好時 (HSY) 2010 Q2 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Hershey's Company second quarter 2010 results.

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

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions).

Thank you.

Mr.

Mark Pogharian, you may begin your conference.

Thank you, Chrissy.

Good morning, ladies and gentlemen.

Welcome to the Hershey Company's second quarter 2010 conference call.

Dave West, President and CEO, Bert Alfonso, 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 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 2009 filed with the SEC.

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

Included in the press release is a consolidated balance sheet and a summary of consolidated statements of income prepared in accordance with GAAP.

Within the notes section of the press release we have provided adjusted pro forma reconciliations of select income statement line items quantitatively reconciled to GAAP.

As we've said within the note, the Company uses these non-GAAP measures as key metrics 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.

We will discuss our second quarter 2010 results (inaudible) pre-tax charges.

The 2010 charges relate to the project Next Century and the Godrej Hershey goodwill impairment charge, while the 2009 charges are associated with the global supply chain transformation program.

These pretax charges were $86.2 million in the second quarter of 2010, and $42.7 million in the second quarter of 2009.

Our discussion of any future projections will also exclude the impact of these net charges.

With that out of the way, let me turn the call over to Dave West.

Thanks, Mark, and good morning, everyone.

Results for the second quarter were solid.

Net sales increased a strong 5.3%, and adjusted earnings per share grew 18.6%, as core brands continued to perform well in the marketplace.

These high-quality results are driven primarily by volume.

We gained US market share in the second quarter, and are pleased with how our brands continue to respond to the investments we've made.

Overall the confectionery category remains healthy, increasing at the high end of the historical growth rate.

Investments in the category, in the form of advertising and/or innovation, are present from most major manufacturers.

Given the high household penetration and the impulsivity of the category, as well as affordable price points, we believe retailers will continue to value the confectionery category.

As a result, we would expect the category to continue to consistently secure key merchandising space and programming.

As reported in the IRI and Nielson syndicated data, our US retail take-away and market share performance for the most part has been balanced across channels.

Growth has predominantly been driven by volume gains, as consumers have migrated to higher retail price points.

This is allowing us to continue to be efficient with our trade promotion dollars, as trade promotion rate was about flat versus year ago during the quarter.

Similar to Q1, this is better than our initial expectations.

This is noteworthy in the context of the volume gains we've achieved in 2010.

Let's now take a look at retail take-away.

The IRI and Nielsen data in the second quarter encompasses the period from March 21 to June 12.

In 2010, Easter occurred on April 4, and in 2009 on April 12.

While the first quarter this year benefited slightly from an earlier Easter, the timing did not materially impact our second quarter marketplace performance.

In fact, we gained share in both the first and second quarters.

My remarks related to marketplace performance include seasonal data in all periods.

We're pleased with Hershey's marketplace progress.

Total USCMG, that's candy, mint, and gum, or total category retail take-away for the year to date period through June 12, per the custom database, in channels that account for over 80% of our retail business.

So here I'm talking about food, drug, and mass, including Wal-Mart and convenience stores, so on a year-to-date basis was up 5.6%.

Excluding Wal-Mart, Hershey's year to date FDMxC retail take-away is up 5.1%.

Hershey's second quarter retail take-away for the twelve weeks ending June in FDM including Wal-Mart and convenience was up 4%.

Excluding Wal-Mart, Hershey's FDMXC retail take away was up 4.1% in the 12 weeks.

The launch and rollout of new items such as Pieces is progressing nicely.

And in the second quarter, again, new products were a net positive to the top line, about a one point contribution to our overall net sales growth.

We gained market share in all classes of trade except drug, which as expected was down, but sequentially improved for the second quarter in a row.

Hershey's seasonal Easter retail take-away increased, up 6.7%.

And sell-through was solid as we gained Easter market share of 1.3 points.

Our market share in this key season expanded to over 37%.

Similar to the last few quarters, our performance was driven by the core brands upon which we have focused.

Specifically, in FDMxC, the combined retail take-away on the Hershey's, Reese's, Hershey's Bliss and Hershey's Kisses, Twizzlers and Kit Kat brands increased mid single digits.

York, Almond Joy and Mounds, brands that we have just started advertising in January, posted FDMxC retail take-away up in the low double digits, excluding the Pieces new products.

Now for some further details.

In the food class of trade, confection category growth was 5.4% in the second quarter.

Hershey retail take-away in this channel exceeded the category, driven by chocolate up 7.7%, and non-chocolate up 5.9%, resulting in a total market share gain of 0.5 points in the food channel.

In the convenience store class of trade, the CMG category growth rate accelerated in the second quarter, as the category grew 3.3% versus 2.3% in the first quarter.

In the second quarter, Hershey's c-store take away increased for the ninth consecutive quarter, and was up 5.4%, resulting in a market share gain of 0.5 points.

In the second quarter, Hershey's c-store chocolate and non-chocolate take-away was up 8% and 4.5%, respectively, driven by volume and mix, as both standard, loose, and king-size pack types performed nicely.

Strong in-store merchandising and programming, driven by the Iron Man movie tie-in and a Coca-Cola and Reese's joint promotion, drove balanced growth across core brands.

We believe the category will continue to grow in c-stores.

Category dynamics, as well as investments by CMG category participants, continues to drive variety, news and excitement, and thus category growth.

As we exited the second quarter, the targeted number of c-store associates were on board to deliver the overall 8% increase in in-store hours that we planned for 2010.

As a result, we expect our c-store business to maintain its momentum in the second half of the year.

Looking at the overall category, CMG continues to grow within its historical range, that's 3% to 4%.

In FDMCC, here excluding Wal-Mart, the CMG category grew 3% and 3.9%, respectively, in the second quarter and year to date.

We are gaining share with our roughly 4% take-away.

Hershey marketplace performance is tracking nicely, and selling and merchandising initiatives are in place for the second half of the year.

The pace of category and new product introductions in the marketplace is picking up in 2010.

It's a mix of in and out products, as well as permanent items.

We have concentrated on the latter, permanent items, and feel very good about our base business, current new product performance and our upcoming December launches.

As we look to the remainder of the year, we'll continue to focus on the strategic poll model initiatives that are driving the business.

These include in-store focus to sell and gain display activity.

New innovation on our Reese's and Hershey's franchises, increases and greater frequency of quality merchandising and programming, and further core brand advertising investment.

I'm pleased with the merchandising and programming in place for the third quarter, including to name just a few, the Reese's loves you back promotion, where we'll be giving back up to $2 million in cash prizes.

Consumers win instantly if they open a specially marked Reese's product, that includes a game piece worth $10, $25, or $100.

We have a Twizzlers are irresistible summer promotion to win money towards a summer vacation.

And we have a combined Almond Jay and Mounds contest to win a grand prize trip to the Caribbean.

And we will continue our summertime s'mores programming, as well as the launch of our Halloween programs.

During the global sweets and snacks expo in Chicago at the end of May, Reese's Mini Minis and Hershey's Drops were broadly displayed.

Customers are excited about the December launch of these new products, which will be available as both a king-size instant consumable item, as well as a resealable stand-up pouch.

We continue the strategic work we've discussed related to insights driven performance, or IDP.

