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COCA-COLA ENTERPRISES, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Overview Business and Basis of Presentation Coca-Cola Enterprises, Inc. ("CCE," "we," "our," or "us") is a marketer, producer, and distributor of nonalcoholic beverages. We market, produce, and distribute our products to customers and consumers through licensed territory agreements in Belgium, continental France, Great Britain, Luxembourg, Monaco, the Netherlands, Norway, and Sweden. We operate in the highly competitive beverage industry and face strong competition from other general and specialty beverage companies. Our financial results are affected by a number of factors including, but not limited to, consumer preferences, cost to manufacture and distribute products, foreign currency exchange rates, general economic conditions, local and national laws and regulations, raw material availability, and weather patterns. Sales of our products tend to be seasonal, with the second and third quarters accounting for higher unit sales of our products than the first and fourth quarters. In a typical year, we earn more than 60 percent of our annual operating income during the second and third quarters. The seasonality of our sales volume, combined with the accounting for fixed costs, such as depreciation, amortization, rent, and interest expense, impacts our results on a quarterly basis. Additionally, year-over-year shifts in holidays and selling days can impact our results on an interim period basis. Accordingly, our results for the second quarter and first six months of 2014 may not necessarily be indicative of the results that may be expected for the full year ending December 31, 2014. For reporting convenience, our first three quarters close on the Friday closest to the end of the quarterly calendar period. Our fiscal year ends on December 31st. There was one less selling day in the first quarter of 2014 versus the first quarter of 2013, and there will be one additional selling day in the fourth quarter of 2014 versus the fourth quarter of 2013 (based upon a standard five-day selling week). First Second Third Fourth Full Quarter Quarter Quarter Quarter Year 2014 63 65 65 68 261 2013 64 65 65 67 261 Change (1 ) - - 1 - Relationship with The Coca-Cola Company (TCCC) We are a marketer, producer, and distributor principally of products of TCCC with greater than 90 percent of our sales volume consisting of sales of TCCC products. Our license arrangements with TCCC are governed by product licensing agreements. From time to time, the terms and conditions of these agreements with TCCC are modified. Our financial results are greatly impacted by our relationship with TCCC. For additional information about our transactions with TCCC, refer to Note 5 of the Notes to Condensed Consolidated Financial Statements in this Form 10-Q. Financial Results Our net income in the second quarter of 2014 was $198 million, or $0.78 per diluted share, compared to net income of $182 million, or $0.66 per diluted share, in the second quarter of 2013. The following items included in our reported results affect the comparability of our year-over-year financial results (the items listed below are based on defined terms and thresholds and represent all material items management considered for year-over-year comparability): Second Quarter 2014 • Charges totaling $54 million ($36 million net of tax, or $0.14 per diluted share) related to restructuring activities; and • Net mark-to-market gains totaling $8 million ($5 million net of tax, or $0.02 per diluted share) related to non-designated commodity hedges associated with underlying transactions that relate to a different reporting period. Second Quarter 2013 • Charges totaling $34 million ($25 million net of tax, or $0.09 per diluted share) related to restructuring activities; and • Net mark-to-market losses totaling $8 million ($6 million net of tax, or $0.02 per diluted share) related to non-designated commodity hedges associated with underlying transactions that related to a different reporting period. Financial Summary Our financial performance during the second quarter of 2014 reflects the impact of the following significant factors: • Growth in both sparkling and still beverage sales driving a year-over-year volume increase of 3.5 percent; 19-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC.• Flat year-over-year bottle and can net price per case growth reflecting the impact of our planned promotional activity, including activities for the 2014 FIFA World Cup, and competitive marketplace dynamics, particularly in Great Britain; • Year-over-year bottle and can cost of sales per case decline of 1.0 percent due to mix-shifts into lower cost packages and recent favorable trends in the cost of some of our key commodities; and • Modest underlying operating expense growth resulting from improved volume performance and 2014 FIFA World Cup promotional activity. Consolidated operating income grew during the second quarter of 2014 driven by volume growth across our territories and a decline in cost of sales. Despite this performance, we continue to face the effects of persistent operating challenges, including heightened competitive and marketplace pressures, particularly in Great Britain. These factors, coupled with planned promotional activity and package mix-shifts, contributed to flat bottle and can price per case growth in the second quarter of 2014 versus the second quarter of 2013. Volume in our continental European territories increased 4.0 percent during the quarter, reflecting strong sales growth of our Coca-Cola trademark brands and sparkling beverages. Volume in Great Britain increased 2.0 percent, primarily driven by increases in the sales of our Coca-Cola trademark beverages and our water brands. Across our territories, Coca-Cola Classic volume increased 4.5 percent and Coca-Cola Zero continued to perform well, growing 14.5 percent during the quarter. Our water portfolio also grew 9.5 percent, led by Chaudfontaine and Schweppes Abbey Well. We continue to promote our brands in the marketplace through key marketing initiatives including the relaunch of our "Share a Coke" campaign with expanded personalization and promotions for the 2014 FIFA World Cup. We also remain focused on package and product innovations to create value for our customers and consumers, including the recent introduction of our 1.75 liter contour bottle for Coca-Cola trademark brands in Great Britain and the launch of Finley, an adult sparkling non-alcoholic beverage, in France. In addition to innovation, we are committed to expanding our brand portfolio with offerings that are intended to appeal to a wide variety of consumers. Some examples of these expanded offerings include the launch of Smartwater and Coca-Cola Life, a lower calorie, naturally-sweetened beverage, in Great Britain which are planned for the second half of 2014. Bottle and can cost of sales per case declined 1.0 percent during the second quarter of 2014, reflecting mix-shifts into lower cost packages, particularly cans, and recent favorable trends in the cost of some of our key commodities, principally sugar. Although the overall cost environment still remains somewhat volatile, the degree of volatility has recently abated. We continue to seek and execute opportunities to mitigate our exposure to price changes through the use of supplier agreements and hedging instruments. During the second quarter of 2014, we incurred higher year-over-year operating expenses reflecting an increase in restructuring expenditures and currency exchange rate changes. This change also reflects a modest increase in underlying operating expenses related to planned marketing activities, as well as the operational expense impact of improved volume performance. Diluted earnings per share performance benefited from operating income growth and the continuation of our share repurchase program. Share repurchase activity increased diluted earnings per share by approximately $0.06 during the second quarter of 2014 when compared to the second quarter of 2013. We plan to continue our share repurchases during the remainder of 2014 and expect to repurchase approximately $800 million of our shares during the current year. 20-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. Operations Review The following table summarizes our Condensed Consolidated Statements of Income as a percentage of net sales for the periods presented: Second Quarter First Six Months 2014 2013 2014 2013 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 63.7 65.1 64.4 65.4 Gross profit 36.3 34.9 35.6 34.6Selling, delivery, and administrative expenses 23.7 22.3 24.2 25.0 Operating income 12.6 12.6 11.4 9.6 Interest expense, net 1.2 1.1 1.4 1.2 Other nonoperating income (expense) - (0.1 ) - (0.1 ) Income before income taxes 11.4 11.4 10.0 8.3 Income tax expense 2.9 3.0 2.6 2.2 Net income 8.5 % 8.4 % 7.4 % 6.1 % Operating Income The following table summarizes our operating income by segment for the periods presented (in millions; percentages rounded to the nearest 0.5 percent): Second Quarter First Six Months 2014 2013 2014 2013 Percent Percent Percent Percent Amount of Total Amount of Total Amount of Total Amount of Total Europe $ 321 109.0 % $ 309 113.5 % $ 545 114.0 % $ 454 118.5 % Corporate (26 ) (9.0 ) (37 ) (13.5 ) (66 ) (14.0 ) (71 ) (18.5 ) Consolidated $ 295 100.0 % $ 272 100.0 % $ 479 100.0 % $ 383 100.0 % During the second quarter and first six months of 2014, we had operating income of $295 million and $479 