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Executives

Peter Warne -

Wan Ling Martello - Chief Financial Officer, Executive Vice President and Member of Executive Board

Analysts

Jon Cox - Kepler Cheuvreux, Research Division

Eileen Khoo - Morgan Stanley, Research Division

Jean-Philippe Bertschy - Bank Vontobel AG, Research Division

Jeremy Fialko - Redburn Partners LLP, Research Division

Warren Ackerman - Societe Generale Cross Asset Research

Alain-Sebastian Oberhuber - MainFirst Bank AG, Research Division

James Edwardes Jones - RBC Capital Markets, LLC, Research Division

Patrik Schwendimann - Zurcher Kantonalbank AG, Research Division

David Hayes - Nomura Securities Co. Ltd., Research Division

Nestlé S.A. (OTCPK:NSRGY) H1 2014 Earnings Call August 7, 2014 2:30 AM ET

Peter Warne

Good morning, everyone, and welcome to the Nestlé Half Year Results Conference Call. We'll take the usual disclaimer slide as read, as usual, and now I'll hand over to Nestlé's Chief Financial Officer, Wan Ling Martello, for the presentation.

Wan Ling Martello

Thank you, Peter. Good morning, and good afternoon. Thank you for joining us on this call. Let me start with some highlights of our group performance this year, then take you through the business in more detail before opening up to Q&A.

Our results reflect a resilient performance over the first half. The group's sales momentum has accelerated, both in terms of real internal growth of 2.9%; and organic growth, 4.7%. Where necessary, we have taken pricing, either in response to input cost inflation or as we thought of some of the extreme currency moves we have seen this year. Looking at these highlights on a constant currency basis. Our trading operating profit margin increased by 30 basis points, underlying earnings per share increased by 3.6%, and we generated nearly CHF 3 billion of additional free cash.

The global operating environment has not changed much since the last time we spoke. The emerging markets continue to grow but at a lower rate than historically. The developed markets still face deflationary pressures and weak consumer sentiment. What has become more dramatic is the effect of foreign exchange. This has had a significant impact at all levels of our performance, from sales to profits to cash flow to earnings per share. You can see that it accounts for some 40 basis points of difference between our trading operating profit margin in constant currencies and our reported margin. A difference of that size is just unprecedented. However, the progress we have made in the first half does allow us to reconfirm our outlook for the full year, and that is organic growth of around 5% and improvements in margins, underlying earnings per share in constant currencies and capital efficiency.

An additional highlight is our announcement this morning concerning a new share buyback program. Our intention is to complete an CHF 8 billion share buyback by the end of 2015. I'd also like to confirm the message repeated on our roadshows. We remain committed to our AA credit rating, consistent with our Gold standard within the industry. This proposed buyback program, in line with our sustainable dividend policy, provides a very competitive return to our shareholders while, at the same time, underscoring our belief in the future of our business.

So those were the group highlights. I would now normally jump into more detail on our business performance. But this time, I want to give you a bit more context, specifically reiterating our group strategy, a strategy that has been very consistent and successful over the years. Our objective at Nestlé is to become -- is to continue our transformation into the world's leading Nutrition, Health and Wellness company. It is clear that in today's highly competitive environment that seems to have unending volatility and headwinds, products that deliver on the promise of Nutrition, Health and Wellness are among the fastest growing in our industry. They offer consumers more added value, so increasing our presence in this space and building more Nutrition, Health and Wellness arguments into our portfolio has led and will continue to lead to sustainably higher levels of growth and profitability.

In terms of strategy, the first half of 2014 saw us develop Nestlé Skin Health. It is in addition to Nestlé Health Science as yet another platform for our focus on delivering science-based breakthrough products that help people live healthier, happier lives. Of course, strategically, there is always going to be an ongoing realignment of our existing portfolio. Divestitures so far this year include businesses in chilled culinary, ice cream, waters and nutrition. In terms of organization, Paul and I have both talked about the evolution within Nestlé. Sustainable improvement and profitable growth requires us to leverage our scale, generating greater efficiency from our back offices and operations through GLOBE and Nestlé Business Services. We've stepped up our discipline using robust and streamlined tools to assess our portfolio, ensuring that we are investing all of our resources behind the real value drivers for the future and holding ourselves accountable for their success. In a nutshell, that is what our Roadmap is all about, an ongoing strategic and organizational evolution, focusing on our growth drivers, leveraging our strategic pillars and investing behind our competitive advantages.

Turning back to giving you some more color on our first half results. You can see here how our focus and determination has played out, with broad-based organic growth from across all 3 geographic regions. When looking at both the zone and globally managed businesses, together with our -- organic growth was 4.9% in Americas, 1.4% in Europe and 7.5% in Asia, Oceania and Africa. Real internal growth was 2.4% in Americas, 2.3% in Europe and 4.2% in AOA. The resilient performance reflects the strength of the group's diversity, especially given some wide variations in the operating environment within these regions.

