Coca-Cola Femsa SAB de CV (KOF) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to Coca-Cola FEMSA’s second quarter 2004 earnings conference call. My name is Alisa and I will be your operator. [OPERATOR INSTRUCTIONS]

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

Financial information for the second quarter and six months ended June 30, 2004, on a consolidated basis and by country include three-month and six-month results of the original Coca-Cola FEMSA’s territories, Valley of Mexico, south-east of Mexico and Buenos Aires, Argentina, and all of our new territories acquired from Panamco. Our consolidated results for the second quarter of 2003 include 3 months of our original territories and 2 months of our new territories acquired from Panamco on a quarterly basis. Coca-Cola FEMSA’s financial information will not be comparable with previous quarters until the third quarter of 2004, and on a yearly basis until the end of 2005.

As a reminder, ladies and gentlemen, this conference call is being recorded. I would now like to introduce your host for today’s call, Mr. Hector Trevino, Chief Financial Officer for Coca-Cola FEMSA. Please go ahead, sir.

Good morning, everyone. Thank you for joining us today. After speaking with investors throughout the year, I have noticed an increasing interest in our Mexican operations. For this reason, today I’m pleased to be joined by John Santa Maria, Chief Operating Officer of our Mexican operations.

Each of us will make a few remarks of our Company’s performance during the quarter. However, we plan to use most of the time for questions and answers. I will provide you with a brief summary of our performance in our Latin Central American subdivisions. John will follow with his remarks about Mexico. And then I will close with a financial overview.

In Central America, we post incremental carbonated soft drink volumes of approximately 2%, despite the price increases implemented in Guatemala and Costa Rica during the quarter. Volumes of brand Coca-Cola increased approximately 2.5%. Our core Coca-Cola brand still represents 70% of total volumes sold in the region.

For the first time since we took over consolidated Guatemalan operations, we surpassed our main competitor in market share volumes in both CSDs colas and flavors. Our price increases were eventually followed by the competition. Our 2L returnable PET 600ml and one way PET presentations contributed significantly to these results. Guatemala was the driver of volume growth in the region, and Costa Rica and Panama led in the way in terms of profitability.

In Costa Rica, we launched Tai, the value protection brand we successfully launched in Argentina to provide a more affordable product to direct clients and core customer segments.

In Colombia, recent management changes and our strong focus on brand Coca-Cola are generating positive results. Volumes of brand Coca-Cola increased 3.5% during the quarter, with Coca-Cola Vanilla contributing more than 25% of the Cola segment’s incremental volumes. Brand Coca-Cola’s volume growth more than offset the volume decline in flavored carbonated soft drinks.

In May, we implemented an across-the-board price increase of 14%, which was eventually followed by the competition. Despite this price increase, volumes of brand Coca-Cola, as I said, increased driven by revenue and packaging management strategies for each channel and geographic region, brand innovation, with the launch of Coca-Cola Vanilla, tactical investments in media coverage to revitalize the Coca-Cola brand among young consumers, incremental point-of-sale brand coverage and a strong focus on multi-serving package availability to foster future carbonated soft drink consumption.

During the quarter, we also launched a 1.25L returnable presentation of Quatro, our grapefruit-flavored carbonated soft drink brand. We continue evaluating several package and product strategies with the Coca-Cola Company to foster growth of flavored carbonated soft drink brands.

Our implementation of revenue management strategies, aimed at increasing the profitability of the Water business, caused our Water sales volumes to decline 17%. This quarter, Bottled Water volumes represented 14.2% of total sales volume, down from 17% in the same period a year ago.

We feel confident that the strategies that we have implemented over the last 14 months will help us to improve our profitability in a more sustainable way going forward.

In Venezuela, volumes increased 7.4%, despite a 14% weighted average price increase implemented at the end of the previous quarter. During the quarter, incremental volume growth was led by an improved value proposition of CSDs, flavored, multi-serving presentations, such as the 1.5L and 2.25L non-returnable PET packages [indiscernible] and Grapette respectively. These packages help us to implement better pricing architecture and packaging segmentation per channel, driving flavored carbonated soft drinks to account for 70% of incremental volumes. Our Juice-based, non-carbonated orange flavored brand, Sunfield, accounted for the majority of the remaining growth.

The introduction of Coca-Cola Vanilla and the incremental growth of Coca-Cola Light partially offset the volume decline of brand Coca-Cola, leaving the segment almost flat versus last year.

Now, I will talk about our [Brazilian] division. For the first time since the Panamco acquisition, our Brazilian operations are posting incremental CSD volume growth, mainly driven by brand Coca-Cola and its line extensions. We posted 9.7% growth in colas during the quarter.

Volume growth from brand Coca-Cola offset the volume decline in flavored carbonated soft drinks. The majority of the volume growth comes from the multi-serving presentations in 2.25L, 2.5L and 3L non-returnable presentations. These presentations have taken share from our 2L non-returnable presentation, which represented 52% of our total volume for the quarter, compared with 59% a year ago.

Despite generating a [indiscernible] incremental volumes from larger presentations, our average price per unit case in Brazil is improving because of our channel and product shift. We increased the percentage of total volumes sold to small retailers from 45% a year to more than 50% today.

In [indiscernible], average price per unit case is higher for small retailers than supermarkets. At the same time, we are selling more volume of brand Coca-Cola and its line extensions, and less of our value protection brands, which are sold at lower prices and are less profitable for us.

The new volume growth has helped us to increase our share of industry CSDs to bring sales 300bp year-over-year. Market share gains in the cola category more than offset market share declines in flavored carbonated soft drinks. We continue concentrating our efforts on brand Coca-Cola and we are working closely with the Coca-Cola Company with the value of our portfolio of flavored CSD brands.

Our solution for turning around our Brazilian business, facing decreased consumption, has been supported by 1) taking more control of the execution functions, especially pre-sale, 2) developing a packing diversification strategy by channel, especially for brand Coca-Cola, and 3) improving our relationship with the rest of the Coca-Cola system to reduce industry trans-shipments, with the support of the Coca-Cola Company.