million, respectively, compared to $272 million and $383 million in the second quarter and first six months of 2013, respectively. The following table summarizes the significant components of the year-over-year change in our operating income for the periods presented (in millions; percentages rounded to the nearest 0.5 percent): Second Quarter 2014 First Six Months 2014 Change Change Percent Percent Amount of Total Amount of Total Changes in operating income: Impact of bottle and can price-mix on gross profit $ (2 ) (1.0 )% $ 4 1.0 % Impact of bottle and can cost-mix on gross profit 12 4.5 13 3.5 Impact of bottle and can volume on gross profit 24 9.0 16 4.0 Impact of bottle and can selling day shift on gross profit - - (9 ) (2.5 ) Impact of post-mix, non-trade, and other on gross profit (2 ) (1.0 ) (4 ) (1.0 ) Net mark-to-market gains related to non-designated commodity hedges 16 6.0 15 4.0 Net impact of restructuring charges (20 ) (7.5 ) 40 10.5 Other selling, delivery, and administrative expenses (27 ) (10.0 ) (11 ) (3.0 ) Currency exchange rate changes 20 7.5 32 8.5 Other changes 2 1.0 - - Change in operating income $ 23 8.5 % $ 96 25.0 % 21-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. Net Sales Net sales increased 8.0 percent in the second quarter of 2014 to $2.3 billion, and increased 5.0 percent in the first six months of 2014 to $4.2 billion. These changes include currency exchange rate increases of 5.5 percent and 4.5 percent when compared to the second quarter and first six months of 2013, respectively, reflecting strong appreciation in the euro and British pound sterling relative to the U.S. dollar. Net sales per case increased 4.5 percent in the second quarter of 2014 when compared to the second quarter of 2013, and also increased 4.5 percent in the first six months of 2014 when compared to the first six months of 2013. The following table summarizes the significant components of the year-over-year change in our net sales per case for the periods presented (rounded to the nearest 0.5 percent and based on wholesale physical case volume): Second Quarter 2014 First Six Months 2014 Changes in net sales per case: Bottle and can net price per case - % 0.5 % Bottle and can currency exchange rate changes 5.5 4.5 Post-mix, non-trade, and other (1.0 ) (0.5 ) Change in net sales per case 4.5 % 4.5 % During the second quarter of 2014, our bottle and can sales accounted for approximately 95 percent of our total net sales. Bottle and can net price per case is based on the invoice price charged to customers reduced by promotional allowances and is impacted by the price charged per package or brand, the volume generated by each package or brand, and the channels in which those packages or brands are sold. To the extent we are able to increase volume in higher-margin packages or brands that are sold through higher-margin channels, our bottle and can net pricing per case will increase without an actual increase in wholesale pricing. Bottle and can net price per case was flat during the second quarter of 2014, reflecting the impact of our planned promotional activities and competitive marketplace dynamics, particularly in Great Britain. Volume The following table summarizes the year-over-year change in our bottle and can volume for the periods presented, as adjusted to reflect the impact of one less selling day in the first six months of 2014 when compared to the first six months of 2013 (selling days are the same in the second quarter of 2014 and 2013; rounded to the nearest 0.5 percent): Second Quarter 2014 First Six Months 2014 Change in volume 3.5 % 0.5 % Impact of selling day shift(A) - 0.5 Change in volume, adjusted for selling day shift 3.5 % 1.0 % ___________________________ (A) Represents the impact of changes in selling dates between periods (based upon a standard five-day selling week). Brands The following table summarizes our bottle and can volume results by major brand category for the periods presented, with the percentage change adjusted to reflect the impact of one less selling day in the first six months of 2014 when compared to the first six months of 2013 (selling days are the same in the second quarter of 2014 and 2013; rounded to the nearest 0.5 percent): Second Quarter First Six Months 2014 Percent 2013 Percent 2014 Percent 2013 Percent Change of Total of Total Change of Total of Total Coca-Cola trademark 4.0 % 68.5 % 68.0 % 1.5 % 69.0 % 69.0 % Sparkling flavors and energy 1.0 18.0 18.5 (0.5 ) 17.5 17.5 Juices, isotonics, and other - 10.0 10.5 0.5 10.5 10.5 Water 10.0 3.5 3.0 7.0 3.0 3.0 Total 3.5 % 100.0 % 100.0 % 1.0 % 100.0 % 100.0 % During the second quarter of 2014, volume increased 3.5 percent when compared to the second quarter of 2013. Our volume performance during the second quarter of 2014 included