The Coca-Cola Company (KO) Q1 2011 Earnings Report, Transcript and Summary

At this time, I would like to welcome everyone to the Coca-Cola Company's First Quarter 2011 Earnings Results Conference Call. Today's call is being recorded. [Operator Instructions] Media participants should contact Coca-Cola Media Relations department if they have questions. I would now like to introduce Mr. Jackson Kelly, Vice President and Director of Investor Relations. Mr. Kelly, you may begin.

Good morning, and thank you for being with us today. I'm joined by Muhtar Kent, our Chairman and Chief Executive Officer; and Gary Fayard, our Chief Financial Officer. Following prepared remarks this morning, we will turn the call over for your questions. Before we begin, I would like to remind you that 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. In addition, I would also like to note that we have posted schedules on our company website at www.thecoca-colacompany.com under the Reports and Financial Information tab in the Investors section, which reconcile certain non-GAAP financial measures that may be referred to by our senior executives in our discussion this morning and from time to time in discussing our financial performance to our results as reported under Generally Accepted Accounting Principles. Please look at our website for this information. Now I will turn the call over to Muhtar.

Thank you, Jackson, and good morning, everyone. Let me begin by saying that I'm pleased with our first quarter results. Despite ongoing global geopolitical challenges, we once again delivered consistent quality growth across all 5 of our geographic operating groups. We are winning share in the marketplace. We gained volume and value share globally in our nonalcoholic beverages as well as in both the sparkling and still ready-to-drink beverage categories. We are winning with our global sparkling beverage portfolio. Brand Coca-Cola grew 3% in the quarter. In addition, Fanta is our fourth global brand to surpass the $10 billion retail sales value threshold. And we are winning with our global still beverage portfolio, as Del Valle, the brand we acquired in 2007 recently, achieved $1 billion dollar brand status. Del Valle is now our company's 15th $1 billion brand and our first with roots in Latin America. Importantly, we are decisively executing our 2020 Vision, together with our global bottling partners and delivering consistent, long-term sustainable growth. Before we review this quarter's operating results, I'd like to take a moment to address recent events in Japan in light of last month's tragic earthquake and tsunami. First, I'd like to acknowledge and sincerely thank our leadership team in Japan for their tireless efforts in helping to ensure the health and safety of our associates and the people of Japan during this time of crisis. I'd also like to express our heartfelt appreciation to all of our Japan bottling partners who've been at the very forefront of our system's efforts to assist with immediate disaster relief. Our bottling partners have been diligently producing, distributing beverages to affected areas and restoring our business operations. Last month, days following the earthquake and tsunami, I visited Tokyo to meet with our associates, customers and our…

Thanks, Muhtar. Good morning, everyone. As Muhtar shared, we're off to a good start this year, advancing our momentum with 6% worldwide volume growth and the delivery of another quarter of consistent quality growth in line with our expectations. We feel particularly good about these results since we delivered them while productively integrating our North America business and while navigating several unforeseen global events including the tragedy in Japan, the unrest in the Middle East and a volatile global commodity costs environment. While, as expected, there are many puts and takes to consider in reviewing our quarterly results, and I'll go through all of those, I want to affirm that except for Japan, we do not see any of these puts and takes changing our full year bottom line expectations. In fact, this quarter's good results are a testament to our global system's ability to execute our strategic plans in keeping with our 2020 Vision and long-term growth targets. So let me start by reviewing our earnings results for the quarter. As outlined in our release, we reported comparable earnings per share of $0.86, up 7% versus the prior year and in line with our long-term growth targets. While this result came in $0.01 below consensus in many analyst models, it includes a $0.01 dilutive effect from the timing of marketing expenses as we are required to conform our newly acquired North American bottling business to the Coca-Cola Company's accounting policies. Let me take a moment to explain what this accounting treatment means in plain English. As many of you know, we apply something we call a sales curve accounting policy to our marketing expenses, which means we recognize marketing on a pennies-per-case basis. So, basically, the same pennies-per-case of marketing for the full year as we spread the marketing…

[Operator Instructions] And, sir, our first question comes from Carlos LaBoy from Crédit Suisse. Carlos LaBoy - Crédit Suisse AG: Can you shed some light on the drivers that sustain this momentum going into the second half? But I think if you could please direct a portion of your answer to the Bottler Investment Group [Bottling Investment Group] performance I think specifically, we'd like to hear if you can expand on China? How important is Pulpy to the relative mix there now as it continues to grow? In India, what drivers sustain the growth in the second half? And in the Philippines, you always seem to use these macro downturns or these economic periods of difficulty to reset the business in your favor. How do you modify the Philippine plan to win in this inflationary environment?

