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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 third quarter and first nine 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 third quarter of 2014 was $238 million, or $0.96 per diluted share, compared to net income of $289 million, or $1.07 per diluted share, in the third quarter of 2013. The following items included in our reported results affect the comparability of our year-over-year financial performance (the items listed below are based on defined terms and thresholds and represent all material items management considered for year-over-year comparability): Third Quarter 2014 • Restructuring charges totaling $1 million ($1 million net of tax) related to our Business Transformation Program; • Net mark-to-market gains 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 relate to a different reporting period; and • Net tax items totaling $6 million ($0.02 per diluted share) principally related to the tax impact of both changes in underlying rates and cumulative nonrecurring items on the quarter. Third Quarter 2013 • Restructuring charges totaling $7 million ($4 million net of tax, or $0.01 per diluted share) related to our Business Transformation Program and Norway Business Optimization; • Net mark-to-market gains totaling $1 million ($1 million net of tax) related to non-designated commodity hedges associated with underlying transactions that relate to a different reporting period; and 20-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC.• A deferred tax benefit of $71 million ($0.26 per diluted share) due to the enactment of a United Kingdom tax rate change that reduced the corporate income tax rate by 3 percentage points of which 2 percentage points were effective April 1, 2014 and 1 percentage point will be effective April 1, 2015. Financial Summary Our financial performance during the third quarter of 2014 reflects the impact of the following significant factors: • Year-over-year volume decrease of 4.0 percent driven by sustained macroeconomic softness, a difficult retail environment, poor weather early in the quarter, and strong prior year volume comparisons; • Flat year-over-year bottle and can net price per case reflecting the impact of planned promotional activity and challenging operating conditions; • 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 the impact of favorable cost trends in certain key commodities; and • Lower underlying operating expenses resulting from reduced volume, strong expense control, and the realized savings associated with our Business Transformation Program. Our operating and financial performance during the third quarter of 2014 was impacted by challenging marketplace conditions, including persistent macroeconomic softness, a difficult retail environment, and poor weather early in the quarter, particularly in France. Third quarter volume declined 4.0 percent year-over-year driven by declines in both sparkling and still beverage brands. Our bottle and can net price per case was flat versus prior year reflecting planned promotional activities and mix-shifts to lower priced packages. During the third quarter of 2014, volume declined 5.0 percent in our continental European territories and 2.5 percent in Great Britain. This volume performance was primarily driven by declines in Coca-Cola trademark and other sparkling beverage brands versus strong prior year volume comparisons. Despite these decreases, we continued to see overall growth in Coca-Cola Zero and energy drinks. During the third quarter of 2014, we continued our brand and product initiatives with the Share a Coke promotion as well as the launch of two new products, Coca-Cola Life in Great Britain and Sweden, and smartwater in Great Britain. Furthermore, Finley, an adult sparkling non-alcoholic beverage introduced in France earlier this year and recently expanded into Belgium, continues to receive a positive consumer response. We remain committed to expanding our offerings through further portfolio innovation to create value for our customers and consumers. Bottle and can cost of sales per case declined 1.0 percent during the third quarter of 2014, reflecting mix-shifts into lower cost packages, and benefits from favorable cost trends in some of our key commodities, principally sugar. Despite these recent favorable trends, the cost environment remains volatile. As such, we continue to seek opportunities to mitigate our exposure to commodity price volatility through the use of supplier agreements and hedging instruments. Our underlying operating expenses declined during the third quarter of 2014 as a result of lower volume levels, strong operating expense controls, and the realization of cost savings associated with efforts under our Business Transformation Program as we approach its completion. Our diluted earnings per share benefited from operating income growth and the impact of share repurchase activity, which increased diluted earnings per share in the third quarter of 2014 by approximately $0.07. During 2014, we repurchased approximately $800 million of our shares under our share repurchase program. 21-------------------------------------------------------------------------------- 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: Third Quarter First Nine Months 2014 2013 2014 2013 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 62.2 63.8 63.7 64.8 Gross profit 37.8 36.2 36.3 35.2Selling, delivery, and administrative expenses 21.6 21.8 23.3 23.9 Operating income 16.2 14.4 13.0 11.3 Interest expense, net 1.5 1.1 1.4 1.3 Other nonoperating income (expense) - - - - Income before income taxes 14.7 13.3 11.6 10.0 Income tax expense (A) 3.6 - 2.9 1.4 Net income 11.1 % 13.3 % 8.7 % 8.6 % ___________________________(A) During the third quarter and first nine months of 2013, income tax expense reflects the enactment of the United Kingdom corporate income tax rate reduction. 