Fomento Economico Mexicano SAB de CV (FMX) 2007 Q2 法說會逐字稿

Good morning, everyone, and welcome to FEMSA's second quarter 2007 earnings results conference call.

OPERATOR INSTRUCTIONS)

During this conference call, management may discuss certain forward-looking statements concerning FEMSA's future performance that should be considered as good faith estimates made by the Company. These forward-looking statements reflect management expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the Company's actual performance.

At this time, I will turn the call over to Javier Astaburuaga, FEMSA's CFO.

Please go ahead, Javier.

Thank you. Good morning, everyone, and welcome to FEMSA's second quarter 2007 earnings conference all. Joining me today are Alfredo Fernandez and Juan Fonseca, both of whom you know well.

Our second quarter results reflect progress made in every one of our businesses in the context of continuing challenges, such as tough comparisons, as well as inflation pressures in certain raw materials.

Despite a slowdown in our key Mexican market, we again delivered strong consolidated top-line growth of 7.4% in real terms. Consolidated income from operations grew a slight 0.6%, combining soft but improving results at FEMSA Cerveza, a solid quarter for Coca-Cola FEMSA and another good quarter for OXXO, with gross margin expansion compensating for some weakness in same-store sales growth.

Below the line, a reduction in other expense and the positive effect of a strong peso more than offset an increasing interest expense and the lower effective tax rates contributed to an increase of consolidated net income of 32.5%.

Moving on to our business units, at FEMSA Cerveza, beer volume growth in Mexico again started the quarter very slow, resembling the dynamics of the first quarter, as a slightly lower consumer demand across the country was [instigated] by unseasonably cold and rainy weather in the north, specifically during the first half of the quarter.

Again, as the quarter progressed, so did volume growth, and for the quarter we were able to deliver 3.2% growth in Mexico. In Brazil, we achieved volume growth of 8.1%, with our brand Sol delivering the majority of the growth, even though it was launched only nine months ago. Year-to-date, we are up 11.4% and continue to grow ahead of the industry.

In exports, volumes grew a robust 27%, driven not only by the rapid growth of Dos Equis in the Eastern U.S. and Tecate in its Southwest strongholds, but also by a solid performance of Sol in other key markets.

In terms of pricing in Mexico, we implemented a selective price increase, starting in late May and through the month of June, and therefore the quarter's revenue per hectoliter figure of 2.2% down does not reflect the full benefit of this increase. It'll do for the third quarter.

In Brazil, where we implemented a price increase late in the first quarter, revenue per hectoliter increased 2.8%, while in our exports revenue per hectoliter fell 3.6% as the effect of inflation and a strong peso offset an increase of 3% in dollar terms.

Finally, revenues for packaging fell during the quarter, reflecting the fact that at this point we are not making any third-party sales of glass bottles, as all capacity is being used for FEMSA's own requirements. So total revenues grew 2.7% for the quarter.

On the cost of sales front, we saw an increase of 7.3%, resulting mainly from total volume growth of 6%, and from higher prices for grains as the price of aluminum is gradually trending toward last year's levels and is no longer the main raw material problem. To a lesser extent, we were also impacted by the fact that we are buying some glass bottles from third parties, as our own glass facilities are working at full capacity. In the short term, this will continue to be the case, as our volumes keep growing.

Income from operations decreased 16.8%, reflecting our moderate ability to take pricing in Mexico, as well as increase operating expenses in other markets. Administrative expenses were well contained during the quarter, growing by only 1.4%. However, selling expenses increased 11%. Brazil contributed 3 of the 11-point increase, and yet we managed to breakeven at the operating income level in Brazil for the quarter.

Selling expenses, ex Brazil, grew slightly below the trend of previous quarters. This growth is linked to our continuing investment initiatives aimed at strengthening our market position in Mexico and developing our brands in Mexico and the U.S.

In Mexico, we continued to strengthen our core Sol and Tecate franchises, while we further develop our portfolio with new brand extensions such as Sol Cero, our nonalcoholic beer, as well as Bohemia Oscura, a high-end dark lager with a super-premium position. In the U.S., we are increasing the support for Dos Equis and launching Tecate Light in selected markets.

All in, these results are slightly weaker than our expectations for the second quarter, and we can sum up the main reasons as poor weather, delayed pricing and raw material pressure in grains. As we have stated since the beginning of the year, our business plan for 2007 always looked like a tale of two halves, where the first half would look weak and the second half would look strong, impacted by comparisons and the expected behavior of raw material prices.