This is Muhtar. Let me just start. I think what you saw in the first quarter global -- huge global geopolitical challenges, natural disasters. And I'm very pleased, I can say, that we have delivered consistent quality growth across all 5 of the geographic operating groups. That gives me confidence about going into the year. We're winning with our global sparkling beverage portfolio. Brand Coke, again, grew an impressive 3% in the quarter, in addition, Fanta, which is our fourth global brand, passing the $10 billion retail value. So with growth in all 5 geographic operating groups, excluding our cross-licensed brands of 6% internationally, and if you look at -- it's important to look at what we're cycling each quarter. We are consistently delivering volume growth in line with our long-term targets or above. And what you see from an international perspective is Q1 of 2010, we're cycling 5%. So we're actually increasing the momentum. Last quarter of 2010, Q4 was 5% international. We're, again, accelerating that growth in the midst of huge economic, political and natural challenges. So I think that gives us confidence as we go into the year. And, again, when you look at our U.S. business delivering again the fourth consecutive quarter, we're investing. As we do this, our brands are now getting healthier. Our share results, market share and value share, volume and value share results in this past quarter are the best we've seen in a long time. And in fact, we have a chart that shows by category, by region, share. Except for 1 metric on that chart, everything is green this past quarter, which we haven't seen it like that for a very long time. So again, India and China, you've referenced, I think, China as we -- Q1 sparkling gained volume…

Our next question comes from Mark Swartzberg from Stifel, Nicolaus. Mark Swartzberg - Stifel, Nicolaus & Co., Inc.: I wanted to probe a little bit more. If we could ask for more visibility on what is going on with Germany. That 4% number is a good number. Can you talk about 2 things, Muhtar? #1, what you think is driving that, the role of spending in that? And then #2 as we think about your gross margin outlook for Germany, you've got, potentially, the benefit of some volume leverage, potentially, the benefit of mix. Potentially, some positives there in the GM side. But, of course, commodities are a challenge. So how are you thinking about the gross margin outlook for Germany as well at the bottling level.

I think first as you see, all restructuring that we've been involved in for the past 36 months in Germany is beginning to pay out as volume grows in that restructured and more productive infrastructure that we have both in terms of production, as well as distribution, as well as warehousing in Germany. And then with strong brands, when you look at brand Coke, again, in Germany, which was actually up 4% supported by very strong marketing, and then some other brands, Sprite, a very healthy growth, up almost 7%, very good brand portfolio metrics in Germany. And, also, still beverages doing very well like Nestea in Germany. So, overall, I would say that gross margins, we don't give forward-looking outlook. But I'd to say that we're pleased with the improvements we're seeing across our margins in Germany, particularly as the benefits of the restructuring are beginning to come alive, as the volume is beginning to pick up in multiple channels in Germany. And then also, I'd like to stress all the work that is being done by our Bottling Investments Group under the leadership of Damian in Germany is also beginning to show in the immediate consumption transactions in Germany.

Mark, it's Gary. One other thing to recognize as well is that when you referenced commodity costs versus Germany, remember that all of those -- most of all of those commodities are priced in dollars. And I was talking about in the prepared remarks, there is an inter-relationship to a large extent between commodities and currency. And so in Germany, with the strength of the euro, is offsetting some of the costs of commodities as well. So you get different views on commodity costs if you look at different countries.

And one last thing, Mark, please note that this is the highest absolute unit case volume sales in Germany we've seen in a decade. And the way the bottling business works if you look at this restructured, more productive, leaner system that we have in place after the hard work of the last 36 months and as you sort of model increase in volume, that translates into better margins. Mark Swartzberg - Stifel, Nicolaus & Co., Inc.: Helpful stuff. If I could make one follow-up there. Muhtar, the role of package mix in the bottling operations, you mentioned immediate consumption. But how impactful, how beneficial is package mix affecting the bottling ops there.

