好時 (HSY) 2004 Q2 法說會逐字稿

Good morning.

My name is Amanda.

And I will be your conference facilitator.

At this time, I would like to welcome everyone to the Hershey Foods Corporation quarterly earnings conference call.

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

After the 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.

If you would like to withdraw your question, press star then the number 2.

Thank you.

Mr. Edris you may begin your conference.

Thank you, Amanda and 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.

Rick will provide an overview of the company's performance for the quarter.

Frank will provide the specific details and then we'll take your questions.

We welcome those of you listening via the webcast.

Let me remind everyone who 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 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 10K for 2003 filed with the SEC.

If you have not seen the press release, a copy is posted on our corporate Web site, www.Hersheys.com in the Investor Relations section.

Included in the press release are the 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 this non-GAAP measurement as a key metric for evaluating performance internally.

This non-GAAP measurement is 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.

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

Rick?

Thanks, Jim and good morning.

I'm pleased with our results for the second quarter as they build upon the momentum from early in the year.

We delivered solid top-line performance as we continue to shift the portfolio to higher margin on trend items.

This sales growth combined with further productivity gains to deliver record profitability and returns.

We remain committed to achieving balanced, sustainable performance over the long-term.

In terms of specifics, net sales increased by 5% as a result of favorable net price realization overall and solid unit volume gains on higher margin items.

Our innovative platforms such as Swoops, Hershey's one gram sugar carb, Ice Breakers liquid ice and caramel Kisses were key drivers of the sales growth.

Importantly, we continue to benefit from value-added limited editions that leverage Hershey's advantage brands.

During the quarter, limited edition varieties of Kisses, Kit-Kat, Hershey's, and Almond Joy were solid contributors.

A key component of the sales growth was better utilization of our trade funds as we gain further traction behind our revised straight promotion structure.

We're investing in those customers that are supporting both the categories and our brands.

In addition, we're now benefiting fully from last year's sales force restructure in terms of better allocation of retail coverage.

The combination of relevant product news and effective retail execution expanded Hershey's market leadership.

Given the Easter timing shift within the quarter, the 13-week information is less relevant.

Therefore, I'll provide retail take away and market share performance for the quarter, the most recent eight weeks and the year-to-date period.

In all three time periods, Hershey experienced strong take away and share gains.

In channels that account for about 80% of our retail business, take away increased 2% for the quarter, was up 7% for the most recent eight weeks, and is up 4% through the first half.

As a reminder, these channels include food, mass, including Wal-Mart, drug and convenient stores.

In the reportable FDMXC universe, which excludes Wal-Mart, we gained 0.2 share points during the quarter.

For the most recent eight weeks, market share has increased by 0.6 points.

We're increasing take away in gaining share in the more profitable outlets where consumers are increasing their shopping trips, such as convenient stores.

During the quarter, we experienced an 11% increase in convenience store take away with a market share gain of 1 full point.

This brings the year-to-date C-store growth to 12% with a 0.9 share point gain.

Our share gains were broad based.

We increased our leadership within both the chocolate and the non chocolate segments.

The introduction of Ice Breaker's liquid ice resulted in a substantial improvement in our position within the intense mint segment.

This product form represents a good future growth platform.

We continue to experience favorable price realization at retail.

This is the result of our new products and continued emphasis on higher margin, single-serve items.

Our loose bar business achieved a 40% share of the segment through a combination of higher net price and an increase in real unit volume.

On a year-to-date basis, loose bars are up 10% in take away.

Regarding brand support, total spending was up 4% versus year-ago.

More efficient spending resulted in a slight reduction of 30 basis points on a percentage of sales basis.

We continue to focus on customer-specific events that are brand-oriented.

While television advertising is important for product news, the ability to get tailored customer support behind our 360-degree initiatives provides the most impact.

Two examples are Jessica Simpson for Ice Breaker's and Talia for our Hispanic initiative.

The combination of solid sales growth and supply chain productivity yielded a gross margin of 40.3% up 100 basis points versus year ago.

We're clearly seeing the benefits of our SKU rationalization efforts.

Diluted earnings per share on a pro forma basis increased by 18%.

In a moment, Frank will provide more specifics regarding the income statement.

Turning now to the remainder of 2004, our second half efforts will continue behind the key strategic growth areas of taste, convenience, better for you, and market segmentation, notably the Hispanic opportunity.

Within the benefit area of superior taste, we'll be introducing inside-out varieties of both Reese's and Kit-Kat.

White chocolate Kit-Kat will now become a permanent item based on the success of white chocolate Reese's Peanut Butter Cups.

We'll have a new line of Hershey's miniatures called nut lovers, an assortment of four different nuts and three different flavors of chocolate.

The big news, however, is the national introduction of Hershey's take 5.

This is a major new single serve bar that's a blend of five snacking favorites, pretzel, peanut butter, caramel, peanuts and, of course, rolled in Hershey's chocolate.

Take 5 launches in late fourth quarter and delivers against consumer's desire for a salty, sweet snack.

Hershey's snack bars and take home packs, which combines chocolate, crispy rice, and other wholesome ingredients began shipping this month.

A single serve item follows in the fourth quarter.

Turning now to the better for you area, Hershey's one-gram sugar carb bar has been a cost effective approach to capitalizing on this fast-moving trend.

We're expanding the low carb platform in two ways.

First, we're adding Reese's and Hershey's dark chocolate to our one-gram sugar carb lineup.

Second, we're introducing a four-variety packaged candy line called carb alternatives.

These products have 50% fewer carbs than their regular counterparts.

Hershey's Smart Zone, our alliance with Dr. Barry Sears, the creator of the zone diet, remains on schedule for a late third quarter introduction.

