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The Coca-Cola Company (NYSE:KO)
Q3 2014 Results Earnings Conference Call
October 21, 2014 09:30 a.m. ET
Timothy K. Leveridge – Vice President and Investor Relations Officer
Muhtar Kent – Chairman and CEO
Kathy Waller – CFO
Ahmet Bozer – EVP and President of Coca-Cola International
Sandy Douglas – SVP, Global Chief Customer Officer and President, Coca-Cola America
Irial Finan – EVP and President of Bottling Investments
Bryan Spillane – Bank of America Merrill Lynch
Ian Shackleton – Nomura.
Ali Dibadj – Bernstein
Dara Mohsenian – Morgan Stanley
Bill Schmidt – Deutsche Bank
Judy Hong – Goldman Sachs
John Faucher – JPMorgan
Mark Swartzberg – Stifel Nicolaus
Steve Powers – UBS
Good morning and thank you for holding. At this time, I would like to welcome everyone to The Coca-Cola Company’s Third Quarter 2014 Earnings Results Conference Call. Today’s call is being recorded. If you have any objections, please disconnect at this time. All participants will be on a listen-only mode until the formal question-and-answer portion of the call. (Operator Instructions)
Due to the interest in this call, we request a limit of one question per person. I would like to remind everyone that the purpose of this conference is to talk with investors and therefore questions from the media will not be addressed. Media participants should contact Coca-Cola’s Media Relations Department, if they have any questions.
I would now like to introduce Tim Leveridge, Vice President and Investor Relations Officer. Mr. Leveridge, you may begin.
Timothy K. Leveridge – Vice President and Investor Relations Officer
Good morning and thank you for being with us today. I’m joined by Muhtar Kent, our Chairman and Chief Executive Officer and Kathy Waller, our Chief Financial Officer.
Before we begin, I would like to inform you that you can find supplemental materials on our website that support the prepared remarks by Muhtar and Kathy this morning. This conference call may contain forward-looking statements including statements concerning long term earnings objectives and should be considered in conjunction with cautionary statements contained in our earnings release and in the company’s most recent periodic SEC report.
I would also like to note that we have posted schedules under the Financial Reports and Information tab in the Investors section of our company website at www.coca-colacompany.com.
These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning’s discussion to our results as reported under Generally Accepted Accounting Principles. Please look on our website for this information.
Following prepared remarks by Muhtar and Kathy this morning, we will turn the call over for your questions. Ahmet Bozer, Executive Vice President and President of Coca-Cola International; Sandy Douglas, Senior Vice President, Global Chief Customer Officer and President of Coca-Cola North America; and Irial Finan, Executive Vice President and President of Bottling Investments will also be available for our Q&A discussion
Now, I’ll turn the call over to Muhtar.
Muhtar Kent – Chairman and CEO
Thank you, Tim and good morning, everyone. Today I am going to start with an overview of our quarterly performance and then spend the rest of the time addressing the strategic initiatives we announced earlier this morning in our set of release.
So let’s look at our performance for the third quarter. Our overall topline results for the third quarter were below our expectations. Comparable currency neutral net revenues grew 1% in the quarter and after adjusting for structural items due to factors both within and outside of our control. We continue to face a challenging macro environment; more challenging than was expected when we started the year.
In many of our key emerging markets we see deteriorating economic environments coupled with continued softness in consumer spending in the U.S. and particularly in Japan and Europe. This is placing strong pressure on the short term performance of our business. These factors have driven a deceleration in personal consumption expenditures and as a result the non-alcoholic beverage industry is growing one to two points slower than our initial forecast at the beginning of the year.
With that said, there is no question that we need to improve our execution in many markets especially our consumer marketing and commercial strategies. Although we could point to various markets, this was most prominent in Europe where we saw continued challenging macroeconomic environment and also aggressive competitive pricing. We achieved a 3% price mix in Europe which was partially offset by a volume decline of 5%. While we are not comfortable with our year-to-date share performance in Europe, we along with our bottling partners know we must light better consumer and commercial strategies and execution that can benefit from incremental investment in the market place and we’re taking actions to address this situation.
That said, we are not discouraged nor are we any less enthusiastic about the opportunities in front of us. In markets where we executed our strategies well we saw solid progress in North America our disciplined approach to pricing supported by incremental media investments, high quality marketing programs such as Share a Coke and disciplined price pack strategies as well as improved execution is paying dividends with increased incidence particularly among teams and revenue growth in our Sparkling portfolio.
In key emerging markets including India, Sub-Sahara Africa as well as the Middle East are incremental media investments drove recruitment with solid net revenue and volume growth. This gives us confidence that when we invest in our brands, align on our system plan and focus on execution we do see positive results. But to be clear, we recognize that our incremental media investments which already started in earnest around the FIFA World Cup will take time to pay off.
Stepping back from our quarterly performance, we’ve taken a hard look at our progress to date. Our strategies and our actions and realize that while the five strategic priorities we laid out at the beginning of the year are on the right track we recognize that we must do more. Above all, the scope and pace of our actions must change to improve our ability to capture non-alcoholic beverage industry growth.
