好時 (HSY) 2015 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Hershey Company's second quarter 2015 results conference call.

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

(Operator Instructions)

Please note, this call may be recorded.

Thank you.

Mr. Mark Pogharian, you may begin your conference.

Thank you, Steve.

Good morning, ladies and gentlemen.

Welcome to the Hershey Company's second quarter 2015 conference call.

J.P. Bilbrey, Chairman, President and CEO and Patricia Little, Senior Vice President and CFO will provide you with an overview of results, which will then be followed by a Q&A session.

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 2014 filed with the SEC.

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

Included in the press release is a consolidated balance sheet and 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.

The Company uses these non-GAAP measures as key metrics for evaluating the 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.

As a result, we will discuss 2015 second quarter results excluding net pretax charges of $282 million or $1.23 per share diluted, primarily related to a non-cash impairment charge and costs associated with business productivity initiative announced in June.

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

With that out of the way, let me turn the call over to J.P. Bilbrey.

Thanks, Mark.

I want to thank all of you on the phone line and webcast for joining us today.

In our long-term strategic planning cycle, we know there's always the potential for volatility, particularly in international markets.

The combination of macro, economic influences and competitive activity in our core China chocolate business, along with disappointing Golden Monkey performance have resulted in negative short-term results in this part of the business.

I'll talk more about this in a few minutes.

Importantly, we're committed to our long-term strategic plan, and believe the balance and performance of the strong North America business and attractive growth opportunities in key international markets should enable us to deliver solid growth over the long-term.

Our scale and profitable North America business gives us flexibility in the near-term, while maintaining focus on building our brands in China, Mexico, Brazil, and India.

The investments we've made in North America over the last few years are paying dividends.

Our focus on consumer capabilities and customer insights provides us with the framework to build our brands with retailers.

We're also working with innovative firms like Palantir that are building our predictive analytical capabilities in the areas of consumer insights and enterprise connectivity.

The implementation of the US price increase we announced last year is on track, and the related CMG volume elasticity is in line with our modeling.

This was partially offset by increased levels of promotions and discounts related to the spreads and baking chips businesses.

Our overall year-to-date US retail take-away of 3.1% is in line with our expectations; however, this was impacted by a shorter Easter season.

Looking at the everyday base, CMG business retail take-away was up mid single-digits in the second quarter.

This is a solid indicator that our advertising or pull efforts is working.

Additionally, our continued focus on core brands has resulted in market share growth across the Hersheys, Kit Kat, Brookside, Kisses, and Ice Breakers franchises.

We continue to optimize and refine our North America marketing model and execution capabilities.

We're focused on advertising and marketing returns, and are optimizing our spending across the portfolio.

For example, we're increasing our investment in the highest return chocolate business, and increasing digital within our media mix.

We're also leveraging our precision marketing capability to accelerate growth by executing in-store programming against consumer and geographic preferences by store.

Where we're implementing these plans, those retailers are outperforming the market.

Nielsen's second quarter measures do not encompass the entire Easter season in both the year-ago and current periods, therefore, my remarks will refer to year-to-date marketplace performance for the 28 weeks ended July 11.

Year-to-date, CMG, that's candy, mint and gum category growth in the xAOC+

C channels was up plus 2.7%.

The Hershey CMG retail take-away for the year-to-date period through July 11, 2015 in channels that account for about 90% of our US retail business was up 3.1%.

Looking past the Easter time frame, as expected our retail take-away accelerated, and is up 4.8% for the eight weeks ending July 11.

Our overall market share increased to 31.3%, an increase of 0.1 points.

Performance by segment is tracking as expected with share gains in chocolate, mint and gum.

We're pleased with our chocolate performance, where our year-to-date market share is up 0.3 points.

This was partially offset by non-chocolate candy performance where we lost market share as anticipated, as we lap prior year Jolly Rancher line extensions, and last year's launch of Lancaster.

We're also making progress within snacks.

Brookside bars are now available, with initial demand and velocity to be on par with the category leaders.

This launch, as well as Snack Bites and Snack Mix products, will expand our confection equities to source volume across the broader snacking space.

Reese's Spreads is on track, as this flavor profile is differentiated versus the other chocolate spreads within the category.

However, the overall jar segment of the chocolate spread category has slowed with household penetration flattish.

The instant consumable segment of the spreads category is growing, although it's become more competitive.

The Krave business and integration is on track versus our plans.

Krave is growing faster than all major competitors, driven by distribution and velocity gains.

Items per store and merchandising is growing, and net sales should nearly double this year.

Outside of the US, in our international markets beyond China, business is relatively on track with our plans.

In Mexico, net sales in local currency are up mid single-digits on a percentage basis versus last year, and in line with retail take-away.

As expected, the category in Hershey continued to improve, as we lap the VAT tax that was instituted last year.

In Brazil, net sales in local currency declined mid single-digits on a percentage basis versus last year, due to the timing of Easter and last year's Reese's launch.

But despite the tough macroeconomic environment year-to-date, the chocolate category growth in Brazil has been resilient, and is up high single-digits on a percentage basis versus last year.

