Diageo PLC (DEO) 2010 Q2 法說會逐字稿

Good morning and thank you for your time today. I want to welcome Deirdre Mahlan for her first set of results as Diageo's CFO. Deirdre will take you through the results that we released this morning in more detail and then I'll review the trends we have seen and the investments that we've made in the half. Our four regional presidents, Ivan Menezes, Andrew Morgan, Stuart Fletcher and Gilbert Ghostine and, Andy Fennell, our Chief Marketing Officer, will then join the two of us to take your questions.

We are building momentum across the clear majority of our markets, double-digit growth in International, stronger performance in North America and an improving top-and bottom-line growth in Asia Pacific. The global economic recovery is uneven and Europe was weaker. The economy rebounded in Russia and Eastern Europe and we generated very strong growth.

We grew modestly in markets such as France and Germany. However, in the rest of Europe we did face challenges. Weaker consumer and business confidence in Greece and Spain, import restrictions in Turkey and pressure on margins in GB from the shift from on-to off-trade and from Spirits to Wine; these depressed our performance in Europe in the half. However, mix improvement and focus on cost of goods led to gross margin improvement and we invested significantly in marketing; up 10% in the half. This increase was focused behind our strategic brands in North America and the growing number of middle-class consumers in Latin America, Africa and Asia Pacific.

Operating profit grew 2% and EPS pre-exceptionals grew 9%, while our focus on cash generation again led to strong free cash flow; GBP775m in the half. Our priority is investing to drive growth and we are confident in the strength of our business, therefore, we are increasing our interim divided by 6%.

And now I'll hand you over to Deirdre to take you through the figures in more detail.

Thank you, Paul, and good morning, everyone. As Paul said, I am now going to take you through the results in more detail. Let's look first at volume and net sales.

Organic and reported volumes grew 3% in the period, led by Spirits. The organic increase in net sales of 4% reflects the return to volume and growth and improved price mix in North America, and our strong volume growth in Asia Pacific. By category, Scotch and Vodka were the biggest drivers of top-line growth, while the faster growth of premium and super-premium brands drove positive price mix.

The weaker Venezuelan bolivar had a negative FX impact of GBP211m. In H1 last year the bolivar/US dollar exchange rate was 2.15 and this year we have moved to nine. Excluding this impact, exchange would have had a positive impact mainly due to appreciation of the US and Australia dollars and the South African rand, although the euro was weaker. The scope change is the disposal of Wine businesses in Europe and North America as we restructure these businesses to improve returns.

Turning now to organic net sales growth on a regional basis, in North America high levels of unemployment and low income growth continue to restrain consumer confidence and are holding back a broad-based recovery in consumer spending. However, there are signs of a gradual recovery in Beverage Alcohol, with an improvement in the on-trade environment and the faster growth of some super-premium spirits.

We took the decision to reduce discounts on our brands in US Spirits. We knew it would lead to share loss but that it would contribute to better price mix, and this is what happened. The overall economic and consumer environment in Europe continues to be weak. In Greece and Spain the financial crisis has led to a further decline in consumer confidence and reduced the availability of working capital for local businesses, which led to trade de-stocking.

In Ireland the ongoing contraction of the on-trade led to a decline in our Predominantly Beer business. In GB net sales growth was driven by the growth of Wine, which reduced margins, as did the very competitive pricing environment on Sprits. In contrast, the consumer recovery in Russia and a bounce back in Eastern Europe, aided by some wholesaler restocking, led to strong double-digit growth in these emerging markets. We continue to drive double-digit top-line growth in International, benefiting from our brand range and strong distribution.

In Latin America and the Caribbean Johnnie Walker grew over 20%, maintaining its leadership of the Scotch category in the region. Our strategy of widening the brand range beyond Scotch to appeal to the emerging middle class is now contributing to growth. Smirnoff and Captain Morgan both responded well to an increase in marketing spend and delivered exceptional growth. And we will continue to invest in these emerging middle-class opportunities.

In Africa our range of Beer brands at various price points again provided strong growth. The performance of Asia Pacific improved in the half. The emerging markets, primarily India, Thailand, Vietnam and Taiwan grew very strongly, offsetting a flat performance in Australia, which represents nearly 30% of the region's sales. We extended our number-one position in Scotch in the region with share gains in all markets. We have returned to positive price mix; up one percentage point.

In North America the stunning growth on Ciroc and, to a lesser extent, Scotch, led to net sales growth of the premium and above-premium segments in the high single digits, while the value and standard segments recorded a small decline. This improved mix, combined with reduced promotional activity, drove positive price mix.

In Europe there was negative price mix as the slowdown of the on-trade in Southern Europe and Ireland led to declines on Scotch and Beer respectively. Overall, though, the delivery of price mix at a Diageo level reflects the strength of International, which now has the scale to impact overall performance.

Price mix was primarily driven by favorable brand mix, as Super Deluxe Scotch grew double digit, and by price increases, primarily in Venezuela, to keep step with local inflation. Although there was faster growth of premium and super-premium brands in Asia Pacific, this positive mix impact was offset by some price reductions and an intense promotional environment in Australia, our largest market in the region.

Now looking at net sales growth through the lens of price segments, the stronger growth of Scotch in emerging markets, and Ciroc in North America, meant the super-premium segment grew strongly and was the fastest-growing segment in each of our four regions. The premium segment also grew well, mainly due to Johnnie Walker Black Label in the emerging markets and Crown Royal in North America.

The standard segment was held back by declines in Scotch, primarily Johnnie Walker Red Label and J&B Rare in Spain and Greece, and Whisky and Wine in North America, offset by the growth of Johnnie Walker Red Label in Latin America. The value segment comprises just 3% of total net sales and growth in the half was very localized, over half coming from increased distribution of Senator Beer in Kenya.

Overall this data is encouraging, suggesting that some consumers are again moving up the price ladder, but it is very market specific and category specific. And as the performance of Ciroc demonstrates, sometimes brand specific.

Looking at the growth of our business by category, our Spirits brands in total drove over 80% of our growth in the half and the largest categories of Scotch and Vodka made the biggest contribution. Within Scotch, Johnnie Walker grew net sales 10% overall, with growth of over 20% in emerging markets as the Walk with Giants platform was activated across the globe.

Other Diageo Scotch brands also performed strongly, with double-digit net sales growth in the premium segment on the strength of Windsor in Asia and Buchanan's in Latin America and Caribbean. In the standard and value segments White Horse, VAT 69, Johnnie Walker Red Label and Black & White all grew very strongly as emerging market consumers across the globe returned to the category.

Growth in Vodka was led by North America, mainly Ciroc and the launch of ROKK and Moon Mountain Vodka. Smirnoff grew very strongly in emerging markets, but performance was held back in the highly-competitive off-trade led markets of Great Britain, Australia and the United States.

Our Beer brands remain a growth engine for Diageo, but it's a story of two regions. Once again our local Lager brands in Africa offset the decline of Guinness which was impacted by the continuing contraction of the on-trade in Ireland and Great Britain. Wine grew 5%, driven mainly by growth in Great Britain, partially offset by the decline of Wine in the US.

You will have seen from this morning's release that we have changed the way in which we report brand performance. Over the last year we have moved to a category approach to ensure we have brands at each profitable price point in each major category. Our 14 strategic brands will replace our global priority brands, which we introduced in 2002 following the Seagram acquisition. We are reporting in this way because it better reflects the way we manage our brands. It is a natural evolution, having dropped the classification of local priority and category brands this time last year.

Turning now to operating profit, on a reported basis the FX benefit to operating profit was GBP70m. A transaction benefit of GBP96m and a GBP2m benefit under IAS 21 were offset by the negative translation impact of GBP28m, again relating principally to the Venezuelan bolivar.

