好時 (HSY) 2006 Q2 法說會逐字稿

Good morning.

My name is Deshanta, and I will be your conference operator today.

At this time, I would like to welcome everyone to The Hershey Company second-quarter 2006 results conference call. (Operator Instructions).

Thank you.

Mr. West, you may begin your conference.

Thank you and good morning, everyone.

Welcome to Hershey's second-quarter conference call.

Rick Lenny, Chairman, President and CEO, and I will represent Hershey on this morning's call.

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 risk and uncertainty.

Actual results may vary materially from those contained in the forward-looking statements because of factors, such as those listed in this morning's press release and in our 10-K for 2005 filed with the SEC.

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

Included in the press release are 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.

Other charts, which highlight the quarter's results, are also on the Web.

As we said in the press release, the Company uses these non-GAAP measures as a key metric for evaluating performance internally.

These non-GAAP measures are not intended to replace the presentation of financial results in accordance with GAAP.

Rather, the Company believes the presentation of earnings excluding certain items provides additional information to investors to facilitate the comparison of past and present operations.

Therefore, we will be discussing the second-quarter results for 2006 excluding net pretax charges of $2.6 million associated with our previously-announced business realignment initiatives to advance the Company's value-enhancing strategy.

Any future projections will also exclude the impact of net charges related to these business initiatives.

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

Rick?

Thanks, Dave.

Hershey's second-quarter results were excellent as strong sales growth of 6.4% combined with solid productivity to deliver a 13.5% increase in diluted earnings per share from operations.

The sales performance was broad-based as our new product platforms continued to build momentum.

Dark chocolate, refreshment and Kissables were the major contributors to this quarter's growth.

Seasonal shipments also positively impacted sales.

In terms of marketplace performance, Hershey expanded its category leadership.

The second quarter marked the eighth consecutive quarterly increase in market share.

Given the Easter timing in 2006, which inflated category sales during this year's second quarter, we will be reviewing our performance on a year-to-date basis.

For the year-to-date period, Hershey's total retail takeaway was up 6.6% in all channels including Wal-Mart.

In the reportable FDMxC confectionary universe, our share increased by 0.8 points.

We gained market share in all major segments and across most classes of trade.

Moreover, Hershey accounted for nearly two-thirds of the entire growth within the category through the first half.

For the second half of 2006, we remain committed to investing in our strategic growth opportunity areas.

By delivering a superior value proposition to both consumers and customers, Hershey is able to build businesses that are highly incremental and sustainable.

To get us started, Dave will discuss the quarter's results in detail.

In addition, he will highlight the financial situation for the balance of 2006.

I will then review how we will deliver against our growth objectives throughout the second half and the early part of 2007.

It's this combination of continued solid sales growth and good visibility into total input costs that will enable Hershey to deliver our 2006 full year expectations.

David?

As Rick highlighted, our Q2 results were strong with a good rebound on the top line and strong cost controls, enabling delivery of EPS diluted from operations of $0.42 in the quarter, up 13.5% versus prior year.

We remain committed to our full year estimate, somewhat above 4% net sales growth and slightly above 11% diluted EPS growth from operations.

Let me give you some details starting with sales, where we were very pleased with the performance of new platforms including Kissables, refreshment and dark chocolate.

Seasons also contributed nicely with Halloween accounting for about 1% of the 6.4% growth.

Overall retail takeaway market share performance remained very strong.

Given the later Easter in 2006 versus 2005, reported retail takeaway comparisons for the latest 12 weeks are distorted.

Therefore, I will discuss year-to-date marketplace performance.

So year-to-date in channels that account for over 80% of our retail business, Hershey's consumer takeaway increased by 6.6%.

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

In the reportable FDMxC universe excluding Wal-Mart, Hershey expanded its leadership position by 0.8 share points.

In chocolate, our share increased by 0.9 points.

In sugar confectionary, our share leadership expanded by 0.5 points.

And within mints, we've increased our share this year by 6.6 share points.

Hershey's year-to-date market share gains in the confectionary market were broad-based with share gains in food, 0.8 points; drug, 1.1 point; and mass excluding Wal-Mart up 2.1 points.

The one exception is with c-stores.

The c-store channel has grown at 4% for the year-to-date.

We did gain share in this channel in chocolate, sugar confectionary and mints.

Our everyday c-store candy business is growing at a rate greater than the category.

But our total Company growth rate is just shy of 4% as we deemphasize limited edition offerings and certain gum brands.

As such, our c-store share declined by 0.1 point in the quarter.

We continue to monitor consumer traffic and gas prices in the channel and have strengthened our second-half c-store customer programming and store level coverage.

Across all channels, we continue to expand our [ACV] with gains of over 6% on a year-to-date basis.

Our dynamic retail deployment model and strong platform innovation continue to drive our performance with Hershey accounting for almost two-thirds of the growth in the category on a year-to-date basis.

Turning now to margins, where strong cost controls enabled solid 11.4% EBIT growth.

And EBIT margin expanded 70 basis points, up 17.6% from 16.9% a year ago.

SM&A expenses were done 180 basis points from last year.

The majority of this reduction is in G&A expense.

This reduction was enabled by the realignment and early retirement initiatives enacted late last year.

In the quarter, total brand spending, advertising consumer promotions and trade promotions, was up over 4% versus prior year, although down slightly as a percentage of sales.

We continue to refine our marketing mix.

Hershey's trade promotion return on investment increased again in 2005, the third consecutive year of ROI increases.

As such, we continue to focus spending on trade promotion programs which drive merchandising and on consumer programs which drive trial.

During the quarter, spending in these areas increased.

Ad spending was slightly lower as we focused on new platforms, such as Kissables, Mini Kiss Cookies and Ice Breakers Ice Cubes gum.

Consumer promotion spending increased primarily in the form of sampling as well as our eBay WrapperCash events and our sponsorship of select concert tours to reach specific demographic groups.

Gross margin of 38.7% was down 110 basis points, primarily from obsolescence costs related to the SKU rationalization and product line shifts we highlighted in Q1.

We recognized certain costs related to rationalizing or exiting SKUs or product lines, such as Liquid Ice, Smart Zone and Swoops as we began to streamline our portfolio.

Other inventory and packaging write-offs were incurred during the quarter related to below forecasted revenues of certain items.

In the quarter, we did achieve favorable net price realization with carryover list pricing from last year only partially offset by slightly increased trade promotion expense.

As expected, we are experiencing broadly higher input costs.

We continue to have very good visibility into our cost structure and productivity initiatives, and there were no surprises in these areas during the quarter.

Interest expense for the quarter increased, coming in at $27.5 million versus $20.6 million in last year's second quarter, reflecting higher short-term borrowings to fund continued share repurchases and to pension contributions made last year.

The tax rate for the second quarter was 36.6%.

This is 40 basis points higher than last year and above the average rate we anticipate for the full year, which we project at 36.2%.

For the balance of the year, we expect quarterly rates to be 36.2% in the third quarter and 37.1% in the fourth quarter.

Weighted average shares outstanding on a diluted basis for the quarter were 240.1 million versus 249 million shares for the second quarter of 2005, leading to EPS of $0.42 per share diluted from operations compared with $0.37 per share diluted for the first quarter of 2000 -- the second quarter of 2005.

