好時 (HSY) 2006 Q3 法說會逐字稿

Good morning.

My name is [Tashanta] and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Hershey Company, third quarter 2006 results conference call. [OPERATOR INSTRUCTIONS].

Thank you.

Mr. Pogharian, you may begin your conference.

Thank you, Tashanta.

Good morning, ladies and gentlemen.

Welcome to the Hershey Company's third quarter conference call.

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

We welcome those of you listening via the webcast.

Let me remind everyone 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 into 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.Hershey.com in the Investor Relations section.

Included in the press release are consolidated balance sheets and summary of consolidated statements of income, prepared in accordance with GAAP as well as our pro forma summary of consolidated statements of income quantitatively reconciled to GAAP.

As we said in the press release, the company uses these non-GAAP measures as 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 third quarter results for 2006 and 2005, excluding net pretax charges of $1.7 million, and $101.4 million associated with our previously announced business realignment initiative to advance the Company's value enhancing strategy.

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

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

Thank you, Mark.

Hershey's results for the third quarter were below our expectations, following a period of consistent end market success, we experienced a slowdown in retail take away and thus a loss in market share.

We had solid retail growth within both our sugar, confectionary and refreshment businesses, however, these gains were more than offset by a decline in the chocolate business.

The shift from line extensions to more sustainable, value-added platforms has taken longer than anticipated.

For the quarter, net sales increased by 3.3%.

This was driven by growth within dark chocolate, Hershey's fastest growing business, and seasonal shipments.

We continue to hold the line on overall expense control and this resulted in diluted earnings per share from operations increasing by 8.3%.

Obviously we are not pleased with these results.

As such, we have increased our consumer and customer support in the fourth quarter with the objective of regaining marketplace momentum.

This higher investment will focus on leveraging our core brands and retail scale, while delivering strong introductory programs behind our new platforms.

Dave West will discuss the quarter's results in detail.

I will then review our specific plans for the balance of 2006 and the early part of 2007.

Dave?

Thanks.

As Rick highlighted, our Q3 results were below our expectations with a 3.3% growth on the top line and EPS diluted from operations at $0.78 in the quarter, up 8.3% versus prior year.

Let me give you some details starting with marketplace performance.

Our retail take away and market share performance were disappointing during the quarter.

For the 12 weeks ending September 10th, in channels that account for over 80% of our retail business Hershey's consumer take away increased by 0.9%.

As a reminder these channels include food, drugs, that's including Wal-Mart and convenience stores.

In the reportable FDMxC universe, Hershey's market share declined by 0.8 share points, the first such decline after a period of the same share gains stretching back to early 2004.

The share loss was in our chocolate business where we lost 1.7 points in FDMxC.

In sugar confectionery, our share leadership expanded by 0.1 points.

Within mints, we increased our share this quarter by 2.3 points to 30%.

The chocolate share loss was from poor marketplace performance resulting from a programming gap created by the shift of closer-in limited editions to more sustainable platform innovation.

As a result, during the latest 12 weeks, Hershey had less news and activity for consumers and customers, resulting in a reduction in merchandising activity.

In addition, our velocity to retail were lower than historical levels as prior limited edition programs already in the market sold through at retail.

Without our leadership-driving growth, the category in FDMxC slowed to a 1.7% growth rate in the quarter.

Importantly, retail prices did increase during the period.

The soft 12-week performance brings Hershey's year-to-date increase in FDMxC to 4.9%.

In the reportable FDMxC universe Hershey's year to date share leadership has expanded by 0.3 share point.

We expect the share performance to stabilize and the category growth to increase as we support our new platforms and seasonal business with enhanced customer and consumer activity throughout the balance of the year.

The slowdown in retail take away growth impacted our net sale performance in the third quarter as we had only a slight increase in shipments of our everyday items.

Our seasonal business continues to post gains with good Halloween sell-in.

We also had good shipments of our holiday line.

We continue to execute earlier seasonal shipping to capture incremental display activity at retail with holiday shipments in the quarter accounting for over one point in growth.

We are encouraged by the early performance of our new dark and premium chocolate platforms, as well as by layered cookies which shipped during the quarter.

Price realization during the quarter was minimal.

Turning now to margins.

Where strong administrative cost controls delivered 5% EBIT growth, and pro forma EBIT margins expanded 30 basis points up to 22.7% from 22.4% a year ago.

SM&A expenses were down 100 basis points from last year.

This reductions reflects continued control of administrative costs enabled by the realignment and early retirement initiatives enacted in the second half of last year.

Other compensation costs were also lowered during the quarter, reflecting anticipated reductions in certain incentive expenses.

Total consumer spending, advertising, and consumer promotions, increased at a rate two times that of sales.

This increased support began late in Q3 and we expect it to continue into the fourth quarter.

Rick will discuss the increase in our consumer and customer programming in greater detail.

Gross margin of 38.4% was down 70 basis points on a pro forma basis.

Product mix had a negative impact on gross margin with stronger seasonal sales and shortfalls in everyday items generating an unfavorable mix impact.

As discussed last quarter, obsolescence in product return costs were also a detractor to margins in the quarter.

Interest expense for the quarter increase coming in at $31.8 million, versus $23.7 million in last year's third quarter, reflecting higher short term borrowings to fund continued share repurchases in the pension contributions made last year.

The tax rate for the third quarter was 36.2%, this is 20 basis points lower than last year.

For the full year we project a rate of 36.2% with a rate of 37.1% expected in the fourth quarter.

Weighted average shares outstanding on a diluted basis were 237.7 million versus 248.4 million shares for the third quarter of 2005, leading to EPS of $0.78 per share diluted from operations compared with $0.72 per share diluted for the third quarter of 2005.

That's an increase of 8.3%.

To recap year-to-date pro forma results, net sales increased year-to-date by 3.3%.

EBIT from operations increased 7%, and the EBIT margin increased 70 basis points to 20.0 from 19.3%, driven by strong reductions in SM&A, which has declined 150 basis points as a percentage of sales, principally from the benefits of our realignment initiatives and lower incentive compensation expense.

Gross margin was 38.3% year-to-date versus 39% last year.

Higher impact costs were substantially offset by price realization of productivity but product mix and obsolescence costs impacted progress.

EPS diluted from operations increased 9%, to $1.69 per share.

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

At the end of the third quarter, net trading capital increased around $133 million compared to last year's third quarter.

Accounts receivable grew by about $78 million due to the timing of shipments and additional seasonal receivables opened versus last year.

Our AR balance remains extremely current and is high quality.

Inventories were higher by some $15 million compared to last year, primarily reflecting higher raw material inventory levels.

The timing of last year's realignment and lower ingredient tables resulted in a reduction in accounts payable and accrued liability.

The balance sheet also reflects the issuance of $500 million in long-term debt in September of 2006.

Let me give you specifics on cash flow items.

During the quarter capital additions including capitalized software for $43 million, and for 2006, we again continue to target total capital additions to be in the range of 190 to $200 million.

Depreciation and amortization totaled $51 million in the quarter and should be at 190 to $200 million range for the full year.

Dividends paid during the third quarter were $61 million.

We spent $129 million for 2.4 million shares in our share repurchase program during the third quarter.

We have $115 million remaining on the $500 million authorization approved by the board in December of 2005.

Shares acquired through our repurchase program are held as treasury shares.

In addition during the quarter, we repurchased $14.8 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.

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

During the quarter, total business realignment charges of $1.7 million pretax were reported against the initiatives we announced last July.