To split this global perspective another way, let us now look at emerging and developed markets. Our businesses in developed markets grew 0.6%. I don't need to tell you that the trading environment in these markets has remained tough around the world. In many cases, we're dealing with deflation. Consumer confidence also remains low. So ensuring that our portfolio is fit to win is more important than ever. We need to make sure we're truly differentiated and offering value to the consumers, and I believe our positive RIG performance across the developed markets speaks volume to this. Our emerging markets grew 9.7% and today represent CHF 19.1 billion of sales. The environment in the emerging markets remains a mixed picture. We continue to see very good growth in many of the smaller markets, some recovery in South Asia, while China remains soft in some categories. We've also taken a series of price increases across our emerging market businesses, either in relation to increased input costs or on the back of currency movements. However, our sustained growth demonstrates the strength of our brands, the quality of our innovations and how well our people are executing our strategy. I should also highlight once again our ability to deliver growth in both emerging and developed markets.

At the group level, let's now turn to the trading operating profit margin. As a reminder, our H1 margin last year benefited from a lower input cost environment. Also, this time last year, we had increased our consumer-facing marketing spend by 15% in constant currencies. For the first half of 2014, we faced some increases, as expected, in our input cost basket in the low single digits. The biggest increase was seen in dairy, and that's partially offset by our ongoing efficiency programs. The 20 basis points increase in distribution is mainly related to a mix effect. We have yet again stepped up our consumer-facing marketing spend, up 5% in constant currencies. The 30 basis points improvement you see here in marketing and admin came from several restructuring programs and improved efficiencies. We've invested more into R&D, feeding the pipeline for future development. Finally, here again is the effect of the strong Swiss francs on our reported margin, 40 basis points, the greatest recorded impact from currencies. This gives us an overall 30 basis points improvement in our trading operating profit margin in constant currency.

So with that overview on group performance, let us now look at the segments in more detail, starting with Zone Europe. Zone Europe achieved 0.6% organic growth with 2% real internal growth, offset by pricing action that was taken in what is generally a deflationary environment. When we look across the categories and markets, it is clear that the investments we have made in the past behind new products and brands are supporting this performance. Western Europe saw a continued recovery in Iberia, with Switzerland, The Netherlands and Austria also delivering good growth. The U.K. continues to be challenged, particularly due to tough market conditions and tough comparisons. France showed signs of a pickup despite deflationary pressures. In Germany, softer performances in Maggi, chilled culinary and confectionery were offset by good growth in pizza, in soluble coffee, as well as in ice cream. The growth in Eastern Europe was driven by Russia, especially in confectionery and ice cream. Ukraine accelerated as we went through the start of the year, this despite the ongoing tension in the region. Elsewhere, the highlights included Hungary and improvements in the Czech/Slovak region. Poland had a tough start to the year, especially with the flooding there, but we do see signs of improvement.

Across the zone, Nescafé Dolce Gusto, Wagner and Buitoni in frozen pizza and Felix, ONE, Gourmet and our range of cat snacks are some of the key brands that have driven a lot of the growth. Premium offerings of Nescafé delivered good results, with Gold leading the growth. In confectionery, we had a solid recovery versus the first quarter, as expected due to the late Easter, but the tough comparisons in the U.K. and France had an impact. In ambient culinary, sauces, soups, snack and noodles and the continued rollout of Papyrus cooking papers were the standout performers, particularly in the Great Britain region and Germany. To wrap up the categories for Europe, ice cream had a strong growth in many markets, especially with Mövenpick, but a lot of this was offset by the weather and economic conditions in some markets, such as Greece and Italy.

The trading operating profit for Zone Europe was 14.8%, slightly down 10 basis points, and this mainly reflects impairment costs.

Now moving on to Zone Americas. The zone achieved 4.9% organic growth, 1.7% RIG, and both North America and Latin America contributed. In North America, the frozen food business continued to be weak. However, as we discussed just a few weeks ago at our Investor Seminar in Boston, we will continue to drive innovation in this category, both with new product launches and our consumer communications.

Staying with the frozen aisle but moving on to ice cream. The Dreyer's premium business remained weak, but our super-premium segment had a solid first half, as Häagen Dazs Gelato continues to grow well. Both the impulse Drumstick and Outshine brands also did well. Confectionery had tough comparables for the half in the U.S., and the Butterfinger Cups remain the highlight. Confectionery in Canada enjoyed a strong performance, driven by Kit Kat and Aero. Soluble Coffee accelerated as we went through the half, and Coffee-Mate delivered another good performance, especially given the good growth we saw at the same time last year. As with many positive stories, it is our support in innovation and renovation, particularly the special flavors we have launched in liquid, which continue to drive this growth. PetCare continued to deliver good growth through line extensions and new product introductions. The brand beyOnd was relaunched and is a key initiative in the natural segment. The Lightweight litter continued to drive growth. And we have reintroduced Waggin' Train snacks to the market.

In Latin America, Brazil again delivered, with expected confectionery growth recovering in the latter part of the first half. Mexico was more challenging, in large part due to the indirect effects of the fiscal legislation changes there, but it did improve versus the first quarter. The majority of our smaller markets across Latin America also performed well.

Looking at the categories in Latin America. Nescafé Dolce Gusto continues to do well across the region. And I would highlight the performances of Ambient Dairy and powdered beverages, ice cream and PetCare. In fact, PetCare across the region continues to do remarkably well, the drivers being Dog Chow, Pro Plan and the Revena launch for the pet specialty category in Brazil.

The zone's trading operating profit was up 10 basis points at 18%, and this was primarily due to lower restructuring and other expenses that offset the increase in our consumer-facing marketing spend.

