customers are dedicating new sections to premium chocolate, that is terrific. We haven’t been participating broadly enough so I will take Cacao Reserve for a second.

First off, Cacao Reserve is doing well, it’s largely in line with our expectations but it is a small component of our scale play in the broader premium segment. That is why we’re moving quickly to build scale with the Starbucks announcement, our work with Barry Callebaut, Cacao Reserve and our other brands. Think of it as, Cacao Reserve was our initial foray into premium and dark chocolate and the mass premium. We’re learning a lot. We said we are evolving the portfolio.

As all items, when they are introduced, some items do well, some don’t do as well. We will continue to refresh that part of the business.

But most important, this is a scale play and we think we can do within premium and dark chocolate exactly the way Hershey has been competitive in mainstream chocolate. If the consume is going towards premium from mainstream and will continue to support mainstream and premium is high growth, we need to participate more broadly which are the steps that are being taken.

Terry Bivens - Bear Stearns

My feeling on it would be though that I just wonder how you would feel about the initial strategy? It seems to have not played out as well as you thought, more quickly than I would have thought. You look at the venture with Starbuck, that should bear some fruit, but it raises the issue of why the Starbucks brand, not the Hershey brand?

Maybe if you could just take one step back and what did go wrong -- granted it is early stages with dark chocolate, and as you mentioned, you do hope to scale up with it, but I guess I’m at a bit of a loss to understand why the whole thing got off to what appears to be a pretty shaky start.

Rick Lenny

Terry, it hasn’t gone wrong. I think the important thing is we continue to be the leader in solid dark chocolate, if you think about special dark and extra dark. What we’re saying is we’re seeing explosive growth in a segment, some very strong competitive items and we see the opportunity to participate more broadly.

Cacao Reserve was an initial entry to learn about the mass premium segment; that was never meant to be the only way we were going to compete effectively in this segment. We are talking about a segment that is expected to be over $2 billion. We need to participate broadly.

Starbucks is one of the most iconic brands in the world. We have an opportunity to develop and market that item with our retailers and for consumers and be able to use that as another part of the foundation to bring in additional premium items. We also said that later in the year we will be announcing a major new entry from us. I am obviously not going to get into it here.

Let’s say these are very, very early days. This thing is headed in the right direction, it is going to take some time. But the most important thing, this is a segment that is growing. It is on trend from consumers and customers and we are going to participate broadly.

Terry Bivens - Bear Stearns

Just one quick follow up. On the C store, the share loss there. What portion would be attributable to refreshment and if you could give us some color on where the competition is coming from versus what you may have lost on business we’d look at as more being base chocolate?

Rick Lenny

The refreshment share loss was disproportionate in convenience stores because convenience stores have a larger proportion of total refreshment takeaway. As we talked about a significant competitive activity and we had some trial takeaway a year ago that we are lapping this year and we talked about our innovation in refreshment is going to be more back-end loaded towards the latter part of the year.

But our convenience store initiative is more broad-based than just being competitive in refreshment. We didn’t have the news in convenience stores in first half of the year whether it was limited edition from a year ago or some new items that were in their first year, the previous year; that is not the point.

The point is in second half we saw continued growth in king size. Let me remind you that king size is a major contributor in convenience stores. So whether it is the Elvis promotion, the Coca-Cola and Hershey promotion, or some of the new refreshment items; and again, the added retail coverage we see continued growth in convenience stores and we haven’t done as well as we have in the past and we are going to get back on track there.


Your next question comes from Robert Moskow - Credit Suisse.

Robert Moskow - Credit Suisse

Good morning. I think you said that you’re making changes in your R&D and your new product development process. Rick, the way you described it was you are go to have close-in efforts and you are also going to have sustainable platform type of efforts.

I’m having trouble figuring out how that is different from how you approached new product development before? I’m looking at some of the items you are talking about like Reese’s Crispy Crunchy and Whips and then the Elvis promotion and the Ice Breakers items. Should we think that these are much more sustainable items, these items are going to be much more sustainable because you fixed this process? Maybe help me understand how the process is different.

Rick Lenny

What we are doing is there is a parallel path to innovation. There is the close-in new product news such as Reese’s Whips or a Crispy Crunchy and we are going to size that appropriately, in essence closer to what a limited edition might be or a new variety as opposed to expecting it to be sustainable.

