Diageo's (DEO) CEO Ivan Menezes on Interim 2017 Results - Earnings Call Transcript

Diageo plc (NYSE:DEO) Interim 2017 Earnings Conference Call January 26, 2017 2:15 AM ET

Executives

Ivan Menezes - CEO

Kathryn Mikells - CFO

Analysts

Ivan Menezes

Good morning everyone. As you saw in our results announcement this morning, our performance demonstrates continued effective execution of our strategy. In the half, we have increased our participation in emerging markets by expanding the position of our mainstream spirits brands and through the launch of primary scotch brands in new markets.

We have delivered good growth and positive mix in developed markets through the strength of our scotch brands and the improvements we are driving in U.S. spirits. Through the application of our six priorities, we are building a stronger company, and our performance has not only improved, it is more consistent. This is a set of results which reinforces our confidence in delivering our medium-term guidance and enables our long-term performance ambition to be one of the best-performing, most trusted and respected consumer products companies in the world.

We measure our progress towards best-performing through KPIs focused on efficient growth and value creation. And as you can see on this slide, we made good progress again this half. And Kathy will cover our return metrics, which also look good.

We have delivered improvement in both volume growth and price mix. Volume grew 1.8% and net sales grew 4.4% with stronger growth in scotch and U.S. spirits, two of our focus areas for fiscal ‘17. The cost of organizational change and productivity work is now taken to operating profit, but despite higher costs in the half, growth of scotch and U.S. spirits, together with marketing procurement benefits, has enabled us to maintain margin.

This is a stronger outcome for the half than we had anticipated at the time of the AGM. The half has seen continued strong cash generation with cash conversion and average working capital ratios both improving. EPS is up significantly at 21% given exchange benefits, organic growth and higher associate income.

The business continues to have positive momentum, reflecting our strategy at work. We’ve delivered steady improvement over the past 18 months and the growth is broad based with all regions performing well. As we look to our specific focus areas for fiscal ‘17, growth in scotch and U.S. spirits have driven over 50% of our organic net sales growth. When you include our performance in Europe, this number goes to almost 70%.

In India, we have strengthened our business and we are gaining share on key prestige and above brands. In the half, while performance was hit by demonetization, sales were up mid-single-digits with prestige and above up double-digit.

Effective execution of our strategy is reflected in our broad-based momentum and the progress we have made in our specific fiscal ‘17 focus areas. Acceleration of volume growth and mix improvements and our margin trends into the second half reinforces our confidence in delivering our guidance for mid-single-digit top line growth and 100 basis points of organic margin improvement in the three years ending fiscal ‘19. This improving performance trend and the further opportunities we pursue across the business, enable our long-term performance ambition to be one of the best performing, most trusted and respected consumer product companies in the world.

And now, I’ll hand over to Kathy to cover these results in more detail.

Kathryn Mikells

Thank you, Ivan, and good morning, everyone. As Ivan said, this is a strong set of results, which demonstrates the actions we are taking to deliver our strategy and build an organization that’s consumer-centric, agile and aggressively pursues efficiency and effectiveness across every aspect of our business.

Solid and improving volume growth, up almost 2%, underpins the positive momentum we have built. And while the environment hasn’t been favorable to raise prices, mix remains strong, and coupled with volume growth, has driven top line growth to over 4%, more than double that of the prior period.

Operating profit growth was in line with net sales, which is consistent with our guidance that margin would be impacted by the costs of our productivity work and the gain on the sale of UB shares in the comparable period. Strong growth in scotch and U.S. Spirits enabled us to maintain operating margin despite this.

EPS grew 21% driven by earnings growth and favorable exchange, which more than offset the impact of divestitures and the higher tax rate that we guided to in July. Cash flow at £1.1 billion, improved £245million on last year, again with higher operating profit and favorable exchange more than offsetting disposals and higher tax payments. Our continued active management of working capital led to further improvements in operating cash conversion.

Reported sales were £6.4 billion, up 15%, with organic growth and significantly favorable exchange more than offsetting the £236 million reduction we saw from disposals. We are building consistent momentum behind both volume and price mix.

This chart shows the steady improvement through fiscal 2015, 2016 and this half. We saw a mixed benefit of 2 points this half driven by growth in the U.S. and Europe, as well as the return to mid-single-digit growth in our scotch business. Price contributed about 65 basis points to net sales growth, reflecting the subdued global economic environment, as well as some of the price corrections we have made on Smirnoff and Captain Morgan in the U.S.

Every region is delivering growth. On this chart, you can see how that contribution is split between volume and price mix. North America built on the momentum of the second half of last year. We delivered both volume growth and richer mix, driven by Crown Royal, Bulleit, Cîroc, Don Julio and Johnnie Walker’s reserve brands.