However, we did not expect such atypical weather hurting volumes during the first half, and we have mentioned that pricing has been softer than anticipated. Still, even where we stand right now, we believe our stated objective of achieving full-year operating income in line with 2006 levels in real terms remains achievable. The challenge today seems a bit stiffer than it did only three months ago, but we are stepping up our efforts accordingly.

In order to get there, we basically need volume growth in Mexico to be at or slightly above 5% during the second half, consistent with June and July trends. We have hedged approximately 7% of our aluminum requirements for the rest of the year already, and we expect the price of grains to remain close to current levels for the second half.

We have also hedged a significant percentage of our net dollar requirements for the rest of the year at attractive rates. We will continue to work on containing administrative expenses while maintaining current levels of selling expenses that will allow us to continue making progress on the development of our long-term competitive position. And when is all said and done for this year, our beer operations should be stronger.

Turning to our soft drink business, Coca-Cola FEMSA delivered a solid quarter, where the Mexican operations showed clear signs of improving volume and profitability dynamics, while most operations outside of Mexico again achieved outstanding results.

Total revenues increased 8% and income from operations increased 10.5%, representing an expansion of 40 basis points in the operating margin. In the key Mexican market, revenues increased 4% with flat pricing. Despite facing a tough comparison from 2006, volumes increased 3.8%, primarily from growth in brand Coca-Cola, including continued strong performance from Coke Zero.

Better pricing and controlled operating expenses mostly offset significant raw material pressures deriving from high sweetener costs and operating income fell by 1.6%. Operating income generated by our operations outside of Mexico continues to represent a growing share of the total and for the second quarter it amounted to 34%, up from 27% in 2006.

If you were unable to participate in Coca-Cola FEMSA's conference call last Friday, you can access a replay of their webcast for additional details on the results.

For its part, and just like our beer operations, OXXO was affected by adverse weather in northern Mexico, particularly during April, which included the key Easter holiday this year. As a result, and compounded by tough comparisons versus 2006, same-store sales started off slow but improved as the quarter progressed, reaching good levels in June and delivering average real growth of 1.2% for the quarter.

Traffic again was the driver, increasing 1.8%, while average ticket decreased 0.6%. We opened 159 new stores during the period and grew revenues by 12.3% during the quarter. As was the case, gross profit improved, driven largely by the implementation of improved pricing strategies, as well as a strong performance from some high-margin categories, such as coffee and sweets.

Administrative expenses decreased by 10% for the quarter, as the first layers of the Oracle IT platform were fully amortized, and operating expenses remained stable as a percentage of sales.

Income from operations grew by 36% and operating margin expanded by 90 basis points to reach 5.1% of revenues. So except for the one-off effect of the bad weather in the first half the quarter, OXXO once again delivered a strong set of numbers and continues to execute according to plan.

Finally, I would like to touch briefly on two developments that have taken place in recent days and weeks, both of which represent meaningful steps toward the achievement of our long-term goals.

First, the Mexican Antitrust Commission has approved the joint acquisition of Jugos de Valle by Coca-Cola FEMSA and the Coca-Cola Company, subject to certain conditions. As Hector Trevino mentioned on the conference call on Friday, we expect these conditions to be acceptable from the perspective of our business.

The acquisition will provide us with a strong platform to develop our portfolio of still beverages across our operations and will crystallize our new joint venture business model with the Coca-Cola Company. We expect that transaction to closer later this year.

And, secondly, Coca-Cola FEMSA has reached an agreement with the Coca-Cola Company to achieve the bottling territory of REMIL in Minas Gerais Brazil, which includes the city of Belo Horizonte and serves approximately 50 million people. Valuation of $380 million is within KOF's current valuation on a per-case basis and is subject to customary due diligence, currently taking place.

Once we incorporate that volume to our existing KOF operations, it will represent approximately 30% of the volumes of the Coca-Cola system in Brazil. From the perspective of FEMSA, Brazil will contribute over MXN14 billion to our annual consolidated revenue, or approximately 10% of the total.

We expect this transaction to close in the first half of 2008. And, with that, I would like to open the call for your questions.

Operator, please?

(OPERATOR INSTRUCTIONS)

And our first question is from Andrea Teixeira with JPMorgan.

Hi, good afternoon, everyone. My one question is regarding I understand Hector was very, very -- I'm very pleased with his expectations on Friday regarding the CFC requirements, but I would say what is the risk which is only for the callers and the OXXO stores, what is the risk that they implement the same kind of model for the FEMSA portfolio, including beer, and hat would be the risk in your top line at this point? In other words, how much you sell through OXXO on the exclusive side of the OXXO stores? Thank you.