Now moving on to Zone AOA. We had 4.7% organic growth and a slowdown in RIG from the first quarter to 1.9%, and this is partly due to the pricing we've taken in several key markets and, of course, a subdued China. Overall, our premium offerings and rollout of new products continued to deliver good growth for the zone. Just as an example, Nescafé Dolce Gusto delivered double-digit growth as its rollout continued. New launches, including Yinlu walnut milk in China and renovated packs for Milo in Australia, both had excellent starts. In the emerging markets, strong performances in the Philippines, Turkey, Pakistan and many markets in Africa were offset by continued softness in the zone's largest market, being China. However, we do see the fundamentals of our business there improving. South Asia has recovered somewhat, its growth reinforced with new products and beverages in India, Nestlé Masala Buttermilk and Nestlé Sweet Lassi. We also launched Nesquik Opti-Start in some markets. This new and improved Nesquik has been a success in Europe and has now had a good start in Turkey and the Middle East. There was solid growth across the zone for Milo in cocoa and malt beverages, Maggi in ambient culinary and for creamers. Developed markets had a reasonable start for the year, with a particularly strong few months -- first few months in Japan. Our 2 biggest -- our 2 big categories in Japan, confectionery and coffee, with Kit Kat and Nescafé, continue to deliver. In Oceania, we had a successful rollout of low-fat Carnation Cooking Cream and Felix cat food.

Zone AOA's trading operating profit margin decreased by 20 basis points to 18.9%, reflecting the input cost increases, mainly in dairy, but also the currency environment in which we're operating.

Next up, Nestlé Waters. The bottled water market continued its growth trend in developed markets and grew double digit in the emerging markets. Nestlé Waters ended the first half with 6.1% organic growth, confirming the good trend of the first quarter, which was 6.2%. All geographies had solid volume performance. However, pricing remained challenged in mature economies. We had RIG of 7.3%. More specifically, in North America, we saw an acceleration of our growth versus last year, and this was driven mainly by strong volume across U.S. retail, thanks to our regional spring waters and our international brands, Perrier and San Pellegrino. In Europe, while pricing was down, reflecting the market environment, RIG was very good, with some markets double digit. Now of course, the good weather did help. In our emerging markets, Nestlé Pure Life continued to drive growth, especially in China, in Egypt, in Brazil, Turkey and Pakistan. Just as a side note, I'd like to remind you all that Nestlé Pure Life was first created in Pakistan, which just goes to show that Nestlé is a company that can take innovations from anywhere in the world and turn them into global successes. To close the comments on Waters, the 80 basis points increase you see here in the trading operating profit margin was largely driven by leveraging the growth I've just described and also by the continuous improvement mindset that has resulted in cost reduction across all parts of the Nestlé Waters value chain.

Looking at Nestlé Nutrition. An organic growth of 7.9%, 3.8% of which was RIG, showed acceleration through the first half. The main drivers were double-digit growth in Infant Formula and Infant Cereals. The pattern of growth was similar to that of the first quarter. Our emerging markets remain the key driver of growth. And as I said back in April, the choices we've taken in the U.S. on being more selective, focusing on value generation and optimizing use of our assets has had an impact on our top line growth for developed markets. The trend with regard to our Infant Formula brands is the same as the first quarter, too. The premium and the super-premium offerings, such as NAN and Illuma, delivered outstanding growth. Infant Cereals had good growth, especially in Latin America and in Africa. The U.S. has also had a good half year, following the new packaging designs launched last year. Our meals and drinks business has suffered as a result of the declining category in Europe and the intense competition in North America. The improvement of the trading operating profit margin to 21.1%, up by 110 basis points, reflected the good performance of Wyeth Nutrition and active portfolio management, focusing on value-added innovations such as NAN H.A., our hypoallergenic formula.

Finally, taking a look at what we call our other businesses. They achieved 5.9% organic growth with 4.7% RIG. Nestlé Professional growth gathered momentum during the first half. Our emerging market businesses were the key drivers in Professional. We saw signs of recovery in our Chinese out-of-home market. And the Philippines, Malaysia and Singapore did well. Russia was the standout performer in Eastern Europe. In Western Europe and North America, the macro conditions continue to affect growth. The beverage business in Latin America has had a good start to the year. And our dessert solutions had a good performance in Zone AOA.

Nespresso. Nespresso again delivered strong global growth. The business has shown its resilience in the increasingly competitive market of single-portion coffee. We continue to grow well where the brand is established and have accelerated our geographic expansion, opening 14 new boutiques around the world in the first half. Innovation continues to drive performance, whether it is through the extension of our Grand Cru -- I know I'm mispronouncing Grand Cru. Every time I mispronounce this, I know my French makes Jean-Marc Duvoisin, who runs our Nespresso business, cringe. Well, it's probably the Chinese-American-Filipino accent -- Grand Cru coffee range, the introduction of new machines or even the Nespresso Cube, a completely automated boutique. I'm also happy to report that our investments in North America with the VertuoLine system has seen a good response.

Moving on to Nestlé Health Science. New products and the continued rollout into additional markets of Peptamen, Alfamino and Vitaflo's Carbzero and Betaquik achieved good results. Boost in the U.S., Meritene in Europe and Nutren in Brazil also achieved solid growth. The trading operating profit margin for other was 18.4%, down 80 basis points, and this is a reflection of our marketing investments, such as those of -- for Nespresso. We also had currencies impacting our margin, particularly from Professional's emerging market businesses.