We are engaged in working with select retailers to understand their specific opportunities, and how to jointly leverage them through our proprietary business techniques, capabilities, and category management insights.

Additionally, advertising expense will now increase 45% to 50% in 2010.

This is greater than our previous estimate of a 35% to 40% increase.

Due to timing, the majority of this advertising will not be broadcast until later in the year, and we expect its impact on net sales to occur primarily in 2011.

This pattern of investment is similar to that which we executed in the latter part of 2009, and which has clearly aided our strong start to 2010.

Lower than planned trade promotion spend and earlier than expected achievement of a portion of the productivity savings discussed at Cagney conference in February, both of which we largely achieved in the second quarter, will offset a portion of this additional 2010 advertising investment.

The acceleration of advertising in 2010 allows us to reach desired on-air continuity levels on many US brands faster than our initial expectations.

It also enables us to invest at higher levels in key International markets.

While it is premature to offer specific 2011 details, we expect advertising to be up year-over-year in 2011, however not nearly at the level of the last couple of years.

The brand investments we've made have traveled well Internationally.

Where we have made investments Internationally, our brands are responding.

Following macroeconomic challenges of last year, our business in Mexico is performing well this year, and our business in Brazil, which underwent a restructuring in late 2008 and 2009, is performing nicely.

As is our business in China.

We continue to grow in India, although we have not gained traction as quickly as we planned.

The India market remains a strategic growth market for the Company.

The non-cash goodwill impairment charge we announced today reflects revised and achievable growth targets for the business.

They have been developed given the increases in local input costs, primarily sugar, the macroeconomic environment which slowed distribution expansion plans, and the slower implementation of products targeted at new price points that we had planned when we entered the joint venture in 2007.

We will continue to apply our global confectionery know-how, and strong balance sheet and cash flow, to actively invest in India and other existing International markets, as well as to look for new opportunities in key strategic geographies.

Our flexibility to acquire and our partner leaves us with many potential opportunities, which we will pursue in a disciplined manner.

Let me wrap up.

Our brands continue to perform well in the marketplace.

We have solid relationships with retailers in all channels, including select mass customers and value formats.

Recently we received supplier of the year awards from a large mass customer and a national convenience store for the economic value that Hershey brings to the retailer and consumer.

We will continue to build on these relationships.

The CMG category continues to grow, and it is being driven by volume gains.

Macroeconomic challenges still exist, however we feel good about the prospects, as the confectionery category is unique.

It's highly impulsive, it's a destination category, especially in the second half of the year.

It's expandable and profitable for the retailer, and affordable for the consumer.

There are some seasonal shifts out of Q4 2010 into Q1 of 2011, and Bert will have more on this shortly.

Despite this shift, the brand building investment initiatives we have in place are expected to drive net sales growth at the top end of our long-term net sales target for the balance of the year.

Therefore, for the full year 2010, we expect net sales growth of about 7%, including an approximate one point benefit from foreign currency exchange rates.

For the full year, we have good visibility into our cost structure, and expect to achieve adjusted gross margin and adjusted EBIT margin expansion that will result in adjusted earnings per share diluted in the $2.47 to $2.52 range, an increase of low to mid teens on a percentage basis versus 2009.

I will now turn it over to Bert who will provide some more detailed financial information.

Thank you, Dave, and good morning to everyone.

Hershey posted another quarter of quality results, as second quarter consolidated net sales of $1.233 billion, increased 5.3% versus the prior year, and adjusted earnings per share diluted of $0.51 increased 18.6%.

Overall, results were driven by sales volume increases, price realization from lower US markdowns, list price realization outside of the US, and supply chain savings.

These items more than offset higher input costs, increased marketing investments, and a higher effective tax rate of 37.7% that was 940 basis points above last year's second quarter.

Investment spending in the latter part of last year has resulted in a good start in 2010, as demonstrated by our financial results in the IRI and Nielsen market share data.

Similar to last year, solid first half results have given us the financial flexibility to increase brand building initiatives in the second half of 2010, while delivering on our previously communicated financial commitment.

From a margin perspective, the year has progressed slightly ahead of expectation.

And as we communicated during the first quarter call, full year adjusted gross and EBIT margin expansion will be driven primarily by first half results.

Over the remainder of the year, adjusted gross margin will improve at a slower rate, as we have now achieved all of the global supply chain transformation savings, lastly August 2008 price increase, and expect input costs to be higher in the back half compared to last year.

Adjusted EBIT margin will be slightly down in the second half of the year, reflecting increases related to various growth initiatives, including advertising and investment in go to market capabilities, as well as our work in IBP.

In addition, the second half of the year will be impacted by sales mix, as this period is driven more by seasonal SKUs and take-home pack types that have a somewhat lower margin than our instant consumable brand.

I'll provide further details related to the outlook in my closing remarks.

Overall, we're pleased with our financial and marketplace performance given the volatile commodity markets and the continuing pressures facing consumers.

Now for some of the details.

The second quarter sales gain of 5.3% was driven primarily by US core brand volume increases, new products, lower returns and markdowns, and growth in our International businesses.

Favorable foreign currency exchange also contributed approximately one point of growth.

We also shipped slightly less Halloween in the second quarter of 2010 versus 2009, impacting the top line by about one point.

During the second quarter, adjusted gross margin increased 540 basis points, driven primarily by sales mix, supply chain efficiencies, some of which are related to fixed cost absorption as volume was greater than a year ago, and supply chain productivity improvements.

These margin gains were partially offset by higher input costs of about 60 basis points, reflecting total consolidated cost increases for raw materials and packaging.

We have good visibility into our cost structure for the remainder of the year, and expect continued adjusted gross margin expansion in 2010, although at lower rates than year to date.

Second half adjusted gross margin expansion will slow as a result of input costs are expected to be higher, mix is impacted due to higher seasonal pack types versus Q1 and Q2, trade promotion efficiency expected to subside given the higher seasonal merchandising of the back half, and we do not expect LIFO inventory accounting to be favorable as it was in Q4 2009, which at that time contributed about $12 million.

Second quarter adjusted income before interest and income taxes increased 32.2%, resulting in adjusted EBIT margin expansion of 350 basis points to 17.1% from 13.6% last year.

This was driven primarily by higher adjusted gross margin, partially offset by higher advertising expense of about 50% or 200 basis points, selling expenses and other marketing expenses as we added more US in-store hours and continued to build global capabilities, and higher employee related administrative and legal costs.

As Dave stated earlier, we continue to invest in our core brands, and expect full-year advertising expense to increase from 45% to 50% in 2010, and this is greater than the previously communicated estimate of 35% to 40%.

Due to timing, the majority of added advertising will be broadcast in the latter half of the year.

Therefore we expect it to have a greater impact on net sales in 2011.

But despite these advertising increases, as well as the timing of other growth initiatives, we expect adjusted EBIT margin to increase for the full year, although it will be slightly lower than 2009 in the remainder of 2010.

We believe the business investments we are making will enable us to maintain momentum as we close out 2010 and enter 2011.

Now let me provide an update on our International businesses.

On a reported and constant currency basis, net sales increased in our key International markets, including Canada, Mexico, India and Asia.

Overall, our reported International sales increased low double digits.

On a reported basis, including FX, profitability improved across the majority of our International markets in Q2.