Yes, I think Hector made the point that the conditions that are of our knowledge doesn't really represent something that puts at risk the future of the business when looking at Jugos del Valle on its own. And the imposed condition of in time going away from the exclusivity condition from Coca-Cola to OXXO is limited to exactly that. That is, Coca-Cola won't be able to impose an exclusivity condition on OXXO, and it will be for OXXO to decide what to do with that new let's say cola products only. And that is a condition that is set for cola products only, not flavors, talking about CSDs and, of course, on the noncarbonated thing also, not being able also to manage Jugos del Valle products on an exclusivity basis.

As I'm sure you all know or are aware, today OXXO manages precisely who makes the competitors' products on an exclusive basis. So that would be my comments on the CSDs and the noncarbonated products.

That doesn't have anything to do with the beer products at all, and that's very, very clear. Some of your point on what percentage of beer is sold through OXXO on the beer products, Andrea, is at this stage about 10% of our products are sold within OXXO.

But we don't see any case, looking at the way the category is being commercialized and sold in Mexico as any threat or any condition being discussed at all in terms of having a condition on exclusive or non-exclusive beer products on OXXO for the future. So we are not really either considering or thinking that there is a risk there so far.

Okay, great. Thank you so much.

Thank you.

We'll take our next question from Bob Ford, with Merrill Lynch.

Hey, good afternoon, everybody. With respect to your COGS breakdown, there have been some pretty big moves in terms of aluminum and barley, this shift toward buying glass from third parties. Javier, can you give us a sense of what your cost of goods sold breakdown is today and what the breakdown is in the second half as we go forward and just factoring the price increase, some additional perhaps pricing pressure from barley and third-party glass?

Yes, Bob, going a little bit away from the first part, which the breakdown Juan can spend some time later on outside the conference call, but on the second one is, as I said, we feel pretty much comfortable with the outlook for the second half in terms of raw materials. I would say that barley is kind of the only I would say piece that are still of a little bit of concern, because the negotiations for establishing the price within September, October are just starting and we're just kind of measuring the waters here.

But in the rest of the cost components, we feel very, very comfortable, as I said, not only because we have hedged both prices and FX for the most important requirements that we have in both aluminum and raw materials coming or linked to the dollar. And that's why I'm still optimistic in terms of even though we're going to have a tougher second half in order to get to the objective that we set ourselves, because we had a little bit more softer quarter than the one we're anticipating for the second one, we feel pretty comfortable with the room that we have to maneuver, and we're doing extra efforts to really manage the business for the long term, but yes, looking very, very consciously about the environment for the second quarter.

So, Bob, just I would say domestic barley crops being the most important one, but again, the impact for the second quarter as a whole would be not very significant, because we will be talking mainly effects for maybe two to two and a half months of requirements. So the rest of the requirements for the quarter have been already negotiated for good.

Fair enough. And in your comments, you suggested that purchases of third-party glass were temporary. Is that correct, and just curious, when do you plan to add another furnace and what's the CapEx investment associated with that?

The impact on the P&L of the Company, I think it's pretty much, I would say, going forward minor for the second half and then I think it will be better for next year, due to the fact that the capacity that we lost on the first quarter, it's already up there, so we are now producing full capacity and even a little bit more, because with the refurbishment of the furnace, now we are having the ability to produce slightly higher capacity than we were before, because that furnace was kind of something like nine years old since its prior refurbishment.

The prices that we have established for the outside purchases that we're doing has already been set, not only for the second quarter, but for the next two years also. And, as I said, we just hedge at attractive rates the dollar-denominated purchases that we will be doing in glass, as well as some other raw materials.

And looking in a much more, I would say, longer term, we are in the middle of a process to finalize our analysis to conclude if we're going to expand our internal capacity on glass or we are analyzing everything in terms of long-term contracts for outsourcing our requirements and we're measuring those against the attractiveness of increasing our own capacity of glass.

We think that we have a first-class world operation. We have good quality, good costs, internally, but of course are looking for external also sources of sourcing of that capacity that we need. And we will come with a final decision on the fourth quarter of this year, and as soon as we have a decision on that, we'll let you know.

Fair enough. Thank you very much.

Thank you.

We'll take our next question from Lore Serra with Morgan Stanley.

Good afternoon, Javier. I wanted to ask you to talk a little bit more, if you could ,about the pricing environment. You mentioned that you had taken some pricing in late May into June, but it didn't show up in the quarter. Actually, it looks to me like your pricing actually declined slightly in the quarter, which is in contrast to what we saw earlier, when we saw Modelo report.