Our market share in Brazil is up 0.3 points, with Hershey's and Reese's continuing to gain traction.

Now let me address the challenges that we're facing in China.

Our chocolate performance this year has been impacted by macroeconomic challenges that we believe impacted shopping behavior.

Recall, we gained market share in the first quarter, but our growth was lower than the historical performance and our own expectations.

And in the second quarter, while category growth returned to low double-digits, competitive activity increased as manufacturers responded to poor Chinese New Year sell-through.

This resulted in higher levels of increased trade promotion allowance and discounts that impacted net sales and profitability.

June year-to-date chocolate category growth in China was nearly 6%.

Hershey year-to-date China chocolate retail take-away was 4.3%, with market share off 1/10 of a point.

We believe the category will continue to increase at the low double-digit rate we saw in the second quarter, putting it on track to be up 8% to 10% for the full year.

Some of the initial work we've done to help ensure that we execute against our plan in China and get back to our winning ways, includes the broader roll-out of Brookside chocolates, distribution into smaller format stores, and continued focus and acceleration of our e-commerce business.

Our e-commerce business, while small is up 60% this year.

We're partnering with key third-party online retailers like Tmall, Jingdong and [Yao Din], and learning a lot about digital consumers in China that will help us going forward.

China is a priority market for us, and we'll be focused on executing against our core brand-building business model.

For 120 years, our Company has persevered and prospered with great people, purpose, and brands, and we believe this model will work in China as we look to gain share in this evolving country and category.

As it relates to Shanghai Golden Monkey, I'd like to address some of the factors leading to the estimated impairment charge that we announced in this morning's press release.

As we've indicated previously, we acquired the Golden Monkey business to broaden our footprint in China, by leveraging both the sales force and the regional and local distributor network in order to diversify Hershey's chocolate growth, which has historically been leveraged to Tier 1 hypermarkets.

Results have been disappointing.

We initially thought this was primarily due to macroeconomic headwinds in China.

As the integration has progressed and the situation on the ground evolved, we've come to understand that there are significant business issues that we need to address in order to achieve our goals.

Accounts receivable collection has remained challenging, and sales continued to slow in the second quarter.

Our assessment of the distributor network has made it clear that the network is not as stable as we believed, and therefore the related retail customer reach is not as broad as we believed it to be.

As a result, the sales forecast for the business in 2015, around $90 million is less than our initial expectations of at least $200 million.

This disappointing performance is impacting profitability.

Despite these near-term results, we remain committed to the long-term success of this acquisition as well as the China market.

We're taking steps to build a strong foundation for future success, including the appointment of a new Chairman and General Manager for Golden Monkey, with solid China consumer packaged goods experience.

We're also looking at the cost structure and different integration strategies that are intended to get the business back on track as quickly as possible.

We'll continue to assess and address these issues and their impact on the value of the business, as we work towards acquiring the remaining 20% of the business which we now anticipate will occur in the fourth quarter of 2015.

The timing and terms of the second closing will be informed by the results of our ongoing assessment.

We estimate that our international and other segment net sales will be about $1 billion this year, with a chocolate share of nearly 10% in China, 14% in Mexico, and 5% in Brazil.

We like the future growth outlook and prospects in these markets which are an integral part of our international profile.

Now to wrap up.

Core brand merchandising, programming and innovation accelerates over the remainder of the year.

With the exception of China, there's no change to our advertising and marketing methodology.

In these same markets, we continue to refine our plans and we expect North America advertising and related consumer marketing expense to increase at a rate about 2 times greater than the organic net sales growth rate, and it's generating results.

Patricia will provide you with all the details related to the full year outlook, but excluding China chocolate, M&A, and unfavorable FX, net sales are expected to be up around 3.5% to 4%.

We feel confident in our North America business plans where we generate the majority of the Company's sales and earnings.

The situation continues to evolve in China, and our outlook reflects all the inputs that are available to us today.

While further volatility could occur in this market, we wouldn't expect it to have a material impact on our cash flow and strong balance sheet.

Our profitable and on track North America business more than offsets the expected dilution from acquisitions and divestitures, primarily Golden Monkey of about $0.20 per share, which we expect will result in 2015 full year adjusted earnings per share diluted growth of 3% to 5%.

Let me end by saying that despite these challenges, I am optimistic about our future.

We're focused and know what we need to do to succeed.

We're building strong plans that will put us in a position to win wherever we compete.

I am very pleased that we continue to work as a focused team across the entire Company.

We have experienced leaders in place who have strong records of success and are all focused on increasing value for our shareholders.

Now let me turn it over to Patricia, who will provide some additional detail on our financial results.

Thank you, J.P. Good morning to everyone on the phone and on the webcast.

Second quarter net sales of $1.58 billion were in line with our revised guidance, and generated adjusted earnings per share diluted of $0.78, an increase of 2.6% versus last year.

Excluding the negative impact from foreign currency exchange rates of 1.3 points, net sales increased 1.3% versus the year-ago period.