I am now going to take you through the main drivers of the 2% growth in operating profit by region. I'll start with Corporate. As you know, the performance by region is reported using budget transaction exchange rates and the difference between the budget and actual exchange rates is taken to Corporate. For H1 F '11 this amounted to an adverse movement of GBP39m. Corporate costs amount to about GBP200m a year. In the half they were GBP94m, down GBP4m against H1 last year.

Since I was appointed to the senior leadership team at Diageo and, of course, since I became CFO, my focus has been on how we can consistently improve the efficiency of our P&L. We will do this most effectively if we manage the drivers of gross margin, the effectiveness of our marketing spend and our investment in other operating expenses. I am now going to show you the effect these three had on operating margin by region.

Gross margin improved on an organic basis in the half, up 50 basis points. There was a full percentage-point increase in North America, led by cost-of-goods reductions and an improved brand mix led by Ciroc and Crown Royal. The gross margin decline in Europe was driven by margin decline in Greece and Turkey and in Great Britain, driven by the growth of Wine there and the shift to the off-trade. In the rest of Europe gross margin increased.

In International the faster growth of premium and super-premium Scotch delivered significant price mix, leading to 70 basis points of gross margin improvement. In Asia Pacific the one percentage point of negative price mix I referred to earlier was the main driver of the gross margin decline. Marketing spend increased significantly in the period, which reduced operating margin by 80 basis points. It was focused by region and category, investing where our future growth will come from.

In fact, over 60% of our incremental marketing spend was focused in the emerging markets, and 35% was targeted at driving growth of our strategic brands in the United States. In addition, we are focused by category. In the half over 90% of the incremental marketing spend was behind Scotch and Vodka, which, as you saw on the previous slide, were the greatest contributors to overall net sales growth.

Outside of these categories the global rollout of Captain Morgan continued using proven drivers. Almost 50% of the incremental spend on the brand was in markets outside North America. In these markets the brand grew 37% and now accounts for over 20% of total sales.

Of course, in being selective we have chosen where not to invest and this led to some sharp reductions in Iberia and Southern Europe where the returns on activities, such as on-trade consumer promotions, are no longer attractive. I would expect that we will also see marketing spend grow ahead of net sales growth in H2.

The negative impact on margin of increased overheads is exaggerated by the inclusion of the budget to actual FX movement, which is included in Corporate and which I referred to earlier. Overheads reduced in North America and Asia Pacific and grew less than sales in International. In Europe overheads were up as a percentage of sales, although overheads were reduced in Greece and Spain.

In summary, despite double-digit marketing spend increases the operating margins of North America, International and Asia Pacific all grew in the period. Negative price mix in the developed markets of Europe and an increase in marketing investment in Russia and Eastern Europe led to weaker margins in Europe.

Moving onto the other lines of the income statement, associate income increased by GBP10m, mainly Moet Hennessey. Net finance charges fell GBP28m. The net interest charge was broadly flat. The effective interest rate was 4.9%, up 20 basis points from H1 fiscal 2010 on lower average net debt of GBP7.5b, as against GBP8b last year. This gave a pre-IAS 39 interest charge of GBP184m. The IAS 39 impact increased the interest charge by GBP12m.

Net other finance charges were GBP27m lower than last year, with the main driver being the lower IAS 19 charge for post-employment plans. Other finance charges were GBP10m, comprising GBP8m for the unwinding of discounts on liabilities. For the full year I would expect our interest charge to be about 5%. It increases in the second half as we move to a higher proportion of fixed rate debt. Last year in the second half we benefited from the sale of interest rate swaps which will not reoccur this year.

Moving now to exceptional items, operating exceptional charges were GBP9m comprising the global supply and Ireland brewing restructuring programs. For the full year I would expect total exceptional charges in respect of restructuring programs to be approximately GBP45m, while the cash expenditure is likely to be GBP150m.

The overall tax charge increased by GBP42m, the underlying tax rate remained at broadly 22%, as per last year, and we expect to maintain this going forward. The impact of higher reported operating profit growth, together with lower finance charges and exceptional costs, delivered 16% growth in profit for the period. There was a continued focus on cash delivery in the half. Increased operating profit and lower interest and tax paid all contributed to our strong free cash flow in the half. As this slide shows, we have reduced working capital as a percentage of sales over the last two years, and in the half it reduced from 4.6% in H1 last year to 2.3% this year.

Moving now to EPS, EPS pre-exceptionals is 48.2p per share, compared to 44.2p last year; an increase of 9%. Foreign exchange benefits drove five percentage points of this growth, while organic operating profit drove three percentage points of EPS growth, and the lower post-employment charges under IAS 19 added two percentage points.

In summary, in my first set of results I can say that Diageo has performed well in a world which is presenting both opportunities and challenges. There have been some exceptional performances, both by brand and geography. Ciroc in North America and Johnnie Walker in Latin America and Global Travel are particular highlights. Europe was weaker, as some markets have been operating in environments which were significantly more challenging that last year. Overall, the return of positive price mix to our business, although small, is an encouraging sign.

This mix improvement and the efficiency programs in our supply business, to reduce underlying cost of goods per case, led to a further gross margin increase and we continued to invest in those brands and markets that we believe will drive growth. Primarily, this has been in emerging markets and in North America where we see signs of a fragile recovery.

We have kept our focus on cash and maintained working capital efficiencies, improved return on invested capital by 50 basis points and economic profit by GBP68m. This improved performance and the investments we have made give us the confidence to increase the interim dividend by 6%.

And now I will hand back to Paul.

Thank you, Deirdre. The world economy and, therefore, our performance in the first half was uneven; double-digit net sales growth in emerging markets, improved trading in North America and a challenging economic situation in Europe. Now last year I outlined the ways in which we had strengthened our business in the tough environment we faced. In this half, as the global economy recovers, albeit at a very uneven pace, we are moving into growth mode.

And we've done this in four ways; increased marketing spend ahead of net sales, with over 60% of the incremental investment directed to emerging markets and with the balance being behind our strategic brands in North America; an innovation program, tailored to different opportunities around the globe, which delivers a steady stream of sustainable growth from a balanced pipeline of over 180 new ideas; building new routes to market, particularly focused on the middle-class consumer in emerging markets; and continuing to build customer relationships which identify new growth opportunities both in developed and emerging markets; and, finally, making those changes and investments which will improve our supply footprint and deliver further cost savings.

Diageo's strengths continue to provide us with a platform for consistent growth. Our global reach and brand range give us the diversity needed to win in this environment. We are investing to drive top-line growth behind the opportunities presented by the emerging middle class in Latin America, Africa and Asia, and behind specific brand and category opportunities in the developed markets. Our operational strength is underpinned by our financial strength, which we have enhanced again this half with strong cash flow and improved returns.

I am now going to look at how we are using our strengths to deliver growth in this new global environment. As this slide shows our investment profile is changing, as we give greater focus to the emerging market opportunity. Marketing spend in the half reflects the focus we have placed behind brand building in emerging markets. In developed markets we focus spend in North America behind our leading brands as signs of recovery emerge.

In recent years operating expenses have represented a larger proportion of net sales in emerging markets as we built infrastructure. In the half we've continued to invest in the infrastructure we have in emerging markets, but here overheads were down as a proportion of net sales as we generated leverage through the P&L. In developed markets we are focused on driving efficiency from the overhead base we already have in place.

Finally, capital expenditure. In the developed markets CapEx was driven by changes to drive efficiencies, primarily in Europe. In contrast, in the emerging markets CapEx is driving growth, primarily through expanding our Beer supply footprint in Africa. Despite the different pace of growth across markets, effective marketing remains key to driving growth in both developed and emerging markets. We have focused spend in these four ways.

Firstly, we have aggressively increased spend behind our proven growth drivers, skewing the spend to categories, brands and markets where we see the greatest opportunity. For example, Nightlife Exchange for Smirnoff and Johnnie Walker Keep Walking campaign, Grand Prix sponsorship, and the highly successful mentoring program.

