好時 (HSY) 2010 Q3 法說會逐字稿

Good morning, my name is Beth, and I will be your conference operator today. At this time I would like to welcome everyone to the Hershey Company third 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, Beth. Good morning, ladies and gentlemen. Welcome to the Hershey Company's third 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 also 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 risks and uncertainties. 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 a press release, a copy is posted on our corporate website, www.hershey.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 note section of the press release we have provided adjusted pro forma reconciliation of select income statement line items quantitatively reconciled to GAAP. As we said within the note, the Company uses these non-GAAP measures of 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 third quarter 2010 results, excluding net pretax charges. The 2010 charges relate to the project Next Century program while the 2009 charges are associated with the global supply chain transformation. These pretax charges were $4.5 million in the third quarter of 2010 and $11 million in the third 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. I'm pleased that despite the macroeconomic challenges that persist, Hershey delivered another strong quarter of operating in market place results. During the third quarter and on a year-to-date basis, the CMG, and that's candy, mint and gum, category continues to grow, outpacing salty snacks, cookies, crackers and bakery snacks. Our business is solid in all classes in trade, and our retail partners value the importance of confectionary category and the leadership Hershey provides. During these challenging times, retailers are looking for traffic and profitable solutions, and confectionary is one of the answers to both of these objectives. Hershey's third quarter net sales reflected continued momentum of our brand. Net sales increased 4.2%, driven primarily by volume gains in both the US and international markets as we continue to invest and execute in the marketplace.

Additionally, as we exited the third quarter, the timing of some seasonal shipments dampened third quarter net sales by approximately one point. These shipments have already occurred in early October and will be reflected in our fourth quarter results. In terms of Hershey's marketplace performance, preliminary CMG consumer takeaway for the 12 weeks ending October 2 and year-to-date periods, per our custom database in channels that account for over 80% of our retail business was up about 4% and 5% respectively. As a reminder, these channels include food, drug, mass, including Walmart, and convenience stores. In the third quarter, I was particularly pleased with the sequential improvement in resale takeaway trends at one of our larger retail customers and in the drugstore channel.

We do want to note that during the third quarter, Nielsen contacted some of their customers, including Hershey, and informed them that they're currently reviewing the production methodology of their C-store universe for syndicated data. This is a C-store channel specific issue impacting a number of categories and manufacturers with the impact limited to Q3 data. We believe the data we have been provided and that we are sharing with you today is directionally correct and that any potential adjustment will not materially impact our overall reported market share.

We continue to feel very good about our convenience store business. In Atlanta at the NACS conference, that's the National Association of Convenience Stores, two weeks ago, we had the opportunity to meet with our C-store customers. The constant theme was that Hershey and confectionary category remains solid. Within FDMxC, that's Food, Drug, Mass and Convenience, here we're excluding Walmart, preliminary Hershey and category growth for the 12 weeks ending October 2 and year-to-date period per our custom database increased relatively in line with the category's historical growth rate.

Hershey's preliminary US CNG market share is up 0.2.points for the year-to-date period and was flat in the third quarter. The category continues to perform well despite the macroeconomic challenges as confectionary is among the highest with respect to household penetration and impulse purchases. This impulsivity continues to translate to merchandising opportunities and as we move through the balance of the year, the category is a seasonal destination with our branded products remaining available at reasonable price points. As a result, we would expect the category to continue to consistently secure key merchandising and programming space and to grow within the historical 3% to 4% range.

The category continues to be driven by mainstream everyday confections as its trade up, gifting and novelty subsegments remain soft. Year-to-date, premium and trade-up chocolate on a net basis is about flat. As we stated in July, as expected, there were investments by major manufacturers in the category in the form of innovation and trial-inducing program during the quarter. Activity varied by channel and despite this, Hershey resale takeaway increased in all channels.

In the third quarter, food class of trade category growth was plus 4.2%. Hershey retail takeaway increased 2.5% in the third quarter, resulting in a market share decline of 0.5 points in Q3 in the food classic trade. However, Hershey's food channel market share is still up 0.1 point year-to-date. Q3 results were due to the year-over-year timing of innovation, merchandising and programming. Marketplace activity can and will vary from quarter to quarter, and our programming for the balance of the year in the food class of trade is solid. This year's Halloween season is marked by bit of an unusual calendar. Labor Day was late, September 6, and October 31 falls on a Sunday. With this pattern we expect consumer purchases to be especially compressed towards the end of the season.

To date, customer Halloween orders and resale sell-through are tracking in line with our expectations, although we will not have a complete read on sell-through for another couple of weeks. Halloween specific seasonal promotions, merchandising and advertising are being executed. We believe we made the necessary investments to ensure solid category sell-through and will work closely with key customers over the next 10 days to monitor consumer reactions and shopping behavior.

Turning now to the C-store class of trade. In Q3, Hershey preliminary C-store takeaway increased for the tenth consecutive quarter and was up within historical category growth rate, resulting in a share gain of approximately 0.2 points. On a year-to-date basis in the C-store channel, syndicated data indicates we have gained 0.6 market share points. In Q3, Hershey C-store chocolate and non-chocolate performance was solid, driven by volume and mix as both standard loose bars and king size packages performed well in the marketplace behind the Reese's Double the Love promotion, the two for $2.50 king size promotion and the Hershey's Pure Happiness standard bar program.

In the fourth quarter, we expect convenience stores to remain on track behind MCAA football tie-ins as well as additional king-size and standard bar programming. In the third quarter, our business in the drug class of trade improved. For the 12 weeks ended October 2, Hershey resale take away in this channel increased 3.2%, resulting in a market share gain of 0.6 points. While this is partly a result of easier comp versus the year ago period, we have notably increased level of investment and focus on this channel and are markedly improving our results.

As we look to the remainder of the year, we have strong initiatives in place during the fourth quarter across all channels. Some of the core brand merchandising and consumer promotions include an NCAA football promotions and for the holiday season, we're offering consumers a free customized photo calendar and coffee mug in conjunction with Snapfish with the purchase of two participating Hershey candy products. We're also adding excitement to our traditional holiday and baking programming with a Bake, Share and Win promotion, and we are most excited about the December launch in Hershey's drop in Reese's Minis.