The total after-tax impact of these activities was net expense of $1.1 million which reduced reported diluted EPS by $0.01 for the quarter.

This brings product-to-date expense against the July 2005 program to $105 million of the realignment charges and $21 million in costs of sales or total of $126.1 million pretax.

The after-tax cost is $79 million and $0.31 per share diluted and that's been spread out over the past five quarters.

We expect to complete the realignment initiative this year, with the cost to be somewhat below $130 million for the entire program.

The savings are tracking in line with our expectations.

Let me now talk about the rest of 2006 and 2007.

During the fourth quarter, our focus will be on restoring Hershey's marketplace momentum and overall confectionery category growth.

We will be sharpening our consumer and customer programs behind new platforms and seasonal business.

Investments in advertising, consumer promotions, and retail coverage and merchandising events will be made.

Rick will cover them in greater detail.

We expect this to result in a year-over-year P&L growth profile for Q4, similar to that of Q3.

When combined with year-to-date September results for the full year we anticipate that net sales growth will be within our long-term 3 to 4% target.

We have expect growth in full year EPS diluted to be slightly below our long-term target of 9 to 11%.

As we look at 2007 we believe the innovation will be more incremental and sustainable, and that our investment in the latter part of this year, behind these initiatives, will get them off to a good start. .

At this time, we see 2007 net sales growth within our long-term 3 to 4% growth range.

We have also begun to get good visibility into our total 2007 cost basket We see input costs for 2007 being higher than 2006, but with the increase not nearly as sharp as that which occurred in 2006, versus 2005.

We are confident in the productivity and the cost control initiatives planned to help mitigate these cost factors, including the savings from the changes in our pension plans we announced last week.

As such we see growth in 2007 diluted EPS from operations within our long-term range of 9 to 11%.

Now here's Rick to talk about some of the specifics.

As Dave highlighted, resulted were not up to expectations, in the third quarter we erred in terms of not having the typically strong consumer and customer programming that has delivered solid resulted for a sustained period.

We have a very good assessment of what happened, why, and most important we are fixing it.

In the short term, here the next steps: first, we are adding consumer activities supporting our new items and core brands.

This includes both advertising and sampling.

Spending levels will be up low double digits versus last year.

All of our marketing mix modeling continues to reinforce that spending closest to the point of consumption is the most effective.

As such, sampling days will be up dramatically during the fourth quarter.

To coincide with black Friday, the biggest shopping day of the year, we have a fully integrated program in support of dark chocolate.

The dark Friday program elements include sampling in retail outlets with high dark chocolate penetration, targeted print advertising and coupon support.

Two, we are increasing our customer programming to ensure strong in-store activity.

It's important to reinforce that this programming is in support of the consumer efforts.

It's not designed to drive aggressive pricing and here's why.

Deep discounts did not drive category growth.

The absolute low price points as a reminder of 40% of the units scanned are under $1, and the high impulse nature of the category are not conducive for price discounting.

Moreover, the slowdown experienced in the third quarter was not due to aggressive pricing by competition.

On our price per unit basis, loose bars increased by lightly more than 2% for the category with our unit pricing increasing at somewhat higher levels.

Regarding specific classes of trade, the mash channel is showing some recent improvement.

For the latest four weeks, our take away is up 9%, led by Wal-Mart.

We'll build upon this momentum with unique programming on dark chocolate, single serve, and holiday.

We are increasing retail coverage by one-third with a comprehensive program focused largely on convenience stores.

This will ensure that the consumer and customer programming are well executed at retail.

Within convenience stores, the coverage will increase by over 40% versus prior initiatives.

The focus will be on core item distribution, new item merchandising and placement of consumer incentives at point of sale.

The distribution drive will target Hershey's top selling single serve chocolate and refreshment items.

Both king-size chocolate bars and the mint business continue to be bright spots within convenience stores.

During the third quarter, king size growth outpaced the segment, thereby increasing Hershey's leadership by 48%.

Within mints we increased our leadership position by 2 points to 33% during the quarter.

During the fourth quarter, there's an in-store shipper program in support of three new items: Reese's Crispy Crunchy Bar Icebreaker sours tins and York chewy mint tins.

Within other classes of trade, we are also increasing retail coverage and in-store merchandising activity.

That's an overview of the short-term plans.

Equally as important as the commitment to the ongoing strategy of achievement profitable organic growth by delivering a superior value proposition to consumers and customers.

As such the 2007 plans are designed to, one, accelerate growth behind Hershey's core brands, two to successfully build new platforms primarily within dark chocolate and refreshment, and three better leverage Hershey's retail scale.

For Hershey's core brands, we will continue to deliver the appropriate amount of news with items such as Reese's Crispy crunchy bar and new filled Kisses.

Line extensions have proven successful in terms of gaining incremental merchandise support.

Next year marks the 100th anniversary of the Kisses brand.

Earlier this week we kicked off the year long celebration with the unveiling of the 2007 love and kisses postage stamp.

Throughout 2007, we will be running new Kisses advertising at spending levels well up from 2006.

In addition, there will be customer specific events leveraging custom kisses products and unique in-store merchandising activity.

New platforms will be the major source of growth in 2007.

While the shift to platforms has taken longer than expected, the early results have exceeded expectations.

We believe that it's helpful to provide our definition of the new platform.

We are defining a platform as a line of products that leverages Hershey's iconic brands, confectionery and nut expertise and marketplace scale to deliver a meaningful consumer benefit beyond variety.

I will highlight four platforms.

They are, dark and premium chocolate, refreshment, substantial snacks and health and wellness.

I will begin with dark chocolate.

Dark chocolate clearly offers tremendous growth potential for Hershey.

Household penetration increased six points over the past year, a sizeable increase regardless of the category. .

This increase reflects both consumers' understanding of the benefits of higher antioxidant in dark chocolate, as well as their desire for bolder taste profiles.

For the customer, dark chocolate in addition to providing attractive growth rates well above most other categories is also highly profitable.

Hershey is well positioned to continue winning in dark chocolate.

We have the top four brands during the segment and during the third quarter, our increase in retail take away approached 70%.

Hershey's Extra Dark, aligned with the bolder tasting dark chocolate, was introduced to compliment our existing Hershey's Special Dark business..

Hershey's Extra Dark has become the number two selling brand within the segment in less than one year's time.

Here's what we are doing to capitalize on the opportunity.

In December, we are introducing two new extra dark flavors in stand-up pouches, mint and espresso.

In terms of consumer support, we are launching a targeted print campaign beginning in the fourth quarter.

This will run throughout 2007.

Total spending on dark chocolate will be well up next year.

This higher spending level will ensure that Hershey as a segment leader is building dark chocolate segments.

We are targeting the premium segment to further capitalize on the growth potential within the total chocolate market.

This large segment at over $2 billion in retail sales is growing at about 5%, and is new for Hershey.

In September, we launched Cacao Reserve by Hershey.

Cacao Reserve has ten items, 8 of which are bars, and 2 are drinking cocoa.

While early in its introduction, this line is off to a good start.

We expect to achieve a 70% level of retail distribution by the first quarter of 2007, with particular emphasis on those customers who are capitalizing on the trading up phenomenon.

For 2007, this platform will be extended to the introduction of Cacao Reserve truffle tins and four country of origin bars, all designed to deliver a very unique premium taste profile.

The truffle tins provide a portable indulgence in a convenient bite-sized format and deliver higher margins for the trade.

To ensure strong consumer trial, our marketing plans for Cacao Reserve include special advertising partnerships witH Food and Wine, Gourmet and Wine Spectator magazines.