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): Third Quarter First Nine Months 2014 2013 2014 2013 Percent Percent Percent Percent Amount of Total Amount of Total Amount of Total Amount of Total Europe $ 366 106.0 % $ 350 111.5 % $ 911 110.5 % $ 804 115.5 % Corporate (21 ) (6.0 ) (36 ) (11.5 ) (87 ) (10.5 ) (107 ) (15.5 ) Consolidated $ 345 100.0 % $ 314 100.0 % $ 824 100.0 % $ 697 100.0 % During the third quarter and first nine months of 2014, we generated operating income of $345 million and $824 million, respectively, compared to $314 million and $697 million in the same periods of 2013. 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): Third Quarter 2014 First Nine 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 ) (0.5 )% $ 13 2.0 % Impact of bottle and can cost-mix on gross profit 12 4.0 25 3.5 Impact of bottle and can volume on gross profit (31 ) (10.0 ) (14 ) (2.0 ) Impact of bottle and can selling day shift on gross profit - - (9 ) (1.5 ) Impact of post-mix, non-trade, and other on gross profit 3 1.0 - - Net mark-to-market gains related to non-designated commodity hedges 7 2.5 21 3.0 Net impact of restructuring charges 6 2.0 46 6.5 Other selling, delivery, and administrative expenses 13 4.0 3 0.5 Currency exchange rate changes 10 3.0 41 6.0 Other changes 13 4.0 1 - Change in operating income $ 31 10.0 % $ 127 18.0 % 22-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. Net Sales Net sales decreased 1.5 percent in the third quarter of 2014 to $2.1 billion, and increased 2.5 percent in the first nine months of 2014 to $6.3 billion. These changes include currency exchange rate increases of 2.0 percent and 4.0 percent when compared to the third quarter and first nine months of 2013, respectively. Net sales per case increased 2.5 percent in the third quarter of 2014 when compared to the third quarter of 2013, and also increased 3.5 percent in the first nine months of 2014 when compared to the first nine 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): First Nine Months Third Quarter 2014 2014 Changes in net sales per case: Bottle and can net price per case - % - % Bottle and can currency exchange rate changes 2.0 4.0 Post-mix, non-trade, and other 0.5 (0.5 ) Change in net sales per case 2.5 % 3.5 % During the third quarter of 2014, our bottle and can sales accounted for approximately 94 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. Our bottle and can net price per case was flat versus prior year as a result of planned promotional activities and negative mix-shifts to lower priced packages. 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 nine months of 2014 when compared to the first nine months of 2013 (selling days are the same in the third quarter of 2014 and 2013; rounded to the nearest 0.5 percent): First Nine Months Third Quarter 2014 2014 Change in volume (4.0 )% (1.0 )% Impact of selling day shift(A) - 0.5 Change in volume, adjusted for selling day shift (4.0 )% (0.5 )% ___________________________ (A) Represents the impact of changes in selling days 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 nine months of 2014 when compared to the first nine months of 2013 (selling days are the same in the third quarter of 2014 and 2013; rounded to the nearest 0.5 percent): Third Quarter First Nine Months 2014 Percent 2013 Percent 2014 Percent 2013 Percent Change of Total of Total Change of Total of Total Coca-Cola trademark (3.5 )% 67.5 % 67.0 % - % 68.5 % 68.0 % Sparkling flavors and energy (6.5 ) 18.0 18.5 (2.5 ) 17.5 18.0 Juices, isotonics, and other (4.5 ) 11.0 11.0 (1.0 ) 10.5 10.5 Water (2.5 ) 3.5 3.5 3.5 3.5 3.5 Total (4.0 )% 100.0 % 100.0 % (0.5 )% 100.0 % 100.0 % During the third quarter of 2014, volume declined 4.0 percent when compared to the third quarter of 2013. This decline reflects the impact of persistent macroeconomic softness, a difficult retail environment, strong prior year volume comparisons, and poor weather early in the quarter, particularly in France. Our volume performance during the third quarter of 2014 included a 4.0 percent decrease in the sale of both our sparkling and still beverage brands. Volume in continental Europe decreased 5.0 percent during 23-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. the quarter, primarily driven by France. Great Britain experienced an overall volume decrease of 2.5 percent, driven by declines in both our sparkling and still beverage brands. In the third quarter of 2014, our Coca-Cola trademark beverage brand sales decreased 3.5 percent when compared to strong volume performance in the prior year. This decline was primarily attributable to a 4.0 percent decrease in Coca-Cola Classic sales and 9.0 percent decrease in Diet Coke/Coca-Cola light, offset by Coca-Cola Zero growth of 2.0 percent. Our sparkling flavors and energy category volume decreased 6.5 percent during the third quarter of 2014, driven by declines in sparkling brands, including Sprite and Fanta, offset partially by increases in our energy portfolio. Juices, isotonics, and other volume declined 4.5 percent in the third quarter of 2014 driven by declines in our juice and sports drinks brands, offset partially by growth in Nestea. Sales volume of our water brands decreased 2.5 percent in the third quarter of 2014, reflecting declines in Chaudfontaine in continental Europe and Schweppes Abbey Well in Great Britain. During the third quarter of 2014, we continued our brand and product initiatives with the Share a Coke promotion as well as the launch of two new products, Coca-Cola Life in Great Britain and Sweden, and smartwater in Great Britain. Furthermore, Finley, an adult sparkling non-alcoholic beverage introduced in France earlier this year and recently expanded into Belgium, continues to receive a positive consumer response. We remain committed to expanding our offerings through further portfolio innovation to create value for our customers and consumers. 