We saw a stronger growth in Europe, continued good growth in Turkey, and while the rate of growth slowed in Russia, it was a good performance with net sales up 6%. Russia and Turkey were driving price, with increases in Russia to offset devaluation, and in Turkey prices were increased in tandem with a rise in excise tax rates.

In Europe, in addition to volume growth, we benefited from positive mix with growth in scotch and reserve. In Africa, volume was a stronger driver of growth with negative mix in the beer business as consumers have traded down in response to the recession in Nigeria and tax increases in Kenya. We had good growth in mainstream spirits, which was up 20%, and continued to benefit from our beer distribution footprint.

Growth in Latin America and Caribbean accelerated, driven by strong gains in Mexico and Colombia. In Mexico, scotch was up 20% underpinned by successful marketing campaigns and improved execution of commercial drivers. Tequila was also strong, up 31%. Scotch sales also accelerated in Colombia, up 31% driven by Johnnie Walker and the re-launch of Buchanan's. Volume was roughly flat due to declines in Venezuela as well as Brazil.

Asia-Pacific experienced negative market mix, driven by growth in India against the decline of Windsor in Korea and weakness of scotch in Thailand. Greater China net sales were up strongly at 22%, fuelled by Chinese white spirits which benefited a bit from an earlier Chinese New Year.

In India, demonetization did impact growth. However our first half results have showed resilience, with net sales up 4%. USL’s prestige and above brands performed well growing 11%. We expect the impact of demonetization will run into the third quarter, so our fiscal ‘17 top line growth for India will be muted relative to the growth potential of the market.

We continue to look to premiumize, and you can see across our biggest brands, our global giants and local stars, it’s the reserve brands and variants that are growing faster. The reserve variants of our global giant brands grew 9% with Johnnie Walker Green Label and Johnnie Walker Gold Label Reserve the main drivers. Local star reserve brands grew 47% driven by Chinese white spirits and Buchanan’s. Our reserve brands not included in global giants and local stars grew 6% led by the strong performance of Don Julio, with double-digit sales growth, and Bulleit with net sales up 29%. Overall our total reserve portfolio grew 9% with growth across all regions except Africa which was flat.

In addition to broad-based growth across all our regions, we saw a broad-based growth across categories. Scotch growth was fuelled by Johnnie Walker, up 6%, and Buchanan’s up 24%. North America whiskey reflects growth in Crown Royal, which benefited from the launch of Crown Royal Vanilla, as well as Bulleit.

In the U.S., we now over index in value share in North America whiskey relative to the industry. The weakness in vodka is driven by Smirnoff, which declined 2% and Ketel One which was down a bit in the half. This was partially offset by gains in Cîroc, driven by the launch of Cîroc Mango.

On Smirnoff, in Great Britain we gained share with sales impacted by inventory reductions in the retail sales channel to improve efficiency. In North America, Smirnoff’s share performance improved. Our sales performance was impacted by price adjustments to improve competitiveness, as well as negative mix with higher sales of our largest format. We continue to make changes in our Smirnoff marketing programs to remind its core consumer base of its strong credentials as an award winning quality vodka and bringing fresh news to the brand through seasonal innovations like Smirnoff Peppermint Twist.

Rum growth of 2% is driven by Captain Morgan growth in Europe and Russia and the focus on mainstream spirits with growth coming from Kenya Cane Rum. IMFL Whisky performance was largely driven by our product re-launches in India, but in the half we also launched both McDowell's No.1 and Royal Challenge in Nigeria. Gin grew 7% with Tanqueray leading the growth. Tequila is growing on the back of a strong performance of Don Julio in the U.S. and Mexico.

Beer performance was broadly flat, with a net sales decline of 1% in Africa as performance continued to be impacted by the significant increase in duty on bottled beer in Kenya. Across the region, we are capturing those consumers who have traded down. In Kenya with Senator Keg up 17%, and in Nigeria with Satzenbrau which has more than doubled net sales in the half. We delivered growth in beer in Africa regional markets and Nigeria. Europe, our second largest beer market was flat as we lapped the big rugby world cup activities last year with Guinness growing low-single-digit driven by innovation.

We have made significant progress on our three focus areas for fiscal ‘17. I am going to touch upon each and how that progress has translated to improved net sales growth. Scotch grew 6% and contributed about 1.5 percentage points to Diageo’s growth rate this half. Growth was broad-based across all price segments with increased activation behind brands tailored by market and sales channel.