In Q4 versus previous expectations, we'll accelerate the timing of and begin execution of certain aspects of our strategic plan. Therefore, SG&A spending will rise sharply and be driven by higher levels of incremental investments in the building out of the Insights Driven Performance initiative, further go to market strategies in both the US and other markets around the world as we add selling capability and points of distribution in global markets such as Mexico and China. We'll increase sampling, supporting new products, especially in the markets where we're adding points of distribution.

Advertising expense will increase and for the full year is now expected to be up 50% to 60%. This is greater than our previous estimate of 45% to 50% increase. We'll increase spending on brands on which we initiated activity earlier this year. Reese's, Mounds, Almond Joy and York have responded to the ad spending and will accelerate towards continuity levels of GRPs on these brands. We'll also begin airing copy on Hershey's Syrup and Payday for the first time since 2001. And we'll be adding to our consumer spending in Mexico, China and Canada as we complete and implement our demand landscape learnings in these geographies.

Over the remainder of the year, we expect the macroeconomic challenges facing this consumer to continue. Category growth rates will most likely continue to fluctuate from quad to quad. Importantly, the inherent characteristics of the category I spoke about earlier should endure, resulting in a category growing within its historical growth rate of 3% to 4% in 2010 and 2011. Our plans are in place for the upcoming key seasonal periods. As a result, we reiterate our full year 2010 net sales target outlook of about a 7% increase, including an approximate 1 point benefit from foreign currency exchange rates.

For the full year, we have good visibility into our cost structure. And while input costs will be higher in the fourth quarter, we expect adjusted gross margin and adjusted EBIT margin to expand. Therefore, we have increased our full year adjusted earnings per share diluted outlook and expect it to be in the $2.52 to $2.56 range, an increase of mid to high teens on a percentage basis versus 2009 and greater than our previously estimated range of $2.47 to $2.52.

As we plan for 2011, we believe macroeconomic challenges and consumer confidence will continue to be a headwind. However, we believe category dynamics, similar to those I've discussed and continued support of our brands will enable the category and Hershey to grow. In 2011, we expect our advertising expense to increase. However, the year-over-year percentage increase will not be at the rates achieved over the last two years. As a result, our initial expectation for 2011 is for net sales growth within our 3% to 5% long-term objective. While we do anticipate higher input costs in 2011, productivity and cost saving initiatives are in place to help mitigate the impact. Therefore, based on our current views and expectations for 2011, we expect growth in adjusted earnings per share diluted within our current long-term target of 6% to 8%. I'll now turn it over to Bert who will provide some additional financial detail.

Thanks, Dave, and good morning, everyone. Hershey posted another quarter of quality results as third quarter consolidated net sales of $1.547 billion increased 4.2% versus the prior year and adjusted earnings per share diluted of $0.79 increased 8.2%. Overall year-over-year results were driven by volume, mix, net price realization and supply chain savings which more than offset increases in marketing investments and selling capabilities. The third quarter sales gain of 4.2% was driven primarily by the continued growth of core brands including new products.

As we ended the quarter, the timing of some seasonal shipments lowered our third quarter net sales by about 1 point. Therefore, our fourth quarter seasonal shipments will be greater than the prior year, maintaining our full year net sales outlook of about 7%. In addition, lower levels of customer returns and markdowns, as well as July 2009 carryover pricing in Canada, generated net pricing realization of about 1 point while favorable foreign currency rates contributed approximately 0.5 point.

During the third quarter, adjusted gross margin increased 290 basis points, driven by favorable supply chain efficiencies including continued higher productivity, payroll sales mix and lower levels of obsolescence. Input costs were about flat in the quarter and favorable versus our previous estimate as a result of certain commodity strategies executed in Q3. We currently have good visibility into our cost structure for the remainder of the year and expect input costs to be higher in the fourth quarter versus prior year. Despite this increase, year-over-year adjusted gross margin is expected to be a bit higher in the fourth quarter, but below the rate achieved in the third quarter. Third quarter adjusted EBIT margin of 19.7% is up 10 basis points. This is driven primarily by higher adjusted gross margin,offset by higher advertising expense up about 46%, selling expenses as we continue to invest in consumer insights and building global capabilities and employee related expenses.

As Dave stated earlier, we continue to invest in our core brands and expect full year advertising expense to increase 50% to 60%, greater than our previous estimate of 45% to 50%. Similar to last year and as previously communicated, we're planning additional advertising in the fourth quarter and in both the US and other key markets to enable a strong start to 2011. We expect adjusted EBIT margins to expand for the full year, although it will be lower versus the fourth quarter of last year. And that's due to lower gross margin expansion, as well as business investments which Dave already described.

Now, let me provide an update on our international businesses. Overall, our reported sales outside of the US increased low double-digits. On a reported in constant currency basis, sales increased in our largest international markets while in Asia, we focused on preparing for the upcoming Chinese New Year. During the third quarter, strategic investments in brand building and go to market strategies were higher, including an advertising increase of 65% outside of North America. As a result, our local currency basis, operating income increased in Canada, but declined in the rest of our emerging market businesses. We are committed to investing in our international businesses, and we anticipate that these investments will generate meaningful brand awareness and some raw take over time.

Moving further down the P&L. For the quarter, interest expense is $22.3 million, consistent with the prior period. In 2010, we now expect interest expense to be down about 1% versus 2009. The tax rate for the third quarter was 35.1%, or 210 basis points less than the prior year, due to the impact of interim tax accounting and a favorable income among geographies. For the full year, we now expect the tax rate to be about 35% to 35.5%, slightly higher than our previous estimate of 35%. In the third quarter of 2010, weighted average of shares outstanding on a diluted basis were 230.5 million versus 229.6 million in 2009, leading to adjusted earnings per share diluted of $0.79 up 8.2% versus year ago.

Let me provide a quick recap of year-to-date results. Net sales increased 7.6%, adjusted gross margin was 43% year-to-date versus 38.3% last year. Gains were driven primarily by favorable supply chain efficiencies, including volume and greater levels of productivity. Favorable mix and lower obsolescence also contributed. Adjusted EBIT increased 23.5%, resulting in EBIT margin gain of 230 basis points to 18.3% from 16%. Advertising increased 54% on a year-to-date basis, and adjusted earnings per share diluted for the nine month period increased 26% to $1.94 per share.