With that wrapping up our segment reporting, I will now move on to take a brief look at our product segments. I've touched on much of this already from the zone perspective. From a sales point of view, we have had good organic growth in the majority of our categories. On the flip side, our prepared dishes have been challenged, as I mentioned earlier, mainly due to the frozen aisle in the U.S. Confectionery had tough comparisons in terms of organic growth, and the competitive environment in our key markets remain intense. From a trading operating profit perspective, I would highlight the improvement in Nutrition, in Waters and PetCare, with PetCare being affected last year by the voluntary withdrawal of Waggin' Train. Prepared dishes and cooking aids margin reflects the lack of volume growth in frozen. And confectionery faced higher commodity costs.

Now looking below the trading operating profit to the rest of the income statement in more detail. You can see that we have a drag on the net operating expenses, and this is mainly due to monetary corrections driven by hyperinflation accounting. It is also clear that there is an impact on net profit, which, when coupled with currencies, has affected the reported earnings per share. However, like I mentioned earlier, underlying earnings per share in constant currency is up almost 4%. Our free cash flow is at a similar level to last year, especially when given the currency impact. I realize that this is not the whole picture, as we're only halfway through the year. But looking at CapEx spend and other elements, we've seen an improvement. In terms of working capital, the delta from last year is a tough benchmark, as it was quite a major improvement. Having said that, we have continued to lower working capital as a percent of sales. I can assure you that from an operational perspective, our people continue to focus on delivering sustainable improvements on all areas of working capital year-on-year.

Perhaps at this point, it is a good place to remind all of you listening to our priorities for the use of cash. First and foremost, our priority is to continue to invest in our business behind our brands, creating innovative products, investing in future growth drivers of our businesses. You've heard me talk about the new rollouts, and hopefully, you can see the evidence of our work wherever you buy our products. At the same time, we have stepped up the rigor in our capital allocation decisions, focused very much on the higher-return, higher-growth opportunities.

Second, we continue to look -- we continue to enhance our portfolio with acquisitions. As we've always said, acquisitions have to meet all 3 criteria, not 1, not 2 but all 3, and that is: first, a compelling strategic rationale; second, good financial return; and last but not least, a strong cultural fit between us and the acquired company. Looking at 2014 post our Nestlé Skin Health transactions, the likelihood for the balance of the year will be bolt-on acquisitions. In addition to acquisitions, we continue to either fix or divest underperformers. Like our CEO Paul Bulcke always said, it's we accelerate, we fix or divest as we look at our portfolio, dealing with businesses or assets which are making inefficient calls on our capital, capital that we can employ behind businesses that are clearly doing well or our businesses that has a lot of potential that we should be accelerating.

Thirdly, we also believe in a competitive shareholder return through a sustainable dividend policy and, where appropriate, share buybacks. Our announcement today of the CHF 8 billion share buyback is a consequence of our discipline in generating and managing our cash.

So to recap, our half year performance was one of broad-based profitable growth in what remains a tough and volatile trading environment. Positive contributions from both the emerging and developed markets reflect agility of our different businesses to react rapidly and effectively to their individual challenges. Our performance to date also shows the value of our brands and the importance of innovation that allows us to price as necessary while delivering volume growth. And in terms of our execution and the Nestlé Roadmap, I've talked about strategic -- the strategic and organizational transformation that continues within the company. Our portfolio continues to be reshaped in line with our Nutrition, Health and Wellness strategy. And I'm very happy to confirm our outlook for the year, which is organic growth of around 5% and improvements in margins, underlying earnings per share in constant currencies and capital efficiency.

And on that note, I would like to open up to questions.

Question-and-Answer Session

Peter Warne

Many thanks, Wan Ling. [Operator Instructions] So with that, we have the first question from Jon Cox of Kepler.

Jon Cox - Kepler Cheuvreux, Research Division

I have a couple of questions for you. Just on the organic sales growth in Q2, which it appears to accelerate to around 5.2%, obviously, from 4.2% in the first quarter, just wondering what you think the Easter impact was. Do you think it was like maybe 20, 30 basis points in Q2? Or are you pretty comfortable for us just to go away and stop entering in? You're now above 5% organic sales growth for the second half of the year? That's the first question. Second question, just on your sort of outlook today and, obviously, the CHF 8 billion share buyback you've announced today, I guess we can just -- just maybe you can just reiterate, you don't see any sort of big bang M&A then for the remainder of the year. I know you won't comment on individual cases, but there is obviously a lot of speculation in the Infant Nutrition and medical nutrition space specifically. And then just a last question on the hyperinflation accounting. I wonder if you could just elaborate a little bit. I guess you're talking about Argentina there specifically.