So could you help us understand, just so we can think about it, how much pricing you think you put through into May and June, and why didn't it sort of filter through into second quarter?

Sure, sure, Lore. The first comment I will make is what we put in pricing very late in May, and I should have said most of it in June, was, if you remember, kind of a second price increase as we did after we did some territories in early January.

So, of course, quarter to quarter, it's a much more smaller figure than the one that you should expect from our competitor, which didn't really increase in the first quarter and took most of its pricing during April and early May. That is one thing.

The second one, which also creates kind of a sequential number which is different on FEMSA's numbers as opposed to our competitors is that we had, as I said, a geography effect in the case of our northern territories having suffered more the weather effect. So there's a geography effect in terms of the highest price per hectoliter regions, not only not growing at the pace of the national average, but as a matter of fact decreasing. So that also creates a kind of a pressure.

And the third effect, which would be a package mix, it's kind of almost offsetting itself because still non-returnables are growing ahead of returnables. But, within returnables, the 40-ounce presentation returnable glass in some brands, we are also rolling out to some geographies, as well as the competitors is doing. And there is also a kind of a pressure for price per hectoliter to go slightly down.

So that's kind of I would say the three or four main reasons that I can present to you that explains our sequential price performance.

Thanks for that. That's helpful. And if you think about the pricing you're going into, or you have gone into, third quarter with, can you give us a rough sense of how much higher pricing you think you have today versus beginning of the year?

I would say that around half of inflation maybe, Lore.

So you're at about 2% over the last six months?

Yes.

Okay, thank you.

And we'll take our next question from Jose Yordan with UBS.

Good afternoon, everyone. I guess my first question was answered, but the second would be you had been guiding to margin expansions at OXXO of roughly 30 basis points per year, and it seems to me like you're way ahead of that and the second quarter appeared to have been a bit of an inflection point. And, of course, the margin levels of OXXO have been much lower than they should be, I guess, long term, so do you have a revised guidance for what we should look at in terms of margins for OXXO going forward?

Yes, hi, Jose. I think we had a stellar second quarter in terms of margin expansion for the quarter and a number of reasons behind that I would say could make us a little bit more optimistic going forward. And, believe me, when we're looking at numbers going forward, we have a very, very -- I wouldn't say tough stance with management of OXXO, but a very, very aggressive stance, yes, in terms of developing the business as aggressively as we can in terms of generating value for shareholders.

But it is still a business in which some of the explanations on a quarter by quarter basis on the performance in some categories still showss the tremendous leverage we have in terms of being a perfect solution for some suppliers in Mexico for the development of the products. And that helps a lot in terms of really, I would say, being successful in terms of negotiating with them specific programs.

And, of course, because of the quarter being very, very soft in terms of same-store sales in terms of a number of reasons, I think that we were very, very aggressive. And some suppliers also were very, very aggressive in terms of pushing their products and having special promotions and specific programs

But all in all, going forward, I would tell you that the business, we're still modeling with a number that the one you mentioned, 30 to 40 basis points on a yearly basis seems to us is the reasonable thing to set as a medium-term target, and we think we have the ability to, I would say, at least deliver that number and hopefully over deliver in time. But, also, the quarter was very, very, I would say helpfully impacted by the termination of the amortization of the Oracle [Retake] IT platform that we have been putting in place.

Going forward, I can tell you that this is a never-ending story, and as we speak we are now in the process of bringing in the new generation of the point-of-sale solution, which will not represent such a tremendous investment in IT as the Oracle Retake IT platform implied, but it will demand some resources, some incremental resources.

And there is kind of a lag between the termination of the amortization of the previous Oracle Retake platform as the time when the new point of sales solution and architecture is going to be, and now being, rolled out. So we will have some, maybe a couple, quarters which will have the full benefit of that, but, going forward, it will be an increase.

So, all in all, I would say qualitatively we are every optimistic in terms of now OXXO, as you know, being reach a scale of more than 5,000 stores, precisely during the quarter in which we are now discussing. And, going forward, we are keeping our pace of growth and we are improving our capabilities.

So that should translate eventually to bigger margins, but we're still sticking to our guns in terms of saying 30 to 40 basis points is kind of the number that we're still communicating to you guys.

But it's fair to say that for this year, at least, it's going to be significantly higher than that, and when that is as a base, then looking at 30 to 40 from that higher base?

'07 can be a year in which we exceed that long-term guidance, yes, you're right.

All right, thanks a lot.