We're going to continue making the necessary investments in increasing brand awareness and driving trial, including higher advertising in Q3 and Q4 in certain International markets.

The Godrej Hershey joint venture remains a focus business and is a strategic growth market.

We entered India in 2007 when global financial markets were more positive, and business valuations were generally richer.

With the change in global macroeconomic environment, we have adjusted our plans for in-country expansion, the implementation of new price points, the launch of new products and portfolio rationalization.

We believe that the revised outlook is more in line with how we see the business going forward, although it does require us to record a non-cash goodwill impairment charge of $45 million or $0.20 per share diluted.

Despite this charge, this does not change how we feel about the business or the Indian market.

Going forward, we plan to apply some of the same consumer oriented demand landscape learnings that we have successfully executed in the US in other markets, including India.

Now moving down the P&L.

For the quarter, interest expense was relatively flat, coming in at $22.8 million versus $22.7 million for the period.

For the full year 2010, we expect interest expense to be in the $90 million to $95 million range.

Adjusted tax rate in the second quarter was 37.7%, due to the timing of certain tax events and the related accounting.

Although we continue to expect the full-year tax rate to be about 35%.

In the second quarter of 2010, weighted average shares outstanding on a diluted basis were 230.3 million versus 228.5 million in 2009, leading to adjusted earnings per share diluted of $0.51, up 19% versus year ago.

Now let me provide a quick recap of the year to date adjusted results.

Net sales increased 9.7% in the first half, adjusted gross margin was 43.2% year to date versus 37.4% last year, or 580 basis points higher.

Gains were driven primarily by sales mix, net price realization, productivity improvement and supply chain efficiencies.

Adjusted income before interest and income taxes increased 40%, resulting in EBIT margin gain of 380 basis points to 17.6% from 13.8%, and advertising increased 59% year to date, and earnings per share diluted in the first half increased 42% to $1.15 per share.

Now turning to the balance sheet and cash flow.

At the end of the second quarter, net trading capital decreased versus last year's second quarter, resulting in a cash inflow of $16 million.

Accounts receivable was up $49 million, and we continuously monitor our accounts receivable aging, which remains extremely current and of high quality.

Inventory declined by $39 million, and account payable increased by $25 million.

In terms of other specific cash flow items, capital additions including software were $39 million in the quarter.

For 2010, we are targeting total capital additions to be in the $190 million to $210 million range.

This range includes base business CapEx of about $150 million, plus project Next Century CapEx of approximately $55 million.

Depreciation and amortization was $46 million in the second quarter, including accelerated depreciation of approximately $1 million.

Therefore operating depreciation and amortization was $45 million.

For the full year 2010, we're forecasting total operating depreciation and amortization of $175 million to $185 million, while accelerated depreciation and amortization related to project Next Century is estimated to be $10 million to $15 million.

Dividends paid during the quarter were $71 million.

We did not acquire any stock in the second quarter related to the current repurchase program, and there remains $100 million outstanding in that authorization.

During the quarter, we did repurchase 69 million of our common shares in the open market to replace shares issued in connection with stock option exercises.

And year to date, approximately 133 million of common shares have been repurchased to replace shares issued in connection with stock option exercises.

Cash on hand at the end of the second quarter was $249 million.

This was up significantly versus year ago period, and relatively in line with the 2009 year end balance.

As we exit the second quarter, we are well positioned to manage the seasonal working capital needs of the business, which peak in the third quarter, as well as higher capital expenditure requirements related to project Next Century.

Now let me provide an update on project Next Century.

The forecast for total pre-tax GAAP charges and non-recurring project implementation costs remains at $140 million to $170 million.

Note that this morning's press release appendix was updated to reflect the most current thinking, and the expected timing of events.

Specifically, we now expect to record $75 million to $85 million program charges in 2010.

While this is a $25 million increase versus our initial estimate, you will note that 2011 and 2012 there is a combined $25 million decrease.

The change is due to the accounting timing of racked severance related costs, and does not change the timing of cash flow for the project.

We're moving forward with our plan to have initiated construction in West Hershey where the new facility will be built.

While difficult, decisions made were necessary to ensure that Hershey's has a flexible and cost competitive supply chain.

Savings from the project will give us the flexibility to make investments that will deliver core business growth, and position us for the long-term success in the competitive confectionery marketplace.

By 2014, ongoing annual savings are expected to be approximately $60 million to $80 million.

In terms of timing, savings from project Next Century will not be realized until late 2011, with the majority coming in 2012 and 2013.

Now let me summarize.

Our goal for the second half of the year is to maintain our marketplace momentum as we exit 2010 and enter 2011.

To support this objective, we plan to increase full-year advertising expense by 45% to 50%.

In addition, we will continue to invest in consumer insights and brand building initiatives, as well as selling and go to market capabilities in the US, as well as other markets.

Therefore, we expect full year net sales to increase about 7%, including an approximate one point benefit from foreign exchange.

While spot prices for some of our major commodities continue to fluctuate, we have good visibility into our cost structure for the remainder of 2010, and expect gross margin expansion during the remainder of the year, although not at the same rate realized during the first half.

We expect adjusted EBIT margin to increase for the full year, and adjusted earnings per share diluted in the $2.47 to $2.52 range, on a percentage increase of low to mid teens versus 2009.

Before we go to Q&A, I would like to summarize some unique items that impact our financial results in the second half.

As you work on your models, please note the following.

We expect a shift in seasonal shipping patterns from Q4 2010 into Q1 2011, to be greater than a similar shift that occurred at the end of last year.

This will impact top line by a couple of points in the fourth quarter 2010.

Favorable trade promotion expenses should abate going forward, as the second half of the year is driven by higher seasonal sales, which by nature are more heavily merchandised.

In Q4 2009, LIFO inventory accounting was favorable, and we do not expect this to repeat in 2010.

As we have discussed, the revised advertising increased in Q3 and Q4, but also recall that investments in category management, selling capabilities and other global growth initiatives are also back half weighted.

Higher than earlier expected achievement of a portion of productivity savings discussed at Cagney conference in February will offset some of the higher brand investments in the back half of the year.

And finally, we continue to expect full-year tax rate to remain at about 35%.

We'll now open it up for Q&A.

(Operator Instructions) Our first question comes from Terry Bivens with JPMorgan.

Good morning, everyone.

Hi, Terry.

How are you?

Very good, thank you.

Just on the gross margin, which came in considerably higher than we were looking for, Bert, I know you don't like to share a lot just in terms of where you are hedged, but I guess one question would be obviously this UK hedge fund that seems to have taken in a lot of cocoa beans.

Can you give us kind of a road map, at least for how you see input costs developing through the back half and possibly into next year?

Yes, probably will not comment so much on next year.

It's a little premature for us during the midyear to talk a lot about 2011, but what we did say is that our gross margin expansion was a little bit ahead of where we thought we would be and some of that clearly comes from the better volumes.

So that's giving us a better absorption rate through our factories.

We've also had some lower markdowns, and that's helped, as our seasonal sales have been better.

And clearly what we are seeing is a continuation of good productivity with our normal continuous improvement programs, but the second quarter on particular benefited from some of the productivity that we talked about at Cagney.