The total better for you area will continue to be a major growth initiative no matter how or when consumer needs evolve.

In the area of convenience, we're adding two flavors, cinnamon and spearmint, to the successful Ice Breaker's liquid ice platform.

Also, Ice Breaker's duel packs, combining both gum and mints in the same on the go packaging, will be expanded.

We're bringing greater convenience and innovation to the non chocolate segment.

We're introducing several new items under the Jolly Rancher and Twizzlers franchises that are single serve and can be merchandised at the check out counter.

JR Rocks will be in convenient tubes similar to mini Reese's pieces.

Turning to the last area, the Hispanic opportunity, our alliance with Talia, the popular Mexican actress and singer is gaining momentum.

We will build upon the success of caramel filled Kisses by introducing Dose' Delecte filled Kisses one of the four co-branded Hershey and Talia items.

In addition, we're introducing a very unique white-covered wafer product Tahita Elegancita wafer bar of format very popular with Mexican Hispanics.

In terms of our seasonal efforts, we have solid plans in place to hold or gain market share while improving overall profitability.

We've decoupled back-to-school and Halloween so as to capture two distinct merchandising opportunities.

We expect back-to-school, Halloween, and holiday shipments to be about equal to last year, which is very good when the seasonal compression is considered.

While seasons remain important, we achieved greater price realization from our everyday and single serve businesses and from new items.

Given that profit margins track closely to average selling price, higher price utilization usually translates into higher profitability.

Nonetheless, the second half of the year has a much stronger seasonal orientation and will be impacted by retailer's actions and competitive pricing pressure.

We will remain disciplined and will not chase unprofitable seasonal sales.

Therefore, Hershey's sales growth for the second half of 2004 will be within our long-term 3 to 4% range, bringing the full-year growth in at slightly above this level.

In terms of profitability, diluted earnings per share on a pro forma basis for the second half will be within our long-term 9 to 11% expectations.

For the full year, we expect it to be slightly above the 9 to 11% range.

Now Frank will review the quarter's results in greater detail.

Frank?

Thank you, Rick and good morning, everyone.

I'm very pleased to discuss our second quarter results.

In order to give you the proper perspective on our business, I'll be discussing our second quarter results excluding the reduced tax rate in the second quarter of 2004 and the restructuring and realignment charges in the second quarter of 2003.

Elimination of these items would yield adjusted earnings per share diluted of 33 cents compared with 28 cents in 2003.

An increase of 17.9%.

During the second quarter, we had a non cash reduction of income tax expense.

This resulted from the settlement of IRS audits for the 1999 and 2000 tax years as well as from resolution of a number of state audit issues.

Based upon the results of the audit and our judgment of current tax risks, the adjusted income tax -- we adjusted income tax contingency reserves.

The result was a reduction to income tax expense of $61.1 million and a reduction to goodwill on the balance sheet of $12.6 million.

A substantial portion of the income statement impact relates to acquisition and divestiture tax reserves and the interest that accumulates within the tax reserve for potential assessments.

In our judgment, the remaining tax reserves are adequate for future tax contingencies.

In the financial statements which were part of the press release this morning, you may have noticed that we reported two basic EPS numbers.

Let me explain.

In March, the financial counting standards board approved a method for reporting basic EPS for companies which have more than one class of stock.

We are now required to compute a separate basic EPS for our common stock and class "B" common stock.

This method of calculation resulted in a second quarter basic EPS of 34 cents per share in the common stock and 31 cents per share on the class "B" stock.

The difference, essentially boils down to the different dividend rate paid on the two classes of stock or about 10%.

This change does not apply for computing fully diluted EPS.

The earnings metric on which the market focuses and the metric I'll be discussing today.

Now I'll review the financial results from operations from Hershey's second quarter.

Record consolidated net sales for the second quarter of 2004 increased by 5.2%.

As Rick mentioned earlier, this sales performance was achieved primarily through unit volume growth, which was stimulated by the introduction of innovative, higher margin new products and limited editions.

We also saw some benefit of pricing, a carryover from the price increase of December 2002, which was not fully utilized -- not fully realized until late in the second quarter of 2003.

As we have stated on many occasions during the past year, one of the major challenges for us in 2004 is significantly higher commodity costs.

Despite these higher costs, adjusted gross margin continued to show improvement.

In fact, as Rick mentioned earlier, by 100 basis points.

Coming in at 40.3% versus 39.3% in 2003.

About 2/3 of this gross margin expansion came from improved productivity throughout the supply chain, of course, driven by unit volume growth and about 1/3 from a better mix of products and pricing.

Adjusted selling, marketing and administrative expenses decreased 30 basis points as a percentage of net sales, coming in at 23.4% versus 23.7% last year.

As a result of discipline in all spend areas and better targeted, more efficient brand support.

Adjusted earnings before interest and taxes of $150.9 million increased by 13.9% with a -- compared with the second quarter of 2003.

And the EBIT margin was 16.9% versus 15.6% last year.

A 130 basis point improvement.

Interest expense for the quarter was essentially flat compared with last year's second quarter.

Coming in at $15.5 million.

The effective income tax rate for operations in the second quarter of 2004 was 36.4%, down slightly from last year's 36.7%.

We currently expect this rate to persist throughout 2004 in regard to the ongoing operations of the business.

Record net income from operations of $86.1 million was 16.4% higher than the second quarter of 2003 and our net margin was 9.6% versus 8.7% last year.

Weighted average shares outstanding on a diluted basis for the second quarter were 261.7 million shares versus 264 million shares for the second quarter of 2003.