Let me give you an example of one that we learned a lot from. I think that is what is driving us towards this approach. Let’s take Take Five. In Take Five what we thought could be more sustainable innovation, consumers viewed it as more of another variety and thus its performance has been more short-term than we would have liked. So while we treated that as a brand and we invested accordingly, that is not a long-term viable proposition.

So the learning for us is that true innovation must be more platform-based versus new items unless it is close-in and leverages an existing brand equity such as Reese’s Whips. So when we do a Reese’s Whip or a Crispy Crunchy that is not a huge cap investment, we know exactly how to merchandise it, we know which customers to take it to. But when we do something like premium and dark chocolate which is a huge segment from the consumer standpoint, we need to participate more broadly and that is where platform-based innovation is going to play.


Your next question comes from Eric Katzman - Deutsche Bank.

Eric Katzman - Deutsche Bank

I want to ask you maybe a little bit of a longer-term oriented question. When you first came on you justifiably raised the targets, you had a lot of costs to take out of the business; you did well with the new products and the limited edition effort.

Since this year and I guess last year you’re going to under perform on the targets and we’ve had a lot more cost volatility than anybody expected across the industry. We’ve learned that any commodity is at risk to standard deviation to volatility beyond expectations.

How do you feel about the long-term targets and to the extent that may try to push the organization beyond what is reasonable at this time, given the cost environment and the competitive dynamics?

Rick Lenny

Eric, one way to think about it is our primary and sole focus right now is to get the store momentum in the second half of this year and begin to get the foundation in place on our joint ventures in high growth emerging markets such as China and India. We are in the early stages but making a lot of progress on our global supply chain transformation. Those are the type of efforts that we believe over the long term will provide sustainable, profitable growth for the company.

We still view the U.S. market as a very attractive one, we have the leadership position, we have great scale at retail and selling capabilities so we’re not go to get into a discussion of what long-term expectations might or might not be.

Your points are well taken around commodities and competition, but we faced those in the past and we’ve done well in the past. What we’re talking about is getting our foundation back on track and then ensuring that we have a broad view of where to capture strategic growth opportunities going forward.

Eric Katzman - Deutsche Bank

I don’t know if when you woke up this morning and read the Journal, but when I read the Journal and saw that PepsiCo was in conversation with Nestle, I was just shocked. From an M&A perspective I know you can’t talk specifically about Hershey and its place in the world, but to the extent that these huge companies are talking about combining, how does that make you feel about the company’s position and how long of an effort does the international expansion, how much time do you give that before the need to look elsewhere to grow is necessary?

Rick Lenny

Eric, you are right, I can’t talk about any potential M&A activity. Your observation is obviously a sound one. We think about the scale we have within a category as opposed to a company that is large because it maybe competes in multiple categories and may not have scale in all of those.

We certainly like our position in the core U.S. market, but we also know that in order for us to deliver on our long-term expectations we need to get profitable growth outside of the U.S. and we like the steps that we’re taking and we want to see how those play out. I’d leave it at that for now if I might.


Your next question comes from Christine McCracken - Cleveland Research Company.

Christine McCracken - Cleveland Research Company

Just wanted to touch a little bit -- and I know you don’t provide specific commentary on your commodity cost exposure. But I did want to talk about maybe your relative exposure. Generally looking at what is happening in dairy markets and expecting maybe a sustainable increase in costs, do you look at formulations as a consideration or is there any way that you can manage that exposure over a time by maybe shifting away from some of those costs?

Dave West

Christine we continuously look at formulation. There are a number of things within a product that we can do and are certainly already looking at, and some of them we’re already doing to shift from lactose to other things.

There are a number of things that we continue to look at and obviously we take a look at the global dairy market as well as the other markets which have become very global and we will continue to do what is appropriate for us, not only to get the product formulation to the most cost-effective and consumer preferred, but also as we’re going to have to look at our margin structure going forward and our pricing structure. So those are all things that are under study and I can’t really comment any further than that. It is something underway.

Christine McCracken - Cleveland Research Company

With your relationship now with Barry Callebaut does that change your exposure to commodities at all? Does that shift some of that to their responsibility with more outsourcing of chocolate production?