Turning to the balance sheet and cash flow. At the end of the third quarter, net training capital is relatively in line with last year. Accounts receivable was up $38 million and remains extremely current and of high quality. We continuously monitor our accounts receivable aging and despite macroeconomic conditions, we do not -- we have not seen an impact on our customers' payment patterns to date. Inventory increased $35 million, driven partially by previously mentioned timing of the third quarter sales while accounts payable increased by $65 million. We do expect net training capital to improve in the fourth quarter as we cycle through the peak seasonal period of our business.

In terms of other specific cash flow items, capital additions, including software, were $49 million in the third quarter and $124 million year-to-date. These amounts included $20 million of project Next Century capital expenditures. For 2010, we are targeting total capital additions to be $190 million to $210 million range. This range includes base ongoing CapEx of $140 million to $160 million, plus project Next Century CapEx of approximately $50 million.

Depreciation amortization was $52 million in the period, including accelerated depreciation of approximately $6 million. Year-to-date, reported depreciation amortization was $146 million and included $7 million of accelerated depreciation related to the Next Century program. Therefore, adjusted operating depreciation amortization year-to-date was approximately $139 million. In 2010, were forecasting total operating depreciation and amortization of $175 million to $185 million while accelerated depreciation amortization related to project Next Century is expected to be $10 million to $15 million.

Dividends paid during the quarter were $71 million. We did not acquire any stock in the third quarter related to the outstanding repurchase program. There remains $100 million outstanding on the current authorization. Year-to-date, we -- approximately 133 million of our common shares have been repurchased to replace shares issued in conjunction with stock option exercises, and option replenishment is about current at quarter end. Cash on hand at the end of the third quarter was $245 million, up versus the year ago period and relatively in line with 2009 year end balance. As we exit the third quarter, we are well positioned to manage the capital leads of the business, as well as higher capital expenditure requirements at project Next Century.

Now, let me provide an update on project Next Century. I'm pleased to confirm that we have begun to work on west Hershey plan expansion. Excavation on the property has begun, and we expect to begin receiving manufacturing equipment during the third quarter of 2011. We also anticipate initial production line start up during the first quarter of 2011 with continued rollout in implementation throughout 2012.

The forecast for total pretax GAAP charges and non-recurrent project implementation, cost remains at $140 to $170 million. For 2010, total GAAP charges related to the program are expected to be $75 to $85 million. By 2014, we continue to expect annual savings of 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. During the quarter, we recorded net pretax charges of $4.5 million for project Next Century, consisting mostly of accelerated depreciation.

Now, let me summarize. We are pleased with our third quarter and year-to-date results. Our goal for the remainder of the year is to successfully launch new products, including Hershey's Drops and Reese's Minis and 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 50% to 60%. In addition, we expect to see some shift in 2011 seasonal orders from the fourth quarter of 2010 into the first quarter of 2011 due to the timing and refinement of shipments. As a result, we reaffirm our full year 2010 net sales outlook of about 7% versus 2009, including an approximate 1 point benefit of foreign currency exchange rates. We have good visibility into our cost structure for the remainder of 2010 and expect input costs to be higher in the fourth quarter.

Despite this increase, adjusted gross margin is expected to be a bit higher in the fourth quarter, but not at the rate achieved in Q3 and potentially subject to the volatility of dairy markets. Additionally, we do not expect LIFO inventory to be favorable as it was in Q4 of 2009. Given our strong business results, we will make additional fourth quarter strategic investments in both the US and international markets that we did not initially plan. These investments will benefit Hershey both in the short and long term.

Aside from the aforementioned increase in advertising plans, these include acceleration increase of Insights Driven Performance, additional selling and go to market strategies in both the US and international markets and higher sampling to support new products and distribution. Given our continued momentum, we have increased our full year adjusted earnings per share diluted outlook and expect to be in the $2.52 to $2.56 range, an increase of mid to high teens on a percentage basis versus 2009 and greater than our previously estimated range of $2.47 to $2.52.

As we look to 2011, we'll continue to focus on our core brands and leverage Hershey's scale at retail. Advertising expense is expected to increase in 2011, however, the year-over-year percentage will be lower than the previous two years. Our current expectation for 2011 is for net sales growth to be within the 3% to 5% long term target. While we anticipate higher input costs in 2011, productivity and cost savings initiatives are in place to help mitigate the impact.

Included in our productivity outlook is a portion of the additional $80 million to $100 million we identified at CAGNY. While we achieved more of these savings in the second half of 2010 than we initially estimate, primarily in cost of sales, the majority of these savings will still be attained in 2011 and 2012, although starting next year, some of these savings will also flow through the SM&A line. Therefore, while still early, given our current views regarding business investments and cost structure, we expect 2011 growth and adjusted earnings per share diluted to be within our long-term target of 6% to 8%. Let's now open it up for Q&A. Operator?

Ready for questions?

Yes, we are.

(Operator Instructions) Your first question comes from Jonathan Feeney, Janney Montgomery, your line is open.

Thank you very much. I appreciate it. The only one question I had is when you look at the guidance for next year, clearly it's been a period here of some pretty significant competitive share gain, it appears, and what are you hearing in -- are we seeing in that, 6 to 8 guidance a thought that maybe some competitive activity would accelerate from Wrigley Master Foods who seem to have been out of the market in a lot of places? Or what kind of competitive assumptions go into that guidance as you look forward to 2011? And to the extent that you can comment on anything different at the margin.

Yes, Jonathan, what I would say is the view of the category that we talked about, the category growth rate,continues to be within the longer term, this is a 3% to 4% growth category. Actually, on a year-to-date basis it is growing a little better than that 4%. So, we would start with the category growth assumption and then within that category growth assumption say we don't see anything that changes that longer-term growth algorithm for 2011, and we would expect to be competitive with respect to programming and share.