Diageo was an early adopter of digital channels for media. Broadband penetration on PC and mobile is high almost everywhere; marketing is now digital. We have built strong relationships with the technology companies of Silicon Valley and with entertainment providers around the world. The fundamentals of great marketing haven't changed, but our approach has. For example, in Kenya Guinness is the producer of a peak-time football-based TV show. Five million people have directly participated either by appearing on the show or by texting into it.

In November 14 cities swapped Nightlife as Smirnoff partnered with MTV, Facebook and 50,000 consumers to create the content. In the last two months in China 12 films were created under the Keep Walking campaign, in partnership with a celebrated Chinese film maker. Five million people have engaged with the content in less than eight weeks. Downloading the films, discussing them and commenting on them and what they should do next, these are all just a few examples of how we intend to stay at the cutting edge of marketing in the digital era.

Scotch has been a key driver of our performance in the half. Increased spend has driven growth in the emerging markets. In addition, we have spent more on brands such as Black & White, VAT 69 and White Horse to reach the increasing number of middle-class consumers in the emerging markets. And the fourth pillar is increased spend on reserve brands, which has delivered 40% of our growth this half. This isn't global. It is in a targeted, marketed way and supports the dedicated sales teams that we have for reserve brands in a number of cities.

As Deirdre showed, the growth of our super-premium brands has out-stripped the growth of premium and standard brands in the half. As the global economy continues to recover, this will become an increasingly important growth driver for us. Our innovation pipeline is delivering a steady stream of sustainable growth and, again, there are four pillars to our innovation strategy.

First, premiumization. We have been successful across a range of brands and price points in bringing new premium offerings to consumers who desire the quality assurance of our brands, but while still looking for something new. In the half Johnnie Walker Double Black in Global Travel and Crown Royal Black in North America were key contributors to brand performance and overall growth. In emerging markets innovation is geared to increasing accessibility and building categories as these markets develop.

In Africa we've introduced 20cl formats for our market-leading International Spirits brands, which has brought these brands to new consumers and allowed us to participate with Spirits in mainstream Beer-led outlets. In Columbia Haig Supreme is providing Deluxe Whisky packaging at a standard Whisky price point, to capture the emerging middle-class consumer looking to celebrate a special occasion.

In developed markets innovation is driving growth in new consumer occasions and maintaining consumer interest in mainstream categories by broadening our offerings. For example, Bundaberg Bear pre-mix in Australia leveraged the trend for low-carb beers and diet soft drinks and offers consumers a Bundaberg pre-mix rum with no-sugar cola. And, finally, we are building a pipeline for the future. While most of our focus is on keeping our current brands fresh and dynamic, it is important to have a broad and powerful pipeline of ideas and new- to-world brands, especially as we reach out to the new emerging middle class.

These are brands such as the tests we are running on Blackburn Blended Whisky in Mexico. We have entered into a number of strategic partnerships to grow our business and enhance the range of brands we offer to consumers, again, primarily in emerging markets. Some have been in place a number of years, although we are trying to deepen them, for example, our interest in Shui Jing Fang in China and our exclusive arranger -- arrangement for Zacapa rum.

More recently we've announced a new strategic partnership in Vietnam and the acquisition of the controlling interest in Serengeti Breweries in Tanzania, as we extend our footprint in emerging Africa. And where we've established routes to market we have also continued to improve our operating model. For example, the new arrangements we have with Glazer's in North America. Here, we've enhanced our dedicated sales force model with a more efficient leadership structure and increased the resources behind our key priorities; the on-trade; multi-cultural consumers; and innovation.

Stronger customer collaboration is also part of the way we do business in emerging markets. With Wal-Mart in Mexico we created Mundo Fiesta, which makes the Beverage Alcohol aisle more appealing to female shoppers. This concept is being rolled out to over 40 Wal-Mart stores in Mexico. As our operating margin demonstrates, we have an efficient supply organization. However, we are driving further improvements as we build an efficient supply organization which supports our growth agenda.

In November we opened our new rum distillery in the US Virgin Isles. This facility will supply a significant cost-of-goods benefit for Captain Morgan. That will, in turn, allow us to fund further marketing spend behind one of our top performing strategic brands. Our new distillery at Roseisle is now up and running to support the considerable emerging market Scotch growth.

Looking to the future, we will be investing to increase brewing capacity in Nigeria, and we are already discussing expansion at the new Sedibeng brewery in South Africa. Whilst we build new capacity to support future demand, we are also improving efficiencies and driving down costs across our 70 manufacturing sites.

Before we take your questions, let me summarize by region. In North America increased marketing spend behind our strategic brands and continued strong innovation has improved top-line growth. Reduced costs in both our supply and our demand organization, especially in Wine, have improved operating margin. And as the economy improves we will continue this strategy and build our position as the leading Spirits Company in the US, to drive growth in the world's most profitable Beverage Alcohol market.

In Europe we have scale and leading brands. The economic situation is changing the consumer environment. While some of these changes were dramatic in their scope, we can manage the impact on our business. We will continue to invest behind the growth markets of Eastern Europe and Russia. Specific issues, such as import restrictions in Turkey, should be resolved with legislative changes now taking place. In Spain and Greece we have seen the impact of further de-stocking, but we have customer programs in place to manage through this and we've up-weighted innovation to drive the top line.

While the top line grew in GB margins and operating profit declined, and there were some one-off costs in the half. These costs won't be repeated and we have plans to improve margin. In the emerging markets the investments we've made over a number of years are now delivering the top-line growth they were designed to generate. We are reaching a growing number of middle-class consumers with local brands, such as Jun Daiti Sake in Brazil and Senator in Kenya, with International brands such as White Horse and Guinness, and innovations such as Blackburn.

We are also building our leadership position in Scotch in Latin America and Asia to grow premium and super-premium brands across all categories. We have a great many strengths in Diageo, namely, our people, our brands and our routes to market and also our balance sheet. In the second half we will be focused on the opportunities which will come from improving consumer confidence in North America, from the investments that we are making in emerging markets and on improving the operating profit performance in Europe. Therefore, I expect us to deliver full-year results which improve on the momentum we have delivered in the first half.

And now we'll take your questions.

(Operator Instructions). We will take our first question from Ian Shackleton from Nomura. Please go ahead.

Yes, good morning, Ian Shackleton at Nomura; two questions. Deirdre talked about, obviously, the discount momentum slowing for you in North America. I just wondered to what extent you'd seen some of your competitors also moving in the right direction there.

And the second question was really around free cash flow utilization. You've not announced today any renewal of the buyback. I wondered if you could just give us some thoughts about where you see free cash flow being utilized over the next year or so.

Okay, hi, Ian. Maybe if I take the free cash flow question. And then it's probably better than Ivan speaks to the promotional environment in North America.

First of all, building on very strong cash flow last year we are delighted with the performance in the first half. So that has allowed us to actually increase our dividends by another 6%. So you saw a 6% increase last year; we are increasing by 6% on top of that. We will continue to look at our credit ratios, we will look at our cash generation and we may change our position as the year unfolds. It depends what opportunities are presented to us. So we are in the mode at the moment of driving cash flow, increasing dividend and keeping all options open.

Ivan, do you want to speak to --?

Sure. Ian, if you look at the recent trends the level of volume done on promotion for the industry is coming down, but Diageo is reducing discounting and promotion more than the industry is. So we are reducing it even more quickly than the industry. I think, more importantly, if you look at the overall trends in the last few months, what's encouraging to see is the premium, super-premium and ultra-premium tiers are doing better. And the overall price mix momentum is improving in North America as well as the on-premise coming back. So I am feeling much better right now about the environment.