Rick Lenny

One thing I would say, Christine is we’ve already been moving, we moved production of cocoa powder outside last year, we moved production of cocoa liquor outside. So some of the things where we don’t think we add value in the process we’ve already moved outside and you have seen a reduction in our raw material inventory levels over time. You’ll probably continue to see some of that as we use third-party suppliers where we don’t really feel we add a competitive advantage ourselves. So you will continue to see that.

It will change our inventory levels a little bit, but it doesn’t change the way we view the market and our market expertise in terms of procurement will still be there. But again, obviously, I think on some level it also opens us up to share knowledge with someone else who does this for a living as well.

Christine McCracken - Cleveland Research Company

Just one other question on seasonal it seems like you put more of a focus on seasonal, increasing some of your advertising around that. I am curious because you have backed off that in recent years. I am curious if there is a big shift, I guess, in your strategy there?

Dave West

Christine, what we’re looking at in the back half of the year importantly for us is to make sure that in the marketplace we are competitive, that we get our market share growing in the right way. It is a very large seasonal component. We have continually run our marketing mix models over the last few years and what we found is the ROI of the advertising in the season has come back as very, very high and we’ve adjusted our spending models accordingly to run there. In both holiday and Halloween you will see advertising. It goes a long way with the lightest users in the category so we can capture that purchase occasion.

Frankly, the way the seasonal business works, it is very important to get sell-through because it is how you base your next year’s order on it. We want to make sure as we leave the end of this year that we have very good sell-through.

Christine McCracken - Cleveland Research Company

And the early read on Halloween and back-to-school is good?

Dave West

Solid. We have a solid Halloween program in place. Holiday and Valentine’s Day have been a little tougher for us the last few years because a good portion of the category has moved towards premium gifting and we did not have solutions in the past there. We do have some very good Cacao Reserve and Scharffen Berger items in gifting this holiday and into next Valentine’s season so we think we will be okay.


Your next question comes from David Eddelman - Morgan Stanley.

David Eddelman - Morgan Stanley

I wanted to ask a question about share buybacks and the balance sheet. Clearly, even this quarter, your EBITDA interest coverage is north of 7X. This is a seasonally weak part of the business. Presumably you are optimistic on the long-term prospects for the company. Between ‘04 and ‘06 you brought back almost $2 billion in stock. Essentially, at an average share price close to where the stock price is today.

What is the argument, given those dynamics, against doing a large leverage recap at this point?

Rick Lenny

Right now, David, where we currently sit we have a board authorization and clearly the capital structure of the company is a board level decision. I can’t give you any more specific commentary in terms of what the future plans are.

Let me tell you how we are thinking about it today. Within the quarter, we made some investments in joint ventures in both India and China. We have significant capital expenditure this year and into early next year behind our global supply chain transformation project and also the costs associated with that project in terms of cash flow.

So as we look at the levers in terms of using cash, we have a pretty balanced use of cash in the quarter. We will continue to look to buy back shares. It is accretive. We do believe the stock is a good value and so you should expect to see us continuing to exercise our ability to buy back shares.

Beyond that, I don’t want to go any further than that because the capital structure strategy needs to happen at the board level.


Your next question comes from Eric Larson - Piper Jaffray.

Eric Larson - Piper Jaffray

Good morning, everyone. A quick question, Rick, on China and India. Obviously right now you don’t have an equity line that discloses what your investment, what the drag to earnings is on that. We all know how long joint ventures do take to start producing real earnings, et cetera. What is the size of your investment, what is the drag on earnings and what is the payback period in terms of when you would see those ventures contributing to the bottom line?

Rick Lenny

Let me give a bit of an overview and then David will give you some of the specifics that you asked. Let’s take India, for example. In India we have the joint venture with Godrej. We started with a going concern when Godrej acquired the [Nutrine] confectionary business about a year or so ago. We have a going concern that is profitable.

You’re talking about a chocolate market in India measuring maybe $400 million in sales versus one in the U.S. that is close to $8 billion. We see the opportunity to get in there and help influence consumer taste preference. It is certainly not a share gain within India.

China, we have a manufacturing joint venture and we certainly expect to deliver profitable sales as we get that up and running. Both of those certainly require brand and customer investment but done so in a way to build a profitable business over the long term.

Dave, do you want to give any specifics?

Dave West

I did, actually make a comment. We invested $77 million in the quarter in Godrej Hershey in India and with Lotte in China. As Rick said, the important thing to know about the Lotte JV in China, it is a manufacturing JV. Essentially, if you think about it, if we didn’t have a manufacturing JV partner we would have had to go in on our own and make the investment to manufacture.