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 nine months of 2014 when compared to the first nine months of 2013 (selling days are the same in the third quarter of 2014 and 2013; rounded to the nearest 0.5 percent): Third Quarter First Nine Months 2014 Percent 2013 Percent 2014 Percent 2013 Percent Change of Total of Total Change of Total of Total Multi-serve(A) (4.5 )% 63.0 % 57.0 % (1.0 )% 64.0 % 58.0 % Single-serve(B) (3.0 ) 37.0 43.0 - 36.0 42.0 Total (4.0 )% 100.0 % 100.0 % (0.5 )% 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 nine months of 2014 when compared to the first nine months of 2013 (selling days are the same in the third quarter of 2014 and 2013; rounded to the nearest 0.5 percent): Third Quarter First Nine Months 2014 Percent 2013 Percent 2014 Percent 2013 Percent Change of Total of Total Change of Total of Total PET (plastic) (3.5 )% 43.5 % 43.0 % (3.5 )% 43.0 % 44.0 % Cans (5.0 ) 40.5 41.0 1.5 41.0 40.0 Glass and other (2.0 ) 16.0 16.0 1.0 16.0 16.0 Total (4.0 )% 100.0 % 100.0 % (0.5 )% 100.0 % 100.0 % Cost of Sales Cost of sales totaled $1.3 billion and $4.0 billion during the third quarter and first nine months of 2014, respectively, representing a decrease of 4.5 percent and an increase of 0.5 percent when compared to the third quarter and first nine months of 2013, respectively. These changes include a currency exchange rate increase of 1.5 percent and 3.5 percent when compared to the third quarter and first nine months of 2013, respectively. 24-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. Cost of sales per case decreased 0.5 percent and increased 2.0 percent in the third quarter and first nine months of 2014 when compared to the third quarter and first nine 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): First Nine Months Third Quarter 2014 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 1.5 3.5 Post mix, non-trade, and other (1.0 ) (1.0 ) Change in cost of sales per case (0.5 )% 2.0 % Bottle and can cost of sales per case declined 1.0 percent during the third quarter of 2014, reflecting mix-shifts into lower cost packages and benefits from favorable cost trends in some of our key commodities, principally sugar. Despite these recent favorable trends, the cost environment remains volatile. As such, we continue to seek opportunities to mitigate our exposure to commodity price volatility through the use of supplier agreements and hedging instruments. Selling, Delivery, and Administrative Expenses Selling, delivery, and administrative (SD&A) expenses decreased $10 million, or 2.0 percent, in the third quarter of 2014, and increased $3 million, in the first nine months of 2014. These changes include currency exchange rate increases of 2.0 percent and 3.5 percent when compared to the third quarter and first nine months of 2013, respectively. 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): Third Quarter 2014 First Nine Months 2014 Change Change Percent Percent Amount of Total Amount of Total Changes in SD&A expenses: General and administrative expenses $ (4 ) (1.0 )% $ 25 1.5 % Selling and marketing expenses (7 ) (1.5 ) (6 ) (0.5 ) Delivery and merchandising expenses (2 ) (0.5 ) (4 ) - Warehousing expenses (2 ) (0.5 ) (12 ) (1.0 ) Depreciation and amortization expenses (1 ) - (5 ) (0.5 ) Net mark-to-market gains related to non-designated commodity hedges 1 - 1 - Net impact of restructuring charges (6 ) (1.0 ) (42 ) (3.0 ) Currency exchange rate changes 8 2.0 47 3.5 Other 3 0.5 (1 ) - Change in SD&A expenses $ (10 ) (2.0 )% $ 3 - % SD&A expenses as a percentage of net sales was 21.6 percent and 21.8 percent in the third quarter of 2014 and 2013, respectively, and 23.3 percent and 23.9 percent in the first nine months of 2014 and 2013, respectively. Our underlying operating expenses declined during the third quarter of 2014 as a result of lower volume levels, strong expense control, and the realization of cost savings associated with efforts under our Business Transformation Program as we approach its completion. 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 approximately $240 million, including severance, transition, consulting, accelerated depreciation, and lease termination costs. 25-------------------------------------------------------------------------------- Table of Contents COCA-COLA ENTERPRISES, INC. Approximately $20 million of this amount is expected to be non-cash. During the third quarter and first nine months of 2014, we recorded nonrecurring restructuring charges under this program totaling $1 million and $63 million, respectively. During the third quarter and first nine months of 2013, we recorded nonrecurring restructuring charges under this program totaling $6 million and $87 million, respectively. To date, we have recorded nonrecurring restructuring charges totaling $208 million under this program. 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 $5 million in the third quarter of 2014 to $31 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): |