From a retailer perspective, we will rely on sampling and in-store media.

In addition it to our new product development, we are building our premium platform via acquisitions.

Today, we are announcing the acquisition of Dagoba organic chocolate.

This business compliments our premium and dark chocolate platforms, and positions Hershey as a key player within the high-growth on-trend organic market.

As with the Scharffen Berger and Joseph Schmitt acquisitions, Dagoba will extend our reach to consumers and customers seeking a superior chocolate experience.

Refreshment is the second platform to highlight.

From a business that was underperforming two years ago, Hershey's refreshment business has performed extremely well.

As a reminder, the refreshment business is highly incremental at over 80% versus the total Hershey portfolio.

Ice Breakers is the number one selling mint brand and experienced an 18% increase in retail take away during the quarter.

Ice Breakers growth has been consistent, gaining 16 share points over the past three years.

The introduction of Ice Breakers Ice Cube gum has extended the Ice Breakers franchise across the refreshment segment.

From a retail channel perspective, the refreshment business is particularly important to convenience stores, accounting for one-third of total confectionery take away, versus only 20% within the FDMX universe.

Importantly, Hershey's advantage here was a 33% market share of mints in convenience stores versus a 29% share in all other measured channels.

We'll continue to build our refreshment platform through form and flavor innovation.

Ice Breakers sours gum and York chewy mints shipped during the fourth quarter.

The third platform to highlight is substantial snacks.

Although currently small, it does represent a good source of incremental growth.

Our goal is to deliver products that leverage Hershey's taste credentials and core brands and selling capabilities particularly in on-the-go channels.

Currently we are doing this with our layered sandwich cookies and the recent introduction of brownies primarily to the convenience store customers.

Single serve soft cookies began shipping in December.

Another focus area for substantial snacks is value-added snack nuts.

While Mauna Loa grew at 4% during the quarter, the value added chocolate covered segment grew by more than 40%.

We'll capitalize on this high level of consumer acceptance through the introduction of four new chocolate-covered items.

These are Hershey's Milk Chocolate covered almonds and macadamia nuts, and Hershey's Special Dark Chocolate-covered almonds and macadamia nuts.

The fourth platform is health and wellness where the initial focus is in the area of portion control.

Within chocolate, the 100 calorie line and 60 calorie sticks are off to a good start.

This is a great example of leveraging Hershey's scale brands to be easily understood and on trend consumer benefit, portion control.

Snacksters, the 100 calorie line of salty sweet lunch box snacks has started off well.

We believe this initial represents a meaningful source of profitable growth within the portion control benefit arena.

This sums up the work that is under way to build Hershey's leadership within chocolate, accelerate growth within refreshment, and capitalize on selected opportunities within the broader snack market.

Regardless of the consumer initiative, we are equally as committed to leveraging our mint scale at retail, through a combination of unique programming, that's tailored to each customer's retail strategy and dedicated in-store coverage, Hershey is committed to delivering profitable category growth to our customers.

In order for the category to grow, Hershey must lead this growth.

During the first half of 2006, the category grew by 3%, driven by our growth of 5%.

In contrast during the third quarter, the category increased by only 1.7%, with Hershey below this level.

Now to wrap up.

While the results for the third quarter were not up to our historical levels of performance, there were several bright spots particularly related to some of our new platforms.

We are accelerating these efforts while addressing near-term opportunities for improving Hershey's market share position.

Based on our plans for the balance of the year and the increased investment to regain momentum we anticipate net sales growth for 2006 to be within our long-term range of 3 to 4% with the increase of diluted earnings per share from operations to be slightly below our long term expectations of 9 to 11%.

Through 2007 through a combinations of improved marketplace performance and overall cost control, we expect to achieve net sales growth within our long-term goal of 3 to 4% with an increase in diluted earnings per share from operations within our ongoing 9 to 11% expectations.

We will now open it up for questions.

The first question, please.

[OPERATOR INSTRUCTIONS].

Your first question comes from Steven Krom with Goldman Sachs.

A couple of questions.

First, Rick, on the marketing with the increased spending you are talking, about you talked a lot about shifting that marketing mix away from traditional and more towards consumer and trade promotion.

On a go-forward basis, the increase dollar expenditure that you are referring to, is the mix going to change at all?

You have also spoken in the past about the great returns that you get from trade promotions.

Can you maybe speak of that in light of some of the market share changes that we have seen?

And then one other question for Dave on the gross margins side.

You know, the mix of new products that you are introducing, I think in the last call you talked about those being a positive contributor to gross margins.

Can you talk about when we might see gross margins start to expand a little bit again?

And then if you can shed a little bit of light on the savings that are going to flow through from the pension next year in the '07 year guidance.

Thanks.

I will start with the first question and talk about the marketing and modeling.

As we said for quite sometime and we continue to update our work.

Marketing and modeling still reinforces that trade has the highest level of return on investment and then within consumer support, the selected executional devices and, again, those closer to the point of consumption of point of sale tend to have the higher return, which is why from a consumer stand point, while we are using advertising to create awareness for our new brands and some of our new platforms, we view in-store support, whether it be sampling, or activities tied in with the customer strategy as the best way to capitalize on those higher return investments.

So that the investment that we talked about, the increase in the fourth quarter of 2006, the profile looks more similar than dissimilar to what we have done in the past with the sole exception of some increased advertising behind our kisses brand.

Steve, let me take the question, first on pension.

The savings for 2007 will approximate about $10 million, and we look at the total benefit costs kind of in aggregate, we will have some good savings.

We will be spending a little bit more as we enhanced the 401k program and then we'll have some other medical inflation.

So we tend to look at the cost in all in one bucket.

The savings from the pension are about $10 million in 2007.

That's factored into our overall look at costs for 2007.

Where we do see the -- the -- we start to get contraction in the marketplace behind the new initiatives which are premium priced at a higher margin than the average in the portfolio, we would expect to see some favorable mix impact in 2007 from the product standpoint.

And then just a follow-up.

The visibility that you have currently on cocoa and sugar?

I don't want to talk about any one of them specifically.

We have good visibility and a total bucket of costs for 2007.

It is up, 2007, versus 2006 but not nearly at the same level as 2006 was versus 2005.

Importantly we feel very good about our productivity programs as we go into next year.

We also have some things in our P&L in 2006 related to obsolescence product returns, et cetera as we kind of shifted from limited editions to more sustainable platforms that we see one-time in nature to come out of the P&L.

So as we look forward to 2007, we expect to get back on track in the gross margin standpoint.

Thanks.

Thank you.

Your next question comes from John McMillin from Prudential Equity Group.

Good morning, everybody.

I can see why Jim Edress and Lenny Teitelbaum left town.

It's tough to come back.

With respect to advertising, you have clearly put more money in promotion, limited advertising.

Does that kind of reduce your flexibility to do bottom line numbers?

John, I'm -- I'm not sure about the question, but --

You can look at CMR data that show that you have -- in the last year and a half, you have cut your advertising spend, your giving over guidance today food companies that you have been part of it.

I mean, it starts the circle of doom, that they have made marketing or advertising reductions to kind of do numbers.

To the extent you have done that, does it limit the financial flexibility of the company?

As it pertains to 2007, how much flexibility do you have in this guidance to do your targeted range next year.

I think what is important to continue to reinforce is that we compete in a very attractive category and it's much more atypical than typical of other food categories.

If you think about the breadth of retail distribution, high household penetration, frequency of purchase, and clearly the absolute low price point, we continue to see -- and that's why the question before, John, we continue to see a bundle of executional tactics to support our brands so what we are focused on is how do we get our platforms off to the right start?