Our Argentine operations continue [indiscernible] posting strong volume and sales growth. Despite the different seasonality in South America’s winter months, Argentina posted the highest operating income margin outside of Mexico. Recovering from Central Argentina, combined with price increases and a well-segmented strategic portfolio of brands and packages, foster volume and sales growth in every carbonated soft drink category.

During the quarter, 55% of incremental volumes were generated by our core Coca-Cola, Fanta and Sprite brands, with returnable presentations. 32% was generated by our Tai protection brand, and balanced mainly by our premium Coca-Cola Light and Sprite CO brands.

It is important to note that our Argentine operations are posting higher average prices per unit case, despite the higher volumes sold in lower-priced returnable presentations. This is a consequence of our well-implemented revenue management strategy by channel.

Now, I will ask John to comment on our Mexican operations.

Thank you, Hector. And hello to everyone. As you know, in Mexico, we faced tough year-over-year volume comparisons for the quarter, particularly in the Valley of Mexico, where a year ago we experienced record-levels of heat and launched our dual cola upsizing strategy from 2L to 2.5L presentations, both in one way PET and rough PET.

In comparison this year, we faced extreme cold weather and higher-than-normal rainfall, resulting in a very disappointing May. Total volumes decreased 6% during the quarter, mainly driven by jugged bottled water volume declines. Our carbonated soft drink volumes fell 1.8% for the quarter, as colas declined 3.6%, which was partially offset by a 4.2% increase in our flavored business. The vast majority of this decline took place in the Valley of Mexico, and the decline was evenly split between CSDs and Water.

Year-to-date, our total volume is 3.3% down, due to significant reductions in our jug water volumes, which represent more than 80% of the decline. In CSDs year-to-date, our volumes are slightly ahead of last year. Year-to-date, our jug Water volumes have declined more than 20%, mainly driven by tough weather conditions, a rapidly-changing competitive environment, given the expansion of jug Water resellers in the marketplace and the implementation of our price increase strategy intended to improve the profitability of our bottled Water business.

The second point I’d like to talk to you about is about price. As you have seen, our average price per unit case on a sequential basis has declined 2%, excluding jug Water volume. If you look at it versus last quarter -- or similar 2003 -- our price declined 5.5%. This decline has been primarily driven by an upsizing of multi-serve presentations, a packaging mixture from single to multi-serve presentations, and a lack of minimal price increases, and not by price discounting in our marketplaces.

Year-to-date, multi-serve presentations represented almost 51% of our total volume, up slightly from 48% a year ago. Excluding these developments, our pricing architecture in our markets has remained stable in nominal terms.

In terms of market shares, as measured in unit cases, we have suffered marginal erosion during the second quarter. However, measuring market share in terms of transaction or retail revenue, our share of industry sales and industry transactions remained practically flat in all our market territories year-to-date. Currently, our share of sales in the cola category is higher than 86%, and is 48% for flavors.

Despite a horrendous May, we have seen a good rebound of our volumes in June that has been holding through the month of July, and that is something that we’re very pleased to see.

During the past year, we have heavily focused on integrating our Mexican operations. To date, we have closed 4 plants, consolidated 39 warehouses, reduced headcount by 2,000 people, standardized our accounting systems on a single platform, finalized the rollout of SAPVIS in the Valley of Mexico, which is our sales force automation system, which will allow us to enhance revenue management capability in Mexico.

We have consolidated our commercial organization from 4 commercial directors to 1. We have formed a very solid commercial team, but more importantly, we have rebuilt Panamco’s operating capability through the entire value chain. Thus far, we have achieved $45 million worth of gross synergies on yearly basis in our Mexican territories, and we are on track to reach $70 million annualized savings by year-end.

Over the last couple of years, industry dynamics have changed significantly. And to address this changing environment, we have tested and implemented several packaging, pricing and promotional strategies. As a result, we have reconfigured our entire packaging portfolio in both single- and multi-serve presentations.

Over the last 6 months, we have focused on getting the right product portfolio and pricing architecture in place for each of our very different territories. In this regard, we have recently initiated the rollout of multi-flavors on a segmented point-of-sale basis to compete against regional brands in various territories. This strategy is complementary to our core flavored brands, which is centered in 2.5L, and allows us to target the profitable 10 peso 2L non-returnable packaging segment. Additionally, we are in the process of rolling out Coca-Cola 1.5L non-returnable packaging presentations in the Valley of Mexico, priced at 10 pesos to the consumer.

This strategy is addressing small family needs that find our 2.5L presentations too large. This is another example of how we are complementing our various portfolios. Also throughout the quarter, we continued to innovate on various fronts. In the flavored segment, we have recently launched Lift Golden Apple, replacing Green Apple in many instances with extraordinary results.

Currently, we are also in the process of rolling out Fanta Orange with Chamoy, which is a CSD first in Mexico. It combines a very typical mix and candy flavor with a carbonated soft drink. This too is far exceeding our expectations.

Also through the quarter we strengthened our Coca-Cola single serve portfolio with the launching of the 8oz Coca-Cola can priced at 3 pesos to the consumer. This is proving to be a very effective entry point to the single serve Cola category.

And regarding our non-carbonated portfolio, we are in the process of launching Nestea Light and Nestea Peach flavor and have rolled out during the second quarter our kids drink, [Coloco] throughout all of our South East territories.

Today, with a lot of the integration dirty work behind us, we can more fully focus on the main priorities of our Company, which is to increase top line growth. To achieve this we are going to be concentrating on the following priorities.

First, continuing to drive profitable single serve presentations in both flavors and brand Coca-Cola. We have developed a broad portfolio for brand Coca-Cola giving the consumer choice to satisfy each consumer occasion. This portfolio has dealt with different price points allowing consumers a choice from 3 pesos to 7 pesos.

Currently, we are also in the process of testing different personalized portfolios in flavors as well.

Our second priority will continue to develop a highly competitive multi-sort portfolio in order to enhance our dominant position. 1.5L Coca-Cola in the Valley of Mexico is an example of this.

Number three, we continue to focus on increasing our share of volume and value in the flavor category through continued innovation. Currently, we have 45% market of volume in the flavor segment and that provides us with ample room to grow.