So, in the third quarter here we were flattish on share. We were still up on a share this year on a year-to-date basis, and we would expect that, the gives and the takes in the marketplace are such that you start with that 3% to 4% assumption and assume we're going to be competitive within the share gain, and that is kind of how you start -- that is how we start the algorithm. There was a lot of activity in the third quarter which we talked to you about in July that was around innovation from some of the competitors in gum and in chocolate, and that that happened in the third quarter. And despite that competitive activity and innovation, we still were able to basically hold onto our share in the third quarter.

Okay. Thank you.

You're welcome.

Your next question comes from Terry Bivens, JP Morgan, your line is now open.

Good morning, everyone.

Hi, Terry.

Good morning, Terry.

Hi. Just a couple of quick things and then a more general question. In Q4, do you expect kind of the inflow you've identified from the third quarter to roughly equate to the outflow you've talked about for Q1?

Yes, I think that's the way to think about it, Terry. I think that when we talked to you at the end of the second quarter call, we were still looking at some Valentine's and Easter shifting out of the fourth quarter into the first quarter of next year. That shift still happens, but it's now a lot set in the fourth quarter by a little bit of Halloween that moved out of September into October. So, I think what you're seeing is that those two things now offset each other in the fourth quarter number.

Okay. And Dave, we have a source that's occasionally right on C-stores, not always. So, we were looking at roughly around 6% growth in the C-store channel in during Q3. Is that close to what you guys saw?

Our growth was not quite that, Terry. We gained some share in the quarter. I think on a year-to-date basis we're still feeling the C-store is outperforming most of the other classes of the trade, but we didn't kind of see that kind of 6% number.

Okay. And then just more generally, and I guess this question always comes up, the cash flow, of course, looks very good here. I guess you guys do have a bond that expires this year and maybe a note next year, but could you just give us your general thoughts on allotment of cash flow here?

Yes, we -- we're obviously pleased with our cash flow, and we have cash on the balance sheet now, which wouldn't have been true last year where we were still on the commercial paper market. We actually do, in terms of our bond maturity, we do have a bond maturing next year, and that's in 2011. And so obviously, we're already thinking about that given that it's already moved from long-term to short-term position on the balance sheet.

Cash flow continues to be good. We -- I already mentioned we're about current on our share repurchase program with respect to replenishment of stock options. The question that always comes up, obviously is around buy-back, and that may be what you're insinuating. It is a discussion that we potentially have at the board, and we continue to have that, and we have other options in terms of cash use. So we're pleased with where we are from a cash flow perspective, working capital and otherwise and strong gross margin growth, and we'll take the appropriate action going forward.

Okay. Thank you very much.

Thanks, Terry.

Your next question Alexia Howard, Morgan Stanley -- I'm sorry --

Good morning, Alexia Howard from Bernstein here. I'd love to hear a little bit more about China and India. I know that you talked a little bit about it earlier on. Are you able to actually comment on what percentage of sales those two markets are expected to contribute in 2010? And what kind of lift are you getting on the quarterly numbers in terms of how much it's contributing to sales growth year on year? And maybe just more broadly or qualitatively, what lessons have you learned, and what do you see as the biggest opportunities in those two markets?

Yes, I think we have made some investments in -- outside of the US pretty broadly. Asia is a place where we are investing. We've invested in some go to market capabilities with respect to the way we're distributing and selling in both India and China. I think the international growth rates added maybe, lets call it a 100 basis points of the growth in the quarter to our growth rates. Again, that is across the board.

The third quarter in China particularly is a seasonally light quarter, because we ramp up for the Chinese New Year, which is in the early part of next year, and that ramp-up really starts in September on. So, there is not a lot of activity sales wise in China in the third quarter. We spent some time building out distribution, and we'll support our brands in China in the fourth quarter. When I talked about the incremental advertising spending that we're having in the fourth quarter, China is one of the places where we are certainly adding some sampling and some support behind our brands. And I think -- as you think about our plans for 2011 on a go-forward basis, we would expect that the non-US businesses would be added to the topline growth rate for next year as well.

Great. Thank you very much. I'll pass it on.

Your next question, Vincent Andrews, Morgan Stanley, your line is now open.

Thanks, and good morning, everyone. Just a couple of quick ones, and I apologize if you covered some of this. I had to hop off during your prepared remarks. But your initial outlook for 2011, you are going to have very tough comps against 2010 on the top line. So, what is it in particular that is giving you the confidence that you can still sustain what will be pretty robust top line growth next year? Is it the advertising levels of promotion or the work you're doing around some of the Mounds and Almond Joy type brands? What is it that is driving that?

A combination of things in the US in particular. Our innovation, we've launched Pieces earlier this year, and that has done very year. But remember, we have the Hershey's Drops and the Reese's Minis that will ship in December. And so that innovation becomes additive for us next year, and we have other innovation in our pipeline for 2011 that we feel very good about, and so that will be an additive component for us next year.

We are advertising and added some GRPs across a number of brands this year. We are in the fourth quarter increasing the GRP levels on Mounds and Almond Joy and York, and then we're adding some advertising support across Payday and Hershey's Syrup for the first time since 2001. So, that will add to, we think that the impression of the brand. And then we're also continuing to look at better sales force execution, and we're gaining some distribution points in the convenience class of trade as we brought on extra resources this year. So, we have a number of additive levers that we've invested in this year, and we'll start to test Insights Driven Performance which we are investing in here pretty significantly in the back half of the year. It will be more in a pilot form next year. We think it will help us as we get set up for the latter part of 2011 and into 2012.

Okay, you actually answered my other question, and I appreciate it. I'll pass it along.

Your next question comes from the line of Robert Moskow, Credit Suisse, your line is open.

Hi, just a couple of questions. You talk about the investments in the international business. Is there any chance you can give us just a little bit on how dilutive you think investment in international is going to be for the next couple of years? Campbell did this once. And then also, your market share gains are great this year but they are slowing, and yet you're dialing up advertising and you have a huge increase this year in advertising. Why wouldn't these gains be more sustainable, or do you just think the competition is having its -- having a go at it in the third quarter, and now you're going to launch your new products and that will kind of reverse it the other way again as we head into the next couple of quarters?