That's an increase of 13.5%.

To recap six-month results, net sales increased by 3.3%.

Gross margin was 38.2% versus 39% last year.

SM&A declined 160 basis points as a percentage of sales coming in at 20.1% versus 21.7% last year.

EBIT from operations increased 9% and the EBIT margin increased to 18.2% from 17.2, up 100 basis points.

EPS diluted from operations increased 11% to $0.92.

Now, let me turn to our balance sheet and cash flow.

At the end of the second quarter, net trading capital increased around $100 million compared to last year's second quarter.

Accounts receivable grew by about $70 million due to the timing of shipments and additional seasonal receivables opened versus last year.

Our AR balance remains extremely current and of high quality.

Inventories were higher by some $20 million compared to last year, primarily reflecting higher raw material inventory levels related to delays in certain outsourcing projects.

Despite the higher absolute levels of working capital, year-to-date cash flow generated from operations is running about $140 million ahead of last year.

During the quarter, capital additions including capitalized software were $49.1 million.

For 2006, we again continued to target total CapEx to be in the range of 190 to $200 million.

Depreciation and amortization totaled $49.9 million in the quarter and should be in the 190 to $200 million range for the full year.

Dividends paid during the second quarter were $56.2 million.

During the quarter, we spent $146 million for 2.7 million shares in our share repurchase program.

We have $244 million remaining on the $500 million authorization approved by the Board in December 2005.

Shares acquired through our purchase programs are held as treasury shares.

In addition, during the quarter, we repurchased $16 million of our common stock shares in the open market to replace shares issued in connection with employees exercising stock options.

Our goal is to repurchase all such shares, and we are current at the moment.

Let me quickly update you on the impact of various business realignment initiatives recorded in the quarter.

During the quarter, $3.7 million pretax was recorded in the business realignment charge caption against the initiatives we announced last July.

In addition, we also updated our 2001 and 2003 realignment initiatives by recording a $500,000 charge in the restructuring caption and a credit of $1.6 million in the cost of sales caption related to an adjustment of estimates for items recorded through cost of sales.

The total impact of these activities was net expense of $1.8 million, which reduced reported diluted EPS by $0.01 for the quarter.

This brings project to-date expense against the July 2005 program to $104 million in realignment charges and $21 million in cost of sales for a total of $124.5 million pretax.

After-tax cost is $78 million or $0.31 per share diluted spread over the past four quarters.

We expect to complete the realignment initiative this year and expect the cost to be somewhat below our original estimate of 140 to $150 million pretax, likely closer to $130 million.

Let me now talk about the rest of 2006.

For the full year, we continue to anticipate that net sales growth will be somewhat above our long-term 3 to 4% target.

Marketplace performance remains strong with year-to-date takeaway up 6.6% and the strong programs, which Rick will highlight shortly.

We expect continued share gains during the balance of the year.

Our EBIT margin expansion target of close to 90 basis points for the year remains in place.

As the year progresses, we'll continue to have tight SM&A spending controls, although not as strong as the reduction in the first half.

Given first-quarter mix impacts and obsolescence costs anticipated in Q2 and Q3, we now expect gross margin for the full year to be down slightly versus 2005.

We continue to have good visibility into 2006 input costs and productivity programs and expect broadly higher input costs to be offset by price realization and improved supply chain efficiencies.

At this time last year, we announced our realignment program which gave us greater visibility into our total 2006 P&L outlook.

And we therefore gave some initial view of our expected 2006 performance.

While we're now gaining visibility into the total 2007 cost basket, it is still too early to comment on 2007 beyond our ongoing long-term goals.

So to summarize the quarter, Q2 was marked by a strong rebound on the top line with net sales up 6.4%.

Strong expense control contributed to good EPS performance, up 13.5%.

Marketplace share and takeaway remains strong, and we remain committed to achieving full year performance somewhat above 3 to 4% growth in net sales and slightly above a 9 to 11% increase in EPS from operations for 2006.

Here is Rick to talk more about our growth programs.

Thanks, Dave.

As Dave just highlighted, we had very good sales performance during the quarter.

And through the first half, consumption exceeded shipments.

This performance should position us well for the balance of 2006 as we execute our strong seasonal programs and accelerate the efforts behind our strategic growth opportunity areas.

I'll now provide an in-depth look at three of these growth opportunity areas.

They are continuing market share gains within core confectionary, expanding innovative new platforms and building single-serve leadership.

I'll begin with core confectionary.

Our strategy of leveraging Hershey's iconic brands continues to deliver.

In 2002, our top three brands accounted for about one-third of our total retail takeaway.

In 2005, they accounted for over half.

Kisses is a great example.

The Kisses brand has been transformed from primarily a seasonal brand to an all-the-time brand.

The ratio between seasons and every day has reversed from 60/40 seasonal to 60-40 every day.

This shift has been accomplished through the filled Kisses platform and the successful introduction of Kissables in the single serve format.

Both filled Kisses and Kissables will have expanded offerings over the next several months.

These include filled Truffle Kisses, which began shipping at the end of June and the introduction of Dark Chocolate Kissables.

Reese's, a brand that grew over 6% during the second quarter, will benefit from the introduction of Reese's Crispy Crunchy Bar.

This provides another opportunity to deliver the salty/sweet taste profile that consumers desire and do so in the highly-profitable single-serve format.

We're now shipping Hershey 100-calorie snack packs in two varieties, Reese's and Hershey's Snacksters.

In September, we will be launching 100-calorie bars in three varieties -- Dark Thin, Wafer Bar and Pretzel Bar.

This enables us to deliver superior-tasting chocolate products in the portion-controlled size that is on trend with consumers.

In addition, these 100-calorie packs deliver a higher margin to both the retail trade and to us.

The big news in chocolate is dark chocolate and here's why.

Household penetration of dark chocolate has increased from 8% to 25% over the past two years.

For the year-to-date period, the dark chocolate segment experienced a growth rate of better than 40% with Hershey attaining a market share of over 70%.

What began as just a few items under the Hershey's Special Dark brand is now a major growth business, comprised of Special Dark, Extra Dark and Scharffen Berger -- all highly incremental to the Hershey portfolio.

Here is how we intend to further build Hershey's leadership position in the profitable and fast-growing premium dark chocolate segment.

The Cacao Reserve by Hershey's line begins shipping late in the third quarter.

The Cacao Reserve items include single-serve squares and truffles in premium tins -- all to be merchandised on the front end at retail, the most profitable location for snack products.

Take-home bars of dark chocolate and milk chocolate will be introduced during the fourth quarter.

Also during the fourth quarter, we will launch four country of origin take-home bars, including Java, Santo Domingo, [Areba] and Sao Thome.

These products will capitalize on consumers trading up within the chocolate category and provide distinctive flavor profiles, much like what's happened with premium coffee.

Cacao Reserve by Hershey's will compete in the mass premium chocolate segment.

This segment, one in which Hershey doesn't currently compete, is large and more than $1 billion in retail sales and growing at better than 5%.

Trade acceptance has been very strong as Cacao Reserve will deliver premium pricing and good margins to the retailer and premium profitability to Hershey.