Number four, we will refocus our Water strategy by competing in the 20L jug business and by more heavily leveraging our personal Water portfolio. Over time, we expect to downsize the volume of Jug Water business, refocus it on more profitable channels while maintaining a similar level of revenues and profitability. Currently, we are evaluating a segment pricing strategy by region and by channel.

Number five, aggressively participate in the non-carbonated segment with the Coca-Cola brands.

These alternatives, along with continued reductions in our selling and delivery systems in terms of costs and we believe we continue to have ample opportunity to reduce cost in our selling and delivery system, along with increasing our brand equity and executing the basis of our business, will drive our level of total sales and profitability higher in Mexico in the future.

The market has changed in Mexico and we are learning to change with it. During the last 14 months we have been building the foundation of our future business model in Mexico and one that I am confident that will enable us to continue to create value for our shareholders.

Thank you John. On the financial charts we reduced our total debt by $148.7 million and increased our average maturity profile to 3.8 years during the quarter.

Now we shall have a well balanced capital structure with 63% of our total debt denominated in local currency. Mostly Mexican pesos and slightly over 70% of our total debt with a fixed rate.

During the quarter we also obtained a favorable finance ruling in the Mexican Federal Court that allows the losses arising from the sale of shares in 2002. As a result of the ruling, we expect to recover more than 1,230 million pesos, which will increase our consolidated net income by approximately 1,286 million pesos. More than 85% of this amount will be in the form of a cash reimbursement and the balance will be in the form of a tax deduction going forward. We expect to use the proceeds of this tax reimbursement to reduce debt.

In closing, we are pleased with our Company’s overall performance despite a difficult competitive environment in Mexico and I believe it is important to highlight the success of the integration of the acquisition of Panamco in all of our territories.

The profitability of our total mix is improving at a very rapid pace. Every operating metric we use to measure integration performance is improving. We have strengthened our capital structure by reducing debt and increasing its local currency and fixed rate component. We have implemented our improving CapEx program without making significant changes to our business plan. Our cash flow generation is helping us to reduce our debt balance as planned.

The success of this process has to be evaluated in light of a more difficult environment in Mexico. Going forward, we are confident that the strategies and practices we have put in place over the last 14 months will position for continued growth and value creation across our markets where we grow.

Thank you for your attention and now I would like to open up the call for any questions that you might have.

[Operator instructions]. The first question is from Jeff Kanter with Prudential Equity Group. Please go ahead.

Good morning everybody. John, the Coca-Cola Company talked about increasing investment in Mexico. I was hopeful that you could expand on that and what will be your participation going forward? First question and then I have a follow up.

Good morning Jeff. Yes, as the Coca-Cola Company has said, they are increasing their marketing expense in Mexico. Basically we have a couple of programs in place and how we are participating in that is as we always have been. We’ll be splitting the marketing funding as typically we usually do. Getting into more particulars of that I think would be beyond the scope of the question at this point and revealing information I don’t want to go ahead and reveal at this point in time.

But basically it is just ensuring that we have the appropriate level of activity in the market place given the environment that we’re under right now.

So your selling expenses though per case, all else being equal, would be expected to trend higher, is that fair?

I think in terms of where we are, that increased marketing expense is already in our numbers.

Okay and pricing has declined sequentially. Not by a material amount. Do you feel like we've found a base here?

I think it is leveling off Jeff because a lot of this is just due to the fact that the packaging mix has shifted you know. And when you look at that, what you're really seeing is the consumers are really -- basically your relationship with the consumers change and they're just going to different packages and they're find they're all level in the water right. Basically I think at this point in time things are hitting where they should be hitting. So we shouldn’t see that much reduction going forward.

Price increases going forward will be more of a function of mix rather than rate?

Right.

And finally, Hector, the rights offering. Is the plan to kind of go ahead with it and if nobody subscribes so be it? Or would you ever want to revisit it down the road?

The reserve price is the price at which we would be doing this, the rights offering. We continue with the plan to do it. It will be during the third quarter. Basically the idea that we have this year is that we basically made a promise in May of last year. This rights topic has been hanging here for more than a year now and the idea that we have is to work in with that. In all of our financial plans as you look at our debt structure, we feel very comfortable with the debt levels that we have and the way we have structured this. Taking advantage also with the [rates] on the market in terms of getting great resources with very attractive rates on [indiscernible]. We were not counting this early on these resources for any strategic debt reduction that we need to share ratings or whatever. So I think that we would go ahead and just go with the price offering and then if in the future we need to reduce it back, then we will reduce it back.

Okay. So there is a potential once your stock goes above 2,217 pesos down the road that we could see it again?

No, I don’t want to calculate that. We need to fulfill this promise, do the rights offering. If nobody subscribes then we are there. Even feel in the future that we need capital for any specific project, or specific situation with our debt structure that we need to upgrade, then we will reduce back in the future. But we don’t have any specific plans right now.

Okay. Thank you very much.

The next question is from Lore Serra with Morgan Stanley. Please go ahead.

Yes, I have 2 questions both on Mexico so I will direct them at John. I guess my first question John is that despite poor volumes, weak pricing, and as you mentioned in the press release sugar and packaging costs, you managed to hold on to your gross margin at the 53% level. And yet for the second and third quarter in a row we've seen the SG&A expenses been a lot higher than some of us had forecasted, even though as you say you're sort of done with the dirty work in terms of the integration. So could you give us a sense of you know, in this environment, how are you protecting your gross margin? Or maybe more importantly, why the SG&A expenses despite the level of integration you're at right now could remain so high? These are levels pre-deal.

Hi Lore, that’s quite a large question and a long one too. But I'll try to address it. In terms of gross margin I think one of the things that you have to remember is first of all in Mexico over the last year, on a gross basis, sugar prices have increased dramatically. If we look at sugar just alone, without taking into consideration any of our initiatives to reduce our sugar cost, gross sugar prices in the industry went up 17%. That obviously didn’t affect us at that rate. We’re running at an increased sugar rate expense of about 7%. So we’re defending ourselves there and we’re also defending ourselves very well on PET and there is a lot of savings in PET, which I will let Hector talk about later on. But we haven’t added a lot of synergies on any of the acquisitions and we've also done a lot of lightweighting in the Panamco territories, which is resulting in lower PET costs. So those are 2 primary drivers in terms of where our savings are coming from.

