Coca-Cola Femsa SAB de CV (KOF) 2012 Q2 法說會逐字稿

Good evening everyone, and welcome to Coca-Cola FEMSA second quarter earnings event conference call. As a reminder, today's conference is being recorded, and all participants are in listen-only mode.

At the request of the Company, we will open the conference up for questions and answers after the presentation.

During this conference call, management 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 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 now turn the conference over to Mr. Hector Trevino, Coca-Cola FEMSA's CFO. Please go ahead, Mr. Trevino.

Good afternoon everyone. Thank you for joining us today. As some of you may have had little time to review the press release we just sent out, I would like to use this conference call to discuss our results and operational trends and allow our team to [revisit] additional questions after this call.

In the face of a continued challenging cost environment, coupled with the volatility of our main currencies and tough weather conditions in some of our territories, our operators delivered double-digit revenue and EBITDA growth in both of our divisions.

During the second quarter of 2012, we continued to integrate the results of Grupo Tampico, Grupo CIMSA, and [since made] Grupo Fomento Queretano in our Mexican operations. Their performance contribute positively to our Mexico and Central America division and our consolidated results.

Organically, the main drivers of our Company's performance continued to be our strategy of selective price increases implemented over the past several months; the execution skills of our operators; and the strength of our multi-category beverage portfolio, led by innovation in our still beverage category and our extensive sparkling beverage portfolio.

In the second quarter, our reported consolidated revenues reached more than MXN36 billion, up 28% from the second quarter of 2011. Organically, excluding the integration of our newly merged territories in Mexico, our consolidated total revenues grew more than 16% for the quarter. This increase was driven by average price per unit case growth in every operation and volume growth mainly in Venezuela, Argentina, and Brazil.

Our consolidated sales volume grew 16%, including our newly merged territories in Mexico. Organically, our volume remained flat. However, once again, innovation contributed significantly to 12% volume growth in the still beverage category. This growth was driven by our recently launched Fresh brand orangeade in Venezuela; our consumers' preference for the Jugos del Valle line of beverages in Mexico and Brazil; and the launch of Fuze Tea in most of our territories since May, replacing Nestea and reinforcing the Coca-Cola system's bet on this fast growing beverage segment.

The performance of our strong portfolio of flavored sparkling beverage brands, such as Hit in Venezuela and Fanta in Brazil, coupled with the growth of brand Coca-Cola in Argentina, Mexico, and Central America compensated for overall volume declines in Columbia and a decrease in volume from our water portfolio in Mexico.

During the quarter, savings arising from lower PET cost in most of our operations and lower sugar cost in South America division were only partially offset by increased cost of fructose in Mexico and Argentina, combined with the [adverse] depreciation of our main operations' local currencies as applied to our US dollar-denominated raw material costs. Consequently, our consolidated gross margin expanded 10 bps, to 46%, in the second quarter of 2012.

Our consolidated operating income grew 8%, to MXN4.7 billion in the second quarter. Organic operating income remained flat. As in the previous quarter, we continued to reinforce our marketplace execution and invest in our returnable packaging base. We continued to experience higher labor costs in Venezuela, in combination with increased labor and freight costs in Argentina and slightly higher freight costs in Brazil, due to changes to the transportation regulation in that country.

We've registered additional expenses related to the development of information systems and commercial capabilities in connection with implementation of our commercial models, and we made certain investments related to the development of new business lines. Most of these expenses will recur going forward as we continue to prepare our Company to capture more opportunities in the future.

During the quarter, as a consequence of a change in the labor law in Venezuela and a change to labor tenure among other areas, we registered a one-time provision in our other net non-operating expense line.

During the quarter, a tax shield related to interest on capital included in the dividend declared by our Brazilian subsidiary resulted in a lower effective tax rate at the consolidated level.

For the quarter, our consolidated net controlling interest income remained almost flat, at MXN2.7 billion.

Now, I will spend some time talking about the performance of each division. In the second quarter, as reported, our Mexico and Central America division sold more than 504 million unit cases of beverages.

As reported, our Mexican operations volume grew 28%, including 106 million unit cases contributed by our newly merged territories.