Wan Ling Martello

Thank you, Jon. Hey, on organic growth, clearly, like I said before, and you're right, we saw an acceleration in Q2. But let me be clear on this. In terms of guidance for the balance of the year, we remain -- we -- I reiterated that it is going to be around 5%. And earlier this year, we spoke of growth being weighted to the second half. At the first quarter, we expected the growth for the full year to increase sequentially. And indeed, like you said, the second quarter is much stronger, so much so that we now expect organic growth to be more balanced between the first and second half. Now the difference in timing reflects the volatile environment, as you would have already seen in the results reported by so many other companies. And I should also say that our business is large and diversified, and so forecasting to the last basis point is kind of meaningless. So to just give you a sense, 10 basis points amounts to something like a few hours of sales for Nestlé. So what's important to bear in mind is that we confirm our outlook for the year, organic growth of around 5%, so improvements in margin, underlying EPS in constant currency, capital efficiency, in short, progress on both top and bottom line. On your question in terms of monetary corrections related to Venezuela, this is a result of hyperinflationary accounting. I'm not going to go and recite what the IFRS paragraph is on this. The corrections have been made on monetary items on the balance sheet that is exposed to currency devaluation. And this is something that we do year in and year out. This is not something new. We do this. There was an amount that was recorded also last year, and so -- and again, I think I said this in the follow -- during our 9 months conference that Nestlé has been in many of these countries for many, many years, and so it's been there, done that, got a t-shirt for it, so this is nothing new. It's something that we're very comfortable with. Venezuela is a relatively small market for the Nestlé Group. You mentioned Argentina. Argentina is even smaller. And like I said, we've been present in Venezuela since, I think, 1895, when the first product was sold by distributors. So we continue to serve our consumers in Venezuela, and we clearly -- so this is not something that we lose sleep over. In terms of the CHF 8 billion buyback, the pacing of the share buyback program, our plan is to complete it by the end of 2015. And clearly, it depends -- the pacing of it depends on market conditions. I think that answers your 3 questions, Jon.

Peter Warne

Next question is from Eileen Khoo of Morgan Stanley.

Eileen Khoo - Morgan Stanley, Research Division

Eileen Khoo from Morgan Stanley. A couple of questions from me. The first one is actually on the emerging market growth. And it looked like there was sequential growth -- sorry, sequential acceleration to around 11% in the second quarter. I was wondering if this was a natural -- actual underlying trend. Or are there timing-related factors or such that you'd like to call out? And if so, what is the actual sort of trend overall on an underlying basis? And then secondly, would you be able to remind us what sort of leverage ratios you need to remain within in order to satisfy your AA+ credit rating, so metrics like net debt to EBITDA, et cetera? And finally, on the environment in Europe, which is deflationary overall, I mean, do you have any view on whether this is primarily a cyclical issue, i.e. due to the recession, or are we potentially looking at a more long-term structural issue, maybe a shift in the balance of power between retailers and producers? Just need to get your view there.

Wan Ling Martello

Eileen, let me start with emerging market. Like I said before, it's mixed. We see acceleration in smaller markets, subdued in China, although that is -- again, in China, we're seeing a mixed picture even within China because some categories are doing really well, and some other categories are actually -- have slowed down. Let me just remind everybody, emerging markets now account for, at least in H1, 44% of our sales. Now even though these economies have slowed, we continue to be bullish because it does represent a huge opportunity for the future. And growth in emerging markets is usually volatile. So what we saw in Q2, it's broad-based acceleration versus Q1. And even in BRIC, we also saw acceleration. India and Brazil improved. China, for us, on a NiM basis, also accelerated. And by product, the drivers for Q2 acceleration were confectionery, infant and culinary. In terms of your AA, we're very -- even with the CHF 8 billion buyback over this year and next year, it allows us to maintain the AA credit rating. And there are many criteria that the credit rating agencies look at, but obviously, one of the main financial criteria is EBITDA to net debt. And so -- but I'm not going to go into the details in terms of how much and what it is. And in terms of Europe, we do not -- we are seeing some pickup in terms of -- I mentioned before Iberia region, but I don't -- I mean, we don't foresee any change in terms of the deflationary environment that we continue to operate in. It's -- in terms of RIG in Zone Europe, if you look at our business, RIG did accelerate after a slow Q1, and so -- but as you can see, it's very obvious, price remains in the negative territory. And so at some -- and it depends on the country and on category. Dolce Gusto, PetCare continues to accelerate it, and some categories picked up because, as we had called out, because of the Easter impact. So good luck with your baby, Eileen.

Peter Warne

The next question comes from Jean-Philippe Bertschy of Vontobel.

Jean-Philippe Bertschy - Bank Vontobel AG, Research Division

The first one would be on Russia. You were like saying that the market was quite strong there. How do you see distribution right now with the particular situation, and if you see some impact from the announced agricultural import ban that was announced last night? And the second one, on China, if you could share with us maybe the growth rates, if it was like in the low single digits.

Wan Ling Martello

In 2 questions, I think the first one is Russia. It's -- obviously, the situation in Russia continues to be fluid. We pay close attention to international function and, obviously, ensure that our business activities are conducted accordingly. Now I just want to point out, over 90% of our products produced in Russia are distributed and sold domestically. So I mean, clearly, whatever happens going forward will have an impact in terms of consumer demand, but we're very pleased with the performance in H1 for -- in Russia. It's -- we have 8 factories, 10,000 employees there, good first half growth thanks to innovation despite the economic uncertainties, driven by its Nescafé Dolce Gusto; confectionery, especially with Kit Kat; PetCare; and ice cream. In terms of China, we are not the first to tell you that China has slowed down, so that's no new news. For us, the difficulty relates to some categories like coffee, wafers, but that's -- if you think about a big market like China, and a big market slows down, there is -- to us, there is going be a certain level of destocking that has to happen when it slows down. So that is exactly what we're seeing. But in categories like Professional, Waters, Nutrition, we're doing well. And our expectation for the second half in China is, in fact, a gradual recovery. So I think that answers both of your questions in terms of Russia and China. Thank you, Jean-Philippe.