The profit margin on Cacao Reserve indexes at better than 125 versus the Company average.

In terms of winning the seasons, we expect to have solid seasonal performance during the second half of the year in both shipments and at retail.

Hershey has increased its seasonal market share for the past seven seasonal merchandising periods, while improving overall profitability.

We will continue to streamline our seasonal offerings and deliver more profitable solutions to our customers.

Now on to the second growth area, new platforms.

During our first-quarter conference call, we established the role that new platforms would play in delivering incremental and sustainable growth.

During the second quarter, this was clearly the case.

New platforms were the major source of growth, while limited editions delivered at a level consistent with our strategic intent.

Through the first half of 2006, limited editions represented less than 2% of Hershey's net sales, a level roughly half that of the year-ago period.

Here's how we will continue to build the three major platforms of refreshment, cookies and snack nuts, starting with refreshment.

Ice Breakers is Hershey's fastest-growing brand with year-to-date sales growth and retail takeaway of nearly 30%.

Ice Breakers is the number one mint brand in the segment with a market share of over 20%, an increase of 6.1 points versus 2005.

Ice Breakers is not just driving sales growth, it's also delivering profitable growth.

Our strategy of trading up in refreshment is paying off.

The retail trade benefits from a higher dollar ring, indexing at 130 versus two years ago, while Hershey gains a higher profit margin with an index of 114 over the same period.

In the fourth quarter, we will be expanding the Ice Breakers Sours franchise with the introduction of Ice Breakers Sours Gum, a perfect complement to our Sours Mints and a great opportunity to capture incremental growth in the higher margin intense gum segment.

We will be extending the iconic York brand into the refreshment segment.

In the fourth quarter, we will introduce York Chocolate-Covered Chewy Mints packaged in a round tin, similar to the very successful Ice Breakers Sours Mints.

Here is another opportunity to build one of our leading brands, yet do so in a way that captures the highly incremental and high margin single-serve refreshment opportunity.

We will support all of our refreshment initiatives through a combination of advertising and targeted customer support.

Refreshment is one segment where advertising is very effective.

Ice Breakers Liquid Ice experienced a 126% velocity increase pre-versus-post advertising.

Ice Breakers Ice Cubes Gum registered an increase of 74%.

Now on to cookies.

As we expand our cookie platform, we're building distribution, consumer trial and retail takeaway.

The successful introduction of Mini Kisses Cookies as well as a strong increase in retail distribution have enabled Hershey to become one of the fastest-growing cookie brands.

Here is how we will continue to build this important business.

Sandwich cookies have been well accepted by the trade and begins shipping during the third quarter.

The three varieties -- Hershey, Reese's and Heath -- all leverage very strong brands and provide a unique taste experience, using a layer of real chocolate in addition to the other fillings.

Our cookie business will receive dedicated TV advertising and sampling during the second half.

The snack nuts segment continues to represent a profitable growth opportunity.

In just the first six months, Really Nuts! has already obtained distribution and velocity levels approaching that of the market leaders in the convenience channel.

During the second half of the year, we will be expanding our Really Nuts! line with take-home packages of cocoa-dusted almonds, peanuts and macadamia nuts.

In addition, there will be new flavored snack nuts under the Mauna Loa brand.

The third strategic growth opportunity area is single serve.

This is a very attractive segment in that it offers consumers great taste and variety that's both affordable and accessible.

For the retail trade, it's profitable with an average retail margin 50% higher than take-home confectionary.

Across the entire snack market, Hershey is the clear leader in single serve.

Within the FDMxC universe, our single-serve takeaway is up 4% on a year-to-date basis with King Size up 6% and refreshments up 14%.

Hershey's single-serve market share within total snacks now stands at 18.4%, up 0.3 points for the year-to-date period.

With the goal of having one-third of our total portfolio being single serve in three years, we continue to make solid progress.

In addition to the new Cacao Reserve and Ice Breakers items, most of which are single serve, we have several other single-serve growth initiatives.

The big news during the second half is on king size.

And here is why King Size is so important.

Within convenience stores, Hershey is the clear leader in King Size and growing.

Year-to-date, Hershey's King Size takeaway is up 8%.

This has resulted in a market share gain of 1.1 points, increasing our segment leadership to 48%.

On a brand basis, Reese's King Size is the number one c-store King Size confectionary product.

The importance of King Size extends to profitability.

The penny profit for retailers on King Size indexes at 128 versus the standard bar.

For Hershey, the profit margin on a dollar basis indexes at a level above 150 versus our standard bar.

Here's how we will build this very profitable leadership position.

During the second half, we're introducing Reese's Crispy Crunchy, Reese's Big Cup with Nuts, Hershey's Peanut Butter-filled Chocolate Bar and Kissables -- all in King Size.

To ensure that we continue to profitably build our convenience store business via single serve, here are two additional initiatives to highlight.

Beginning this past Monday, we concentrated our distribution merchandising drive to 80,000 convenience stores.

As before, the focus will be on those 12 items by market by customer that represent the strongest growth potential.

The second major growth initiative within convenience stores is our effort to compete in the area of substantial snacks.

While our cookie launch has enabled us to successfully enter the cookie segment in convenience stores, the big opportunity in this class of trade is substantial snacks.

Whether it be large cookies or brownies, substantial snacks is a large, growing and profitable business for the c-store operator.

Hershey is entering the substantial snacks segment with the August launch of indulgent brownies under the Reese's and Hershey's brand names.

This will be followed by the introduction of Hershey's and Reese's Big Soft Cookies in December.

Clearly, our brands are relevant in this area.

With these two introductions, Hershey will now participate in a segment that measures $1.3 billion in sales within convenience stores and growing at about 4% per year.

We'll broaden our offerings in early 2007 behind several additional single-serve substantial snack offerings.

Our single-serve initiative is transferable to seasons.

Currently, single serve accounts for only about 10% of our total seasonal sales.

This will increase to about 25%.

This also improves the profitability of seasons, given that the single-serve profit margin indexes at 130 versus regular seasonal pack types.

In addition to our single-serve product and seasons initiative, expanding distribution to new channels will also drive growth over the long term.

Hershey's expansion with Home Depot is gaining traction.

Single-serve sales within Home Depot on average are comparable to those levels achieved within our major drug customers and approaching that of major c-store chains.

Importantly, velocity is increasing weekly.

Home Depot in addition to other high-growth retailers will continue to benefit from our innovation in single serve.

All-in-all, our strategic growth opportunity areas represent significant potential to accelerate profitable growth.

These areas deliver the product, flavor and form benefits that consumers seek from the snack category.

For our customers, our growth areas provide attractive retail margins, thus enabling Hershey to build distribution and capture incremental merchandising opportunities.

Now, to wrap up.

The results for the second quarter are balanced with strong gains in both sales and profitability.

Our growth initiatives are resonating with consumers and customers.

Equally as important, the organization is committed to delivering our productivity targets.

As we enter the second half of 2006, we're encouraged by our prospects.

A combination of new product innovations, solid seasonal programming and good visibility into our total cost structure will enable us to deliver our full year objectives.