Leading to an EPS of 33 cents per share diluted, compared with 28 cents per share diluted for the second quarter of 2003.

An increase of 17.9%.

During the second quarter, we repurchased approximately 1.7 million shares of our stock for $75 million.

To date on our $500 million authorization, we have purchased 12.1 million shares or $425 million, or at an average price of $35.24 per share.

Thus, we have completed 85% of the current authorization.

Turning now to the balance sheet, at the end of the second quarter, net trading capital increased by $45 million compared to the same time last year.

The entire increase is related to higher inventories.

Part of it because of more costly ingredients and the rest from accumulating introductory quantities of new products.

On a rolling 12-month basis, however, net trading capital declined 100 basis points as a percentage of sales.

We do continue to focus on collection of receivables, control of inventories and expanding payables relative to the growth of our business.

Free cash flow's tracking pretty much as expected and should exceed last year's level by year-end.

Now I'll cover a few additional items of information frequently asked by many of you.

In the first half of 2004, capital additions, including capitalized software were $115 million.

For the full year we continue to expect capital additions to be about $190 million.

Depreciation and amortization for the first half totaled $94 million.

For the full year we also expect D&A to be about $190 million.

Dividends paid during the first half were $100 million.

As many of you know we have increased dividends annually for the last 29 years and our policy has been to increase dividends in line with earnings and cash flow growth.

That concludes our comments and now we'll be happy to take your questions.

Amanda, the first question, please.

Your first question is from John McMillin with Prudential.

Good morning, everybody.

Congratulations.

Thank you, John.

Good morning, John.

Thank you.

Seems like you're having a quieter summer than two years ago, Rick.

You should try reading the -- the new book "Candy Freak."

Have you read it?

I've seen it, yes.

It's cute.

You have a very underleveraged balance sheet, despite the share repurchases and I guess a dividend increase may be in the offing, but to what extent, you know, are you looking at acquisitions to staid leverage, I mean, Kraft earlier this week kind of hinted that maybe even Lifesavers might be around -- you know, just kind of what do you think the likelihood of Hershey making an acquisition is over the near-term?

I think, John, as you know, we don't comment specifically about any potential acquisitions or divestitures, but your point is one that we've talked about strategically if there's a business we think fits in with our overall strategic direction and we look at them obviously on an ongoing basis and we will make the appropriate move at the appropriate time.

But I'd prefer not to comment on any one particular business.

And just in terms of the sales growth in the quarter.

It was very good at over 5%.

So, you're basically suggesting your take away was only 2% for the 80%.

You know, some quarters you ship a little more than consumption.

Some quarters you ship a little less.

This does appear to be a quarter where because of some new products you might have shipped a little bit more, is that right?

Take a step back and that's why I think we look at the most recent eight weeks, because in another week or so, the shift in Easter this year versus last year comes out of the 12 weeks, so, you really have a one-week issue within the comparable thirteen-week quarters.

On a year-to-date basis, our take away is up about 4% and I think our sales growth is up maybe close to 5.8, maybe 6%.

So, that's pretty close.

You do have some inventory behind some of the newer items -- new items and then also we're seeing some growth in -- in unmeasured channels and classes of trade that we don't even report on.

Club is a good example of one where we're doing well on a year-to-date basis.

So, a little bit of it is inventory build, appropriately behind new products.

Some of it is also just the thirteen-week period inclusive of the Easter shift and a year-to-date basis, both sales and take away match up well.

And with the quarter-ending July 4, were there any extra selling days in this quarter?

No -- no, there really were not, John.

You may recall we had four extra selling days in the first quarter.

I said at that time that that really had no impact on our business and I think having a second quarter with essentially the same number of shipping days as last year is pretty much proof of that.

Okay.

Well thanks a lot.

Sure.

Thank you.

Thank you, John.

Your next question is from Chris Growe with A.G. Edwards.

Good morning.

Good morning, Chris.

Just a follow-up, those four extra shipping days from Q1, do those come out through the year at all, just so I'm clear on that?

Yes, we will have the same number of shipping days through the entire year and most of those will be in the fourth quarter.

Okay, that's what I was curious on.

Okay.

Well, that was obviously a great quarter.

I'm just curious, I guess, Rick, if you're seeing any real evidence of higher prices in your chocolate or non chocolate categories given some commodity pressure there?

Well, what we've said and we're saying is from a retail take away standpoint we're still experiencing some positive price realization, again, a lot of that is shifting the mix.

I think the other question is what type of competitive activity are we seeing and we will see pockets of competitive pricing pressures, primarily on some packaged candy items and a little bit on loose bars.

That's in selected customers within the food class of trade, but we're not seeing broad pricing pressure one way or the other.

And therefore not seeing higher prices, if anything, you're seeing a little more promotion there you're seeing.

In terms of --

Higher list pricing.

We're seeing a little bit at retail, but nothing dramatic one way or the other, Chris.

And I'm just curious on all these new products you have coming out, it sounds like a whole bevy of new products, especially in the third and fourth quarter, how should we think about your marketing investment, especially if you include slotting and I'm guessing a hot promotion as well in these next couple of quarters coming up here?

We expect our introductory support to be consistent with what it's been, we've introduced other items.

I think the way to think about it is limited editions require very little incremental support.

One of the benefits of limited editions, when a limited edition item goes out and a display-ready shipper within that shipper is the base brand as well.

So, we have seen a lift of the base brand, when we've been promoting limited editions which is why we continue to have a strategy of limited editions, it is a very cost effective way to bring news and excitement to the category from a consumer and customer standpoint.

The big new product entry that I mentioned, Take 5, that begins shipping in the end of the fourth quarter.