Secondly, I think when you start looking at where our expenses are on a per case SG&A basis, you’ve got to remember where we’re coming from. First of all, last year when we compare it versus the last year, it is unfortunate but what we found was the Panamco Company had significantly under-invested in a lot of maintenance okay and they were cutting costs well before the second quarter. Before the first quarter and even in the year 2002. So when I'm talking about rebuilding their operating capabilities, it is really getting their whole value chain up to speed and it took us a lot more maintenance than what we thought. I think what you'll see is during the third quarter a more reasonable comparison for what costs are. And what you're seeing over here is that we are seeing savings on an SG&A basis slightly being offset by incremental marketing expense. If you took that out, there would be a tremendous amount of savings.

Okay.

I hope that addresses your question Lore.

Yes. I mean I guess, let me ask the other question and then just a small follow up to that is how much of the rationalization in terms of the distribution infrastructure is in the second quarter, or it will be in the second half?

My second question which I don’t think is any less deep is, if we sort of look on a 2 year basis and sort of try to equal out whether your Cola volumes first half of the year are pretty flat despite the upsizing.

Right.

So I'm wondering you know a lot of the original reason for the upsizing was to increase consumption and it doesn’t seem like its working and I wonder if you could put it in the context of your views on market growth versus market share. I mean is this an issue of the Cola category not growing for some reason even with the upsizing, or is this an issue of the encroachment of other brands on your market share?

Well first of all I think we have to go back and understand what the upsizing was for okay. I think the whole genesis of launching 2.5L rough PET was not so much to upsize consumption, but it was going out there to block price driven brands in the market place. And I think that has been very, very effective at doing so.

So effective that our price brand competitors in Mexico have moved from a 2.6L presentation to a 3.1L presentation right and currently if you look at their volumes and their package, they're pretty much flat. So I think it is a very good defensive mode. It just resulted well for us. So well that other bottlers, other major bottlers in Mexico are rolling this out throughout the system. That is the first point.

Second point. I think what you also see is that in terms of just our volumes, we are working with tremendous price gaps versus our competitors okay. When you start looking at our price gap versus PPG or Pepsi Cola, sometimes we’re up to 60% depending on what type of discount they're at at the day.

So if you look at, where we are, we feel very comfortable that we have a sustainable business model. One that is profitable right and one that we’re going to start focusing on complementing to reignite growth. At the prices where our competitors are being pushed to price, we don’t see a lot of sustainability in some of the cases.

In terms of SG&A and distribution costs, okay, I think the second thing is we've taken out, as I told you, 38 distribution centers. Now we still have 110 distribution centers to go okay and not only is it now going to be a case of consolidating distribution centers, it is also changing the way we go to market and changing the way we sell and distribute in a lot of different other locations. Towards when will we see the consolidation? I think those are initiatives that will probably start during the latter part of the year and roll into 2005. So basically we've taken a lot of low hanging fruit out of selling and delivery, but now we have to go more to the bone and that’s going to be a little bit deeper surgery.

Thank you.

You're welcome.

The next question we have is from Carlos Laboy with Bear Stearns. Please go ahead.

Yes good morning. Thanks for having John on the call. John, you spoke of modifying how you segment pricing in the Mexican market place as you go forward. Can you expand on this and also talk a little bit about how your tools for managing price and package by channel will improve as you go into 2005? In other words, you have new tools for revenue management in 2005. What are they and how important are they?

Hi Carlos, hi are you? In terms of how we’re going to be segmenting pricing going forward, I think we've done a lot of learning over the last year. I think that’s one of the keys that I'd like to bring to this discussion. You know over the last 12 months, and more recently, in the last 9 months, the Mexico division has been doing a lot of testing in terms of finding what is appropriate relationships in terms of package, price, product and overall portfolios with the consumers. We have a lot of different type of consumers throughout our Mexican region.

We've also been picking up a lot of learning from our Buenos Aires division, which I think is probably the most advanced in terms of revenue management that we have within Coca-Cola FEMSA. So we’re putting all that together and what we’re trying to do at this point in time is trying to segment by competitive intensity and by socioeconomic level. So what we’ll be looking forward to do on the balance of the year is begin testing that segmentation strategy based in Mexico City.

Along with that, we will be coupling with that, our SAP system, which is part of the heart of the whole strategy. What SAP is allowing us to do is basically segment price per point of sale and also complement that with different tools that we have in SAP, which is pricing and promotion that allow us to automatically go out there and figure out where pricing and promotions will be taking place, when they’ll be taken out of the market. We’ll be basically downloading all this information directly from the handhelds of the pre-seller.

So those are very important tools that we will be having in place in Mexico and we will be rolling those out to the rest of the country as well by the end of 2005.

Thank you.

You're welcome.

The next question is from Dan [Quitosky](ph) with Schroders. Please go ahead.

Hi. A couple of questions. One is on the gross margin. What are your expectations for the second half and looking at 2005 if we look at PET and sugar prices? Should we be expecting further gross margin pressure in Mexico actually?

Yes, hi Dan, this is Hector. In general we do see margins similar to what we have. Gross margins because until we see a further reduction in sugar prices and PET prices, as John said, we have been able to do some initiatives there. Costs are still increasing versus the prices that we have.

On the pricing front, as John has been explaining, owing to this competitive environment, we don’t see a lot of flexibility to increase prices for sugar. I am seeing the gross margin level similar to what we have at present.

Okay, great. Could you actually quantify how much the increases in PET and sugar prices have actually cost you year-over-year?

I do not have that calculation [indiscernible] for our Board meeting for the quarter is not measured in year-over-year basis. But it basically represents -- it was compared with some internal information which is not necessarily all of that comparables, but it is a good estimate that we have. Sugar prices in Mexico and PET prices have basically 100 million pesos effect in this second quarter. Second quarter cost of sugar and PET versus what we have on some internal comparisons that we have versus last year. It is higher by $10 million.

Great. Okay. In terms of the next 25 million value of synergies coming through before the end of the year, can you just outline where they're coming from?

