Earnings Transcript for DEO - Q2 Fiscal Year 2015

Executives: Ivan Menezes - CEO, COO Deirdre Mahlan - CFO

Analysts: Ian Shackleton - Nomura Chris Pitcher - Redburn Nik Oliver - Bank of America Jason DeRise - UBS Simon Hales - Barclays Trevor Stirling - Sanford Bernstein Nicolas Ceron - Societe General Martin Deboo - Jefferies International Andrea Pistacchi - Citigroup Eddy Hargreaves - Canaccord Anthony Bucalo - Santander

Ivan Menezes: Good morning and thank you for joining the webcast. Today I am going to look at the key drivers of performance in the half and Deirdre will take you through the results announcement we released earlier today. I am going to start by looking at the half in the context of our performance ambition. Diageo is the leader in an attractive industry with a compelling future. When we look at the long term opportunity for spirits in the US, the opportunity for beer and spirits in the emerging markets where there will be over a billion new consumers in the next 10 years, and the opportunity globally to grow our reserve brands as the number of high net worth individuals increases, we can see that despite the current environment Diageo’s growth potential is undiminished. Even in a tough environment the strength of our business has come through. We have delivered share gains and margin improvement and driven better cash performance. We have continued to invest in proven growth drivers in marketing and route to consumer. Our market teams are now focused on sell out not sell in and depletions are now ahead of shipments. The long term opportunity and the strength of our business are important to bear in mind as we look at what this set of interim results says about Diageo. In these first six months of the year the global trends we saw in fiscal 14 continued. In the US the full benefit of the economic recovery has not yet reached all consumers. A number of Western European countries are finding growth tough to achieve and deflation is a possibility so consumer confidence is subdued. Geopolitical events including sanctions on Russia and the anti-extravagance measures in China continue to impact consumer demand for international spirits. These conditions were compounded by currency volatility which distorted trading in some of our key scotch markets, and currency devaluations impacted the price of imported goods for local consumers. While falling oil and commodity prices will benefit developed market consumers, there are no clear indications of which consumer sectors will see increased spend, although the on trade has traditionally benefitted when oil prices fall. There are, of course, negative impacts on those economies which are dependent on oil revenue for growth. In a challenging world, the robustness of strategy is even more important. Our strategy is clear and it is creating a stronger business. This half we completed the acquisition of USL. As I will come onto, we have established the strategic priorities and the integration, while not complete, is well on track. Sales of Diageo brands in India are up as are sales of USL brands. It is a great start. We entered into an agreement to acquire the 50% of Don Julio we did not own and sell Bushmills. This will give us full control of an exciting brand in a high growth segment of the tequila market and it will strengthen our position in Mexico now that Smirnoff is back with us and we have Don Julio in the market. We continue to leverage Ypioca, transferring Smirnoff to local production and expanding coverage of our international brands in Brazil. In Turkey, Premiumisation drove double digit net sales growth of our Raki brands and we gained share in international spirits. We are getting better visibility on customer depletions as we reduce the level of inventory in trade and reach better trade terms with our business partners. We need to absorb the impact on net sales growth, but these stock reductions are part of the solution -- one that will provide us with much clearer insights on how the consumer is behaving, helping to inform our commercial strategies and investment decisions. Our route to consumer program underpins this focus on the consumer. This means everything we do is being driven by sell out not sell in. We are also reaching new consumers and new occasions with scale innovations. Haig Club, for example, has been designed to introduce new consumers to the scotch category. We’ve increased the focus of our senior management on improving cash performance by introducing an annual cash conversion metric into our incentive program. And we’ve done all of this while maintaining our discipline on cost and margin improved in the half despite the market mix going against us as we reduced inventory. In December we introduced an ambitious new set of targets for alcohol, communities and the environment to create a positive role for alcohol in society through partnerships and programs which impact misuse to equip people, particularly women, with skills and resources to build themselves a better future, and make our products and business operations even more environmentally sustainable. By better articulating who Diageo is and what we stand for we will engage our people around our ambition and drive the culture and behavior change we need to become one of the most trusted and respected consumer products companies in the world. With that as context, let’s look at the performance of the 21 markets in more detail. The performance of our markets in the half breaks down broadly into three groups. Those where our performance has been particularly challenged, those where our performance was stable, which are mostly developed markets; and those markets, mostly emerging markets, where we have seen good performance despite the effects of the global economy and currency volatility. In terms of net sales in the half, those markets I think of as being challenged saw net sales decline £94 million in total our developed markets were almost flat, and the growing emerging markets saw net sales increase £87 million in aggregate. This chart also illustrates the global nature of our business. We do expect to have a more stable performance from developed markets and a degree of volatility in the emerging markets. But as I said earlier on, the opportunity in the emerging markets is based on strong demographics and long term economic growth. We are building our position in these emerging economies for long term future growth, while delivering good growth today in many of them. So, let’s start with those markets that have been a bit more challenged and look at some of them individually. In South East Asia, our focus in the half has been on driving sell out and the depletions from wholesale channels were up double digit, with particularly strong growth of Johnnie Walker premium and above variants. However last year stock rose in the wholesale channel and in this half we have reduced stock which resulted in net sales down over 80%. We plan to reduce inventories further in the second half although the rate at which we can do that will depend on depletion levels. Performance in South East Asia was also impacted by the political unrest and a slowdown in consumer demand in Thailand. In the border zones of West LAC, the strong U.S. dollar had an impact on underlying demand and currency devaluation led to inventory reductions of about 300,000 cases. A good performance in the domestic business in West LAC, where net sales were up 4% helped mitigate the impact of the challenges we faced in the border zones. Reducing stocks in these two big, profitable markets is definitely causing us pain and we estimate that this, and inventory reductions in Nigeria and Russia, impacted net sales growth by about 1.5 percentage points. But it will benefit us in the future as we have greater visibility of the stock in trade, which will bring us closer to our consumers, allowing us to better understand the marketing and trade executions that really resonate with them. In Venezuela, trading has been severely impacted by the devaluation of the bolivar as the import of finished goods has been restricted and we’ve seen very high inflation. Inevitably we have had to increase prices and scotch volumes have been impacted. But we’ve also seen good growth of the strong local brands we have in Venezuela. We leveraged the leadership position of Cacique, increasing prices and launching a super-premium variant Cacique Leyenda, and we invested in the growth of Gordon’s vodka, recruiting consumers from the imported vodka segment. Together with strong growth of Smirnoff Ice this led to a 6% increase in total net sales, a very creditable performance in a challenging environment. The political and economic situation in Russia has had a considerable impact on the consumer environment there, leading to trading down within spirits. The strength of Diageo’s scotch portfolio which accounts for nearly 60% of our business there and the introduction of locally produced whiskey and rum spirit brands, Rowson’s Reserve and Shark Tooth, meant we were able to gain share in a tough environment. A great example of acting quickly to optimize sales in a difficult situation. The impact of the anti‐extravagance measures in China is well documented. The Baijiu market has been fundamentally reshaped and the modern on trade outlets where so much of our Johnnie Walker was sold have become intensely competitive. This means how we reach our consumers by channel and outlet has had to change. So what have we done? We’ve innovated. We’ve innovated in product, and we’ve innovated in the way we connect with our consumers. Haig Club was launched in China in November with the support of our partners, David Beckham and Simon Fuller. It is targeted at new consumers and a new occasion, and we’re piloting a new distribution approach selling through the Shuijingfang sales force. It’s very early days and the brand is performing well, but in building this brand to its full potential we aim to go slowly and build a sustainable platform for long term growth. We’ve also innovated in Baijiu to extend our participation at lower price points and Master Distiller’s No.8, which competes in the premium Baijiu segment, was a contributor to an improved performance of Shuijingfang, with net sales up 25%. In Nigeria the beer market has shifted and our reactions as I’ve said before have not been fast enough. We now have a new management team, new packaging and new promotional programs on Guinness, a refocused value beer portfolio, introducing Satzenbrau and repositioning Dubic and we’ve reduced trade inventory for Harp and our premium spirits to improve visibility on consumption patterns. This is work in progress and the results will be ongoing. But we have already seen share improvements of Guinness and we have grown overall share in beer in the last four months following the launch of Orijin, an innovation at a mainstream beer price point. Orijin is giving us the performance headroom we need as we make these changes. Route to consumer is central to this plan. During the half we continued to make distribution gains through the successful program we are piloting in Lagos. The insights we gained from this are driving more effective coverage throughout Lagos and beyond. Together with investment in our core brands in beer and premium spirits, and the reshaping of the Nigeria leadership team, I am confident we are competing more effectively and we will return this business to good growth. Moving on to develop markets. These markets have seen some headwinds on industry growth from uneven economic recovery and weak consumer confidence. But Diageo is delivering some good share growth as we focus on our strategic priorities building our route to consumer, innovating at scale and winning with our reserve brands portfolio. The beverage alcohol market in North America is a competitive place. Millenial consumers are looking for brands which are new, interesting and authentic. They are a multicultural group, internet savvy, less category loyal and they are one third of the U.S. population. Similarly, the attractiveness of this industry makes it one others want to enter, so there has been proliferation of brands in most categories. How are we tackling this challenge? In Canada our new distributor model was fully operational at the start of fiscal '15 and gives us stronger sales execution more feet on the street representing our brands every day. We’re also leveraging our strength in innovation. In the last quarter Ciroc Pineapple was the number three spirits innovation and Crown Royal Regal Apple, launched in October to recruit new fans to Crown Royal, claimed the number one spot for year one innovations in December according to Nielsen. Our first innovation in the Discovery Series, Guinness Blonde American Lager has had a great reception. We’ve also complemented the brand credentials of Guinness with another offering, Guinness 1759 which is focused on the fine dining and gifting opportunity. And we’re also leveraging our marketing capability. Smirnoff is