So there won't be any consumer support until the first quarter of 2005.

And then for snack bars and some of our other new items, that's all part of our ongoing advertising promotion plans.

Okay.

So, we won't necessarily see a spike in marketing promotions in the second half of the year?

No, on balance, Chris, particularly related to trade promotions, I would expect our rates will be fairly consistent first half versus second half.

Okay.

Thanks so much.

Thank you.

Your next question is from Pablo Zianek with JP Morgan.

Yes, good morning, Rick.

Just a question on this (INAUDIBLE) product.

What -- what -- what do you have in terms of channel?

Are you going to focus mainly on convenient stores initially?

Or are you going to be aggressively taking space at checkout counters at supermarkets?

And just give us a sense in terms of distribution and points of sale for that product?

And also, when I think of Smart Zone and snack bars, taking a three-year view, what percentage of your sales would you expect to be generated by those two products?

Thank you.

I think the important thing, taking a step back, we said we were going to get into the logical adjacencies and snack bars is one such execution of that, as well as the Smart zone bars.

We said we're going to go where the business is.

In many instances it's on the front end.

It's where other instant consumables are merchandised, it's also we're seeing a good volume for our instant consumables, whether it's on the front end of drug stores, convenient stores, et cetera.

So, think of our introductory distribution following where we've been able to see growth in our existing business.

I think the second part of the question, the second question was three years from now where do we see this part of our business evolving?

It's too early to tell.

We're in the early stages of getting into the adjacencies.

What we like about it is it leverages our core competencies of our brand franchises, certainly confectionery expertise and a terrific selling organization with broad distribution.

So, at this point we haven't said what's it going to look like three years, except that we do expect to continue to look for other opportunities within the adjacencies.

Okay.

And just a quick follow-up.

The Take 5 product, you know, I realize that's an adjacency, but it's more of a distant adjacency, right, that's going to go in a different aisle not necessarily in the chocolate aisle.

No, the Take it is a bar product.

It's closer in to our core chocolate.

Think of it as a -- a pretzel bar that has layers of caramel, peanuts, peanut butter, enrobed in Hershey chocolate.

So, it is in essence in that regard a chocolate bar, but what we like about it and at least what consumers have played back to us in our extensive testing is that it does bridge that gap between salty and sweet.

All right.

Thank you very much.

Thank you.

Your next question is from Evan Morris with Bank of America.

Good morning, guys.

Good morning, Evan.

Good morning, Evan.

I think I may have missed this, Frank, but the sort of the upside in the gross margin in the quarter.

How much of that was related just to volume versus other productivity initiatives?

We said about 2/3 of it was related to unit volume increases but -- but not directly unit volume increases, this is the impact that unit volume and productivity gains have throughout the supply chain.

So, it's 2/3 sort of supply-chain related but, of course, getting unit volume increases helps that.

And then roughly 1/3 coming from price and mix combined.

Okay.

But then looking into the back half of the year, would you expect to be more in line with your 70 to 90-basis point type target, as you're saying sales are likely to come more in line with your 3 to 4% range.

Is that a fair way to look at it?

Yeah, that's a fair way to look at it.

That's why we're still staying with the guidance for the full year of being closer to the lower end of our guidance range.

And as Rick said, the second half does have a little more reliance on seasonal business.

Okay.

And can you just, you touched on it briefly, but can you just break down the sales gain in the quarter?

You know, how much was volume, how much was pricing?

I think you've said you may have had a benefit from, you know, lower trade promotion and -- and Rick, if you can just talk, I guess incrementally, you know, what percentage of growth or what percentage of the volume came from new products, you know, let's say versus your core business, I don't know if you can break it down that far.

A couple of things, our trade expense was up slightly versus a year ago for the quarter and what's -- what we like about that is we're -- we're seeing continued effectiveness in our trade promotion category certainly showing up in merchandising and sales share and take away gains.

In terms of breakdown, I think you said between core and new, I don't want to get into the specifics of that, but a couple of things.

We saw good growth in some of our core brands, the limited editions, which is really a cost-effective extension off our core brands, did very well and then we had great new product contributions and the platforms are identified.

So it's really, there was core brand growth and then those other two contributed disproportionately.

Okay.

And then if you can just lastly break down between price and volume?

Or price mix and volume?

Well, it -- we -- we've already mentioned that -- that unit volume would have contributed about 2/3 of the increase and that --

Okay.

Okay.

Terrific.

Okay.

Thank you.

Your next question is from David Nelson with Credit Suisse First Boston.

Good morning.

Good morning, David.

Good morning, David.

I guess I wouldn't mind starting a bigger picture, please.

You see -- keep seeing reports of how the lower end consumer keeps getting squeezed.

Are you seeing any impact of that on your business and what might you be doing tactically to address it?

Well, if I understand the question, we've seen good growth in the more value-oriented class of trade, the dollar-type stores, maybe you're referring to that.

We're seeing some opportunities there.

And we had a very good item, which was our 10 packs, and as the price increase came through last year it made the 10 packs less profitable for us and we've scaled back on that.

It's important to know we're introducing an 8 pack and a 12 pack, which is going to give us a very good entry price point at that dollar price point and also a very good value at the 12 pack.

So we'll be introducing that broadly later this year.

I think that takes -- takes -- capitalizes on the opportunity for all of those who are looking for a value item.

I don't think that answers your question, David.

Yeah, I think it does.

On sales.

You know, up 5.8 in the first half and you're saying slightly above 3 to 4.

So, maybe a little slow down in the second half.

Is that mainly because of the four days?

And then also the lapping of the price increase?

No it has nothing to do with either of those.