We have seen some very good success through the early goings and we believe it's a combination of advertising, consumer promotion, primarily samplings and well executed trade programs.

I believe it has less to do with more or less or flexibility but more to do with we believe this is the right way to get these platforms off and running.

And your confidence level in '07 numbers?

That's what we believe is -- what the business will do next year and based on the plans we have in place and we have highlighted some of the cost profile we think we have these programs off to the right start and increase our marketplace momentum.

That's the number one objective.

Dave, you quantified the $10 million in pension savings.

Can you talk about your overall costs for '07, what number you are assuming in this?

Yes, John, I think as I said, we expect the total bucket of input costs to be up '07 versus '06 but not nearly as '06 was over '05.

So as we look at 2007, versus 2006, from a margin standpoint, the new platform certainly should help us from a product mix and price realization standpoint and then we also feel pretty good about our ability to get productivity to offset the costs.

So as we have looked towards 2007, we would expect to get the margins back on track.

Okay.

I will hope for colder weather.

Thanks, John.

Your next question comes from John Sweeney with Wachovia.

Good morning.

Yes, good morning.

Just to follow up, I guess on John's advertising question.

Just different takes.

I mean, do you think your cuts to advertising recently -- I'm not talking this year but over the past few years.

Independent of their -- you know given the efficiency for your company, do you think that's only hurting interest in the category as a whole?

And, you know, specifically as, you know, you look at 2.5ish, 3% type advertising sales level, do you think that's a sustainable level going forward or are you telling us today that maybe you need to invest a little bit more in that area specifically?

I think what is important is to put this quarter in the context of a lot of previous quarters and we have been able to show very good share gains and broad based across all segments and all classes of trade and that is a combination of innovation in our core brands from new items and very strong retail execution.

And from that standpoint, we believe that that's the right formula going forward.

I think as we said before, we are going to support the brands in the way that is consistent with what we see is the drivers within the category.

And so in terms of what we lay out going forward, we think it's in line with the right approach strategically in terms of what it takes to continue winning in this category.

Thanks.

And just one follow-up question, if I could, Rick.

If you talk a little bit about the competitive landscape, you know the margin share loss in this quarter.

I think, maybe a little transition period, things you do in your own portfolio but do you see anything interesting or different or threatening in the competitive environment that you think you need to respond to specifically in terms of confectionary and other management changes than your biggest competitor.

We certain address anything to one specific competitor.

I think what is important is we had not during the third quarter seen any aggressive pricing, as we have talked about pricing in luspar was up about 2% for the category and we were up slightly more than that.

We have not seen aggressive pricing or deep discounting.

What was important to remind ourselves and also Dave talked about, that it was really the absence of programming for us, that drove the reduction in our take aways.

That was that gap between unwinding from being too dependent on limited editions and getting our platforms up and running.

The important thing is that the platform performance we have seen to date, albeit just getting started has been positive from a competitive standpoint, we are seeing some new products within the marketplace, but certainly have not yet seen aggressive pricing.

Okay.

Thanks very much.

Thank you.

Your next question comes from Dave Nelson with Credit Suisse.

Hi, David, how are you?

Great, how are you.

Good.

Just looking at the bigger picture.

As far as looking back at that December meeting, boy, it was -- I guess I can't recall seeing so many new initiatives.

Do you think you were trying to do too much at that time, and why maybe there's a loss of focus on execution in a few things this year?

I think there's a couple of things.

Again, this is a category that certainly responds to news and innovation and the ability to get distribution quickly and trial are all positives, I believe.

As we talked about before, we didn't get some of the instrumentality from some of the new items that we had anticipated which is why our platforms are well beyond just providing variety, even in a variety seeking category, you can provide too much variety.

So the platforms are more focused on specific benefits, whether it be the antioxidant benefit of dark chocolate refreshment or breath freshener in our refreshment category, or portion control within our 100-calorie line.

I think it's less about the breadth of items but more focused on delivering a specific benefit.

Okay.

And then just thinking about the mental model here, some of the new platforms are additive to margins, some of them aren't.

You've got a very aggressive gross margin targeting a 70 to 90 basis points per year.

Some of the new platforms seem to be lower margin and how does -- how does that cook?

David, we're looking to get somewhere around 90 basis points of EBIT margin expansion.

We have gross margin and SM&A leverage is that would go in there.

The premium dark chocolate and refreshment will have prior price realization and come in at a higher margin.

We are focusing on bars, to the extent -- bars, and tins in particular, give us higher margins.

So we are focused on trying to get the gross margin up through product mix.

You will also -- if you think about going into 2007, in 2006 in the first quarter, we had some retailer destocking on loose bars.

We didn't have a particularly good loose bar performance.

As we look at next year, a more normalized kind of selling pattern, with limited editions out of the base, we would expect to get product mix to be going in our favor from the margin standpoint.

And just again, the gap in loose bar growth in the quarter was a gap in innovation, new product launches.

We really, David -- cycling -- we still had a lot of limited editions in the mark but I think what really happened was the effect of merchandising on that.

We didn't have the type of new news and excitement to get the types of merchandising events that we wanted, one; and then that got coupled with the fact that the product that was in the market didn't have the same velocity rate that we would have liked it to have had.

When you look at total merchandising effectiveness, the stuff that was out there, it just doesn't turn as fast as we wanted it to.

So you can talk about trade promotion, effectiveness in the quarter it wasn't very high because we didn't get the lift off the merchandising we wanted.

Great.

Thank you very much.

Your next question comes from Chris Growe with AG Edwards.

Good morning.

Good morning, Chris.

Hi.

I just had a couple of questions for you.

The first one is, maybe this question is for Dave in terms of the sales numbers from this quarter from the early shipments, and perhaps any holiday shipments that were shipped earlier than they did to the prior year, would that quantify most of the benefit you had with sales over and above the industry growth rate in the quarter?

The category growth rate?

We had, as we said, a little betting in the points of sales from holiday items shipping in the third quarter, versus prior year.

The rest of the growth rate is really related, for the most part new products, to being reserve.

Layered cookies and some of the other initiatives in dark chocolate.

That's largely the makeup of the growth in the quarter.

And again, this is a unique quarter for you.

There's still a pretty -- there was a pretty wide gap between your reported sales and, say, the FDMxC data.

Again, is that just the part that you are referring to in terms of the shipping above the category growth rate?

Yes.

Round numbers, 1% take away and 3% net sales growth, the difference is the holiday shipments as we talked about and the new products that certainly within confectionary as well as within snacks are gaining ground.

And then just one more for you.

That is regarding the pretty significant savings you have had in SM&A or SG&A, whatever you call it, those savings have been a function of the restructuring program put in place last year; is that correct in terms of the incremental savings in 2007, would they more heavily favor growth margin versus SM&A?

I think, you know, we have gotten quite a bit of traction in G&A from the realignment initiatives as one would expect and that's been a good benefit this year.

As we look to next year, we will expect to continue to get scale leverage and be able to hold the line on G&A costs but, yes, we should be able to get more gross margin.

Obviously we had on a year-to-date basis, we are looking at a 70 basis point decline in gross margin.

As we go to next year, in terms of the initiative, and talk productivity, and product mix, et cetera, we would expect to get gross margins back on the right side of the track.

And just to clarify that, is 2007 the year, Dave, for significant savings or amount of savings from the restructuring program, incrementally?

No, most of it actually occurred in '06 on an incremental basis.

Thank you.