starting to benefit from the new campaign, ‘Exclusively for Everybody’, new retail programming and new packaging. Brand equity is strengthening and consumer pull is picking up which together with more competitive pricing activity, is resulting in an improving share position. On Ciroc, we’re augmenting our Pineapple launch with a new ‘Blue Dot Focus’. Following on from the successful ‘Luck be a Lady’ campaign, ‘Step Into the Circle’ captures scenes of celebration amongst everyday consumers who enjoy Ciroc as a centerpiece of their special occasions. Increasingly we are using fully integrated campaigns such as this one that span broadcast, print, out‐of‐home, digital, on and off premise and experiential events. And with Buchanan’s we’re really connecting with a growing consumer group. Buchanan’s is now the second largest super premium blended scotch to Johnnie Walker’s number one position. It is strongly positioned for the demographic trends in the U.S. as it plays well with the Hispanic community, a group that accounts for over 20% of scotch consumers. Many of these consumers know the brand from their home countries and now seek it out in the U.S. Rooted in the consumer insight that Buchanan’s makes any celebration bigger, we have continued to support our campaign ‘A lo Grande’, which encourages men to choose Buchanan’s as a symbol that they’ve made it. This year we we’ve built upon our successful on trade activations and expanded beyond Mexican American markets to connect with the growing number of Dominican, Colombian and Venezuelan communities on the east coast with activations such as sponsoring the Latin GRAMMY’s. Bulleit goes from strength to strength in the North America, growing net sales 59%. It is now the number one rye whiskey in the U.S and Bulleit Bourbon is no longer a small brand and is likely to reach over 750,000 cases this year. That said, it still maintains its craft image. Like other reserve brands, Bulleit consumers are looking to discover brands and don’t respond positively to overt marketing. Therefore we continue to focus on recruiting influencers with events as well as cultivating ambassadors in the trade. After a few difficult years, we have stabilized Western Europe and in this half net sales were again broadly flat. GB delivered good results driven by innovation and the solid performances of Captain Morgan and Baileys. While the decline in spirits hampered Ireland’s top line, I am pleased that we have returned Guinness to growth through good execution in the on trade. While there was continued weakness in Spain, there are some encouraging signs. We’ve made headway in our route to consumer program and seen some restocking in the on trade after stabilizing prices. The other Southern European markets improved with Italy and Greece in growth. We are well positioned to lead the way should these markets come back to growth. In Germany, we are implementing a revised commercial investment strategy and we are focusing on making sure our improved execution is consistent with other countries in Western Europe. Our leadership in luxury really stood out in the performance of Western Europe. Strong net sales growth in vodka, gin and scotch where our scotch malts and the launch of Haig Club in GB contributed to 18% growth in reserve brands. Moving on now to those emerging markets that are delivering growth. Again there are a couple of broad themes when we look at these markets. We’re seeing our investments in leading local brands and an outstanding distribution network pay off in Turkey, India and Brazil. In others, we’ve focused on clear priorities either by category, segment or channel to capture the biggest opportunities. And in others, the key driver is the strength of our portfolio, our unrivalled ability to provide customers with the price and category breadth they require for consumers to access our brands. In many cases, local production helps us to move quickly and cost effectively to meet these needs while also mitigating against foreign exchange volatility. Let me talk to a few examples now. The consumer dynamics in Turkey, with a growing, LDA+ population that’s increasingly wealthy, make it an incredibly attractive market for both the short and long term. Despite restrictive regulation around advertising, our business is performing very well as our international spirits benefits from the Mey Icki platform. Diageo’s expertise in building premium brands has supported the Premiumisation of our Raki portfolio with super premium variants driving a 14% increase in Raki net sales. The broad network and customer relationships we acquired through Mey Icki together with increased investments in off trade activations has helped our international spirits brands gain share. Our reserve brands have also been a strong contributor to Turkey’s performance with net sales up 35%. And this type of synergistic relationship is also working in Brazil. As we mentioned in our route to consumer webcast in September, Brazil is one of our Wave 1 markets for route to consumer work. And while net sales for the first half were flat, I feel good about the performance there. Let me explain. We’ve expanded coverage increasing the number of small retail and mainstream on‐trade outlets we cover by 12,000 in the half. In addition, we are investing in a new distribution partnership that will deliver 10,000 more outlets. We’ve also made significant changes to our trade terms, put mechanisms in place to avoid price disparity and introduced incentive schemes to focus distributors on the right behaviors to build our brands. As part of this work we’ve adjusted our pricing in the first quarter to take into account tax variations by state. This together with the reduction of commercial discounts led to distributors reducing inventories during the half, impacting Johnnie Walker net sales in particular. In the second half shipments should be more in line with consumption trends. Now fully integrated the acquisition of Ypioca has transformed our route to consumer. It has given our brands access to outlets alongside Ypioca where we previously weren’t present, and it is already benefitting our international brands. This year the Ypioca brand, while still strong in its core region of the North East, didn’t perform as well as we would have liked elsewhere. Last year we expanded the brand into new regions, but the execution of our sales activities was not consistent or good enough. We’ve since changed distribution partners and believe this, coupled with expanded coverage, will drive share gains and net sales growth in the second half. The decisions we’re making now in route to consumer are giving us a competitively advantaged platform to win in both international and local brands in Brazil. Mexico is a great example of where we’ve used our broad portfolio to optimize category participation. As the slowdown in the economy translated to weaker consumer spending, our participation in standard scotch has enabled us to retain consumers within Diageo brands. Broad distribution along with the media campaign ‘Keep Walking Mexico’ drove Johnnie Walker Red’s 40% contribution to total net sales growth in Mexico. We also introduced Black & White to participate in the standard segment and the brand has gained share from competition. Within premium scotch, Mexico’s leading brand, Buchanan’s 12 year old Deluxe, increased net sales 9% driven by strong above and below the line execution. There is also growing demand for super premium scotch in Mexico, and the growth of Johnnie Walker Platinum and Gold Reserve was strong enough to offset the mix impact of our Red Label success, resulting in 8% net sales growth for the brand. Africa is another great example of how our local teams execute strategies that leverage the strength of our global giants and drive performance of local stars. In East Africa this enabled us to deliver 11% top line growth. In beer, double digit growth in both Tusker and Guinness driven by football related activations and trade investment, and new‐to‐market innovations in lower priced beer and spirits including Senator Dark, Kibo Gold and Jebel Gold and Coconut contributed to 6% growth in beer and 26% growth in spirits. East Africa’s strong route to consumer and its drive to increase mainstream coverage together with local production capacity allowed us to get product into the market quickly and cost effectively. It’s a similar story in our Africa Regional Markets where the variety of consumer occasions means our brand range delivers real advantage. Performance here benefitted from a more than threefold increase in spirits in Angola as we improved our route to consumer by appointing a new distributor and implementing a new route to consumer strategy. In Ghana, the transformation we have made to our route to consumer is driving performance as increased sales coverage and more efficient sales calls are giving us greater visibility of Diageo’s brands in a fragmented trade environment. During the half we expanded our sales force and introduced a new incentive scheme. We established a network of 50 new micro‐distributors in the off trade who sell to 3,000 new smaller outlets we weren’t covering before. Outlet coverage has increased 20% and net sales in Ghana are up 28%. The performance in Africa during the half really demonstrates the power of our platform. Beer was up 5% and spirits 19% on double digit growth in every market. It was a great result and there is still more to play for. While focusing on delivering on our strategic priorities, we have captured inorganic opportunities as well. In November we announced the acquisition of the remaining 50% we did not already own of Tequila Don Julio. In gaining full global ownership and management control of the brand and its supply assets, we will enhance our position in the high growth segments of super and ultra‐premium tequila. With this deal we are also repatriating the Smirnoff brand into our in‐market company which will allow us to extend our leading position in spirits in Mexico, a market with huge potential. The opportunity was realized through the sale of Bushmills to Casa Cuervo. Bushmills is a good brand however this was the right strategic decision for Diageo as we build our presence in the world's fastest growing markets and invest behind the biggest growth opportunities. And none come as big as India. India, and our acquisition of USL, is an important and unique opportunity for Diageo. The demographic in India is very positive with a forecast increase in the working age population of 270 million by 2030. This translates into an increase each year of 4 million consumers of legal drinking age who are open to alcohol consumption. In addition, western style spirits is the biggest category, accounting for over half of all beverage alcohol consumption in India. However, despite spirits being a high proportion of total consumption, per capita consumption is low. These positive macroeconomic and demographic trends will lead to a rapidly growing middle class, which given low per capita consumption of spirits, gives Diageo, as the leader in spirits in India through our new subsidiary, a unique opportunity. Not only will these factors drive growth in spirits, they will also drive a shift with growth in higher margin more premium brands likely to exceed that of low margin popular brands. This is the Premiumisation of the Indian spirits market. Our focus now is on integration to capture this opportunity though the creation of an iconic business. When we completed the share purchase agreement in July 2013, integration was focused on governance. We are now moving to the changes we want to make in the wider business starting with the portfolio to ensure we have the leading brands in the fastest growing profit pools in Indian spirits. These are luxury, where we now have a full offering following the distribution agreement; premium, where our strategy is to drive growth and leadership in scotch and vodka; and prestige, which is already 50% of USL’s gross profit and the categories projected to grow high teens over the next few years. In the popular segment we will be selective as to which brands to prioritize and our strategy is to grow our popular brands in those markets which offer opportunities to drive value. This participation strategy will lead to a tailored portfolio approached focused on around 12 USL brands and 5 Diageo brands. We are also looking at how the already advantaged point of sale coverage which USL’s sales team has can be augmented by Diageo’s route to consumer work and the team is in place to deliver this. In addition USL now has an enhanced innovation capability. Our focus on the brands which contribute around 75% of USL’s net sales will, over time, remove complexity allowing margin to benefit from the scale USL has. There is a lot of work to do as you can see but the strategy is now clear and the opportunity is huge. Which seems a good place to pause and I’ll now hand over to Deirdre, who will take us through the results we reported earlier today.