Pricing and net acquisitions and divestitures were a 5.8 percentage point and 1.4 percentage point benefit, partially offset by 3.6 points of volume elasticity related to the previously mentioned price increase and lower sales in China.

Promotional spending, driven by China direct trade and returns, discounts and allowances, was a 2.3 percentage point headwind.

As J.P. stated, North America continues to perform well.

As is typical, the second quarters is our smallest quarter as it relates to overall net sales growth, given the launch and timing of new products and seasonal growth associated with Halloween and holiday.

North America net sales increased by 1.8% versus last year.

Excluding the 60 basis point impact of unfavorable foreign exchange rates in Canada, net sales increased 2.4%.

North America net sales were slightly better than expectations, primarily due to solid US CMG performance that was partially offset by snacks and grocery softness, primarily due to increased spreads and baking chips competitive activity.

Net price realization was 5.5 point benefit and was offset by volume of 3.6 percentage points due to snacks and grocery sales that were less than anticipated, and elasticity related to the pricing action that was in line with estimates.

On a net basis, the Allan Candy Company and Krave acquisitions, as well as the Mauna Loa divestiture was a 50 basis point benefit.

Turning now to margins, adjusted gross margins increased 130 basis points in the second quarter, driven by net price realization and supply chain productivity and cost savings initiatives, partially offset by obsolescence, unfavorable sales mix, and lower volumes.

For the full year, we continue to expect that gross margin will increase 135 to 145 basis points, driven by price realization.

Operating profit in the second quarter increased 3.3% versus last year, resulting in operating profit margins of 18.3%.

The increase was driven by gross margin gains, and a decrease in advertising and related consumer marketing expense of about 3%, primarily in China.

As expected, North America operating profit increased double-digits on a percentage basis, versus last year and was ahead of plan.

This was partially offset by international performance, again, primarily China.

Excluding the acquisitions and divestitures, SM&A expenses, excluding advertising and related consumer marketing was about the same as the year-ago period.

Now let me provide a brief update on our international business.

Total international and other segment net sales for the second quarter declined 12.1% versus last year.

Unfavorable foreign currency exchange rates were a 6 point headwind, and the Shanghai Golden Monkey acquisition was an 8 point benefit.

The international and other segment core businesses was off about 14 points, due primarily to China chocolate business performance where sales declined $35 million.

We believe China chocolate category performance was impacted by macroeconomic challenges and trends that are affecting consumer behavior, lower trips in Tier 1 hypermarkets, increased competitive activity, and accelerated momentum of e-commerce and online purchases.

As J.P. stated, over the remainder of the year, we're focused on the broader roll-out of Brookside chocolates, distribution into smaller format stores, and continued focus and acceleration of our e-commerce business.

None of us are happy with the developments around the Golden Monkey acquisition and integration.

Our latest outlook for the business is obviously different than the acquisition model.

Our initial estimated non-cash impairment charge of about $250 million reflects the write-down of the goodwill.

There's a lot of in-country analysis and field work going on to assess the potential of the business, and the value of the sales and distributor network.

Once this work is complete, we'll have a final amount related to the impairment charge.

We estimate full year Golden Monkey net sales of about $90 million, but this is subject to change based on the ongoing work mentioned previously.

On a constant currency basis, net sales in Mexico, Brazil and India were relatively in line with our expectations.

Given the macroeconomic and competitive environment in Mexico and Brazil, we're pleased with our performance.

Looking at year to date, because of Easter timing, local currency sales in Mexico and Brazil are up about 10% and 7%, respectively.

Plans are in place that should result in similar net sales increases over the remainder of the year.

In India, Q2 local currency sales were off about 2%.

The brands that we are investing in, Jolly Rancher, Soffit and JUMPIN and are up double-digits.

This was offset by the legacy low margin hard candy business which we previously indicated we would rationalize.

Therefore, we expect total international and other segment net sales including foreign currency headwinds and net contribution from M&A to decline mid single-digits for the full year.

Moving down the P&L, second quarter interest expense of $18.9 million declined $2.4 million versus last year.

For the full year, we continue to expect interest expense to be in the $75 million to $80 million range.

The adjusted tax rate for the second quarter was 35.3%, relatively in line with our estimates.

Last quarter, we stated that the full year adjusted net tax rate would be slightly lower than a year ago.

Driven by US government investment tax credits, we expect the tax rate to be about 30% in the second half of the year and around 32.5% for the full year.

However, there will be a corresponding offset or expense related to the write-down of the investment tax credit within the other income expense line item.

Hence, the net effect of the full year net income of the tax credits is only about $5 million.

For the second quarter of 2015, weighted average shares outstanding on a diluted basis were approximately 221 million shares, leading to an adjusted earnings per share diluted of $0.78 or an increase of 2.6% versus a year ago.

Let me now provide a quick recap of year to date adjusted results.

Net sales increased 1.9% in the first half.

Excluding the negative impact from foreign currency exchange rates, net sales increased 3.1% versus the year-ago period.

