好時 (HSY) 2004 Q4 法說會逐字稿

Good morning.

My name is Lisa and I will be your conference facilitator today.

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 No. 1 on your telephone keypad.

If you would like to withdraw your question, press star, then the No. 2 on your telephone keypad.

Thank you.

Mr. Edris, you may begin your conference.

Thank you, Lisa.

And good morning, ladies and gentlemen.  Welcome to Hershey's fourth quarter conference call.  Rick Lenny, Chairman, President, and CEO;

Dave West, SVP 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.  Dave will provide the specific details, and then, we'll take your questions. 

We welcome those of you listening via the web cast.  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 risk and uncertainty.  Actual results may vary materially from those contained in the forward-looking statements because of factors, such as those listed in this morning's Press Release and in our Form 10-K for 2003 filed with the SEC.  If you have not seen the Press Release a copy is posted on our Corporate website, www.hersheyfoods.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 measure as a key metric for evaluating performance internally.  This non-GAAP measure 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.  Hershey's results in the fourth quarter were excellent.

It represented a continuation of the  strong performance that we have achieved throughout 2004.  Net sales for the quarter increased by 7.5 percent, benefiting from new platforms, such as TAKE 5, Snack Barz, and Hershey's Cookies, and solid gains from our core brands. 

We maintained our excellent performance and instant consumables, particularly, in the high-growth, more-profitable customers and classes of trade.  Seasonal sales were in line with expectations and limited editions continued to be a source of profitable growth.  Our momentum at retail accelerated during the quarter as we gained market share in all classes of trade strengthening Hershey's category leadership position.  For the most recent 12 weeks, in channels that account for over 80 percent of our retail business, Hershey take-away increased by 10 percent.  As a reminder these channels include food, drug, mass, including Wal-Mart, and convenience stores.  This take-away was balanced with both higher net-price realization and stronger volume growth. 

In the reportable FDMxC universe market share expanded by 1.1 share points.

Here are a few specifics -- Hershey scale-brands experienced a 10 percent increase in take-away.  Convenience store growth was 9 percent, resulting in a market share gain of 0.8 points.

Instant consumables grew by 10 percent, with loose bars up 14 percent.  We expanded our leadership within the large and highly profitable chocolate segment with a 9 percent increase in measured take-away and a 2.0 gain in market share.  Importantly, we over took leadership of the mint segment within the refreshment market, behind the continued growth of our Ice Breakers Liquid Ice platform.  Two key enablers of this performance were increased retail distribution and a cost-effective trade strategy.  Regarding retail presence total points of ACV distribution increased by 6 percent during the quarter.  However, in the high-growth more-attractive classes of trade the gains and distribution were well-above the combined FDMx measure. 

In terms of trade promotion effectiveness we continue to better leverage our scale, as well as structure more cost efficient higher ROI events customer by customer.  This capability will strengthen in 2005. 

We're making good progress in terms of expanding into adjacent snack segments.

Our Snack Barz line is gaining momentum through both increased distribution and velocity.

Our four-item line of cookies having just launched last month is now building distribution and trial.  Initial results are most favorable.  The Hispanic initiative is showing good promise.  In Hispanic define stores, as measured by IRI, Hershey's 12-week take-away is up 21 percent, resulting in a market share increase of 1.8 points.  With a combination of expanded Hershey offerings full-year sponsorship of Thalia, and U.S. availability of our recently acquired Pelon Pelo Rico brand, we expect very good results in 2005 within this high-potential market segment. 

Turning now to expenses.  Total SM&A improved as a percent of sales as we have become more efficient with our total brand support and continued to better leverage our fixed cost structure.  In terms of profitability, the fourth quarter was strong.  On a Pro Forma basis EBIT increased by 11.7 percent, with diluted EPS increasing by 17.2 percent.  Hershey has delivered double-digit EPS growth over the past 4 years while improving both margins and returns. 

In 2004 our sales performance showed improvement, which was solid and consistent.  We achieved gains in both sales and market share in each quarter.  We established several strategic [indiscernible] parties at the beginning of the year.  The key ones were as follows -- No.

One, increase Hershey's leadership position within the highly profitable U.S. confectionary market;  Two, expand into selected snack market adjacencies;  Three, acquire high-potential brands, platforms or businesses as appropriate;

And Four, deliver superior financial performance.  Here's a brief recap of how we did.  Through a combination of new product innovation, both platforms and with our proven limited edition strategy, we achieved solid retail growth.  Full-year take-away was up 7 percent.  This resulted in a 0.6 point gain in market share and we have now gained market share in 10 consecutive quarters. 

Our strength in confectionary leadership was achieved behind the strategic growth areas that we've been emphasizing over the past few years.  Instant consumables were up 8 percent, with loose bars growing by 12 percent.  Within the chocolate segment take-away was up 8 percent, resulting in a 1.4 point increase in market share.  Convenience stores had another exceptional year.  Take-away was up 11 percent and market share increased by 0.8 points.

The key measure of profitable retail performance is the trend in base sales.  In 2003, base dollar take-away represented only 11 percent of our total growth.  However, in 2004, base take-away accounted for better than 85 percent of total retail growth.  This step-up was attributed to increase distribution, better trade promotion execution, and the higher velocity of our new products.  Caramel-filled Kisses, Hershey's 1g Sugar Carb, TAKE 5, and Ice Breakers Liquid Ice all played a critical role in driving base sales growth.  Our second priority was to expand into relevant snack segments.  Here we introduced 3 new platforms.  Two within Health and Wellness, and one in the Indulgent area.  In Health and Wellness, which includes wholesome snacking, we launched 3 varieties of Snack Barz, as well as 4 varieties of the Hershey's SmartZone Balanced Nutrition bars and partnership with Barry Sears, founder of the Zone Diet. 

In December we began shipping our line of Premium Indulgence cookies, which I have mentioned have started off strongly.  Acquisitions were our third priority where we closed on 2 buy-and-build types of businesses.  First was Grupo Lorena, a leading sugar confectionary company in Mexico.

We see great promise for this business and its iconic Pelon Pelo Rico brand both within Mexico, and here in the United States.  We're aggressively expanding retail availability, as well as product offerings  under the Hershey, Jolly Rancher, and Pelon Pelo Rico brand names, all using the innovative packaging for which Grupo Lorena is so well-known.