Thank you.

We'll take our next question from Sohail Ahmer with Lusight Research.

Good afternoon. My question was more with regard to inventory days that seemed to have gone up, so I'm just wondering, is that because of inventories in terms of raw materials or finished goods going up? Also, as more of sales are generated from OXXO, I'm just wondering if there is a secular long-term change in terms of your working capital position becoming weaker in the long run?

Hi, Sohail. This is Juan. You mentioned inventory days going up in what business?

Well, I can't tell you in what business. Generally, in total, because you have one balance sheet, right?

Right, so you're talking consolidated numbers.

That's right.

Quite frankly, I need to look into it and follow-up with you offline, because this is not something we track on a regular basis, but we can certainly follow-up.

Okay, that's fair enough. Could you perhaps tell me whether in terms of any particular business, you are seeing inventories of either raw materials or finished good being higher?

No, not at all. I mean, business is business as usual, and there has not been a significant, extraordinary event that we can comment on.

Okay, and finally, then, in terms of with OXXO taking up more of the sales, consolidated sales, do you see that your cash position -- in terms of working capital management, is it going to be tilted more towards a drain on cash or is it going to me that your working capital position is going to improve over time?

I would say for the short and medium term, we are looking at a business which still is generating all the resources it needs to grow, and that was the case last year, and this is basically the case this year. It will depend a lot on our long-term perspective on if we are going to continue at the pace, the number of stores, that we have today.

If that's the case, OXXO will start to generate more resources than it needs to grow, and then it will be the decision of allocating those resources within the FEMSA different business units going forward.

But for the short and medium term, I don't think that's going to be a huge number, because of, again, the pace of growth that we have had in OXXO is basically one that really consumes all the cash that it generates. It doesn't need capital infusions, but it doesn't really generate a lot of excess cash yet.

Great, thank you very much.

Thank you.

And just to add to that, this is Juan -- I mean, in terms of working capital, as you know, OXXO is a negative working capital business, whereas obviously the beverage businesses are the highest consumers of capital.

And we'll take our next question from Alex Robarts with Santander.

Hi, everybody. I guess the one question I'd like to pose here is that the guidance really for the beer assets for the rest of the year -- 32% I guess has been the decline in the first half in operating income, and I can appreciate the steep kind of second-half objective that you really are going to need to get into the flat overall guidance for the year.

And I can also appreciate barley as being one of those things that's tough to track. But, I guess, as I put in the 5% beer volume growth that you're talking about for the second half, I'm still finding it really difficult to get to this breakeven. And I'm wondering, really, as far as the OpEx is concerned, and I guess for the first half of the year, your OpEx has been outpacing the sales growth by a rather high multiple, and whether it's the marketing in the U.S. with Tecate and Dos Equis, whether it's the Brazilian marketing and selling expenses, or the launches that you're doing in Mexico.

Of those three elements, what is and could be the reason why that OpEx kind of slows down, so that we can get to perhaps some operating leverage and towards your target. If you could kind of comment on the OpEx line, that would be great, going forward.

Yes, sure, Alex. Again, yes, second semester should look very different from the first one to really achieve our goal, and you're right. I mean, 5% looks different than the 3% we have gotten in the first semester, but, again, we feel confident. June, July trends shows us that those numbers can be there, and when you look at the comparisons that we're going to face, going from August to December, we think that that number could be better than that.

It will depend on a number of things, of course, but at least that's the number we're modeling in our estimates. Pricing, well, it's going to be different once we've taken at least these almost half-inflation numbers that we did in the first semester. It's going to help. And raw materials, we discussed that we feel much more comfortable both because we have hedged and because of the trends that some raw materials trends have today that we're comfortable.

So, all in all, operating expenses is one, what I would say, think that we are managing for the second semester. But also we have things that make us optimistic in terms of our goal. The first one is just remembering that last year we had also a very different look for the two semesters. We grew close to 20%, our operating profit in the first semester in 2006. That was our comparison base, and basically the operating profit for the second half was slightly below '05.

So we are going to have much more easy comps going into the second semester. And Brazil also, we have shared on the first quarter that the core of spending in Brazil because of the job that we're doing in terms of repositioning Kaiser and Bavaria Premium and also with the launching of Sol. the level of expense as opposed to revenues for the first quarter as opposed to the fourth quarter are going to be totally different. We started the launch of Sol on the fourth quarter of '06, and that was the highest spending in marketing that when you look at the full eight quarters '06 and '07 Brazil is going to have. So also we're going to have also a lift just because of the comparisons we're doing.