Operating profit decreased 2% resulting in an operating profit margin of 19.4%.

Year-to-date adjusted gross margin was 46.6%, versus 46% last year, or 60 basis points higher as a result of net price realization gains, and supply chain productivity and cost savings initiatives, partially offset by higher input costs and obsolescence.

Adjusted earnings per share diluted in the first half decreased about 1.6% to $1.87 per share.

Turning now to the balance sheet and cash flow.

At the end of the second quarter, net trading capital increased versus last year's second quarter by $80 million.

Accounts receivable were higher by $20 million, and remain extremely current.

Inventory was higher by $19 million and accounts payable declined by $41 million.

Total capital additions including software were $90 million in the second quarter.

For the year, we continue to expect total capital expenditures to be about $375 million to $400 million, including the capital related to the Johor Malaysia project of about $110 million.

During the second quarter, depreciation and amortization was $60 million, in line with our estimates.

Dividends paid were $115 million.

Earlier today, we announced a dividend increase of 9%.

We have strong North American marketplace position, and remain confident about the long-term growth potential of our business.

In the second quarter, no shares have been purchased against the $250 million authorization approved in February of 2015.

In the second quarter, the Company repurchased $9 million of common shares, or $143 million year-to-date to replace shares issued in connection with the exercise of stock options.

Cash and short-term investments at the end of the second quarter were $402 million.

This is lower than a year ago, primarily due to the Krave and Golden Monkey acquisitions.

The Company continues to generate substantial free cash flow and has a strong balance sheet.

It is well-positioned to fund our working capital needs, capital expenditure requirements, and acquisitions.

As J.P. summarized, over the remainder of the year net sales will be driven by strong Halloween and holiday seasonal programming, and the continued roll-out of new products in North America.

In addition, we have made adjustments to the China business strategy to address the changing environment.

In North America, advertising and related consumer marketing is expected to increase about 2 times the organic net sales growth rate.

These investments will enable us to build on our North America momentum, positioning us to deliver on our objectives.

As a result, the Company estimates full year net sales will increase about 1.5% to 2.5%, including a net contribution from acquisition and divestitures of about 1 point, and the unfavorable impact of foreign currency exchange rates of about 1.5 points.

Excluding unfavorable foreign currency exchange rates, full year net sales are expected to increase about 3% to 4%.

We continue to have a significant focus on gross margin, and expect solid North America price realization and productivity and cost savings to result in 2015 gross margin expansion of 135 to 145 basis points.

Combined with the $10 million to $15 million in savings from the productivity initiatives announced in June, we expect adjusted earnings per share diluted to be in the $4.10 to $4.18 range, an increase of 3% to 5% versus last year.

This includes dilution from acquisition and divestitures of about $0.20 per share.

Thank you for your time this morning.

J.P., Mark and I will now take any questions you may have.

(Operator Instructions)

Please note, this may be recorded.

Our first question is from Matthew Grainger from Morgan Stanley.

Your line is open.

Good morning, Matt.

Good morning, Matthew.

Thanks.

J.P., I just wanted to ask two questions, which I guess point a little bit toward sort of setting our expectations for the next 12 to 18 months.

Just firstly, on the international and other business.

You faced some structural issues in the category, but obviously a fair number of temporary headwinds as well.

Just as we're thinking about your expectations for the margin profile of that segment, is there any guidance you can give us just to sort of help set our bearings for where things could correct to in 2016, once promotions subsides, once all the inventory absorption is behind you?

Well, specifically on that, I think I would make two comments.

The first comment is we're always gross margin focused, and we're always very aware of, how can we ensure that the activities we have outside the US are directionally constructive for us from a gross margin standpoint, as we continue to build our manufacturing footprint around the world.

We continue, I think to head in a positive direction there.

In terms of investment, in structure, we want to make sure that we continue to pace ourselves to right-size for what we see is the opportunities.

As you know, we currently have this project in place where we're looking at the structure of the organization, so we'll be very mindful of that.

And then as we specifically look at a market like China, and we think about investment in the second half, we want to make sure that the profile that we have in terms of DMEs, et cetera, is appropriate to what we see as the opportunities, and where we continue to expand our brand.

So we're going to be working on building our core distribution.

We want to continue to deepen our distribution coverage.

But at the same time, based on that pace, will also dictate how we activate our brands from a DME standpoint, et cetera.

So I think those are some things that you'll continue to see.

Okay.

Thanks, J.P.

Yes, thanks.

And then just with respect to share repurchases, Patricia, you talked about the fact that you've done relatively little this year, other than offsetting the options dilution.

But as a result of working through some of the issues that you've been facing and the impact on the stock, is your thinking regarding the opportunity to utilize the share repurchase authorization shifting at all?

What's the argument against increasing leverage a bit, and becoming a bit more active on the buyback?

Yes, so I would point out that long-term we really haven't shifted our point of view.

I mean, our first goal is to invest in the business, both organically and through M&A.

Then we're going to look to the dividend and then share repurchase.

But I think your point, I think it's a good one, and it's one of the things that we're looking hard at in this space.

