好時 (HSY) 2002 Q2 法說會逐字稿

Good morning.

My name is Tamara.

And I will be your conference facilitator.

All lines have been placed on mute to prevent any background noise.

After these speakers' remarks, there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star, then the number 1, on your telephone keypad.

And questions will be taken in the order they are received.

In order to withdraw your question, press star 2.

Thank-you.

I would now like to introduce Mr. James Edris, Vice President of Investor Relations.

Mr. Edris, you may now begin.

Good morning ladies and gentlemen.

Welcome to Hershey's second quarter conference call.

Rick Lenny, Chairman, President, and CEO, Frank Cerminara, Senior Vice President, and CFO, and I will represent Hershey on this morning's call.

Frank will discuss the results of the second quarter and then will be happy to take your questions.

We welcome those of you listening via the webcast.

Let me remind everyone here that is listening that today's conference call may contain statements which are forward-looking.

These statements are based on current expectations which are subject to risks and uncertainties.

Actual results may vary materially than 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 2001, filed with the SEC.

With that, let me turn the microphone over to Frank Cerminara.

Frank?

Thank-you, Jim and good morning, everyone.

By now, we assume all of you have had a chance to read our press release, issued earlier this morning.

As you know, the reported results included net charges for business realignment initiatives, totaling $2.5 million, or 1 cent per share diluted, as we previously disclosed.

In addition, goodwill amortization has been eliminated from our 2002 second quarter results but is still contained in the 2001 second quarter results as they were reported.

Therefore, the elimination of the realignment charges from our 2002 second-quarter results, would yield earnings per share diluted of 47 cents compared to 40 cents per share diluted in 2001, assuming the elimination of goodwill amortization from 2001 second quarter results.

This is an increase of 17.5% and was included in the pro forma statements which accompanied our press release.

Since this scenario describes our ongoing business, my remaining remarks will be made in this concept.

Let's start with our sales performance.

I should again point out that this year's top line has been affected by the new rules requiring the reclassification of trade from promotion allowances and last year's sales has been restated to reflect this is as well.

For the second quarter of 2002, consolidated net sales increased by almost a one percent on quarter basis.

And domestic sales increased by 2% on a comparable basis, reflecting much-improved core brand performance as well as growth of our more profitable tax hikes, offset somewhat continued rationalization of under-performing brands.

The 2% domestic sales growth was approximately one-half volume mix and the other half was price.

Hershey's strategy to emphasize key brands, as well as more profitable tax hikes and trade channels continues to be evident in the second quarter results.

In fact, sales of key brands increased in the high single digit range.

Our most profitable pack type, loose bars also increased as a brisk pace.

Limited edition Kisses provided a nice boost to the iconic brands in a seasonally slow period, as did the red, blue, and silver Kisses associated with the Great American Dream program.

Our convenience store initiative also continued to make progress as we gain share leadership in instant consumables in this profitable growth channels.

We expect our sales growth rate to accelerate and meet our 3% to 4% organic growth targets during the second half of the year.

As I review retail performance, reference to FDMXC is the IRI data for the food, drug, mass merchants, excluding Wal-Mart and convenience store channels.

Given the Easter timing in 2002, versus 2001, the more meaningful time frame for assessing retail performance is year-to-date.

For FDMXC, the candy, mint, gum category is up 4.4% in dollar take-aways.

Hershey has increased take-away by 2.5% with solid gains in chocolate and the mint segments.

While our total shares is off .5 points, .3 points of this are attributable to gum.

We have numerous initiatives in the second half of 2002 to improve our gum performance.

Most importantly, we continue to gain momentum in our higher margin iconic brands.

On a year-to-date basis, these advantage brands have generated 6% increase in take-away, with Hershey's Kisses leading the group, up 11%.

This growth was the result of strong sales and in-store merchandising activity in support of the limited edition Kisses, the red, blue and silver Kisses and bonus bags that I mentioned earlier.

Our new product strategy is showing good results at retails.

On a year-to-date basis, Hershey has four of the top ten fastest turning new items in FDMXC.

Recent FastBreak is number two, Carefree Coolers Gum is number three.

With the strategy of building our core brands, our core business growth exceeded same-store sales for the second quarter in Wal-Mart.

The combination of significant new product activity in the second half of this year, an anticipated strong seasonal performance should yield continue improvement in Hershey's retail take-away.

Let's now turn the gross margin and the rest of the cause of the income statement.

We're pleased to report the gross margin during the quarter continued to show significant improvement.