And that change starts with me. I’ve asked my leadership team to take this journey with me and to facilitate this change throughout our company. It’s a journey we are ready to embark upon. In some ways, we’ve already enhanced our business with strategic investments in Keurig Green Mountain and intend to further do so with our pending investment in master beverages which underscore not only our ability to adapt the changing consumer trends but also our commitment to further innovation. But these partnerships alone are not enough that is why we are laying out today a series of actions we firmly believe will drive the necessary changes to continue to deliver long term shareholder value. First, we are streamlining and simplifying our operating model in order to speed decision making and enhance our local markets focus to drive growth.
This work is moving forward aggressively and we expect to focus the role for our corporate center and further scale our back office to support processes and policies globally. This will also enable our local operations to focus intently on demand creation in their individual markets.
And as previously announced, we are revising our long term incentive metrics to provide a clear line of sight between our employees around the globe and the metrics they can best influence. Second, we will drive efficiency through aggressively expanding our productivity program. We plan to expand the program from 1 billion in savings by 2016 to 2 billion in annualized savings by 2017 and 3 billion by 2019. This productivity program will build on previous successful programs encompassing our entire spend base and will supplant our existing plan announced earlier this year.
A number of actions are already taking place. We are restructuring our global supply chain including optimizing our manufacturing footprint in North America and investing in technology to streamline – to further streamline our operations. We are implementing zero based budgeting across our organization and are dreadfully prioritizing and redesigning our normal activities to further reduce costs. As I have previously mentioned we are streamlining and simplifying our operating model which will enhance our speed and agility and result in lower operating expenses overtime.
Finally we are working to drive even more disciplined and efficiency in our direct marketing investments. As a result of these initiatives we plan to fund the marketing programs and innovation required to reinvigorate and deliver sustainable net revenue growth. At the same time, we expect these actions will drive margin expansion and increase return on investment capital overtime.
Our third action is to refocus on our core business model of building the world’s greatest beverage brands and leading an unmatched global system of strong local bottling partners. In North America, we have a clear and definitive plan to refranchise the majority of our company owned bottling territories by the end of 2017, so at that time we will retain approximately one third of the total bottling distributed volume in North America. With respect to the remaining territories our intent is to ensure the bulk of these are refranchised at the latest by 2020.
Finally outside of North America we will continue to pursue opportunities to refranchise other company owned bottlers where it makes sense, where the business is ready and where we have able and willing partners. Fourth, we will drive disciplined brand and growth investments with a long term view across both Sparkling and Still categories. We will take a balanced approach to ensure we can build our business while consistently delivering bottom line results.
In Sparkling as outlined earlier this year, we will continue to work to improve the quality of our marketing and scale our global investments through a network marketing model to improve topline growth across trademark Coca Cola, Fanta and Sprite.
During the second quarter of this year we began to step up our media investments. Our investments target markets and categories where our current media is underfunded relative to the market opportunity we see as well as where we have the right price package architecture and finally off course execution alignment with our partners. In Still beverages we will continue to invest in our core growth priorities where we are a leader and notably juice and juice drinks and enhance the hydration.
We will expand our investments in selected profitable categories where we believe we can capture value such as value-added dairy. And we will continue to leverage our partnership model with companies such as Keurig Green Mountain, Monster and FairLife as well as targeted M&A to enhance our growth in key categories. We expect these efforts to build on our global leadership in Still beverages and accelerate growth overtime.
This we will drive revenue and profit growth across our markets with a further focus on geographic segmentation recognizing that each market has an important role to play within our portfolio. We’ve targeted our markets with clear role is to drive topline growth with some markets focused on price, others on volume and the remainder on the balance of the two. Beginning 2015, our incentive metrics will be expanded to include revenue growth and will be tied to these clear portfolio roles.
We are confident that the action we are announcing today will ensure that the Coca Cola Company is best positioned to capture growth in non-alcoholic beverages and continues to deliver long term value to our shareholders. Since its inception our 2020 vision has served to focus our system on the opportunity and to align on our common set of strategies.
We have begun the process of evolving our 2020 vision with our bottlers earlier this year, a process that will continue over the coming months. Together, we remain confident in the growth potential for non-alcoholic beverages. While growth rates will be challenging in the short term given the macroeconomic volatility, we believe that overtime consumer trends will support mid-single digit revenue growth.
Importantly, the core Sparkling category remains resilient and has growth retail value globally for the first nine months of the year 3% outpacing the non-alcoholic ready to drink industries total value growth of 2%. And we also see effective profitable growth opportunities in still beverages, ones that we are well positioned to take advantage of but ones that requires faster action and greater and focused investments.
While we have more work to do here, it is clear that our 2020 vision will remain focused on delivering value growth for our – ahead of the industry. Importantly, the goal of doubling system revenues one our system can always aspire towards it, but it is not a goal to be pursued at any cost over a fixed time frame and we are realigning our expectations based on where we are today and the outlook for our industry.