Our marketing communications and physical availability has also improved. We delivered better performance in each region with the exception of Asia, where weaker travel retail and the mourning period in Thailand following the death of the king impacted sales. In the standard price category, we delivered overall growth of 6%, with Johnnie Walker Red Label up 7% and J&B up 5%.

VAT 69 in India and East Africa, Black & White in Latin America and India, and the launch of brands such of Bells in new markets including Mexico, also contributed to growth in the Standard category. We are continuing to adjust price and pack size of these primary brands within Standard to ensure we have the best offerings and physical availability for our consumers. The premium and super deluxe segments grew 6% and 5%, respectively. Buchanan’s was the main contributor in premium, delivering nearly half the growth. Main contributors to growth in super deluxe include Johnnie Walker Green Label and Old Parr. We up weighted activations around festive gifting using personalization and smaller formats to create more differentiation and to widen the gifting options.

Now I’ll turn to performance in our second focus area, the U.S. U.S. Spirits is our biggest and most profitable market and we have made important changes there over the last 18 months with a new leadership team, a new marketing strategy and a new approach to how we launch innovations. The work Deirdre and the team have done shows in the numbers this half.

In North America whiskey, Crown Royal and Bulleit delivered the strongest growth and continued to make share gains. Crown Royal net sales increased 17% with the launch of Crown Royal Vanilla, and we sustained growth in Crown Royal Regal Apple. Scotch was also strong. Johnnie Walker net sales grew 8% fuelled by growth in Johnnie Walker Black Label and the reserve variants. Cîroc performance improved this half, up 6%, as the brand benefited from the earlier launch of its Mango flavor.

In India, our focus on prestige and above brands led to 11% growth despite the impact from demonetization. McDowell's No.1 Whiskey and our Signature brand continue to see the benefit from product re-launch last fiscal year, with McDowell’s No.1 up 17% this half and Signature growing 35%. Scotch grew 11%, with Johnnie Walker up 23% and a strong performance by VAT 69 and Black and White. We have successfully launched innovations within our core prestige portfolio with McDowell’s Silk, a honey flavored variant launched in the half and we have also launched Captain Morgan Dark Rum.

Demonetization has impacted the first half and I expect the impact to continue through Q3. We have made changes to accommodate this and we continue to focus on growing share in the prestige and above segments.

Moving now to operating profit. Organic operating profit grew by 4.4% while reported operating profit was up 20%, with a positive impact from exchange contributing over £300 million to our reported results

In the half, reported margins were up roughly 150 basis points with organic margins broadly flat. The change in USL’s accounting treatment for third-party manufacturers in the prior period contributed about 37 basis points to our reported margins, and favorable exchange improved margins by 64 basis points. The disposal of our wine businesses and non-core beer assets also had a positive impact, as these were lower margin businesses.

Overall, organic operating profit grew in line with our top line, with growth achieved across all regions, with exception of Asia-Pacific which is lapping the sale of the UB shares. Excluding the gain from the UB shares, Asia-Pacific delivered 5% profit growth with gross margin expansion, lower marketing spend in Thailand and productivity initiatives reducing their indirect costs.

In North America, positive mix led to gross margin expansion, which together with marketing efficiencies and lower overheads delivered 6% organic profit growth. Similarly in Europe, Russia and Turkey, operating profit growth was driven by gross margin improvement and more efficient marketing spend.

Africa delivered 2% operating profit growth with zero base budgeting initiatives reducing indirect spend, helping to offset a decline in gross margin from negative mix and inflation as well as the upfront cost of organizational changes. In Latin America and Caribbean, we also experienced pressure on gross margin in Brazil. However this has been offset by lower marketing spend in Brazil and productivity benefits across the region enabling overall operating margin expansion.

As you can see, we held operating profit margin flat on an organic basis even after taking the costs of our productivity work to the P&L. Gross margin improved 39 basis points as a result of volume growth, positive mix and productivity savings, which more than offset the impact of inflation.

Procurement savings reduced the cost of our marketing activities in the half despite increased activity in line with sales growth. Looking forward to the second half, I expect A&P related margin gains to subside as we invest more of our productivity savings back into the business.

As you can see, the movement in other operating expenses negatively impacted margin in the half. As we said at the time of the AGM, we don’t adjust out the cost of organizational change and other costs associated with our productivity work through exceptionals. In the half, the biggest incremental cost has been driven by reorganizing our business to improve efficiency and effectiveness. As we go forward, these costs will be lower and will be more than offset by the run rate savings we are delivering. The sale of the UB shares in the prior period also negatively impacted margin in the half.

In the first half, we have continued to benefit from procurement efficiencies, which resulted in an underlying increase of 4.2% to our marketing spend. Productivity is a platform to enable us to be a more efficient, effective and agile organization and to create more capacity for investment to fuel our growth.