We acquired Mauna Loa in late December.

Mauna Loa is the leading processor and marketer of Macadamia snacks with a 40 percent share of the Macadamia Nut business.  Mauna Loa superior brand equity and portfolio of premium macadamia nuts, nut-based confections, and cookies are a great addition to Hershey.  We see tremendous long-term potential for this iconic brand as we focus on product innovation and expanded retail availability.  We've already begun developing Hershey confectionary products using Mauna Loa ingredients.

In terms of our financial performance 2004 was an excellent year.  We delivered sales growth of 6.2 percent with diluted EPS increasing by 15.1 percent.  We were able to achieve these results, despite a significant runup in input cost.  This points to excellent cost control throughout the business system and reflects countless cost saving projects that were implemented throughout the year.  As a result, gross margins expanded by 40 basis points with EBIT margins increasing by 90 basis points.

It was the strong operating performance that enabled us to enhance our capital structure.  We executed a 2-for-1 stock split in April, followed by the repurchase of $500 million in stock from the Milton Hershey School Trust in July.  The dividend was increased by 11.4 percent in August.  All in all we're pleased with the progress made in 2004, these results reflect our long-term objective of delivering sustainable, balanced performance, and positions us well for the future. 

In 2005 we intend to build upon our marketplace success by driving innovation at both the consumer and customer level.  We believe that new products should represent about 5 to 10 percent of annual sales.  In 2004, we were at the upper end of this range.  In 2005, we'll continue to be at the high end.  Indulgence and variety within the chocolate segment represent a key growth platform.  Both Reese's Fast Break and Hershey's S'mores have been enhanced delivering superior taste.

These will be available in the first quarter.  TAKE 5 is off to a great start and will be capitalizing on the popularity of our white chocolate varieties with a white chocolate TAKE 5 in the second quarter.  For Reese's, our largest brand, we're kicking off the Reese's "vote" promotion.  In March we're introducing 2 Reese's Peanut Butter Cup Limited Editions, one with more peanut butter, and one with more chocolate.  Consumers will get to vote on their favorite Reese's.  Based upon the success of Reese's Big Cup as a Limited Edition, it is now a permanent item.  There are several additional new products in the pipeline to build our leadership within chocolate. 

Moving onto Health and Wellness, sugar free continues to be a major growth platform as consumers seek out this key benefit.  Hershey's sugar free business was up 50 percent in 2004 and we will be expanding this platform in 2005.  We'll introduce a new Twizzlers sugar free variety in the first quarter.  Based on learning from the existing business, as well as from Hershey's 1g Sugar Carb entry, we will restage the entire sugar free line, later in 2005 with superior taste, added fiber, and new single-serve items.  For Hershey's SmartZone we're introducing 4 new varieties with a crunchy texture to further broaden the appeal of this brand.  In the area of refreshment we're adding several new flavors of Ice Breakers, both Liquid Ice and Intense Mints.  These items bring additional scale to the Ice Breakers platform, particularly, in convenience stores. 

As for seasons, we'll focus on holding or gaining market share, provided that it is profitable share.  We continue to believe that while important, seasons are not a major source of growth and provide less of an opportunity to build consumer loyalty over the long term.  Here's a brief perspective -- in the year 2000, seasons accounted for 60 percent of Hershey's total sales growth.  In 2004, seasons were flat.  Our strategy of offering fewer, yet more impactful items customer-by-customer is the most appropriate course of action.  It's worked over the past couple of years and we intend to continue this approach.  Within the adjacent snack segment, both Snack Barz and Hershey's Cookies will continue to expand with selected new varieties added later in the year.  As mentioned, Mauna Loa will build retail distribution, as well as provide premium ingredients for use in both new confectionary and new cookie products.

Whether it's through internal development or through acquisition here's why we are encouraged by the growth prospects within the broader snack market.

While Hershey is No. 1 within the confectionary segment, we're No. 3 in the much broader total snack market.  However, in the very attractive convenience store channel, Hershey is the No. 2 snack marketer overall.  In terms of instant consumables, which are higher margin, faster turning items, Hershey is the No. 1 snack marketer.  Therefore, we have both scale-to-leverage and room to grow.  Hershey's selling capabilities will continue to be a major fact in our 2005 performance.  We're gaining traction in the key areas of headquarter selling and retail execution.  For example, we've developed activity-based costing models for all classes of trade and the majority of our customers.  This now enables us to better plan promotion events and target high potential-growth opportunities.  At retail we have expanded the capabilities of our hand-held technology in the areas of routing, call frequency, and in-store execution. 

Turning now to the supply chain as in 2004 we're experiencing higher input costs.  There are numerous productivity projects under way to insure that we can adequately support our brands and selling capabilities, while still achieving moderate gains in gross margins.  Good cost control across the business system will result in further EBIT margin expansion.  Based on our 2004 results, and the plans in place for this year, we expect 2005 net sales growth to be at the top of our 3 to 4 percent long-term expectations before the benefit of last year's acquisitions.  Diluted EPS growth for 2005 should increase within our long-range goal of 9 to 11 percent on a Pro Forma basis.  Now, Dave West will review the fourth quarter and 2004 full-year results in greater detail.

Dave?

Thanks, Rick.

And good morning everyone.  In order to give you the proper perspective on our business I'll be discussing our fourth quarter results, excluding the pre-tax charge related to business rationalization and realignment initiatives taken in the fourth quarter of 2003.  Elimination of this item would yield adjusted EPS-diluted of $0.68 compared with $0.58 in 2003, an increase of 17.2 percent. 

For the fourth quarter of 2004 consolidated net sales increased by 7.5 percent.  As Rick mentioned earlier most of this sales increase was achieved through unit volume growth, which was stimulated by the continued success of innovative new products introduced earlier in the year, such as Liquid Ice, Caramel Kisses, Snack Barz, as well as by fourth quarter introductions of TAKE 5 and Hershey's Cookies.  Net sales in the quarter also benefited from a reduction in our trade promotion rate as we continued to improve our program effectiveness.  Sales from the Lorena acquisition were $6.9 million in the quarter.  Importantly, retail consumption was even stronger than our sales performance.  As Rick mentioned in the latest 12 weeks Hershey's retail take-away and outlet is accounting for 80 percent of our sales increased 10 percent.  Attesting to the momentum in our business.  We gained 1.1 share points in measured food, drug, mass merchants, excluding Wal-Mart, and convenience outlets.