And just maybe building on that point, if you look across our global business the rate of improvement in our reserve brand portfolio is very encouraging. We are now starting to see the higher-end marques really outperform the average for the Group, which is what we want it to do.

Just coming back on the first point there, Paul, in some of your comments earlier on there was a big focus on investment within the business in emerging markets. When you think about M&A opportunities do you also think about that as a key priority?

First of all, we will invest in the business that we currently have to make sure that our infrastructure, particularly in the emerging markets, can deliver on the growth potential of that market. Secondly, we are very mindful of M&A opportunities. And you saw in the first half we moved in Tanzania, we've moved in Vietnam and I would hope that we can continue to find such opportunities and deploy our cash flow accordingly. So those are the priorities.

Thanks very much.

We will take our next question from Trevor Stirling from Sanford Bernstein. Please go ahead.

Good morning, three questions, please. Deirdre, you referred in the call that the percentage of operating costs in Europe as a percentage of sales rose, despite sales costs being cut in Greece and Spain. Could you perhaps just give us a little more color on where the problem area lies in Europe at the moment?

Second question, Paul, you talked a lot about the new route to market to middle-class emerging market consumers and you talked about the brands that you were developing. But could you talk specifically about the route-to-market aspect of that?

And in the final area of -- talking about investment in infrastructure and marketing in emerging markets, clearly, China has received a lot of investment in both infrastructure and marketing. Is it therefore somewhat disappointing to see a 3% decline in organic net sales in the half in China?

Okay, well, maybe let's ask Gilbert in moment to speak specifically to China and Deidre can take the issue on operating cost. But I guess in operating cost terms it's simply the fact that sales fell at a rate whereby we could not remove cost at quite the same rate. I think that in nutshell is what the issue is.

Regarding routes to market and the emerging middle class, I think there is no question that we are seeing more consumers available to us at price points where we believe we can make good money. For many years in these emerging markets there have been consumers there, but their ability to purchase the kind of brands that we will get appropriate margin from has been more limited. So that is now changing, it's changing fast and we are basically trying to build our sale force that we'll be to get into far more outlets than previous has been the case.

Gilbert, do you wish to speak to China?

Yes, Paul. Regarding China, when you look at China, Scotch Whisky category grew 3% in the first half, Johnnie Walker was up 9% and our Super-Deluxe brands in China where up 22%. And the performance was not only strong on the Scotch side, but also on the Beer side. Our Beer business, Guinness, was up 26%.

Now what we need to take into consideration in the first half that we expanded our distribution on Johnnie Walker Black Label. At the same time, with the strength of the renminbi and the impact of the exchange rates, this opened opportunity for flow of goods from outside the market and this has driven the impact on our profitability in the first half.

Now the good news on China is the momentum continues in the second half; Johnnie Walker had a very strong Chinese New Year. Black Label performed very well and, most importantly, Johnnie Walker Blue label has very strong January performance and Chinese New Year performance in China.

Anything to add to the operating cost issue?

The only thing I would add with respect to Europe, because Paul is absolutely right about the timing of taking costs out, is I also referred to some one-time costs that will not repeat. There are some costs associated with a reclaim of VAT, where we had reclaimed VAT in a prior period. As those claims came through the amounts that we're actually going to successfully receive were lower than what we've originally submitted, so there was a one-time adjustment, a write-off of that VAT receivable, which also impacted the total operating costs in the period.

Thank you very much.

Thank you.

We will take our next question from Ann Gurkin from Davenport. Please go ahead

Good morning.

Morning, Ann.

Continuing with the discussion about Europe, since the Q1 interim statement really what changed? Did the consumer behavior weakened further than you expected, or the lift from marketing not come through as expected, or was it some kind of inventory de-stocking? Can you just help me understand that better?

I'll ask Andrew to comment on it in more detail but, basically, we have to keep Europe in the right context. We're basically talking about importation restrictions in Turkey; we believe that situation will be addressed. We then have very, very weak economies in Greece, in Spain, in Ireland. Nobody should be surprised by that. I would say, though, that the consumer confidence is weaker and, therefore, our sales are a little weaker than we expected them to be.

However, the flip side of the coin is Russia is doing extremely well, Eastern Europe is doing extremely well and Germany and France are just fine. We've got some issues that we have to address in the UK and we will do that. So I would say those markets are a little weaker, but we shouldn't be surprised by what we're seeing out of Greece, Spain and Ireland. Andrew.

Yes, Paul, I think that's exactly it. Diageo has had significant positions for many years in Greece and in Spain and in Ireland, so we shouldn't be surprised that we've been impacted by the economic situation in those countries. But I think it is fair to say that come November, December the declines were greater than we had originally planned and we had to react accordingly, and that was kind of late in the half, as Deidre already indicated earlier, to get a significant reaction on the cost base. But you will see the impact of that coming through in the second half in improved operating margins.

As Paul says, Europe is rather like Diageo as a whole; it's a mix of high-growth markets and some more challenged environments. So we've got 31% growth in sales in Russia reported in the half, 8% sales growth in Germany, which is doing very well for us, growth in France, 6% growth in Benelux. We're being careful to make sure that we continue to fund those growth environments and the brands and the categories that are continuing to do well for us, while, at the same time, resizing our cost base in the more challenged territories. But we did see a more difficult environment as we got towards the end of the half than we had expected.

Thank you. And in North America if you could just comment on, as you look out to the second half, how do you balance holding pricing or reducing level of promotions versus market share losses?

Ivan, can you take that?

Sure. Ann, I'd say we're sticking with our strategy, which is around reducing discounting and promotions, keeping our marketing investments, though it will moderate in terms of growth rate second half versus first half, and focusing on the premium and reserve upper end of the portfolio. So we have a strategy here that's working and we plan to hold it and, as and when consumer conditions improve, we will benefit even more.

It's interesting if we look six months ago I think I described the US as being a market of some false dawns. We had a good data period, then we had a weak one and we went along like that. We're now putting together trends that are definitely trends in the right direction. They may not be as robust as we would like, but they are in the right direction.

And I'm very pleased by the performance of our high-end marques in that marketplace and the fact that we've been able to drive that performance at the same time of withdrawing promotions support. So I'm encouraged. And let's not lose sight of the fact that we are putting 30% of the marketing increase behind the strategic brands in the States. You should that as a vote of our confidence in that market.

Great. And then, Paul, if I could just ask is the Company -- is Diageo in a position -- a comfortable position where you could make a large-scale acquisition in the Spirit space if interested?

You can see our balance sheet, it is extremely robust, but you also know our track record. We invest wisely. We expect and economic return on those investments. And I've said it in the past; whatever we buy, if we buy anything, it has to be accretive to the growth rate that we can already deliver internally.

Great, thank you very much.

Thank you.

We will take our next question from Mitch Collett from Goldman Sachs. Please go ahead.

Hi. You mentioned that the decline in Europe was because of the top line essentially declined faster than you could take out cost. I wondered if that had been addressed for H2.

Secondly, you also mentioned that November and December had been weaker than expected. Does that imply that the shape of the half was such that it got weaker as the half went on and, therefore, we shouldn't really expect a recovery in Europe in H2?

And then, finally, I suppose linked to all that, you've mentioned that you have increased confidence that you can meet guidance for the year. Obviously, the comp is a lot harder for H2 in terms of organic operating profit growth. Can you give us a bit more color on what gives you that confidence? Thanks.

Paul Walsh; I think Andrew's already covered some of the points that you raise, but maybe you can repeat them, Andrew.

Regarding our outlook, I've said in our press release that I have more confidence that we can build on the momentum that we've already seen. That confidence is predicated on the fact that we are not expecting any rebound in consumer confidence in Southern Europe anytime soon. We think we have to deal with the cards we have been dealt with in those markets.

However, look at the emerging markets; those trends are robust and continuing. Look at North America; we believe that that will continue too. So that is what gives me the confidence to believe that we can absorb the issues of Southern Europe going forward. Andrew.