I am excited about the opportunities that the work is opening up for Diageo, and I look forward to exploring this with you in more detail at our Capital Markets Day in May. For today, I’ll just take you through a few examples to give you a better feel of how this work is setting us up for long-term success.

I’ll start with Australia and the work they are doing on net revenue management. Australia has used a trade promotion management tool, XTEL [ph], to improve activity-based customer promotional planning and enable better analysis of customer profitability. Armed with the new information, the team has shifted promotional spend to where it will be most effective and enable overall pricing improvement. We estimate a benefit of greater than £1 million in the first half with additional benefits in the second half and beyond.

In supply, one of our areas of focus is something we call tram-lining. This is where we tear down the individual costs of our products and compare them to other products in the marketplace as well as to internal benchmarks. This enables us to really challenge the cost/value trade-offs we make and adjust our products where we see incremental opportunity. One example is the work we have done on our biggest brand, Johnnie Walker. We took a look at our labels. The look and feel of our brands is important, with decoration of our products costing up to 40% of the bottle cost.

In comparing two of our variants to the competition, it became clear that by using the latest pressure-sensitive label technology, we can maintain the right look and feel of these products at a lower cost with an estimated benefit of £2.5 million.

In marketing, you have already seen the benefits we are generating by driving cost efficiencies in our marketing spend. This has come through procurement savings achieved by consolidating our spend with fewer agencies and ensuring we use them more efficiently. We’ve now implemented our marketing catalyst tool in 19 markets. This tool leverages internal and external data to perform econometric return and other analysis so we can improve the allocation of spend across brands, marketing programs and media mix.

While investment allocation has always been part of our annual planning process, for fiscal 2018, this tool will give us more granular insight into where investment will deliver the best returns, enabling us to make bigger shifts with a greater level of confidence.

Now I’d like to give an example of our organizational effectiveness work. In Nigeria, where we have seen significant volatility recently, it was clear we needed to not only reset our cost base, but also build an agile organization that can respond to a constantly changing environment. In addition to simply rightsizing our internal organization, we identified a number of non-core activities that could be outsourced or contracted. This enables our team to put more of their focus on the highest value activities. It also enabled us to simplify our structure to enable faster decision-making.

Finally, turning to zero-based budgeting. For fiscal ‘17, the annual plan was built using a detailed tool and methodology across six categories of indirect spend. We attacked consumption levels and unit rates, supported by changes in policy. Our plan anticipates a 10% reduction versus fiscal ‘16 and we’re on track to deliver this, and we have additional cost savings in the pipeline across all of our areas of spend for next year.

Free cash flow delivery continued to be strong at over £1 billion and up £245 million in the half versus last year. The improvement was driven by higher operating profit and favorable exchange. Working capital positively impacted the year-over-year change in free cash flow. Creditors were a bigger source of cash since year-end as we extended payment terms and provisions were also favorable. These gains were partially offset by higher growth in trade receivables since year-end driven by our top line growth. The growth in inventory was similar to what we experienced in the prior year.

Overall we continue to see improvement in our working capital efficiency with both operating cash conversion and average working capital, showing improvements in the half of 3 points and 2 points, respectively. The improvements are being driven by the effective management of inventory and creditors.

Net CapEx was £184 million, £12 million lower compared to the same period last year, mainly due to phasing of spend between the first and second half. I expect CapEx spend to be a bit under £600 million for the full-year.

Tax payments were £163 million higher year-over-year, reflecting both the timing of payments and the higher tax rate. Other activities included higher pension payments, again due mainly to phasing of payments.

Average net debt decreased about £600 million, largely driven by disposals of non-core assets last year and strong free cash flow. Lower interest charges were largely driven by lower average net debt, with our effective interest rates slightly up as we anticipated, reflecting an increase in the U.S. LIBOR rate and the lower usage of commercial paper.

For the full-year, I expect our effective interest rate to increase to 3.6%. In the half, the further weakening of sterling increased net debt by £270 million. Other finance charges increased £16 million, driven by an accounting charge for our Zacapa option triggered by an increase in valuation, as well as by higher pension costs. I expect the level of finance charges for the second half to be at about the same amount as we saw this half.

We expect our cash flow delivery to remain strong. As a result, we expect net debt to further decline in the second half, assuming stable exchange rates and post-employment liabilities. Right now our leverage ratio is squarely within the 2.5x to 3x range that we target.