Deirdre Mahlan: Thank you Ivan and good morning. Ivan has outlined the actions we have taken to deliver our performance ambition and he has also told you how we are managing macro and specific market challenges. Now I am going to take you through how this is reflected in our results for the half. Our net sales were broadly flat, overall and in developed markets and emerging markets. In developed markets, we have seen a slowdown in the U.S spirits market as the economic recovery remains uneven remains uneven and in Western Europe continued softness drove a modest decline. Our results in emerging markets reflect the market challenges that Ivan has mentioned. Pressure on household incomes has impacted our ability to take price, yet we have delivered overall positive price mix, with growth of reserve and improved mix in beer. We have maintained our focus on cost across all lines of the P&L. Our global efficiency program is on track and the savings generated from this program in the first half delivered an improvement in operating margin. We have driven efficiencies in all areas of spend including commodity prices and media fees and we’ve rationalized service providers. We have reinvested these benefits into our brands and into extending our influence and coverage through route to consumer initiatives, prioritizing spend toward our long term growth drivers. And I am pleased our cash delivery has improved. However, there is more we are doing here to drive sustained improvement in our working capital. Let’s now go through the results in more detail. Reported net sales were down 0.5% and I want to highlight some of the drivers of this before we look in more detail at our organic performance. USL was fully consolidated for the first time this half, accounting for the majority of the movement in acquisitions and disposals. It will contribute to our organic performance next year and as Ivan has mentioned this business presents a great opportunity for Diageo in an attractive market. Last year in the first half we used a rate of 9 Venezuelan Bolivar to the U.S. dollar to consolidate our Venezuelan business. In March 2014 we took the decision to change the rate to Sicad II when we consolidated our results for the full year and have continued to use this rate. This reduced reported H1 fiscal ‘14 net sales by £237 million. Other negative FX movements reflect the strengthening of the pound against many currencies. This includes developed market currencies, in particular the Euro and the Canadian dollar, and also emerging market currencies, such as the Russian ruble and the Turkish lira. Organic net sales were broadly flat with volume decline largely offset by positive price mix. Volume was down 2% driven by our decision to reduce trade inventory levels in certain markets, a challenging environment in Venezuela and Eastern Europe, and lower shipments of standard brands in the U.S. In South East Asia, volume was impacted by the comparison with last year when shipments were ahead of depletions for the first half and by the impact of our decision to reduce high inventory levels. The same decision to reduce inventories led to volume decline in West LAC. Increased prices, due to high inflation and limited availability of imports significantly impacted volume in Venezuela. Volume in Eastern Europe fell, as we lap the pre excise duty buy-in in Poland in the comparable period, and volume in our Eastern Europe partner markets was impacted by the prolonged crisis in Ukraine and a change in distributor in Kazakhstan. U.S. spirits volume declined 3%, largely driven by Smirnoff, given comparison again high shipments in the prior period, and Captain Morgan which was impacted by a more price competitive spiced rum category as well as lapping the launch of Captain Morgan White Rum. While shipments were lower in the half, Captain Morgan White Rum is performing well and was the number one innovation in the U.S. in the latest 12 month data, driving share gains for Captain Morgan. In Brazil, as part of our route to consumer work, as Ivan described, we’ve developed stronger commercial partnerships with our distributors to support long term growth. This has reduced the number of intermediary customers, leading to lower inventory levels which impacted volume performance. In Africa, spirits now represents 30% of net sales and we’re driving real momentum with volume up 25%, and each market in the region is contributing to this. This growth is coming from consumers trading up to Diageo international brands such as Johnnie Walker. Smirnoff grew in South Africa on the back of new packaging, sampling programs and in store promotions. The success of local spirits, such as Jebel in Kenya and Orijin spirit in Nigeria, which provide a value offering for consumers, also contributed to this growth. Positive price mix generated £98 million of net sales growth. This is net of a £15 million negative market mix impact from the volume decline of South East Asia and West LAC. The impact of foreign exchange volatility on discretionary incomes in emerging markets and a low inflation, low wage rise environment in developed markets makes it much harder to take price on our brands and we have to be selective. Therefore, I don’t expect price to be an important lever of growth this year. Across the majority of our markets, mix is the biggest component of the positive price mix we have delivered. Looking at the individual drivers, the continued growth of our reserve brands contributed positive price mix. U.S. Spirits, including the contribution from reserve, delivered a third of our positive price mix, with declining volume of standard priced brands, such as Smirnoff and Captain Morgan, the other key driver. Pricing in Venezuela contributed to positive price mix but as I will come on to higher cogs in Venezuela and negative product mix meant this did not drive gross margin improvement. We have seen positive mix from our beer portfolio in Africa, largely due to lower volume of Senator in Kenya and the successful launch of Orijin in Nigeria. The decline in net sales of our global giants is largely driven by Johnnie Walker which was the brand most impacted from the volume declines in Southeast Asia and West LAC. Lower volume of Smirnoff in the US and Baileys in the US and Europe, as we lap the successful sell in of prior year innovations, also contributed. As you would expect, local stars have been more protected from the impact of global events and so have performed better. 10% growth in net sales for reserve brands was a significant contributor to our net sales performance with the economic slowdown having a more moderate impact on wealthier consumers. Ciroc innovation, strong growth of scotch malts, Don Julio, and Bulleit, up 57%, led this growth. Beer was up 2%, led by Africa where Orijin performance drove a mid-single digit increase in net sales. Guinness was down 4% largely due to performance in Nigeria. Following the re-launch of the brand in Nigeria in December 2014 we have seen improvements in brand equity, however the pressure on discretionary income continues to drive a shift towards the value segment, impacting the brand’s performance. We have up weighted our investment behind the brand in the half, focusing on promotions and activations in the trade to drive depletions. Elsewhere in Africa, in Ghana, Cameroon and East Africa, Guinness improved, and while the brand is slightly down in Western Europe this reflects category performance as Guinness maintained share in Great Britain. In Ireland, net sales for the brand were up and we gained share. Ready to drink was down 1%. In Latin America and the Caribbean, the segment grew double digit across every market, allowing our brands to access more consumer occasions, and in Australia, innovation targeted at wine occasions and a price increase delivered net sales growth. In South Africa we lapped the high production of Smirnoff Ice Double Black & Guarana for DHN last year. Looking at our growth across the half, we saw improvement in the second quarter, with net sales up 0.7%. This improvement was driven by the comparatives as we began to lap a number of challenges we faced last year, and by the accelerated performance of innovation in the second quarter, mainly Crown Royal Regal Apple in the US, Orijin in Nigeria and Haig Club in a number of markets. The biggest driver of improvement in the second quarter was Africa which grew 9%, driven by performance in Nigeria, led by innovation, and by performance in East Africa where the duty change on Senator has now been annualized. Asia Pacific also contributed as trends improved due to the performance of our Baijiu business, which was up nearly 80% in the second quarter. Quarterly trends were relatively stable in North America. DGUSA performance was stronger in the second quarter following the launch of Guinness Blonde American Lager. However, US spirits declined 1% as we lapped high shipments last year going into the holiday period. The second quarter was also impacted by phasing of scotch shipments last year which were weighted to the first half. A stronger second quarter for Europe was driven by Russia and Eastern Europe, given negative price mix in the first quarter as a result of higher trade spend. In Latin America and the Caribbean there was a modest improvement in net sales performance in the second quarter. This was largely as a result of Brazil where, as we mentioned in our first quarter IMS, net sales performance was impacted when we realigned pricing across states and net sales were down in the first quarter but up in the second. Marketing spend as a percentage of net sales increased across all regions except Asia Pacific. And while the total movement in marketing spend was in line with Diageo's net sales growth, we generated procurement efficiencies worth 3 percentage points of marketing spend, hence increasing our effective marketing investment. In North America, we up weighted investment behind priority areas, building Smirnoff's credentials with the new 'Exclusively for Everybody' campaign, growing our presence in tequila, and supporting our innovation agenda. In Western Europe incremental investment was focused on innovation and reserve, the future growth drivers for this market. A double digit increase in marketing spend in Africa supported the strong growth we have seen across the spirits portfolio in the first half and additional spend on Guinness to drive recruitment of the next generation of consumers, with spend focused on the ‘Made of More’ platform. In Latin America and the Caribbean marketing spend increased 3% with Smirnoff in Brazil benefitting the most from this increase. Spend more than doubled to support the national roll out of the Smirnoff global platform via the 'Cheers to Real Life' campaign and we have seen good improvements in brand equity in the half. In Asia Pacific, we took the decision to reduce our spend in China and South East Asia where difficult market conditions and competitive dynamics meant we were not confident that we would drive good returns on investment. In these markets we have reprioritized spend behind long term growth drivers such as the Premiumisation of scotch through Johnnie Walker Blue Label mentoring and media campaigns in China and in Thailand. Another important growth driver that we are investing behind is expanding scotch into new consumer occasions, for example, testing new campaigns for Johnnie Walker Black Label in the off trade in China, up weighted investment behind Johnnie Walker Red label in Thailand to encourage consumers to step up to international brands and the successful launch of Haig Club. Organic operating margin improvement was 28 basis points in the half, leading to 1% organic profit growth. Gross margin declined slightly. Price increases in Brazil did lead to gross margin improvement for the market but at a Diageo level this was offset by negative Negative price movements in other markets, such as Chinese white spirits with a reduction in pricing on Shui Jing Fang and pricing adjustments on Harp in Nigeria. In Venezuela where we did have significant price increases, gross margin declined slightly as this was offset by higher cogs and negative mix. Mix benefits from the growth of reserve were offset by some negative market mix and the impact of lower volumes. As I have mentioned, we increased our marketing spend across a number of different areas of our business but the significant procurement efficiencies that we delivered funded this increase, hence marketing spend had little impact on operating margin. Other operating expenses were lower this half and were the main driver of the 28 basis points operating margin improvement. Our global efficiency program delivered £53 million of the £110 million we plan to deliver this fiscal. This was partially offset by spend on route to consumer initiatives and foreign exchange differences arising in the half. While operating profit was up on an organic basis, reported profit was down 11%, impacted by £268 million of adverse foreign exchange. Almost 70% of the negative foreign exchange relates to our business in Venezuela given our decision in March 2014 to change the FX rate we used to consolidate this business. Based on current spot rates we expect foreign exchange to reduce operating profit by £85 million in the full year, primarily driven by currency weakness in emerging markets. Associate income, largely Moet Hennessy was down £68 million. Average net debt increased by £1.5 billion principally as a result of the acquisition of the controlling interest in United Spirits and the consolidation of its debt. While net debt increased, our effective interest rate reduced and therefore, net interest charges were broadly in line with last year. Lower interest rates achieved on new term debt and an increase in the proportion of floating rate debt through the use of fixed to floating interest rate swaps were the main drivers of the lower effective interest rate and this more than offset the 0.5 percentage point's negative impact of consolidating USL’s debt for the first time. The increase in other finance charges largely reflects our updated projections for Zacapa that resulted in an increase in the estimate of dividends payable to ILG. EPS was down 8.9 pence or 14%, mainly as a result of the impact of negative foreign exchange on operating profit and lower income from associates. Our tax rate pre-exceptional reduced from 19.4% last year to 18.3% this fiscal. The higher tax rate last year was a result of the relative weighting of profit from our Venezuelan business given the consolidation exchange rate. The 18.3% tax rate for this half is in line with our full year rate for fiscal 14. I expect our cash conversion performance to improve this fiscal and we have seen that in the first half. The executive team and our 21 market General Manager are all incentivized on this measure. And across markets we are making changes. For example, in July, we completed the roll out of our global sales and operations planning process to all 21 markets and 60 individual business units. All markets are now using one common process. The impact is two‐fold. First we improve our sales forecasting accuracy to that of a top quartile FMCG and second, we link this with disciplined inventory management to drive an improvement in working capital. Around half of our 21 markets have improved their forecasting accuracy in the last six months and this has enabled us drive inventory reductions across a number of markets. Australia is a good example of a market which is closely managing their overdue debt. One way in which they are doing this is by carrying out forward looking reconciliations with our customers to resolve payment issues before they become overdue. As many of the changes that we are making are about improving our business processes, I don’t expect the impact of these changes to be felt overnight, but I am tracking our progress. More than two thirds of our 21 markets over delivered their cash conversion target for the half, a clear step in the right direction. Looking at our performance this half our free cash flow increased by £373 million. Working capital improved £454 million compared to last year. In fiscal 14, early phasing of marketing spend impacted our cash delivery. This year our marketing spend was more in line with normal patterns with a 7% increase in the second quarter. This phasing and more efficient management of our payables resulted in higher creditors at the end of the half. Net CapEx in the half was lower than last year as the new brew houses in Ireland has been completed and with lower spend on scotch capacity and on beer in Africa. For the full year I expect net CapEx to be around £650 to £700 million, somewhat dependent on spend relating to United Spirits. Lower tax payments were largely as a result of the timing of tax audit payments last year and lower taxable profits in fiscal '14. Our net interest payments reduced significantly in the half as we benefitted from our recent refinancing of debt and the timing of payments. The favorable cash movement on pension payments is largely driven by the one off payment made into the Irish pension scheme last year. The Interim dividend is 21.5p which is a 9% increase on last year. Diageo's dividend philosophy has been a consistent increase in the annual dividend payable while maintaining dividend cover between 1.8 and 2.2 times relatives to EPS. In recent years that has allowed us to increase our dividend by 9% a year. Given the economic slowdown in emerging markets, and the associated currency weakness we continue to see and which had such a significant impact on our reported results in fiscal ‘14, our dividend coverage ratio is now below the lower end of the range we set. However cash flow is improving as these results show and the strength of the dollar is providing some offset to emerging market currency weakness. Therefore we have maintained interim dividend growth at 9% but we will review this for the full year results and if necessary vary the rate of increase to the final dividend to manage our coverage ratio albeit at the lower end of the range. In the half we incurred exceptional operating charges of £171 million. This includes £145 million in respect of the expected settlement of the dispute with the Korean customs authorities. It also includes £26 million relating to business restructuring, largely the global efficiency program that we announced in January 2014 and the supply excellence program. In the second half of the year we expect to incur an operating charge of £83 million in relation to these programs. Exceptional non-operating items in the half is mainly a gain of £103 million which resulted from the recognition of the market value of the shares we acquired in United Spirits in fiscal ‘14. This arose following our acquisition of our controlling interest in USL in July 2014. There was a similar step up gain last year when we moved from investment accounting to associate accounting for USL. In the first half of fiscal ‘15 we made cash payments of £62 million in respect of exceptional restructuring items and I expect to incur around a further £120 million in the second half relating to the global programs. So let me sum up my view of how we have started this fiscal year and what we expect to see in the second half. Our top line performance in the half reflects the current weakness in emerging markets, slowdown in the U.S. and some specific challenges in a small number of emerging markets. However we have managed this environment well, we are making the right investments in our markets and brands and maintaining our focus on costs to deliver improved margin. I expect macro trends will be broadly unchanged for the remainder of the fiscal year, however, I also expect Diageo’s performance to improve in the second half as we lap some of the challenges that we faced in fiscal ‘14. For the full year, as our investments in growth drivers continue we expect to grow our share and with continued management of costs will deliver margin improvement. Let me now hand back to Ivan.