At Cagney we talked about realizing $80 million to $100 million over the next two to three years, primarily in non-packaging and non-raw material areas.

So that includes logistics and other services.

We've had more traction on that in the second quarter than we expected, and so that's coming in a little bit faster in the year, and giving us a better gross margin year to date.

In the back half, one thing we wanted to be clear on is that we do continue to expect gross margin to expand in Q3 and Q4, and obviously for the year, but it would not be at the rates that we've seen in the first half of the year.

With respect to commodities, we did mention that commodity increases do happen throughout the year.

If you recall the first quarter call, we actually had a favorable commodity in terms of the way we accounted for dairy, one year versus the other, but we've seen commodity increases in the seconds quarter versus the last year and that continues throughout the year.

Certainly dairy is one component of that, that continues.

In terms of the cocoa news that you have seen, obviously we follow it very closely.

We think it's unusual, obviously a very large purchase of beans by a hedge fund that otherwise would normally purchase financial products versus the commodity itself.

Our commodities remain very volatile right now, and we're starting to gain some visibility toward 2011, and we'll certainly be providing more information on that as the year progresses.

Okay, thank you.

Just a quick follow-up on the marketing side possibly for Dave.

Dave, it does look as though the Mars Hershey combination, we've talked about this a little bit before, has been perhaps less aggressive on the sales front than we might have expected.

What are you looking for from that competitor for the balance of the year and into next year?

You said the Mars Hershey combination.

I hope you meant the Mars (Inaudible).

No one told me about.

I thought we would have probably filed an 8-K and I would have known.

With respect to Mars Wrigley, and actually within the category, I think what you are seeing is innovation, increases in innovation, particularly you're seeing some of the competitors in chocolate, some of the other competitors in chocolate are a little more focused on some in and out type of innovation, very focused a little bit more on permanent items, but within the chocolate part of the business we're seeing is a little bit more innovation.

Then in gum, there's between Cadbury and Wrigley there is some innovation and some pretty good activity there.

So we are seeing innovation pick up, and we believe overall that's helping drive category growth rate in some of the volume in the category.

As we look to the rest of the year, it becomes a seasonal -- seasons become a larger part of the equation, and it's a destination category across the -- but everybody in the category tends to benefit from the destination nature of Halloween and holiday.

So our overall, we're see going gross margin expansion, we're seeing volume in the it category and we're seeing better than historical category growth rates.

Right now we feel pretty good about how the category overall is positioned, and most of the majors are holding their own and enjoying some pretty good growth.

Thank you very much.

Your next question comes from Eric Katzman from Deutsche Bank.

Your line is now open.

Good morning, everybody.

Couple questions.

First, you are doing so well and your reinvesting is a lot, which I think is logical, given the competitive landscape, but I just -- I may have asked this question in the past, but I'm kind of wondering if you have any plans for, let's say, the more premium oriented product where the Company has struggled in the past.

Right now the consumer is kind of favoring, let's say your more mass market oriented price points, but is there kind of a strategy in the background to just figure out a way to maybe capture your share when the consumer trades back up, if they do?

Hi, Eric.

Good question.

What we saw actually in the second quarter for the first time in pretty close to two years, give or take, but let's call it the last couple of years, we did see a little bit of growth in the premium segment of the market, kind of mid single-digit growth for the first time in this quarter.

The trade up segment was down a little bit actually in the quarter, but premium was actually up some.

So you are starting to see at least some moderation in the premium and the trade up segments.

But most of the growth and most of the attention from the retailer in consumer remains in the mainstream segment.

So from a programming standpoint, and the actual current investment, you are seeing us really focus on mainstream right now because we think that's where the bang for the buck is and that's where consumers and retailers are going.

That doesn't mean that we're not working in our pipeline and in innovation on the premium segment.

We just don't think now is a particularly good time to be launching and investing behind that segment.

Okay.

And then maybe as a follow-up to Terry's question, to the extent that I guess a lot of soft commodities seem to be moving up, whether it's cocoa or sugar or coffee, what have you, Dave what's your sense, I know did you a lot of work on pricing architecture.

What's your sense on the category and your ability to take price up, even though the industry or the category took very, very significant pricing over a couple of years?

Yes, I'm not going to comment, Eric, on pricing as we look out into the future.

We have built very good -- I think you're correct, we've built very good analytical models.

We have just worked our way through the August 2008 increase, and we're driving pretty good gross margin expansion and now starting to get volume back through the factory, which is a virtuous thing.

Right now we're pleased with how the category is growing, and the kind of attention that we're getting from consumers and retailers.

So we monitor commodities.

We're hedged anywhere from 3 to 24 out but I'm not going to speculate on where the market -- what pricing may or may not happen in the market.

It's not appropriate.

One quick follow-up on Godrej.

Is there any competitive issue here with Cadbury and Kraft maybe doing more in that market, and therefore your longer term assumptions prove too aggressive, and that's why you're taking the present value non-cash charge?

Let me just give you some background.

We bought that business in -- and went into the joint venture in 2007 at a time when marketplace expectations on a number of fronts, including overall market growth rates, commodity markets, financial markets were at a very different place.

And so as I think about when he we set the initial assumptions for valuation of that business, we set it at a time in 2007 when I think there were a lot of frothy expectations around a number of things.

Our key expectations of that business, I think the two biggest areas where we've fallen place from marketplace standpoint, the brands themselves were and still are to a large extent, it's sugar confectionery brands, household names.

In certain regions we were expecting to get national a lot more quickly.

Distribution-wise.

The other thing is we were hoping, through innovation to get to higher price points by giving the consumer innovation, so moving off of a half a rupe price point or a rupe price point and up, and given some of the macroeconomic issues that proved to be a little bit harder than we initially expected.

And then when you layer in on top of that the poor Indian sugar crop over the last 18 months, those three factors I think were where we missed in the model.

The business is still growing.

We're starting to see our plans in terms of getting the cost structure right and the commodity market coming back.

So while we're short of the initial expectations and the time frame they were set, it still remains a growth market for us, but I wouldn't read in anything competitively.

Again, it's sugar confectionery part of the marketplace, not where Cadbury would have a strong chocolate division position, per say.

So I would say it's a little bit more about how we set expectations for the business and we're able to execute, and I would say that that's not necessarily a marketplace phenomenon.

It was more our inability to get some certain of the assumptions done.

Okay, thank you.

I will pass it on.

Your next question comes from the line of David Driscoll from Citi Investment Research.

Your line is now open.

David Driscoll your line is now open.

Your next question comes from Judy Hong from Goldman Sachs.

Your line is now open.

Good morning, everyone.

Good morning.

Dave, I want to get a little bit better understanding of the trade efficiency benefit that you saw in the quarter, how much did that help you in the second quarter?

Then I think Bert talked about the second half, maybe that benefit waiting, so can you give us a little magnitude in terms of how we think about that and maybe a little bit more color in terms of a lot of different categories.

In food you're seeing increased promotions, and obviously in confectionery, that doesn't seem to be the case.

So what is really the differentiating factor in terms of what you're doing and what the category is doing?

Yes, Judy, let me give a little setting of the stage.

If you remember, back in the first quarter, we actually had had trade promotion rate below prior year.

So we actually had two to three points of growth in the first quarter, net sales that were related to having lower trade promotion rates.