Moving now to exchange. With the weakening of the pound, exchange has been favorable in the first half, benefiting net sales about £850 million and operating profit by about £300 million. Using the rates outlined here for the full-year, exchange is forecast to benefit net sales by £1.4 billion and operating profit by roughly £460 million. There are still a few variables around exchange in fiscal ‘17 which could affect this forecast, including any further movement on the pound and the euro and continued volatility in emerging markets.

Looking forward to fiscal ‘18, I expect there to be further favorable transaction exchange given our hedging policy which is focused mainly on the U.S. dollar and typically provides decreasing coverage levels out to 24 months.

EPS before exceptionals was up 21%. The favorable exchange, organic operating profit growth and higher associate income, more than offset the impact of disposals and higher tax rate. Our tax rate increased from 19% to about 21%, consistent with our guidance. Greater focus by government is exerting upward pressure on tax rates for all multinationals and the impact of exchange is also reflected in the higher rate.

The interim dividend is 23.7 pence per share, up 5% from the previous year. Dividend growth is expected to remain at a mid-single-digit rate to enable recovery to our target cover of 1.8x 2.2x times.

Return on invested capital increased 186 basis points, mainly driven by favorable exchange and organic operating profit growth, partially offset by higher tax charges. As Ivan said earlier, we are off to a strong start for fiscal ‘17 and one that gives us confidence we are on track to deliver our medium term goals.

Our efficient growth metrics improved overall, with margin broadly flat in the half impacted by the upfront productivity costs we incurred. We expect better margin performance in the second half, as the benefit of our organizational effectiveness work increases and the year-over-year increase on cost eases. Zero-based budgeting will deliver similar benefits in the second half, and I expect benefits from our other productivity work streams to build.

We have seen some strong improvements in the half on earnings per share and ROIC, which have benefited from favorable exchange and good organic growth. While it’s difficult to call exchange, based on current rates we would expect favorable exchange, organic growth and margin expansion to enable continued gains overall in our financial KPI’s in the second half.

Finally our total shareholder return was 17% last year, reflecting a significant increase in share price post the EU referendum and 3% for the first six months of this year.

Before I hand back to Ivan, I want to look at the balance of the year in the light of what we have achieved in this first half. Our net sales performance at 4.4% organic growth in the half did benefit from the earlier Chinese New Year and the earlier launch of the new Mango flavor of Cîroc. We expect a further improvement in underlying net sales growth in the second half.

Reflecting this phasing, we anticipate net sales growth for the year will be broadly in line with the first half. In the first half, the flow-through to profit from our productivity activities were muted by implementation costs, especially the incremental costs associated with organizational change. In the second half, costs are expected to be lower and the benefits will accelerate enabling improved margin. This will be partially offset by weaker category mix and higher A&P as we reinvest more of our productivity savings.

With respect to categories, beer and mainstream spirits growth is expected to accelerate in the second half. Exchange should continue to be favorable in the second half, and as I mentioned earlier, at current rates, we expect a £1.4 billion benefit to net sales and £460 million benefit to operating profit for the full-year.

Given continued strong cash generation, I expect net debt to decline with expected LIBOR increases and foreign exchange taking our effective interest rate to 3.6% for the year, consistent with our prior guidance. Our outlook for tax is unchanged at 21% for this year.

And with that, I’ll hand back to Ivan. Thank you.

Ivan Menezes

Thank you, Kathy. I started my presentation reminding you of our strategy, our six priorities and our performance ambition. Kathy has just taken you through the way in which our execution against our strategy has delivered efficient growth and value creation

While we don’t have half year KPIs on the measures for credibility and our people, we have also executed well against these performance measures. For example, in a first of its kind, we introduced a virtual reality experience in the U.S., called Decisions. It’s for legal drinking age consumers and it’s about making responsible decisions when drinking.

In India, we are leading a major road safety anti-drink driving campaign. Our LGBT reputation is most obvious in our U.S., U.K. and European markets where there are strong rainbow networks, but we are also encouraging similar networks in other markets. In H, we received external recognition from the Human Rights Campaign Foundation for our approach.

Now I want to talk about how this set of results demonstrates our strategy in action. We are driving improved performance through execution of our six priorities and making good progress against our three focus areas for fiscal ‘17. This has reinforced our confidence in delivering our medium term guidance and has enabled our long-term performance ambition.

We have an agile consumer focused organization. Our focus on sellout has been supported by sharpened execution against our six strategic priorities. They will deliver our strategy, to increase participation in the emerging markets and support premiumization in developed markets. Great execution against these priorities will also deliver consistent best-in-class performance in line with our performance ambition.

I’m going to illustrate the effectiveness of our six priorities by looking at our performance in Europe. Deploying our executional priorities in Europe over the last three years has turned a declining business into a vibrant business that can deliver sustainable growth, and a business which was losing share to one which is making sustainable share gains, gaining 70 basis points of share in the past 2.5 years.