All in all, those are the comments that of course being very challenged in the second half in order to reverse a red number for the accumulated June figures would demand very, very decisive actions and also kind of the environment behaving the way we are describing to you guys in terms of volumes and pricing and specifically some raw material specifics such as barley, for example, in Mexico.

But, all in all, the operating expenses are pretty much modeled following the rationale that I just described.

Okay. And just on the marketing, the last follow-up would be interested to hear that Dos Equis focused, or at least the ramp up there, is it safe to assume that that brand going forward might really get kind of the lion's share of the incremental marketing? Is there kind of a thinking now at FEMSA that that could be a second, if not maybe primary, brand to have in the U.S.? And who do you think you took some share from, because you're clearly on the first half, as you mentioned, indexing above the import segment growth and maybe you could share with us some thoughts of who you think you might have taken share from.

On the first question is I wouldn't speak about lion's share for Dos Equis. What I would tell you was this was a brand that in the past didn't get the resources that it deserved. Back in the good old days before Heineken, for a very simple reason, we did not think that the brand would deserve the fair treatment in terms of its development and we were not willing to really put money behind the brand because of that.

But now, when we have I would say aligned the vision for managing a true portfolio of brands with Heineken and we have really gathered some very, very helpful insights on consumers and we have fine-tuned the positioning and the communication strategy for the brand, I would say that aligning the vision for the brand going forward with the most important wholesalers in the U.S., we think now it's the proper time to put resources behind the brand.

So it's going to get the amount of resources that we think the brand needs in order to achieve a vision that we have aligned with our partners in Heineken and the wholesaling network in the U.S.

The rest of the portfolio, which is basically the more important ones -- Tecate announced the rolling out of Tecate Light -- are getting the resources that they need also. It's not like we're coming up with a certain amount of money and then slicing it down to see what we can do for each brand. It's the other way around. It's building it from down to top in terms of what do we need to do to really development these brands at its full potential, and then put in the resources, the time and the effort, to each of those brands in order to really achieve that portfolio vision.

That's for the first point. For the second one, I think even though Dos Equis is growing at tremendous rates, it's still from a very, very small base, so I would not rather say, well, we're gaining share from certain brands. What I can tell you is we're gaining awareness. We're increasing the top of mind awareness.

Dos Equis is a brand that with aided awareness, it has a lot of recognition, but with unaided awareness it did not. So I think we're doing the right things in terms of bringing unaided awareness, distribution, but now with a very, very we think very well thought out and very well executed positioning and communication campaign.

So it's very early in the game to say, well, we're gaining share from X or Y brand. We think we're gaining share of mind with consumers and that hopefully is going to keep helping the brand to develop itself.

Okay, thank you.

Thank you.

We'll take our next question from Reinaldo Santana with Deutsche Bank.

Yes, good afternoon, Javier. Most of my questions have been answered, but I have an additional one. Are you maintaining your estimate or guidance of flat EBITDA or breakeven EBIT in Kaiser in Brazil for 2007?

Yes, directionally we are saying this is the year in which we would like to break even at the EBIT line in Brazil, Reinaldo.

And so far you said in the second quarter you reached EBITDA breakeven, but in the fourth quarter you will have very easy comps as compared to last year. Do you think -- is there a higher chance to achieve higher EBIT than the breakeven?

No, no. To tell you the truth, I think we will have easier comps in terms of spending in marketing specifically for the fourth quarter, but, again, we will have much tougher comps in terms of volume because the launching of the product, it comes all the time together with filling the pipeline, so we will have tougher comps on volume.

So all in all we are still managing the year in a balanced way, considering those elements and we're I would say confident that we're going to be able to break even at the EBIT. But we're not so bullish to say that we're going to be better than that.

And also, Reinaldo, this is Juan -- remembering that in the first quarter, we have this big number that we talked about of some MXN200 million that we're going to be carrying. So the fourth quarter will help get to the breakeven, but we still have a big piece of luggage from the first quarter.

Thank you.

(OPERATOR INSTRUCTION)

We'll take a follow-up question from Andrea Teixeira, JPMorgan.

Yes, just thanks for taking that question, but just on following up regarding the SG&A to meet the guidance, as far as I understand, what you explained is that you're going to be keeping the same sort of expenditure -- the part of expenditure that you had in the first half of the year.

But as I see the numbers here, the third quarter of '06 was actually a quarter that you guys had an improvement in SG&A. Can you elaborate if that is going to mean they're putting -- I mean, as far as I remember, you had some launches of SKUs in the third quarter of last year. Is that where, over last year, that's where you're going to be saving money? Or can you elaborate more on the SG&A expenditures? I would appreciate it. Thank you.