Ivan Menezes: Thank you, Deirdre. So bringing it all together. This is a strong business and this half demonstrated that. We’ve delivered share gains in many markets and categories, growth through innovation, growth in many emerging markets and continued growth in our reserve business. It is a strong business we can make stronger. And we’ve continued to strengthen it in the half with the acquisition of control of USL; the agreement to acquire the half of Don Julio we did not have; investment in route to consumer and the delivery of the global efficiency program and the savings which we identified. And in this half we have also demonstrated that when we see areas we can improve, we identify the action and implement it. In the half for example, we’ve seen our performance in Nigeria improve as a result of the changes we’ve made; Smirnoff in the U.S. is stronger and our cash performance is stronger. Good progress but more we can do. And there are some areas where we’ve taken the right actions but the impact on results will take longer to come through. Guinness for example is already stronger in Ireland, Ghana and East Africa as a result of the changes we made in marketing and packaging and route to consumer. However the steps we’ve taken in other markets to grow Guinness will take longer to come through. Similarly our focus on sell-out in place of sell-in will drive better visibility of market trends and through that growth. But in the half it has had a negative impact on sales as we reduced inventory in five markets. Delivering this performance in a consumer and economic environment which gives us mostly headwinds is a testament to the platform we have. We have momentum in this business which will drive performance improvement in the second half and for the longer term the quality of these results reinforces my confidence that Diageo has enviable potential and we can deliver it. Thank you for your time.