Therefore, we anticipate net sales growth for 2006 to be somewhat above our long-term range of 3 to 4%, and the increase in diluted earnings per share from operations should slightly exceed our long-term expectations of 9 to 11%.

We will now open it up for questions.

Operator, the first question please?

(Operator Instructions).

Eric Serotta, Merrill Lynch.

I'm just wondering whether you could give some additional color into the obsolescence costs and the -- how -- whether you expect that to continue into the second half.

I know you mentioned you would see it in the third quarter.

But could you give some color as to whether that impact should be diminishing in the third quarter and into the fourth quarter?

Sure.

In the second quarter, most of the margin decline in the gross margin area was caused by the obsolescence factors.

For the year -- when we came into the year, we expected to have broadly higher raw and packaging material inputs costs as well as higher freight costs.

And that is -- those costs have been pretty much in line with what we expected.

We have gotten the price realization and productivity that we expected to offset that.

So, our kind of ingoing algorithm of increasing input costs but better productivity and price realization has pretty much been on target.

The two surprises I think from a marketing standpoint in the first half was -- one, the destocking by retailers in the first quarter on some of the standard bar items caused us to have a negative margin due to mix in the first quarter.

And here in the second quarter as we have really looked to shift our portfolio -- we started talking to you about that in the first quarter -- moving much more to platforms deemphasizing some of the limited editions but also Smart Zone, Swoops, some of the Liquid Ice SKUs for example.

As we started to write those off to get the portfolio I think a little bit more right sized to emphasize the platforms, we took a hit in margin in the second quarter.

And, that was a fairly sizable hit for us.

That is certainly going to diminish as the year goes on.

We would expect to see a little bit more cost from that in the third quarter and then back to normal levels from there on out.

Sure.

Then a quick follow-up on the SG&A as a percentage of sales.

I know that you mentioned the restructuring programs that you announced at this time last year as being a major driver of the reduction there.

But how sustainable are we at the current SG&A ratios?

I think as I said in the comments, we had enjoyed 160 basis point reduction in SM&A spending in the first half.

That is not a sustainable level.

But we also had an 80 basis point decline in gross margin in the first half, and we don't believe that that's really the run rate either.

So we would expect to see as we go through the balance of the year kind of a balance of costs and productivity, so kind of more flattish gross margin for the rest of the year but improvements in SM&A as the year goes on but certainly not quite as good as 160 basis points -- so a little better gross margin performance, not quite as strong on the SM&A, and still approaching that 90 basis point to EBIT margin expansion for the year.

Pablo Zuanic, JPMorgan.

Can we go back to the -- just trying to understand the doubling trends here.

Can you tell us of your total sales, what percentage is coming from snacks these days and roughly if you leave the means -- the refreshments, the sugar, candy and chocolate out, where are we after two years with the snack platform in terms of contribution to sales?

I think there's a couple of ways to think about this.

Last year in the second quarter, we had a major introduction of some cookies and so that would have been a big impact in last year's second quarter.

The big news on cookies for us in '06 is in the second half of the year.

So, we anticipate snacks to continue to grow in the second half of the year.

I think the important thing is that regardless of the platforms, whether it be within core confectionary or in snacks, we see opportunities to build our brands broadly.

So in any one quarter, snacks may be a big contributor.

But throughout the year, it's going to have the appropriate takeaway contributions to the total business.

Now, just moving on to the c-store side.

You're saying that on your core business confectionary, you're actually still gaining share.

But can you just elaborate in terms of your shelving plan and it's really what I asked in the last quarter.

In the past, you had made a big deal of the shelves that you were installing in that channel.

In my view, I was hoping (indiscernible), more lifts -- what's really going on there?

I mean from outside, it seems that you're getting some pushback from competitors and that plan is not going according to plan.

No, that's not the case.

Let me start more broadly with convenience stores and Dave will pick up specifically on the first part of your question.

What we said within convenience stores, our share on a year-to-date basis was down about 0.1 point.

We gained share in chocolate.

We gained share in non-chocolate or sugar confectionary.

We gained share in mint.

We gained share in single serve.

We gained share in standard loose and in King Size.

What was happening is the gum segment grew quite rapidly, and so it lifted the overall category slightly above what our takeaway.

But at a 4% or close to 4% year-to-date takeaway within convenience stores, we feel good about that because we feel good about the business that we are running through our convenience stores.

The important thing is given the breadth of our retail distribution, we do not need convenience stores to grow at above historical growth rates for us to deliver the type of growth prospects that we're looking at.

We saw excellent growth -- 9% in mass [ex] and drugstores during the first half.

So we like the breadth of our distribution.

We saw club stores growing at 7 or 8%.

So, what we're not going to do is chase any level of unprofitable sales in any one class of trade.

So, I guess the short answer is we feel that convenience stores continue to represent a very profitable growth business for us.

We're focused on those items that make sense by market by customer, and we continue to look for ways to build our single-serve leadership.

(multiple speakers) Rick, and just one last -- I'm sorry; go ahead, Dave.

I just want Dave to touch specifically on the first part of (multiple speakers) --

-- your question was on merchandising units and racks.

We continue to place new racks, but there is still a large percentage of the universe out there that doesn't have rack placements in it.

And probably given the size and the velocity in those stores, we would never necessarily place a rack in them.

And so what we're really doing is working through the merchandising plan to make sure we have the right items in the stores, which is why we are rerouting our sales force to touch a lot more stores than we would have in the past more frequently.

So I think what you're seeing for us is as we get the product line right -- and that's where some of the obsolescence costs came in -- as we start to deemphasize some of the limited edition offerings and I think some of the gum SKUs that just haven't been doing as well -- what you're seeing is kind of a swapping in and out from ourselves into our own existing space.

So that merchandising unit might not have been as productive in the first half as we would've liked it to have been, but we think we have the plans in place to make it much more productive in the back half.

Just one last question -- in terms of receivables and the trends you're showing working capital, which you partly explained, is there an issue at some of your merchandisers just moving less [wearup] stores and it's a way to prevent returns -- you're actually having to explain terms to your customers?

No, the receivable aging has nothing to do with velocity of retail.

Really, what's happened from accounts receivable is we've changed our seasonal model in the last five or six quarters.

But we've shipped the seasons earlier and versus historical models; that's why we've had higher accounts receivable balances.

That's really been a very good thing for us in the marketplace as you look at our share gains and our profitability for the seasonal business.

So, we think that takeaway continues to exceed shipments.

Our receivable balances are very, very current.

Our dispute balances are at almost record lows for almost a 10 or 15 year period of time.

So, we don't have an aging issue with our receivables; it's just the timing of the way the shipments are running and how we're executing our seasonal program.

As we go forward here, we would expect through the rest of the year that we'll improve our working capital position by the end of the year.

One last one and I'll pass it on.

When I follow your snacks platform, I know that the business is really indulgence.

But I thought also it was an opportunity for you guys to become more functional.

Then, I am looking at these snacks products -- you know $0.99 cents, 400 calories.

I am just wondering, is there -- I suppose there's a consumer for that.

Obviously, the Planters and the other nuts seem to be much lower calories.

Is that an issue, which (indiscernible) just the whole snack platform or indulgence and leveraging the indulgent brands more than functionality of the portfolio?

It was never one over the other.