a 3.5 percent increase in the sale of sparkling beverage brands and a 2.0 percent increase in the sales of still beverage brands. Volume in continental Europe increased 4.0 percent during the quarter, while 22-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. volume in Great Britain increased 2.0 percent. This volume performance reflects implementation of our marketing initiatives across our territories and the strong opportunity provided by the 2014 FIFA World Cup. Our Coca-Cola trademark beverage brand sales increased 4.0 percent in the second quarter of 2014 when compared to the second quarter of 2013. This increase was primarily attributable to a 4.5 percent increase in Coca-Cola Classic sales and the continued success of Coca-Cola Zero which grew 14.5 percent. These increases were partially offset by a decline in the sales of other Coca-Cola flavors, including Cherry Coke Zero and Vanilla Coke. Sparkling flavors and energy volume increased 1.0 percent during the second quarter of 2014, driven by growth in our energy portfolio, including NALU and Relentless, offset partially by declines in sparkling brands Sprite and Dr Pepper. Juices, isotonics, and other volume remained flat in the second quarter of 2014 driven by strong growth in Nestea, offset by declines in our juice and sports drinks brands. Sales volume of our water brands increased 10.0 percent in the second quarter of 2014, primarily reflecting the success of Chaudfontaine in continental Europe. We continue to promote our brands in the marketplace through key marketing initiatives including the relaunch of our "Share a Coke" campaign with expanded personalization and promotions for the 2014 FIFA World Cup. We also remain focused on package and product innovations to create value for our customers and consumers, including the recent introduction of our 1.75 liter contour bottle for Coca-Cola trademark brands in Great Britain and the launch of Finley, an adult sparkling non-alcoholic beverage, in France. In addition to innovation, we are committed to expanding our brand portfolio with offerings that are intended to appeal to a wide variety of consumers. Some examples of these expanded offerings include the launch of Smartwater and Coca-Cola Life, a lower calorie, naturally-sweetened beverage, in Great Britain which are planned for the second half of 2014. Consumption The following table summarizes our volume by consumption type for the periods presented, with the percentage change adjusted to reflect the impact of one less selling day in the first six months of 2014 when compared to the first six months of 2013 (selling days are the same in the second quarter of 2014 and 2013; rounded to the nearest 0.5 percent): Second Quarter First Six Months 2014 Percent 2013 Percent 2014 Percent 2013 Percent Change of Total of Total Change of Total of Total Multi-serve(A) 4.5 % 65.0 % 58.0 % 1.0 % 65.0 % 58.5 % Single-serve(B) 1.5 35.0 42.0 1.0 35.0 41.5 Total 3.5 % 100.0 % 100.0 % 1.0 % 100.0 % 100.0 % ___________________________ (A) Multi-serve packages include containers that are typically greater than one liter, purchased by consumers in multi-packs in take-home channels at ambient temperatures, and are intended for consumption in the future. (B) Single-serve packages include containers that are typically one liter or less, purchased by consumers as a single bottle or can in cold drink channels at chilled temperatures, and are intended for consumption shortly after purchase. Packages The following table summarizes our volume by package type for the periods presented, with the percentage change adjusted to reflect the impact of one less selling day in the first six months of 2014 when compared to the first six months of 2013 (selling days are the same in the second quarter of 2014 and 2013; rounded to the nearest 0.5 percent): Second Quarter First Six Months 2014 Percent 2013 Percent 2014 Percent 2013 Percent Change of Total of Total Change of Total of Total PET (plastic) - % 42.5 % 44.0 % (3.0 )% 42.5 % 44.5 % Cans 7.5 41.5 40.0 5.0 41.5 39.5 Glass and other 2.5 16.0 16.0 2.0 16.0 16.0 Total 3.5 % 100.0 % 100.0 % 1.0 % 100.0 % 100.0 % Cost of Sales Cost of sales totaled $1.5 billion and $2.7 billion during the second quarter and first six months of 2014, respectively, representing an increase of 6.0 percent and 3.5 percent when compared to the second quarter and first six months of 2013, respectively. This change includes a currency exchange rate increase of 5.5 percent and 4.5 percent when compared to the second quarter and first six months of 2013. 