Now turning to gross margin.

As you know one of the major challenges for us in 2004 has been significantly higher input costs.

These cost pressures did not abate in Q4, as fuel, transportation, and other costs continued near all-time highs.  We continued to generate supply chain productivity to help offset these increases.  However, as you know the first half of 2004 benefited from the price increase of December 2002, which was fully realized in the first half of last year.  We didn't have this pricing benefit in Q4.  This, coupled with startup costs from the accelerated pace of new product introductions, combined to result in some contraction of gross margin in the quarter, from 40 percent to 39.7 percent.  This trend will be corrected in 2005.  For the full-year 2004, net price realization and productivity improvement throughout the supply chain contributed to a gross margin expansion of 40 basis points.  Selling, marketing, and administrative expenses decreased 120 basis points as a percentage of net sales coming in at 17.1 percent versus 18.3 percent last year.  This is a result of discipline in all spend areas, including better targeted more efficient brand and customer support.

The absolute cost increased slightly during the quarter, but the leverage of strong sales growth reduced the expenses as percentage of sales. 

During the quarter the Company reached an agreement with the Fleming Reclamation Creditors Trust, which resolved matters relating to the Fleming Bankruptcy.

Based on this agreement the Company reduced its bad debt reserves by the $5 million which should have been added at the time of the bankruptcy filing in 2003.  Favorable impact of the reversal was largely offset in the quarter by charges related to warehouse closings and expenses related to due diligence with respect to a potential acquisition.  Our EBIT margin was 22.6 percent versus 21.7 percent last year and 90 basis point improvement as earnings before interest and taxes of $286.5 million increased by 11.7 percent, compared with the fourth quarter of 2003.  This increase is significant as the expansion came despite the previously mentioned decline in gross margin.  We continue to add capabilities to our business with accelerating innovation, improving selling capabilities, and the ability to leverage our growth through our existing business system,   we have created multiple levers to deliver profitable growth beyond relying solely on gross margin expansion. 

To recap some non-operating costs, interest expense for the quarter increased somewhat, up to $17.9 million from $16.1 million in last year's fourth quarter, primarily reflecting higher short-term borrowings to fund a $500 million share purchase from the Milton Hershey School Trust, which was executed in July.  The effective income tax rate for operations in the fourth quarter of 2004 was 36.6 percent, down slightly from last year's 36.7 percent.  We expect 36.6 percent to be our effective rate in 2005.  On the bottom line, record net income from operations of $170.3 million was 11.9 percent higher in the fourth quarter of 2003, and our net margin was 13.4 percent versus 12.9 percent last year.  Weighted average shares outstanding on a diluted basis for the fourth quarter of 2004 were 250.5 million shares versus 262.6 million shares for the fourth quarter of 2003.

Leading to an EPS of $0.68  per share-diluted, compared with $0.58 per share-diluted for the fourth quarter of 2003, an increase of 17.2 percent. 

Turning now to Pro Forma full-year results.  Sales increased 6.2 percent.  Gross margin grew by 40 basis points up to 39.5 percent from 39.1 percent.  SM&A decreased by 50 basis points as a percentage of sales at 19.1 percent versus 19.6 percent.  EBIT increased 10.9 percent and EBIT margin went to 20.4 percent from 19.5 percent, increasing by 90 basis points.

That increase -- net income was up 11.6 percent and EPS increased 15.1 percent. 

Let me review our balance sheet, which remains quite strong.  At the end of the fourth quarter net trading capital increased by $49 million or 6.4 percent compared to last year.  A quarter of this increase is working capital related to the Mauna Loa acquisition.  Also we built inventory in advance of new product launches and the anticipated price increase buy-in.

On a rolling 12-month basis net trading capital decreased 30 basis points as a percentage of sales.  As we continue to focus on collection and receivables, control of inventories, and expanding payables.  Free cash flow of $441 million tracked ahead of last year by about $164 million, a result of higher earnings,  tight control of working capital, and a timing of pension asset funding. 

Let me just take a minute to cover a few additional items frequently asked by many of you.  In 2004 capital additions, including capitalized software, were $196 million.

For 2005 we expect capital additions to be a similar amount.

For the full-year depreciation and amortization totalled $190 million.  Again, we expect a similar amount in 2005.  Dividends paid in 2004 were $206 million, and as many of you know we have now increased Dividends annually for the last 30 years.  The combination of open market share repurchase and the privately negotiated transaction with the Milton Hershey School Trust led to total share purchases of $617 million in [2004.]  There's still $55 million remaining in our current repurchase authorization approved in December 2002.  Acquisitions accounted for $167 million of our cash flow in 2004. 

Looking ahead to 2005, we are certainly exiting 2004 with good business momentum.  We would anticipate achieving full-year 2005 organic net sales growth near the top of our ongoing 3 to 4 percent target range.

Sales from the Lorena and Mauna Loa acquisitions will be additive to that amount. 

As for gross margin, the price increase announced in December, and effective in the first quarter, will help us cover various input cost increases in the areas of commodities, fuel, utilities, and employee benefits.  As the price increases will have more effect as the year progresses, we anticipate gross margins will   improve throughout the year, with the full-year exceeding the 40 basis points expansion we enjoyed in 2004, and approaching the bottom of our ongoing guidance to 70 to 90 basis points, before the impact of integrating 2004s acquisitions.

As Lorena and Mauna Loa have gross margins below our Company average we would expect them to reduce this organic margin improvement by 20 to 30 basis points as we report results.   We will continue to control our SM&A costs and leverage our growth and acquisitions through our existing infrastructure.  As such we continue to target our long-term 7 to 9 percent EBIT and 9 to 11 percent diluted EPS growth rates on a Pro Forma basis.  That concludes my comments and now we'll be happy to take your questions.

Lisa, the first question please.

The first question comes from David Adelman.

Good morning, everyone.

Good morning, David.