Yes, I think to be more specific, on Greece, Spain and Ireland there's nothing at the moment to suggest that we will trade any better at the top line than we've been doing in the last six months. However, you will see an improved bottom-line performance as the re-adjustment of our marketing and cost base kicks in for the whole of the six months. The other parts of the region we expect to continue to get growth in, in France, Germany, Benelux, and especially in Russia and Eastern Europe.

Thanks.

We'll take our next question from Jason DeRise from UBS. Please go ahead.

Hi, two questions, and I know there's been a number of questions already on it. But there's a difference between consensus expectations and the vague guidance. Is it possible to get to a mid single-digit growth? Would that be a heroic assumption to have in for the rest of the year? As was already mentioned, it's a tough comp for parts of the business in H2. So what else can you offer to give us more confidence about the growth rate stepping up?

And then the second question is a bit longer term in nature than just the half. When we think about what you did over the past decade, it was very steady, consistent growth; EBIT generally hitting 7% growth; a few years you were at 9%. Where do you see the business model taking you in the mid term? Can you get back to those types of growth rates, assuming the economies recover?

The problem with offering guidance is that it is then used in isolation from the context of the GDP figures is which is -- has to be weighed against. If the global economy continues to improve there is no reason this business cannot get back to the historic growth rates, none at all. Regarding your question "can we get to mid single digits in profit growth", we will. I'm not sure quite when that is and I can't be that specific to say it's definitely going to be in the next four months. What I can say is that momentum is building and we will definitely outperform the results we turned in last year.

Paul, I would just add to that. If you remember -- I know there's been some discussion about the difficult comps. If you look at the first half, putting Europe aside, which Andrew has addressed with respect to what we're doing to deal with Europe, the margins are expanding in every region. And we do have or we've spoken about the specific places where we feel strongly that momentum is building.

So if you take into account the margin expansion even after significant marketing investment in the first half, which shows that that investment is returning with respect to our ability to price through the line, that gives us the confidence to say that, yes, we will continue to build on the momentum in the first half, even through it's true that last year's second half was a stronger performance.

Thanks, Deidre, a good point.

Just on that point, on the A&P, it increased substantially above sales and I know you've already said that it would increase above sales in the second half. Does it need to increase by that rate? Do you think that that's the way to think about it, or will it slow a bit?

It will be in the zone of high single digits to 10% that we've already shown. And that is very much around backing the momentum that we're seeing, taking the ideas that we're seeing in emerging markets and in the US and investing behind them, and gaining share as a consequence.

Just one more on the H2 performance. To get a better performance overall, is most of that about stabilizing Europe, and -- or do you need to see an acceleration in other parts of the business?

We need the trends to continue in emerging markets and North America and we need some stabilization around margin and cost in Europe. As I said, in Southern Europe we're not expecting the fundamentals around the consumer to improve.

Okay, thank you.

Thank you.

We will now move to Jamie Isenwater from Deutsche Bank. Please go ahead.

Good morning. Three unrelated questions from me, please. The first one, in terms of media inflation can you talk about what seen, maybe deflation, in the last six months and what you're expecting for the second half of the year?

The second question's about Swellfun in China, whether can give us an update on what's happening there. I think the shares are now below the minimum offer price, so any light you can shed would be useful.

And then the third question is how much of the 4% price mix that you've delivered in International has actually come from Venezuelan price increases. Thanks.

First of all, on China I can't comment on the stock price movement; it is what it is. We are going through the process of approval. It is longer than we thought it would be, but we remain confident that we'll prevail in this regard. And we have to be respectful of the Chinese process that they're putting around their assets, so nothing really new to report there. And the stock price, as you've seen, ebbs and flows, so I don't think that's an indicator of what's likely to happen in the process of approval.

Around media, I'll ask Andy to comment on rates, but my sense is that the notion of simply looking at media inflation is an old concept. We need to very much look at our media mix going forward, particularly as we move more and more into the digital space. And, by the way, the Gilbert's earlier point on Johnnie Walker in China, just look at some of the films that are being shown in China and the loyalty that that is building with Chinese consumers for the Johnnie Walker brand; it is very, very impressive. And that is a very different approach to marketing.

But, Andy, the raw media rates.

You've made the key point I think, Paul, which is we need to think about the effectiveness of our marketing and it's our job to make sure that it gets more effective every single year and, indeed, that has been the case in this half. The campaigns running, particularly in emerging markets, are driving the returns that you can see in the top line in those markets.

So the answer to your question is that there is inflation now at a media level. It varies massively from market to market. In aggregate it would be low single digits. We've combated that completely with our mix and effectiveness programs, which are ongoing year in year out.

Some of the examples now coming out Africa on how we're actually using digital media is very, very impressive. I'm very pleased with the work that the team's have been doing in that regard.

Stuart, on the price mix in International.

Yes. Price mix across International, actually, was pretty board based and, of course, Venezuela was a component. Across the whole of Latin America we got seven points of price mix, we had positive price mix in Africa and five points of price mix in GTME. And then when you look across the brands, again, it's a very consistent story; six points of price mix on Baileys, four points on Johnnie Walker, seven points on Smirnoff. So this is a pretty broad-based price-mix performance and Venezuela was a component, but that's what it was, a component.

Great, thank you very much.

We will take our next question from Jonathan Cook from RBS. Please go ahead.

Thank you. I just have two questions on the use of capital. You talked about strategic partnerships in emerging markets and I think these were referring mainly to distribution agreements and sales force investments. But I just wanted to check, to do you actually expect to make further equity of financial investments and buy up local spirits companies, as I think you had done in Vietnam?

Then the second question is on Ketel One. I see the option period for that, the option window, opens in June this year, so I wondered if you had an update on any news on that one, please.

Well, let's take the Ketel One question up front. In fact, Ivan and I had dinner with the Nolet family only a few days ago. They are delighted with the investment. They're delighted with the partnership. The fact that Ketel One has grown its non-North American sales by 55% since it came under our ownership delights them and, therefore, I think it's highly unlikely that there will be any change in the equity arrangements of that brand in the near term. And I'm very pleased that that's the way it is.

Regarding this issue of use of capital, let me first say that our job as managers is to generate the cash first; we're doing that. It is then to make sure that we are maximizing the opportunities for our existing business wherever it operates, and we've done that progressively through infrastructure investments, strategic partnerships etc., etc. That's the first call. We will then look at M&A opportunities. And I've said many times that I am very compelled where it makes sense to deploy more capital into the emerging markets.

And we then have the opportunistic M&A opportunities that often get cited around Moet Hennessy or Cuervo or whatever, that, by and large, are outside of our control. Here today we are very much focused on growing our organic business and making acquisitions where it makes sense in the emerging markets. If the other situations change, so be it.

Okay, that's great. Thank you very much.

Thank you.

We will take our next question from Chris Pitcher from Redburn Partners. Please go ahead.

Good morning, a quick follow-up question on some of your Asia businesses. You mentioned that Johnnie Walker saw good volume in China, but made a comment alluding to some price competition increasing. Overall, China saw minus 1% price mix. Could you give us what the net sales growth for Johnnie Walker was on the volume growth of 9% and maybe flesh out a bit about your competition comment on the on-trade?

And then, secondly, obviously India is heavily distorted by your change in route to market there. I was wondering if you could give us more of a feel of what underlying growth is there for Johnnie Walker volume and value, and some update on how some of your initiatives in local Spirits are developing in India. Thanks very much.

Okay, I think that's coming your way, Gilbert.

Yes, ready for it, Paul. Thank you for this question. Let me start with India first. In India we have a new route to market and we are delighted with the impact that this is having on our business. I would start with the regular brands because Johnnie Walker has an iconic status in this market, has a leading position in Whisky and we're expanding Johnnie Walker Red, Black and Super Deluxe. But let me just make a point on VAT 69 and Smirnoff, just to highlight the impact of our new route to market in India.