Dan, a lot of that is going to be coming from SG&A. A lot of the headcount reductions that we've taken out will be hitting the bottom line by the end of third quarter.

Okay. Great. Last question which is on Central America. Your gross margin actually increased from about 48.1% to 49.8% on a sequential basis yet your operating margin fell from 12.6% to 9.8%. Can you explain what's happening there and why your operating expenses seem to be getting higher and what the expectations for the rest of the year are?

Dan, Let me ask Alfredo to produce those numbers in detail and get back to you later on.

Okay. Thanks very much.

The next question is from Alex Robarts with Santander. Please go ahead.

Yes hi. Just the first question to drill a little bit more into the synergies. I know this could be probably tough to give us some color on, but just to understand I mean you talked about the gross synergy number. And I appreciate that with commodity prices and the marketing uptick that that’s not going to be the net number. But could you give us a sense of really where you think, at the end of the year, what might have been the net synergy number? Would it be something like half of the gross synergy number or less? Could you give us some color there?

Then kind of the second aspect here is just to understand the best practices element of the $120 million synergies. I mean is it safe to assume that at the end of the year is where you start to work on the 50 million and that’s really kind of the project that goes into 2005 as far as that part of the synergies?

Alex this is John. Look in terms of where we think we will land up in terms of the synergy numbers for the year, I think the gross number is about $70 million. The net number is about $50 million.

The second part of the question about whether we start working on the $50 million there on out. The $50 million was really price related issues and packaging launches and volumes and a lot of commercial related opportunity that we had. Under the new pricing environment that we have in Mexico I find it very difficult that you could assume that that would be something we could work on further.

However, what I do think we have is more than the $70 million going into 2005 in terms of reconfiguring our selling and distribution system. As I explained before, we still have out of 110 distribution centers and routes that we have out there, we have a lot of work to do in reconfiguring and bringing down our cost structure. How much that number is we will be probably getting more into that number towards the end of the year?

Okay. So just to understand then perhaps this initial $50 million number that you talked to us about last year is being let's say reassessed?

Right.

In terms of the absolute amount. Thereby implicitly the 120 million number becomes perhaps something $70 million plus this number that you are going to kind of refine as we go into the end of this year and then into early 2005. Is that a safe way to think about it?

I think that’s the correct way to think about it.

So that’s the best number. Okay. I guess just, and I notice this is a second question is around pricing. It’s tough to kind of call the bottom here on the Mexican average pricing. But if you say that really rate is not a possibility and it’s going to be really mix, it would seem to me that the trend in mix is to reduce perhaps down to the 25 pesos level for your average pricing. And I'm just wondering do you think that basically starts to turn this year, or do you think maybe we do the 25 pesos, 26 pesos next couple of quarters and then get into the kind of scenario where we get into higher average pricing? Because one of the things it seems to me you have a more rational pricing environment at least in Mexico City with the PBG increasing 9% on some of the packaging in the quarter. That seems to give a little bit of room on the upside. But it sounds like you want to be conservative there. Is that a safe way to think about it?

I think the way you have to think about it is where our large sizes transactions are going. First I think you're correct that we have a more stable and rational pricing environment than we had over the last couple of quarters. I think things are settling down a little bit. In terms of the amount of discounting in the market place, we’re seeing a reduction in that.

I don’t forecast that we’re going to see a larger mix shift going forward Alex, than what we have today. So in that sense I think we’re about where we should be in terms of pricing.

Okay. So maybe we could end up in fourth quarter. I mean it seems to me that it is a fair chance of having a higher price in the fourth quarter compared to the first half of the year. I mean is that kind of a safe assumption to have or still too early?

I think the opportunity is there. It is a little bit too early to call.

Okay. Fair enough and the final is just a clarification on the way that you're treating your expenses generated by the coolers. If I understand this correctly, is this something then that -- is this only just for tax purposes, or do we see some impact in the reported P&L vis-à-vis your selling expenses in Mexico?

Alex, this is Hector. It is just for tax purposes. Let me explain a little bit here. The tax authority in Mexico published a month and a half ago a new set of criteria trying to define how people should interpret or understand some of the rulings that are in place. Before that, it was not very clear and the way we were accounting for tax purposes, the investment in coolers were taking that up on expense of material. Therefore deducting the full amount of the investment during the year. The authorities now are saying this is expenses. Coolers are assets and therefore you’ve got to amortize that over say its own life. That has not been determined. We are in the process of negotiating as an industry with the authorities the life of the coolers so that we will amortize that over a certain number of years.

The effect on the P&L is zero. It is just the cash outlay that we will need to pay because of these adjustments. The P&L is actually zero because obviously we have the deferred tax line that would be adjusted to reflect again the full tax rate that we should have you know. But again, on a cash flow basis, we will need to pay some interest and some payment because of the way we were treating this in the past. The authorities are saying this is not changing the [indiscernible] interactively. It is just clarifying the way the law was written. So we do need to pay some interest and penalties. Then the cash outlay every year will be a little bit higher you know.

Okay. That’s helpful. Thank you.

The next question is from Yang Sang with HLM. Please go ahead.

Hi. Good morning. I have 2 questions. The first one is on the free cash flow generation. I wonder how much of the $111 million debt reduction is from free cash flow? That’s the first question. I will follow up with a second.

That amount the figure that was used to repay debt in this quarter was somewhere around the $85 million to $90 million. We had some contributions, some reimbursements in taxes not related to the amount that we have in the future. We have some other contributions. Basically the cash flow generated was used to pay CapEx taxes into us and then repaying this amount of -- after this amount of CapEx interest and taxes we were left with close to $90 million to pay our debt line.

Just to clarify. The rebate from the tax ruling, it’s not in yet?

It is not in yet.

I see. The second question is on the competitive environment. First of all on Pepsi, just a little bit confused. I heard that the comment, John commented that Pepsi’s discount has been reduced during the quarter. But do you still see like Coke intends to increase its investment in Mexico. I don’t know how to reconcile the two. Anecdotally, people are saying that in Mexico City at the retailing price level, you don’t see much change there for Pepsi. I don’t know whether that is true.

Second question is on big Cola. I heard they started to increase their volume a lot. I don’t know whether you see it being in your territories? Thank you.