What we said was that we had very good sales growth in the first two quarters and that we expected the second half to be more in line with our long-term expectations of 3 to 4%.

Which is still good growth in a category which grows about maybe 2% a year.

It has a lot to do with as we continue to see seasonal compression and as I mentioned, we expect our seasonal sales to be about equal to last year, which is good performance in light of compression.

And we also have some new items we're shipping, last year we also shipped Swoops and S'mores in the fourth quarter.

So it's really the mix of all of that that gets us more on line with our 3 to 4%.

Okay, that helps.

Just lastly, please, more on the accounting and the balance sheet.

Accounts receivable were down quite a bit.

Inventories up and then I'd like to ask a question on accounts payable.

Anything driving that accounts receivable decrease and inventory increase?

I guess it's the new products on the inventories?

Well it really -- what you're comparing, though is mid-year this year, David, versus the end of the year.

And it's not unusual at all, of course, to have that kind of shift on receivables, for instance, last year's receivables were 230 million.

This year's are 256.

So, you can't -- it's a little more difficult to compare to year-end if you see what I mean.

Uh-huh.

And -- and the same thing is true with payables.

If you compare apples to apples you will find them a little bit closer.

Just one last thing, then, please, on accounts payable.

General Mills talked about accounts payable going down because EDLP operators are asking for promotion funds to be taken off invoice instead of billing them for the promotional funds later.

Are you seeing that?

And should we watch that in your accounts payable line?

In payables or receivables?

You're talking about our customers, David?

Or our vendors?

Your customers.

Okay.

That would show up in receivables, then.

And --

Mills talked about it in the context accounts payable but I see what you're saying.

Yeah, I mean, it would be in the -- so, we don't see any great movement right now, at least in that direction.

And we'll just continue to, you know, to really focus on our receivable balances as we have.

Okay.

Thank you very much.

Sure, David.

Your next question is from Christine McCracken with MidWest Research.

Good morning.

Good morning, Christine.

Good morning, Christine.

Just on the number of new products that you're introducing, are you worried at all about SKU proliferation again?

And I'm not referring to limited edition, I'm really referring to, you know, you have a number of new products that are going to be core to your line and I know you,in advance of this, took some SKUs out of the line, we just talked about that earlier, but wondering what your view on this is and how do you keep that under control?

A couple of things.

One, is we've already gotten very good trade acceptance on many of the items in fact all of the items that I've talked about.

And when we introduce a major new entry such as Take 5, that's going to be a major brand for us and one that customers understand how we're bringing innovation to the category.

We continue as, you know, being category managers, or category captains for the majority of our customers, we continue to go through and discontinue many of our own items and -- and ensure that what we're doing is driving overall category growth as well as building our share.

So, we -- it's something that's very much a part of our portfolio strategy as it is adding new items.

Okay.

And then -- so do you have new systems in place to -- to track kind of ideal mix?

Or ideal tax size?

Or are you still -- are the retailers being more responsive to say going with, you know, kind of your list of SKUs rather than kind of specifying their own?

Well -- well, if I understand the question, we certainly work in collaboration with all of our customers and we have a category that's frequently purchased high household penetrations that's responsive to new items and merchandising so there's maybe more degrees of freedom for all the category participants, but I think what's important is we're bringing -- we're bringing in items on the success of existing platforms, if you think about Ice Breaker's liquid ice, we're introducing two new flavors, which capitalize on the success of the initial flavor.

When we come out with carb alternatives, which is a packaged candy variety of -- of lower carb confectionery items, it builds on what we've done with one gram sugar carbs.

So, the important thing is you're not just seeing item after item for proliferation, you're seeing items that are part of existing or new platforms that we're building and that's where the discipline comes in.

Christine, if I might add something to that, because you mentioned it a little earlier.

We do have new processes in place over the past year and a half or two, that basically force the discipline that Rick is talking about.

So we are continuously evaluating the line to make sure that it doesn't get reproliferated and as we introduce new items, some items have to come out of the line and so we'll keep to that discipline and not only is it to keep from getting more new -- more items in the line, but it's also to make sure that we keep the right mix of it so that our gross margins continue to expand.

Okay.

And then secondly, Kraft during its -- its meeting the other day talked about the low carb trend affecting their sales.

You're coming out with a number of new low carb products and yet we continue to read about kind of the plateauing or maybe the inflection point being reached here for low carb.

What's your take?

Have you seen any impact?

Are you trying to meet everybody's needs?

It's -- it's recognition that as people are talking about is it peaked or not, what's trend and what's fad?

We still continue to see very good customer interest and consumer acceptance of products that provide lower carbs.

And one gram sugar carb has done well and as the carb alternative that I talked about gets us into the candy aisle in packaged candy format.

And as I mentioned for us better for you is going to be a strategic growth platform, no matter how it evolves and whether it's one gram sugar carbs, carb alternatives, Smart Zone or whatever the next benefit is that we want to provide, we need to be in the game of better for you to better understand where consumer preferences are evolving.

It's somewhat analogous to maybe to, fashions, if you think about it.

Some fashions come and go, but fashion is always a benefit and something desirous with consumers and we'll continue to track consumer behavior and respond accordingly.

Great, thanks.

Your next question is from Eric Larson with Piper Jaffray.

Good morning, everyone.

Congratulations.

Thank you, Eric.

Good morning.

My question gets to your growth margins and your -- your continued improvement -- I think your long-term goal is 70 to 90 basis points a year and you guys admirably have been beating those numbers fairly consistently.

And now with your improvement in your marketing spend trade expense up, your operating margins were up 130 basis points in the quarter.

Maybe it's more appropriate to talk about operating profit margins rather than even growth margins.