Peter Warne

Next up, it's Jeremy Fialko from Redburn.

Jeremy Fialko - Redburn Partners LLP, Research Division

Jeremy Fialko, Redburn, here. Really just one question, which is on your pricing in emerging markets. You talk about the RIG, particularly in Zone AOA, coming under some pressure because of the fact that you'd taken pricing to offset higher input cost. Could you talk about what the competition is doing, whether you've actually been the one that's gone in front and then other people now are catching up? Or do you find your competitors haven't really responded to the higher costs, and you're still losing a little bit of market share because you're the one that moved? If you could just give us some more color on that, it would be very useful.

Wan Ling Martello

Hey, Jeremy, at the risk of sounding like a broken record, pricing is local. It depends on category, it depends on market. But let me give you some color. It's pricing overall, like I said, slightly driven up by emerging market, and we'll -- our expectation is we should accelerate further in H2, but again, we don't guide on pricing based on sitting here in Vevey. Now pricing in H1 of 2014 was driven by, like we talked about, emerging markets. It's in terms of category. It was dairy, confectionery, Nutrition. Coffee pricing is starting to also take place, but developed markets continue to be very deflationary. And if you compare Q2 to Q1, pricing did increase. And so that's all I can say about pricing. And in terms of competition, I don't really comment on what competition is doing. Again, our local market does what it has to do to remain competitive, and we go back to pricing is local, pricing depends on market, pricing depends on category even within a market. Thanks, Jeremy.

Peter Warne

And the next question is from Warren Ackerman, Société Générale.

Warren Ackerman - Societe Generale Cross Asset Research

Wan Ling, it's Warren Ackerman here, SocGen. Two questions. The first one is just on the U.S. Obviously, coming back from the Investor Seminar, you gave us a lot of detail about your thoughts on the U.S. But I was wondering whether you could just tell us what the RIG and pricing was in the U.S. in the first half. Do you -- is there any reason to expect an acceleration in the second half? That's the first question. And the second one is just on input costs and coming a little bit back to Jeremy's question. I've been thinking about the 4 of your big ones, dairy, sugar, coffee, cocoa, we've seen some big differences in movements. Sugar's well down. We've seen the global dairy trade auctions now down 40% since February, which ought to give you a big gross margin tailwind. So just wondering whether you think you can retain these benefits. And then on coffee, coffee prices have moved up a hell of a lot year-to-date, and you talked about taking some coffee pricing. But also, we've seen cocoa pricing moving up a lot as well. One of your competitors yesterday talked about significant pushback from the trade on getting that pricing through. So obviously, we've got a lot of different moving parts here, Wan Ling. I'm just wondering whether you can sort of talk about those 4 commodities and what it all kind of means for you, particularly with reference to sort of second half margins.

Wan Ling Martello

Warren, let me start with your first question, which is in the U.S. And you -- as you rightly pointed out, we took the opportunity in our annual -- our yearly Nestlé Investor Seminar to deep dive and give our investor community a lot more color and specificity on a specific area of our business, and this year was in Boston, highlighting every single category in the U.S. So for those of you who did not have the opportunity to participate, the presentations are all on-demand on our website, so please, I would encourage you to do that. And in the presentation, we -- our management team was very transparent in highlighting what the issues are and what the plans are going forward in terms of addressing those issues. But let me come back to H1 from a U.S. standpoint, and I will talk about NiM. NiM, U.S.A., no question, is subdued, but positive RIG and organic growth at a NiM level, okay? So we saw a news site talked about that. Frozen and ice cream continues to be challenged; but PetCare, good growth; Water continues to be good; Professional improving from a -- albeit from a low level. The environment is challenging, but no other company has the breadth of Nestlé, with like 40 segments in the U.S. Consumer spending is low, and due to rise -- it's a whole host of factors. But we're focusing on improving communication, focusing on NHW and adjusting to trends like natural, protein, gluten-free. And we also -- the really good news, too, is we've achieved cost reductions in the U.S. and continue to be focused on that. In terms of COGS, it's -- or input costs, let me just give you color in terms of agricultural commodities. Now you know we do take hedging and forward cover to deal with short-term volatility of prices of our key agricultural commodities. And so year-on-year, we've seen price increases, mainly in coffee and cocoa, while it has been more benign on -- for other raw materials. I think coffee prices, as you know, has been up, especially arabica is up 40, I think, year-on-year due to Brazil drought and the fund buying. Cocoa price is also up, supported by strong demand. So if you look at our COGS, we talked about where our COGS was up 20 basis points due to a slight input cost increase in dairy and cocoa. But our input cost increase was more than -- was offset by NCE efficiencies. For the full year 2014, we still see input costs up in low single digit. Now that's -- but higher than in 2013. Now pricing taken in the first half help COGS -- should help COGS in second half with regards to higher costs of coffee and cocoa. And cost of other raw materials should be more benign. So that should answer your 2 questions. Thank you, Warren.

Warren Ackerman - Societe Generale Cross Asset Research

Can I just follow up very quickly just on dairy, Wan Ling, because I think that dairy is one of your biggest soft commodities, and we've seen global trade auctions, pricing collapsing. I mean, you were talking about down 40% now since February. I mean, should that not give you quite a big gross margin tailwind?