You're welcome.

Your next question comes from Terry Bivens with Bear Stearns.

Terry?

Yes, can you hear me?

Yes.

Can you hear us?

Yes, I'm always confused by the mute button.

A couple of things here in '07, I guess you quantified in some ways the incremental marketing spin to '06.

Can you give us some notion of how that is likely to track in '07?

We're not going to get into the specifics.

We Noel be up but that's about as much as we want to highlight at this point.

Up year-on-year in '07.

Yes.

Okay.

In terms of the 3 to 4% sales goal for next year, Rick, given all the new product activity and the increase in marketing, do you think that's high enough?

I mean, I frankly would expect it a little better there.

That's been our long-term expectations for net sales growth for now going on five years and based on where we think we see the category growing and what type of market share performance based on our ability to drive take away we think those are the right numbers.

Okay.

And then lastly, just a broader question.

I mean, it's pretty clear you have been in a transitional period between growth drivers.

Where would you say you are in that process?

I hesitate to suggest a baseball analogy, but somewhere, where you think you are along that time line.

It's tough to -- tough to semi quantify.

I think it's an important thing that we are more early on than not.

And in terms of the platforms that we have gotten good traction on, and why we believe that we can say the results are ahead of our expectations, we have begun gaining distribution.

We do see better price realization, particularly in mints and dark chocolate and we are starting to see strong velocity within both dark chocolate and the Ice Breakers brand.

So I think we've got a good start on it, but, again, we are shipping a lot in the balance of this year and early 2007 and we'll take it from there.

Okay.

All right.

Thank you very much.

Thanks, Terry.

Your next question comes from Eric Larson with Piper Jaffray.

Good morning.

Good morning, Eric.

A question on the gaps that you had on the marking spend in the third quarter.

Did you make a more aggressive shift in your strategy, sort of midstream in your 2006 budget year that probably didn't give you enough time to maybe create those programs?

Would that be a fair observation?

I think if you think about where we were in 2006, we were -- we were planning on, as we talked about earlier in the year, taking less of a reliance an limited editions and moving to platform growth.

We didn't get the platform track -- with enough traction as quickly as we would have liked and at the same time, the limited edition velocity slowed, I think a little bit faster than we expected.

So we created a little bit of a gap and frankly in the early part of the quarter, there was really nothing for to us program against, to spend against.

The own thing we would have been able to do is really reduce price points which is not the right thing to do in the category.

We really didn't aggressively go after programming in the earlier part of the quarter.

We didn't have anything to program against.

Come September 1 with the new launch of the platform, as you go to the back part of the year we are now seeing much more proactive in our programming.

Okay.

And just a follow-up question related to that topic.

As you add trade spend and merchandise spend in your fourth quarter, my experience has been that, you know, many times as you add that money in, the retailers are very happy to take your money but you send to get more slippage in your sales for the dollars spent than you normally would get if you planned that program for a full year.

How do you -- how are you going to make sure that you don't get slippage in your volumes versus your spending rates in the third quarter.

I think primarily the spending not related to lower price points.

It's tied to insuring we get the right merchandising and distribution and trial devices on our new platforms which is why we set up the spinning in the low double digits.

The largest increase is in samplings.

That gets passed through directly to consumer behavior impacting event.

So it's less about higher yield rates to drive lower price points.

It's more about what is the right programming to get events based on a customer-specific strategy.

Okay.

Good.

And then just one final question.

Rick, I guess it's sort of been addressed a little bit in some previous questions, but, when you look at your operating margin for the third quarter, you are almost at 23%.

You have done a phenomenal job on your margins.

Is there a point -- where do you sit on margins over the longer term?

Let's say the next two, three, maybe five years at some point your margins get to a point where you really don't want them from a competitive point of view to get much higher.

How would you look at your longer term view on your operating profit margin?

I think what is important is to put it in context of the formula that we have seen work successfully, more often than not over the past few years, which is a reasonable level of sales growth, a good level of EPS growth, and then some level of margin expansion, obviously between the two.

And we believe there is leverage throughout the P&L, both at the gross margin line and at the operating margin line, and we have not yet gotten some of the improvements within gross margin that we believe we can get, if you look at our gross margins versus some of the peer group and that's where we think this continued potential to expand margins, where we will always be very mindful of not just expanding margins to deliver profitability and insure we have the right level in our brands and selling capabilities.

That's one thing that's so important to reinforce in our category and given our leadership position, breadth of distribution, that our consumer and customer programs go hand in hand.

They are not set out there independently.

They work very well together.

So we are mindful of having the right levels behind consumer programs.

Thank you.

Your next question comes from Dave Driscoll with Citigroup Investment Research.

Hi, David.

You talked about the quarter in terms of you didn't have those programs in place until September 1st and it makes sense that you don't get the expectations that you are looking for.

The fourth quarter, however, your guidance would seem to imply 4% EPS growth.

If you have got the programs in place, and you can spend against them, what is it that's holding us back in the fourth quarter?

Have you just taken a breath here and said we will not guide to something higher than that because we don't know how the new platforms will show up in the fourth quarter?

David, let me talk about -- we will never get into specific quarterly guidance.

I mean, I think, the fourth will be somewhat as similar as the third and that's about as close as I will get.

From the top line standpoint, we expect to have -- we expect to have good take away of our seasonal business in the fourth quarter and the seasonal business is the large part of fourth quarter marketplace consumption but a lot of that has already been shipped.

We would expect to have kind of flat year-over-year Easter, '06 to '05, so not a lot of contribution from seasonal business, and clearly given where the category growth rate is, we know we have to get the category moving again.

We know we will have to invest to do that.

It remains to be seen how quickly we have to get that traction.

So there's limited edition lag out there.

I think those are the components we are looking at.

We are making an investment to get things going again on the platforms and that's going to be in our P&L.

And we do still have a little bit of kind of the returns and obsolescence that will dribble into the fourth quarter.

Those are the factors that are moving into the P&L and on the top line in the quarter.

We want to regain marketplace momentum and get ourselves back on track.

Just two detailed question, did you give us the c-store sales growth in the quarter or take away growth?

No, we did not.

C-store take away was down about a percent.

For the quarter.

And market share?

Market share we lost about a point. 0.9 to be exact.

And good growth in king size and good growth in mints but offset by a luspar decline.

And primarily due to limited editions a year ago versus not this year.

Final question, Dave, can you talk to us about interest expense?

I think you issued $500 million in long-term debt.

What is -- where do you see interest expense trending in '07?

I think at this point, I will not give anything too specific on it.

The $500 million in notes is really a slot between short term -- short term facility and terming it out to long term.

It will cost us a little bit more money year-over-year on a rate basis but we think getting to a more fixed versus variable in the debt is the right place given where interest rates are in the market.

Our interest rates have been higher due to the pension funding and the buyback.

So at this point in time, I don't think I will really give a specific comment on '07.

But directionally, it would be up, though?

Again, I will not make a specific comment.

Okay.

Okay.

Well, we'll follow up later.

Thank you.

All right.

Your next question comes from Eric Serotta with Merrill Lynch.

Good morning.

How are you doing?

Not bad.

I don't want to beat a dead horse here but do want to get back to the question of the holiday shipments.

You commented that the early holiday shipments, I think, added about a point of growth from the quarter.

Now, my understanding, maybe it was wrong, but my understanding was that you really began this accelerated shipment of holiday or seasonal merchandise in the year ago period.

So I'm wondering why we saw an incremental shift or an incremental benefits this period and where does that end?