What -- what can we look forward going forward on those numbers?

You've obviously had significant improvement.

What's left in maybe your marketing efficiency programs?

The way we look at that, Eric, is really embedded in our long-term guidance.

We -- we do expect year-end and year out, although it may not be the same every year, to improve gross margins in that 70 to 90 basis point range and -- and a -- while we've achieved a level of near 40 gross margin that certainly isn't the top of -- of the -- of whether it's the food group or consumer packaged goods.

So, we think we have a ways to go.

In terms of -- in terms of operating margins, it's almost -- you know, the math almost makes it work that way, right?

If we're looking to increase EBIT and have done successfully between 7 and 9% and you're expanding margins at the same time and expanding top line 3 to 4, we will continue to expand our operating margins as well.

So we see that long-term guidance still making sense for us and we're working very hard to achieve that, that set of guidelines.

Okay.

In your first half, if you look at -- we know you're up against, you know, higher commodity costs and particularly cocoa because of your -- just the differences in your hedging.

Would your pricing -- would your little bit of pricing offset part -- your commodity cost increase in the quarter?

The way it looks is that your margins will be even dramatically better given what we think we know what's going on with your costs.

Well, I've mentioned on a number of occasions that we have great visibility to that cost structure for the year and that we expect that cost structure, not just have visibility to it, but we keep it fairly constant through the year in the way we run costs through our income statement.

Our -- we have a variety of things that we've done this year to make sure that we offset the cost increases and at the same time expanding margins and I mentioned a number of those, of course, and that's better productivity through the supply chain.

Some of that, of course, coming from unit volume increases that we mentioned.

Some are, pardon me, better mix of our products continuing to shift to higher margin products like loose bars and going through channels, growing faster through channels that have that better mix of product.

Like convenience stores.

So, it's a combination of price, mix and then as we get the volume of a more productive supply chain.

Great.

Thanks, everyone.

Thank you.

Thank you.

Your next question is from Andrew Lazar with Lehman Brothers.

Good morning.

Good morning, Andrew.

Good morning, Andrew.

Rick, when you started at Hershey I think you had mentioned that the Company was, you know, I think it was the under indexed is I think the word you used in the very profitable C-store channel relative to channel market share in other channels and when I look at some of this data, you know, more currently, you know, given the action that you took in C-stores you know back when you had started, if certainly appears that you've obviously improved those market shares, you know, meaningfully in that higher profit arena.

First of all, do I have that right?

And if so, it just begs the question from me of, you know, how much more there is to do or upside you can do from a market share perspective, you know, in that key channel?

And then where it's going to come from, given it's been already such a key driver of your growth.

We have made very good progress from where the Gap was between us -- at that time it was FDM.

FDM just actually wasn't excluded at the time.

So FDM a few years ago and convenience stores there was more of a market share gap than there is today.

So we've made good progress.

I think the more important question is whether it's a 30 share in FDMX or 20 or 28 and change share in convenience stores, our relative market share advantage versus our next largest competitor is not nearly as wide as it is in other categories.

So that leads us to continue to believe that there's more than a share upside, not just in convenience stores, but certainly, excuse me, in food, drug and mass, as well.

If we continue within convenience stores to bring the right products at the right price points and most important, very tailored promotions to specific C-store groups, I think we continue to gain share.

Okay.

Thanks very much.

Thank you.

Your next question is from Leonard Teitelbaum with Merrill Lynch.

Good morning.

Good morning, Leonard.

Good morning, Leonard.

I just tried to work something here.

And I guess I'm just not getting it for some reason.

Frank I want to get this gross profit margin increased.

If we get a 3% growth in volume and a 9 -- translates into a 90-basis point or 100 basis point increase in gross margin, is there a linkage we can make for every 1% gain in volume is so much of the gross profit line or not?

No.

I don't think there is as direct a linkage or that easily measurable, but, you know, think about all of the fixed costs that are part of a supply chain and the absorption of those fixed costs as you increase unit volume.

That -- that helps raise margins automatically.

Right.

And then you add onto that the change in mix and the change in price and other profitability -- or other cost savings measures that we have throughout our supply chain and that kind of stuff all works synergistically.

But, yes, every time you get unit volume increase you ought to be having better absorption of your fixed costs so that automatically helps you with your margin expansion.

Okay.

No, I understand that part of it.

I guess what I'm trying to get to is that I think there's no question that this year we're certainly going to get the increase in gross margin given the unit volume growth.

It is so much better than the peer group that I'm just wondering are we -- are we drawing to a close and we ought to be looking for more like a 30 to 40 increase in gross profit, increase in gross profit percentage as we start to go through the next year or so?

Or could we still look for that say 90 to 100 basis points.

What we've talked about and we repeated it here, our ongoing expectations are 3 to 4% net sales growth, 70 to 90 basis points in margins. 7 to 9 in EBIT and 9 to 11 in EPS there's no change there.

I think what's important is that 4% sales growth, what makes up that 4%?

Is it a higher price realization, therefore higher margin loose bars?

Or is it seasonal novelties?

So think of it strategically as we continue to shift the mix to where consumers are going where we know we have greater opportunities for net price realization.

I think that's where we still feel there's opportunities on the -- on the revenue side.

The second part is, you know, the midwest distribution centers just coming on stream in the second quarter and we expect some benefits from that in 2005.

So we see further supply chain opportunities, which also contributes to the 70 to 90.

And that -- that -- that's very helpful.

Rick, you had mentioned at the outset that you want to decouple or break through the back-to-school and the fall season, if you will.

How do you see that playing out?

And then I have a question on the tax rate when you get done.

All right, this is the first year we did it.