In the second quarter our trade promotion rate versus year ago was roughly flat.

And so we didn't -- we weren't lower, but it was better than our expectations going into the quarter.

So for the first half we have better trade promotion efficiency.

As we get into the back part of the year, we're looking for that -- that's probably not going to be the case, and if you think about it, it makes some sense because the second half of the year for us is much more merchandising intensive given the seasonal nature of the business.

So I think what you are seeing from us realistically is we are investing in new items and we're investing in our existing core brands with advertising.

So our base velocities are increasing and so when you look at the mix of base versus promoted you are seeing us do a much better job with base and therefore on a relative basis not as much promoted.

And so I think that's one of the things in the category.

Then the other thing is the category, because it is such a destination category, we are going to continue to get good merchandising and that's just a factor where that historically, the retailer knows that it's a consumer destination and they're going to get -- we're going get our level of display.

So I think it's one of those virtues of the category.

Then just following up on that, if you look at the second quarter, it sounds like the bulk of really the sales growth did come from volume growth, and as you think about balance of the year, especially as you think about the fourth quarter shift into Q1 2011, are you expecting volume trend to get better as the year progresses?

And if that's the case what should drive that improvement?

It's interesting.

I think if you dive in under the numbers, the base volume trend is actually about the same throughout the year.

There's -- in the first quarter we were up roughly 14% on the top line.

We said half of that was price related.

So it was list price plus the trade promotion efficiency and a little bit of foreign exchange.

So 7 of the 14, then we realistically had in the first quarter 7% volume, 2% of it was a shift from 2009 into 2010 related to seasons.

And then we got new products and base velocities that added up to 5%.

So new products were a couple points and base velocities around 3%.

That was the first quarter.

Here in the second quarter we're up roughly 5%, trade efficiency and foreign exchange add a point or two, and so when you look at base velocity, it's, again, around 3% to 4%.

We shipped a little less Halloween in the second quarter than we normally would.

So base velocities between the new items are still that roughly 3% to 4%, same as they would have been in the first quarter.

And then as you look at the second half of the year we don't expect to get any of the trade promotions or pricing efficiency that we got in the first half.

We're talking about being close to the top end our 3 to 5 long term for the back half of the year.

So that would implying a gain, that same kind of 4% to 5% from base volume and new items.

Remember, we have the two new items in the back part of the year on pipeline, which will be the Reese's Mini Minis and the Hershey's Drops.

I think throughout the year you are going to see similar volume trends, base and new, across the balance of the year, then the difference really is in the first half we got better price and trade efficiencies.

Thank you very much.

Your next question comes from David Palmer with UBS.

Your line is now open.

Thank you.

Hi, everybody.

Congrats on the quarter and the year.

Question for you.

Just kind of a big picture question since my other ones were answered.

When you are looking at your overall business, you have clearly been reinvesting very heavily in marketing and advertising, and now innovation at a more rapid clip, and it's been working great.

In terms of International or other growth vehicles, we talked a little bit about premium before.

Are you sort of in search of other areas, ways that could you maybe spend more today to kind of create other legs of growth that might seed your business and your growth all grow them all few years out, or are you content with what you've got here and thinking that you have such a long runway of growth and you feel so good about the domestic chocolate category that you are content to just keep on reinvesting in the core?

Yes, I think, David, it's a good question.

We are investing in capabilities beyond simply the investing in the core and advertising.

We're investing in insight driven performance, which is a new way to think about category and drive insights and create some intellectual property.

We're starting to do some experimentation and investment in digital media.

We continue to invest in go to market capabilities in the US, retail coverage expansion and go to market capabilities and some of the other International markets.

So we're investing in core confectionery in a meaningful way and capability building beyond just advertising.

We remain a good generator of cash.

We've been very clear that we'd like to invest that cash in M&A in a very disciplined way.

As assets come up, we will certainly continue to look at them, and that's the way that we think we can continue to create value.

I think we're very pleased that we continue to see very good returns on the investments that we've made in the core, and we see a lot more runway there.

So we're pleased at that, but we're not content with that only.

We are looking at other avenues.

Thanks and congrats again.

Thanks, David.

Your next question comes from Ken Zaslow from BMO Capital Markets.

Your line is now open.

Good morning everyone.

I didn't catch all the IRI numbers, but my sense is just listening to it was the growth at mass merchandisers seemed to decelerate to the growth rates more in line with the traditional grocery stores.

My first question, is that true?

Did I catch the numbers right?

If so is there some sort of change we should know about?

Is the growth rate of groceries coming up or are mass merchandisers coming out?

Just a little color on that would be helpful.

if you think about it, our first quarter FDMXC, so food, drug, mass-ex, Wal-Mart, convenience, our first quarter growth there was about 6% and when you look at it all in, FDMXCW it was 7.5%.

That's the last quarter where we had price realization in those numbers.

In the second quarter, FDMXC was 4.1%, and the all in number, FDMXCW was 4%.

So the category was a little slower in the second quarter than the first because of mitigating pricing, but still 4% for us pretty good.

Those are our growth rates, I'm sorry, not the category.

So overall for the category we're up 5 FDMXC and 5.7 FDMXCW.

So you did you see a bit of a slowdown in the overall mass kind of customers in the second quarter.

Food grew very nicely.

So I think as you listen to conference calls and other talk out there in the market, there seems to be a little bit of a shift back towards food and closer to home shopping a little bit more of the traditional pattern.

Convenience store trips were up as the quarter went on.

We saw a nice improvement in convenience store traffic through the quarter, and then I think our drugstore business is improving, albeit it slowly.

So I think overall there was probably a little bit of a shift, and it's consistent with what you would read externally in the news about kind of some of the traffic moving from mass and food being up up a little bit.

Convenience continues to look good.

Then the drug and the club -- the dirty dollar and club class as a trade continue to be very good.

Our relationships at the major mass retailers continue to be very good.

We did win an award at Wal-Mart for the -- one of the awards for adding value to the consumer.

So we feel good about the relationships, and overall category growth rate still remains pretty good.

My next question is I know on the chocolate, I think you said there's a lot of runway, what's your thought on the runway on the non-chocolate confectionery, and what are the next brands that you expect to be advertising or doing new product innovation behind that could even the portfolio a little bit in terms of the growth rate on the non-chocolate confectionery?

Non-chocolate is growing.

We've actually invested very nicely behind the Twizzlers brand, and that is -- that has responded very well.

We do believe that there continues to be growth in non-chocolate as well as in chocolate.

We're going to -- as we go through the rest of the year, one of the things we're doing is getting to continuity advertising on a number of other brands.

You saw us start advertising on the refreshment brand, the Ice Breaker brand in the second quarter here.

We're looking at adding potentially another brand, but I don't want to talk about which ones that we would add as the year goes on, but there is room for growth there.

It's growing very nicely.

And so we will continue to invest there.

Twizzlers is the one that's gotten the most investment right now.

Great, I appreciate it.

Thank you.

Your next question comes from Vincent Andrews from Morgan Stanley.

Good morning everyone.

Could you characterize what inning you think you are in terms of stepping up the ad spend and so forth?