What we are doing is sharing costs in terms of overhead absorption with someone else who also needed to manufacture in China. What that JV is doing is transferring product to us at cost plus a mark-up.

Essentially, the sales and marketing aspect of it is our own to control. The valid question would be less about the JV, more about what the market looks like in China and how long it is going to take us to get to scale and profitability? That is a fair question.

We’ve got some good plans in place in the back half . The India JV, since we have a 51% stake in that, that will be consolidated into our results and there will be a minority interest line that will be newly added to our balance sheet. You will be able to see progress in India and then the China JV is recorded as an equity investment. We did discuss how big it was.


Your next question comes from Todd Dubick - Banc of America.

Todd Dubick - Banc of America

I wanted to see if you could follow-up a little bit on the share repurchase. Obviously you have been repurchasing shares and I know you can’t comment on specific plans with respect to a leveraging event, but if you could tell us what your free cash flow priorities are currently and in the context of your strong investment grade rating, with a lot of your peers basically saying we don’t need to be a strong A-rated company today. How are you thinking about your credit rating in light of your capital structure?

Dave West

I am probably not going to give you much more satisfaction than I did before. Again as I said, right now as we look at cash flow usage we have a large capital project, the largest in the company’s history in terms of the global supply project and a new facility in Monterey, Mexico. That obviously is ongoing. We have a lot of cash, one-time cash costs associated with employee costs and start-up associated with that. We do have a buyback in place. We are making investments in the joint ventures I just talk about and we obviously have continued to pay a dividend.

So we have a balanced approach to this. All of those things are at relatively high levels for us versus historical, so I think the balanced use of cash is clearly one we’re looking at. As we go forward, in terms of uses, I would rather not speculate on what we may or may not do.

Todd Dubick - Banc of America

To recap, it sounds to me like what you are saying is your free cash flow priorities are first to invest in the business; if you have excess cash flow beyond that you may consider repurchasing shares, but that would be a secondary use?

Dave West

No. Actually I think as I said, we have intentions in all of those areas. We have an existing buyback in place. We have been active buying back shares in the past. Our dividend, we continue to pay a dividend. Our dividend policy, we have had increases in the dividend 30 plus years in a row.

We are investing in the business in terms of the manufacturing infrastructure and globally. I think it is across the board and I’d rather not go back and state a policy for you.


Your next question comes from Alexia Howard - Sanford Bernstein.

Alexia Howard - Sanford Bernstein

I think you mentioned that net pricing was somewhat down this quarter but that you’re actually pushing through more of the price increase you announced earlier in the year. Are we expecting to see a benefit from that as we go into the third and fourth quarters?

Dave West

Alexia, in the second quarter given the timing of the price increase we really protected promote and price points for the most part in the second quarter. You should see an increase in some of the list price pass through in the third and fourth quarters. As I just mentioned, you will also continue to see increased promotional activity both in the way we are looking at some couponing on some of the new items in the back part of the year and we’ll also be looking at some programming in convenience stores; and again, the seasonal part of the business.

I don’t believe price realization will be as big a drag as it was in first half but I would really look more towards 2008 to start to see some real big benefit of it. I think we are going to spend back in the second half.

Alexia Howard - Sanford Bernstein

We talked a lot about share changes over the last few quarters. Can you speak to what you see happening across your measured channels in terms of total chocolate category growth? We seem to be seeing consumers shifting into healthier snacking options and certainly I guess the growth in dark chocolate is part of that as well.

But for the chocolate category as a whole, are you seeing a little bit of a slow down relative to where we were a of couple years ago?

Rick Lenny

No, we are seeing very good overall chocolate category growth.


Your next question comes from David Driscoll - Citigroup.

David Driscoll - Citigroup

I wanted to go through some numbers here. This is a follow-up to a question previously asked. When I look at the change in the guidance from May 10, it is something like $0.20 to $0.25. When I do it on a pre-tax basis that is something like $80 million in terms of the delta.

You have lowered your sales expectation; it is always hard to say with the way you guys write this, but something like 2 percentage points. Again, the profit impact there, the pre-tax impact would be like a $20 million impact. That would leave $60 million remaining.