I was curious, did the -- I assume it's not the case -- but did the fourth quarter sales benefit at all from the buy, and from the trade regarding the pricing?

No.

Okay.  And in terms of SM&A costs in '05, can you give us an indication in general in aggregate what kind of growth rate to expect?

I think that, our ongoing target, David has been flat.  And I would say that we will continue to assert that.  Right now I don't -- we wouldn't change our long-term guidance.

Flat as a percentage of sales, David, or flat in dollars?

Yes.

Flat as a percentage of sales.

Okay.

Thank you.

You're next question comes from David Nelson with CSFB.

Good morning and congratulations.

Thanks, David.

Good morning.

You're getting into snack nuts.  You're getting into cookies.

You're starting to look a little bit more like Nabisco.   Is there anything that you would rule out, like salty?

I think what's important is we have such a strong position within core confectionary.  We saw these opportunities to extend our brands into logical adjacencies.  So for us, it's where can we take our brands selling capabilities and confectionary expertise?   So if you think about everything that we're getting into, capitalizes on those capabilities.

So I'd rather not comment on any one particular segment.  But we've said all along just purely getting into salty snacks does not capitalize on our capabilities and would probably not be the place that we would look first.

I guess, given your answer, how does the nuts fit into that?

Well, it's a couple of things, first off it's a value-added high-growth on-trend segment from a consumer standpoint.  It represents good profitability for the trade.

And much of Mauna Loa's existing products are already confectionary products that include nuts as well as confectionary items and that's where we see great opportunities to leverage Mauna Loa with the Hershey -- into the Hershey business, and obviously, the reverse is true as well.

Right.  How high can EBIT margins go?  Obviously, you've made great progress in recent years.

We'll continue to -- you know we continue to look forward and our guidance is in our long-term model is the same.  We continue to have productivity opportunities.  We feel very comfortable with the value chain opportunities that are out in front of us.  And as we continue to grow we'll leverage that through our existing business system.  So they can continue to grow.  And, I don't see any reason why they can't.  And obviously, they'll ebb and flow depending on business opportunities and where we may choose to invest.

You referred to cost related to the due diligence for a potential acquisition, was that the Kraft sugar confectionary business?

Yes, that's right, David.

Great.

Thank you very much.

Your next question comes from John McMillin with Prudential Equity.

Great numbers.

Thanks John.

Good morning.

Pretty soon, if you keep growing 15 percent everyone will believe 9 to 11 percent growth rate, I guess.  15 with great numbers.  Also the Mauna Loa nuts that I'm looking at now, have Ghirardelli Chocolate, I guess you can -- that's one of the first things you're going to do is change that, I guess, right?

Yes, that was an easy decision to make.

Okay.

Well, that's the easy stuff.

Yes.

Just -- can you give us any kind of quarterly trends in terms of this 9 to 11 percent targeted EPS growth, Dave?  Do you see any -- how it might unfold in terms of trends?

You know, John, we're probably not going to get much into the quarterly split at this point.  I think the price increase will certainly, as the year goes on, help us on a margin basis.  But I don't want to get into the -- necessarily the timing of all the new products and innovations which would move quarters around.   I think it's pretty much going to be delivered consistently across the quarters is the way I would look at it.

Great.

And if you can help us.  I know you're a simpler company than some others we follow.  But a lot of them breakdown sales growth by volume, currency, I guess you have a little Canadian currency help.  Acquisitions, to kind of get us to an internal number.  Could you do that for the quarter -- for the year's 6.2 percent growth and maybe even the quarter?

Yes, but, I mean, we'll give you some order of magnitude.  For us, we don't really have, John, a particularly big international business.  So we're not getting the same type of foreign exchange benefit, that's at the wind at the back at some of the other companies.  Essentially it's really unit volume-based for us. 

If you look at the full-year -- almost -- let's just say 5 of the 6 percent roughly is unit volume growth and then the rest of it is price realization, which is a combination of a little bit of carry over pricing and also trade effectiveness.  So, really -- it's for the full-year it's a unit volume story.

And really the same thing holds true for the fourth quarter as well.  It really is very much a unit volume story.

Even though you did say that acquisition out at 7 million or so?

Right, and that's -- in the quarter, the 7 million bucks -- it's about a half a point from the acquisition.

And where is the $5 million bad debt reserve?  Is that -- that's part of the reason SG&A didn't go up much?

Actually it's down in SM&A, but offsetting in the quarter we had the costs associated with the due diligence on the acquisition.

And we also had as we opened our Midwest distribution center we closed another distribution center.  We had some exist costs associated with that.  So those 3 things together pretty much net each other out for the quarter.  We had the gain on funding it, but they were offset by the warehouse.

And they were all in the same line?

They're all in the SM&A area.

Okay.

Thanks a lot and congratulations.

Thanks John.

Your next question comes from Judy Hong with Goldman.

Good morning, everyone.

Good morning, Judy.

Just looking at the expansion, that you have made into this broader snack categories, can you give us some perspective whether you have certain goals of reaching "X" percent of market share, whether it be on the Snack Barz or the premium cookies category?

Is there a level of market share you need to achieve to be a major player in those categories or do you need to be as successful an entrance into those categories?

I think it's less about if there is an absolute level of market share.  One of reasons we were -- we got into whether it would be Snack Barz, snack and nutrition bars or also cookies, those categories where we're going after them, they are already where Hershey is well distributed.  So if you think about it, we have talked about building our presence in high growth more profitable classes of trade, such as drug, mass, convenience stores, and that's where these segments that we're going into are very well developed. 

So for it's more about expanding our reach where Hershey is currently available as opposed to going into a part of a store or an outlet that -- where we don't have a presence.  But, in terms of a specific market share, internally we have thresholds by which we know we need velocity distribution, things of that nature, but I would rather not get into specific share goals.

Okay.

And then secondly, can you elaborate on some of the initiatives that you would be making this year in terms of strengthening the trade promotional efficiency.

I know that you have made a lot of progress on that front and you've talked about strengthening that in 2005.

Can you just give a more color on that?