Organically, our volume in Mexico declined 1%, [cycling] a 7% volume increase in the second quarter of 2011. An 8% volume decline in our water portfolio, mainly driven by our efforts to improve the profitability of our jug water platform, offset the increased volume of brand Coca-Cola, driven by the performance of our single-serve platform and returnable multi-serve presentations, and the 6% growth of our still beverage category, led by the consumers' preference for the Jugos del Valle line of products and the launch of Fuze Tea, our system's bet to continue winning in this important and growing beverage segment.

In Central America, we generated 2% volume growth in the second quarter. This increase was driven mainly by 6% volume growth in the still beverage category, supported by the Estrella Azul portfolio, the launch of the Fuze Tea brand, and the performance of brand Coca-Cola, which grew 2% supported by our returnable base.

Our divisions reported total revenues grew 30%, to MXN17.6 billion. Organically, the divisions' total revenues grew 6%.

Our strong point-of-sale execution and our ability to deliver the right package at the right price for every consumption occasion supported a 7% organic increase in our average price per unit case in the division during the second quarter.

With regard to our profitability, this quarter we experienced the highest volatility of the Mexican peso since 2009, a devaluation of more than 15% on average. This depreciation of the peso as applied to our US dollar-denominated raw material costs in combination with higher high fructose prices in Mexico offset savings resulting from lower PET prices. As a result, our gross margin was 47.5% for the second quarter of 2012.

Our operating income increased 5%, to MXN2.7 billion. In order to achieve our net synergy target, we continue to incur expenses and make investments related to our newly merged territories in Mexico. Among others, these include costs related to restructuring the distribution and manufacturing network and certain one-time charges such as legal and banking fees related to the merger.

Organically, our operating expenses increased due to continued reinforcement of our marketplace execution to bolster our competitive position. Moreover, we made investments related to the development of information systems and commercial capabilities in connection with implementation of our commercial models. In addition to these investments, certain other items, many of which are related to the development of new lines of businesses, affected our year-over-year comparability.

Our Mexico and Central America divisions continued to deliver positive results despite the challenging environment. We continue to foster single-serve consumption of our sparkling beverages, especially brand Coca-Cola. We led the Coca-Cola system efforts to launch Fuze Tea with excellent results, doubling historic point-of-sale coverage we achieved with the previous brand. Additionally, the brand equity of our [products] and our operators' ability to implement selective price initiatives enabled us to partially mitigate the effect of the Mexican peso volatility. Furthermore, we continued to benefit from the investments we have made in returnable presentations, which once again contribute significantly to our sales volume for the quarter.

In our still beverage portfolio, consumers' preference for our Valle Fruit Orangeade continued to grow. We also heavily levered the strength of our sales, marketing, and distribution to successfully launch Fuze Tea. Moreover, in Panama, on top of our existing distribution of the Estrella Azul line of products in our red trucks, we complemented our offerings with Del Prado, the leading juice brands in that country.

Now, I will briefly expand on the integration of our newly merged territories in Mexico. With regard to Grupo Tampico and Grupo CIMSA, which we rapidly and completely integrated into our Mexican operations in the fourth quarter of 2011, we have already launched the Sidral Mundet brand, increased cooler covers, and raised prices to par with the rest of our territories. We accomplished all of this while restructuring the distribution and manufacturing network to further improve the efficiency of these new territories.

Since May of this year, we have already incorporated Grupo Fomento Queretano franchise into our Mexican operations with even greater speed. (inaudible), raised prices of certain products, and reinforced their local sparkling beverage brand, Victoria. Our in-house teams have done a tremendous job so far and, consequently, we are well on track to meet the MXN800 million of net synergies we outlined for you at the end of 2011.

Should currency volatility recede, we look forward to a more stable cost environment for the second half of 2012. In addition, the following factors will provide a more stable sweetener outlook for 2012. Sugar prices in Mexico have been sequentially stable. We continue to benefit from our stake in Grupo Piasa, and we have locked in prices for most of our fructose consumption needs. Furthermore, we have seen a more moderate PET pricing environment, which should remain in place for the rest of the year.

In this improved cost environment, we are confident that our operators' discipline and superior skill sets will continue to deliver positive results for our Company.

Now, let me talk about South America division. Our South America division's total sales volume grew close to 1% in the second quarter, reaching close to 266 million unit cases. This increase was driven by volume growth in Venezuela, Argentina, and Brazil, which compensated for a volume decline in Columbia.

In our Columbian franchise territory, volume was down 6% in the face of tough weather conditions during the quarter and 10% volume growth in the second quarter of 2011.