These are brands that we use to market over the last few years in India. The impact of our route to market on these brands in H1 was VAT 69 was up 68% versus the same period last year and Smirnoff was up 40%. This is the impact of our new sales force that is going into more cities and enhancing the capabilities of the team we have on the marketplace.

Moving now to Johnnie Walker, the biggest news on Johnnie Walker in India is now Johnnie Walker is marketed directly by our dedicated sales force in India, which was not the case last year. Last year we used to go through a third-party distributor, now Johnnie Walker is with the core team in India and we see big upside potential for Johnnie Walker in India. So this is with regarding India.

Now moving to China, China, when we look at Johnnie Walker, volume was up 9%, NSV was up 1%. Most importantly on Johnnie Walker in China is we are gaining share in Deluxe and, most importantly in Super Deluxe, and this is a momentum that is continuing in the second half. And we could see the NSV growing faster than the volume in the second half, based on us having addressed the situation that has affected our volume to NSV mix in the first half.

Could you just give a bit more color on -- you mentioned price increases being rolled back. Is the pricing environment in China for Scotch becoming weaker, or did you just go in at too high a price point and that's had to be rolled back? I'm just trying to get feel for whether this is the beginnings of a weak pricing environment for China Scotch now.

It is not a weak environment for pricing in China. The situation is very easy. Johnnie Walker is becoming more popular in China, more successful. We launch a big mega campaign driven by clear Chinese insights. The Johnnie Walker brand is expanding its footprint and Johnnie Walker is a global brand. Because of the strength of the renminbi we had a flow of goods from outside the market and this did put pressure on our pricing in China. It is not impacted by our competitive position in China. It's impacted by the strength of the renminbi and the success of the Johnnie Walker franchise in this market.

Thanks very much. And one final question just for Paul, please. You mentioned in response to earlier question on acquisitions that acquisitions had to be accretive to internal growth. I haven't heard that comment before. Could you give a bit more clarity? Is that internal growth in terms of operating profit, earnings, returns? I'm just trying to get a gauge for what your M&A hurdle rates are now.

Well, first of all, I meant they have to be accretive to the NSV growth rates that the Company is currently enjoying. In other words, simply buying something as a cost-reduction opportunity isn't that appealing to us. We want brands that can come into our stable that we can drive further, such as Ketel One, with the example I just cited around its international development. And that's they way that we look at acquisitions. And I think on the whole question of deployment of cash I've probably answered that as comprehensively as I possibly can.

Thank you. I just wanted to clarify what you meant by growth, and that was clear, thank you.

Thanks.

We will take our next question from James Edwardes Jones from Espirito Santo. Please go ahead.

Yes, morning team. Two quick questions, if I may. You had, I think, a 40 basis-point decline in your depreciation charge in the first half. Can you explain that a bit further, given the amount of investment that's been going in to the business?

And, secondly, you had a working capital outflow of around GBP0.5b in the first half of the year. Working capital was obviously a big contributor to the cash generation of the business last year. Can we expect negative working capital for the year as a whole, or will you be able to repeat the cash inflow you did last year?

We have said that, as a consequence of our performance last year, we see that as being the first year in step changing our cash flow generation capability. Now there are certain things that we did last year around vendor terms that won't be repeated, but we will hold onto it. So I expect another strong year of cash flow, not quite as strong as last year.

On the depreciation (multiple speakers).

Yes. On the depreciation, the decrease is due to the exceptional accelerated depreciation associated with the supply restructuring that we announced last year -- in 2009, which was a lower impact this year. So it doesn't have to do with our underlying CapEx investment rates.

Got it. But would I be right in thinking on that basis that the 40 basis-point lower depreciation charge would have benefited your operating margins?

Yes.

Sorry.

Yes.

Yes, it did. Thank you.

We will take our next question from Nico Lambrechts from Bank of America. Please go ahead.

Thank you for taking the question. Hello Paul and team.

Hi, Nico.

I'd just like to come back to the comment on guidance. As you're aware, the market is currently at 5% organic EBIT growth for the full year. You haven't changed your guidance. Are you, therefore, comfortable with the market expectations for the full year and, therefore, a second-half growth rate of around 8%?

And, related to that, should Diageo give us positive operating leverage this year, in other words, organic EBIT growth be greater than organic sales for the full year?

Can't you be a bit more direct, Nico? I am confident that our second-half performance will accelerate on what we've already delivered. Whether that gets us to 5%, I don't know; it's certainly in that territory. But I know that the second-half performance will be very robust and will build on the performance of the first half. We are going to continue to invest in marketing ahead of sales in the second half. The reason for that is that we do see opportunities now emerging that investment this year is going to position us very, very well in the outgoing years.

And to round it all off I come back to a point I made earlier. There is nothing fundamental in this business that has changed. I do see our ability to progressively move this business back into the high single-digit operating profit growth levels that we saw before. And what I believe, as consequence of what we're seeing in North America, outstanding performance in emerging markets, we are on the road to that delivery.

And in terms of the operating leverage, should we expect fiscal '11 and possibly also fiscal '12 as years where you invest with A&P in order to capture these opportunities? In other words, operating leverage we might only see in fiscal '13? Is that the sort timeframe --?

I think that's too far out. I think that too far out. We'd have to look at it next year. Certainly, this year that's what we're signaling. But rather than look at operating profit leverage, look to gross margin, and that's where you are definitely going to see positive mix coming through.

The 50 basis points which we saw in the first half, that's full year?

Yes.

A follow-on question on the US. You are saying in your outlook statement that you have increased your investment in the US to bold brand equity and move away from promotional support. Could you maybe comment on the brand equity or strength of your major brands like Captain Morgan and Smirnoff? I remember during 2009 you were talking of positioning Captain Morgan and Coke in the Beer aisle. Captain Morgan gives you 40 drinks versus Beer gives you 24. Has that not changed the status of Captain Morgan in the consumers' mind and are you getting that back to a premium, because these are your big brands in the US?

Ivan.

Sure. Nico, if you look at our priority portfolio, the big brands like Captain and Smirnoff and Crown Royal and Johnnie Walker in the US, what I'm very pleased with is our brand health and equity measures are strong and improving. Now part of what you're seeing and why our volume performance is subdued in some of these brands is we are reducing discounting and promotion, and our price premium relative to competition is widening. So we're improving equity, we're improving our price premium and I think that positions us very well. We have a lot of confidence in our campaigns on these brands and that positions us very well, as I said, as the recovery comes for these brands to come back.

On some of these brands, Captain Morgan's a good example, we've got a lot of new entrants coming into spiced rum at lower prices and at better value. And I actually feel pretty good in that environment, where a brand like Captain Morgan is holding its own, retaining its premium credentials and is widening its price gap at a time when there's a still a fair amount of discounting and lower-value brands coming into the category. So overall for the most part on our premium portfolio in North America I feel very good about the health of the equity and that, indeed, is why we feel confident in stepping up the marketing investment.

So despite you being confident on the health it is very competitive because of the new entrants?

Yes, but it's quite amazing when you look at our ability to hold onto the price premium and the strength. And that's where the -- when you look at the leverage coming through the P&L, where we're growing gross margins and growing operating margins. I think we've got the mix right for this environment, which is a focus on price mix improvement, drive strong gross margin improvement, which we're doing across the portfolio, invest ahead, which we are doing in marketing, but through all of that we're expanding operating margins through very tight cost control both on the cost of goods and the overhead line.

So I like the mix of how the P&L is shaping and I like the way the brands are positioned. And you're going to see some pretty new and exciting work as well developing on Captain Morgan as we go into the third and fourth quarter. We have some terrific campaigns which are going to be backing strongly into the second half and into next year as well.