Yes, we continue to improve our knowledge base both by brand level and at a customer level.  So, we are looking at only better understanding which brands and types need to be [indiscernible] at what customer, is very different.  So we have created a lot of flexibility in the [indiscernible] trade promotion spending so that customers qualify for money on a fair and equitable basis, but then have the flexibility closest to the customer in joint planning sessions with our team to use those funds, in the merchandising and marketing -- customer marketing components that work best for them. 

So the flexibility is improving.  That's one.  And we continue to focus on shelf management.  We continue to pay, gross dollars based on differential growth.  So we have really taken the ability for us to continue to innovate and introduce items, which are leading off the shelf and don't get promoted.  So those are really the 2 biggest gains, I think.

As innovation is coming at a highly incremental way on the shelf and doesn't need to be promoted as much and then we also have the flexibility closest to the customer.

Okay.

Thank you.

Your next question comes from Terry Bivens with Bear Stearns.

Good morning, everyone.

Good morning, Terry.

On the gross margin, for the quarter, Dave, maybe, could you give us a better idea of kind of how that is allotted between higher input cost and those new product development costs you referred to?

Terry, all year long we were able to overcome substantial increases in input costs by generating supply chain productivity and gaining price realization.  On the price realization most notably we had in the first quarter, we had single-bar carry over pricing, and in the third quarter we were able to get some weighage up in our back-to-school Halloween line-up.  So we didn't have the same type of price realization in the fourth quarter, although we did generate some promotional efficiency.

So, I think the real answer there is not quite as much price realization in the fourth quarter, and the productivity from a supply chain standpoint, pretty much consistent all year long.  I think the real difference is the inherently inefficiencies in new product startups that occur from time-to-time that can put some pressures on margins. 

For example, to strengthen the launches of cookies and TAKE 5 bars we've launched them in display-ready formats, which have inherently lower margins than straight stock.  It certainly has resulted in better speed-to-market and guaranteed display activity out there.

But it did have some impact on margins.  Also in the fourth quarter we absorbed some charges related to some inventory write-offs and some other [indiscernible] lessons items, which occur as you continue to innovate and put new items into the portfolio you obviously take other items out. 

So I would say that, the real change year-over -- from quarter-to-quarter is around some of those costs related to innovation and that's -- that can crop up occasionally, but the good news is we continue to deliver the EBIT margin and the bottom line.  So we're very pleased that we have more levers to pull on.

Its really not just the margin story.

It's innovation and selling capabilities as well.

Okay.

Terry, this is Rick, one thing if I might just add a comment as Dave was talking about the step-up in our new product activity, whether it be TAKE 5 or cookies in December.

It's important to note that in the 10 percent all channel retail take-away that I cited and Dave cited earlier that does not include any benefit from TAKE 5 or from cookies.  So we see that momentum in the first quarter.  So that 10 percent was excluding those new products that we shipped aggressively in the fourth quarter.

Yes, and that are doing quite well, right?  I know that going forward we would expect to see some degree of expense for new products, but I was trying to get at the point that if indeed it's valid that maybe there was a little bit of spike in those kind of expenses in Q4 that may not necessarily be with us as we go forward.

That's right I think in particular I believe the obsolescence and some of the inventory write-offs that occurred in the fourth quarter, were not typical of the rest of the year.

And would not necessarily be typical as we go forward.

Okay.

And then when you talk about gross margins, Dave, being up, probably greater than 40 percent approaching the bottom-end of your 70 to 100, that is including the negative effect of the acquisitions, correct?

No, we're looking at -- we're looking at being north of where we were this year, which was greater than the 40 and approaching the bottom of the 70 to 90 before the impact of the math -- it's really the math of integrating the acquisitions, which have lower margins.  So, we would look to be in that, range of higher than this year, but a little bit to the top.

So the bottom of the range on an ongoing basis before we would integrate.  And then obviously on a reported basis we'll be a little bit lower than that.

Okay.  And, Rick, just a quick one for you as you look into this year, obviously, the distribution, the ACV gains have been very impressive.  Do you feel there's a major channel where you still have what you term an outstanding opportunity?

Yes, I think it's interesting if you looked at the absolute market share, which we don't talk as much about, we always talk about share point gains.

But if you look at the absolute market share and we have about a 30 percent share FDMx, excluding Wal-Mart and adding in convenience stores.  We're slightly overdeveloped in the food class of trade and slightly underdeveloped, or still underdeveloped in drug, mass, and convenience stores.  

So we still see growth opportunities in those channels and customers that happen to be a more profitable, more single-serve oriented, and have been responding to our new product initiative.

So the short answer is, yes.

Okay.  Great.

Thanks very much.

Your next question comes from Eric Katzman with Deutsche Bank.

Hey everybody. 

Good morning, Eric.

I have a few questions.  One, I guess, Dave, your kind of new to the CFO position,  but given that the Company now generates over 4 billion in sales and 900 million in EBIT, have there been any discussions with the SEC about forcing you to start breaking apart and reporting on a segment basis, whether it be chocolate versus non-chocolate, something along those lines?

No.  Nothing, Eric.

There are companies that are smaller than you that are forced to do that.

So I'm not -- it's not clear to me why you're able to maintain just reporting one line item?

We haven't had that discussion.

Okay.  And then, I find it -- I guess I'm not clear to me as to why you're signaling sales growth in '05 of 4 percent "X" the acquisitions.  I mean acquisitions by my math should add about 3, right?

You're going to get, based on the numbers, Rick, you gave us at [Cagney] last year, in the new snack categories that you're entering, cookies and Snack Barz, if you only get 1 percent share of those categories, you're talking another, let's say 120 million -- 130 million in sales, which would be 3 percent growth.  Plus, you got the base business and you have pricing. 

So it seems to me that you are lowballing unless you don't really think you can get anywhere close to 1 percent share of those categories.  But I don't see why you would enter them unless you didn't think you could get there.

Eric, let me make a quick comment about the over all numbers and I'll let David touch on some of the specifics and we certainly won't break it down as much as some might like.

We said all along that the long-term growth rates from net sales was 3 to 4 percent on an organic basis.  We said that's what we were going to achieve when we put the strategy in place 3 years ago.  And that's why we cited the organic growth rate at the high end of the 3 to 4 percent range.

We could sit here and say we believe the acquisitions will add about "X", but there's also the notion of not getting into what we intend to accomplish in specific segments. 