In fact, by 140 basis points, coming in at 38.1%, versus 36.7% in 2001, on a comparable basis.

This year's gross margin was enhanced by improved product mix, overall supply chain efficiencies, especially lower ingredient and packaging costs and better selling price realization.

Previously, we had guided you to an expectation of margin enhancement for the full year of 80 to 100 basis points.

Our current view of the gross margin will improve by 125 basis points or more for the year.

Absent the realignment charge, selling, marketing and administrative expenses were 30 basis points lower in the quarter coming in at 28.4% in sales, versus 24.1% last year.

Direct marketing expenses were flat in the quarter.

While administrative costs were lower as a result of realignment.

Despite incremental costs related to the work stoppage, for perspective, let me remind you that last year's direct marketing expenses increased substantially compared to the year 2000.

I might add that flat marketing expenses indicates that we are utilizing the insights regarding the responsiveness of our brands to the various types of sellings and marketing activities, to make us smarter spenders.

Also, we did not wish to overspend in view of the work stoppage during the quarter.

As we move through the second half of the year and throughout 2003, we'll continue to learn more about our brands and spend more wisely behind them.

EBIT, or earnings before interest and taxes, of $118.2 million increased by 14.3% compared with the second quarter of 2001.

And the EBIT margin was 14.3%, versus 12.6% last year.

A 170-basis point improvement.

Interest expense for the second quarter 2002 was 15.9 million dollars, compared with 16.9 million dollars last year, primarily reflecting lower interest rates and lower net borrowing levels.

The latter, of course, was aided by a strong overall cash flow in our business.

The effect of income tax rate in the second quarter of 2002 was 36.7%, compared with 35.8% in second quarter of 2001.

With both years reflecting the eliminization of goodwill amortization.

On a pro forma basis, net income of $64.8 million, was 16.8% higher than the second quarter of 2001.

And our net margin was 7.9%, versus 6.8% last year.

Weighted average shares outstanding on a diluted basis were essentially unchanged, and EPS of 47 cents per share diluted, compares with 40 cents per share diluted for the second quarter of 2001.

That's an increase of 17.5%.

As Rick mentioned in our press release this morning, in light of our excellent first half results, year earnings per share diluted growth may be slightly above the long term guidance of 9 - 11%.

Turning now to the balance sheet, as we have stated previously, one of our strategic initiatives is the more efficient use of capital.

The reduction and raw material inventor in the fourth quarter of 2001, jump-started this process and we have continued momentum.

Net trading capital, that is inventories plus accounts receivables, less payables was reduced considerably compared to the first half of 2001.

The net result is the generation of about 112 million dollars in additional cash flow from this more efficient use of working capital.

As I mentioned earlier, strong free cash flow has kept our short-term borrowings at a minimum, and as a result, total debt to total capitalization stood at 4% compared to 49.7% at the end of the second quarter of 2001.

With our improved margins in profitability as well as improved balance sheet management, our economic return on invested capital for the rolling 12-month period increased by 90 basis points, from 15.7% to 16.6%.

That concludes my comments, and I will be happy to take your questions.

At this time, if you would like to ask a question, please press star 1 on your telephone keypad.

Your first question comes from Terry Bivens with Bear Stearns.

Good morning, everyone.

Congratulations on a strong quarter.

Thank you, Terry.

Good morning.

Two questions.

Just I want to make sure I'm clear on your core volume growth for the quarter.

What would -- was that around 1%?

For the domestic business, on a comparable basis, Terry, when you remove the Luden's business and the drink box business that we sold, it's really 2%.

And as I mentioned, it's about half volume, half price-related.

And I guess with roughly two thirds of the earnings still in front of you, you are clearly pretty comfortable with that 3 to 4 range that you laid out before?

The 3 to 4 range is the top line for the second half, right.

Okay.

In terms of the free cash.

I mean, as you look at other companies in the category, you guys are clearly one of the major out-layers in terms of leverage.

What can we expect -- how can we expect to see that free cash deployed going forward?

Terry, this is Rick.

Couple of things.

First off, use of cash is a board-level decision.

And it's certainly something that we discuss on an ongoing basis.

And we're looking across a number of alternatives in terms of assessing from an internal and external standpoint, and I would like to leave it at that, please.

Okay.

Very good.

I'll yield the floor.

Thanks very much.

Thanks, Terry.

Your next question comes from Christine McCracken from Midwest Research.

Good morning.

You obviously are facing higher cocoa costs going forward.

And I know in the past, you mentioned you have a pretty aggressive program to lock those in when they're lower.