What we like about the category is the breadth of benefits that we can offer to the consumers.

So with Really Nuts!, we're offering obviously the protein with the nuts.

PayDay Pro is a terrific product that is actually more balanced than not.

Within convenience stores, you might see more indulgent offerings.

And then in other classes of trade, you might've seen those that have more of a better for you profile.

But it's never going to be one versus the other because no consumer just selects one to the exclusion of the other.

Well just in terms of mints, would you say that mints are taking category share from chewing gum just because of breath-saving benefits?

Do you see that happening?

We look at it broadly from an overall refreshment benefit, and we're seeing growth in both the intense mints and the intense gums.

And that's why we like leveraging one major platform, which is Ice Breakers.

David Nelson, Credit Suisse.

Congratulations.

You alluded to it, but I may have missed if you made a specific comment on when you're talking about c-stores -- consumers' purchases being affected by gasoline prices -- are you seeing anything there?

As of now, we haven't seen any impact, and so I think it's too early to tell.

We've seen decent growth.

As I said before, we have seen good share of performance in our segments.

But, as of right now, I think it's too early to discern any impact of higher fuel costs.

The consumer marketing spending this year versus last year, did you give that?

I think overall advertising consumer spending for the year would be slightly down.

Advertising is down and consumer promotions are up.

So, as we continue to move much more towards trial and sampling, generating vehicles given the instant consumable nature of the category at store level.

Terry Bivens, Bear Stearns.

A couple of quick things.

Dave, could you break down your top line into volume and pricing?

It's basically almost all volume.

A little bit of price in the quarter but almost all volume.

My other question deals with Home Depot.

Obviously, this is one that has a lot of potential.

Rick, I just want to get some clarification there.

Did you say your sales there are already approximating those at some of the major drug chains as well as some of your major distributors to c-stores?

No, at c-stores, meaning at retail.

So we're saying the velocity is approaching some of those levels.

The velocity but not the absolute sales number?

No.

Can you give us a little more color on how that's coming relative to your expectations?

As we roll out -- I think we're in about 1,300 Home Depot's and we aren't going to get to the entire universe I think by August it is.

We feel very good about the multiple locations that we're getting within a Home Depot.

There's multiple snacks fixtures.

We're at -- let's see -- racks at the checkout.

You scan racks; they are near the soda cooler.

So, we like the multiple placements we're getting within Home Depot.

We expect to be in -- close to 1,700 stores by the end of July.

We're in about 1,300 stores that have been set.

So I think we feel very good about it.

But for competitive reasons, I probably won't go any other than that.

Just one last thing.

I assume by the absence of this in your remarks, there was no destocking effect to any significance in the quarter?

Very little.

There was a little bit but nothing really to speak of.

We shouldn't worry about that in the second half?

We worry about everything, but it's not one that's on the top of the list.

Chris Growe, A.G. Edwards.

I just wanted to ask the question -- you mentioned I think that your year-to-date retail takeaway trend was up 6.6%.

If I recall correctly, it was up 4% in the first quarter.

I'm trying to put those numbers together.

Was it a pretty material acceleration it would seem in second-quarter takeaway, or is it more seasonal related maybe?

What we've said is the Easter shift, which was in the second quarter in 2006 and the first quarter in 2005, and so you would see that spike in the second quarter.

So that's why we said we gained market share in the second quarter, so we gained share in the eighth consecutive quarter we talked though to get a more balanced look at the takeaway we did on a year-to-date basis.

And it was 6.6% for the year-to-date period.

Then you had mentioned that Halloween was a 1 point benefit to sales growth this quarter.

So if you put Easter and Halloween together, can you give us a rough idea of what that helps in terms of sales growth for the quarter?

No, because Easter shipped in the first quarter.

Then my next question would be on the SKU reductions.

Is that program then it's in place and started in -- was there any noticeable volume effect from that program?

I mean it's in place and it has started.

It will flow throughout even into 2007 for a large part of that.

There was some progress in the quarter, and you saw it in some of the obsolescence numbers.

Obviously, we grew the top line 6.4%.

But we really feel good about the platform innovation and the ability for us to kind of change the portfolio, taking some of the limited editions and underperformers out and still get the kind of growth out of the platforms that we got.

My last question really to Dave is on receivables and just a follow-up on the earlier points.

But now that you are five quarters into the significant growth of over and above sales growth, at what point do you start lapping again the programs you put in place a year ago?

I thought that would've occurred this quarter and then you still have this pretty strong growth in receivables.

You did see some of it in the quarter -- in this quarter, and you should see it as the year goes on -- is that we've got those programs in place now.

The back half is a much bigger half for us than the front half and you'll start to see it then.

When you say see that, you would see less growth in receivables over sales.

Correct.

Eric Katzman, Deutsche Bank.

A few questions -- let's start with the seasonal business.

I guess I'm just -- it's just unclear to me what has changed that seasonal seems to be more of an emphasis for the Company.

I know when you first did the analysis, seasonal was kind of skewing manufacturing and distribution with spikes and that made it a much less profitable business to be in.

So maybe you could explain to me what has changed and why like a retailer such as Wal-Mart would be willing to accept Halloween candy in the second quarter, given that its three or four months away?

Why would they want that kind of inventory?

Eric, a couple of things.

One, we have changed our seasonal model a little bit.

We have really rationalized the number of SKUs that we have.

We've gotten much more focused on the bigger, more powerful brands.

And our goal for the seasons for the retailer as we look at it from a category management standpoint is not really for their seasonal business -- the absolute seasonal business to grow.

But that for them to be much more focused on the big brands that sell through better and help them economically.

From that perspective, we would obviously expect to gain a bigger share, given our breadth of brands.

So, it's really a shift in trying to get the economics of it right.

Therefore, what we were seeing is we are getting a greater share of not necessarily a bigger pie but a greater share.

So, our business is growing.

One of the other things that's a little bit unique about our business is we don't go direct to store.

So, for us to get our Halloween staged properly, for example, we don't go direct to Wal-Mart with our Halloween business.

We go through a third party.

So it needs to get somewhere to get staged to get set to go in.

So it's not like we're shipping it today, and it's going to show up tomorrow.

There is a lead-time there.

Let's say in the past, you may have been shipping Crackle or Mr. Goodbar product into season and now you've basically moved away from that and it's just focusing on the bigger brands' platforms, whatever it is -- Reese's, Hershey's or Kisses.

Right.

It's fewer SKUs but the ones that do a better job when they are merchandised.

And we've said it for the past couple of quarters if we can get out there a little bit early and we get merchandised earlier and we get -- we have better sell-through and that has paid off in terms of both market share gains as well as improved profitability.

So, as David said that the goal is how do we continue to build profitable share, not necessarily how are we going to increase the total seasonal business.

Then just next question has to do with the gross margins.

I guess you answered some of it with the obsolescence issue.

But, a lot of the products, Rick, that you talked about with much higher index in terms of profitability, I mean it seemed that almost every single product you highlighted had an index well above your average.

You've deemphasized kind of the gross margin lines starting with the analyst meeting that you held at the headquarters.

And obviously, we realize that input costs are a pressure.