Because of course, we have it broken out all the way down, but we're not going to reveal and you can appreciate for competitive reasons how much growth we believe we can get out of the cookie segment or certainly out of any of the adjacencies.  So it's not lowballing or not believing, it's simply these are the numbers that we are communicating externally.

I think, Eric, to give some flavor, the 3 to 4 percent we are saying on that kind of organic basis we're going to be at the top-end of that 3 to 4.  And from our filing's you'll see that between the Mauna Loa and Lorena businesses, somewhere between 100 and $110 million of additional business.  Although, we did have 7 million of the Lorena in the fourth quarter, so that's not incremental year-over-year.   But you know you can do the math from there.  I think as Rick said the long-term -- our long-term goals are really designed in the context of the peer group and, marketplace performance.  They're going to vary from year-to-year.  We do have good momentum going into '05.  But our snack adjacency strategy is really still early in the development stages.

We have 2 acquisitions to integrate and we have a price increase to implement.  So, I think at this point we feel pretty comfortable at the top-end of that organic range and, we have some work to do.  So we are just at this point, we are just really comfortable with that range.

Okay.

All right.

Thank you.

Thanks, Eric.

Your next question comes from Christine McCracken with Midwest Research.

Good morning.

Good morning, Christine.

Maybe just to approach Eric's question from another perspective, because if you really talk about these new products adding in your words, a 10 percent of your sales base.  And not completely additive clearly, but if you go through the list of new products, the big new products that you have introduced, let's just say.

And even in the fourth quarter you're talking about at least 100 million in incremental sales from that in '05, and it's early still.  But the early results are positive. 

It seems like, at a minimum, it seems like from new products along with some of the items Eric was talking about, that you really should be looking for faster sales growth.  And, in addition to that it seems like, given, the profitability of some of those products that your mix improvements should drive faster earnings growth.

Can you address that?

There's a couple of things.  Again, we have established our long-term growth rates and that's what they were long-term a few years ago.

And we've been successful over the past few years from certainly an earnings and return standpoint and this year we had solid top-line growth, and it was across all quarters.

And we started to see some momentum improving and that towards the end of 2003. 

A couple of other things that are important.  We talked about seasons not being the major growth opportunity it was before.  So if seasons accounts for about 25 percent of our business than the remaining 3 quarters has to grow well-above that 3 to 4 percent if seasons are in fact going to be flat, which we assume that they will be.

And, you raise some good points it's whatever the new product's contributions happen to be.  They are overlapping new products that were introduced this year, for example, 1g Sugar Carb had a great start.  We all know what's happened to the low carb trend, broadly not for any one particular category.

And we also have a couple of businesses that we need to improve upon.  So that's why it is not a number that we don't think is achievable.  We do think it is achievable.  But we also believe that's the right set of parameters to keep the Company profitable and keep investing for the long-term.

And just in terms of the margin split.  If you look at these products it seems like, a lot of the new products that you've been introducing and you've outlined this in the past relative to your strategy is really focusing on high margin introductions.  I think a chart you showed at Cagney was rather impressive last year in terms of what the margin opportunities might be for some of these.

And clearly there's launch costs.  But, over and above that you should be seeing I would think, even greater margin expansion that you're talking about.

Well, there's a couple of things.  As we continue to focus on instant consumables or single-serve, which have inherently higher margins in the more profitable classes of trades, that's a positive.  As I had answered to one of the conference call question after the third quarter when we announced the introduction of cookies, we said cookie margins are going to be somewhere between package candy and loose bars.  So there's one that is a very good market opportunity for us and will give us all incremental dollars, but it doesn't have necessary the same impact from a margin standpoint.  So over the past 4 years we've increased gross margins by over 400 basis points. 

Over the past 4 years we've increased operating margins by over 400 basis points.

We still see opportunities to expand both of those, but the goal is how do we continue to build our leadership position profitability and expand out of confectionary into the broader snack markets?  So that's the relationship between where we see growth opportunities and how we continue to view the opportunities to expand margins.

And so you're trying to balance essentially your growth opportunities with your margins over time, I assume?

That's correct.

Just one quick other question on commodities, a lot of news out lately relative to the nut markets, Kraft yesterday talked about pressure there.  How are you managing that?  It seems like a fairly contained market.  Not a lot of alternative sourcing options.

How is that affecting you specifically in almonds?

Actually I'm not going to comment specifically one way or another on any individual input costs.  For competitive reasons.  We look at the entire basket it cost as we go forward.  We had visibility into what those costs were all the way along.  And, as we get into 2005 we know what those costs look like.  Obviously, when we looked at our decision that we made in December to take some list price increases, we knew what those costs were.  So we're managing the entire basket of input cost, including cocoa, peanuts, almonds, energy, fuel, transportation rates, et cetera, against that price increase.  And again, I don't have a clue into terms of how our competitors are or are not hedged forward.  So, I couldn't really comment on what their costs are running through their P&L.   I only know what mine are for 2005 and we've priced accordingly and, we'll move forward.

All right, thanks.

Thanks, Christine.

Your next question comes from Homer [Altbalson] with Piper Jaffray.

Yes, good morning.  Just one quick question, could you tell me your interest expense estimate for 2005?

I think, it's about 69 or $70 million is about what we have for the year.

Okay.  Thank you.

Your next question comes from Andrew Lazar with Lehman Brothers.

Good morning.

Good morning, Andrew.

Just 2 quick things.  One, you already touched a little bit on some of the systems and your capability around, sort of customer specific profitability.  Do -- my sense is, is that you started putting that in place in a really much more major way in '04.   So can I take it that you still feel there's quite a lot more room to go in the way you kind of implement that with your key trade customers going into '05 and beyond?

Yes, Andrew, I think it's -- we've been developing as we've gone along and we've added tools incrementally each year.  We started with an analysis of the entire marketing spend and we did that really back in 2002 on the integrated business intelligence front to understand the drivers of each brand, between advertising, consumer, and trade.  That really started us down the path of understanding some of the profitability and some of the right ways to invest by brand and by customer. 