That's good questions, Rob. I'll tell -- let me just give you some perspective. On a year-to-date basis FDMxCW, so that's 80% of the universe, so, I'm talking year-to-date. Our takeaway is up 4.7%. So, that's very solid nine months through ten to take away. And if you look at the third quarter takeaway, we were up roughly 3.5%. So our FDMxCW was 3.5%, and we held share within that 3.5%. So, we still are seeing 3.5%, pick a number, 3.5%, 4.5% category, takeaway growth.

So, good numbers. Within the third quarter, we were sequentially much better in the drug class of trade for the first time in a number of quarters, we actually gained share in drug. We talked about 3.2% takeaway and a 60 basis-point gain in share in drugs. We were very pleased with sequential improvement in the mass retailers and in convenience, we held and gained a little bit of share as well in the quarter. Where we lost share, the one area which I talked about was, we lost 0.5 share point in food off of a 2.5% takeaway growth, and that's really where we lost in merchandising in the third quarter. We had talked about some new items that some of the other chocolate competitors were coming with in the third quarter. We lost some merchandising in food, and we also moved away from a promoted price point on one of our tax types that we didn't like particularly much in food that wasn't as profitable for us.

So, when I think about the business overall in the third quarter, still good category growth rates, although a little bit more of a share skirmish. And remember, our innovation comes in the fourth quarter in the form of Reese's Minis and Hershey's Drops. So, overall, category's still growing very well. We feel good about it. We're gaining -- we've got volume returned in this category, and I think the growth rates are pretty good. So, the advertising, it's working on the brands we're putting it on, and then we significant added some advertising spending.

We have been fortunate to be performing pretty well here in the last few years within the US business. And as that US business has performed well, we have taken advantage of the opportunity to go off and take the demand landscape learning that worked so well for us in the US, and we used that learning in Canada, Mexico and China, for example. And what we're now doing is accelerating our investment in go to market capabilities as well as in brand building in those markets. So, we've absorbed that type of ramp-up in spending in the international markets in our results in the last two years and when we talk about next year, we also see similar kinds of investments in international within the long-term 6% to 8% number that we gave you. So, we're able to grow our earnings base and still those international investments.

You don't want to give us a number on the dilution effect.

Well, just to be clear, I think in first remarks we said it, that operating income, the only market outside the US where we saw operating income growth was in Canada. We had operating income declines in the rest of the market. So, it is -- it's clearly had a dilutive effect for us, but we are, as I said, we have been able to absorb that in our core businesses in the US and particularly in Canada with the investment levels, and we see ourselves able to do that again next year and into the long term as we talk about that 6% to 8%.

Well, thank you very much.

Thank you.

Your next question comes from Ken Zaslow, BMO Capital Markets. Your line is now open.

Good morning, everyone.

Good morning.

Can you talk about the timing between advertising spending and the incremental sales growth? What I'm trying to get a sense of is when Hershey spends a dollar of advertising, how do you assess or how do you expect to get the incremental sales growth and just timing of how that works? Because you are spending a lot of advertising, and I would expect it to have an implication for 2011. So, if you could just bridge that a little bit, that would be helpful.

Yes, I would say, and I think we've mentioned it before, we take a pretty disciplined approach in terms of our ad spending, and so we keep a keen eye on how we think about ROI. Clearly, brands with scale are the ones that will give you the better ROI. So, you're right, there certainly is a lag effect in terms of advertising spend today and brand building in consumers' minds and purchases in the future.

So, as we think about fourth quarter spend in particular, we do expect and we have our own internal calculations of how that impacts the first couple of quarters of next year and certainly, there is a positive correlation. We look at those ROIs on a brand basis, on a monthly basis as well. So it is not something that we do at long intervals. We keep a constant review of what that ad spend is.

When Dave mentioned syrup and Payday, which we haven't had on air since 2009, certainly there was a lot of analytical and work done around that -- or 2001, rather, analytical work beyond that to determine whether those were the right two brands to put on air and at what levels. So, the only thing I would add to that, which is a different dynamic, is in international markets, ROIs certainly are lower, and that gets back to the scale comment I mentioned earlier. The larger the brand, the greater lift you're going to get, simply based on that scale. And so in the international markets it is more about long-term brand building but in the US, the immediate -- the payoffs are much more immediate and they normally, as we think of it, come in the next couple of quarters.

How many more brands, and I know you won't tell me which ones, but how many more brands do you have that have significant under investment similar like a Payday or the syrup. Are you coming to the end of that and then you're going to move to the internationals, or is there still some runway in term of the non-chocolate confectionary side?

We're -- you never say we're coming to the end. That sounds like a -- let me rephrase that. We've gotten good investment on the majority of the brands that we would expect to see good lifts. We have been able to accelerate some of them. We certainly were able to do Mounds, Almond Joy and York earlier this year based on the successes that we had back in 2009, and we're able to do Payday and Hershey's Syrup a little bit earlier than we would have expected. So, maybe another brand or so. And with respect to international, in the last few years we have already made those investments. I think Burt mentioned a number of about 65% or so increase in ad spending in the international markets outside of the US in the third quarter. So, that's already in our numbers. And so when you see the increases in advertising as we kind of roll through the year, what we are doing is really accelerating some of the strategic plan work that we're doing with respect to the demand landscape work that we've shared with you to get to some of the brands where we think we can activate them pretty smartly because they have unique characteristics. And in the international markets, I think we're applying some of the really good learnings from the US and doing it a little quicker than I think we would have expected we would have gotten to it.

I really appreciate it. Thanks.

Thank you.

Next question is from Judy Hong, Goldman Sachs. Your line is open.

Hello, good morning, guys, Jason English here. First, I just wanted to say that I think some degree of congratulations is in order for pretty solid results in this quarter and year-to-date, particularly in light of what we're seeing across Foodland. But now my questions do turn to the outlook and how you keep the momentum going. Inflation is obviously a concern. I think you guys are calling it out in your press release, mentioning it as a potential headwind for next year. As you lay out guidance here, what degree of inflation are you guys contemplating within that?