Could you explain what your exposure is to rising costs going forward on the cocoa side?

If you could just comment on that?

Sure.

I'd be happy to, Christine.

If you recall earlier in the year and throughout the year, my guidance has essentially been a combination of commodities and packaging costs in total, which make up a pretty substantial portion of our cost in sales that those were going to be flat to slightly down.

And in fact, they are slightly down.

And we anticipate that to be the case for the full year.

We are prepared to do today is extend that to 2003.

And basically to say that for 2003, our expectation is that the total package of commodity costs and packaging costs are going to be essentially flat with this year.

And can you give us just a little bit more color how you are able to navigate around that rising cost environment?

Well, there are a number of pluses and mine minuses that I won't necessarily go into.

But it's clear that cocoa costs have gone up considerably.

In fact they've doubled over the context of this year.

But there are minuses to cost as well.

Things like peanuts will be cheaper for us next year.

And we continue to make a lot of headway on our packaging costs.

You take the bundle of them together and the fact that we do cover ourselves pretty far forward when markets are very, very low, has allowed us to be able to tell you that we're comfortable with next year's costs being essentially flat with this year's.

Fantastic.

And then just secondly, on Halloween, obviously, you know, with this strike, there was some concern that things would be disrupted as we head into the selling season here and things start shipping over the next few months.

Wondering if you could just give us an early outlook on the season?

Sure.

Right now, our back-to-school and Halloween orders are coming in exactly where we had anticipated.

We have very good trade support planned.

I've participated personally in several talks with key customers.

And we're in very good shape.

I think what's also important as we saw the core brand momentum, particularly on Kisses in the second quarter, it reinforces that where we put our emphasis and where we clearly are focusing on our competitively advantaged brands.

A lot of that activity will continue through the second half.

That goes beyond seasonal activity, which we anticipate to be strong.

But we have limited edition Kit Kats, we have new sizes of FastBreak, we have several new items in our gum business to turn around our sales and share performance there as well.

We have quite a bit of new items behind our Bites platform.

So in addition to strong seasonal efforts we anticipate some good strength in our core brands as well and particularly as we continue to gain traction in the convenience store channel, we're obviously a core branch starting to gain some momentum.

Fantastic.

Thank you.

Thanks Christine.

Our next question comes from John MacMillan with Prudential Securities, Inc..

Good morning.

Congratulations on a good quarter.

Thank-you.

Is it possible to quantify what the work stoppage -- how much has hurt you in the quarter?

John, like any other quarter, there are pluses and minuses to it.

I think we were able to show that we generated a number of cost savings, and they more than offset the cost of the strike, which was really pretty nominal for the quarter.

Okay.

I think this was not like any other quarter, wouldn't you say, Rick?

I would say so, John.

Your optimism in terms of doing -- the 3% to 4% number in the second half is not top-line sales.

It's organic sales, right?

Yes, that's correct.

Could you just refresh me?

What percent of your business does core brands represent?

When you say core brands growth is up "X" what percentage of your business is core brands?

Well, more than half, we would say, John.

Okay.

And -- but you don't expect the full year sales to achieve that 3 to 4 target?

Just the second half.

Just the second half.

And you can see that -- you know, you can see that now in July based on the early order rates or...

Just because, you know, Rick, since you became CEO, a lot of good has happened because there's there's been a lot of reduced sales expectations along the way, and this quarter's top line wasn't great.

But just in terms of why you see this kind of step up in volume trend, is it your expectation because marketing plans are going up, promotions -- what caused that increased optimism.

Happy to do that, John.

Take a step back on an operational basis in the domestic market which accounts for over 90% of our business.

It was essentially flat in the first quarter.

Despite the strike-impacted second quarter, that business was up 2%, versus year ago, again, as we saw great improvement on our iconic brands, particularly Kisses as well as improvements in C-Stores.

So as we go into the back half, and we're looking at 3 to 4%, again that's on organic basis, there are a couple of things that give us reason to believe that's we're going to end up.

First is that the previous question was how do we feel about the Back-to-School and Halloween and then the subsqents season?

We feel very good about the additional programs for that.

And as I indicated, we have several efforts behind our core brands and new items, additional merchandising activity.

And again we're seeing some good growth through the balance of the second quarter in terms of take-away in our C-Store business, which accounts for 15% or so of our total take-away.

And if you look at the combined FDMXC, it accounts for about 32% of that total.

Just my last question, Frank, in terms of use of cash, just to expand upon that.

Have you used the weakness in the stock market to buy back stock?