We then added the new trade promotion strategy in 2003, which was much more flexible, and then in 2004 we added hand-held computers out into the retail environment to start to gather some data that way and allow us to reroute our sales reps.  So we have really added some layers along the way.  We really now do have an understanding not only between gross and net, what the promotional activity should look like, but also what the true cost of serve is from our logistics capabilities, as well as what it cost us to serve at retail.

So we're beginning to build that capability, and in 2005 we've got some pilots going on to start to understand how to best use that with customers and to find the best way to get mutual growth out of that.  So 2005 we will continue to learn and then in 2006, I think from an activity-based costing will be much more active in the marketplace in using that data.

And then lastly, some of the pricing that you're taking, obviously it went through smoothly, or you executed it well in '03.  This time around, you're doing a little bit more also on the package side, which I realize can be I guess a bit more price sensitive just given the item and the channel it goes through.  But, I'm assuming it's, obviously been kind of unilaterally done across sort of competitors and such.

But is that something that you need to watch more closely around sort of [IM] implications or not necessarily?

On the packaged candy, actually Mars increased packaged candy in early December, and we evaluated that and decided that we wouldn't want retail prices to creep up at the shelf without our participating in that increase.  So we also increased on our package candy.  The timing of it is it's time to flow in after the seasonally heavy Easter and Valentine periods.  So we won't have that seasonal period to deal with the price increasing.

You are right because package candy tends to be more seasonal in nature it is much more merchandising intensive as a segment.  So we'll continue to have to hit promotional price point's on that business to insure that we continue to get the right displays at peak times.  So it is a little, it's one that we have to manage much more closely because of the merchandising intensiveness.  So we'll watch it and we'll watch the responsiveness at the first key seasons after the price increase goes into effect to make sure that we're seeing the elasticity effects that we would have anticipated.

Great.

Thanks very much.

Thank you, Andrew.

You're next question comes from Leonard Teitelbaum with Merrill Lynch.

Good morning.

Yes, I thought I had it right and then I checked my notes and maybe I'm sure.  Dave, on gross margin, you said you're going to hit in '05, you're going to hit the lower end of your 70 to 90 basis point improvement or did I mishear you?

Actually, I didn't say that exactly.  What I did say was, we will be north of the 40 basis points that we expand in 2004, approaching the bottom of the 70 to 90 basis point ongoing range on the organic business.  Then the simple, the algebra of integrating Mauna Loa and Lorena, which have lower margins in the portfolio average as we report, that range is between that higher than 40 and kind of lower than the 70, will then be adjusted downward by the integration cost of Lorena and Mauna Loa.

Good.

Now, look I used to follow Mauna Loa a long time ago and I understand   unless it has changed substantially, about 70 percent of that product goes home under somebody's arm when they leave, either Honolulu or Guam.

The problem that has obviously been the distribution in the U.S.  I think Nabisco tried it and some other people had tried it.

What is it in there -- is it just that you felt it was an undermarketed item and it gave you the opportunity or is there something in there that you see that makes it more -- introducing products of higher input costs?

Higher shelf price?

Or what's the big strategy here?

Len, let me take that.  First off, currently about 25 percent of Mauna Loa's business is in Hawaii, the rest is outside of Hawaii.

So our goal is, how do we continue to take it from the Island to the mainland?  And the point of that is is there's numerous opportunities to expand distribution in club customers,  mass customers, convenience stores,  they have a very small business in convenience stores because they don't have single-serve or in-serve consumable-type of products.

As they broaden their portfolio, they being Mauna Loa, over the past year with snack nut confectionary-type products,  even macadamia nut cookies, we just see a terrific platform that's been undernourished and has not had the level of innovation that hopefully we can bring to it.

It will be interesting to watch.  Thank you that's all I have for now.  Thank you.

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

Good morning, everyone.

I'm just trying to understand in terms of coverage how long it takes for the new products to really reach all the points of sales that you are targeting?

And the reason I ask that is it goes, SmartZone, and Snack Barz were launched in the third quarter, but I don't see it in many of the sisters that I visit around the country, especially in the east side.  So I'm just wondering how long does it take?  Because so far it seems to be -- to me it seems to be selective.   A checkout counter in a supermarket seems to have a lot of Power Bars,  but I don't see SmartZone there.  So just give me a sense into how long does it take to reach your target coverage?  What are your real target coverage?  And did you just decided you did not want to have as many displays for SmartZone, and say a Power Bar for a balance?

I think first off it varies by product platform and it varies by channel class of trade and customers.  Cookies have gotten a very, very quick start because it's viewed as very unique and there hasn't been as much innovation within the premium cookie segment, which is where we're targeting this particular entry.

Snack Barz was introduced after the back-to-school period, so you wouldn't have seen as much merchandising, but where we have got distribution -- we are starting to build distribution, we see very good movement.

Of the 3 Snack Barz -- excuse me, SmartZone is off to a slower start, and that's an indication less about our product and more about just the -- all the items that are being introduced and you're seeing a category that isn't growing as rapidly as it was.  So as I mentioned in the comments we're going to be introducing 4 additional SmartZone products that have a crunchy texture and that's going to add scale and breadth to the line.  So that -- I can't comment specifically on how long it takes to get to shelf because it varies based on the level of innovation, what type of competition and how customers view the potential.

Okay.

But when I think in terms of category growth and I look at what's happening with cookies, although it's a single-serve, and even with cereal bars -- Snack Barz, it just seems to me that the real growth potential here is more on the nutritional bars and SmartZone.

And I would have expected you guys to be more aggressive on that product than you have been so far.

I mean in just in terms of displays, again.  What was the reason for that slow start?  Was it because they were not crunchy enough?

Or what's going on with that --?

No, I think it's a couple of things.  First off, we think cookies is a terrific growth opportunity.  Cookies has not had the innovation.  That's one of the reasons that it hasn't had the growth.  And it's a very large profitable category.  And we can bring innovation into where cookies aren't as well-developed.

Most notably the front-end in convenient stores. 

When it gets to the whole snack and nutrition bar segment we're not seeing as much growth overall and customers aren't adding nearly as many points of distribution retail customers as they were previously.  So I probably just repeated by saying Snack Barz are off to a great start.  SmartZone is a little bit slower than what we want.

But the most important thing to take a way from all of this is we view Health and Wellness as a major platform for us.