Yang, this is John. Let me take you through what has happened. But basically the increase in marketing is due to the fact that we have additional programs we want to put in place to jump start some of the Cola volumes that we do, as you saw, are lagging a little bit.

In terms of pricing, the Mexican price environment right now is that we have our 2.5L PET at 12 pesos. Pepsi Cola has its 2.5L PET one way at 12 pesos and we have a 2.5L one way presentation at 16 pesos. So that’s where the price gaps are.

Now, when Coke is talking about incremental marketing, they don’t necessarily talk about putting it all into discounts and allowances, or discounting it in price. So in terms of reconciling that number that there was other activities out there and other programs and plans that they want to put in place to grow volume in Mexico. Not price related activities.

In terms of the second question you had in terms of big Cola, I guess what you have is anecdotal evidence. But in terms of where Nielsen is saying things are going is they have picked up a little bit versus prior quarter. But in terms of volume, their volumes are flat. So I don’t know where you get your anecdotal evidence, but I would suggest we talk to the Nielsen guys to understand what is going on there.

Thanks.

You're welcome.

The next question is from Joaquin Lopez-Doriga with Deutsche Bank. Please go ahead.

Hi. Good morning gentlemen. I wanted to ask you about recent statements by the Coca-Cola Company regarding their investments in bottlers around the world and the potential reassessment of these investments. Are you guys expecting any reassessment of the level of equity in Coca-Cola in the medium-term?

Joaquin, this is Hector. No, we have not -- remember that in Coca-Cola they recently announced some changes at the management level. We would have meetings with them in the near future for the first time. They are meeting with us 2 weeks from now. But we have not heard any approach on that front to us.

Thank you Hector.

The next question is from Robert Ford with Merrill Lynch. Please go ahead.

Good morning everybody. John, I have a question with respect to [indiscernible] and that is at the tail end of the June quarter they launched a 620ml packages at 3 pesos 50 centavos. I was wondering what the impact of that has been so far and what responses are you seeing maybe by Pepsi and how that impacts your business and your pricing architecture?

Hi Bob. I was wondering when that question was going to come up. Look, what we’re seeing in the market place, let me give you a couple of the pieces of data points. In the Valley of Mexico we’re seeing, depending on what area, but between 2% to 4%, 5% distribution levels in the Valley of Mexico. That’s pretty similar across all territories. The feedback we’re getting back from the traders is it is not moving. That’s pretty consistent with what we were thinking since a personal size occasion is very much your own occasion. People really prefer their core brands. So right now what we’re really working on is maintaining our coolers intact of any type of big Cola proliferation. I know they're struggling with getting refrigeration.

The response we've seen in the market place with Pepsi is doing exactly the same and frankly, nobody is out there going out there and getting a little bit riled up about pricing. So far everything is stable.

So when you say Pepsi is doing the same, they're just getting their coolers. They're not matching on price. Is that correct?

They are not doing anything on price. They're just going out there and protecting their coolers as well. We’re both talking to the retailers about how much more money they're going to be making with us. And that what they call it because if you look at it, either Pepsi or us, the retail channels, or the retailers will be making, in terms of absolute dollars, more dollars per case than what they would be making with big Cola.

Great. Thank you very much.

You're welcome.

The next question is from Tobias Stingelan with JP Morgan. Please go ahead.

Yes thank you. Hello everyone. I just wanted some additional clarification regarding SG&A expenses. I was surprised at the increase in administrative expenses in Mexico in the second quarter versus the first quarter. I would like to see if you could give us the new number going forward?

Then I would like just to have some additional comment about operating expenses going forward. I know that the question was already asked. But I just wanted to have an idea. On the one side you have the rationalization of the cities which is an opportunity, but you might have higher marketing investments. I just wanted to have an idea how we can model what will happen in the second half of the year? Thank you.

Hi Tobias, how are you? This is Alfredo Fernandez. Just to clarify your question. There was a decline on the absolute amount on the expenses. Now what was your question, in terms of a sequential basis where was the decline on that number?

I was talking administrative expenses. You had about 400 million pesos in the second quarter and in the first you had something closer to 350 million pesos.

Well that line we were saying before that could go up or down in the range of 5% to 10% and that would be related to either fees paid to either advisors or traveling expense. There is some normal adjustment for the quarter. We don’t see nothing irregular in that number.

Okay. So I should assume the range between 5% to 10% was something I was not expecting. But if I can just have some clarification about the whole line and we can talk about SG&A including selling expenses in the second half of the year. What should we expected based on the different trends that you have?

I think in the medium-term we should be expecting more or less a 5% movement. I don’t think that should change in any significant way.

In terms of the selling expenses, as John said, that we expect to capture most the synergies towards year-end now. If your question is related to what would be the level that you should be forecasting in the future, we’re not providing a specific guidance. I mean I would expect that the rate we have right now is quite reasonable going forward.

Okay. Thank you very much. If you can just provide me some additional information. I still want to understand the reason for the Company to sell a piece of its business in Brazil. Can you just explain to me again the rationale behind that?

This is Hector. [indiscernible] remember that when we were announcing the transaction we said that the Coca-Cola Company had mentioned to us that they wanted to analyze what they used to call the Brazilian solution for the Brazilian Coca-Cola system. So we figure out that for us to stay in Brazil with the potential that we were seeing there was important also to have some Brazilian national also in that process. Combined with that, we did find some specific tax situations with respect to the way the business was handled in the past, particularly with the different tax between the different States. We ended up paying a substantial amount of taxes that was inherited from the previous administration. Then we were looking for someone local that would help us in all of those relationships and we think we ended up with probably the best partner that we could have in Brazil in the guise of Mr. [Gonzales] who is a very reputable business person. He has a very substantial business somewhat related to our business in the orange juice business. I think that he will help us tremendously and keep helping us tremendously identifying some opportunities in Brazil and the relationship with some of the other bottlers in the process to work positively for the Company, but also very importantly with the other bottlers to start bringing the business for us less trans-shipments. Right now we can say that we basically have reduced significantly, not totally, the trans-shipment. But it is at very reasonable level now and obviously all the relationships with authorities also important for us.