We have not.

This quarter, we did not buy back any stock, John.

As Rick pointed out, the use that was cash is really a board-level decision.

And it's to consider both internal and external projects.

Okay.

Thank-you.

Thanks, John.

Your next question comes from David Nelson from CSFB.

Good morning, David.

Can you comment on what you see the current situation to be?

A couple of things.

What we've seen in the second quarter is pockets of some competitive activity.

But obviously where we talking about our brands doing well, and where our take-away and key brands were doing well.

We didn't see nearly as much from where we sit in the second quarter as we did in the first quarter.

As go into the second half again to reiterate, feel very good about the current level of acceptance of our specific Back-to-School and Halloween programs.

We also have our trade and consumer programs well funded to ensure we deliver what we're expecting to.

Were the pockets by geography products type.

It was, say, a little bit customer by customers and some product types.

I probably wouldn't go too much more into it.

As to the top line, 2% is better than a number of other companies we've seen in the food industry and consumer products.

But we've seen weaker-than-expected top lines across consumer products industry in the last -- well, quite fairly this year, are you seeing anything in the overall environment for consumer products that is weakening sale.

People talking about trade deloading, others including yourselves [INAUDIBLE] rationalization?

Are you going to see anything in the overall environment?

I probably wouldn't want to comment particularly on overall environment.

I think what we have said all along is we believe that the 3% to 4% ongoing organic growth is a good number for us in terms of how we want to balance top-line sales, improve margins and returns to get it to long-term 9% to 11% EPS growth we have been talking about.

I think the important thing for us is we have a category that is up 4% on a year-to-date basis, and that excludes Wal-Mart.

Which we know Wal-Mart is growing a very good clip, and we're exceeding their same-store sales, we did for the quarter.

I think we feel pretty good about the long term - continue to feel pretty good about the long-term transfer of this particular category within the overall snack market.

If I could ask just one last question, please.

On the guidance that it might be higher than that, 9 to 11, that's mainly coming from smarter spending, from Frank's working capital management, obviously major gross margin improvements.

Anything you'd care to highlight there?

Those are pretty much it, David.

I mean, the gross margin improvement, you know, with the new guidance, is a much bigger expansion than we anticipated earlier.

We're also getting savings from project fitness, the realignment project that we've called Project Fitness, relative to GNA type expenses.

So a combination of those things allows us to expand our EBIT margins and with the second half acceleration in sales it all works together to give us confidence that we can be slightly above that 9% to 11% long-term goal.

On the gross margins, is that spending less or spending smarter?

On gross margin?

Yeah.

Well, those are essentially -- you know, this quarter they were essentially a combination of better product mix.

Right.

Better supply chain costs, particularly raws and packaging and also a little bit better price organization.

So it's the combination of all three of those things.

Thank-you very much.

Sure.

Your next question comes from Eric Katzman with Deutsche Bank.

Good morning, gentlemen.

Good morning, Eric.

I have a few questions here.

First -- not to focus too much on the details because obviously you guys are doing well.

But organic sales, are you talking volume plus price, plus mix?

Volume alone?

What exactly do you mean by "organic sales"?

Yeah.

We mean basically our brands without -- If you take our base business, Eric, and you exclude the stuff that we sold -- the brands that we sold, that make its our organic business.

And as I said earlier, the growth -- that 2% growth is essentially split half and half between volume and price realization.

Half volume, half price?

And now, you were kind enough to give us the U.S. business, being up 2% in sales.

But I -- because the domestic business is such a small percentage, that must have collapsed in the quarter.

Is that fair to say?

Because you said the total was up --

No.

The international business or rest of the world was off in mid-single digits.

And then -- I guess the -- the one question I had, which I don't understand in terms of the category growth, if I remember correctly, when we reviewed the first quarter, the category was kind of flatish.

And now all of a sudden, we're seeing year-to-date, it's up 4%.

Again, using IRI data, which obviously is less than perfect.

But still, does that mean that the second quarter was just a huge rampup?

And what would account for that?

Yeah, Eric, there are a couple of things.

First, as I was trying to define during the presentation, the data that we're reporting on -- because we have good, accurate data now for convenience stores, is really IRI data that takes all four pieces of food, drug, mass merchants, without Wal-Mart and convenience stores.

Convenience store retail sales have been growing at a faster rate than the other three pieces.

So -- at almost four times the rate of the other pieces.

So what -- maybe we gave you a little bit of apples and oranges, because this time and from here on out, given that we have the good data from convenience stores, we're reporting all four of those channels.