So whether it is sugar free, which is doing well, 1g Sugar Carb, Snack Barz,  SmartZone,  and we have several more new items coming in Health and Wellness, for us it's all about a broad platform.

Not any one particular initiative.

Okay.

And just one last question, are there any legal issues pending with [indiscernible] regarding their Zone Perfect product?

The -- anything that we would need to talk about obviously, we'll file.

Nothing new from what we talked about in the past.  It's pretty much status quo to the last time we talked about it.

Okay.

Thank you very much.

Your next question comes from David Driscoll with Smith Barney.

Hi good morning, everyone.

And certainly congratulations's on a fantastic quarter and a great 2004.

Simple question, though, when you were giving the breakdown, David, you said that the, I think you were talking to John and he was asking about the breakdown from sales, you mentioned that most of it was volume.  But, I believe that Rick mentioned in his opening that promotion was down and that benefited sales.  Can you give us a sense of how much that was?  And also kind of talk about promotions at a high level.

I had thought that what you had said was, that promotional spendings -- paid promotional spendings were a very good spend and that Hershey had been increasing that spending for quite sometime.  So I guess I was a little bit surprised that it was down.  So maybe kind of reconcile those factors for me if you could?

I think we continue to believe, David, that the in the category, because of the responsiveness, the categories and impulse oriented category, it's expandable, and when displayed it grows the category incrementally.

We continue to believe that trade promotion is a good spend for us.  That is still an absolute truth.  However, that doesn't mean we're not going to try to be much more efficient and effective in the way we spend the money.  A couple of things; with these level of innovation that we've had, base-volumes, or as IRI defines it off-the-shelf volume rather than display volume is up for us, which would help us be much more efficient. 

We're also learning from our trade ROI work, that I referenced earlier, one of the tools that we're doing from activity-based costing methodology is what the right merchandising vehicle is by brand, by pack, and by customer.  So we're just going to continue to get more efficient with our spend.  And that's I think that's a good thing.  It doesn't mean that as part of the marketing mix that we believe the trade spending is any less important.  And as I said earlier, if you wanted to characterize the 6 percent growth for the year, roughly 5/6 of it -- was really unit volume.  The rest of it is price realization and included in our definition of price realization is the ability for us to be efficient with the trade, and get that kind of rate reduction.  So I don't know if I gave you an answer there that satisfies your question.

Was trade down in the fourth quarter?  Maybe I can just ask it straight forward.

On a rate basis, yes.

Then the next question is, you know you talked a lot about gross margin expansion and a number of callers have already asked this question.  But Bites and Swoops were things that, Rick, I think you even presented this at last year's Cagney, how they carried a higher average price then the rest of your portfolio.  It was my impression that we should then see a real improvement in mix kind of every single quarter going forward given as those types of products develop and percolate through the P&L.

But the fourth quarter, gross profit margins were actually down 20 basis points.  So is -- what's really going to carry the day as we look at price versus mix in the portfolio going into 2005?

My sense right now is that really it is price and it's related to that price increase?  And mix is not going to be perhaps as big a factor as I used to think it was, but, again, how do you see this developing?

Let me just give a couple of thoughts, David, and then maybe Dave West will add a little bit.  We had shown some of the items and their primarily the bar products that have higher price realization and those should, in fact, result in positive mix.  You had mentioned Bites and Swoops, it's really more things, such as, S'mores, White Reese's, now TAKE 5, things of that nature.

The more single-serve fewer bar-type products.

What happened in the fourth quarter and we talked about it, but it maybe bears repeating.

That we deliberately chose to accelerate new platform launches to maintain a marketplace momentum.  So for us it was worth a bit of "margin dilution" or using your terms, maybe "negative mix" and the near term to get moving quickly with the items we highlighted, particularly, given our customers's keen interest in wanting to get this product merchandised and get the early trial. 

As we look look ahead to '05 we look at price and mix combined and for us that's price realization, whether it is list price increases, higher net price items, or certainly shifting the mix.  Things of those nature -- of that nature, excuse me, as well as volume gain.  So I don't think we've ever broken out exactly price mix and volume.  But we continue to see opportunities to improve the mix.  But you have to take a step back.

For us,  it's how do we continue to balance topline growth by delivering the benefits that our customers want to offer to consumers and continue to increase our leadership position in the marketplace.  That's really what drives us moving backwards from the marketplace, not moving from inside, mix first, out to the marketplace.

David, I think that if you were to characterize our 2003 growth versus 2002 when you talk about price mix versus volume it was much more price mix oriented.

In 2004 we were more volume oriented.

And in the fourth quarter of this year, our EPS growth was probably driven more on an SM&A leverage than it was within gross margins. 

I think what you are seeing from us is the long-term goals that we have out there, the guidance of 3 to 4, and on the top 9 to 11 on the bottom line.  We just have more levers to pull on.  And we've built more capabilities over the years -- over the past few years as we have executed our strategy.  So there's not going to be any one given way.  We're going to execute the model necessarily.

We're going to continue to innovate.

That's going to drive volume for us.  We're going to continue to look at pricing and price realization as an opportunity, one, to cover input costs, but also as we innovate we believe that the consumer will pay for that innovation.   So it is going to be a balance for us, but we have been very pleased that we've been able to build the opportunity to pull on different levers.  Rather than -- we're not really a gross margin play any more, which would have been the case probably 2002.

Very good.  Thanks a lot for the information.

Thank you, David.

At this time there are no further questions.

Before we conclude, this is Jim Edris, before we conclude, I have a [maya colpa] here.  When the gentleman from Piper Jaffray asked about our interest expense in 2005, I looked through the wrong part of my bifocals and read the wrong line.  It really should be the low 70s and not the 69 million that was cited earlier.  So low 70s for interest expense in 2005.  So if there are no more questions we'll conclude today's session.  [Mauna Fern] and I will now be available to answer any additional questions you may have.  As a reminder our first quarter sales and earnings release and conference call is scheduled for April 21st, and we'll release earnings at 4 p.m. that day and our conference call is scheduled for 4:30 p.m.  Thank you for your interest and good day. 

This concludes today's Hershey Foods Corporation quarterly earnings conference call.  You may now disconnect.