Deirdre Mahlan: We’ve had a chance to go through the press release and listen to the webcast, so why don’t we go right to questions and open up the conversation.

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Ian Shackleton from Nomura. Please go ahead with question.

Ian Shackleton : Good morning Ivan and Deirdre. Free cash flow looks pretty good in the half, and I think, Deirdre, in the presentation talked about the cash conversion improving for the full year. I just want to know if you’re able to give us a little bit more granularity what that might mean, particularly where working capital might go for the year. I think last year you produced free cash flow about 1.2 billion. Can you give us a bit more granularity of where it might be this year?

Deirdre Mahlan: I can say that we have been focused on improving working capital. You will see that we had a good performance in the first half and there is still good opportunity for us in the second half. We’re aiming to get our cash conversion to a 100% and working capital will play, obviously, a piece of that. I wouldn’t comment on the specific elements of working capital because it does depend on where the various growth elements are and, to some degree, the saving of shipments towards the end of the year. But, it will still remain our goal to improve our cash conversion and we expect to make consistent improvements in working capital through that period.

Ian Shackleton: Perhaps just as a follow-up, and it touches on this. When we think about the investment in scotch whisky and stocks. I think in this first half the maturing stocks went up 170 million still, should we still expect you to be laying down stocks in the same way you have been given the weakness we’ve got in some of the key scotch brands?

Deirdre Mahlan: We look at our Scotch whisky production over the long-term and we make adjustments as and when appropriate. You should expect that we will continue to lay down stock. I won’t comment specifically on the precise areas from the first half, but I wouldn’t expect there to be material short-term changes in our maturation cost piece.

Operator:

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Chris Pitcher: One of the statistics you’ve put in the presentation that struck me was the fact that half of your business has improved its forecasting accuracy and the result of that is you’ve found you’ve got a lot more stock perhaps than you may otherwise have wanted. Could you give us a bit more detail what was actually required to improve the forecasting accuracy? What were the failings beforehand and does this mean there is still half of the business where we could see further improvements? And a follow-on from that is just to give us a feel for the scale of the stock issue when you sort of took over as CEO and can you be confident that it should find a base by the end of this financial year? I know you mentioned you expected some more in the second half, but are you comfortable you’ll get your business clean by the end of the year?

Ivan Menezes: On the first point on forecasting, as you know, we’ve put tremendous focus behind our route to consumer Must Do initiative and within that, as an opening process, discipline is something that the General Managers and Deirdre and the supply teams are leading very strongly. So, this is just fundamentally putting a lot more focus on stronger execution and getting the basics right. We are demanding this of our markets and General Managers. We’re measuring this with a lot more rigor and you can see the improvements begin to come through. I would say we’re still in relatively early stages of this journey, but they’re not letting up and so this will be one of the sources of improving working capital and cash conversions over the next couple of years. On your broader point of stock reduction, will it end by this fiscal. Let me just first characterize it. There are two things that determine that. One is the level of depletions that are happening in markets and clearly, the second is what we ship in. And the picture is a little varied. I would say overall I expect to make a significant dent into it this year, but there will be places, and I point to Southeast Asia where I don’t think it will be true because the depletions are still weak in the free trade zones in Asia. So, we will have some amount of this continuing into next year. But, you know what? This is all good stuff and we’re doing the right thing for Diageo to get the visibility back to the right place. Likewise, I cannot quite predict when we will see the acceleration in depletions. Say West LAC right now is somewhat stable, but at some point we would expect to see improvements come through, but it hasn’t happened yet. So, I would say that’s a bit of how I view the world. We’ve made a significant dent into it this year. There will be some pockets which will continue into next year, but we will manage that in the profile of the total business growth momentum as we go into fiscal '16.

Chris Pitcher: And if I may while we’re on the topic, in terms of finding a base in F15 specific to the India business, the sales momentum for United Spirits seems to have improved in the last couple of quarters. Do you feel that with their original efforts and your subsequent efforts that by the time you close this financial year that the shape of portfolio will be much more where you want it to be and we could expect growth off that base?

Ivan Menezes: We are in the middle of the integration and transformation in United Spirits. As you probably know, in the second half we will be integrating with Diageo brands fully into the United Spirits platform. That’s a complex process which will take us through the second half of the year. I must say overall on India, and on United Spirits and Diageo, I feel very good about where we are. We’ve got the new management team in place. We’ve put in place our governance through those changes. So, the momentum is good. You can see it in the Premium and Prestige brands continue to do well. Our portfolio strategy is clear which brands we’re going to support. We’re bringing the Diageo skills into India on revitalizing the brands, the portfolio, and our innovative skills. So, I’m confident that India should deliver good growth both for the balance of this year and then into fiscal ’16. Fundamentally, all the elements are on track.

Operator: Our next question comes from the line of Nik Oliver from Bank of America. Please go ahead with your question.