The summary around this idea was to take the decision of [Biogen] to be a partner in our Brazilian operation.

Okay. Thank you very much again.

The next question is from Carlos Laboy with Bear Stearns. Please go ahead.

Yes. John, I just wanted to follow up on my previous question. You said that you’re going to have some very important tools in place for price segmentation by the end of 2005. Is this project running late? Is it on time? Will you have no new tools to drive the top line differently in terms of price segmentation from early 2005 on?

Let me try to understand your question a little. What you’re saying, Carlos, is if we’re going to have anything in place prior to the end of 2005?

Yeah. Will you have different tools for doing price segmentation in place in Mexico from the fourth quarter on this year, or from early 2005 on? Will we be seeing price clusters in Mexico, or different segmentation in carbonated soft drinks throughout all of 2005, or not?

I think what we’re doing, Carlos, is rolling this out throughout the different territories, and by the end of 2005 we should have over 80% of our volume concentrations on these systems. So what you’ll be seeing is a continued rollout throughout Mexico, as you well put, in terms of pricing clusters, and in order of importance by volume, in terms of where we’re going.

There’s not a case –- it’s going to be evolutionary, it’s not going to be revolutionary, at the end of 2005.

Okay. Thank you. And for Hector. On the [indiscernible] transaction, is there anything that you can tell us about why it was done at the Brazil level only, as opposed to at the Coke FEMSA level? And any further insight you could give us on valuation of that equity stake?

Yes. As I was trying to say, Carlos, for us it was very important, because of the relationship with the Coca-Cola Company and the relationship with the bottlers to have a local partner in Brazil. Remember that the Coca-Cola Company had all these ideas that maybe they will ask us to buy from us the Brazilian operation when we did an acquisition. So that’s why we decided to have their participation specifically in Brazil, because that’s where we feel that they can help the most. If it is operating out of Brazil directly.

The total transaction price was $50 million for that stake, representing a group of our shareholders. We initiated this process of negotiating with him at the very early stages of last year, after the acquisition. Immediately after we heard these ideas that we’ve got this Brazilian solution that the Coca-Cola Company wanted for Brazil, and we were convinced that it had a lot of potential. We wanted to stay with a Brazilian operation. So we were working, basically negotiating the price, and the agreement with him and his shareholders, from the beginning of the third quarter of last year.

But that’s basically it. I don’t know if I’m answering all the questions, Carlos.

Thank you very much, Hector.

Sure.

The next question is from Jose Yordan with UBS. Please go ahead.

It’s a follow up to the question asked by Alex, and I guess to your comment. It seems to me like it’s a major revision of the synergy number that was put out on May of 2003. You’re basically going from $120 million down to somewhere between $70 million+. $70 million, $80 million.

And I was just wondering, when did you know this, and shouldn’t this have been announced being a much more material thing, if you’ve known about it for a while?

I think that it is important that we clarify that a little bit better. When we first did the announcement of the acquisition back in December of 2002, we said that we were going to have $70 million in synergies. That had to do with closing down facilities, reducing overheads, especially through closing Miami and closing the Mexico City office, procurement, and systems, if I remember correctly. Those were the 4 things.

And then, when we were doing this small road show, we also commented that in addition to these synergies -– and this $70 million was based on this analysis that was done by the two companies, together with Accenture, a couple of years before, or 3 years before that.

We reviewed that. We said this number is correct. And the $70 million is what we are basically we saying we feel we are on track for that. During this small road show or conversation that we had with investors and analysts after the acquisition was announced in early 2003, we said we should not characterize this as synergies, but we also see some savings in the commercial practices of Panamco/KOF.

If we were able to reduce the [indiscernible], to change the compensation structure of the commercial people and all of that. We did some of those changes, and as John has explained, part of the synergies are related to closing down all of these distribution centers. We still see room for improvement on that.

We changed the compensation scheme for some of the presenters and the sales persons. That second part has resulted against us, as we were moving from a 100% buyer compensation to a compensation that has a fixed portion and a variable portion. Which is the way we think it should be and is the way we have it in the other reference [indiscernible]. In other words, the way Panamco had this distribution system compensation arrangement, it was impossible to do any synergies like closing down facilities or [indiscernible], because if you continued to sell the same number of cases, they would pay the same expense, or the same commission, regardless of the number of sales that you would have.

We changed that. Volumes that worked against us will not. The compensation scheme that we have is a little bit more expensive than what Panamco had, because of this change. And, as John was saying, part of the expectations from this $50 million synergy had to do also with the way we were pricing and the way we were competing in the marketplace.

The competitive environment has changed dramatically. I would not necessarily say that the $50 million is lost. I would not characterize it as forget about that $50 million. We have had a very difficult competitive environment this year. Probably the $50 million is not the right amount if the competitive environment stays as it is. But if we start to see a pickup in volumes we will start to see some savings on the compensation for the sales people. And we think we should be –- we should comfortable with the structure that we have in terms of compensating these people.

What is difficult to see, Jose, is that when you have the pricing and volume pressures that we have had in Mexico, the pricing –- excuse me, the price of sugar and the price of PET increasing as it has increased. And the effect of the foreign exchange, which has the effect on [indiscernible] 60% of our rate. It’s very difficult to see all these savings that we have achieved to translate into P&L numbers because we have a lot of other variables that are working against those synergies.

Right. But presumably the $45 million you said that you’ve captured already is the gross number, based on what you’ve captured, and are not in that number when counting the increases in sugar price and the dollar movement against you and all that, right?

Yes. What I’m trying to say is we need to separate two issues here. One is the acquisition of Panamco and the integration of Panamco, which I think that is working very well according to plan. By every measure that you can look at it, in terms of number of plants, the number of headcount, the efficiencies of the production line, the efficiencies of the distribution system, the efficiencies of pre-sale, meaning the success of the effort when the presenter goes to the store and on how many cases they sell and how many cases are delivered the following day. And production plans and all of that.

And a separate issue is the environment we are facing in Mexico, where we are facing a very difficult environment. So if I were to characterize these two separate things, and say that the acquisition of Panamco and the integration of Panamco has been a very successful story, probably faster than we were anticipating against the speed at which we are moving.