But, if you are successful with a lot of these new items and I'm understanding the mix/margin impact, when should we start to see gross margins start to either flatten out or turn up ex-the obsolescence issue.

You're right in the commentary because as we continue to shift the mix towards the higher margin and on a higher net price basis, whether it be in refreshment or single serve, we will start to see that particular benefit in the gross margin.

As David highlighted, we continue to get some price realization and that's not just a higher list price or a more efficient trade promotion.

It's a combination of those two, but it's also based on the sales mix that we're executing.

So we'll continue to see some of those improvements over time.

We also could have sold a lot more Ice Breakers during the quarter, and we're seeing a business that is having trouble keeping up with demand.

So there's one that's higher margin as well.

So I think you'll start to see the improvements and it takes time.

But we've also said we're committed to the shift to single serve and we're committed to those products that provide a higher margin.

But as we ship the new products with those higher margins, it does take a while to get the learning curve from a manufacturing and distribution efficiency.

Jonathan Feeney, Wachovia.

This is [John Baum] on behalf of Jon Feeney.

I am (multiple speakers) tell me of your key inputs.

We've seen reports of a potential cocoa crop disease in the Ivory Coast about a month or so ago.

And now, with the recent flare-up of violence over there, what are your views on your sourcing ability and the supply of cocoa in general as we move through the second half of the year?

We don't want to comment specifically on any given input.

I think if you look at the costs in the current market and that's not by any means am I saying that that's what we are either buying or selling at.

But if you look at what's happened in the cocoa market over the last week or so and look at the pricing, it would not indicate to you that there's going to be any kind of a shortage.

But we don't like to comment on what our practices are.

David Palmer, UBS.

Could you just elaborate for me about what obsolescence costs were specifically?

Was it an inventory write-down, perhaps deals with the trade?

Could you perhaps tell us a little bit about that?

In the gross margin impact, it would not be deals with the trade.

Deals with the trade, the markdowns, those kinds of things would be up between gross sales and net sales.

So, it's really inventory that we have in our possession.

So for example, as we move through the product lifecycle of something like Liquid ice for example, we are now at the point where Liquid Ice -- we don't need all the number of SKUs.

We probably need one or two of the SKUs, not four.

So several of the flavors of Liquid Ice as we go through that product lifecycle, we wrote off.

Swoops and Smart Zone are a couple of items that have not done well that we're going to discontinue.

So whatever packaging material inventory and raw material inventory and finished goods that we still had in our possession, we would write off.

And then in some instances as we're leaving and exiting limited edition, there's packaging material and some inventory there.

So, it's all stuff that's in our own possession that hits the gross margin line.

In the quarter when you look at the decline that we had in gross margin, obsolescence is really almost all of that decline.

What do you think your seasonal shipment impact -- the timing impact will be on the back half?

Is that going to continue to be a boost do you think just standpoint that you're going to be shipping earlier for each of the holidays?

Also, given what sounds to be a bullish outlook for your seasonal business and what you seem to have -- be aggressive plans for single serve, I'm wondering perhaps you can give us a sense will single serve do you think will be growing faster than your overall revenue do you think in the second half?

Comment on that?

I think on the seasonal -- the way we've been merchandising and shipping seasons, we are now in the back half, lapping similar practices in the back half of last year.

So I would not expect a significant seasonal shift; although, we really haven't started to have scheduling for holiday and Easter with our customers yet.

But I wouldn't expect the seasonal shifts to be that big in the back half.

And we've not really historically commented that much on specific pack type or segment growth.

Although, as Rick said, most of our growth initiatives in the back half are in single-serve format.

One last one -- you mentioned in your discussion on working capital that outsourcing was delayed.

It just brings up the question -- maybe you can elaborate on that -- but also, could you perhaps give us a sense about what outsourcing could mean to your cash flow growth versus perhaps your earnings over the next one, two or three years?

Could you perhaps elaborate on that?

On the outsourcing -- the specific outsourcing we've been talking about with you has been cocoa liquor outsourcing.

We have begun receiving outsourced liquor from several suppliers in the second quarter of 2006.

However, one of our suppliers, who we expected to get the lion's share of that liquor from, has had some construction delays, is not going to be at full production until either later this year or the early part of 2007.

And that's why we were holding a little bit more raw material there.

Going forward, the liquor outsourcing is the only one that we really have discussed in terms of strategy.

David Driscoll, Citigroup Investment.

Congratulations on the solid top-line performance.

Question -- can you just give us the top-line impact of the SKU reduction for the second quarter?

Really none to speak of.

So back last quarter when you guys discussed the 20 to 25% reduction in SKUs, the sales that go along with the SKUs that you were discussing back then, it's extremely small.

Is that accurate?

What we said was we were targeting that I think over an 18 month period, and we really didn't get into the specifics of what those sales might or might not be.

Obviously, you can assume they are small and declining, but it was also the complexity that they were bringing into the system.

We probably wouldn't want to go much further than that.

Can you just give us then an update on that?

If it's the 18 month window, how far along is it -- is it more front-end loaded here, where you get more of it done now and there's just a long tail, or is it evenly through that period?

I think it's going to be -- it's going to more than likely come in chunks.

So, for example, the entire Swoops line is something that we've opted to discontinue.

And it will come more than likely in concert with customer-scheduled resets at the shelves.

So things will probably likely come off that scheduled reset.

So it will come in pieces rather than kind of on a smooth flow.

But beyond that because we haven't had the conversations with our customers, I don't think it's appropriate for us to talk about them at this point.

Rick, can you comment on the total category dollar sales in the convenience stores for cookies and then separately snack nuts?

We haven't broken it out for convenience stores.

We've said the cookie market overall as measured by our IRI Nielsen is about a $4 billion universe.

We said that we like the convenience store aspect of that because it was relatively underdeveloped.

We had very strong single-serve position, and we were entering the cookie market initially with single-serve indulgent a little bit higher priced cookies and that has been successful.

I think the important thing was once we got into single-serve cookies within convenience stores, we saw the opportunity for this much bigger segment called substantial snacks, which is why we are introducing the brownies and the large cookies over the next several months.

Moving on, can you just give us a little bit of an update on your international plans?

You mentioned you had a nice presentation at the Holiday at Hershey's, but it still seems to be a very small fraction of the total Company sales.

Where's the next event going to happen in international?

Or is there something that's ongoing right now that you can elaborate on?

I probably don't want to comment on any international events.

But, I think we continue to see good opportunities within Mexico.

We like the progress that we're making.

We have a balanced portfolio within Mexico.

We saw some good progress in some of the Far East markets.

And again, the issue for us is what is the appropriate route to market?

We understand and we know that we have very high levels of consumer brand awareness and acceptance, despite the fact we maybe don't have the right portfolio yet and certainly don't have broad levels of distribution.

So, we continue to see the same opportunities in key Asian markets and selected Latin American markets because that's where the growth is.

And as we've said before, we like the strategy of expanding with the global retailers, and we continue to do well with Wal-Mart and 7-Eleven c opportunities more broadly down the road.

Then, just one last question but this is one for maybe both you, Rick and Dave.

Your debt to EBITDA is about 1.6 times.

It's certainly one of the lowest levered companies in the large-cap packaged food group.