We used to merchandise, we always called it a back-to-school Halloween as though it came at one time.

And we see opportunities with customers, if you think about when kids go back to school across the countries at different times, obviously in the south it's earlier than in the north.

So, there's opportunities to gain two different merchandising events, one for back-to-school in let's say early August or mid August and September.

And then the traditional Halloween, which is in September and early October.

So, this is our first -- our first attempt at this this year and we will see how it plays out and I bet it will work well with some customers and we'll retool it t with other customers.

So that's the perspective on why we decoupled the two.

And should we see results this year or is this going to be the ground setting for future years?

Too soon to tell.

Again, we're selling in the promotions now and by the end of the year we'll be able to know something about take away but that's when we'll be able to judge how well it worked.

Okay.

And tax rate for the last half of the year, Frank?

If you said it I missed it and I apologize.

Yeah, excluding, of course, any one-time events like -- like we just announced, we would expect it to continue to be 36.4%.

Okay.

The 85% completion on the share authorization mentioned, would you normally re-up that authorization at the same time you review the dividend or not necessarily?

The board on an ongoing basis reviews any type of potential capital structure decisions and we'll leave it at that.

Thank you very much.

Excellent quarter.

Thank you, Len.

Thank you, Leonard.

Your next question is from David Adelman with Morgan Stanley.

Good morning.

Good morning, David.

Is it still the intent, Frank to finish the share repurchase this year?

Yes, it is.

And secondly I didn't hear it, was the snack bar product, is that ship initially in the second quarter?

No, we just -- the snack bars -- the take home pack is just beginning to ship in July and then the single serve or instant consumable variety of that will ship in the fourth quarter.

And is the intent to merchandise that or position it within the food channel with other cereal bars?

Or is it going to be positioned in the confectionery area.

Well, what's good about that is it really is dependent on where the customer has their section and where they view this product as having the most appeal.

So even within the food class of trade it could be in the snack bar section or it could be on the front end and so for competitive reasons I will leave it as saying, we're working that on a -- on a customer-by-customer basis, but I think the important thing is we've gotten very good trade acceptance for all three varieties of the snack bars.

Okay.

And then lastly, Rick, you, as a company, had had an interest in either repealing or altering a Pennsylvania state law that had been earlier enacted that would have in certain circumstances limited some of your flexibility was that law altered or amended to your satisfaction?

They're still working on it.

And from where we sat, what we want to do is make sure that the Hershey Foods board of directors has the same flexibility as any board of any publicly traded company.

And that's really the essence for wanting to get that revised.

But no -- it has not been revised as of yet.

Thank you.

Thank you.

Your next question is from Terry Bivens with Bear Stearns.

Hi, good morning, everyone.

Good morning, Terry.

Good morning, Terry.

Just a couple of quick things, in the second quarter was there any drag on the top line either through the last remnant of SKU rationalization or, you know, perhaps with for an unfavorable comparison with the seasonal business a year ago?

Yeah, what we would have seen, Terry, is an increase maybe of another 100 to 125 basis points in the top line.

So, the SKU rationalization, which has, you know, come to an end but in looking at not -- not just SKU rationalization, but some of the gum products that we sold, had we excluded those from the base then we would have been up rather than 5.2, maybe closer to 6.5.

Okay.

Very good.

Secondly, I know it's early and I know we're in I guess the silly season with the Ivory Coast.

We saw a spike earlier this week in commodity costs, but if things continue on track and maybe the spike goes away and prices return kind of where they were pre-spike, is it too early, Frank, to get a read on whether cocoa costs will be favorable for you in '05?

You know, the way -- the way I would like to answer that, Terry, is basically -- you've got to look at our entire mix of commodities and other costs that are coming, you know, through the income statement.

Yep.

And you know, we study fundamentals pretty closely.

We have forward price cover on a variety of commodities.

Some farther out, some may be closer in.

For competitive reasons we try not to get overly specific on it.

But the way I would answer that is in general we would expect some modest inflation in input costs next year as companies are seeing pretty much.

But that could be commodities, it's benefit costs, you've seen what's occurred in energy.

I think the important thing, though, is while we may see modest inflation in these things, we've also demonstrated that -- that through, you know, a combination of levers as I called them last year, whether it's supply chain, productivity-related, or a mix of products and introduction of innovative, you know, new higher margin products, we're able to -- at least we've demonstrated we're able to recoup those costs and still expand margins.

So we'll continue to work on those commodities.

It is a little early, we are in the silly season for cocoa, obviously.

But we'll continue to assess it as we go along and -- and, you know, in summary we would expect some modest inflation that we'll be able to cope with.

Okay.

And then lastly, just on the ever popular use of cash topic.

I guess, Lenny, you know, has already asked about the authorization going forward, but would you be able to comment on whether there have been any discussions with the trust, you know, some -- some years the trust will come in when the price looks good and sell a big block of shares?

Any discussions like that that you would be free to talk about?

Can't comment on any of that.

Okay.

All right.

Thanks very much.

Thank you.

Thanks, Terry.

Your next question is from George Askew with Legg Mason.

Yes, good morning.

Congratulations.

Good morning, George.

Good morning.

Thank you.

Good morning, George, thanks.

Most of my questions have been asked and answered.

But is there any lingering legal issues regarding the use of the zone name for the Smart Zone product that launches late in the third quarter?

That's still in -- that litigation is still pending so I can't make any comments beyond -- beyond that.

But you're still on target for a late third quarter launch?

Yes.

Okay.

Okay.

And then the Take 5 product, is that going to be using the Hershey name?

I mean will it be Hershey Take 5?

Yes, it's Hershey's take 5.

Hershey's take 5.