Unfortunately, we are facing now a very difficult environment in terms of volume and prices, that it’s very important in this industry. Again, an internal computation, because all of these numbers are not comparable, but if we were to compare second quarter numbers versus the best estimate we have previous year, we are close to $80 million or $90 million short on revenue, just in Mexico, that we need to compensate with all these savings.

So when you are short of that in revenues, and then you have these extra costs on sugar and on PET prices because of the dollar, I think that the job that has been done in Mexico by John and his team is tremendous. Now I just wanted to make very clear that we are not saying that the $50 million in synergies, we should necessarily forget about that. We are saying that under this environment, it is very difficult to continue with that promise, although we are moving in the direction of doing all the things with distribution and commercial systems that we have envisioned.

I don’t know if this is clear.

Yeah, that makes it a little more clear. I just get the feeling that the market estimates out there are taking into account all the operating difficulties you have right now, but perhaps expecting some sort of bigger pickup in costs, bigger reduction in costs in 2005 and 2006 than what you seem to be implying now. And so there’s probably another round of revisions on the way. But thanks for the color. That makes it clearer.

Okay. Thank you Jose.

The next question is from Eduardo Estrada with [Espeval]. Please go ahead.

Good morning gentlemen. Well, just two questions. One for follow up to another question they have made you. Does this local partner that you have in Brazil have an option to increase the stake in the company there? And while the second question is for John. Can you tell us a little bit more about, do you see that Pepsi has equated price in a wide manner in the 2.5L one-way presentation?

The first question, the answer is no. They don’t have any option on any additional shares on our Brazilian operations.

I’m sorry. Could you repeat the second question on Pepsi pricing?

Yes. You told us that you see a more stable pricing environment then, and you said that Pepsi has increased its price in the 2.5L one-way presentation from 11-12 pesos. Of course, you have a wider research than I do, but I still see the price of Pepsi lower than that little. So can you tell us a little bit about what’s happening there?

It depends on where you’re looking at the pricing, I think.

Yeah, sure, yeah.

If you look at their feature price in supermarkets, they’re going to be hovering around 10.90 pesos and what have you. But that’s a lot less aggressive than they were before in terms of supermarket pricing. And up and down the street, also, in certain other territories they were in, basically, they had dropped their price to 10 pesos. On a segmented basis, I must say it’s not necessarily all over the place. But their discounting was the deep on a segmented basis, and those practices are being rolled back a bit. And that’s what I was referring to.

Okay, thank you very much.

The next question is from Jose Jiménez with Inbursa. Please go ahead.

Jose Jiménez: Good morning, everybody. Hector, given the conditions in the Brazilian market, and the previous behavior of volumes in both segments, colors and flavors, have you determined a pricing strategy for both segments in the next six months in Brazil? And I don’t know if you can tell us a brief comment of what is the competitive environment in the flavor segment there. And what will be the strategy for your beer operations there in Brazil?

Yes, good morning. On the prices, let me give you the flavor of Brazil, that will also help you understand a little bit the pricing environment. The first task that we had when we arrived in Brazil was basically to put a very disorganized and very dismantled business into place again and just work with the basics.

If you were to look at our business plan, none of the other countries, you have ideas of how to improve package price, channel execution, and segmentation and architecture and all of the efficiencies in the production line. In Brazil, the name of the game was let’s get control of our distribution and forget about all these wholesalers that were affecting our tax contingencies in Brazil and, obviously, our execution capabilities in the market.

I think that what Ernesto and his team are doing in Brazil has been very important, and doing a lot of progress in that front. And at the second stage we will need to start focusing on some of the other fundamental questions in terms of production facilities and rationalization. Although we have not stopped working in that front, we have slowed down on facilities. But also working on some of the other basics of the business.

But for us it was very important to take control of the channel again.

As you see, even though we have moved to larger presentations that carry a lower price per ounce, we have been able to increase prices in Brazil because we have precisely changed our mix of channel coverage for the direct sale that we think is the right way to do it in Brazil.

Now Brand Coca-Cola has very good indicators, very good presence. I think that we should just, again, carry on and piggy-back a little on the strength of Brand Coca Cola. In the flavor brand segment we do have tough competition, especially with Antarctica, which is a very important product to our competitor. And we need to start finding our space, launching new products, as we have been doing with [indiscernible], with orange flavor that we’re launching in [indiscernible]. We have been finding spaces in some premium products like Coca-Cola Light with Lemon, charging an extra price there.

So you get the idea, as you see in our numbers, we have no prohibitive charge in flavors. We have gained in colors. We need to work a lot on the flavors, and we think that there are very good opportunities there, because our share in flavors is around 30%. So we have lots of opportunities there.

But again, we are still working on the basics of the business, of getting more control on the execution and how we go to market.

On beer, beer volumes were down again this quarter. It’s important to point out that in order we get into this agreement with Molson where they were responsible for the sales function, different from what we had when we arrived. So the only function that we are doing is that we are distributing whatever they sell. And we have a nice return on that distribution effort. And that is really the story on beer.

Jose Jiménez: Okay. So the pricing in colas, is there a gap to increase in the second half for the Brazilian market?

Hi, it’s [indiscernible]. How are you?

Jose Jiménez: I’m fine, thanks.

We expect that the majority of the price increases that will be taking place in Brazil is going to be a consequence of package and ship, so a better pricing architecture that we’re implementing, and more sales coming from small retailers that carry pricing from – it’s a wide range, but from 5%-20% higher prices than supermarkets.

So initially I think there is a component coming from the way we go to the market. And certainly we’re going to be taking pricing initiatives when possible.

Jose Jiménez: Okay, if I understand, the increases in price will be a consequence of another mix of coverage.

Correct.

Jose Jiménez: Okay.

And it will have tactical activity, but in mainly the first part.

Jose Jiménez: Okay, thank you very much.

And we have no more questions in the queue at this time.

Well, we’d just like to thank every one of you for your interest in the company. I’m sure Julieta will be available to answer any remaining questions that you might have. Thank you for your attention.

Ladies and gentlemen, thank you for joining today’s conference. This concludes the presentation. You may now disconnect. Good day.