So how have we executed against each of the priorities to enable growth? Our marketing focus in Europe has evolved significantly and it is stronger than it’s been in years, with each brand supported by a strong marketing platform which is driving recruitment. Great examples include the award-winning Made of More campaign for Guinness; Smirnoff has the We’re Open platform; Don’t mind if I Baileys, a multi-channel campaign designed to trigger consumption; Johnnie Walker sharing inspiring stories with Lesvos and Colombia; and consumers can Live like the Captain. The results say it all. These brands grew 3% in fiscal ‘16 and 6% this half. And all of our premium core brands have gained value share in the past 12 months

Diageo reserve brands, are for the second year in a row, the best-performing collection of spirit brands in Drink's International Bar Report. In Europe we have a strong line up. Single malts are half the Europe reserve portfolio and we have a range that is second to none and is gaining share. In addition we're also growing Don Julio, Zacapa, Ketel One, Tanqueray Ten, Bulleit and Cîroc. Reserve brands now account for 20% of our Europe’s spirits business, up from 13% three years ago.

Our market share is now 22% and with the strong heritage, quality and crafted credentials behind our brands, this strong growth is sustainable. Our reserve model is focused on key cities and the most influential and trend setting bars covering 5,000 accounts. Through World Class we’ve trained 7,000 bartenders in Europe creating advocates for our reserve brands in the on trade. We’ve also equipped our broader sales force to sell and activate our mass luxury brands in the on trade and grocery channels increasing availability. In GB for example, using the existing sales force, we have increased distribution of the single malts in the off trade by over 50% in the first half.

Three years ago, we focused investment behind our innovation agenda to recruit, re-recruit and disrupt. Approximately 10% of Europe's sales now come from innovation. It’s become a consistent and reliable growth driver for Europe.

The development of The Brewers project has been key to reframing and getting Guinness back to growth. Within spirits, we launched Johnnie Walker Blenders’ Batch Red Rye Finish, Smirnoff Cider and Haig Clubman. We have innovated beyond new brands and into trade channels in what we call the third space. The third space is neither off-trade nor on-trade. These venues cover festivals, markets, pop-ups, even offices. We executed over 700 events last year and another 425 this half.

Developing a more advantaged Route to Consumer has been key to our success in Europe. Over the past two years we’ve added almost 200 sales people, a 35%increase, while more than doubling the number of accounts we cover directly. We have also improved the capabilities and effectiveness of our sales force through rigorous training programs and extensive use of automation. We now cover around 100,000 of our highest priority on and off-trade outlets, with stronger executional focus during key merchandising periods.

We have increased distribution while reducing inventory, improving operational and working capital effectiveness. We have clear standards of execution, both for physical availability and activation by outlet type. And through automation, we now have the tools to be able to track and audit that execution, allowing us to close any gaps quickly. These increases in scale, efficiency and effectiveness of our Route to Consumer have delivered our highest levels of availability and visibility in both the on and off-trade.

Finally, we have a dedicated team focused on e-commerce which is becoming an ever more important trade channel. Over the past two years, we have grown share in this channel. However there is plenty more opportunities.

Europe is leading the global productivity work. The culture of driving out cost to be able to reinvest more in the business has been critical in the turnaround of Europe’s performance. Europe’s savings in overheads and marketing spend has funded investment in Route to Consumer, reserve and innovation. We’ve significantly reduced the number of media agencies we use. Non-working spend is now lower and POS has been rationalized into a single platform.

We have centralized support teams and applied ZBB to indirect spends. We have embedded net revenue management into our business rhythm, building the right capability, data quality and analytics. Europe is also leading the marketing effectiveness work. For example, we are using a future profit potential model to reallocate spend to underinvested categories and brands. We are also launching a growth driver module that identifies the marketing activities that have the highest ROI, allowing us to execute the optimal mix of activities that will drive growth for our brands faster. Europe’s improved performance has built our confidence in our strategy

As you know, our strategy has two parts, emerging and developed market goals Our second priority, increasing our participation in mainstream spirits is about emerging markets So let me now show you the progress we’ve made this half building our mainstream spirits platform in Africa.

First, let me recap our strategy in Africa. We will consolidate our leading position in beer, and use that to build a mainstream spirits business and grow our premium spirits. Mainstream spirits are now almost 15% of our net sales in Africa, growing 20% this half. Africa has a growing number of legal drinking age consumers, low per capita spirits consumption, a large informal market and low incomes. This means making good quality mainstream spirits affordable and accessible is an exciting opportunity.