I'm just noticing the results continue to come in very strong, and it seems like there's a predication to spending back the upside and you are comfortable you can achieve a certain level of growth for this year, and you seem to already get started on next year, but the ad spend levels are now really up there.

So what's potentially going to happen over the next couple quarters?

Do you have a line of sight on so many other things to do that you can keep doing this, or is there a point at which upside is going to start to flow to the bottom line?

I guess let me characterize it in kind of two different ways.

Our first half sales growth rate is close to 10%.

And we think that's reflective of really kind of getting fairly strong and aggressive in terms of our advertising spend in the latter part of last year, but particularly having a heavying up on some brands like Reese's and Kit Kat late in the year, getting prepared, doing the pre production work on brands like Pieces, Almond Joy, Mounds, and York, and getting them on air right out of the gate in January of this year.

So we think that leaning into the advertising spend in the back half of last year is a large reason why we've been able to grow strongly in the first half of this year.

So we originally, when we started the year were looking at growth rates on the top line within our historical 3% to 5% rate.

We're now closer to something around 7.

So if you think about that upside, which has really occurred here in the first half, and then as we look to the rest of the year, to the higher range of the 5%, we think that's really a lot about the way we've invested in the brand, the new brands particularly.

And so as we've -- that favorability, if you will, if you think about difference between the original 3% to 5% and 7%, a lot of that would essentially have fallen through, because our EPS, when we started thinking about the year, was in the 6% to 8% range, now we're in the mid teens range.

What is a little bit more virtuous to us is the fact that not only have have we gotten that top line, we've also gotten to the productivity gains and a little bit more trade promotion efficiency.

So we've been very favorable in the gross margin versus our initial expectations in the first half, and what we're doing with that favorability is investing it.

So the top line favorability, if you think about it, let's say it's fallen through, but the gross margin favorability we've decided, gross margin favorability in the first half, investing it in SM&A programming in the second half with the belief that we're still getting good ROI on our marketing spend, therefore it should continue a virtuous circle and help us close 2010 fast and get off to a good start on the top line 2011.

We are going to go heavier getting towards continuity programming on a lot of brands we're already on.

So some of the brands we started such as York and Mounds and Almond Joy, looking at copy on other brands, starting digital and getting some international spending in the latter half of the year, we're getting to those continuity levels on those brands a lot faster.

As I said in my remarks, as we look forward into next year, you should see a much more normalized level because we've gotten a lot of the brands on air and the continuity levels much faster, but we think at this point in time it's the right time at a time when the consumer is looking towards our category for value and some indulgence around, and when retailers are looking to us because we have a relatively attractive entry price points and we're a destination category we think it's the right time for us to invest into the brands, and so far so good.

We are see good ROIs so we think it's the appropriate thing to do.

Understood.

Very helpful.

Just as a quick follow-up.

Can you remind me, what's the issue the drug channel?

Yes, I think if you think about what we did in the drug channel, back in 2004, 2005, 2006, even into 2007, and our business model was based on distribution, growth, and variety, in and out type products.

That was our business model.

And we were very effective in the drug class of trade in those years.

They embraced that business model, and then when we kind of stepped back and relooked at the business model and went much more towards the pull orientated advertising based system that didn't match up as well with their go to market strategy.

And so while we got great traction in some other places, as we move more towards the pull strategy the one class of trade where our business model was out of step with what they were trying to do was in drug.

We took a period of correction as we took a lot of items out of the system and have managed our way through that.

Also a class of trade where we don't have retail coverage.

So it was a little hard for us to correct for the new business model and get the he retail right as quickly as we normally would have liked to.

We still have very good relationships through their large customers.

It's turning sequentially for us.

We're feeling good about direction we're headed in but it just it was one class of trade where I think it took us a little longer to get the new model in place.

Thank you.

I will leave it there.

Your next question comes from Robert Moscow from Credit Suisse.

Your line is now open.

Hi, thanks.

Again, congratulations.

I wanted to know, though, the confectionery category goes through cycles, and I think sometimes Hershey's taking share, and sometimes Mars is taking share, and I just think that your company has made excellent investment in product quality advertising and go to market strategies.

And I just want to get your sense, Dave, of what's the duration this time around?

Do you think you've kind of invested and laid the groundwork for something that could last for a couple of years, especially given Mars Wrigley, this so-called integration really hasn't been much of an integration?

And if so is there any reason why you couldn't, for the next couple of years, kind of outpace the long-term growth rate that you have laid out in your algorithm?

Thanks.

Thanks.

I think what we feel good about, the way we're investing in the brands, we think we're getting brand awareness higher, we think we're getting our penetration rates higher on most of the brands in our portfolio.

That's a long-term healthier situation for us to be in.

Innovation is starting to be additive.

A lot of the competitors are coming in with innovation.

We think because of the way the category works, it's an expandable category and the consumer has a number of brands that are acceptable to them on their menu.

We think those kind of things will expand the category, and so it's not -- this is not a category, because it's expandable, and the way it gets merchandised, it's not a zero sum game kind of a category.

We think it is a way that we could see category growing at greater than historical 3% to 4% growth rates in the US business, but again, everything is against a macroeconomic backdrop of consumer confidence, as well as retailers.

There's a lot of retail channel issues and blurring out there, and so it's not the most certain time in the world, and we think what we're doing the is the right investment.

We continue to feel good.

We set our long-term growth algorithm back in the middle of 2008 at 3 to 5 and 6 to 8.

That was against very volatile commodity backdrop, as well as a very volatile macroeconomic environment.

That hasn't really changed.

So we've been pretty transparent about our ability in the short term to be ahead of those numbers and we'll continue to be -- we'll continue to be very transparent about that.

Over the long term, and I think there will be a time as we get a little more clarity here as we head towards 2011 and beyond to give a little bit more certainty around our model.

Okay, and maybe if I could drill down to just one element of what you have invested in, you mentioned the IDP program at Cagney, and you said that the capabilities of that, or that you might be able to extend that even further in 2011.

Can you give us kind of an update on what you've done so far, how many retailers are you working with there, and have you expanded the net to more retailers since then?

We have expanded to more retailers.

We're also working very, very hard to build out a really robust capability set.

We talked about it.

We mentioned the snacks and sweets expo in Chicago, which is a very large kind of US/global show where we talked to a number of customers about [sweeta] the capabilities.

We are in the process of building out capabilities, learning how to do this and collaborate with customers.

We have a number of customers that we're testing with, feeling good about the initial work, and we'll get some benefit from the upfront kind of pilot customers in 2011, and it will be much more meaningful as you get to 2012.

But I think right now we're investing, and one of the investments we're making in the back half in the SM&A line will be around capabilities and insights and making sure that we're building them out.

We're feeling good about progress.

Obviously it's a long way to go.

We think we're building something pretty cutting edge.

It's going to cost aus bit of time and money but we think it's absolutely the right thing to do.

Thank you.

Your next question comes from Andrew Lazar from Barclays Capital.

Your line is now open.

Good morning.

As we're thinking about 2011 and some of the key puts and takes that will you be facing, one, obviously more board level decisions, but sort of the use of cash flow, which has been very, very strong.

Without getting into specifics, I'm trying to get a sense if we're thinking about 2011, how should we think about that, even if it's just kind of priorities or where you think you're likely to use more of that cash, whether it be share repurchase, based on what you are seeing around acquisition opportunities, or potential partnerships globally, is there one way or another that you would sort of point us with specifics to 2011 around how we ought to think about some of that cash being used?