And with those four channels, that's why the year-to-date numbers are quite good with the category being up 4.4% and convenience stores being up much more than that.

Does that help explain it for you?

Yes.

Thank you.

And Eric, as we said in the first quarter call, the reduced universe of FDMX and X excluded Wal-Mart, represented less than 50% of category take-away.

Adding in C-Stores, which accounts for roughly 15 or there about % of take-away, is a very important piece.

And it's a piece we said we are going to emphasize and we are doing much better in that outlook than we have in previous quarters.

That's why it's important to represent FDMXC because it's important for the catagory and it's part of our strategy.

Okay.

That's fair.

I'm not sure how you're thinking about Cap-X and depreciation for this year and possibly next.

Maybe, Frank, you could give us some kind of outlook on that?

Sure.

On DNA, Eric, the first 9 -- I mean, the first 6 months that was about 90 million dollars in round numbers.

And we expect that to be -- you know, to double for the second half.

So for the year, DNA should be in the 180 to 185 million range.

Cap-X, I think the earlier guidance I had given you was that it would be about 165 million, give or take a little bit.

I'd like to reduce that guidance to about 140 to 150 million for the year.

Okay.

All right.

I'll yield the floor.

Thank you.

Thank you.

Your next question comes from Rometha Malley with Goldman Sachs.

Good morning.

Good morning, Rometha.

I apologize if you have answered this already.

But of the organic 3-4% top line growth, should we assume it's half volume half mix, similar to the second quarter?

That would be a good assumption, Rometha, yes.

When I was looking through the Cadbury release last week, it talked about licensing revenue from Hershey being down 16%.

Can you comment on that?

You know what, Rometha -- I did not see it.

I did not see it.

So I will not comment on it.

Then again a big piece of the Cadbury business can be around some of the holidays and we'd have to look into that.

But nothing particularly different going on in those brands?

No.

Not from our business.

That is a small part of our portfolio.

And again, we had 2% domestic growth in our business.

And Rick, Wal-Mart is testing these candy store concepts.

Yes.

How involved has Hershey been in helping them understand the category?

Very much involved.

Obviously like most other CPG firms be, we have a team in place, working closely with them, as we have been.

Not just on a seasonal program, but in terms of better merchandising the entire catagory for all stores, so we are involved.

In helping set up those stores in particular, right?

Yes.

Okay.

Great.

Thank-you.

Your next question comes from Bill Leech with Banc of America Securities.

I have two questions.

Rick, it looks like your after tax margin will key 10% this year for the first time, what do you think is a realistic objective for the company over the next three year.

And second, I was wondering if you could talk about your potential interest in the Adams business.

On the first question, Bill, it should exceed 10% for the first time.

I think the mathematical calculation you need to make, -- frankly, with the top line growing at 3-4% and EPS growing at 9-11, it'll keep improving every year.

Obviously it can't go on forever.

Otherwise you'll get to 100%.

We're see -- saying for our outlook for the foreseeable future as we talk about our strategy going forward, that is, in fact, the guidance we've given you.

And that's 3 to 4% top line.

And 9 to 11 bottom line.

So the math becomes easy.

So you don't have a specific objective a couple years out?

No.

Just to continue to improve it every year by that difference.

The second question was regarding, I think you mentioned, Bill, in terms of Adams.

And we've all heard the same rumblings, you know, when and if there is something there, we will decide if it makes sense for us to look at or not.

I think the important thing is strategically, we've said all along, that we have our plans in place to build a foundation through solid, profitable top-line growth.

And as other opportunities present themselves, we will see if it makes sense for us, clearly from a strategic and a financial standpoint.

But no specific comments whatsoever on any one particular aspect that might be out there or might not.

Okay.

Thanks a lot.

Thanks.

Your next question comes from Andrew Laczar, with Lehman Brothers.

Good morning.

Good morning, Andrew.

I think the 3% organic growth rate in the third quarter is probably a lot, based on what my two kids ate at Hershey Park this past weekend. [ LAUGHTER ]

Did they buy it from a scanable outlet.

That's the important question.

I don't know, what you consider Chocolate World.

Oh, yeah that counts.

There you go.

Just a quick thing.

On the more favorable product mix that you saw in second quarter, is there any reason to believe that that type of product mix doesn't continue into the second half?

I know the second quarter can be a little odd in terms of if it's a small one, not particularly high in terms of seasonal activity.

But the type of improvement you've seen in product mix.

Would you expect that to continue in the second quarter even with higher level of seasonal merchandising?