Hi, Andrea. This is Juan. There isn't any let's say specific launch or specific project that moved the needle one way or the other that as we lapped it this year it would make a big difference. I think, as Javier mentioned, there's a lot of things that have to happen.

If you look at the growth of SG&A, the trend even this second quarter, we already showed a slight improvement vis-à-vis the trend of several previous quarters. So I don't think it's one isolated thing that you can narrow it down to.

The initiatives that we've talked about now for three or four quarters in terms of supporting the brands and modifying the way that we deal with some retailers in terms of the support we provide to them and the margin that we adjust, that will continue. That will continue and there isn't really one thing that I can point to that makes the difference. It's really all of them put together.

And I appreciate that, Juan, but I think one of the comments in past conference calls also, regarding -- and Javier was explaining in terms of increasing direct distribution of purchase of a bunch of distributors, that works against you terms of SG&A level. But what is it that I'm not understanding of a better -- I understand that you (inaudible) but can you give just anecdotal evidence of savings. If that's the ERP systems that are now some of the consultants that you had hired before. Now you don't have that expense, what's really that you're saving?

I understand that in order to make it this top increase from 5% minimum to reach the breakeven on the top line, you cannot save on marketing initiatives. So what's in the downside here in terms of expenses?

You point to one that's accurate, which is the amortization of the ERP. Similar as what's happening in OXXO, we are getting to the point where the first layers have been fully amortized and you begin to see that benefit in the OpEx, but that's just one thing that contributes.

Other than that, it's just overall containment of expenses and managing your launches and your strategies to provide the business with what it needs, but also keeping an eye on the management of the short term.

So you think it's still feasible to keep the same -- the 5% is definitely feasible for the top line second half of the year?

Yes, I mean, if we get the 5% plus volume and, as Javier mentioned, we already put the price increases, which today take us to about half of inflation, then 5% volume with 2% down in real pricing and wherever that takes. But it's still going to be a pretty good top-line number.

Okay, great. Thank you very much. Fair enough.

We'll take our next question from Lore Serra with Morgan Stanley.

Yes, a couple quick follow-ups, thank you. Javier did say that pricing today is like 2% higher than it was at the beginning of the year, post whatever pricing actions you took in May or June. Is that correct? Like, if we take it where you are today versus where you were at the start of the year.

Yes.

Okay, and second quick question is you mentioned that you're fully amortized in most of the ERP. Why did your amortization in beer go up a little more 7% in the quarter? It's pretty flat for the first half, but it's up in the quarter.

That would have more to do with the point of sale exclusivity-related stuff than with the actual ERP. The ERP is really the first layers. Remember that this took us a while to deploy, several years, so it's going to show up over time in terms of taking pressure off the SG&A. I would think, and we can also follow-up on this and see if we can get more granular, but it has more to do with the dynamics in the exclusivity than with the ERP.

Okay, and maybe this is beating a dead horse, but it's interesting to hear you talk about needing 5% volume growth to hit your numbers, because your volume trends have been pretty good in aggregate. They haven't been down.

I guess the question that I'd love to understand a bit better is that SG&A has grown above sales on sort of a sustained basis the last couple of years, and are you basically telling us you're just going to tighten your belt in the second half of the year to be more accountable for hitting your numbers, or are you telling us there's ways in which you can sort of change that equation and having selling and administrative expenses grow less than sales on a more than sort of six-month basis.

This is Javier again, Lore. I would say it's a combination of things. I can share maybe a couple of examples without trying to reconcile the whole operating expenses line on the P&L. But we have talked a lot about differences in the spending of marketing resources in different markets, Brazil, Mexico, things like that.

We have talked about, for example, these finalizing the amortization of the ERP, having some effect on the second quarter but having a much more broad impact for the second half than it did for the first half.

I can share with you, basically, for example, we have talked in the past that we invested a lot in certain things, such as building infrastructure and let's say installing certain capacities in terms of processes and technology in certain markets, which we called I would say the operating model way of doing things at FEMSA Cerveza. And we have talked about the need to now develop competencies and capabilities within people to really use to its full potential that kind of infrastructure.

And there is kind of a number of projects going on at the brewery and, last year, if you look at how much we spent, we spent a lot of money, which we are going to do also this year, but with different seasonality as the one we're going to do this year. So we spent the bulk of it last year on the second half, and we spend now more evenly during the year.