Can you give us some thoughts on your philosophy as to why a very stable franchise like Hershey in terms of cash flow would have a debt to EBITDA ratio this low, why it shouldn't be perhaps several points higher and -- well, let's start their please?

One of the things that we have been doing is we have been realigning our capital structure a bit by taking on some debt to repurchase shares.

So we've been realigning the structure a bit and also getting our cost of capital we think to a more reasonable level.

So, we have been looking at that.

That is a Board level conversation and decision, and so a lot of what we've been doing with the share repurchases is looking at that.

Clearly, we have a very strong credit rating.

We're very pleased that we have a very good balance sheet and it gives us flexibility for the future.

And that's about all I would say.

Maybe a follow-up then is that after the first-quarter report, the stock came down significantly.

It would be -- my takeaway from an outsider -- you certainly have the opportunity then to buy a lot of stock back at lower prices.

You bought back, I think you said Dave on the call, 2.7 million shares.

You know overall, this would seem to me given this balance sheet way too low a number given the opportunity that was there.

And I'm just not sure what's the rationale for trying to keep the balance sheet at such a -- with such low leverage.

We do have a share buyback authorization in place.

We executed it; it's a $500 million authorization put in place last December.

We're about halfway through it.

We think that that would be appropriate in terms of what we're thinking about for uses of cash right now.

And at this point in time, I would rather not go any further.

It's really a Board level decision in terms of the capital structure of the Company.

Andrew Lazar, Lehman Brothers.

Just a quick follow-up on the c-stores and I don't want to obsess about it because I know you're getting some good growth in a lot of the other channels as well.

In the analyst meeting in December, I think you talked about it was like a 200 million opportunity I think in c-stores over the next two years or so.

And I guess off your current c-stores sales base, that would suggest a low double-digit kind of compounded annual growth let's say in c-stores sales over the next two years.

Is that still a reasonable and appropriate target, specifically for c-store growth, given what we've seen -- even the growth has been good in c-stores, I don't know that it's been at that level.

Or is there just so much more in the way of new platform products to come in the c-store that we should expect an acceleration there?

I think there's a couple of things.

I don't remember that specific number.

It might have been for alternate channels or single serves or high-growth channels.

I don't remember the specific number.

I think what we said and were consistent with in convenience stores is we see opportunities to continue to build takeaway and share.

And if we are growing at around 4% right now, that's not a bad number because we're getting good growth in other classes of trade.

But we're not going to be, we never have been and therefore we won't be so fixated on any one particular class of trade.

And we still see convenience stores as a good growth opportunity, particularly if you think about the multiple locations that we have in a relatively small footprint, whether it be minced by the coffee centers, certainly products by the refreshments and at the front and.

So we view it as a good growth opportunity.

Our new platforms, as you cited as well as single service, have a natural gravitational pull to the convenience stores but certainly not at the exception to other high-growth channels.

Then one last one -- as we think about these new platforms, whether it be I think as you call them substantial snacking and things of that nature, is -- as investors and analysts, should we just expect that within these platforms that seems to make a lot of sense to me, we're going to see a continued more rapid flow of products within these platforms.

And some will hit; some won't hit.

But we're going to keep it moving at a pretty quick pace.

Is that just because that's what the retailer and kind of consumer demand may be more of now?

Like, has there been a change in maybe the variety-seeking nature of the consumer in this category, or is it just it's always been there and you are just ramping it up so you can just bring a lot of new news constantly (multiple speakers)?

What does that do to your supply chain?

Right.

I think there's a couple of things in all categories and not just in high household penetration frequently-purchased categories, such as our sales consumers are seeking -- news customers are looking for ways to accelerate category growth.

Fortunately, we compete in a category that continues to be on trend, and we can offer multiple benefits.

The absolute low price point with 40% of the items scanned less than $1, it just lends itself to bringing news and innovation to the category.

I think to answer the question directly, the first part of the question -- what you won't see us do is proliferate in any one platform with a bunch of items that are nothing more than maybe some flavor or packaging variance because that almost gets back down the road of is it nothing more than quick in and out.

So what we're focusing on are those platforms and we discussed three today -- refreshment, cookies and snack nuts -- where we see them representing highly incremental and sustainable growth opportunities.

And that's where we're going to be focusing our efforts.

But, look at some of the news and innovation we're bringing within chocolate.

Dark chocolate is going to be one of our fastest-growing businesses.

And, that's by virtue of bringing new items in and not just coming out with a bunch of varieties under existing brands.

Edgar Roesch, Banc of America Securities.

Interested in your comments on pricing, Dave.

I might have misheard you.

But it sounded like in the first half, there was very little pricing benefit contributing to sales and then you expect a little bit more in the second half.

Is that a good way to summarize it?

Can you tell me what (multiple speakers) --

Yes, the summary in the first quarter was -- the question I think was -- what's the 6.4% and how does it split out price and volume?

And less than 1 point of price in the second quarter and the rest of it is really volume.

I think in the first quarter when we quoted it, it was -- we did get a little bit more price realization than even that in the first quarter.

But, as we go through the rest of the year now, the price increase that we took in the first quarter of 2005 is now behind us.

So we'll probably be getting a little less price realization going forward.

The first quarter, you mentioned that you weren't too far from getting some thoughts together on '07 costs.

Do you have any preliminary thoughts that you care to share?

Or is it too early there?

I have preliminary thoughts but nothing that we're going to share at this point.

We're starting to get a view into the 2007 market basket.

But at this point, we think it still remains a fairly volatile commodity market out there and we're not really at this time ready to make any kind of statement.

One last question here on cookies.

I mean it's very impressive -- the success you've had there -- some terrific new products coming out.

Are you still co-manufacturing most of those products?

Has the success -- if so, has the success with them led you to think about bringing that in-house?

That's it, thanks.

The answer to the first question is yes, and we've also started to see an improvement in throughputs and some margin.

But we won't answer the second part in terms of what we might be doing in the future.

Christine McCracken, Cleveland Research Company.

Just wanted to follow up on the dark chocolate discussion.

Rick, obviously, you've seen a significant increase in household penetration there.

But I'm wondering, how much of that has to do with the house benefits and all of the news around dark chocolate?

And how much of it is kind of increased availability of dark chocolate products to the consumer?

Could you see that level out I guess sometime soon?

Or what are your expectations around that?

I think it's a combination of all of the above.

Obviously, the very favorable press that has come out on dark chocolate with the benefit of antioxidants and I think it is -- again, it reinforces basic consumer behavior that consumers tend to respond more favorably to the presence of something positive as opposed to the absence of something negative.

And so, we see dark chocolate continuing to be a growth platform for us.

We like our position.

We've got a leadership position in a very profitable and fast-growing segment and have no idea what the future will hold.

But we are intent on continuing to capitalize on it.

I think the important thing is we're going at it from multiple levels.

It's not just special dark.

It's certainly Cacao Reserve by Hershey's.

Its expanding Scharffen Berger, and it's also the extra dark and special dark.

So, we see multiple opportunities to capture some growth.

How large do you think dark chocolate can get as a percentage of the overall kind of chocolate category (multiple speakers)?

I don't know.

We wouldn't even want to give at least for public consumption an estimate of it.