Going forward, I would say three months ago we -- I was at least looking at you calendarizing or lapping this shift in seasonal shipments, but, could we see that extend in the fourth quarter again?

I think what we -- what I just said about the fourth quarter is we would expect to have seasonal shipments in the fourth quarter pretty much flat year-over-year.

So in the fourth quarter the comparison is pretty much dead on.

At least that's how we see it right now.

In the third quarter, there was several of our -- of our customers requesting some of the holiday a bit earlier for their own reasons in terms of their own shipping patterns and warehousing needs and I can't really get into anything more specific about a customer than that.

Okay.

You know, I guess can you give us a little bit more color in terms of the receivables growth, your turn deteriorated again and I know in the past, you have attributed that to the -- the seasonal shift, with a longer date of receivables or longer term receivables on seasonal merchandise, but does that fully explain the deterioration this quarter or perhaps were there other items involved in that?

There were.

The -- in the quarter, there's more seasonable receivables.

We have a much larger Halloween program this year than we did year-over-year and, again, giving seasonable time that doesn't really get collected until the end of October.

We did have holiday going earlier but in addition to that, the timing of our new product launches, with most of them coming in the September month, we would -- we had a lot of pipeline fill on items in the September month, which would increase that AR balance as we left the quarter.

Okay.

And then just to clarify, just two points that came out earlier, I believe that maybe it was in response to Terry's question, I forgot whose it was exactly, but you basically said that the seasonal shipment to the value point and then pipeline still added about the rest.

Did I pick that up correctly so that the overall base or quarter sales growth was about flattish?

That's about right.

Okay.

Then did I also understand you correctly in response to the first question, that with the exception of increased print advertising, next year behind Kisses, the overall marketing mix would look similar to '06?

No, what we -- what we were saying is that spending overall was going to be up in the fourth quarter as we highlighted low double digits with the majority of that, a bigger increase in samplings, primary behind the new platforms.

We said that total spending would be up in '07 versus '06 and we think it's similar to what we are doing in the fourth quarter but it's a recognition that we use advertising to support our new platforms but with the exception of having increased advertising on the Kisses brand, primarily in support of the 100th anniversary celebration.

Okay.

So the '07 guidance in terms of the mix was that it would be similar to the fourth quarter, what you planned for this quarter, rather than what you had for the full year?

I guess that's what I meant?

Yes, more so than not.

Strong consumer support, but, again, the consumer support is closer to the point of consumption and purchase than necessarily anything on a broad based -- broad based to begin television or media support.

It would be behind new platforms and targeting advertising on dark chocolate, which works very well and then on core brands, kisses will get a large increase, again, in support of the 100th anniversary celebration.

Okay.

Thanks for the clarification.

Thank you.

Thank you.

Your next question comes from David Palmer with UBS.

Hey, David.

Hey, guys.

Hi, David.

Hi, Dave.

A question for you, I guess.

First is, really, single serve is the big picture here for '06.

There seems to be just broadly disappointing with regards to that.

How much of that is Kissables?

I mean obviously you are making bigger bets with platforms.

How much of it really is the Kissables repeat is not so much what you thought it was.

I think it's less about that.

Kissables is doing well.

It's much more so, if you think about the majority of limited editions from last year, they were single serve.

And with the reduction in limited editions this year and the velocity that David has spoken about last year, this is really the major drag on our single serve business.

Taken another way, a large percentage of our new plat storms will be in single -- platforms will be in single serve or bar format.

We believe that's the best way in terms of where consumers are headed and gets us much better merchandising and broader distribution.

I guess, you know, we already hammered on the advertising point, but with regard to the single serve platform and the convenience channel.

Obviously, your competitor has increased their headroom versus you in advertising in the recent, call it 18 months.

Do you think that any part of this has to do with that?

Any part of?

The share losses that you cited in the c-store channel?

I mean obviously you mentioned limited editions but with regard to the successes or lack of mentality, perhaps and some of the single serve that you had in the c-store channel, do you think that advertising spend is maybe something that needs to be rethought?

Well, we continually update our marketing of modeling and looking at what's working and what's not working.

I think single serve is one of the more interesting levels because of high pulse of impact sales.

I think within convenience stores, the number one goal is getting good merchandising and get those placed behind a new benefit to consumers.

That's our number one goal.

When we say that we had good growth in dark chocolate and refreshment, that's clearly because we're offering a superior value proposition for consumers.

For single serve, we see it as a combination of getting the right benefits and the right in-store availability and merchandise support.

As I said, we'll have the right consumer programs and don't want to get into, again, how much is advertising versus consumer promotion because it's a combination of the two that we have seen success on those products has done well.

And then one last one, we talked about non-traditional channels in the past, not just Home Depots, and Best Buys but with regards to dark chocolate.

One thinks you may be able to go to new places with that sort of platform.

Could really non-traditional channels be a significant upside, one, two, points, something could you really measure in terms of the top line driving, things that we just don't see in FDMxC?

I think so.

The work that we have with Home Depot is off to a good start, but it's not just Home Depot.

We see other high growth alternate channels that make a lot of sense for us.

Also if you realize just the announcement of earlier this morning about the acquisition of the Dagoba organic chocolate business.

That will get us additional access into retailers that we wouldn't be there with our existing product, similar to what we have experienced with Scharffen Berger.

So we think that's another opportunity, particularly as we want to build our presence in the premium chocolate business.

Thank you.

Thank you.

Your next question comes from Eric Katzman with Deutsche Bank.

Good morning, everybody.

Good morning, Eric.

Okay.

A few questions.

I guess one, how much did SKU cuts hurt you on the topline?

I don't know if you quantified that.

I did not quantify it.

We are a pretty good way through the SKU rationalizations that we talked about.

We are certainly up into the double digits in terms of SKUs removed since the end of the first quarter.

I'm not sure that it really hurt us that much from the growth sales standpoint.

It may have hurt us a little bit in some returns and unsalables of some products that were out there in the marketplace.

I don't want to quantify it anymore than that.

It was not a big drag.

The good news is that we are getting through that at a good pace.

Okay.

And then, Rick, I guess, the question is, back at last year's Hershey meeting, the Company focused a lot on pricing leverage.

And, that didn't occur this quarter.

And I'm kind of wondering, since we haven't really touched on the kind of macro impact here, but how much did $3 gas prices and the fact that the bulk of your product line is -- is impulse purchase, and the inability to leverage pricing, I mean is there a relationship there?

I mean, it just seems ironic that the category really weakens at the same time point that gas prices peak.

We have been asked before and talked about whether we see any correlation and it's really hard to quantify whether we see it one way or not.

For us, Eric, the most important thing is what weren't we doing and now what are we doing to restore the growth to our core brands?

From a pricing standpoint, we still believe and the data would support this price realization opportunity is broadly across the category.

The items that they were introducing, as they get to the regular run rates, they will have higher margins and higher price realization than the existing line.

Also, what's been a drag on price or margin realization has been some of the returns on obsolescence that we talked about.

I think what is important is during this q this quarter our trade spending was down.

So we don't believe that the opportunities for price realization pulling multiple levers is beyond our ability to get at this point.

Okay.

And then I guess just last thing on the snack -- the snack initiatives.

It just seems, that maybe it's not a scientific survey or what, but it just seems, I'm flying around the country and going through c-stores or whatever, talking to retailers, it just seems like, the impact of some of the snack nuts or the rice treats or the salty granola -- the sweet and salty granola bars, I don't know, it doesn't seem like it's getting the lift that one would expect.

And -- or maybe what you had hoped for.