In Argentina, we continue to see a positive volume growth momentum, despite an economic slowdown in the country and 9% growth in the second quarter of last year. Sparkling beverage growth was driven by a 5% volume increase in brand Coca-Cola. Aquarius flavored water was the driver behind the 8% growth of our water portfolio. In the still beverage category, Hi-C orangeade grew more than 30%, successfully building on its 2011 launch, while the Cepita juice brand continued to grow at a healthy pace.

In Venezuela, we also continued to see positive momentum, as exemplified by our 7% volume growth for the quarter. Our still beverage volume almost tripled due to the success of our Fresh Orangeade and the launch of Fuze Tea. In the sparkling beverage category, our volume grew 2%, driven by our flavored sparkling beverage brands. Also, the bottled water category generated 8% volume growth.

Consistent with our commitment to innovation, we continue to present our consumers with relevant beverage and packaging alternatives while reinforcing our marketplace execution, especially our cooler covers.

Our volume in Brazil grew more than 1% as compared to 2011. We faced a tough start to the quarter, mainly due to bad weather conditions, but experienced volume recovery in May and June. Our water portfolio volume grew 16% driven by the performance of the Crystal brand. In the still beverage category, our volume grew 12%, driven by the Sucos del Valle line of business and the Powerade brand. Our flavored sparkling beverage volume grew 6%, supported mainly by the Fanta brand.

In the second quarter of 2012, our South American division reported total revenues growth of 26%, reaching MXN18.7 billion, mainly as a result of double-digit revenue growth in Venezuela, Argentina, and Columbia. Our strategy of selective price increases implemented over the past several months across the division accounted for the majority of our incremental revenue growth.

Lower sugar costs in the division, combined with lower PET costs across most of our operations, offset the average devaluation of the Brazilian real and the Argentine peso as applied to our US dollar-denominated raw material costs.

This resulted in a 180 bps expansion of our gross margin, which reached 44.7% for the second quarter of 2012.

Our South America division's operating income grew 12%, to MXN2.1 billion. Operating expenses were affected by higher labor costs in Venezuela, higher labor and freight costs in Argentina, higher freight costs in Brazil, and increased marketing investments across the division to continue reinforcing our point-of-sale execution and commercial models.

Our South America division delivered solid top line results in the second quarter of 2012, despite bad weather conditions in some of our franchise territories. Continuous innovation in the still beverage category allowed us to capture opportunities through the Jugos del Valle platform, while the launch of Fuze Tea will certainly reinforce our offering in a growing beverage segment.

We continue to reinforce our sparkling beverage portfolio with single-serve and returnable alternatives, while our strong portfolio of flavored sparkling beverage brands continues to deliver incremental volume growth. Furthermore, we constantly reinforce our execution capabilities, and we expand our efforts to improve cooler covers in order to support our wide portfolio of beverages.

As we face the second half of the year, we see international sugar prices remaining flat, sequentially, mainly benefitting our Brazilian and Columbian operations. In addition, PET prices should remain stable for the remainder of the year. However, we closely monitor currency volatility which has been offsetting the benefits of lower US dollar-denominated raw material costs.

Finally, I will briefly talk about our financial performance for the quarter. This quarter, our Company continued to deliver increased cash flow from a geographically balanced portfolio of territories, providing us with the continued financial flexibility to look for opportunities in the beverage industry.

As of June 30, 2012, we have a cash balance of MXN9.2 billion, and our total debt was MXN21.2 billion, while our net debt to EBITDA ratio was 0.5 times and our EBITDA to net interest ratio was 18.7 times.

With regard to the potential Philippines transaction, which we previously shared with you, our on-the ground team have nearly completed the evaluation of these operations. On a parallel track, a separate team of our executives is working on the financial valuation model. During the second half of the year, we should be able to reach a decision as to whether we should move forward with this undertaking.

The Coca-Cola system, through Jugos del Valle in Mexico, have taken an additional step in the dairy category in Latin America by acquiring Santa Clara, one of the leading players in this category in the Mexican market. This transaction will broaden our portfolio of beverages. Moreover, we at Coca-Cola FEMSA are enthusiastic about the opportunity to share our joint lessons from the Estrella Azul venture in Panama with our partners at the Coca-Cola company.