So basically in the second quarter, we're very focused on China, making sure that we had good line of sight on that, and that we really could see our way forward on that.

But it's certainly, it's something that's on our radar screen, and I'd say watch this space.

Okay.

Thank you both.

Our next question is from Bryan Spillane from Bank of America.

Good morning, Bryan.

Good morning, everyone.

J.P., my question's about your long-term growth objectives.

And I guess, when you set them originally, there was better growth, especially in the international markets you were targeting, so the macro was better.

And since then, so the growth has slowed, and also frankly you've made an acquisition which isn't going to turn out to grow as fast as you thought.

And you made that acquisition, with the assumption of it, it'd help you achieve your growth objectives.

So I guess my question is, a, why not -- are you considering, and why shouldn't the long-term growth objectives come down?

And second, if they're not, what's going to be better to help you get there?

Because the goodwill write-down in of itself suggests Golden won't deliver as much growth as you thought, and also it seems like the macro's slower.

So if you could just kind of square those for us, that'd be helpful Thanks.

It's probably too early to talk about some of the long-term guidance, as we continue to look at a number of the forces and factors that we're dealing with.

At the same time, we continue to be very positive on a number of pieces of our business.

Certainly, we feel like North America is firming and heading in the right direction.

We want to continue to invest there.

And our other international markets sort of ex-China, things are about where we thought they would be.

Obviously FX is a headwind that is beyond our ability to predict perfectly.

And so, before we add specificity, I would say to how we want to think about the long-term, we really need to get our hands around some of these shorter term issues.

But in terms of our business model, the strategies that we have, we're still very committed to that.

And I guess, one of the things I would say, is when you look at a focused strategy like we have in our international businesses around some very attractive core markets, we don't have a legacy of businesses in every corner of the earth.

We get the significant advantage of those markets when they're doing really well, and we feel it when there could be some bumps along the way, but we still think it's the right approach.

We're still very early in building our brands.

And so, I continue to be really optimistic about the long-term forecast, and usually we talk about that in the fall, and we'll add specificity at that time.

But fair to say that's part of the process, as you're going through your planning process for next year, in your evaluation phase, it's something you are evaluating?

Yes, absolutely.

I think it's important to remember that North America's probably growing in a 3% to 4% range.

That's really healthy.

We feel good about our innovation pipeline.

So as we talk about our growth algorithm, that is still in place.

We continue to grow market share.

So let us get back to you with the specificity in the fall, and just assume that we want to have the best sense of how we see the business coming out of this year.

Okay.

Thank you.

Okay, thank you.

Our next question is from Ken Goldman from JPMorgan.

Operator, do we have another question?

Yes, our next question is from Ken Goldman.

Good morning, Ken.

Good morning, everyone.

So two questions.

This was the second biggest 2Q gross margin in Company history, right, despite higher inputs.

Your gross margins are going up at a time, when many food companies are heading the other way.

And if you have cocoa and milk, dropping next year, which is possible, and you keep getting productivity, you're going to see another gross margin jump again.

So I just wanted to pick your brain a little bit, not to criticize, actually, because it's obviously a great trend, but how sustainable is that?

Because I know the chocolate category has very little private label, but the history of food, right, is when gross margins get too high, eventually value-oriented competitors are going to sniff out an opportunity here.

So I'm just curious, how do you balance that between the goal of taking margin and growing it, and making sure that you're not creating a price umbrella to create or attract competition?

Well, I think a couple of things that I would just point to, is we always talk about being gross margin focused, but we also at the same time don't really set for ourselves a specific level of gross margin that we have to be at.

And if you look at the scale that we have in North America, and the value of high quality chocolate that's available in North America, it's the best cost per pound of chocolate really anywhere in the world, across the major manufacturers.

And I think that's one of the things that the value that the category offers, has really been one of the things that's insulated it from significant owned label or private label entry points.

So that's really the biggest thing that's probably kept it there.

I think another thing that we're thinking a little bit differently about, Ken, that maybe from some of the things we've said in the past.

While we still have the majority of our portfolio, which is both a good value and really mass-position, we also are really spending a lot of time thinking about the premium segment as well.

And so, we're really thinking about it a little bit more broadly, in terms of total available share across the category.

So I think that's another way that we look at within our core business, expanding our footprint.

That's helpful.

Shifting quickly.

One of the reasons Golden Monkey was bought was for the distribution, right, and the ability of I guess, Hershey to flow its legacy product into some new regions or channels.

Sure.

I realize Golden Monkey itself, has been disappointing, but has that other element of its appeal, right, that opening of new paths for Kisses et cetera, been I guess, impaired in any meaningful way?

I think the strategy and intent we have with Golden is still intact.

I think what we're really looking at, is understanding the right-sizing and some of the business model practices that we have on a global basis, and how do we integrate the broadest spectrum of distributors into that?

So I think in terms of, if you look at that business on a weighted basis, and do we still have value within some of those distributors?

The fact of the matter is yes, and the strategy is right.