Are you talking about Germany or... Mark Swartzberg - Stifel, Nicolaus & Co., Inc.: Germany specifically, yes.

I think the only way that we have begun to win with discounters is through a very decisive and very novel and innovative packaging strategy. So you've seen us employ a very innovative packaging strategy in order to be able to be represented with all our brands and also the discounted channels. Mark Swartzberg - Stifel, Nicolaus & Co., Inc.: Great, thank you, guys.

Our next question comes from Bill Pecoriello, Consumer Edge Research.

Gary, thanks on the detailed explanation from the puts and takes on the quarter. A couple of other points I just wanted to clarify. With the 7% operating profit growth in the quarter, currency neutral, you mentioned the commodity hedged timing, the market spend timing, we also have the Easter shift and 1 less shipping day. So trying to best understand your underlying operating profit growth, do you view it as high single digits when you account for those other puts and takes?

Yes, Bill. In fact, this is one of the difficulties as you know, it's -- let's say -- 1 less shipping day, the Easter shift, et cetera. You're now into estimates of what might it have been and those kinds of things, which is why I did not try to actually quantify those. But there are couple of things we know we can quantify. If you put the impact -- if our best estimate is that the impact of Japan is $0.01. The impact of the sales curve on CCR in North America is $0.01 and that wouldn't just reverse this Q1 in Q4. But if you just put those things together, right there, that's 2 to 3 points on OI growth, just those 2 things. And then the hedges that we took, the commodity hedge gains, that's another $36 million, another $0.01. We took those out. Those will go back in kind of primarily third quarter-ish timing. But that's another 1.5 points of growth on OI. So that's why we feel comfortable. I mean, it's a dynamic world out there. But we feel comfortable with all the puts and takes. There's some real bad things like the tragedy in Japan. There's some good things where we've made some decisions to change accounting policies, and it's a Q1, Q4 quarterly thing. It doesn't impact the year at all, but we just think it's the right way to go.

And one other thing to add, Bill, also, you have to see that we are continuing to aggressively invest in our brands. And that is something, so in the quarter you will see -- you will have seen continued growth in direct marketing and marketing expenses. And again, that is something that we are very adamant to continue despite all the different challenges of commodities and other things that are happening around the world.

Great. And, Gary, on the Easter shift, the reason it's also more complicated now into the timing shift but now with the accounting of CCE, the concentrate was booked in the Q1 last year and now shifted into Q2 this year. It's booked along with the bottler case sales. So that was also a complication, how to model the timing on that, correct?

You're exactly right. And, in fact, Bill, I was sitting with some of my finance people yesterday and we were going through exactly that and going through what do we think the impact of the Easter shift was because we're actually starting to focus, as you might imagine, on quarter 2. And then we got into, Okay, so what does this shift in July 4 do? And what days do they fall in the week? If it turns out July 4 is a Monday, if you look. And so that's part of as we're kind of looking. But you do have -- you're actually right. You' have both impacts. You got the calendar impact. And then because of the acquisition, you've got the impact of when the revenue is actually recognized in the financial statements.

Thank you very much.

Our next question comes from John Faucher from JP Morgan. John Faucher - JP Morgan Chase & Co: So I wanted to follow up a little bit on the North America price mix commentary, which you guys said, I guess in the call, you said 1% to 2%. Can you talk a little bit about mix and how we should view mix now that the gap between full revenue cases and concentrate cases is different? I assume we're just going to see significantly less full revenue case mix, et cetera. And then as we look at the scanner data that we get, the pricing doesn't sort of flow with that. So can you talk a little bit about the price pack architecture and sort of how we should look at changes sort of package versus package versus different packages coming through and also some of the channel differentials right now?