We remain confident despite the volatility we faced during the first half of the year. Our operators' capabilities, our wide diverse offerings, and our commitment to flawless execution and continuous innovation will allow us to continue delivering increased value for you, our shareholders.

Thank you as always for your continued trust and support. And, now I would like to open up the call for any questions that you may have.

(Operator Instructions) Your first question comes from the line of Lauren Torres from HSBC.

Good afternoon everyone. Hector, my question is relating to the operating margin pressure we saw in the quarter. It seemed it was like more than we were expecting, maybe you were expecting, too, you know, heading into the quarter. And, I was just curious, you know, if some of these expenses were basically borrowed from the second half? Or, how should we think about the second half? Are they trending higher? You know, both in Mexico and Central America and South America, you know, why was this, I guess, more than you had initially anticipated? Or, at least, we were initially anticipating?

Yes. Good afternoon, Lauren. Certainly, the four areas I'll say where we are having a lot of pressure during this quarter has to do first of all with the raw materials and FX movements that we saw during the quarter. In most of the countries, and certainly the one that I have more at the top of my head being Mexico, the depreciation of the Mexican peso, but it was very similar to other currencies, was close to 15% during the quarter, because we were facing the highest number on the exchange rate this year versus the lowest point that we had last year.

So, that put a lot of pressure on some of the raw materials. So, even though we have PET prices in dollar terms coming down, we couldn't benefit because of that because when you translate that into Mexican pesos or Brazilian reals or Columbian pesos, we were impacted by that.

Raw material prices, I mentioned PET having a more stable environment, actually coming down. Raw materials prices, the surprise was more on high fructose corn syrup. We had some increases in sugar, especially standard sugar, refined sugar. In some of the countries, we had lower prices. Certainly, it was the case for Brazil, but in the markets where we use high fructose, especially the Mexico market, that definitely impacted our numbers.

That's with respect to the cost of raw materials and FX. The other important element has to do and that's more -- let me continue first in Mexico. The other important element is the expenses related to the merger of these three territories. If you look back, Queretaro happened basically two months ago. So, we are just in the process of having a lot of our people doing all the takeover of that and, certainly, reducing the headcount in this territory where we are moving very, very fast.

In the three areas, we have already reduced around 750 people, in headcount, with no labor issues at all, not a single note in the newspaper. So, that certainly will help us going into the second half of the year.

We have some other expenses that are not that significant, but you have a lot of these small things like, for example, some of the expenses related to doing the due diligence in Philippines. We have that as our expenses in the corporate headquarters which are recorded in the Mexico area. We have, as maybe some of you know, we will be moving to a new building, a corporate headquarters, at the end of September, very close to our offices here in Mexico City. It's basically, I don't know, less than a mile away. But, as we already contracted the new building, which we are leasing the same that we have, we are at this moment paying double the rent, because we haven't left the building where we are. So, these are small things that are piling up and certainly not helping in this quarter that was very difficult on the raw material environment.

We have, and we mentioned that during the first quarter, Lauren, and that's important for everyone to understand, we have in -- and let me go back one step and this is for all the territories. In 2010, we received this news by SAP that the system that we have had for many years was no longer -- they would no longer support, because it was also [late] for them. So, we needed to change to, all of our systems, to a new SAP platform. That expense that was incurred basically during two years was capitalized, and we are now in the phase of amortizing those expenses. That's something that we will have in the future. But, certainly, it's an expense that is needed just to support the tremendous number of SKUs in all of our commercial practices.

We have some expenses related to businesses that we are developing like the Blak coffee line of business that we are experimenting, with equipments, and amortizing some of these equipments. And that, so far, if you look at the P&L of the Blak coffee alternative, or the Blak coffee, let me use the word, initiative, we have probably around $1 million that is affecting this quarter as an -- if you were to look at P&L isolated for Blak.

So, when you add up a lot of these little things, that's basically what is not helping us in the SG&A numbers.

When you move to South America, Lauren, which is also very important, it's very important that everyone has in mind that the labor regulations in Argentina and in Venezuela are very tough and that we have suffered increases in salaries and compensations for middle-level workers and even white collar workers in our offices that are substantially above inflation. And, that's something that is changing. That's the situation in those countries.

We have been able to increase prices, importantly, in those two countries, and we think that we basically compensated part of that but not all of that. Some of those labor cost increases affect also the third-parties that give us service for freight plus some of the gas prices that have been increasing.