I think that's the point, Andrew, with the seasonal business, the mix we believe will continue to improve, but perhaps not improve at quite the same pace.

Although, our expectations for the second half is that our increases will be pretty much split, half volume, half mix.

Andrew, a couple of things.

If we are able to continue and believe we will, the improvement in our C-Store business, which is obviously a higher margin and higher net selling priced business, as well as we start to restore and it won't be until well late in the fourth quarter, our gum performance with the new items and continue to see growth in our mints business, which has done very well behind the introduction of our cinnamon ICE BREAKERS in the early part of the year.

We should continue to see, albeit not perhaps to the same extent given your refence and Frank's regarding the packaged candies around the season.

But some improved mix margin.

I'm trying to get a sense.

And I think it's pretty clear from your performance and your comments, some of the longer-term strategies that you put in place, even though it's in the second quarter, if you're starting to see traction from it as you move forward.

That's a great point, Andrew.

And it is.

Okay.

I appreciate it very much.

Your next question comes from John O'Neil with UBS Warburg.

Good morning, everyone.

Good morning, John.

Just a follow-up on the comment on the reduced capital expenditures.

Are you deferring some things into next year or are you finding that this 140-150 is likely to be a new, on-going run rate.

Our run rate generally runs about $130 million for most domestic projects and sometimes our total capital spending will get up to 150, 160 million dollar level as a result of major new projects.

And I think we've had a little bit of a slowdown in major new products because we're focusing on our platform brands.

So the kind of new items we're introducing are really extensions of those brands.

So this year, I think we'll see that drop off.

But on an ongoing basis, 150 to 160 million is probably the right place to be.

Great.

Thanks.

And then if we look at the gross margin expansion, you've given several reasons for it.

How much would you attribute to lower cost of goods as opposed to changes in mix of pricing?

All three of the things that I mentioned, John, are contributing in a reasonable way.

So rather than try to pick it apart at this point, just assume all three of those.

Mix, as I mentioned earlier, the better supply chain costs, particularly commodities and packaging costs.

You know, all those things are contributing.

And all three of those things are also expect be to be favorable next year as well, right?

I didn't say all three of those things, but I certainly made the comment on our total --

Well, you can comment on the other two if you'd like.

Well, we'll get our act together for next year.

And hopefully we can continue to improve the mix.

Okay.

And then with marketing flat in the quarter, can you talk about how much you're looking to increase marketing or looking to increase at all or a percentage of sales in the back-half of the year?

In the back-half of the year, it's expected to be up versus the back-half of 2001.

And again, it's behind our strong seasonal programs.

We're seeing increases in both advertising and consumer promotion.

Behind our seasonal emphasis.

But again in support of the new items that we have planned in the back-half.

I would rather not get into the specifics.

But it'll be up in all key elements of the marketing mix.

But equally as important is we're continuing to learn how best to spend behind our brands and our marketing mix model.

Obviously some of that work paid off in the second quarter and will continue to pay off in the second half as well.

And Rick, you've already talked about some new marketing programs for the back half.

You mentioned new products.

Can you talk about new product activity in the back half?

Yes.

Specifically I'll highlight that too in the gum area.

That was one of the areas of short-term weakness in the first half.

And new products have been a key growth driver for the gum segment.

And Hershey has been absent in this area.

But most important, the one product that I did mention, the Carefree Coolers is number 3 on a year-to-date basis on the top 10 fastest moving new items in food, drugs and convenience stores and we're introducing two new flavors of Carefree Coolers in the back half of the year, eliminating Watermelon.

And then most important, behind one of our key brands Ice Breakers, we're introducing Ice Breakers Unleashed which is a blister-pack tablet type gum in three flavors.

That's on the gum side.

And on the other part of the business, we have a lot of new items on our Bites platform in terms of Bites-to-Go, Pretzel Bites, we have a bonus Bites package as well.

So we're very pleased with the Bites platform with what we're going to do to get some growth out of that part of the franchise.

We also have the continuation, third quarter of limited edition Kit Kat which comes on the heels of the very successful limited edition Kisses, and we also have at the back part of the year, as I mentioned, or in time for Back-to-School and Halloween, the new sizes of Fast Break.

And a bonus Reese pack, three cups with one cup free, so it's 3 for the price of 2.

And then feel good about those efforts well as well.

Terrific.

Thank-you very much.

Your next question comes from Richard Diamond with Edward Capital.

Good morning.

Two quick questions.

One is, when you talk about convenience store growth, how much is same-store sales?