I still don’t understand really what the split is here between investment spending, dairy and commodity and then the negative mix impact from the weakness in the C stores. Can you rank these items for me?

Dave West

I would actually prefer not to get into too much specificity. Volume is a large component of that, obviously, as you said as we looked at the trend that we saw in the second quarter and projected where we were going to be for the rest of the year, volume is a part of that.

Underneath the volume the mix component of the kind of volume where we’re seeing some of the softness is part of that. Dairy cost particularly are a little higher than we would have thought back at May 10th. That would be one component of it, and then the last component, as I said, is the continued increase in our spending behind the brands in the business. It is probably a little bit of all of the four, David.

David Driscoll - Citigroup

So you want to say basically equally weighted across those four different categories?

Dave West

I don’t want to say anything about the weighting of them, but those are the four big buckets and I would let it go at that.

David Driscoll - Citigroup

Let me just be real clear. What I think is going on here is that if it is a dairy impact, a commodity cost impact, people can look through this and understand that ’08 can get back on track if dairy comes back.

If it is really a fundamental issue with the C store business in that it is a mix impact and a volume impact and that is driving the large reduction in your forecast for the second half, then that is really a very fundamental problem with the business strategy that you guys have out there.

Rick can you make some comments here? This is going to be a question all day long and really people are going to be quite upset about how to think about their investment in Hershey.

Rick Lenny

David, no question. No one likes to miss their numbers. What we like less is not addressing the issue and getting the business back on track by the approach we are taking in terms of continuing to maintain that investment: We have grown that investment, we have seen some good results in the first half. We’ve talk about what has been in the base of the prior year comparisons that have created a huge drag in half. Limited Edition much more so in the first half than in the second half. We’ve talked about the innovation that wasn’t as sustainable and that is in the base as well.

As Dave said, we’re not going to split out what the components are. What we are doing is we are saying what does it take to become competitive and restore our momentum and in the marketplace in the second-half and then what are the right levels of expectations for sales and earnings that we have with the backdrop of higher commodity costs.

You keep saying C stores. We weren’t addressing it particularly as convenience stores. We say had lost share, I think 1.5 share points for the quarter and we know exactly where that is and the steps we’re taking.

So we still fundamentally like the characteristics of the category, good position. We’ve been very successful in the past. We understand the missteps over the past few quarters and we are aggressively addressing those.

David Driscoll - Citigroup

One more question on a follow-up; Eric asked a question about your long-term guidance and you really didn’t answer it. You have had this long-term guidance out there and again, another topic of major concern for investors. Are you really just saying right now that you are just not going to talk about it, you are going to withdraw this for the moment, pending getting the business back on track? Is that the right way we should really read your comments?

Dave West

No, absolutely not, David. What we are saying is that the 3% to 4% top line, 9% to 11% on the EPS line has always been a long-term range. We’ve been above it over the past several years. More often than not, last year and this year obviously we’re below 3 to 4, 9 to 11.

We are very, very excited about what we have going on in the business long-term. The global supply chain transformation project is going to generate significant savings for us to invest in our business in the future. The globalization that we have going on and particularly in attractive markets such as India and China, the scale in our core markets where we are just now starting to enter the faster growing segments in premium and dark and we’re going to do it with scale, with very good partners such as Barry Callebaut and Starbucks.

What Rick said is we are focused in 2007 and in early 2008 in getting the business back on track but we still believe in the fundamental strength of our scale and our position in the U.S. Also, what we are doing in the supply chain and what we are doing globally to grow the business in the long-term, so we are absolutely not saying that we are walking away from 3 to 4, 9 to 11. It’s obviously something that we’ll continue to evaluate but at this point in time, we really do feel good about where we are headed for the long-term. But most importantly, we’re focused on getting it fixed in the short-term.


Your next question comes from Steven Kron of Goldman Sachs.

Steven Kron - Goldman Sachs

Great, thanks. Good morning. A couple of questions; first, just touching on the brand support, if I look at the SG&A line, I know it’s been like this for the last couple of quarters. That line as a percentage of sales has come down. I know you’ve commented in the past it’s more on the G&A side of everything and not so much the selling side.

As we get into the next couple of quarters and we start seeing some of these I think productivity, like the global supply chain and other things, start to flow through and we continue to see a mix of some of these selling and marketing expenses perhaps moving more towards the net sales line, should we continue to expect that line to come down or are we going to see a step up across the board, at which case this line could start to creep up as a percentage of revenues?