At the same time, as you can imagine, as you take a significant number of distributors, and you try to align them into a new business model, there's things that you've got to make changes.

And we're just -- we're addressing that quite transparently, upfront.

We want to get moving ahead with building the business.

So all the reasons that drew us to that business and being able to expand our footprint in China still are there.

We just have to get all the business practices aligned with what we believe is appropriate, and what's required of us as a US corporation.

Thanks, and congrats on the new headquarters too.

Thank you.

Our next question is from Robert Moskow from Credit Suisse.

Your line is open.

Good morning.

Hi.

I was just looking at the forecast for, what the implication is for what North America has to do in the back half.

And so, if you have -- I think you said international sales will probably come in around $1 billion for the year.

And so, it's pretty easy to paint that out for international.

I'm getting something along the lines of like 3.5% top line growth for North America then, and that would be an acceleration from the first half.

And I just want to understand if I'm getting the numbers right, and whether you're expecting the business to be better in the second half?

Hey, Rob, it's Mark.

I know going back to -- even the January and the April calls, we've been saying we would expect North America organic sales to be up 3% to 3.5%.

And we're certainly tracking towards that today, and the retail take-away is in line with that.

I think through the first half of the year, we're pretty close to actually 3%.

And you're right, that it is greater than that in the second half, and I know there are a number of new products in season that J.P. or Michele can address.

But I think you're thinking about it the right way.

Let me -- Michele Buck, who as you guys all know, is the President of our North America business, is here with us this morning.

So why don't I ask her to give us a little bit of perspective on the business in North America?

Okay.

Hey, hello, good morning, guys.

Let me talk a little bit about North America overall, and then I'll hit some of the highlights of some of the great programming that we have coming in the back half, so that you can get a little bit more color underneath what's going on there.

As we look at the year, certainly our core brands are doing really well, and a healthy core is a key foundation to our business.

We believe our advertising is working.

We're investing as you know this year incrementally behind that, to really support the pricing conversion.

Our advertising appears to be working.

We have shifted some of our spend to digital.

We think that's a really smart move, and while we don't have all of the robust analytics we have on base advertising, it appears to be working quite well.

We have a new campaign on Hershey that appears to be resonating really well with millennials and driving some nice growth there.

As we came into the year, we said a lot of the year would be dependent on us having successful execution of the pricing, and the price conversion is on track, so we feel great about that.

As I look at innovation, and I'll speak a little bit to the back half of the year, there's a couple factors that give us confidence in the back half.

And I'd say that's innovation, continued momentum on the core, and strong visibility to our seasonal sell-ins.

Both Halloween and holiday, we have very strong sell-ins.

We have the visibility to what the customers are going to buy, so we know what those numbers look like, so feel great about that.

And as we look at our innovation, as you'll recall we launched in Q2 Hershey Caramels, Ice Breakers Cool Blast, so they're really just hitting the marketplace, and the results to date have been positive.

Cool Blasts, our trial and velocities are exceeding our expectations.

And the distribution was a little bit slower than we anticipated, so we have more to come in the back half.

So that should accelerate.

Brookside Snack bars is just launching now, and again, the velocities in market look quite strong, but all the benefit of that volume will come in the back half.

We have Kisses Deluxe that hits in Q4, Snack Bites and Snack Mix launching now.

The acquisitions, especially Krave, will really accelerate towards the back half of the year, as Hershey gets more involved with the integration and execution.

Okay, thanks for all the detail.

One quick question also on tax rate.

If I run through the numbers on the tax rate guidance for 30% for the next two quarters, but then it's offset by other expense, the other expense is really high.

I mean, I'm getting something along the lines of $40 million of other expense.

Yes, in fact, a little bit higher than that.

So we would expect that other expense to be $55 million to $60 million.

It's the structure of these investment tax credits, where you write them off in the top part of your P&L, and the credit part comes in the tax rate.

So it's a write-off?

Yes.

In the other income and expense, will be the write-off piece, and the full benefit of the credit will be in the tax rate.

Okay.

Thank you.

Our next question is from Eric Katzman from Deutsche Bank.

Your line is open.

Hi, Eric.

Hi.

Good morning, everybody.

I guess, let me ask a bigger picture question, J.P. In terms of the Company's, let's say M&A capabilities, because I know -- and this goes back a ways, but I know that at one point in time, years ago, when you tried to establish a business in China, it disappeared overnight, and there was a small write-off.

The Company's history in Europe was one of failure, and now we have this SJM mess.

So is there -- given the M&A, it seems like is still going to be part of your future as you move globally.

Like is there something like culturally missing, or on the due diligence process that you've done in the past, that's just for whatever reason, seemingly made the Company deal with M&A problems kind of after the deal is signed?

Yes, I think, Eric, certainly some of the comments you've made about whether it was Europe, or some of these other things, those are certainly pieces of the history.

I think also inside there, you look at Brookside, obviously we're on the early side of Krave.

[Palone] has been a good one.

We've had some joint ventures, some have gone quite well, and others we've chosen at particular times to exit from.