And how much is increased distribution do you break that out when you talk about organic growth and convenience store.

Most of that would be same-store sales, as versus new distribution because we -- when I give you the velocity of our new items on Fast Break as well as the Carefree Coolers, those are adjusted for distribution.

So that's on the velocity basis.

And clearly we've seen a dramatic increase in take-aways on our core brands, whether it be Reese's or Hershey's, etc., those have been in distribution for obviously a long time.

So that would be increased velocity from the existing outlets.

The next question is just talking about '03, in terms of modeling, I'd just like your thoughts on how I should focus on top line growth, both organic and non-organic, domestic and international for '03.

Thank-you.

Yeah.

At this point, Rich, and I guess the guidance would be - auto assumption would be about 3% to 4% top line growth, organic.

And relative to the U.S. business versus international, I'd have about the same kind of split for right now.

When you say 3- 4% organic, that means on the 50% of the business that represents organic iconic growth --

No.

Oh.

That's total?

All our businesses are organic.

Saying it's going to be 3% to 4%.

If we were to sell off a couple of minor brands, it's making the comparison properly to eliminate those minor brands.

So you can assume our base businesses that exist right now are goals going forward for growing that base business 3% to 4%.

All we're -- saying, we say organic, we're excluding those businesses divested from both years so that it's really a like-with-like comparison.

The other reference was our core brands imbedded in that organic business was more than 50% of the contribution.

Thank you very much.

I appreciate it.

Hopefully that helps.

Your next question comes from Leonard Teitelbaum with Merrill Lynch.

Good morning.

Good morning, Len.

Just a couple of questions, please.

Could you comment on the pipeline status as it exists at the end of the quarter coming into July, versus normal?

And were there any delayed shipments because of the strike that may have gotten push said into Q3?

Relative to the end of the quarter, Len, we don't see any reason to believe that there is anything extraordinary for pipeline at the end of the quarter.

And if we had to look at some delays in shipments, it probably accounted for round numbers, 8 to 10 million dollars, maybe 1% of sales.

So sales would have been 1% higher or 1% of sales would get shifted into Q3 from Q2?

Roughly.

The sales would have been about 1% higher had we shipped those out.

Okay.

C-Stores.

Obviously there was some reaction by Nestle and Mars when you went in there, Rick, for the first six months of the year.

Has that quieted down now?

We're seeing very good take-away of our business within C-Stores.

And as I said before, we're seeing good growth in C-Stores in gum and mint, which plays a little bit less so for the two particular competitors that you mentioned.

And as I answered in one of the questions earlier, there are still pockets of some competitor activity.

But again, year-to-date particularly, our C-Store business is up on a take-away, 9% versus 4% on a 52-week basis.

So we feel pretty good about where we're headed.

A lot of work ahead of us, obviously.

We had margin squeeze because of the competitive nature.

Should we looked for stable margins from the first half into the second?

Or is it possible to see those margins widening a little bit?

In the second half, we expect widening margins compared to second half.

I'm talking C-Stores now, Frank.

And we promoted pretty heavily in the first half of the year in C-Stores.

Now we're down to pockets of resistance.

Is it logical to assume, it's a pretty significant part of your distribution -- we could see margins start to expand in that area, or are you going to keep the pressure on for the rest of the year.

There's a couple of things.

First off, the fact that we had gotten more active in the first half of the year.

We also received some incremental promotional support from C-Store operators.

And again, sometimes they'll contribute some for the promotions.

Sometimes we will.

So what I'll say in the second half, we're going to continue with our efforts.

And the fact that we have some new products going into those channels, specifically into C-Stores, specifically such as gum.

We are going to spend what we think is the appropriate levels.

But we also see good momentum.

So I don't want to comment specifically.

But we haven't seen, at least through the second quarter, some of the same levels of competitive activity that we might have experienced back in the first.

Seems to me that you have an ace in your pocket with that.

But I'll let that pass.

The new product change that you put through, Rick, seems to be working, we're going to have more frequent smaller products rather than loading on one big one.

Is it more expensive to do it that way?

Or are you getting the same lift out of the products that you've gone through a couple of times today than you would say, on a Fast Break on a year-to-year business.

There's always going to be the big bang with the one new product.

But I think we have become a little bit too immersed in every two years coming out with one new product.

And we're more involved with the calendar with new product activity as opposed to what makes sense for our scale brand.

And to answer your question, it's a very effective and efficient way to do it, the way we started to do it.