Yes, in terms of our cost basket, and you're right, we're certainly anticipating, just based on our internal estimates and what we -- the visibility that we have for next year already, we certainly expect that, commodities as an example will be ramping up next year in terms of cost. We have got an awful lot of productivity programs behind providing offset there. And in terms of gross margin, we don't expect to repeat the type of performance that we had this year in a more benign commodity environment. So we're continuously looking for ways to offset that inflation within the manufacturing space, but there is no doubt that inflation is a headwind next year compared to this year. We have it built into how we think about the top line and bottom line, and we still believe we have leverage in the P&L to be able to achieve within that 6 to 8. But the composition of next year's cost basket certainly more inflated than this year.

Thank you for that. Is it possible for you guys to quantify what you're thinking in terms of range? And you mentioned that you're also thinking about the impact on top line. Can I interpret that to mean that you're contemplating some pricing moves to help you mitigate this?

We're not going to comment on pricing at all. I think what Burt's comments were really around was the input cost in terms of the inflation, and our cost basket is, frankly, a bit different than some of the other folks in the food space. We're bigger buyers of sugar and cocoa and dairy than -- we're not in the grain complex nearly as much as others. So, I'm not sure our inflation assumptions would be translatable for you and for competitive reasons, we're not going to get into a blow by blow, commodity by commodity. We do expect that our basket will be higher overall, but we have very good productivities in place to offset some of that, and we think that that's how we're planning our business for 2011.

Very good. One more question and I'll pass it on. I think for the first half of the year you mentioned that your trade spend was running below initial expectations. Has that changed, and do you see a need to bring more trade spend to market?

The rate in the third quarter was about flat versus the prior year's rate. In the first half of the year we had been -- actually been a little bit favorable on a rate basis and when we had gotten in the second quarter call, I think we said -- we had said that that would likely abate as we got in the back half. And so the rate is roughly in line with what it was a year ago. And again, I think when you see, retailers will choose what price points they want to run, particularly the seasonal events, that so far what we've seen year-over-year on Halloween in the marketplace is the pricing is roughly equivalent on promotive basis as it was a year ago.

The back half is always a little bit more, if you want to call it intense, simply because it does have a higher seasonal component, but we're not seeing anything that's a lot different than what we anticipated.

Well, thanks a lot, guys.

Thank you.

Your next question comes from the line of Andrew Lazar, Barclays Capital. Your line is open.

Good morning, everyone.

Hi, Andrew.

Just a quick follow-up and a little bit to the one you just had. I guess some food companies, when they think about their long-term sort of top and bottom line growth algorithms, they'll say our attempt over time is to either offset inflation through pricing, such that we have our productivity to fund the marketing and whatnot to drive the top line. Or we attempt to offset inflation through a combination of pricing and cost saves or what have you. And I don't know, maybe it's -- I apologize if I just can't remember, do you -- have you gotten that granular around your long-term growth algorithm and ultimately, how you anticipate handling inflation over time?

We have not actually given out that level of specificity. And I think one of the reasons we're a little bit more cautious about giving that much specific detail is we're the only ones in the confection space who are giving certain public pronouncements and competitively, we would like to keep our, particularly our commodity strategies a little bit more closer to the vest. I think in principal, Andrew, what you're saying is absolutely right. Over time, you would like to offset and pass on the appropriate increases in your cost basket. We have been particularly aggressive, I think, within our supply chain, obviously with the global supply chain transformation project that we completed where we closed seven facilities and built a new one in Monterrey, Mexico. We have what we're calling project Next Century where we're working very hard to continue to improve the efficiencies of our plant here in Hershey, rebuilding a new facility we're going to invest a couple hundred million dollars here in our home market.

So, we look at those productivity programs as well as just better efficiency in the business by focusing on the core to have given us the flexibility to meet the issues within our cost basket as well our investment needs. But on a go-forward basis, I think in principle I would say we would like to be able to deal with the -- input pressures and eventually be able to pass those along to the consumers as appropriate. But I think the other thing that is somewhat unique about our category is it is so promotionally intensive and so much moves on merchandising, it is really less about list pricing and how consumers feel about promoted price points over time, and those are a little harder to move. They tend to move in bigger increments than simple list prices. So there is an algorithm for us that may be a little bit more difficult to implement because of the significant portion of our business which is seasonal and merchandised in that way. So, we have historically as a category tended to move in bigger increments on promotive prices than maybe you'd see in other categories. But we do over time expect that we'd like to pass on those kind of costs.

That's helpful, and I appreciate that. I do recall that in the last one that you took a while back, you did move the promoted price point, and the move in that price was much more dramatic, whatever it was, 20%, 25% kind of move.

20% and 25% is correct.

Okay, that's helpful. Thanks very much.

You're welcome.

Your next question comes from the line of Eric Katzman from Deutsche Bank, your line is now open.

Good morning, everybody.

Good morning, Eric.

Okay, a couple of questions, just keeping on that same theme, but not to beat a dead horse. The last time the industry or the category raised prices so aggressively there was a kind of, I would say, more elasticity than maybe was initially expected, and I think Dave, you suggested that the premium end of the category is still kind of flattish or not keeping up with the mass part of the business. And so does that kind of suggest to you that putting through a price increase would be pretty -- would be met by a fair amount of elasticity, given what you see from the consumer segments within confection?

Eric, let me just clarify my point. Premium and trade-up, when you look at it in aggregate is about -- roughly flat for the year. Those two segments are not contributing -- on a combined basis, are not really contributing to category growth. It really still is very much a mainstream story. I think when we did take our pricing action that we announced in August of '08 and implemented really in '09 and then spilled over a little bit into early 2010, we did see volumes return a little more quickly than we would have expected from our modeling.

So, we were very encouraged by that. What we all have to continue to monitor is consumer behavior and where consumers are today, and how they're thinking about value. One of the beautiful things about our category is it is an approachable luxury and/or indulgence at a time when consumers are looking for that. So, the category dynamics right now, as I said, we've got good growth in the category, it's a very volume oriented category, and people are playing the innovation approach right now in the category, and we feel very good about that.

So, we think the category growth rates are strong where they are. I don't want to talk very much about forward pricing. I think the -- one of the other factors is as you take a -- taking a look at pricing is what is happening around you in the entire rest of the basket/ And I think there seems to be some inflationary pressure, retailers are talking about, and it looks like some other folks are also, in other categories are going to need to do some things. So, that is also a big factor, is our prices in any category moving up by themselves, or are they moving up in context of the entire basket? So all of those things I think would impact the way the modeling would work for us. We clearly model it out constantly, and I think what I would say right now is we're pretty comfortable with where our business is and that we've got volume returning and beyond that, I don't think I'll comment any further on anything that would happen with the market.