The thing that I would tell you, and I think what's important as we look at this.

If you were to put it within the context of our due diligence process, I don't think we've gone about it in any errant way.

I mean, we used the best advisors, the best names and family names that you can think of, in terms of who you would partner with on looking at these things.

I think the landscape in China is certainly a challenging one, and we're certainly finding that out.

At the same time, we're being I think appropriate, in terms of recognizing things when we understand them.

And I don't think it's as if there's no value to the strategies we have in Canada.

I think the other thing, Eric, that you don't see is, that there's a lot of things that we do work on that we pass on.

And we pass on it for exactly the kinds of things that you would expect, that either once we get under the hood they don't yield what we anticipated, or where there's things that we're concerned about.

So in terms of rigor and so forth, I don't think there's any lack of that.

Our goal is to get as many of these things right as we possibly can.

You're correct, M&A is going to be important to our overall growth, and you can rest assured that we're reviewing every aspect of everything along the way, with regard to this particular acquisition, to make sure we learn as much as we can going forward.

I'd like to think that we don't have some dark cloud that follows us and somehow we're jinxed.

But at any rate, that's really kind of how I think about it.

Thanks for that.

And then as a follow-up, it just seems like in the second half, I guess where there's some I guess maybe one-time issues.

And I'm just kind of wondering initially, how we should think about that to next year?

Are these tax structures that you're I guess, benefiting from or unwinding or however you want to describe it, do those go away next year?

And is there your comp expense being lowered in the second half, and therefore, is likely a headwind to next year?

So let me deal with part of it, and probably it's more appropriate, Patricia deal with part of it.

As we look at our performance this year, certainly as we accrue for comp, we take into consideration what we believe our performance might be, and how that works with our comp plans.

But we tend to -- we accrue comp at a rate that assumes what our plan rates are.

So we typically don't find big swings there, although if you have a year where added comp is lower, and your performance is higher in a subsequent year, that's a cost.

But usually the momentum of the business really takes that into consideration, and so usually those are things that aren't that challenging to overcome.

And then, on the tax bit, I'll let Patricia speak to that.

Yes.

So the -- you're right, the tax credits that we're doing this year are a period.

We can do them again next year, so we'll have that opportunity.

And frankly, I'm just getting into our tax attributes, and looking forward to finding places to improve upon them.

I'll just add one point that J.P. was -- to the comments J.P. made about some of the other things going on in our expense lines, and that is we're really pleased with the execution on our restructuring that we're in the middle of right now.

We look to -- we're very much on plan, on track to get the expected benefit from that next year.

So that will be a positive momentum for us next year, compared to this year.

We'll get a piece of it this year, but the bulk of it will come next year.

Okay.

Thank you.

I'll pass it on.

Our next question is from David Driscoll from Citigroup.

Good morning, David.

Thank you, and good morning.

So I wanted to go back to China here, just to ask a couple of questions.

The first one, J.P., and this has nothing to do with Shanghai Golden Monkey.

I want to focus on the chocolate operations.

The chocolate category in that market is still a very small category relative to the size of the country, [$2.7 billion].

Correct.

Your operation is even smaller there.

I think last year was $185 million or something like that.

So I suppose, what's so hard to understand from the outside is, why aren't ongoing distribution gains the dominant factor in driving the business?

Why is it that we're looking at -- I think in your script you gave like a 4% number for Hershey and 6% number for the category.

I mean, I feel like Hershey's story in China is -- you're in 14 cities where you advertise or something like that, and you should be in 100 cities.

So what am I getting wrong here, and why is this growth not being dominated by distribution expansion across this incredibly large, and hopefully hungry for chocolate country?

Yes so David, I think your comments are certainly appropriate and interesting, and I think we think about it the same way.

I guess, the execution of accomplishing it is a bit of the pace and challenge.

So let me just reset a little bit.

If you think about our business in China and distribution build, as you rightly say we continue to build out our distribution.

It's largely -- if you look at our business, about 60% to 65% of our business is done in three channels.

It's done in Tier 1 hypermarkets, it's done in supermarkets, and about 15% of the business in both B2C and B2B is done in e-commerce.

So our sort of Tier 1 development is pretty significant and specific.

And so, we've been building -- if you go back over the last five years, you've kind of heard us talk about10 cities and 35 cities and 110 cities.

But a lot of that is really focused in a very narrow channels, versus maybe what we ultimately want to have happen.

And those channels also happen to be ones that we're most impacted by some of the macroeconomic influences, and in our portfolio in China tends to lend itself a bit more towards gifting, than it does the everyday business.

When you put all those things together -- and our portfolio they're still relatively narrow, it has made us a bit more volatile to some of these forces and factors than I would like to see going forward.

So your hypothesis of the importance of growing distribution is absolutely right, and that's what we're focused on.

And that's what we want to ultimately be able to do with Shanghai Golden Monkey and HISL, is to be able to get into the best distributors, with the best footprint, and push a broader portfolio of our brands into distribution.

That's really where we're headed.

That hasn't changed.