Dave West

I think the component that you are seeing this year and this quarter particularly, as we’ve internally looked at our expectations for the year, we’ve adjusted our incentive compensation expenses accordingly. So that’s really what you are seeing in the SM&A line this quarter, which is driving it down on a rate basis, is really that reduction in incentive spending.

I would look at that as a one-time and clearly, if you looked at 2008 on a more normalized basis, we would expect to have incentive expenses back in, so that would be a driver of SM&A going up. Advertising spending is clearly going up. From a consumer promotion standpoint, we’ve moved some of our consumer promotion dollars up between trade promotion, up into trade promotion between gross and net. And one of the other things that you are going to see in the back-half of the year here is an increase in investment in selling headcount, which will increase the SM&A line as well. So I don’t think you’ll see continued SM&A reduction on a rate basis going forward. Actually, it will probably swing the other way a little bit.

Steven Kron - Goldman Sachs

Okay and then just on the commodity costs, we’ve talked quite a bit about dairy here. Could you maybe comment on the hedging programs and how locked in you are on some of your other commodities, particularly cocoa?

Dave West

I won’t go too much into specifics, obviously. We are starting to get visibility into 2008 across the entire basket. I don’t want to talk about any one in particular. The markets have been fairly volatile across the board and we are starting to lock in many of our 2008 positions but I think it’s just a little bit too early to make an overall comment.

Steven Kron - Goldman Sachs

But as it relates to 2007, do you have that visibility on the other commodities? I know dairy is a more difficult one.

Dave West

We have visibility into pretty much everything but dairy and we have, as I said, since May 10th probably a little bit more dairy exposure than we though and that’s reflected in the numbers you are getting today. We have our best estimate for dairy at the current time in our numbers for the full year. There is some volatility there but we’ve done our best thinking at this point.

Steven Kron - Goldman Sachs

Okay, thanks.


Your next question comes from Pablo Zuanic of J.P. Morgan.

Pablo Zuanic - J.P. Morgan

Good morning, everyone. I guess what I’m struggling with, on the one hand I’m hearing all the things that personally I was looking for -- a ramp up in innovation, 70% increase in retail coverage, more ad spend, more brand support, more consumer -- it’s where I wanted, I have to say I suppose a lot of investors, the people I talk to.

But I’m having problems believing it, to be honest. And I say that because clearly on the math, on my math, the guidance cut is more related to dairy, mix and volume than really to the brand, to increase your marketing.

At the same time, and related to this, my question is what you are telling us today in many ways is not very different than what you said back in December when you cut guidance. When you cut guidance in December, announced the cost restructuring program and the idea was that you were going to ramp up innovation and spend more on branding. Some of that was echoed again I believe in the first quarter conference call.

The bottom line question is what is different? Can I assume that there’s the philosophical change in the way you are thinking about innovation and brand support? Or is it just that what you tried to do back in December didn’t work? What’s different?

Rick Lenny

Let me go back to some of the messages, Pablo, that we communicated at [Cagney] because that really ties together some of your questions. What’s changed since then when we outlined these plans? Not our spending. In fact, we’ve ramped up our spending since that time and we feel our spending is appropriately focused on the core brands and we are seeing those respond.

Again, that core brand focus, whether it be some of the news and the spending and the retail execution. I think the couple of outages that we’ve talked about and we’re addressing specifically -- one, we weren’t as well-prepared as we needed to be to participate broadly in the explosive growth in premium and that’s one that we’re taking a lot of steps and the appropriate steps so that we can leverage scale or build scale in that very attractive segment.

And refreshment has gotten worse than we had expected -- more competition and therefore we had a slower ACD build on some of our new items, but we are focused on that in the back-half. I think the other aspect that has really impacted our business, and we are going to work through that and that’s a tough one for everybody. We’re going to work through and that’s the drag that we’ve experienced, from shorter life cycles of previously introduced new items and also the impact of limited editions in the year-ago period.

All that means is the things that we had done before were very successful. They had a shorter lifecycle. So we are very much committed to the strategic direction. The fact that it’s taking longer than we would have anticipated for it to be successful does not necessarily mean that it’s not the right approach. What it means is it’s taking us longer.

Having said that, we’ve identified those areas that we have had some missteps and we are aggressively addressing those.