Yes, Andrew, let me try to put that in a couple of different buckets, and it's a good question, and one that obviously we pay a lot of attention to internally.

If you look at that time last couple of years, the one thing that hasn't changed is we continue to generate strong cash flow, and that's been something that's obviously helping us very much in the business.

There has been some change in terms of the profile with respect to cash, and so I talked about the fact that we had about $250 million of cash on the balance sheet.

Last year, in a pretty volatile economy, we chose to pay down short-term debt and we've pretty much gotten out of the commercial paper market at this stage.

We did increase the dividend earlier in the year by 7.5%.

Going forward we think there are a couple ways, with the board's counsel, we think about the cash.

Certainly one is the new next century requirements.

So there will be some requirements that wouldn't have been there prior to that discussion in terms of capital and some of the cash requirements of next century.

And we think we certainly have those well in hand.

But given the level of cash flow that we generate, certainly Dave already talked about it, we do believe there could be M&A opportunities, and we're actively trying to pursue some of those that could give us expansion into the geographic areas that we're already interested in.

And so that's certainly on the list.

And then as we build cash and the fact that we are out of the short-term debt market, questions around further dividend increases and maybe even buybacks is certainly on the agenda for the board and management discussion.

So I think those are the major buckets to think about, and right now we're very pleased with the continued good cash flow to the Company, and we're very happy with the credit rating that we have, and it gives us the ability to have those types of flexibilities in those areas.

Thanks for that.

One last one.

This is I think, more industry-wide.

I'm just curious.

And this gets back to the pricing discussion more from an industry perspective.

Dave, a lot of food companies have talked a little bit recently about should we see some reinflation in commodities, perhaps that's one of the leading indicators to kind of get the industry to take the foot off the promotional gas pedal a little bit, because obviously it's been pretty intense in a lot of categories, obviously not necessarily yours specifically.

But I'm trying to get a sense of how realistic in general you think that thought process is in the sort of next couple of quarters, particularly in light of the level of productivity that all these companies are generating.

They can kind of cover 3%, 4%, 5% input cost inflation from that alone, and realistically, given where the consumer is, where the retailer is, trying to get a sense of how realistic that is.

Again, broadly speaking, not necessarily to your category.

I think I don't really want to engage in hypothetical kind of conversation around pricing or input prices.

I guess what I would say, Andrew, is the consumer remains kind of fragile, and it's tough out there to find volume.

We're very pleased with the way we've gotten volume in the category here, and I think the good news for us is merchandising for us as a category kind of comes naturally because we are such a destination event seasonally throughout the year.

So I think that's one of the things that makes us -- maybe we're even a little bit of an outlier in terms of this conversation because we are such a destination category.

It's one of the things that makes us so attractive.

We're going to get display we're going to get displayed, because what we're offering as a category is what retailers and consumers are looking for.

A fairly attractive entry level price point, a destination, and event marketing.

Those are the things that most retailers are trying to provide and most consumers are looking for in their shopping experience.

So we're somewhat advantaged, and we might be an outlier in the form of the conversation you're talking about, about how to drive merchandising and volume.

Thanks very much.

Your next question comes from Bryan Spillane of Banc of America.

Your line is now open.

Good morning.

I guess a follow-up to Andrew's question.

What we've seen in, especially the food class of trade is retailers promoting out of their own pocket.

So soft drinks have been really promoted pretty heavily this summer, for instance, and a lot of that funding has come from retailers and the motivation there is to drive traffic.

Since you're destination category, you would think that if a retailer is thinking that way that maybe they'd promote confections more aggressively around the holiday, or at least going into the Fall.

Can you just talk about whether that's been a conversation with retailers or a topic of conversation with retailers and just your perspective on the potential for retailer funded promotions in the second half.

I guess what I would say is, we took a pretty significant price increase back in August of 2008 at list, then we also saw category promoted price points move up pretty strongly in 2009.

Consumers have clearly started to adjust to those price points because you're seeing volume in category come back at pretty good levels.

So I think that's the overarching dynamic here is that we are seeing volume in the category at, what is higher than what have been historical promoted price points.

So as you go to the back part of the year, as a destination category, there's going to be Halloween display, there is going to be holiday display, s'mores displays for our business, for example.

Those are already destination events that are out there from a retailer perspective.

So I think, again, the confectionery category, because it is a unique destination category, is already going to get that kind of display, some retailers will make their own choices about what price points they may or may not want to go to market with.

I don't think it's appropriate for us to comment on individual conversations about their go to market strategies.

I think, as I said in our remarks, we're pretty pleased about the kind of attention the category is getting from both retailers and consumers.

We're investing in our brands behind that.

I wouldn't want to comment on what specific retailer may or may not be doing.

It's really up to them and their go to market strategy.

Thank you, David.

Your next question comes from James Targett from Consumer Equity Research.

Your line is now open.

Good morning.

Hi, James.

How are you?

Good, thank you.

I just wanted to go back to the talk about International business.

I just wondered if the experience in India had changed your view on how to go about expansion in new International markets in terms of geography, route to market and suitable products.

Then I wanted to come back to the IDP initiatives this year and just trying to get -- if you could give us some color on how to retailers have responded and when we could start seeing some benefits.

Okay.

Let me start.

I think we've learned some things in India.

I think from a timing perspective, it was, when we bought that business, and it was our partner, Godrej, in 2007 we had a set of assumptions about some macroeconomics, some commodity assumptions and when you think about valuation assumptions in 2007, they're probably a little different than you might see today.

So I wouldn't read into the impairment charge anything other than with the businesses still growing I think we've learned he a lot since 2007, if you will about go to market capabilities.

So since 2007 we've done some things in Brazil and in China en route to market and have some learning there.

We've also done some great learning, I think, in mark like Mexico, for example, and China about the consumer demand landscape and how that ought to work.

So I think we have learned a lot since that acquisition itself, and that's clearly going to be applicable to how we think about growth in markets around distribution capabilities, innovation capabilities and the ability to get product to market.

So I would say we have learned quite a bit, and we'll apply it not only in the businesses we're already in, but as we look at M&A in the future about how to think about valuation and modeling on the way on the way in.

So we'll be very disciplined so that's the learning.

With respect to IDP, as I said, retailers have been very receptive to the conversations.

I think the thing that we're the most pleased about is that we are building collaborative relationships with retailers.

We're talking about data in a different way, sharing data in a different way than we would have in the past, much more strategic in our mutual approaches to it, and really trying to find the intersection between -- we talk about our consumers and retailers talk about their shoppers.

They are one in the same.

It's the same person, but when we talk about our consumer, and they talk about their shopper, they have always tended to come at it much more on a trip mission basis, and we've come at it much more on a consumer demand landscape basis, and we're trying to marry those two things up.

I think what we've been very leased with is as we start to exchange data, initially what we're finding is that there are ways to win together, and actually kind of either satisfy unmet demand or be more efficient in the way that we are satisfying existing demand.

So, so far, so good.

Just in terms of, I think you said the initial pilots should start showing some results in 2011.

But is it really going to be 2012 before we start seeing the major benefits come through?