Nik Oliver : Good morning. Thanks for the question. Just coming back to the comments on the dividend. I just wanted to clarify that we will see growth in absolute full year dividend. It’s just that the rate of growth may be slower than the 9% seen in the first half. And, secondly, just given how strong cash flows are in the business, could we see a situation where dividend cover did dip below the lower end of the 1.8 to 2.2 range in the short-term? Thanks.

Deirdre Mahlan: You’re absolutely correct. Our policy is for a progressive dividend, and we are looking to vary the rate of growth of the dividend. So, absolutely. To your second question, yes, I mean the policy of 1.8 to 2.2, we don’t apply that policy mathematically. But obviously when we get to the lower end of the range or the higher end of the range it will cause us to think carefully about what the dividend will be going forward. So, it is possible and has in the past actually been outside of that range for brief periods.

Operator: Our next question comes from the line of Jason DeRise from UBS. Please go ahead with your question Jason.

Jason DeRise : I wanted to ask about the U.S. business. Obviously you’re flagging the good growth out of Bulleit, but it’s still quite small. So I wanted to get a sense of how you’re balancing the need to keep it crafty but also some of the urgency to make it larger because that part of the market is growing so fast. Then the second part of that is there are other brands that you have in the whisky space that are not performing as well. So, Crown Royal, Johnnie Walker is a bit mixed. Could you talk about the strategies there to be able to better participate with where the U.S market is growing.

Ivan Menezes: First let me say our whisky position in total in North America, across North American whisky and scotch is a very strong one and well positioned for where the market is going. On the specifics, Bulleit, you are absolutely right. I want to make sure Bulleit stays with the hipsters of Williamsburg and does not become a mass brand. But it has got tremendous scale. This is growing at 57%. You talk about Bulleit being small, but 20% of the bourbon and rye growth in the US is Bulleit, so it is having a material impact on the category. Our approach is we’re not going to do large scale TV advertising and kind of what you do with big brands. We’re going to keep building it through advocacy with bartenders. There is a lot of word of mouth. There is a lot of experiential stuff. We’re going to be very focused on the on-premise. The brand is really hot in the on-premise and let the consumers come to the brand. Retaining its craft credentials is crucial. It helps that we have Tom Bulleit and a family behind the brand. Tom is very active in the leading edge elements of opinion forming in the whisky community. So, those are the things we are doing. We are also looking at building it globally. Again, to your point, I’m not going keen to just go chase volume. I want to build this brand the right way everywhere in the world and it’s going to be part of our reserve portfolio. On your point on our other whisky brands and why they are struggling or underperforming, Crown Royal has had a weaker 18 months. We are doing a number of things on Crown Royal which gives me confidence we will see improving momentum. One is the whole approach to the brand is going to come back very much to talk about the craft and the quality of the whisky. It’s a sensational liquid. We’ve got 50 various crafted liquids that go into Crown Royal. We are doing a barrel program with Special Crown Royal. We have several line extensions. There is one in place right now which is early days, but are very encouraging which is the Crown Royal Regal Apple which has been in the market a couple of months. It’s hitting the IRI and NABCA top innovation lists. We’re seeing the base Crown Royal brand improve. So, I’m cautiously confident you will see improved momentum on Crown Royal. The rest of our portfolio, actually, we’ve got a lot going on. We’ve got Orphan Barrel which is the high-end craft bourbons doing well. We are putting more energy behind George Dickel. Dickel is getting quite a cult following as well in the places in the U.S. where whiskey trends are getting set. And so in total I do believe -- we’ve got a couple of new ideas. We are bringing in IW Harper back in, we are introducing Blade and Bow which will be a new entry also in the bourbon segment. So, our North American position where we have underperformed in the last 18 months largely because we didn’t ride the flavor drive. And in most of the North American whiskey boom has happened out of flavors, two test of it. I’m very clear that a brand like Bulleit we’re not going to chase flavors. Bulleit is such a beautiful brand in bourbon and rye. We’re going to stick to our knitting, build it the right way. But with Crown I do see that momentum come back. So, overall, North American whiskey I’m cautiously confident you can expect to see us perform better while continuing the momentum on a brand like Bulleit.

Jason DeRise: The other side of the portfolio in the U.S., the white spirits and I guess most of the focus will be on Smirnoff. How do you think you can turn around the share loss in the vodka category? Obviously there are a couple of brands that are growing rapidly that explain the growth in the vodka category, but what’s your view on when Smirnoff can turn around?

Ivan Menezes: As we talked about for the last 12-18 months we are in the midst of the revitalization program on Smirnoff. I encouraged with -- and then you’ve got another dynamic which is flavored vodka is clearly a challenged and Smirnoff 25%, of the Smirnoff business in flavored vodka. There we are seeing still continuing challenges. On base Smirnoff, we actually are finally seeing market share improvement. Small, but in the last few months Smirnoff Red, the base vodka, has actually grown market share. And as we go into the new calendar year I would hope we will see that momentum continue. Overall, our North American business, as we close this quarter and go into the next quarter both in NABCA, particularly in NABCA, we’re seeing a little more improving momentum on our premium core brands, including Smirnoff.

Jason DeRise: Okay. I can probably ask a few more on this, but I’ll let others have a chance, thanks.

Operator: Thank you. Our next question comes from the line of Simon Hales from Barclays. Please go ahead with your question Simon.

Simon Hales : I just wanted to follow up on Chris’s question really just around stock levels if I can again, Ivan. I appreciate that clearly depletion trends sort of play an important part with how quickly the destocking takes place. But, when you look at something like the destock in South East Asia, I think if we go back to the full year numbers you were expecting that to perhaps be a 70 million hit over the course of this year to your sales. Is the absolute size of that destock, even if it flows into 2016 fiscal year, still at that sort of level, or are you finding further pockets within those different markets where inventory needs to be reduced? And maybe following on from that, back to Deirdre’s comments around the forecasting accuracy that’s improved in half of your 21 markets, is the other half of those markets, is that still to come through improvements, or those other half markets already put those improvements in place and, therefore, we shouldn’t be expecting to find six months from now that you’ve found another big lump of stock in one of these new markets that you’ve applied those improvements to?

Ivan Menezes: Hi Simon. Thanks. First on Southeast Asia, it is still 70 million but it will take a bit longer is what we’re saying. On the other markets, I mean just twice a year we have all our General Managers in and just last week Deirdre and I were with them. There is sharp focus on improvement in all markets. So, it’s not like the other half are where there isn’t room for improvement. So, you will see that discipline continue. And on the broader point on this and on stocks, I mean I think one of the encouraging aspects of our performance in our first half is our depletions are running ahead of our shipments. And I think as I mentioned in the last call, we now track performance at the depletion level and it’s all about sell out. Don’t tell me what you are selling in. I want to know what’s really selling out and that’s what we’re measuring and holding our markets accountable for. So, all these changes, the S&OP process, the sellout orientation in all our metrics, I think that’s part of what is going to make us get far better visibility of underlying trends and make us more agile in terms of responding to marketplace movements. So, it’s all more to play for. It’s well underway and every market has scope for improvement.

Deirdre Mahlan: In fact, I would just add to that. Going forward, as the capabilities in the market improve in that area, because of the focus on sell-out we should have less, this is the intent. We will not have the circumstances where the inventory builds because we have greater transparency into what’s happening on the sellout basis in terms of distribution and rate of sale and, therefore, we can certainly manage better what’s happening to our in-market inventory level.

Simon Hales: Can I just sort of follow up on a separate issue and just ask you about China as we head into the second half of the year and looking to Chinese New Year? I see Deirdre you made some comments earlier on the newswires around thoughts around Chinese New Year. I’m just wondering if you could maybe sort of expand on that a little bit, particularly around your premium scotch business as we begin to lap obviously some of the restrictions into the on-premise that went in earlier in calendar 2014. How are you feeling about the scotch business looking forward?

Ivan Menezes: I would say the scotch business for the balance of this fiscal year will still be tough. I mean, they’re going through a big adjustment and the traditional on-trade has really shrunk. The modern on-trade has gotten very competitive where a lot of scotch is being contracted. We are being very disciplined. We are not chasing volume to buy it. So, I would expect us to have continued decline. As we go forward though, we are confident that we will get the scotch category back into growth and see our business grow. We are putting - our focus is really on Johnnie Walker Blue and the Super Deluxe end of scotch where we continue to remain confident. To your point in Chinese New Year, it’s early, but I would say we are seeing encouraging early trends, but it should be modestly better this year versus last year but it’s early to call. We're seeing Baijiu in particular with Shui Jing Fang.