Okay.

And then just on the commodity costs, you know, setting aside cocoa you talked about some of the other, you know, impacts driving general -- costs generally, but can you address some of the, you know, the -- the raw materials aside from cocoa that have -- and their impact, you know, peanuts, dairy, things of that nature, frankly.

Let me tell you where those stand, at least.

The peanut prices have generally been in the 40 cent area, while they may go up or down a couple of cents a pound, they're not going to be a major influence in -- in the cost structure in any given year unless you have a very, very poor crop and that does not appear to be the case this year.

Corn prices have gone up very significantly, they've back off a little bit.

Almonds is another, you know, commodity that we use a lot of.

Almond prices have spiked considerably but again, that doesn't really tell you necessarily the impact on our cost structure because we do have a tendency to be good forward buyers and look at -- at fundamental prices.

So, the way I'd like to leave that, George, is that, you know, we -- we go back to the statement I made.

We would expect some modest inflation, but not just commodities.

It's kind of a basket of, you know, the total broad basket of input costs that goes into products and we have various levers to deal with that.

Would you say that raw material costs have increased as a percent of net sales, you know, year-over-year?

Is there any way you can kind of give us that data point?

There is a slight increase as a percent of net sales this year and, you know, let's leave it at that.

Okay.

Well I tried.

Thank you.

[ Laughter ]

Your next question is from Eric Katzman with Deutsche Bank.

Hey, good morning, everybody.

Good morning, Eric.

Good morning, Eric.

Can't believe it but I actually have a few questions!

You know, Frito-Lay just kind of announced that their snack and Granola bar business hit a wall in the second quarter.

In subsequent conversations that I've had with them they've discussed the fact that category has slowed across-the-board.

General Mills and Kellogg both introduced new products at lower prices per unit.

So it looks like just as you're entering the snack and granola bar business that it is becoming much more competitive.

Now, granted it's a new area for you, but I'm kind of wondering how that figures in with your plans for that category, even if you if you did have good pipeline fill?

Or will have good pipeline fill in July.

Yeah, I think, Eric, that as we've continued to present these items for authorizations as I've mentioned earlier, we received good authorization and we are now securing merchandising activity.

We feel good about the activity that we have already scheduled and we're not in the "Granola bar" segment.

You know, we're in the broader snack bar and again, it's a -- it's crispy rice, chocolate and peanut butter, it's Reese's and the like.

We see it as a very good opportunity for us to extend our franchises into a relevant segment that consumers, at least on the testing we've done, have been receptive to, but it's like any adjacency or any segment that we're in, there's going to be competitive pressures, we see it in packaged candy we see it on loose bars yet we still find ways to grow our brand.

So I certainly am not reacting to anything specifically that a competitor might have said, but where we have distribution breadth -- and I think that's one of the benefits that we've talked about, is our retail ubiquity will give us merchandising, and points of distribution, and multiple classes of trade that many other competitors have more concentration within the food class of trade.

Okay.

Well, all right.

And then the second question kind of -- I'm just not really sure exactly if I understand you.

You said that promotional spending was up slightly so are you saying that that was a benefit to sales or it detracted from sales?

The trade promotion was up slightly as a -- as an expense so therefore it would have been a slight detraction from sales, but you're talking about just a few basis points.

Nothing substantial.

Okay.

And then, you know, from what I understand and I'm not sure how relevant it is to you, but I think it's important for some of your sugar products, that trans fats are going to be pushed or Wal-Mart is kind of requiring or demanding that no trans fat products be -- be in their store by January 1st of '05.

Does that affect any of your lines and have you had to make changes in your formulation to deal with it?

At the beginning I think we've even commented on this before, it's less than 5% of our total products would have to be labeled for trans fat.

In fact, the snack bars that we just talked about have been formulated so there is no trans fat in those products.

So, it's really a non issue for us.

Okay.

And then in terms of the share repurchase activity, you know, some of the other companies, Frank, have been willing to talk about at what point it is still accretive to buy back stock.

I mean you've made comments to me in the past that, you know, the -- the price move in accretion has become tighter and the stock has only moved up since then.

Can you kind of comment given the outlook as to where it becomes dilutive to be buying back stock or at least neutral?

Yeah, and, of course, Eric, you know that all depends on what the cost of that incremental money that -- that you're borrowing or if you have cash on the balance sheet it depends on, you know, where you're investing that cash.

So it's very, very accretive yet, much, much higher prices than where the stock happens to be right now if you assume, you know, current interest rates or even interest rates that go up 2 or 300 basis points.

So, it will continue to be accretive at much higher prices than the current, you know, 4, 5, 6, $7 price.

Okay.

And then last -- last question is, you know, some of us try to model beyond just one line item that you report in terms of top line sales.

Can you make some comments on how some of the other areas are doing like Canada, grocery, international?

Sure.

Canada, we're doing well in Canada.

And that's been a continuation of a trend.

It's gotten a little bit more competitive as Cadbury and Adams have come together, but we're holding our own in Canada and we have a good business there.

The other part within North America is Mexico and we're doing well within Mexico.

Brazil we have -- the only in-country operations we have in Latin America and it's small but we've seen some improvement there.

And outside of that there's really not much other business to speak of one way or the other, meaning doing extremely well or extremely poorly, outside of what I just highlighted.

Okay.

All right.

Thank you.

Okay, thanks, Eric.

Thanks, Eric.

At this time, there are no further questions.

Are there any further remarks?

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

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

As a reminder, our third quarter sales and earnings release and conference call are scheduled for October 21, 2004.

Thank you for your interest and good day.

Thank you for participating in today's conference call.

You may now disconnect.