Because you take a item such as Kisses, and in the second quarter which had typically quote, unquote a trough, in fact for those six months of the year, the top 15 items, yet you come in with something like limited edition Kisses and that brand is well up in both IRI as well as within our shipment.

So emphasizing our scale brands, we know we have a little bit of a competitive advantage and being able to get those through our system both from a supply chain as well as easily merchandise our sales force, we think is the right way to go for now.

Frank, just a tax rate for the full year, 36.7 in both the third and fourth quarters?

Yes.

That's right, Lenny.

And rationalization, is that pretty much over now?

I know there will always be tweaking of SKUs.

But you've alluded several points in the past that there may be some brands that just aren't on your new intelligence system you've got in there, may just not make it.

Is most of that heavy lifting done?

Or should we look for some, let's say meaningful percentage changes by the end of the year?

I would say most of it is done, Lenny.

There will continue to be tweaks as we look at the SKUs for each brand and each pack type.

But for the most part, as you called it, the heavy lifting kind of stuff is over.

Thank-you very much.

And try to beat the expectations a little better next quarter.

Thanks.

Your next question comes from Mitch Pineiro with [INAUDIBLE] Montgomery Scott.

Most of my question has been answered.

But I do have a couple.

One, Frank, with regard to working capital, what do you expect to happen in '03?

Do you expect to see further reductions there?

Or is it going to sort of flow in-line with sales?

Mitch, I would not expect further reduction on the raw materials part of it because we took out a fair chunk, about a third of our raw material.

On the other hand, I think we can do -- and maybe we demonstrated it during the second quarter, inadvertently, that we can do a better job with finished goods as we build up the seasonal business.

So I would expect us to do a better job in '03 of finished goods, although not necessarily in the second quarter of '03.

And that's where I think we can keep getting some benefits.

Without looking at your balance sheet, what is the ratio between raw materials and finished goods?

It really depends on time of year.

But year end it used to be about 50-50 and then we took a major reduction in raws.

So finished goods would represent more like 60-40 these days.

Okay.

What about -- where do you stand now with your distribution centers?

Is everything complete?

Yes.

Okay.

And when did that happen?

What was -- .

The big Southern Cal distribution systems was up and running in the end of 2001.

Okay.

So that's -- completely -- anything else planned there?

In other words, --

Well --

No?

The system, and maybe and look at the midwest.

But for the most part, the major stuff that needed to be done is done.

And we're starting to get the savings flowing obviously from the big distribution center in Hershey that opened a couple years back.

And then the Southern Cal distribution centers is helping us this year.

Okay.

In terms of having confidence in your back half on the sales line, how do you have confidence, you know, the competition and not knowing what they intend to do?

I mean, is that -- does that mean -- I mean, as your guidance in the 3 to 4 area, is that giving yourself some leeway?

Or do you have some strong insight into the competition?

There's a couple of ways.

As I had said earlier, if you think about our domestic business, which was essentially flat in the first quarter, up 2% in second quarter, despite the work stoppage during the quarter.

And then as we looked toward the second half, what we're looking at is how our customers have responded to our Back-to-School, Halloween initiatives and the orders that are coming in and the planned promotions.

Also, the big brand focus that we have in all outlets and continue to focus on our C-Stores we're guiding ourselves and focused on that 3% and 3 to 4% of organic top line sales growth.

Okay.

So it's coming from your customers at the moment?

I mean, I guess the ultimate will be what the take-away is from the customer.

Right.

And we've seen take-away from our business chocolate specifically.

And that's obviously the largest, most profitable segment.

And then C-Stores and then the new efforts on gum we feel good about.

Gum is a small portion of our business, but we, it's one that we feel we could be more competitive and do a better job in satisfying consumer needs which we're working on.

And finally, the grocery business, how big is that now?

And how did that do on the quarter?

The grocery business is a relatively small portion of our total business, Mitch.

It's under much less than 10% of our business.

And it's essentially flat.

It's a good contributor.

With items like Hershey's syrup.

Okay.

Good enough.

Thank-you very much.

Thanks, Mitch.

You have a follow-up question from Terry Bivens with Bear Stearns.

Mine was answered.

Thank-you very much.

Okay.

Thanks, Terry.

At this time there are no further questions.

Do you have any closing remarks?

Hearing no more questions, we'll conclude today's session.

Mona Fern and I will now be available now to answer any additional questions you may have.

As a reminder, our third quarter sales and earnings release conference call will be held October 17th.

Thank you for your interest and good day.

Thank you for participating in today's conference.

You may now disconnect.