So, when you add all of these [costs], Lauren, I think that the fact that we have pressures on FX, plus raw materials, together with some of these elements of one-time charges, and then this, a bunch of small things that start piling up in a quarter where the wind was not in our tail, but we were headwind, no?

So, my expectation is that the second half of the year, some of these one-time charges will be isolated and removed. So, I expect that the FX environment, although today was a very tough day, will be a little bit more, better for us.

We are expecting prices of cane sugar and PET to remain stable. I'm a little bit concerned with corn, because of what we have seen with corn prices and the potential impact on high fructose. But, I think that, all in all, I do see a second half of the year that will be better on the margins than what we are presenting in this quarter.

It's probably a long explanation, but I think that the results that we have merit that I extended on this answer to all this extent.

Yes. That's very detailed and helpful. Just, can I ask, to round out that answer, I think previously you had talked about an operating margin being relatively stable this year? With a better second half, do you think you could still hit that target?

I think that the good news, Lauren, here is that we are increasing the top line at a faster pace than what we were anticipating, which is very good. I mean when you look at the revenues growing 30%, it's a very important movement. So, with that in mind, I think that margins will be slightly below what we had last year, but what I'd like to think is that once we recapture the profitability of some of these territories and start having all these synergies embedded in the system, we'll certainly start seeing that kind of growth in the bottom line.

The fact that the revenues are growing at this pace, even if it's because of acquisitions, but the fact that we can immediately start putting new pricing architecture in these territories, continue growing volume, continue to penetrate on coolers and market share, I think they are good news for the future.

Every single market where we are operating, we have had increase in market share. The only exception is a small reduction in Brazil in colas. All the other territories, in every category, in every geography, we have positive behavior in our market share numbers. We have positive behavior in brand awareness. So, I think that the base is there for us to start producing the bottom results that this Company deserves.

OK. Great. Thank you very much.

I think that for the end of the year, given the fact that the volume, the revenues is growing faster than what we were anticipating, I think that it's possible that we see a reduction in some of our margins.

Remember also, just to, one final point here, as we look at categories, remember that water and sometimes juices, when the raw material is expensive, and certainly in milk and dairy products, their profitability is smaller than what we have in soft drinks. So, I will also focus in how our amount in dollars, in terms of net income or operating profit, is increasing as well as margins. But, it's normal that as we change the mix of our products, we see some pressure on the margins.

Thank you, Lauren.

Thank you.

Your next question comes from the line of Alan Alanis with J.P. Morgan.

Hi, Hector. Thank you. With regarding your working capital, I mean we saw deterioration of MXN1.8 billion during the quarter. And, on my calculations, your operating cash flow is substantially below last year, second quarter, and the first quarter of this year. What's driving this? Are there some recurrent or non-recurrent elements? And, that will be my first question.

My second question has to do with accretion and dilution of the acquisitions. When do you expect them to be accretive?

Yes, Alan. I think that in general we might have some impacts here on noncarbonated drinks and some of the inventories there, but other than some adjustments that we have done in Brazil on working capital, for the good, but suffering a little bit during the last quarter, I don't have anything in my radar screen that strikes me as odd in working capital.

Let me give you some numbers. When we look at, if I look from the first of January to the first half of the year, during the first half of the year, free cash flow as the ultimate measure of generation power of the cash of this Company, where CapEx are involved, where working capital is involved also, it's growing importantly. We have generated close to $400 million of free cash flow, of which we paid close to $400 million in dividends in May. We paid down some of the expense, some of the indebtedness that was embedded in the three mergers, especially Queretaro because maybe some of those happened at -- probably Tampico happened before year-end. But, some of those since have happened during the first part of the year.

And, a CapEx program that is very aggressive. So, I'm not that worried with working capital. We follow very closely these indexes. We have had some increases that had to do with some inventories, but it's basically 1 or 2 days, but nothing major to move.

I think that, with respect to your second question, Queretaro is still on the works, because we just finalized, we closed the transaction in May. I feel very confident with Tampico and CIMSA. As I mentioned, we are increasing prices to the pricing architecture that we have. We are closing down some of the facilities, production facilities, adjusting some of the warehouses.

As a matter of fact, we just had a board meeting where we have an approval to move one of the returnable [DT] lines from one of the plants in Tampico to our Villa Hermosa plant for better logistics. So, those are savings that we'll start accumulating in the second part of the year, or beginning of next year. And, we also get approval to move two production lines from CIMSA to the new plant that Queretaro built very recently, so that Queretaro will be an important center of production for us.