Our existing platform in Africa can drive growth in mainstream spirits. Our brewing footprint can easily incorporate distilling capability and infrastructure. We have warehousing and storage and excellent procurement capabilities. The distributors who sell our beer are already adapting their product range and operations to include our spirits brands.

On the slide, you can see one great example from our beer distributor in Kenya who has adapted beer trucks to carry spirits through both under-carriage units and compartments built into the main truck. Similarly, bars and stores can expand into spirits with a full range from Diageo, and when the sale is done, one supplier, one invoice.

Consumers in Africa are becoming increasingly curious about new and interesting drinks and spirits is rapidly becoming part of their repertoire. Our insights allow us to develop product offering that meets their needs on all occasions. In Nigeria in the first half, we launched locally manufactured McDowell’s No.1, Smirnoff X1 a mainstream variant from Smirnoff and a new flavor of Gordon’s Gin.

Let me move now from our executional priorities to how we are deploying them against our three focus areas this year. And let’s start with scotch. As you saw from Kathy’s presentation, the improvement of our scotch performance is broad-based. We have the widest scotch portfolio in the industry from affordable primary scotch brands, through premium core, up to unique ultra-premium offerings. In fiscal ‘16 we delivered a significant improvement in performance and this half we built on that led by Johnnie Walker up 6% and Buchanan’s up 24%. Fiscal ‘16 saw a step-up in our primary scotch and our malts and that has continued.

Consistent investment against our four growth pillars for Johnnie Walker is driving performance improvement. We have inspiring stories which resonate with millennials, be it Keep Walking America that celebrates the diversity, which is the fabric of America today, or Keep Walking Philippines that celebrates everyday heroes to show consumers that audacious ambitions are indeed achievable.

We have amazing liquids and serves and we know sampling leads to around 20% conversion. So we are putting liquid on the lips of 13 million consumers all over the world this year, and we are doing it in innovative ways.

In Brazil, the Johnnie Walker Truck is a mobile experience that combines a bar with mentoring. In the second quarter alone, 42,000 consumers were mentored. In the U.S. we are pushing mentorship into the future through Facebook Messenger and Amazon Alexa. 48

I’ve spoken before about scaling up activation in gifting and this half we definitely scaled it up. The Johnnie Walker Gift to Give Since 1820 campaign went live in November into almost 18,000 stores and the top 40 airports globally. In just 18 months, we have scaled our whisky retail boutique, the Johnnie Walker House into 25 locations, through travel retail and partnerships including the shopping shop in Harrods and the world’s first floating Johnnie Walker House onboard a cruise ship.

And finally we continue to reframe scotch for a new consumer, highlighting the skill of our blenders and the richness of our blends. Blenders’ Batch, our experimental innovation is off to a flying start, as we bring to life blender Emma Walker’s journey to create Red Rye Finish. It was launched into 50 markets this year to an extremely positive response.

The amazing growth of Buchanan’s continues.Net sales in the first half were up 24% with strong performance in Mexico and Colombia. In the U.S., it’s looking to break the half a million case mark through Es Nuestro Momento, it’s our time, a new 360-degree marketing campaign that celebrates the greatness and diversity of the Latin community and the positive influence Latinos have on American culture. It partners with J Balvin, a Colombian musician with 20 million Facebook fans to amplify the Latino influence in America.

F16 saw us heavily up-weight our execution around primary scotch. These accessible price points provide emerging middle-class consumers with an affordable option in the scotch category with an alternative to local spirits. Primary scotch launches have been very successful and net sales were up 4% in the half. In Mexico, primary scotch is the fastest growing segment with Black & White, the fastest growing brand. This half we have launched Bell’s at a price point below Black & White with the aim of competing more strongly with standard tequila. In Brazil, Black & White is an affordable scotch brand for consumers. We have significantly increased activation this half and the brand is gaining share in the primary scotch segment.

Turning now to U.S. Spirits. The shared data highlights the improvement we are delivering. Over the past six months we have been closing the gap to industry growth, and in the last quarterly data from Nielsen, our growth is now just 35 basis points lower than the market.

That improvement comes as we build on the momentum of last year and it is broad-based. Our North American whiskey, scotch and tequila brands delivered the strongest performance. Smirnoff share performance improved, although net sales were down as we continued to make price adjustments and saw some negative mix. Performance of Captain Morgan, Baileys, Tanqueray and Buchanan’s improved as share gains accelerated in the half. Net sales growth was however impacted as we manage inventory across the channel to deliver operational and working capital efficiencies.