Wan Ling Martello

Yes, dairy prices have moved down from a high level. It's still up, but it's moved down from a high level, and that's due to global supply increases exceeding the demand growth. And so it's -- that's what we're seeing in terms of dairy.

Peter Warne

Next up is Alain Oberhuber of MainFirst.

Alain-Sebastian Oberhuber - MainFirst Bank AG, Research Division

Wan Ling, Alain Oberhuber, MainFirst. A short question on currencies. If we see currencies remaining stable, how much will be then the negative impact on your margins for the full year? And second question is more specific about France. Could we see a similar situation in the other European markets? Or is France picking up or just staying at these levels?

Wan Ling Martello

Yes, let me answer your first question first in terms of FX. I highlighted in our -- in my presentation earlier that this is -- my gosh, this is like very significant headwind, 40 basis points impact on margin. Now just to remind, I think everybody knows that this is sort of like stating the obvious, FX mainly have a translation impact with small -- and so because we sell where we produce, so with a good match between cost and sales generation, so I don't want people to forget that. A significant impact of FX on H1 figure sales, negatively impact by 8.8%; and trading operating profit margin by 40 basis points. Now having said that, we do not guide what the FX impact should be for the balance of the year, but do remember also that we're comping from an FX standpoint against -- it will be easier comping for the balance of the year. So that's what I can say without giving specific guidance. Now your second question in terms of France. We did see a Q2 pickup in France, but we're still looking -- facing a deflationary environment in France. We saw positive RIG and OG with broad-based Q2 acceleration despite the deflation. OG is still impacted by contracting categories, whether you talk about culinary, you talk about soluble coffee or chocolate. But we still improve and strong performance, Nescafé Dolce Gusto, pizza, ice cream, chilled, water, Nespresso. Where we saw slow performance was chocolate, culinary. And so yes, so that should hopefully give you some color in terms of our French market. Thank you, Alain.

Peter Warne

Next question from James Edwardes Jones of RBC.

James Edwardes Jones - RBC Capital Markets, LLC, Research Division

Wan Ling, 2 questions from you as well, please. Your restructuring costs in the half were CHF 40 million -- CHF 41 million, so less than 0.3% of sales. You have been talking for a while about restructuring costs increasing. Has that got into reverse? And secondly, CapEx -- sorry, working capital, you had quite a chunky outflow in the half year. Are we -- is there sort of easy benefits in terms of working capital being made? Or is there more to come still?

Wan Ling Martello

Let me -- in terms of restructuring, we do not guide on these items as this -- our restructuring expenses are booked when incurred, and it's hard to guide on this. And so I will say, though, trading items decreased 10 basis points in the first half because of lower restructuring in Zone AMS. We had, if you recall, last year in -- what is this -- we had, well, Waggin' Train voluntary recall, so that was an item that was in H1 of last year that, clearly, was not repeated this year. But it's also offset -- partly offset by higher impairment in assets -- of assets in both Zone Europe and Nutrition. So when you talk about restructuring, it's very difficult to forecast and because there's just a lot of moving parts. And in terms of CapEx, it's in line with our objective to lower CapEx to between 4% and 5% of sales. So that's -- we're not...

James Edwardes Jones - RBC Capital Markets, LLC, Research Division

Sorry, that -- I mean, I misspoke. I meant working capital, Wan Ling.

Wan Ling Martello

Oh, no, no, working capital, like I said, we continue to improve in terms of working capital from an operational perspective across -- whether it's accounts payable, receivable, inventory, we continue to improve it. In fact, if you look at working capital in Swiss francs in absolute level, it increased versus last year year-end 2013 but was below the level of June 2013. Now we have some seasonality in working capital for inventories, but -- so it's normal to see an increase at midyear. But I can tell you that working capital as a percent of sales decreased between H1 of 2014 and H1 of 2013. And trade net working capital as a percent of sales is also down. So from an operational perspective, I'm very comfortable and very happy to report that the organization continues to be very focused on it.

Peter Warne

Next question is from Patrik Schwendimann of Zurcher Kantonalbank.

Patrik Schwendimann - Zurcher Kantonalbank AG, Research Division

Wan Ling, again, regarding the input costs, you were mentioning for the full year that you would expect again a low single-digit increase, as has happened in H1. Did I get this right, that you don't expect increased pressure in H2 from the input costs side? That's my first question. Secondly, regarding EBIT margin development in confectionery, which was down 210 basis points in H1. It was already down last year in H1 by 110 basis points. So what's happening here in confectionery?

Wan Ling Martello

Patrik, yes, in terms of input costs, like I said, it's -- we are -- the basket of agricultural commodities that we buy, again, I just have to repeat that for the full year, it's low single digit higher than 2013. In terms of confectionery, the trading operating profit margin is impacted by higher input costs. It's -- the decrease is due to chocolate impacted by cocoa butter and also intense competitive environment, and so in -- and most notably in Western Europe, in developed markets, where the environment is deflationary, and we -- it's tough for our businesses to take pricing. Our confectionery business is growing overall. If you look at that category, in the last 5 years, the average organic growth was 6%; RIG was 3%. And our focus also is continue to grow our confectionery business in emerging markets, and very exciting to see that a global brand like Kit Kat has very good growth even in emerging markets. And so it's -- yes, cocoa price is putting pressure on all chocolate -- on all confectionery players' margin, and we're no exception.