So, we are very well ahead and very active on moving things around in these territories. So, if you ask me right now, are these operations accretive? Yes, these operations are accretive already. I think that Queretaro will need a little bit more time to mature, and as I mentioned, adjusting close to 750 people is expensive, but we already have done that. It's part of our results for this quarter. And, we will start benefitting from that starting next quarter.

OK. Thank you so much, Hector.

Your next question comes from the line of Lore Serra with Morgan Stanley.

Hi. Good afternoon, Hector. I wanted to ask, just as a follow-up to what you're talking about in terms of the mergers, could you give us an estimate of how many, kind of, quote-unquote, one-time expenses you've had associated with the three acquisitions that are in your, I don't know, second quarter or first half numbers associated with some of the issues you've mentioned? And, how much more is left for the third quarter?

During the quarter, Lore, more or less in terms of liquidation expenses and some due diligence expenses mainly related to Queretaro, the number is around MXN200 million.

In the second quarter.

During the second quarter, yes.

And, how much do you anticipate for the balance of the year?

I don't have a definite answer right now, Lore. Let me check with the plans that Ernesto Silva has for Mexico. I know that they are adjusting some of the distribution and production capacity still, going forward. So, we might see some. But, my feeling is that the bulk of Tampico and CIMSA is already done. We might still have some for the Queretaro, because it's very recent. So, I'll ask (inaudible) to review that and give you a better idea for the third and fourth quarter.

And, if we look at the first two transactions, what kind of a run rate are you? If I remember correctly, the first two were about MXN600 million of the MXN800 million in synergies. What --? You know, if we sort of mark to market where you are right now, how ramped up are you on those synergies? Should we see a lot of them, sort of on a run rate basis, into the second half of the year?

I'd say that around 60% of the synergies that we were anticipating for those two first transactions are already in place, and we'll have them for the future.

OK. OK. OK. And, I guess I would like your impression. I mean, the pricing you've taken sort of across markets is really strong. I mean, it's very attractive, given, you know, if we measure it historically. So, I guess it's a little hard to see all the margin pressure. But, when you talk to the operators, how comfortable are they with the pricing environment in the different regions? I'm going to guess you mentioned competitively you're doing well. But, maybe particularly in Brazil where you're going to have to take a lot more pricing I guess with some of the excise tax changes. How comfortable are you with taking pricing from these levels across your different regions?

Yes, Lore, I think that in general the measures are one to give here is, in every market, in 8 of the 9 countries we feel confident that we can continue to improve prices slightly, as always, measuring a lot what the competitors do. I'll give you the examples of the largest markets. Brazil, since we have some impacts where the value added taxes over there, everyone is increasing prices. And, everyone should continue increasing prices in Brazil in the near term.

Mexico. I think that we have flexibility, although I have to recognize that Pepsi, or my competitors, is very aggressive with some specific packages in some specific regions. But, one, just me to -- I mean, I'd like to remind everyone that in areas of the value of Mexico, PepsiCo now is the third brand in colas. So, they are desperate to move, to start getting some traction in volume.

And, the only country that I feel a little bit more cautious about pricing is Columbia. I think that Columbia, because of the reasons we have discussed for many quarters, there is very tough competition that we have with Postobon and the flavored brands. We feel that if we want to get the per capita's of Columbia to the levels that we have in other countries, it might be necessary to do a resetting of the prices so that we start generating a lot of volume growth. And, it's something that we are discussing, as we speak, with the -- (technical difficulty)

Pardon the interruption, ladies and gentlemen. Your conference will resume momentarily. Ladies and gentlemen, we will now resume with Q&A.

Sorry about that problem with the line. I was saying, Lore, that in Columbia it's where I feel a little bit more uncomfortable with respect to the prices, mainly as a result of a strategy that we're discussing with the Coca-Cola company that in order for us to really grow the per capita's in the market there, we are analyzing the possibility of resetting prices probably to have more [attractive] product to our consumers and see how that reacts. And, we will be doing some experimentation over there.

But, in general, I think that the pricing environment continues to be positive as always with the competitive pressure that we have.

Thank you, Lore.

Great. Thank you.

Your next question comes from the line of Margaret Kalvar with Harding Loevner. Please proceed.