Okay. Well, I appreciate those comments. Just moving to, I think it was Ken's question, but I think the last time I heard Hershey talk about getting more aggressive with Payday it was kind of towards the end of the growth story. I think you tried to position that as a sports kind of bar or something along those lines, and that didn't work. And so I guess I just point that out in that you do have the new Drops and bite-sized type stuff that seems to be working. Is the next move kind of an enrobed product which you don't really have in your, lets say, quiver? Because as I said before, I think the Drops and stuff is kind of like a bite-size M&M type product, and the one thing that you really haven't been successful at is putting out something that competes with Snickers or Milky Way or something along those lines.

I think the reference I think you make to positioning Payday as an energy bar, we had a product that we had that we called Payday Pro which had higher and more grams of protein in it. That's not the product we're talking about. What we are talking about here is supporting the Payday bar itself. We haven't had advertising on that on air since 2001. And I think Payday is uniquely positioned in the demand landscape work that we have in our portfolio that it doesn't really interact with much else we have in the portfolio. So, we think it can be pretty incremental for us.

We do think that the Minis and the Drops launches, the Hershey's Drops and the Reese's Minis launches will be good launches for us. We're excited about them, we will support them with advertising unique to those items. And we have other innovation that's planned for 2011 which we're not, at this point in time, going to reveal to you. But again, we are very anchored in the demand landscape in terms of what is incremental to the portfolio and where white space is in the category. And I think we'll share some more of that when we get into the early part of year, probably at CAGNY.

Okay, and if I could just ask one last one, and this is a little bit difficult to ask, but I'll go forward anyway. You moved and created a new facility in Monterrey, and all you hear out of that city is pretty tough conditions. Is that something to be concerned about? Like is that a facility that you use for the export market? Or does that come back in here? Or do you have the capacity utilization to meet demand if things don't get -- if things get worse there as opposed to better?

The facilities in Monterrey, Mexico, it is producing product for the US market. We have embarked, I think like many of the companies in the Fortune 500 and beyond, on a pretty robust enterprise risk management, or ERM program. Supply and sourcing is one of those things that is in that, so this is something that we continuously look at source and supply, not just in Monterrey, but throughout our network.

We experienced no issues in Monterrey with respect to our manufacturing facility, and we haven't experienced any issues bringing product across the border, et cetera. As a matter of fact, that project went very well for us. It achieved its milestones, the productivity that we got back from that back in '09 and closed out this year is very strong. So, we're pleased with how that has gone. It's no different than any other supply situation. You continue to monitor your inventory levels, but it is something that as part of an ERM program you look at, but we are pleased with where we are.

Okay. Thank you. I'll pass it on.

Your next question comes from the line of David Driscoll, Citi Investments, your line is open.

Great, thanks a lot. Good morning, everyone.

Hi, David.

Most of the questions have been asked. Just a couple of follow-ups. On commodity inflation for 2011, Bert, can you just comment on whether or not you feel good about your visibility into the cost structure for 2011 at this juncture?

Yes David, what we said toward the end of -- or at least what I tried to communicate toward the end of my prepared remarks there, were that there certainly is more commodity inflation. We haven't experienced much -- as much this year as we thought. In the third quarter we thought we would have some higher commodities. I mentioned that, and it was really kind of flat. We did that changes, starting in the fourth quarter it starts to move up, and we see some of that continuing. Certainly at this time of the year, we start to get some reasonable visibility in terms of next year. We're very focused on being able to say more about that later on.

And also very focused against the productivity programs of which right now, we mentioned the CAGNY programs, that starts to deliver even more next year. Not just on cost of goods line, but also below that. So, at the moment we feel pretty balanced despite the fact that we expect certainly commodity prices to be higher for next year. And then just to put it in perspective, the only comment that I made was that this year our gross margin, as we all know, has really been terrific. We don't expect to see that next year. But right now we're -- we have reasonable visibility, and we have good visibility, not just on the cost basket, but on the savings. So, we don't provide an inflation, and we will provide more color on that the next time we get together. But we're pretty pleased with where we are right now.

On the productivity savings, you have a number of different programs and frankly, I don't think you guys ever give us a summation of it. But when I do it, I think it's approximately about 3% of cost of sales for 2011. Is that about the right number when you add up all the different productivity programs you have going on?

Yes, we have a couple of things, as you mentioned, that are out there. And what we think of continuous improvement as a year in and year out program. It is not a special program, and that's intended to, I think it was referred to earlier, is intended to approximately offset our inflation. The program that we unveiled at CAGNY which focuses more on non-manufacturing productivity and cost savings to procurement is separate from that. And it's intended to be, at least in 2011 and 2012, 2X the normal productivity. So, if you think about our continuous improvement being an attempt to offset inflation, and we think we can do approximately 2X that, you would assume that 2011 and 2012 has a higher level of productivity. If you exclude obviously Next Century, which doesn't provide a whole lot of saves in 2011, those savings come really into 2012 and 2013.

That's very, very helpful. Last question is more Dave. Dave, when you talk about the international markets, there's -- I've always had the expectation that one of the things you could really do to enhance your growth there was to gain some distribution through some acquisitions. Can you comment at all on the visibility you have on the pipeline of deals that are out there? Some of the other companies like Treehouse and so forth, they really have some color. They don't comment on timing or where it is, because I know that is something that you want to keep close to the vest. But can you give us any general parameters? Is it reasonable for us to expect that you will be out there in the acquisition market trying to add on to those national franchises that you currently have?

You're right, I won't give you additional parameters (laughter). We've -- I think we've been pretty clear that Latin American and Asian markets are where we are focused. Obviously we have good cash flows. That's one of the ways we would look to redeploy those cash flows, and we're going to do a disciplined look on what's out there and beyond that, wouldn't comment. We continue to be very encouraged about the organic growth about our international businesses in those -- in markets around the world. And if you can find something that bolts on nd makes sense, we certainly are interested. But I wouldn't give you anything in terms of timing or any of those things because those things are always so opportunistic.