But we think it will be sizable.

Then on nut, obviously, you guys are doing some things with new products there that.

That has been an area that might have in the past underperformed your expectations.

But do you feel that you're on track there now with the current product assortment that you have, or do you feel like there's still some fine-tuning to do in that division?

I think within snack nut segment, it's a very attractive category for us and it really helps us within convenience stores.

What we talked about was the Really Nuts! introduction has done extremely well.

You may be mentioning -- or maybe referencing Mauna Loa, where we continue to streamline and find ways to unlock some profitability and growth within Mauna Loa.

But having acquired Mauna Loa, what we learned from that business helped us get into Really Nuts! a lot more quickly than we would have otherwise.

Then just if you could on c-stores, obviously, it looks like you're going to start launching some of these substantial snacks through that channel.

Is that kind of your new trial?

I mean obviously, you've seen some good success with trials through that channel let's say over the last couple of years.

Is that your new strategy to test things out in that market and then kind of go full force?

It's more based on the strategy of strengthening our single-serve leadership because that's where the convenience store channel has the greatest proportion of single serve as a pack type.

So I think that is part in parcel.

But then also, we have had good success in the convenience store channel.

We also have a customer base that's very receptive to some of the news we're bringing to consumers.

Especially with new products, where you're trying kind of new ideas and new products?

Yes.

I will leave it there.

Ken Zaslow, BMO Capital Markets.

First broad question -- can you talk about your new product success rate over the last three or so years?

And how you define it and how have you done?

We said that -- a few years ago, we said that we expected a contribution of new products to be somewhere in the 5 to 10% range.

Anything below 5% I think starts the category for innovation; anything above 10% brings some complexities and inefficiencies into the system.

So, I think we're at the high end of that range, and we want to stay at about the high end.

But the most important factor is what comprises that percentage of sales from new products.

So, while we might have emphasized a certain part of the business a couple of years ago, the fact that we are very much keeping our discipline around these major growth platforms and continue to build our chocolate business, I think that should be the most important aspect of where we see new product -- our new product strategy evolving.

But what about the success rate of it?

Really, ex-number of products that you actually bring to market, what is your success rate?

Or how has it changed over the last couple of years?

I think overall, we feel very good about our new product success rate.

Again, we are in a category where we can gain distribution of relatively quickly -- and trial.

One of the reasons we feel good about our new product efforts is that we are leveraging our big brands.

We're not having to invest extensively in advertising but trying to build a new brand.

So, for example, when we advertise Kissables, there's a halo effect on Kisses.

When we advertise Reese's cookies, there's a halo effect on the entire Reese's franchise.

So, we're getting far more leverage throughout the business by extending our scale brands, which is another reason why we had said for us EBIT margins are more reflective of our ability to deliver profitable growth, not just gross margin.

One of the other ways (multiple speakers) --

So the obsolescence is not indication that your ability to introduce new products at a higher success rate has not fallen off?

Not at all.

No, I don't believe so.

I think one of the ways to really think about it is the innovation pipeline that we've launched in the last three or four years, we've really done it for the most part with depreciation and amortization equal to our CapEx.

So, we've been able to do it in the existing infrastructure.

So when you look at the success rate of it and you look at a discounting cash flow -- discounting cash flow basis, we don't have a whole lot of capital investment in these platforms.

We're using existing selling infrastructure but importantly existing manufacturing infrastructure.

So when you look at the returns on these products, while they may not be wildly successful on some of them, we don't have a whole lot of investment in them.

And the return and the learning is worth it.

The other question I have is when you gave guidance I think it was almost a year ago, obviously you didn't think about the obsolescence cost and you didn't think about the retail destocking last quarter.

So those on the negative side have kind of hurt your earnings.

What do you guys exceed in terms of your expectations?

I think what you are seeing is the ability for us to leverage the business system, and you see that in the SM&A leverage that we've gotten this year.

So while we might not have had the gross margin performance, which is really where the destocking and the obsolescence cost has hit us, we have more than made up for that in SM&A leverage, where we've really gotten great use of the business system and really very good leverage of our marketing spending across our brands.

As we introduce a lot of our new items, we're using existing brands that are very strong brands and therefore a very efficient way to go to market.

In the back half of the year, is there something like these costs that we should be aware of that might take us a little bit by surprise or that we can't really see as readily as all the market trends and all the other information that we're able to gather?

No, we've made comments on what we see in terms of what the cost structure looks like and what the full year expected margins are going to be.

Pablo Zuanic, JPMorgan.

Just a quick follow-up on my side.

Dave, if I understand what you said in the use of obsolescence adjusted for that, gross margins were flat year on year.

So, despite the fact that you had no price realization in the quarter, that would imply that your cost per pound despite the inflationary cost environment were also zero or not changed.

Would you care to comment on that, or am I missing something there?

I think what I said was if you look at the gross margin decline in the quarter, it pretty much was almost all related to the obsolescence cost.

And as I've said before, coming into the year, we knew we had broadly higher input costs in raw and packaging materials and in customer freight and transportation.

We also knew we had pretty good productivity programs and price realization in place.

And both of those things have happened.

They pretty much offset each other.

So, really the blow in the second quarter to the gross margin was really around obsolescence.

Just in the case of dark chocolate, Rick, what percentage of your total chocolate sales are dark chocolate right now?

We haven't broken that out.

But it is our fastest-growing business.

Rick, and just one last one -- you don't have to be philosophical.

But you know consistently, the Nielsen data -- and you may not think it's a good -- necessarily a great source of data.

For the [AVM] channel -- traditional AVM channel, your reported sales are consistently below what the Nielsen data implies, which is the opposite of other companies normally.

And the way I interpret that is that you are growing better in that channel, which gets a lot of attention from investors.

As analysts, you're getting a lot better growth in that channel than in the other c-stores and clubs and so on.

Can you comment on that?

The data that we have been consistent in citing for us is a combination of IRI and Nielsen.

It's IRI for FDMxC, and then it's Nielsen for convenience stores.

Then, we do a composite measure, which covers about 80% of our retail takeaway, which is FDM inclusive of Wal-Mart and convenience stores.

Now, we also talked about club stores having a very good performance, and that's not included in any of the data.

So I don't want to get into data source issues.

But again, we continue to see -- at least through the first half of this year and we've seen it consistently in '05 and in '04, where takeaway exceeded that of shipments.

David Adelman, Morgan Stanley.

My questions have been answered long ago.

Hearing no more questions, we will conclude today's session. [Mono Fern], Bryon Klemens, Mark Pogharian and I will now be available to answer any additional questions you may have on follow-up.

Mark Pogharian, by the way, joined us this past Monday from Deutsche Bank, where he held the position of Vice President North America in Equity Research, covering the CPG industry.

Prior to that, he was Senior Manager of Investor Relations at Kraft Foods, and we welcome Mark to the team.

As one final reminder, our 2006 third-quarter sales and earnings release and conference call is scheduled for October 19, 2006.

We will release earnings at 7 AM that day, and our conference call will follow shortly thereafter that morning.

Thank you very much and have a great day.

Thank you.

This conclude today's Hershey Company second-quarter 2006 results conference call.

You may now disconnect.