Maybe you can kind of just -- is that kind of -- is that kind of just anecdotal or are you concerned about some of these new snack initiatives.

No, we are not concerned about the snack initiatives.

It's currently small.

We have seen some good growth selectively and as we talked about for us, the focus areas of cookies and brownies and soft cookies and value-added snack nuts we think those two have the greater potential over the long term.

The ones -- we tried a lot of things and we clearly admitted, some have not worked as well as we would like but in those channels where we are advantaged from our single serve leadership, particularly within convenience stores, mass, et cetera, we think introducing the substantial snacks and single serves is a viable growth opportunity for us.

We never said it would be a huge portion of our portfolio.

We said it would be additive to our overall leadership within the confectionery market..

Okay.

Thank you.

Thank you, Eric.

Your next question comes from [Bill Alexandri] with Garfield Associates.

Hello?

Could you give me an idea of how much your dark chocolate is of your total sales?

We don't -- we don't break that out.

We just said it's our fastest growing business.

Right.

Thank you.

Thank you.

The next question comes from David Adelman.

Good morning.

Good morning, David.

How are you, David?

I'm okay.

Let me ask you a few things.

First of all, what is the risk in '07 in aspiring to hit your long-term earnings target, given the current situation that the organization just doesn't spend sufficiently to improve the momentum in the marketplace?

A couple of things.

We -- when we target the 3 to 4% net sales growth, we look at where we think the category growing and our ability to gain share within the category, and also our ability to -- to grow sales outside of measured channels and I think that's an important one in terms of where we think we can get the 3 to 4%.

And in a business we don't talk about that much is our international business and we have pockets of strength that we believe can contribute somewhat to the top line growth.

The way that Dave articulated our view of the cost and margin struggle from last year, we currently believe that we have a sufficient level of spending behind our new initiatives.

So that we'll get the top line sales and also be able to generate the levels of profitability that we have spoken of.

Okay, and then let me revisit the issue of competition and I realize your comments that there hasn't been an increase or a change in the pricing component of competitive activity, but some of your competitors have been gaining market share of late.

Do you think that's due to their own efforts or do you think that's just the converse of your situation, that they are benefiting as you go through the transition?

I think it's hard to say.

What's important, we didn't -- when we were gaining share we were not citing competitive activities and when we are not getting share, we are not going to cite it as much as we know to drive category growth.

So I won't try to draw any correlation one way or the other.

We still see continued tunes for the category to grow and as a leader to get a fair share of that growth.

And two other things, Rick.

One, is are you surprised at the moderation of your in-store programs has obviously had a dramatic an effect on your marketplace performance?

Has that been a surprise to you?

I think what's important is it shows that when we have the right level of programming, we guest the right level of response.

I think as we said, we didn't have the level of programming as we did not want to spend money to -- to chase unprofitable sales because that would have been primarily been a price reduction.

So I think it reinforces that when we get the right balance of consumer and customer programs, the business responds.

Okay.

And then one last thing, Rick.

You are obviously talking about a number of different initiatives, different programs, different platforms, non-chocolate, dark chocolate, nuts, et cetera.

But what about the growth prospects going forward of some of the big traditional confectionery brands.

You know, Reese's had grown at a rapid rate, just to use it as an example.

Do you think those types of franchises can still grow in line or better than the category in the core confectionary segment?

I think what is important that we continue to see opportunities to drive our core brands and the brands whether it be Reese's as you mentioned or Kisses or Hershey's.

Those are really the key brand names that are leveraging our platform initiatives and the one that we wouldn't have even talked about two years to the same extent is Ice Breakers.

It almost doubled the share, more than doubling the share it.

Reinforces that as we deliver the right benefits we have a lot of equity within the brand franchises.

Kisses saw a lot of growth behind Kissables and some of the filled Kisses initiatives.

And with Reese's we got great growth, primarily through limited editions but some of those items have become permanent items and we see opportunities to continue to grow the Reese's franchise.

Got it.

Okay.

Thank you.

Thank you.

Your next question comes from Kenneth Zaslow with BMO Capital Markets.

Good morning, everyone.

Good morning, Ken.

Just one question.

One of the things I see throughout the prepared remarks was that the list in your promotions wasn't as high and is it because of the proliferation of all of your SKUs that you didn't have focus?

Is that one of the points and I don't know if I read it or I heard it correctly.

No, I think what we were really saying is that we didn't have the new platforms which we believe are much more incremental and have better consumer benefits out in the marketplace in the earlier part of the quarter.

So what we were merchandising was more limited editions, which, frankly, the consumer didn't have as much interest in.

So we were merchandising -- one, we weren't getting the type of merchandising we would like and two, what we had on merchandising wasn't getting as good a lift.

In terms of SKU proliferation, is that still part of the obsolescence?

Will we start to continue to see that under for how many more quarters.

I think we did see it in the second quarter and still some in the third quarter.

As I said earlier, through the SKU rationalization, we are largely through the identification stage and a lot of them are already out of the market.

So, you know, we talked about a 15 or 20 or so percent reduction.

We are already up into the double digits and have identified the rest of it, which will come out certainly by the first quarter.

And the second quarter, obsolescence hit us pretty hard.

A little less of an impact in the third and certainly by the fourth, it should be moderating.

And in terms of your basket of commodities, to -- you know, refined sugar, for example, obviously peaked and then came back down.

So what extent heading into '07.

I know if you talk about it broadly and, you know to what extent did you panic, that you kind of bought at the high or did you let it float a little bit for '07.

I will not talk about any one specific commodity at all just for competitive reasons and marketplace reasons, I'm just not going to talk about them.

I did give a comment about the entire basket for next year, but I won't talk about any one of the individual ones.

And then just one last broad question.

You know, Rick, you talked about a lot of the initiatives outside of the core chocolate business.

I know you are hesitant to say what percentage it was and what it will be, but can you give us an idea of color to, how much the -- the non-core chocolate business represents and how much do you expect it to be a contributor to the growth or to your portfolio or some way that investors can get some sort of comfort in that?

I think it's important because the Extra Dark and the special dark which are our main thrust within dark chocolate are Hershey branded.

When we see growth in nuggets or truffle nuggets, that's a Hershey brand.

I think Reese's is the one while we've had very good success with some limited editions, we are looking at some other ways in terms of accelerating the growth of brand.

When we say outside of our core brands, I think it's important that if it's within chocolate, that's a core brand.

Okay.

Thank you.

Thank you.

The next question comes from Pablo Zuanic with JP Morgan.

Thank you.

Good morning, Pablo.

First, your guidance of sales of 3 to 4% for the fourth quarter, it's a little bit of a concern because you had sales of 3% in the third and take aways were flat.

You are saying that you are going to reshape some merchandise for the third quarter and easter will not be a lift in the fourth quarter.

Your take aways in the fourth quarter are going to be up 6% although they were up only 0% in the third quarter.

Why do you have the confidence to deliver that?

And why do you expect such a big jump?

We didn't say anything specifically about the fourth quarter other than we thought it would have the same profile, both top and bottom as the third quarter.

That means that your growth will be 3% in the fourth quarter, right.

It will look similar.

It will look similar to the third and that's as far as we would go.

We had -- as Rick said we have our new items, our new platform initiatives going into the marketplace now, and we are looking to invest behind them, to get the categories moving again.

Okay.

The gross margins, you talked about, you had a better view, you talked about your visibility in terms of cost for the back half, you talked about those margins, clearly they were below your expectations.

Was it really just mix or was there something else there?