Excellent, and then, just finally, a clarification. You mentioned on China that a part of the price pressure was due to the renminbi strength, but in the text in China it says that part of the sales decline was driven by higher trade investment behind Johnnie Walker. Was there some discounting or promotional activity going on in that market as well, or was this all related to the currency issue?

I would say it is expanding our footprint on Black Label in the on-premise, your going into accounts and also the strength of the renminbi and the exchange rate that opened the door for more goods coming from outside the market.

But have you actually reduced the price premium or reduced below the price points of your competitor brands?

We were alone increasing our pricing on Johnnie Walker last year, so we had to roll back our price to the same price of last year because of the flow of goods from outside the market.

Got it. So you brought your price points closer to the competitor, Chivas?

The same price that we were last year, yes.

Got it. Thank you very much.

Thank you, Nico.

We will take our next question from Simon Hales from Evolution Securities. Please go ahead.

Good morning, everybody. Just a couple of follow ups really. I just wondered, just gong back to the European business and the movement in the cost base for the second half, whether you could just quantify that a little bit more; perhaps help us understand in the first half how much of the decline in profits were due to some of those one-offs that Deidre talked about; how we should think about A&P spend moving H2 on H2 in Europe; and where perhaps some of the fixed cost-base savings are going to come from in that region?

And then, just secondly, just on the Corporate cost outline -- the Corporate cost line, I wonder if Deidre could just run through the movements again in the first half just so I've got it clear and, perhaps, how we should think about forecasting that line for the full year.

I think the one-off costs in Europe were about GBP7m, GBP8m that won't be repeated. And I think it's not appropriate at this juncture to be specific on the cost-reduction targets that we have in place in Europe, but there are in place and we'll be moving forward to prosecute that agenda with alacrity.

Regarding Corporate charges.

Yes. The Corporate costs, I think what I said was that was marginally driven by the budget to achieved rate that, for the regions, are recording at budget rates and the budget to achieve difference goes through Corporate. Again, the impact of that in the second half will, of course, depend on what happens to the difference in the rates. The underlying Corporate costs moved by about GBP4m and as -- I think the point has been made several times. We are actively looking to control our costs in line with the operating environment and would expect that that would continue in the second half.

Okay, perfect, thank you very much.

We will take our next question from Jamie Norman from Evolution Securities. Please go ahead.

Yes, good morning, everybody. Just on question. Really the only fly in the ointment in Asia Pacific seems to be Australia, which, historically, was a good source of growth for you. Just a perspective would be welcome on the retail environment. We know that two major retailers are slugging it out and you're caught on the crossfire. Do you see that continuing?

And, secondly, any update on when the Aussie government might rescind the increase in the Ready-to-Drink tax that hit you last year? Thank you.

Gilbert.

Yes. Talking about Australia, Australia is an important piece of business for us, you're right. This is market where we are leading the category and we are leaders in Spirits and Ready to Drink. Despite the market being competitive we have improved our market position and we gained share in Spirits and in Ready to Drink. Christmas was very strong for us in Australia, where we even improved furthermore our leadership in this market and we see this momentum continuing in the second half.

On the Ready-to-Drink taxation, I cannot comment on this one.

Okay, thank you.

Thanks, Jamie.

We will take our next question from Matthew Jordan from Matrix. Please go ahead.

Yes, good morning, everyone. Two quick questions, please. Firstly, on Venezuela, could you talk about your pricing strategy there, given the exchange rate movement and also what impact the pricing is having on volume?

And the second question is on Johnnie Walker global price mix, which was down a touch despite from, reading the text, very clear mix improvements coming through on that brand around the world. Is that entirely down to this pricing issue in China, or is there something else going on that's a drag on Johnnie Walker's price mix equation? It would be quite good to have a bit of clarity on that, please.

Stuart, can you speak to Venezuela?

Yes, Matthew, hi. Look, the priding strategy in Venezuela is very consistent with where we've been in the past and that is essentially to be pegging our prices in dollar equivalents. And we don't move it every week or every month, but within a relatively short time we look to basically hard currency price.

That has meant, though a combination of the price increases and also, as you know, the restrictions on availability of foreign exchange, that has lead to a volume reduction in Venezuela and we dropped volume 27% in the first six months. But our net sales were up 13%, so we got 40 points of price mix in Venezuela. And I think that just appropriately reflects our strategy on maintaining hard currency pricing and maximizing our ability to generate earnings with the foreign currency that we can obtain.

On Johnnie Walker mix, Deirdre.

I think there is an impact of it, of course, in Asia to the points that we have spoken about, but I think you have to go and look at it market by market as we're looking. So of course in some markets we are seeing a trade up. In other places, depending on what's happening in the differences in the competitive activity between the on-and the off-trade, there would be movements among that. So it is a combination of both pricing activity based upon market conditions and a combination of the trading up; the mix within the brand.

Okay. Thanks very much.

Thank you.

We will take our next question from Gerard Rijk from ING Bank. Please go ahead.

Yes, good morning. Three questions, if I may. First is about the cost of goods sold. Can you give a guidance on that for the second half, how it will develop? I understand that your gross margin is doing quite well but, specifically, this element.

Second one is your remark on the appreciating yuan. Well, you have of course a relatively small exposure still to China, but can you talk about the mechanics? Is that using this additional room for additional marketing spend in this area?

And, thirdly, is about your successful UK story up to now and about cycling the successful cash stream management initiatives. Is UK heading up to a decline in the second half?

First of all, on COGS we're pleased with the work that has gone behind orchestrating structural cost reduction and also the fact that, on a constant mix, we are at least holding our COGS flat.

There's a lot of talk about escalating commodities. Two things I would say is that, first of all, the next six months we are covered; that's not an issue. Also, going beyond that, agricultural input is quite limited regarding the overall cost of goods for our products and, indeed, on a product category such as Scotch, the cost today actually doesn't feature in cost of goods until that product has been matured and relieved from inventory, which could be eight years plus. So cost of goods overall flat and we're not seeing immediate threats from commodity increases.

The other point on GB.

Yes, GB I think it's fair to say is a healthier business than these current numbers suggest. You've seen the one-off impact on margins that we alluded to earlier; that was in the GB numbers. We also had buy-in in June of last year because of -- against the rumors of excise tax increases in the emergency budget, so actually our sales numbers have been diluted by that impact. So the underlying sales trend in the business, I'd say, is more healthy than you're seeing in these numbers.

We've got share gain in Bell's. We've got three points of share gain in Baileys. We lost a share point in Smirnoff, but that's from 49% to 48% of the market, and it was as a result of specific decisions not to participate in binary listing opportunities in some of the on-trade because of the margin implications of that. Our innovation is up 58% year on year in the UK; we're rally raising our game on innovation. And our reserve portfolio at the top end of the business was up 27% in the half as well. So there's a lot of good news around the UK.

The other point that's been mentioned before, I think, is our Wine business was up 18% on sales, actually on a decline in volume of 6%, so we're actually turning our Wine business into much more profitable piece of the business. So I'd expect an improving picture, certainly, at the bottom line in the second half for GB.

Okay, and on China?

China, sorry, Gilbert.

China, we see premiumization back in China. Super-premium brands are growing faster than Deluxe brands and this is where we have invested behind Johnnie Walker. We have a big campaign behind Johnny Walker that we launched two months ago that is yielding very good results and engaging, emotionally, Chinese consumers with the Johnny Walker franchise. And we are also testing higher investment behind Blue Label that is yielding great results. And this is reflected by our performance on Johnny Walker Black Label and, most importantly, behind Johnny Walker Blue Label in January and during Chinese New Year, where we saw very solid performance on Walker and mainly on Johnny Walker Blue Label.

But the appreciation of the yuan, you are taking advantage of that margin increase by investing more in A&P, or is it that you take more profits?