Right, I think the pilots are underway now, and they'll impact us, some customers, key customers in 2011, then the broader learning really comes for 2012, I think.

We have some capabilities and some tools to build out to affect more of the market than just the pilots.

Sure.

Great.

Thanks a lot.

Thanks, James.

Your next question comes from David Driscoll from Citi Investment Research.

Your line is now open.

Thanks for taking the call.

I know the hour is passed.

First off, just wanted to say absolutely congratulations.

These are fantastic results.

Dave, I believe that Hershey is now hitting an all-time record gross margin for the quarter, and projected for the year going back in my data set all the way back to 1997 at least.

So the question really surrounds gross margin and the outlook.

Given the absolute level of gross margins, again, for the quarter and the implied number for the year predicated on the EPS guidance, big picture three to five years out, can this keep going higher, or are we going to be at kind of a steady state level on gross margins?

Can you give us some color around this and your thought process as to the factors that will drive it?

I think the biggest factor always on some levels, commodity prices and commodity fluctuations and volatility, David, and I'm not going to get into any kind of conversation around commodities one year out, let alone three to five years out.

What I will say is we've gotten great visibility into gross margin when we look in 2012 and 2013 from the project next century.

What you are seeing from a gross margin expansion standpoint right now, a lot of the global supply chain transformation has lifted the gross margin level on a systemic basis, and when we get to project next century and build that out in late 2011 and 2012 and 2013, you will also see the same kind of systemic lift.

We're also starting to see some good expansion in our International business.

That's not going to necessarily come at that time same margin, and so that will always be a governor against what we're doing.

But we've done some things systemically that we think are pretty good in the supply chain.

We are starting to also, in the short term here, capture some of the productive teff that we talked about at Cagney which is kind of the non-raw material productivity.

We feel good about the program, the continuous improvement programs and some of the structural things going forward.

The overlay is commodity prices and commodity volatility and fluctuation and again, that's just premature to talk about any of that.

Thanks for those comments.

One follow-up on all the questions on M&A.

The Cadbury folks just sold their Poland and Romanian operations.

Obviously you didn't buy either of these operations.

I'm just curious kind of what does this say about your International strategy?

Did these operations even fit your thought process as to how you want to go about International expansion?

Was there a price issue?

Again, I'm just trying to get a sense for your desire to go off and make acquisitions to bolster the International operations of Hershey.

David, you are correct.

All I can say is we didn't buy that business.

When we look at M&A -- we've talked pretty specifically about Asia and Latin America as being our focal areas.

Obviously eastern Europe has some attractive emerging markets kind of characteristics as well.

We continue to look at places where we can add value.

We're going to do it in a disciplined approach.

But I think the focus areas for us are clearly Asia, Latin America.

Eastern Europe is interesting, but it's not been one that we've certainly prioritized in front of Asia or Latin America.

That makes sense.

Thanks for the comments.

Congratulations on the quarter.

Your next question comes from Robert Dickerson from Consumer Edge Research.

Your line is now open.

Hi.

How are you?

Good morning.

So I just have a question that's probably similar to nab of questions that have been asked, and I know there's a lot of discussion around M&A, and where would you would focus on M&A regionally, but just to step away from you specifically as a company, and what area you would focus on, and where you could add the most value and see the most benefit.

Obviously we understand that the confectionery category in the US is growing about 3% to 4%, which is great relatively, but obviously it's still growing faster than other developed -- excuse me, in other developed markets.

So I'm just curious, over next five years, on a global basis, whether it's Asia or Latin Am, or Eastern Europe like you said, where do you see the growth coming for the category?

Overall I think if you want to go back to our IR website and look at some of the growth rates that we have talked about growth rates by region, if you will in our Cagney presentation, I think overall population growth as well as emerging increases in GDP, as GDP grows in economies, one of the first places consumers trade up into for themselves is in confectionery.

So we would expect as Asian markets and certain Latin-American markets continue to kind of come up the GDP scale in the population scale, you are going to see greater growth there than you would in -- certainly in North America.

North America has tended to grow a little faster than Western Europe.

So I don't think there's any surprise that would you expect to see growth rates in Latin America and certainly in Asia at much higher rates than in Western Europe and North America.

Okay, great, thanks, that's all I have.

Your final question comes from the line of Robert Moscow from Credit Suisse.

Your line is now open.

Hi, have you said what cash flow was in the quarter?

No, we didn't make a specific point on cash flow.

With respect to what we did say was we gained for another quarter on working capital, a little bit slower rate than what we had the last tame around.

Our cash flow continues to be very strong.

I think if you compared it period on period, our cash flow was about flat versus last year's second quarter, and a little bit down from the year end.

And that's largely because last year you had huge working capital benefits in the first half of the year?

That's correct.

If you look at the pattern, we've really been improving cash flow for the better part of the last two-and-a-half years, and we continue to have gains this quarter.

Last quarter I think our gains were somewhere in the $50 million to $60 million range, and this past quarter was about, I think I mentioned was about 16.

So we continue to make progress there, particularly on the inventory as global supply chain transformation allowed us to operate fewer facilities.

So cash flow remains very positive for the organization and the difference that you are seeing is a slowing on the working capital improvement.

Bert, your stock is kind of under attack here, and I don't know if it's because of cash flow or not, but as you think about all the restructuring spending that you are going to have to do, both on CapEx and cash charges, and you look out for the next couple of years, do you think that your working capital improvements will be sufficient enough to kind of offset that, or should we start modeling kind of a net income plus depreciation and then CapEx and all the other spending that's happening?

Is that going to dampen your cash flow outlook for 2011 and 2012?

I think that's probably right in terms of for those years specifically.

If you look at project next century, clearly the heavier CapEx and restructuring charges are going to come, some in 2010, and we mentioned about $55 million of CapEx in 2010 for project next century, and then we're going to be spending about 250 or so total for that project.

So you will see some impact from that in the next couple years.

The savings kick in later in the progress.

So of the $60 million to $80 million that we talk about in terms of savings, you really start to see in that 2012 and 2013.

So there is a period where cash flow will be a little bit lower than it probably has been the last couple of years.

Having said that, we think the base cash flow generation capability of the organization, which in any given year is $500 million to $700 million prior to CapEx and dividends will continue to be the case, and we do see that increasing as the top line grows and as that peak in CapEx subsides over the next 18 to 24 months.

And could you remind us, what's the share repurchase program now, and what's your -- what's the timing of it?

We have 100 million outstanding, and that was part of the 500 million program that was approved toward the end of 2006 with a lot of the volatility that occurred through 2008 and 2009, we have not executed against that 100 million.

We did buy back about 130 million of shares in the open market in the first six months of this year, and it's our normal practice to buy back exercised stock options to avoid that dilution.

So we still have 100 million.

It's a topic for board discussion going forward, and as our cash continues to build, and as I said, I think we have well in hand the capital requirements and the severance requirements for next century, certainly dividend increase and buybacks are a topic that I can we will bring forward and discuss with the board.

Okay, thank you very much.

You're welcome.

There are no further questions at this time.

Thank you for joining us on today's conference call.

Matt Miller and myself will be available for any follow-up questions that you may have.

This concludes today's conference call.

You may now disconnect.