The last year has seen a lot of change in our North American marketing approach and team to focus on the recruitment of millennial and multicultural consumers. Digital spend will be up fivefold this year and spend on multicultural will increase by a factor of four. In the on-trade, the accounts our Activation Army call on are growing faster driven by strong growth in Smirnoff, Captain Morgan, Crown Royal and Ketel One.

In the second half, we will step up this program with reserve ambassadors for trend leading accounts. We are amplifying our brands through partnerships with online retailers and booking services who’ll allow us to place ads for our brands and give us a wealth of data from search results.

And finally, we are building data infrastructure and management procedures to continually evaluate, review and optimize our commercial execution plans.

Diageo is the leader in North American Whiskey in the U.S. and Crown Royal is our biggest brand by value in North America. Bulleit is growing almost 4x faster than the category to a million cases, and we can replicate the success of Bulleit. George Dickel is leading Tennessee Whiskey growth and we are establishing Blade and Bow as the authentic luxury bourbon. We are also repositioning Seagrams 7 as the affordable, tasty, authentic American Whiskey.

Moving now to Smirnoff. In fiscal ‘16 our focus was on recruiting millennials through activating electronic dance music. This stabilized Smirnoff’s performance and recent share performance has improved. There is more work to do however in recruiting and re-recruiting multicultural consumers as well as the Gen-X and baby boomer consumers, who are core to the consumer base. We will do this by building on the strong credentials that Smirnoff has as an award-winning quality vodka and continuing to bring fresh news to the brand through targeted innovations and highlighting Smirnoff’s innovative history as the creator of the Moscow mule cocktail.

We have made similar changes to Captain Morgan and the brand is gaining category share. We know the growth drivers for the brand. We simply remind consumers that the brand is the captain of fun. On trade focused, innovative with Cannon Blast and Jack-O’Blast, and with a digitally weighted media plan to recruit Hispanic consumers.

Moving to our third focus area for fiscal ‘17, India this is a big opportunity and we have a clear strategy. Focus on and strengthen our prestige and above brands; strengthen our Route to Consumer to ensure our brands have great visibility and activation in store; and drive out costs to invest in growth and expand margin. We are making good progress against all three.

We’ve re-launched the core prestige brands Signature, Royal Challenge and McDowell’s No.1 Whisky, the base variant of McDowell’s No.1 and are seeing performance improve. McDowell’s No.1 Whisky and Royal Challenge gained share, while Signature’s share performance is improving. We have launched innovation to accelerate growth with the launch of McDowell’s No.1 Silk, a honey flavored whisky and Royal Challenge Bolt, an espresso coffee flavored whisky. And we recently launched Captain Morgan Dark rum, a mainstream variant of Captain Morgan in the prestige segment, to grow our share in the 44 million case rum category.

The premium and luxury portfolio is also in strong growth. Johnnie Walker and Black & White are driving growth in scotch. And Smirnoff gained share in the premium vodka category.

The sales impact of these re-launches and innovations is amplified through improved visibility. We have introduced the concept of Perfect outlet, outlets that meet specific criteria for quality, distribution, visibility, pricing and promotion. 20,000 outlets now meet these criteria, which is about a third of the total outlets covered by our sales force. And the transformation of these outlets is impactful and they deliver higher sales than similar standard outlets. And if you look at the pictures in the slide, it’s not difficult to see why.

We have similar programs in the on-trade. Bar trolleys with a customized menu with Signature serves and cocktails are being used in fine dining restaurants to drive visibility of our brands. Scotch mentoring events in India this year will reach around three million consumers, and given the unique status of a wedding in India, we are using these as opportunities to drive trial with a dedicated team.

We continue to make good progress on driving out costs to invest in growth and expand margins. Tram-lining is reducing glass costs through light-weighting and a more effective sourcing strategy. Zero-based budgeting is reducing indirect spends. Net revenue management is optimizing trade spend and price increases, while driving growth.

In summary, India remains an attractive long-term opportunity and we’ve been making good progress in accelerating growth as we focus on delivering the long-term opportunity while mitigating short-term impacts of events and legislation.

Before we close, let me make a few points: We are delivering our strategy through six execution priorities. Our results demonstrate real momentum, and as Kathy described, we expect to deliver net sales growth at this level and operating margin improvement for the full-year.

We are making real progress on our three specific fiscal ‘17 focus areas: Scotch, U.S. Spirits and India. Acceleration of volume growth and mix improvements and our margin trends in the half reinforces our confidence in our guidance for mid-single-digit top line growth and 100 basis points of organic margin improvement in the three years ending fiscal 2019. And the improving trend of our financial performance and our pursuit of further opportunities across the business will enable our long-term performance ambition to be one of the best performing, most trusted and respected consumer products companies in the world. Thank you.

Question-and-Answer Session

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