Operator:

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Trevor Stirling: Yes, a couple of questions from my side. One, coming back to U.S sales, maybe one for Deirdre. When I look at the contribution from USL coming into the accounts, Deirdre, it’s implying about a 5% operating margin but looks to be quite a lot lower than what USL are reporting on their accounts. Is that because of translation from Indian into IFRS, or is there some acquisition charges that are depressing margins as reported in your accounts?

Deirdre Mahlan: I would expect that there certainly are some adjustments from the Indian statutory accounts into the Diageo accounts, as well as purchase of price adjustments. So, there would be some combination of the above that will be driving that.

Trevor Stirling: And I know you’ve got ambitions to improve the margins at USL over time. Any broad guidance in terms of how long you think it will take to get USL to a place where you can start to see margins rise again?

Deirdre Mahlan: Well, I think we’ve said in this first period where we’ve been talking about the integration that we’ve been going through that it is on track and we do expect I mean I think when you get past this fiscal year, on the trends that we’re on, you should expect to see some improvement. Now, some of that maybe reinvested behind the brands because as the brands and the market evolve, we'll see. But I think we can start to see some of the pressure that you would have seen, for example, in that 5% come through after we get through the first year when there are a lot of integration costs and accounting adjustments flowing through the account. In terms of underlying performance, that was our expectation of that after we got through the first full year we should start to see some positive trend. I wouldn’t expect it to be an abrupt steep curve, but gradually year-on-year you should start to see improvement.

Trevor Stirling: Okay. And Second question, moving onto Ivan. As I read through the detail of North America Ivan I [indiscernible] that a lot of the brands had tough comps from sort of pipeline filling in the prior year whether it be Captain Morgan White or the premium qualities on Johnnie Walker. If you eliminated that pipeline filling, what do you think will be the benefit to top-line growth in North America?

Ivan Menezes: Trevor, let me just characterize the underlying business, not the shipments, but say the underlying depletion value trend in North America in spirits. We’re running probably about 2.5% growth against an industry or market that’s 3%, 3.5%. So, we’re underperforming it slightly. Now when you look at the source of underperformance and why, there are a few things going on. One is that we did take a lot of price in the last couple of years which has really hurt us on those premium core brands. I mean if you look at the last three years, we expanded operating margins in North America 450 basis points. And a brand like Captain Morgan is now sitting at a 25% premium to the leading rum brand. A brand like Smirnoff had moved on price increases in prior years when vodka was heading the other way. So, we’re making adjustments for that. The second thing is a couple of the category dynamics have gone against us. We did not participate in the North American whisky flavor explosion I think We will be correcting that. Flavored vodka took a big hit which hurt Smirnoff disproportionately since we are by far the biggest market leader in flavored vodka. Now, on the other hand, our reserve brands are very strong. As you know, Bulleit, Dickel, Classic Malts, Don Julio, Zacapa, Ciroc, all of those are performing very well. So, as you look at it going forward, we need to get that underlying depletion improved from where it is. I’m not calling that recovery like fast yet it will take us time as we go through the course of this calendar year. But the trends as I mean we are seeing improving trends on those core brands come through and, as we go through the second half of the year, I would expect those to continue. To your point, there was a lot of innovation in the pipeline. When we closed last year we expected a stronger holiday season. So, we’re adjusting some inventory levels as well as we go through this. If we get upside from a consumer standpoint in the course of the second half, I would say we would adjust it through our shipments. I think we would want to just get our shipments more in line. 400,000 cases of lower shipments is worth about 2% of growth in the half.

Operator: And next question comes from the line of Nicolas Ceron from Societe General. Please go ahead with your question Nicolas.

Nicolas Ceron : Would you be able to talk about the associate net profit which were down sharply this half? Were there any exceptional on it, or shall we expect the same kind of decline in H2? And also maybe a more general question on the U.S. A number of companies in staples are talking about a better consumer environment recently. Is that something you’ve seen? Have you seen any pickup in demand in December and January, or have you seen a better on-trade recently? Thank you.

Deirdre Mahlan: I want to answer the question on associates. As you know, the associate income is a function of the entities which we’re holding a minority share and it is entirely dependent on the performance of those entities. So, in the second half we’ll see what happens to the performance and then that will come through in our accounts.

Ivan Menezes: On the U.S, if we look at the last couple of months, as I think Larry Schwartz said on his call, Thanksgiving was relatively subdued. We didn’t see a big increase. As we closed out Christmas and the New Year, things strengthened a bit. It got a little stronger as we got through December. January feels good. The thing we want to be cautious about because we know in the last two years the U.S recovery we’ve been waiting to see when it will translate into a bit more consumer exuberance. I think you still see people in America fundamentally taking a lot of their gains with the lower gas prices et cetera, there is deleveraging going on and that cycle is still playing out. I would say our signs are cautiously continue to see a bit of gradual improvement in underlying consumer demand. The on-premise has picked up a bit and that’s a good indicator and usually an early sign. But, we’re not going to call it until we see it and I would say our stands on this is we’re prepared to ride it when it comes, but we are cautious in kind of calling it till we see a sustained trend.

Operator: Our next question comes from the line of Martin Deboo from Jefferies International. Please go ahead with your question Martin.

Martin Deboo: Morning everyone. I’m obsessed with inventories as Chris and Simon were, so let me just ask a couple of incremental to what you already said to them. What was the influence of inventory reduction, if any, on the decline in Walker which I think was down 9% in volume in H1? Ivan, you also mentioned something on the webcast. I think you quantified the inventory headwind as 1.5 percentage points, but it wasn’t clear to me if that was a headwind on the group or within a more restricted part of the group. The context of it wasn’t totally clear to me. If we just get clarity on those two that would be good.

Ivan Menezes: Sure. Johnnie Walker, all of it, is inventory. So, underlying Johnnie Walker is healthy. The 1.5 is on the group.

Martin Deboo: Okay very clear. Thank you.

Operator: And next question comes from the line of Andrea Pistacchi from Citigroup. Please go ahead with your question Andrea.

Andrea Pistacchi: Yes, good morning. I have two questions, please, both on the U.S. The first one, you’ve talked about the adjustment on your core brands Smirnoff and Captain Morgan, some rebasing of price to some extent. Now, of course, it depends a lot on what competitors do, but what is your best expectation on how long it will take to fully stabilize these brands? The second, again, on the US you’ve had two big launches with Ciroc, Crown Royal. Ciroc was up strongly, more than 20%. Was there a pipeline fill element in that? Are both brands showing strong depletion trends, and how confident are you that in 2H these brands will have strong underlying momentum?

Ivan Menezes: On the first question, Andrea, on Smirnoff and Captain Morgan, the premium core, this is going to take time. I would say I would hope to see sequential improvements gradually, slowly, as we go through the course of this calendar year. It’s another four quarters of consistency where I would be at a point. I don’t want to call it before we get to the end of the calendar year. But we’ve got these brands in South Europe showing top line share performance. On the two big innovations, clearly, there is an element of pipeline fill because we were launching them in the last couple of months. However, what’s really encouraging is the consumer uptake has been extraordinary and you can see that in Nielsen and NABCA. Ciroc Pineapple is off to a tremendous start and it is really pulling through and we will need to see as we go through the course of the second half those trends continue. Crown Royal Regal Apple actually is also pulling through. In fact, we are out of stock in many markets. We’ve got to make green bags for that product, we’re running out of bags right now. But the brand is -- what’s interesting with Crown Royal Regal Apple is it is showing up. It’s cutting across demographics. It is showing up in non-core Crown Royal markets like in the North East. You’ll find it in New York and Brooklyn now where Crown Royal didn’t have much of a franchise. So, it’s early days. I don’t want to get too excited, but the team is scrambling to keep up demand and I do believe we will have a strong H2 on that brand as well.

Andrea Pistacchi: Is there a technical reason why I see Crown Royal was I think down 1% in NSV in the half yet you would have had a bit of a pipeline fill element? Is there a reason why the brand wasn’t growing more despite the pipeline?

Ivan Menezes: We were counting another innovation launch in the previous half Crown Royal XR. So, that was it. And Maple Finished was a big innovation in the first half of ‘14.

Operator: Thank you. Our next question comes from the line of Eddy Hargreaves from Canaccord. Please go ahead with your question Eddy.