Exactly. We are investing more in A&P. And, again, profitability in China is very clear. We have three businesses in China. We have two joint ventures, one with Moet-Hennessy and one with Shui Jing Fang. And these two businesses are profitable. And we have one other company that is Diageo China Limited, where we have Windsor, Smirnoff and Baileys, and we are investing behind these brands for the future. And this is the business unit where we lose money in China. And this is our own decision. We believe that we're investing behind these brands for the future and we see big potential behind Baileys, Smirnoff and Windsor in China.

Okay. Thank you very much.

We will take our next question from Erwan Rambourg from HSBC. Please go ahead.

Yes, hi. Good morning, everyone, Erwan Rambourg from HSBC. I have three follow-up questions on the US so, sorry, Ivan. Firstly, you have increased advertising to sales and you are committed to continue to do that in H2. You have commented on the fact that there is less promotion going on. I was just wondering when do you think the market will actually see some price increases and you, as the leader of the market, when do you think you will be able to actually increase prices?

Secondly, looking at Johnny Walker volume down 9% in the US, you explained that it is a technical, basically, convergence between sell-in figures and depletion. Is this just a one-off element and do you think we will see other adjustments in terms of inventories in the future in the US?

And then, thirdly, on the Vodka category we see trends on Ciroc absolutely flying, but then quite a crowded space in Vodka, more launches -- actually, more launches from Diageo as well and we see limited growth for the first half on Smirnoff and Ketel One. So I'm just wondering if you think that the launches that the market has made, but also that you have made, have maybe jeopardized the growth that you may have had on Smirnoff and Ketel One. How do you think about, basically, the overcrowded nature of the Vodka space right now in the US?

Sure. Erwan, let me take them one at a time. On the pricing outlook for the business, the way we are thinking about it is we have reduced discounting and promotional support very consistently over the last 12 months, so our price realizations are going up. We look at pricing decisions by market, by brand, by pack size and, in the US, "by market" is by State. And we are following conditions very closely and, as conditions improve, both equity and consumer conditions, we will be in a position to take price and I'd say that's the philosophy we are adopting on pricing going forward.

On your question on Johnny Walker, there was an adjustment in that brand because, if you recall last year, we got somewhat surprised by a weak Christmas and November and on our imported brands we tend to ship ahead out of Scotland, so we were committed to the volumes. So it's nothing unusual; we are just adjusting the inventory level down there.

The brand actually is really healthy. Depletions in Johnny Walker were plus four in the first half and the top end of Johnny Walker is doing amazingly well; Super Deluxe. We had a phenomenal Johnny Walker Blue season in November and December and Black Label is very healthy, increasing its price premium, growing share. I actually feel very good about Johnny Walker.

On your Vodka question, Vodka is indeed a very competitive and crowded category, but I have to say I feel very good about our category approach to Vodka. You have seen the numbers in Ciroc, which are very good. Ketel One reported numbers are flat to 1%, but our depletions in the first half were running over 3% and, most importantly, our on-premise business in Ketel One is running plus 7%, plus 8%, so that brand is very healthy.

We feel -- as Paul alluded to it, we feel very good about where it is. The campaigns are working strongly. There is a lot of price competition in that super-premium segment, people repositioning down, but Ketel has held its position and I feel will really come out of this, and is coming out of this, much more distinctively positioned, holding its price premium and will -- well positioned to grow share.

On Smirnoff, which is the market leader, 20% of the Vodka market in the US, what you have seen in the first half is we have backed-off promotional support, particularly in the chain markets on Smirnoff, to improve, again, price realization. The brand is healthy. We have got some exciting campaigns on Smirnoff with the I Choose campaign and a reality show called Masters of the Mix, both of which trending very well. So Smirnoff, as we ease off pricing and discounting and improve price realization is coming under a bit of share pressure, but the brand is healthy.

And then the new entries are there to really ensure that we keep our category strength strong overall. So Vodkas, as you know, is the fastest-growing part of the US Spirits market still today. We intend to lead the category and I actually, overall, feel very good about the portfolio, including the new innovations, and our ability to manage the total category here and extend Diageo's competitive position.

And I would just take you back two or three years, when we really did not have a position in Vodka to play at super premium and ultra premium. We are in a very different place today and, actually, it's one of the categories I'm most excited about in terms of how well we are positioned going forward.

Okay, thanks. I just wanted to come back to the first question. I understand your -- about price increases, I understand your comment about it depends on brand equity, it depends on the State, it depends on the consumer confidence at data point. Are you in a position on certain brands or in certain States today to put through price increases, or what's the -- basically, what's the time horizon you have?

As you look at what we have done, if you just look at the history in the first half, within those numbers we have taken price increases on certain brands and pack sizes, so on Vodka in [certain] States. We will continue to do that and, again, I can't give you specific plans on pricing here, but our focus is very much to improve price and mix in the business and we will be -- we are geared and positioned to it and you can see it from our posture and advertising and brand-building investment. It's very much to support that ability to improve pricing as market conditions allow.

Okay, thank you very much.

And maybe just to build on the Vodka point, a few years ago people quite rightly criticized us because we did not have an ultra-premium offering. We have now got two brands that are setting the trends in that category. That is the power of our marketing and it's the power of our route to market.

Thank you very much. Thanks.

We will now take our final question from Javier Gonzalez-Lastra from Exane BNP Paribas. Please go ahead,

Yes, good morning, gentlemen, two quick questions. You mentioned in the statement this morning that there has been some liquidity issues with distributors in Spain, which has lead to de-stocking. Could you expand a bit on the situation here and explain whether you have gone as far as recalling product from distributors on concerns that you may not get paid?

And, secondly, a second question is on Scotch and inventories there. You carried out quite a big investment in 2008 on this part of the business. I wonder whether you could update us on your investment plans here, given that demand, at least for ultra-premium Scotch, has improved.

Let me talk about the Scotch issue and maybe, Andrew, you can talk in a moment about Spain. We will continue to invest in Scotch. One, we are very confident about the future of Scotch in our existing markets and we remain optimistic that other markets that currently have got very high tariff levels will progressively -- those tariff levels will progressively come down.

So it behooves us to invest wisely in bulk liquid. We've brought Roseisle on stream, which is a fantastic new distillery in Scotland. Clearly, we have to wait until that liquid matures before we can start to sell it, so there is an inevitable lag here. But, equally, where we have the opportunity to buy bulk liquid that comes to market, we've seized that opportunity. So we are very, very well positioned for the long term to capture the long-term prospects of Scotch.

Distributors in Spain.

Yes, when you got a decline in consumption you get two or three things at play in terms of trade stocks. The first thing is the same forward cover of stock in terms of sales, obviously, is a lower absolute amount of stock, so automatically the lower consumption drives lower stocks in the market.

We were also hit in Spain, though, particularly as you got very negative news flow from about November onwards, by just a psychological factor in the Spanish trade, where they decided to hold lower stocks. And in some cases we decided not to ship as much as we might otherwise to certain customer, for obvious reasons. So you are getting all of those three factors at play.

I would say, actually, the more severe impact that we have seen from de-stocking has been in Greece, where we have had a number of customers on credit hold in terms of taking a more conservative view on risk. But, yes, there has been more de-stocking in Spain, mostly driven by just lower consumption, lower sales right the way down the channels through to the consumer.

Thanks, Andrew. And thank you for your questions. Maybe as we wrap up, just to reinforce a couple of points, first of all, we understand where our issues lie in Europe and we are resolute to tackle those issues. However, the business overall has got fantastic momentum. We are seeing premiumization return, we are seeing operating margin -- sorry, gross margins improve and, whilst we can't comment specifically on pricing, the environment is somewhat better as we see inflation coming into play here.

So we got great momentum and we are investing behind that momentum and we are very confident of our improved performance in the second half. Thank you.