While we're all frustrated sometimes by the bumps in the road along the way, certainly we're experiencing some of that.

But I think as we look over the long-term, I continue to have the same commitment and confidence of how we're going to grow our business there.

And your first comment is the one that I'd like to end on, this is about category building.

It's not about fighting for market share.

It's about participating in the growth of this category for the future in a very large and attractive market.

Appreciate the comments.

Thank you.

Thank you.

Our next question is from Chris Growe from Stifel.

Good morning, Chris.

Hi, good morning.

Can you hear me okay.

You bet.

Thank you.

Great.

I just had a quick question, a follow-up on China and then one question on the US.

I just wanted to be clear on the inventory situation in China, what's out there, if you know where a lot of the good may be?

And just what that effect may have on revenue in the second half of the year?

I think that what you're seeing is in the second quarter is that we are recognizing where we've identified inventory, and where we -- we want to have -- in food in every category, you want to have the freshest, best stuff out there.

So wherever we believe we've had inventory issues, we're trying to remove that product from the marketplace, make sure that we've got the freshest possible product in place.

And so, hopefully we've addressed most of that.

There could still be some cats and dogs here and there I suppose, but we think we've done a pretty good job of confronting those types of issues.

And that's why you're seeing some of the things you're seeing in our second quarter results.

Okay.

And just a question for you then as well, or separately on the US.

Just understand in the second half of the year as you transition to the seasonal merchandise and some pricing coming through there, do you expect elasticity to increase in the second half around the pricing that's coming through now on the seasonal merchandise?

Just to get a better sense of how the revenue growth will kind of play out in the US in the second half?

So I think that if you look at the way we've modeled pricing, elasticity, and some of the things that were in my comments, we feel really good about how it's progressing.

We should get the benefit of pricing in Halloween, because that would be with all of the pricing in, versus last year where it wasn't.

And so again, as we move through the year, we've always said that as we get to the beginning of 2016, we sort of felt as though we would get back to sort of pre-price increase levels, and that appears to be accurate.

Okay.

Thank you for the color.

Thank you.

Our next question is from Alexia Howard from Bernstein.

Your line is open.

Hey, good morning, Alexia.

Hi there, I just have a couple of questions.

First of all, on China, are you able to quantify for us how much of a headwind the Company-wide organic sales growth for Shanghai Golden Monkey deal is going to be in the second half?

Once we lap the anniversary of the acquisition in September, it's going to become part of the organic sales growth base.

So is that already built into expectations, and how much of a headwind is that likely to be?

And then I have a follow-up.

Yes, and Alexia, it's Mark.

We can run through some of the math after.

But I know in J.P.'s remarks, he talked about excluding China's chocolate and all the acquisitions and FX.

North America and rest of world on an organic basis will be up 3.5% to 4%.

So outside of China, I mean, I would qualify it as everything else is going pretty well.

The 0.5 point reduction in the net sales contribution from M&A, was obviously all Monkey related.

So I can help you back into some of those numbers, after the fact.

Great.

Thank you.

And then just a quick follow-up.

At the beginning of the year, you were a little uncertain about the outlook for the US chocolate category.

I think some concerns about premiumization, and just different trends.

Have you become more confident in the outlook as the year has progressed, and are you still planning further diversification moves similar to Krave?

Thank you.

And I'll pass it on.

Yes, I think that we do feel good about the category, and we certainly feel good about our performance within the category as we continue to grow share.

As you think about the overall snacking continuum, we continue to be enthusiastic, both with some of our R&D pipeline, which we reviewed with our Board in fact this past week.

And I think it was enthusiastically received, and we'll be introducing some of those to the market later in the fall, and certainly into 2016.

And we continue to see that as an important opportunity.

So I'll just end with this.

We love the business we're in.

Confectionery is at the heart of everything that we do, and it's on one end of the snacking continuum, and we think it's one of the greatest categories there is.

At the same time, we also see that the consumers have a changing relationship with food.

We see snacking as an important occasion, and we think we have a go-to-market capability and R&D capability to meet those needs.

So if on one end, you look at indulgent, and you were to imagine on the far end, functional, we see that we have a broadening role to play across that entire continuum.

And I am enthusiastic to share with you as we go forward what some of those things are.

Great, thank you.

I'll pass it on.

Operator, we have time for one more question.

Okay.

We'll take our final question as a follow-up from Robert Moskow from Credit Suisse.

Your line is open.

Hey, Rob.

Hi.

Sorry, can you clarify, is your tax rate going to stay at 32.5% next year, because of this tax credit or is this just this year?

That particular impact is a single year impact.

But again, it's another tool in our tool chest that we can certainly reuse next year as well.

You can do it again next year?

Yes, we could.

That's a discrete event decision that we'll make for next year.

So the write-off, it's positive from a cash flow perspective?

Yes.

Yes.

Absolutely.

All right.

Thank you.

Thank you for joining us today.

We'll be available for any follow-up calls you may have later on.

Thank you.

This does conclude today's program.

You may now of disconnect at any time.