So there are some other things that are just because of the arithmetic of where's the money we're spending in the different quarters, now we're going to have the benefit in the second half, as opposed to being hurt in the first half.

So I would say it's a combination. As we have stated, every time here is we are very sure that we have built a now sound vehicle for I would say the resources that we feel comfortable putting with behind the brands in the three markets being there, with different courses of development, of course, and with different intentions. It's a very, very different story that plays. Again, we're trying to play in Brazil with an 8% share, as opposed to the U.S., in which we have a little bit less than 20% on the Mexican import segment as opposed to the mid 40s we have in Mexico, and, more specifically, when you look at the reasons.

So I would say we are not, again, doing whatever it takes -- if we think that the right thing is for the long term for the businesses, keep an increase in the investment in certain things in the second semester, we are sticking to that.

But we are doing some extra efforts in some areas. We are deferring some things which we think are not going to hurt the business long term, and also we're taking advantage of the comparisons which quarter we made some investments on spending in the past as opposed to where we're going to do it now.

I would add, Lore, you mentioned that the volume growth we've had, it's not bad. We agree. 3% doesn't look bad, but it's not where we have been trend wise. It's not where we want to be objective-wise. And, of course, when we make our business plans at the beginning of the year or prior to the beginning of the year, you need to fund your spending with your volume and your pricing.

And if things don't work out fully on that end, then you're short some funding. So even if the volume number looks okay, it's not what we need.

Going back to the second part of your question, we do need to get some things happening not just at the SG&A level, but it's really at the volume level, at the COGS level and at the SG&A level that will get us to the objective.

Okay, thanks.

Sure.

We'll take our next question with Celso Sanchez with Citi.

Hi, good afternoon. I just want to go back to this pricing theme a bit again. It seems, if I'm not mistaken, on a year-over-year basis your pricing was flatter by the inclusion of direct distribution volumes that you picked up towards the end of the second quarter last year to the tune of about 100 basis points. I'm not sure if that's correct.

But, if that's the case, I just wonder, obviously you waited to the end of the quarter with your pricing until you were comfortable. How susceptible going forward do you think you are to competitor pricing activity, or how much of a function is your pricing policy of the competitive environment and how different might that be than five years ago, when you didn't have the systems in place that you have now to execute your revenue management strategy?

Hi, Celso, this is Javier. I would say that even though the industry has been able only to translate into pricing a fraction of the specific inflation of the industry, the environment in terms of promotional activity is pretty, pretty rational.

I think that people that have the opportunity to come down and travel around the country will find, I think, promotional activity being done in a way in which I think it's still working in favor of the, I would say, perceived quality of the category that consumers should have.

It's not like a premise, discounting heavily just for the sake of it. But you will find some, I would say, interesting promotional activity. And I will give you an example. We have now I would say a first promotional activity combining Dominos Pizza and Sol brand, which was unforeseeable I would say in the past, not only because of the capabilities required to execute such a promotion was not there, but also because nobody was thinking about putting together value propositions to consumers such as that.

So my sense is that I would say the rationality within the promotional activity is there, and I think it's been good for the industry to increase the relevance of the category in the minds of consumers. So that will be my comment on the promotional activity.

In terms of the ability and I would say the very, very careful attitude that we may have regarding looking at what the competitor does in terms of its pricing activity all over the place, we are very, very close, day by day monitoring that and reacting as fast as we think we should, in some cases, or just staying the way we are in some others in which we don't think the pricing strategies are ones that will affect our business short, medium-term.

And, of course, we're taking advantage of our ability to react in a very differentiated way. And we're doing that every day in every market, let me tell you that. It's not like there's one thing happening or going on all over the place and we're reacting the same way.

The pricing dynamics have come to be very, very that -- very dynamic, and I think that we're comfortable in that environment. We are in some cases provoking that and in some others we're reacting to that. And we think that I would say the healthier nature of the development of the category has a lot to do with that, with the category presented to the consumers on a continuous way, propositions that would capture their attention, their imagination, and hopefully that they continue to buy more beer than any other beverage product that they may think of in the spectrum of beverages here in Mexico.

Okay, thank you.

Having no further questions, I'd like to turn the conference over to Mr. Astaburuaga for any additional or closing comments.

Thank you very much for your participation, all of you, today. As we have been saying clearly, we have our work cut out for us as we navigate the second half of the year. However, I cannot stress enough that while we aim to balance as much as possible the short and long-term performance, it is the long-term sustainable creation of value that drives our strategy. And we feel very, very optimistic about where we're going.

Have a great week everyone. Thank you, again. Bye.

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