23-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. Cost of sales per case increased 2.5 percent and 3.0 percent in the second quarter and first six months of 2014 when compared to the second quarter and first six months of 2013, respectively. The following table summarizes the significant components of the year-over-year change in our cost of sales per case for the periods presented (rounded to the nearest 0.5 percent and based on wholesale physical case volume): Second Quarter 2014 First Six Months 2014 Changes in cost of sales per case: Bottle and can ingredient and packaging costs (1.0 )% (0.5 )% Bottle and can currency exchange rate changes 5.0 4.5 Post mix, non-trade, and other (1.5 ) (1.0 ) Change in cost of sales per case 2.5 % 3.0 % Bottle and can cost of sales per case declined 1.0 percent during the second quarter of 2014, reflecting mix-shifts into lower cost packages, particularly cans, and recent favorable trends in the cost of some of our key commodities, principally sugar. Although the overall cost environment still remains somewhat volatile, the degree of volatility has recently abated. We continue to seek and execute opportunities to mitigate our exposure to price changes through the use of supplier agreements and hedging instruments. Selling, Delivery, and Administrative Expenses Selling, delivery, and administrative (SD&A) expenses increased $70 million, or 14.5 percent, in the second quarter of 2014, and increased $13 million, or 1.5 percent, in the first six months of 2014. These changes include currency exchange rate increases of 5.0 percent and 4.0 percent when compared to the second quarter and first six months of 2013. The following table summarizes the significant components of the year-over-year change in our SD&A expenses for the periods presented (in millions; percentages rounded to the nearest 0.5 percent): Second Quarter 2014 First Six Months 2014 Change Change Percent Percent Amount of Total Amount of Total Changes in SD&A expenses: General and administrative expenses $ 18 3.5 % $ 29 3.0 % Selling and marketing expenses 7 1.5 - - Delivery and merchandising expenses 8 1.5 (3 ) (0.5 ) Warehousing expenses (2 ) (0.5 ) (10 ) (1.0 ) Depreciation and amortization expenses (3 ) (0.5 ) (4 ) (0.5 ) Net mark-to-market gains related to non-designated commodity hedges (3 ) (0.5 ) - - Net impact of restructuring charges 21 4.5 (36 ) (3.5 ) Currency exchange rate changes 25 5.0 39 4.0 Other (1 ) - (2 ) - Change in SD&A expenses $ 70 14.5 % $ 13 1.5 % SD&A expenses as a percentage of net sales was 23.7 percent and 22.3 percent in the second quarter of 2014 and 2013, respectively, and 24.2 percent and 25.0 percent in the first six months of 2014 and 2013, respectively. During the second quarter of 2014, our SD&A expenses reflect the operational expense impact of improved volume performance, a year-over-year increase in restructuring expenses under our Business Transformation Program, and incremental promotional expenses related to the 2014 FIFA World Cup. Business Transformation Program In 2012, we announced a business transformation program designed to improve our operating model and create a platform for driving sustainable future growth. Through this program we intend to: (1) streamline and reduce the cost structure of our finance support function, including the establishment of a new centralized shared services center; (2) restructure our sales and marketing organization to better align central and field sales, and to deploy standardized channel-focused organizations within each of our territories; and (3) improve the efficiency and effectiveness of certain aspects of our operations, including activities related to our cold-drink equipment. We expect to be substantially complete with this program by the end of 2014 and anticipate nonrecurring restructuring charges of 24-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. approximately $240 million, including severance, transition, consulting, accelerated depreciation, and lease termination costs. Approximately $20 million of this amount is expected to be non-cash. During the second quarter and first six months of 2014, we recorded nonrecurring restructuring charges under this program totaling $54 million and $62 million, respectively. During the second quarter and first six months of 2013, we recorded nonrecurring restructuring charges under this program totaling $24 million and $81 million, respectively. Substantially all nonrecurring restructuring charges related to this program are included in selling, delivery, and administrative expenses (SD&A) on our Condensed Consolidated Statements of Income. Interest Expense, Net Interest expense, net increased $6 million in the second quarter of 2014 to $30 million. This is primarily due to the issuance of €350 million notes in November 2013 and €250 million notes in May 2014. The following table summarizes the primary items that impacted our interest expense, net for the periods presented (in millions, except percentages): |