Yes. Good afternoon. I wanted to ask what your thoughts were about volumes, which seemed a little bit light? And, if you could give me more color on reasons and any trends or views you have or progression during the quarter, either volumes getting stronger or weakening as we went into the successive months?

Good afternoon, Margaret. In general, I think that we have to isolate some of these categories and countries. In Columbia, we suffered a little bit on the volume, but we have a very strong pricing during the first half of the year. And, that certainly -- you look at Columbia in revenues, the revenues were positive even though we have a negative volume trend.

The rest of the countries were good, in general. Mexico was a little bit soft. When you look organically, we were like 1% below. But, it was mainly the issue with [bottled] water.

So, in general, Margaret, I would say that I still feel confident with consumer sentiment in most of the countries. Obviously, Argentina is a little bit tougher to read. Venezuela, the volumes are doing very well. We changed from Nestea to Fuze Tea, to [match their] price. I was taking some reductions there, but volume trends are very good. As we mentioned, we increased coverage to the coverage that we had with Nestea. And, basically, Nestea was not in operation for a few weeks, because they were struggling to get production and distribution in place, as we started in May.

So, I feel confident with that. Obviously, macroeconomic environment affects this. For Mexico, it's going to be important how the US performs macro-economically. For Brazil and Argentina, I'm not a bit worried because of the commodities and the impact that will have, and certainly we have seen some kind of a slowdown in Brazil and Argentina. But, still, our volumes are continuing to be positive.

And, that's more or less the story, Margaret. I think that some products, or some categories are better than others. Brand Coca-Cola continues to be strong everywhere. And, as I mentioned, market share, in terms of market share, we are growing everywhere, everywhere, in every category, in every product, except a little bit (inaudible) in colas in Brazil, and a little bit of flavors in Columbia.

OK. Have you noticed any of the increase in per capita's in the areas of Mexico that are below the median that had been cited as potential drivers of continued volume growth there?

Well, Mexico, it has been more ample. I mean, there is no specific market that is, that has been outstanding either geographically or socio-economic. I mean, it's more in every category and every consumption occasion, we have been growing the volumes. And, for our per capita small that is stable or increasing not very big, you know, depending on some of these categories.

And, that's the same for the other countries. We haven't noticed any specific movement in a specific geographic area or socio-economic area that is improving the per capita.

OK. Thanks.

Thank you, Margaret.

Your next question comes from the line of Antonio Gonzalez with Credit Suisse.

Hi. Thanks for taking my question. Hello, Hector. I wanted to ask two things. First, on the jug water business in Mexico, can you give us some insights, Hector, on what do you think needs to be changed in this particular business so that your volumes are turned around? Is it the distribution channel? Or, is it the pricing that needs to be fixed?

And, my second question has to do with Fuze. Would you be able to share some insights on how were you able to launch a new brand in Mexico so rapidly and with the results that you obviously showed today in terms of your still beverage portfolio? What were the main challenges that you saw there? And, probably, how does this launch talk about the capabilities of innovation that you guys have developed over the last few years?

Good afternoon, Antonio. In water, I think that the jug water business, it's something that if you go back in time a little bit, Coca-Cola, the original Coca-Cola FEMSA didn't have much. Then, we acquired the business from CIMSA, because they were selling jug water in Mexico City. We started to learn from that. Then, when we acquired these new territories, especially CIMSA and Toluca and Tampico, they have very good jug water penetration in their territories, and they have a water business that is profitable.

Some of the learnings there is that jug water cannot and should not travel a lot, because distribution expenses will kill your profits. So, either you sell in the main cities with a small production plant in some of those territories. Or, you'd better stop serving far away territories. And, we are adjusting a little bit of that.

The other important learning is that most of these other companies have home delivery, home meaning offices also, no? But, home delivery is important. And, they have good profitability in there, because you give the retailer margin. And, that's an important element that we have been developing also in Coca-Cola FEMSA.

When you think of the opportunity of, if you have a truck that is taking jug water to homes and you start putting juices and potentially dairy products and some soft drinks, I think that there is combination for a niche business that will bring some profitability in the future for Coca-Cola FEMSA.