Our issue in terms of gross margin year has not been visibility into raw material costs or productivity.

It has been pretty much in line with what we thought.

The two drivers, one is mix.

We have shipped a lot less loose bars in the limited edition slowdown.

That's currently the mix of slowdowns in packaged candies and loose bars.

And then the second in the second quarter and again here in the third is the return of obsolescence.

I have another question.

I am taken back when you say you have nothing to promote early in the third quarter or that you were not going to chase profitable sales.

You have tAke 5 Dark, Take 5 White, and you have the Hershey bar, and you have this -- you have the granola bars, Salty and Sweet which I found and nuts to be more aggressive.

I see a disconnect there.

You say you have nothing to promote in the third quarter when you had so many new products from your pipeline.

Well, if that's what has been interpreted, that's not what we have been trying to communicate.

Let's take it and look at the respective parts.

Take away was up about 1%.

That would exclude any take away growth in snacks. 1% take away is confectionery.

We had some good take away growth in snacks.

Within that 1%, we had good take away on our sugar confectionary, our dark chocolate and our refreshments business.

The big issue in the chocolate decline was the year-over-year impact of strong limited editions growth in the third quarter of 2005, and a flat or declining contribution from limited editions in 2006 third quarter.

What we said is we did not want to simply try to price promote to proper up take away during the third quart.

We had plenty of businesses where we does get promotional support and got in-store execution and we had a result in increase in take away and share.

So the issue is one around chocolate, and today's point, as we said earlier, we did not get some of the velocities in the quarter from some of the limited editions that were there, that we thought that we should.

Okay.

We thought that we would.

And then on shift and brand building and customer/consumer support over the next few months just to put that in context, is it what happened in the third quarter?

Help me put it in context.

Absolutely.

What we are talking about is increasing the total spending in the fourth quarter as we talked about and then increasing it in '07, over '06, but, again, our strategy is to remain disciplined to spend behind the benefit driven platforms and the increase of support whether it be advertising and promotions from a consumer standpoint is in support of the 100th anniversary.

The increase in dark chocolate is in support of the further expansion of Special Dark Extra Dark and Cacao Reserve By Hershey.

So that's -- what hasn't changed is the support behind specific new products and platforms and then recognizing on some of the core brands when we have news we will support them as well.

But in terms of the mix, we still see trade as a very powerful device to build our business in concert with the right levels of advertising, consumer promotion.

But when we talk about trade, take for example, we get a customer to run co-op advertising we get a customer to do in-store advertising, during a trade line, it's certainly not a price promotion.

Right.

And one very last one.

Basically, the category has not really picked up yet in terms of growth from the dark chocolate launch.

I know it's very recent.

Have you done your own research that makes you very confident that the category will be pick up, because haven't seen it in my numbers.

Yes, we are certainly not going to talk anything outside of what we have seen in the quarter with the exception that we saw some improvement in the overall mass channel and the new items that ship in September.

It's obviously too early to see an impact at retail.

Thank you.

The next question comes from Alexia Howard from Sanford Bernstein.

Hello.

A couple of questions.

I wonder if you could give me a little bit of an update on the guidance for the mix.

It seems as though two or three years ago, 21, 22%, I think we're at around 25, 26% today.

Things have come down a little bit over the last few quarters and yet, I think you were talking 33% by 2008.

Can you just let me know where you are at on that and what the drivers would be to accelerate that single serve shift?

Yes, a couple of things.

We're not going to give what the current level is because we said -- and you are correct that we were targeting a third single serve sales by '08 and that's primarily driven as a result of the new products and the emphasis on single serve as David talked about earlier.

So as we continue to deliver our new product innovation, it will be primarily focused on bars or single serve format.

Okay.

Thank you.

And then just going into next year, I know we have talked about the -- the EPS guidance for the next year, but I'm assuming we are sticking with the 90 basis points of EBIT margin expansion.

I guess this year that's a big alliance.

It seems as though next year, we will get a bit of a head wind from increased media spending and marketing in general.

What are the main drivers of the 90 basis point as we go into 2007.

Again, we have -- we talked a little bit earlier on that we will continue to be able to get SM&A leverage, although certainly not at the same levels as this year which was benefited by the realignment.

We do expect to get our gross margin expansion back on track, and our innovation is streaming and should help with price realization.

We have a number of weight initiatives in terms of obsolescence in 2006 which we think will not be present next year and we feel very good about our productivity initiatives against the cost base which is not increasing at the same rate as it did in 2006.

Right.

Could you make a comment on the rollout of the Home Depot stores?

I know that has been something that you have been focused on.

We are close to getting to the level of stores that we had talked about for them.

Again, we are off to a good start.

Again it is a new initiative for us, learning as we go and I don't want to go much further than.

Thank you very much.

Thank you.

Your next question comes from Ed Roche with Banc of America Securities.

Hi.

Thanks for taking the question.

Good morning.

Good morning, Ed.

So on the gross margin front, I think in the second quarter, the inventory obsolescence was the bulk of the year-over-year decline, can you quantify a little bit more of what the effect was in Q3?

I think Q3 was a combination of mix, as I said.

We had loose bar slowed down in year-over-year, which most of the loose bar initiatives were down below prior year and we saw a very good seasonal business.

So those two things would lead to a large part of the gross margin decline.

And we also still had -- as we talked about in Q2, we still have some obsolescence and some returns in the P&L that it did, in fact, occur.

Okay.

Maybe we can follow up on quantifying.

Looking at the seasonal business, so far the take away performance, are you pretty happy there?

And then can you speak about the seasonal Navigator?

I mean, do you continue to see retailers utilize that tool?

We -- we continue to use the proprietary tools.

We have gained share in seasons over the last several years in each of the seasons.

We do have that tool in place.

Halloween has filled in and the retail market plans under place.

That's obviously, you know, we are now in the process of selling it.

So holiday is also sold in relatively nicely and that will move through in the fourth quarter.

Okay.

And you are seeing about the same level of retail participation in that seasonal Navigator as last year?

I'm not going to comment specifically on where we are or who is using what tool, but for the most part, we are using that tool.

Okay.

Have you spoken in the first half about really working on the level of working capital investment and trying to bring that down?

I know we still have a quarter left but so far the trend, you know has not gone that way.

Do you still expect improvement on a year-over-year basis by the end of the year?

At this point in time, without getting into a whole lot of specifics, I think we would -- we would be hard pressed to get improvement year-over-year at this point, as we head to the fourth quarter.

We will see -- we would hope to see improvements in our accounts receivable balances as we head into the fourth quarter but given where we are, I don't think we'll see the kinds of improvement year-over-year we had originally anticipated.

Okay.

And then just two quick ones.

Is the Cacao Reserve being produced internally by Hershey?

And then secondly, am I correct there are more new items shipping around the 1st of December?

Thanks for taking the question.

We're not going to discuss the production in terms of what is mostly here.

But in terms of the new items, we have quite a few shipping in December and that's the way the September shipments of new items from the December shipments of new items are very much tied to when the customer wants to do the category reset.

It's as much driven by the customer than any other reason.

Thank you.

Thank you.

At this time, there are no further questions.

Are there any closing remarks?

Hearing no more questions, we will conclude today's session, we will now be available to answer any additional questions you may have.

As a reminder, our 2006 fourth quarter sales and earnings release and conference call is scheduled for January the 24th, 2007.

We will release earnings at 7 a.m. that day and our conference call is set for 8:30 a.m.

Thank you for interest in the Hershey Company.

Thank you.

This concludes today's conference call.

You may now disconnect.