John, I think, first what I would like to state is that in North America, particularly in the U.S., sparkling IC transactions, again, grew this past quarter. That's the second quarter in a row. And prior to this, you'd need to note that transactions had declined every quarter dating back all the way to 2007. So that's something that, again, we're focusing on very heavily to continue to drive transaction. So, I think, in regards to transactions overall, we grew IC package volume a good 2%, which would translate to overall transaction growth for the portfolio. So that is very positive and that somewhat compensates also for the price of the increases that had been referenced as 1% to 2% in the last call. What I'd like to, also, frame for the remainder of the year, though, is that we will be looking at every opportunity, every opportunity in North America to see if we can generate a higher price than the overall 1% to 2% and more like, maybe, 3% to 4%, as we look into the balance of the year. And we believe that our brand strength will allow us to generate a higher price increase than the 1% to 2%. And, at the same time, we will be diligently, again, putting all our efforts to grow IC transactions in the United States. And recognizing that higher price increase may have some volume impact, but driving transactions will be the key in North America. And I don't know if Gary would like to add to your other question that is related to the revenue realization given that the business is now operating as one integrated business. One other thing I'd like to add is that, again, the 16-ounce package was up double digits again in the quarter, which is giving us, again, goods metrics for the future.

John, Gary. Just a couple of things on North America that I want to focus on and reemphasize one thing that Muhtar just said as well. When we look at it, we took different pricing percentages on different packages and different channels, obviously, as you would expect in North America. But the weighted average of all of that is in the 1% to 2% range. That's announced. That's in the market, and we're getting that. So we have to kind of look at the scanner data that you're referring to because a lot of -- remember that Nielsen and ROI only covers about, I think, about 40% of the U.S., our U.S. market, that there's so much that, that's not in Nielsen and ROI. So that's the large part out of it. But then, as Muhtar says, we're going to look at additional pricing this year in the U.S. as well. Now with that said, I want to emphasize something else he was talking about, which is on driving, on transactions. And we've all talked volume for years and years, but transactions is really about creating health for the brand, wealth and really drives sustainable long-term value, we think, for the brand. And you saw us downsize packages in North America going to the 14- and 16-ounce and the reason to do that was to drive transactions and recruit and rerecruit users of our brands. You will see us doing the same kinds of things of downsizing in other countries as well. So that is going to have an impact on volume results, But, if you will, help drive transactions and could be an implicit kind of price increase as well, where you downsize a package but hold the price and can get pricing as well. And you'll see us doing that in different markets around the world as we talked about it. So, all in all, I think you're seeing some actions that we're taking that we think will prove good long term for the health of brands as well as build value for the company as well. John Faucher - JP Morgan Chase & Co: Great, thanks.

Our next question comes from Caroline Levy with CLSA. Caroline Levy - Credit Agricole Securities (USA) Inc.: I wonder if you could address 2 things. I mean in order to cover the commodity costs pressures, I'm assuming there, you mainly feel them in North America and in the Bottling Group. How much pricing would be required to fully offset that, if you did not have anything else to work with in terms of cost cuts? And then I'm just wondering if you could tell us a little bit more about how things are operating in Japan and where the earnings drag might be? Is it a mix shift? Is it that you need to give away product? Is it the cost of doing business? Just a little more insight into Japan.

As far as commodity, Gary signaled some levels of commodities, the updates in terms of the additional commodity pressures that are coming into our business. Yes, you were right in saying and looking at the fact that, as far as commodities impact for our business is concerned, it's mainly North America and BIG. But we look at this holistically across the world from a system point of view, and there's some hedges in place. There puts and takes. So it's not just a simple equation, here's the number and how much price increase would you need. All we can signal is that as, obviously, you mentioned -- you heard me talk about -- I mean it's consumption, this is growing. That is a big benefit, when you have -- because those packages have a higher margin. They have a higher price. And as the mix shifts in favor of immediate consumption, then, obviously, we get the benefit and a windfall, and we don't have to go out and take pricing across all categories, all channel. That's the way we kind of think about our business. You heard me, again, in my comments talk about the new packages coming on stream in China. You see us doing the same thing in the Philippines, across the whole world, Germany many new packages. So I think we're employing a much more flexible, fast, nimble brand-priced pack channel architecture that is designed to ensure that we don't have to take across-the-board pricing. And that's why this business of ours actually performs so well across the world in such troubling macroeconomic -- in such a troubling microeconomic environment. And also by the way, if there isn't going to be an inflationary period coming, that will benefit us overall as a business, as a system, as…