With respect to the second question, which is more related I assume to Fuze Tea, I think that in general of having this idea that since the beginning of the year, we knew that by May 1, we will stop selling Nestea. The whole system prepared for that. The formula was owned by the Coca-Cola company. So, we didn't have an issue with the formula. The shape of the bottle was owned by the Coca-Cola company. But, the labels and the name and some other small things in the label and the shape of the bottles, some tea leaves that are embedded there, are the property of Nestle. So, we were able to prepare our system to a campaign in advance, a very good marketing campaign in my opinion, starting to create some attraction to Fuze Tea and, obviously, some something. And, then, we put all of our sales force to start selling this product even in places where we didn't sell Nestea before.

And, I think that as a result, I have to be honest, we were lucky a little bit that Nestle as I mentioned was struggling a little bit with production capacity, because they didn't have any production capacity in Mexico, or the other countries, and also with distribution capacity. So, they are doing some, for example in Mexico, and not very well, that they are doing something, some channels with Modelo and some other channels, [distribution] channels with Jarritos to try to leverage that distribution.

But, I think that, also, we were also helped by the fact that they were a little bit late on this process.

Thank you.

Thank you so much, Hector.

Your next question comes from the line of Alex Robarts with Citi.

Hi. Thanks. I have two questions. First, interested to hear a little bit more about the volume trends in Brazil. You talked about them just now. But, we're seeing double-digit volumes just down the road in Rio in the second quarter. You've got CSDs seem to be flat here for you guys in 2Q in Brazil. I mean, I understand, you know, you mentioned the weather issues, but have you been taking price such that you've been seeing some impact on the volumes? And, to the extent that we've got some market share loss in colas, just curious to know what was going on there?

And, if we can kind of get the fuller picture on this tax increase? 3% to 4%. Does that sound like what you need to do to pass on this increase? And, do you expect that to be really done before the October 1 implementation date? So, that's kind of the first question.

And, the second one relates to the Philippines. And, I appreciate you've done and completed some of your groundwork out there. Can you share with us some color or what some of your findings were? The markets seemed to contract. The CSD market last year in the Philippines seemed to have decreased about 5%. Just wondering what the pace of the recovery of that market was this year? And, any other thoughts, if possible, about your findings in the Philippines, that would be great.

Good afternoon, Alex. Brazil first. Brazil, we have increased prices in June. We are planning to increase prices again in September, and probably one more at the end of the year basically, as you say, to compensate for the additional taxes that are scheduled to be implemented, if I remember correctly, by October as you mentioned.

The estimate that we have from our operators down there is that somewhere around 4% price increase should set us level with the new taxes. So, that will basically compensate for the new taxes, and we are OK. We believe that the whole industry will start moving prices.

And, when I say that we've lost a little bit of market share, probably I was being very exaggerated. It's just a few fractions of basis points in market share. But, I'm being completely open with you as I mention that, that that's the only place where we were losing a little bit of points there.

So, my impression is that that's basically what is driving some of the volume [pressure] in Brazil. I mean, remember, if I remember correctly, first quarter, we were around flat volumes. This second quarter, we are around 1.5%, 2% above. But, everything has to be with the fact that the economy is decelerating a bit, and we are increasing prices because of this tax situation that we have in Brazil.

With respect to the Philippines, we have been doing some groundwork as we explained. The trends look positive. It's a 96 million people inhabitant. They sell around a little bit more than 500 million unit cases. The Coca-Cola company reported in their original report that they increased, if I remember correctly, 6% to 7% volumes during the quarter. So, the strengths are good.

I think that in general we are enthusiastic about the opportunity. We need to complete all of our work there and, once we complete that work, to start looking at valuations processes and start negotiating with the Coca-Cola company based on that valuation. And, obviously, as always, as soon as we have more information that we can share, we will share that with you. But, we feel enthusiastic about this idea of -- it looks like an interesting market, Alex. Many aspects very similar to what we have in Latin America. A lot of fragmented retail markets. A lot of small mom-and-pops. CSD consumption is good, because in other parts of Asia, it's more drinks that are warm and not bubbles, noncarbonated. And, brand Coca-Cola, it has good penetration there.

So, I think that as soon as we can share more information, we'll certainly share that with you in the future.

Thank you.

Thanks a lot.

I would now like to turn the call over to management for closing remarks.

Well, thank you everyone for your attention to this call, and thank you for accommodating this call in the afternoon. It was kind of strange, but it was complicated with the agendas. And, Jose and Roland will be available also to follow up with additional answers to these questions.

Thank you so much.