Pablo Zuanic - J.P. Morgan

That’s helpful and just a follow-up; when I think of creating new brands or platforms, and I thought it was interesting the distinction that you made within Take 5, just another chocolate and Cacao Reserve being a whole new platform or Dark being a whole new platform.

I have to say that when I think of Cacao Reserve, I really thought it was a great brand. I loved the single boxes that you put out. I think that the Hershey name was so small that people were really thinking Cacao Reserve. But most people that I talked to anecdotally never heard of the product and that’s probably because they don’t read [inaudible] and the [inaudible].

I just find that when I look at [inaudible], they are launching five whole new brands; Mars, they launched Dove, a huge new brand that’s done very well. It reflects Hershey’s lack of willingness to spend big on new brands and still relying on Reese’s and your core brands. Can you comment on that? I think just the fact that you are doing this deal with Starbucks -- I mean, why not just put more money behind Cacao Reserve, which I think is a great product. It’s just not everyone reads those two magazines.

Rick Lenny

Well, a couple of things. Let’s take the first part. With Cacao Reserve, I think we might have initially thought of it as a more narrow target than we should have, which is why the recent advertising and consumer support and the FSIs are more broader, or more broad-based, so your point is well-taken on that one.

Think of a very large segment where there would be only one segment within that or only one benefit or usage occasion. That’s not the way a $2.5 billion segment is going to evolve, which is Premium and Dark chocolate. Therefore, Cacao Reserve gives us the mass premium approach where the Hershey’s users will trade up to that.

Starbucks gives us a higher-end, superior chocolate experience for consumers who truly appreciate and enjoy the Starbucks experience and that will also provide strong anchors for us to bring them to a dedicated merchandising unit at retail our other items, such as Scharffen Berger and perhaps Dagoba’s. So if we’re going to participate broadly in a $2.5 billion segment, we can’t do it with one item or one line. Cacao Reserve’s a very good entry point but that’s one aspect of it.

Your comments about the core brands, when you have some brands such as we do -- Reese’s, Hershey’s and Kisses -- and they have high response functions and are very profitable and are great merchandising vehicles for the trade and really do well in seasons, which accounts for a large portion of annual sales, it would be foolish for us not to support those as aggressively as we can. And then the strength of those core brands are going to enable us to have the innovation which brings news and excitement, albeit relatively inexpensively to consumers and customers, which is why you’ll see more things like Reese’s Whips but you’ll see them across the other core brands as well.

Pablo Zuanic - J.P. Morgan

Thank you, and just one last one on the Hershey’s Trust, if I may. You’re a board member. Obviously you can’t comment a lot on the trust but the share buy-backs to some extent were driven by the trust divestitures for the last two or three years to a good extent, if I’m not wrong. Maybe they are reaching thresholds that they don’t feel comfortable selling more or they just probably don’t want to sell at these levels. Maybe that’s the reason why there is not a lot of share buy-backs planned in the future.

But more important than that, the dual class share structure limits your ability to do deals, limits ability for a merger or a share swap. How can we think about the trust in the future? Can the trust think of letting Hershey evolve to a single class share structure? Do they view themselves beyond the 51% control? What comments or any color if at all can you give us around that?

Rick Lenny

The first part, over the past years, the trust has not driven the share buy-back strategy. That’s a Hershey board capital structure decision. Last year, the trust did not participate. They did participate I think three years ago now in a buy-back but not last year.

The relationship with the trust has been ongoing and everybody understands that. They are very much supportive of the direction the company has taken and the investments, the necessary investments we are making to build our brands, both organically and do the things through a global expansion.

I’d rather leave it at that and certainly not talk about any speculation, if I might.


We have a follow-up question from the line of Robert Moskow of Credit Suisse.

Robert Moskow - Credit Suisse

I can withdraw my question, thank you.


Thank you. At this time, there are no further questions. Gentlemen, are there any closing remarks?

Mark Pogharian

Hearing no more questions, we’ll conclude today’s session. [Monica], Brian Clemens and myself will now be available to answer any additional questions you may have. As a reminder, our 2007 third quarter sales and earnings release and conference call is scheduled for October the 18th. We’ll release earnings at 7:00 a.m. that day and our conference call is set for 8:30. Thank you.


Thank you. This concludes today’s conference call. You may now disconnect.

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