Let me be clear, we see no change to our long term target of high single digit comparable currency neutral EPS growth. We are updating our net revenue target to mid-single digit growth in order to perfect current reality including the increased contribution from our new partnership model which will impact equity income rather than slowing through net revenues and operating income. And we are evolving our primary profit metric from operating income through profit before tax.
Going forward, the profit before tax this will be 6% to 8% on the comparable currency neutral basis consistent with the previous operating income target of 6% to 8%. With that said, we must also be realistic. While we are very confident in our actions we are cautious in our outlook. The actions announced to date and the additional work we had to do will take time to implement and deliver improvement in our results. As such, we expect to be below our long term EPS growth target for 2014 on a full year basis.
We will come back to you with more contexts in December; however we see 2015 as a critical year, a year in transition as we flawlessly implement our new operating model amidst the continued challenging macroeconomic environment. I am confident however that we have the brands, the greatest and most wide reaching consumer product distribution system in the world, the critical partnerships and most importantly the people to return us to a more robust growth trajectory.
I’ll now hand the call over to our Chief Financial Officer, Kathy Waller, who will provide you with a more detailed look at our financial performance as well as an outlook on our business for the balance of the year.
Following Kathy’s prepared remarks, Irial Finan, Sandy Douglas, Ahmet Bozer, Kathy and I will participate in our question and answer session to address any questions that you may have today. Kathy?
Kathy Waller – CFO
Thank you Muhtar, and good morning everyone. In recognition of our time, I plan to cover key highlights from the quarter and outlook, and then we can move to your questions. Let’s start by reviewing the few key drivers of our financial performance.
After adjusting for unit cases without concentrated sales equivalent, concentrated sales were in line with unit case sales for both the quarter and year-to-date. Comparable currency neutral net revenue growth was 1% in the quarter and 2% year-to-date after excluding the impact of structural items.
Our topline growth slowed from the first half of the year due primarily to a volume deceleration principally in Europe and China. Price mix was positive across each of our geographies with the exception of Asia Pacific due to geographic mix, however due to the composition of growth we saw a negative geographic mix at the consolidated level resulting in 1% global price mix for both the quarter and year-to-date.
Comparable currency neutral growth profit was up 4% in both the quarter and year-to-date after excluding the impact of structural items. Our gross margin expanded in the quarter due to pricing, favorable geographic and product mix and a slight tailwind from commodity cost. We generated one point of operating leverage in the quarter as continued investments behind our brand to accelerate growth including a mid-single digit increase in DME, were offset by tight control over operating expenses and the reversal of certain expenses related to our long term incentive plan.
Comparable currency neutral operating income was up 5% in both the quarter and year-to-date after excluding the impact of structural items. The impact of currency was a three point headwind on this quarters comparable operating income results.
Comparable ECS was even in the third quarter including a currency headwind of six points. Although the currency headwind and operating income was in line with the outlook we provided last quarter, foreign currency unfavorably impacted EPS by six points due to additional currency headwinds related to the measurement gains and losses recorded in the line item other income.
We generated $8 billion in cash from operations year-to-date and returned $1.9 billion to share on us through net share repurchases. As we look ahead to the fourth quarter of 2014, let me take a minute to update you on a few outlook items as we model our business.
We do not expect the current trajectory for unit case volume growth to improve materially for the remainder of the year. We expect structural items to be a one to two-point drag on net revenue growth, and approximate two-point drag on operating income growth in the fourth quarter of 2014.
After considering our hedge positions, current spot rates, and cycling of our prior-year rates, we now expect a seven-point currency headwind on operating income during the fourth quarter of 2014, with a six-point impact on operating income for the full year 2014 We expect net interest income to be approximately $100 million for the full year 2014.
We now expect approximately $2.5 billion in net share repurchases for the year. And we now expect our full year comparable currency neutral EPS growth to be below our long term target.
As we look ahead to 2015, we anticipate continued challenging macroeconomic conditions in most developed markets as well as some key emerging markets. The best way to think about 2015 is as a year of transition.
We will start implementing changes to create our new operating model in the beginning of 2015, but incremental marketing investments and margin enhancements will pay time to fully materialize.
Therefore based on what we see today with our continuing need to invest in our business and recognizing that we are early in our planning process. We do not expect our comparable currency neutral, financial performance in 2015 to differ significantly from this year.
As we move through our planning process we look forward to providing more detail and a methodology to benchmark our progress through 2015 and beyond. As such we plan to host the modeling call in December to discuss our 2015 outlook, including further details of the impacts from our refranchising efforts in North America.
However, given the amount of questions around currency for next year, we did want to provide an initial estimate of the impact at the PBT line to better help you model into next year. We currently expect a mid single-digit currency headwind on profit before tax in 2015. We will come back with more contexts on the December call.
As Muhtar said, we are committed to taking the right actions to reinvigorate our top-line growth over time. We have a strong plan in place and we are aligned as a team to deliver against our objectives.
Operator, we are now ready for questions.