Great. Thank you so much.

Thanks, Dave.

Your next question comes from the line of David Palmer, UBS, your line is open.

Thanks. Hi, guys.

How are you?

I'm wondering how you're thinking about the impact to price per volume from innovation. Obviously, we have Drops and Minis coming, and you're going to be pushing on certain channels, packaging price points. In addition, I'm guessing there is going to be some promotion spending up front that might ease through 2011. So, any color that you can offer about how this might impact your mix in the coming quarters would be great. Thanks.

Yes, I think if you think about what we did when we did the Pieces launch, we have done a very good job. Our sales force executes very well in terms of getting those items to market. We had the Pieces and some of the newer items, but really, Pieces in the first quarter of this year really added almost two points of growth for us into the top line and that has been more like a point of growth from there on. And when you get to something like Minis and Drops, they'll build meaningfully volume as you build pipeline here in December and into the first quarter, and then they'll continue forward.

In terms of mix, those are -- the Reese's Minis and Hershey's Drops will be in both take home stand up bags as well as in king size formats on the front end. So I think from a mix standpoint, probably looks similar to what the rest of the portfolio would look like, although we are very excited about the ability to get some hand to mouth activity on our biggest brands, Hershey and Reese's, which we haven't had, so we hope that it will become a very good consumable item in convenience and front end to the stores. I think, as I said, in the third quarter, innovation was added for some other folks in the category who came with their bigger brands and did some innovation. Ours happens to come in the fourth quarter into the early part of next year.

Separately your net debt, it's dropping to less than one turn of EBITDA. The old Hershey, I think particularly after a nice move in the stock would show up with a big repurchase of a slug of trust shares, and that seems like a million years ago. But my gut is at this point, strategic investments, acquisitions are at the top of the menu. Any comments now that we're getting to these levels on net debt about how you're thinking about investments going forward?

Yes, I wouldn't give any more color than we've already given. I think Dave is right. M&A is certainly high on our list. It is opportunistic. We're fortunate to be in a balance sheet situation where we have those alternatives, and we're looking at all of them considering them going forward. So certainly, we want to put our balance sheet to work, and I really wouldn't comment more than that.

Thanks, guys.

Thank you.

Your next question comes from the line of [Eric Serrano], Wells Fargo Securities, your line is open.

Good morning.

Hi, Eric.

How are you?

Not bad. Most of my questions have been answered, but one area I wanted to follow up on was you commented that -- you commented on the sequential improvement in one of your large mass customers. To what do you attribute that improvement? Was it things going on with the customer that we're largely familiar with, or was it something Hershey-specific? And did you actually pick up any incremental display space with that customer?

I think I probably would rather not comment specifically on anything other than the -- as we've gotten into the September/October time frame in most places, and we get into back-to-school Halloween, we have done a very nice job of executing and getting into that season with good merchandising programs. And I think it is across the board with the exception of I think in the food class in trade where we didn't get that kind of merchandising in the quarter, but we got it everywhere else. So, I think it is really a factor of back to school, Halloween and some decent traffic. And I would leave it at that.

Okay. And just to follow up on, Bert, your comments on gross margin for 2011, I was a little bit unclear when you said something to the effect of it wouldn't be quite as strong as 2010. Were you commenting that gross margin would be directionally down or that we just wouldn't see the massive gross margin improvement that we saw in 2010?

It is the latter. We really haven't commented on the direction for gross margin, but it's certainly -- what I was trying to imply that it wouldn't be, that you wouldn't expect the type of increases and gains that we've had this year. We'll provide more color as we get little bit further down in the year in terms of how we see that gross margin.

Okay, the rest of my questions have been answered. I'll pass it on. Thanks.

Thanks, Eric.

Your next question comes from the line of Bryan Spillane, Bank of America. Your line is open.

Hi, good morning, guys.

Good morning.

Just a question on phasing for next year. I just want to make sure I've got -- a few of the things are that Easter will be later. So, is that -- if you can comment on how that will impact things, just having the Easter season being longer, is that maybe a positive lift for sales in the second quarter? And then also in terms of just as raw material increases go through next year, is there anything we should think about in terms of timing? Is it any more or less of an impact at a certain time of the year? And then also in terms of the way that you're expecting to manage the flow of cost savings, again, is there anything there that we should think about on a year-on-year basis?

The comment on Easter, most of the Easter products, the majority, for all intents and purposes, shifts in the first quarter. It is a longer Easter season and therefore, you would expect us to probably have more Easter shipments than we would. But then as we talked about Valentines and holidays moving out of the -- Valentines and Easter moving out of the fourth quarter into the first quarter, one of the reasons is because Easter is little bit later. I think what you would expect, though, is to see some -- it is really an anomaly and aberration in takeaway. Because as Easter gets later into April, when you look at first quarter data and first quarter market share, the category might look a little slower than normal because the stuff fills later. Easter is a large component of what happens in that March/April timeframe. So, I think market share and takeaway might be more effected by the later Easter, but I think shipments will still fall within the first quarter.

With respect to productivity, if you will remember, we got the last slug of global supply chain transformation productivity in the first quarter of this year, so -- and then we don't see the Next Century productivity until the fourth quarter of 2011, so those are the two big buckets. Other than that, we are on a standard cost system, so essentially the cost increases that Bert talked about would get spread largely across the year based on -- as volume flows out. So, you kind of come up with an average projected price for yourself on a standard basis, and it just flows throughout the year. So, for the most part, most of that commodity gets -- the commodity increases Bert talked about would just get absorbed across the year with a couple of caveats around the supply chain stuff.

Okay. And then just anything else notable in terms of phasing that we should think about in terms of the quarters?

No, I don't think so. At this point, I think we'll give a little more clarity on that as we kind of close out this year and get into next year in January.

Okay, great. Thanks, guys.

Take care.

There are no further questions at the present time, sir.

All right. Thank you for joining us for today's conference call. Matt Miller and myself will be available for any follow-up questions that any of you may have. Thank you very much.

Thank you.

This concludes today's conference call. You may now disconnect. Thank you.