Peter Warne

And the next question is from Corinne Gretler of Bloomberg.

Corinne Gretler

You already answered one of the questions from the analysts about the Russia situation on your business. Can I just ask one more question? Do you think the current prices can and will hurt the economic recovery in Europe?

Wan Ling Martello

I -- yes, I've -- I think we've touched on this before. I think the thing to underscore is the trading environment on a global basis is very volatile, and you've seen it in our sector, outside our sector, given the reporting season that started a few weeks ago. And so it's a very volatile trading environment. In terms of Europe, there is -- we do not anticipate that the deflationary environment will go away anytime soon. But -- so again, this speaks to the strength of our brands, that our people executing very well and our innovations. So yes, I mean, the environment is tough, the environment is volatile, but we will continue to deliver.

Peter Warne

We have one -- another question now from David Hayes of Nomura.

David Hayes - Nomura Securities Co. Ltd., Research Division

Two areas for me, if I can. Just in terms of Europe and, I guess, France, particularly Juan Valdez [ph] yesterday talking about very difficult negotiations in coffee and confectionery, in particular in France, which led to, effectively, a standoff in terms of shipments and ordering coming through, which would suggest some catch-up potential in the second half as those negotiations get resolved. I just wonder whether you'd seen a similar dynamic in Europe and whether you would similarly see, therefore, a little bit of an uplift into the second half as you see that catch up? And then just in terms of one-offs, I'm just wondering whether, in beverages, was there any impact from, I think, the global launch of -- or relaunch of the Nescafé packaging and whether there was kind of stocking into that shift? And then similarly, one-off-wise in terms of Nutrition, RIG contract, I think you've walked away from 3 states year-on-year first half. I just wonder whether you can quantify whether that was quite impactful or what kind of impact that would've had on RIG in the Nutrition business.

Wan Ling Martello

Hey, David, yes, you know what, in terms of France and the impact of, listen, our trading -- our retail trading partners, we -- it's not easy all around. But that's -- hey, this is part of doing business, and so it's -- whether it's in France or it's in any other developed markets -- it's not just in Europe. It's also in North America. It's part of doing business. And our -- so I don't know what else to say beyond that. In terms of beverages category, it's -- our trading operating profit margin was down 20 basis points, and that's because of increased consumer marketing spend behind -- in coffee and cocoa beverages. And so in your other question in terms of Nutrition and U.S. Infant being -- business impacted by the RIG contracts, we do not pull out specifically how many basis points that would have had on our growth. But I will say, though, this lower Infant Nutrition in the U.S. is, in fact, due to selective presence in RIG contracts. You're right, we exited 3 states, and so it's -- and that has had an impact. But that is deliberate because we want to be -- we want to grow our business profitably.

Peter Warne

And now we come to the final question, from John Revill of The Wall Street Journal.

John Revill

Wan Ling, a couple of points. Just wondering, in terms of developed markets, they seem to have slowed quite a bit from last year, so I was just wondering, generally, how much tougher is it getting out there? And can you give us a bit more color in terms of the deflationary pressures you're facing out there, like what particular categories is it affecting? And is that the retailers pushing down the prices? Or is it just consumers refusing to pay high prices, so you want to lower your prices? That's the first point. And what you're doing about it. And then the second point is your divestment program that was sort of announced last year. Obviously, you said that's continuing. Could you just give us any more sort of color about what's going on there moving forward? I mean, are we to expect any further big things moving forward? Or what's going on with sort of the -- to sort of reduce the overall business?

Wan Ling Martello

John, it's -- in terms of macroeconomic environment in developed markets, that continues to be difficult. We are seeing some patches of signs of economic improvement. And in some -- in many cases, it's not translating into sort of like more food and beverage spend. Consumer confidence remain still low. And in many cases, the environment continues to be deflationary. So -- but again, we continued, as you see, evidenced by our growth in H1 in both -- in developed markets, and so especially in RIG, which is our real internal growth. In terms of your second question of divestment, we -- I alluded to, in my presentation earlier, that our CEO, Paul Bulcke, talks about, when we look at our portfolio, we either have to accelerate, have to fix or divest. And so that's an ongoing process. It's divestment. It's not just about divestment, it's also about acceleration, and that is an ongoing process. We are doing that ongoing, and it's a process. So it's nothing more specific that I can share at this point. So I think that answers John's question. And I will say, I have one question for everybody who didn't answer questions. So I think started with Jon Cox, that asked the question about full year organic growth in terms of H2. And so I wanted to also build on that point in terms of trading operating profit for waiting in terms of H2. Our margins benefited from operational gearing on stronger sales growth in H1. So maintaining our momentum through the second half and beyond will require further investment in the business to generate growth, and so we're committed to making this investment. So you should expect a constant currency margin improvement for the full year, which is what we committed and what -- which is what I reaffirmed this morning, but that would be lower than what we show for the first half. So however, again, we reconfirm our guidance of an improvement in constant currency margin.

And so with that, I want to thank you all for joining us. I look forward to seeing many of you on roadshows over the coming months and speaking with you again at our 9 months call on -- in October. That's, I think, October 16. So until then, thank you. Have a great summer, and bye for now.

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