Eddy Hargreaves : Good morning. Thanks for the taking the question. I know a couple of people have touched on components of this, but looking at your overall volume performance down to, within that, obviously your global giants, those six brands, have underperformed that. You’ve mentioned some things that we know about going on in the U.S. destocking, pricing, et cetra, et cetra. But if we look at volume and indeed organic net sales performance of these top six brands, the global giants, it’s clearly quite a tough dynamic to deal with at the group level. When would you think that, as a whole, this group of brands could move back to growth? Do you think fiscal 2017, 2018 is too pessimistic? And then more generally, should we expect these giants to be growing faster than the total portfolio or slower on an ongoing basis medium, longer term? And if I could just pop in with one completely different one, could you perhaps give us your thinking on dropping the quarterly IMS’s going forward?

Ivan Menezes: I’ll have Deirdre address the IMS. On the global giant brands, clearly what you are seeing right now is what we’ve talked about, Eddy, some of the corrections that are happening in stock levels and market disruption. So, you’ve got some of the brands impacted Johnnie Walker is what’s happening in South East Asia and West LAC, but also what you are seeing in Russia where we see a kind of a one-off slowdown. I would expect these brands, as we go through this adjustment, really come back into growth, into decent growth as we get into F16, but then really build from there as we get into F17 and F18. These are our priority brands. These and the reserve brands really are the engine of the company and so our focus is going to be very much on getting the trajectory of improved growth coming through on these. What I would say is if you look at underlying consumption, consumer uptake, I get encouraged about the health of the brands and the underlying consumer uptake that is taking place. Scotch whisky in Latin America, it’s the question I always ask and if you go into Mexico and Colombia, and Brazil, it is very strong, thriving, the inspirational and status values are intact. So, the category and our brands, Johnnie Walker and Buchanan’s, and Old Parr are all in good shape and that’s what we look at very carefully and that’s what gives me the confidence that we will see improving trends come through. IMS?

Deirdre Mahlan: Okay, on the IMS, we will publish an IMS for the nine months ended March 2014. When we come into our next fiscal year we will not publish IMS’s for either the first or the third quarter. We made that decision after some consultation with some of our largest investors who are supportive of that and so that’s going to be our position going forward.

Eddy Hargreaves : I’m, sorry, the reasoning is?

Deirdre Mahlan: I think the reasoning is, consistent with the reason why the regulation was changed, is that we think we’re focused on the long-term performance of the business. We’re very clear in our half-year accounts on what we’re doing to drive performance in the business and we believe that that provides good information to investment community in order to base their decision obviously, if there is something that needs to be reported, we’ll report it. But in terms of just regular quarterly statements, we intend to discontinue them.

Operator:

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Anthony Bucalo: The question is for Deirdre. Simon asked a question about inventory and the response was that you’re moving towards a culture that is much more focused on sort of a depletion culture rather than a shipment culture. Can you sort of talk about that in detail? Do you need better ways to measure your depletions? Do you need to work more closely with your distributors? Do you need to work more closely with the retailers? What is the practical impact of moving from a shipment to a depletion driven culture?

Deirdre Mahlan: I could talk about this for a long time, Tony, but for the sake of everybody I’ll try to address your point. And I think it’s some of all the above. It depends on the nature of the market. So, in some markets where we sell direct to retail and there is good published data it’s quite easy to see AC Nielsen, for example, what’s happening. In other parts of our business like where there are wholesale channels and there are two or three tiers before you get to the consumer, it can be more difficult to really be able to see that and that will then involve our working closely with the first line distributor and then trying to triangulate that with in-market information so that we have the best available information about what’s happening in the market. So, it does vary. I can say, as I was talking about in the presentation in the improvements in sales forecast accuracy, we are finding that the focus that we now have on our executional imperatives around the premium, core, distribution points, rate of sale, what’s happening on reserve brands, planning for innovation, commercial planning, that level of detailed attention is giving us a much better insight not only into sales forecast accuracy, but then obviously, as you look further out, what our inventory requirements are going to be. But, what is required to do that will vary a bit depending on the market structure. In most cases it doesn’t involve a significant investment. In most cases it just involves actually going to track the detail and making sure you are confident in the quality of the underlying detail. There may be some local in-market tools that are put in place to facilitate it, but the most part is just getting really down and clear on what’s happening at the ground level.

Anthony Bucalo: Okay. So, your local operators, are you going to encourage them to spend their time a little bit differently in terms of collecting that information or triangulating that information? Where will that burden fall, generally?

Deirdre Mahlan: Yeah , absolutely it will be at the local level because it is the people who are in the local market, those teams on the ground that have the best information. And it's not that -- in some cases the information was there before but when you have a sell-in kind of structure, they are much more focused on order taking from the first line customer and then they kind of assume the next order will come.

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Operator: Thank you. We now have a follow-up question from the line of Jason DeRise from UBS. Please go ahead with your question, Jason.

Jason DeRise: Thanks for taking the follow-up. On the cost savings that came through in the first half, just my simple math is that would have been a 2.6% benefit to EBIT, the 53 million. Obviously your organic EBIT was less than that at 0.7. How should we think about, going forward, that flow-through? What would need to happen to achieve maybe a better flow-through in the second half of the year?

Deirdre Mahlan: Well, I mean some of those savings that came through was because of the timing of the initiatives. We do expect a bigger savings in the second half than in the first half as they start to come through. So because when the changes take effect, it depends on when those changes come into us. If some of them didn’t actually were not effective in the first quarter, then you only get a piece of it in the first quarter, you’ll get all of the benefit of that savings plus more in the second half. So, I would expect the amounts to improve about 57 million additional in the second half.

Jason DeRise: Okay. That’s the run rate at the end of the half is the 53 million? That’s the way to attribute that, not how much contributed?

Deirdre Mahlan: Exactly.

Jason DeRise: Okay. Any comments about which regions that broke out into?

Deirdre Mahlan: It is spread in a number of different places because the global -- so remember, there were a few different things. There was our global operating model program, the global efficiency program, and then there were some supply excellence programs. It is in a number of different regions. So, there is some savings in every region and through supply as well as in corporate. So, I don’t have in front of me a breakdown of what it is by region, but it is spread throughout the business. It’s not just featuring in one place.

Operator:

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Andrea Pistacchi: It’s on emerging markets. Now, you’ve had a much better performance in some emerging markets. Others like China and Nigeria were clearly less bad, more or less stable. To what extent are these sales trends sustainable, or were there technical aspects besides, obviously the easy comps which may have helped the performance like rolling out, I don’t know, Origin or Haig into China and Nigeria? Should we expect these sorts of trends going forward?

Ivan Menezes: We look at it market by market. But just to the two you picked, in Nigeria we are seeing sequential improvement. Clearly, Origin has been a big piece of that. However, if you look at the underlying executional changes, we’ve got a new management team in Nigeria. We are making rapid strengthening of our route to consumer. We are investing behind our brands, including Guinness which is pretty challenged in Nigeria. But we can see some of the equity measures move and we’re gaining market share in the last few months. Just a little bit. So, I would expect that to continue. Now, clearly, the external environment in Nigeria is pretty volatile. We still haven’t seen the full impact of the oil price reduction play through in the consumer market yet. We’ve got elections coming up. We’ve got the currency clearly depreciating. So, we need to work through that. I feel confident you will see our relative performance, or share performance continue to get strong in Nigeria and our spirits business as well will continue to perform. In China, the Baijiu business is now in a position where I would expect to see good growth clearly from the rebased start. On our international brands, Scotch whisky, Johnnie Walker has taken significant declines this year due to all the channel disruption. So we would see that continue and the second half will be tough, but as we get into fiscal ’16 I would expect us to do better. So, in general, when we step back, Andrea, the way I look at the world is we still have a fair amount of volatility and we’re not assuming a better improving economic environment. However, we do expect our performance in each market from a competitive sense to improve and that’s really where we’re putting all our focus and our energy.

Ivan Menezes: Okay I think that’s the last question captain. So why don’t we ask the operator to or shall I just close it here. Well, thanks everyone. It’s good to have you on the call. Thanks for your questions. Deirdre and I look forward to meeting some of you over the next few weeks. Appreciate to your support and interest in Diageo and have a good day. Thank you.

Operator: Ladies and gentlemen thank you for joining today's conference call. You may now replace your handset. Thank you.