Caroline, I would just add a couple of things and just a little more detail to what Muhtar has told you. All the plants are back up and running. But we've got -- the bottlers have a lot of large automated warehouses, and those are not all back up and running. And so we still have supply chain issues in the country. Additionally, not only do you have channel mix issues as Muhtar referenced, you've got in shifts in product mix as well. But probably and most importantly, and this is where you will see a lot of the impact come through as well, what would normally be happening today is that the bottlers would be just running plants full bore, kind of building finished stock inventory for the summer selling season. We're not able to do that. And so what's going to happen is beginning about third quarter, and this is why I was referencing the impact of really the third and fourth quarter, is that we're not going to be able to supply all the demands, as we believe, because we're not going to be able to manage and build up inventory stocks ahead of time as you normally would in a normal year. So that's -- well, we think we saw an impact in the first quarter that will probably rebound a little bit in the second quarter just around concentrate shipments, and then it's going to reverse back in the third and fourth quarter is kind of what we think is going to happen. Caroline Levy - Credit Agricole Securities (USA) Inc.: Thank you so much.

And we'll keep updating you as we go along, Caroline. Caroline Levy - Credit Agricole Securities (USA) Inc.: That's really helpful. Thank you.

Our next question comes from Dara Mohsenian from Morgan Stanley.

So I have just 1 point of clarification, Gary. The pricing environment potentially improving in North America in the balance of the year, is that more in the sparkling side of the portfolio or more in the still side? And I assume the more robust expectation is due more to less price increases as opposed to mix, is that correct?

Well, couple of things I would say it's going to be -- it would be balanced and if we took you through our pricing architecture in North America. It's actually not -- it's actually pretty complicated. I was going to say not as simple as you would think it would be because you, basically, got different pricing on different packages, on different brands by channel, and so you're going -- you've got different elasticities of demand by package. So you're going to implement different pricing for those different SKUs at about by channel. But we are expecting to see, we have talked about 1% to 2% pricing in North America. We're now saying that we're going to probably be going for more pricing than that this year, and a lot of that is just strictly the environment that we're in. So that's the way we would see it right now.

That's helpful. Just taking a step back and looking in North American margins longer-term, obviously, this year they'll be hurt by the bottler consolidation and some of the commodity inflation.

Yes.

But I was hoping you could highlight for us conceptually the longer-term opportunity you have beyond 2011 in terms of expanding your North American margins given they're still below some of your other regions and what are the key drivers of that would be.

The key of the drivers are going to be IC pushing really making sure that we win every transaction, growing transactions, growing the immediate consumption channel. There's so much work to be done, still opportunities to be had in the immediate consumption channel in the independent stores, in merchandising, in making our products much more desired and making and creating inspiration at the point of sale in those IC channel, just like what, in a way, you saw us do in Philadelphia, and I think CCR and their state of leadership has got the right organization. We've got the right investments in place. And then we have our brands are healthy. That all that translate, if we execute well, which we intend to do, then you will see us expanding margins as IC business grows and as our smaller packs take more attraction inside the 4 walls of our every single customer which we serve.

Thanks so much. And, Gary, just 1 last clarification. Did North American profit come in line with your own internal expectations in the quarter?

Yes. In fact, they came in slightly ahead of our internal expectations.

Thanks.

Good. Thank you. In closing, I'd like to thank many of you who attended our recent presentation at both CAGNY and CAGE conferences this past few months. Our results, as well as our management team's performance and track record provide us confidence in our company today as well as our path forward to 2020. We will keep generating strong cash flows and redeploy that cash to invest in our brands, grow our business and reward you, our shareowners. We will continue to invest alongside our system and execute flawlessly on our 2020 Vision by working closely with our global bottling partners, our employees, our customers and all our key stakeholders. We see tremendous opportunity ahead for our company in all of our markets and remain intently focused on implementing our strategic priorities to generate long-term sustainable growth. Most of all, we thank you for interest and investment in our company. There's no greater responsibility than earning and maintaining your trust and confidence. So rest assured we are working tirelessly to protect and grow the value of your investment in our company. Thank you for joining us this morning.

This concludes today's conference. Thank you for joining. You may disconnect at this time.