COCA COLA CO (KO)
Quarterly Report (SEC form 10-Q)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Beverage Volume - For both the third quarter of 2001 and the first nine months of 2001, our worldwide unit case volume increased more than 4 percent compared to the same periods in 2000. The increase in unit case volume reflects strong performance in the United States and international markets, particularly Japan, China, Russia, Argentina and Great Britain, partially offset by declines in volume recorded by Germany and Turkey. Third quarter 2001 unit case volume growth for the Company's operating segments was 3 percent for the North America Group; 3 percent for the Latin America Group; 4 percent for the Europe, Eurasia and Middle East Group; 9 percent for the Africa Group; and 8 percent for the Asia Group. Worldwide gallon sales of concentrates and syrups increased slightly in the third quarter and increased 4 percent for the first nine months of 2001, compared to the same periods in 2000.
Net Operating Revenues and Gross Margin -
Net operating revenues of $5,397 million in the third quarter of 2001 and $15,169 million in the first nine months of 2001 were comparable to the net operating revenues recorded for the same periods in 2000. Net operating revenues for the third quarter 2001 reflect a slight increase in gallon shipments, price increases in selected countries and the consolidation of bottling operations in Brazil and the Nordic Region, offset by the negative impact of currencies and the deconsolidation of our previously owned vending operations in Japan and canning operations in Germany.
Our gross profit margin increased to 68.6 percent in the third quarter of 2001 from 67.9 percent in the third quarter of 2000. For the first nine months of 2001, our gross profit margin increased to 69.6 percent from 68.3 percent for the first nine months of 2000. The increase in our gross profit margin for both the third quarter and the first nine months of 2001 was due primarily to the deconsolidation in 2001 of our Japan vending and German canning operations, partially offset by the consolidation in 2001 of the Nordic and Brazilian bottling operations. In addition, the increase in the gross profit margin for the first nine months of 2001 was impacted by the reduction of concentrate inventory levels by certain bottlers within the Coca-Cola system in 2000.
RESULTS OF OPERATIONS (Continued)
Selling, Administrative and General Expenses
Selling, administrative and general expenses were approximately $2,394 million in the third quarter of 2001, compared to $2,256 million in the third quarter of 2000. The increase for the third quarter is due to incremental marketing expenses in 2001 as discussed below, the consolidation in 2001 of the Nordic and Brazilian bottling operations, partially offset by the sale in 2001 of our Japan vending and German canning operations and the impact of the stronger U.S. dollar. For the first nine months of 2001, selling, administrative and general expenses were $6,449 million compared to $6,528 million for the same period in 2000. The decrease during the first nine months of 2001 was due primarily to the combination of savings in expenses achieved from the Realignment completed during 2000, the impact of a stronger U.S. dollar and the deconsolidation in 2001 of our Japan vending and German canning operations, partially offset by the consolidation in 2001 of the Nordic and Brazilian bottling operations and incremental marketing expenses in 2001 as discussed below.
During the first quarter of 2001, the Company announced plans to implement significant strategic one-time marketing initiatives in order to accelerate the Company's business strategies. During calendar year 2001, the Company expects to invest approximately $300 million of incremental marketing, or approximately $0.08 per share after tax, in selected key markets, specifically the United States, Japan and Germany. During the third quarter of 2001, approximately $94 million, or $0.03 per share after tax, was expensed on these incremental marketing activities; in the second quarter of 2001, approximately $82 million, or $0.02 per share after tax, was expensed.
Other Operating Charges - In the third quarter of 2000, we recorded total nonrecurring charges of approximately $94 million related to costs associated with the Company's Realignment. For the first nine months of 2000, we recorded total charges of $965 million. Of this $965 million, approximately $405 million related to the impairment of certain bottling, manufacturing and intangible assets, and approximately $560 million related to the Realignment.
RESULTS OF OPERATIONS (Continued)
Other Operating Charges (Continued) In the first quarter of 2000, we recorded charges of approximately $405 million related to the impairment of certain bottling, manufacturing and intangible assets, primarily within our Indian bottling operations. These impairment charges were recorded to reduce the carrying value of the identified assets to fair value. Fair value was derived using cash flow analysis. The assumptions used in the cash flow analysis were consistent with those used in our internal planning process. The assumptions included estimates of future growth in unit cases, estimates of gross margins, estimates of the impact of exchange rates and estimates of tax rates and tax incentives. The charge was primarily the result of our revised outlook for the Indian beverage market including the future expected tax environment. The remaining carrying value of long-lived assets within our Indian bottling operations, immediately after recording the impairment charge, was approximately $300 million.
In the third quarter of 2000, the Company incurred total pretax Realignment expenses of approximately $94 million, or $0.03 per share after tax. Under the Realignment, which was completed during the year ended December 31, 2000, approximately 5,200 employees were separated from almost all functional areas of the Company's operations, and certain activities were outsourced to third parties. Employees separated from the Company as a result of the Realignment were offered severance or early retirement packages, as appropriate, which included both financial and non-financial components. The Realignment expenses included costs associated with involuntary terminations, voluntary retirements and other direct costs associated with implementing the Realignment. Other direct costs included repatriating and relocating employees to local markets; asset write-downs; lease cancellation costs; and costs associated with the development, communication and administration of the Realignment.
RESULTS OF OPERATIONS (Continued)
Operating Income and Operating Margin -
Operating income was $1,311 million in the third quarter of 2001, compared to $1,327 million in the third quarter of 2000. Our consolidated operating margin for the third quarter of 2001 was 24.3 percent, comparable to 24.5 percent for the same period in 2000. Operating income for the third quarter of 2001 decreased compared to the third quarter of 2000 due primarily to the increase in selling, administrative and general expenses as previously discussed, offset by the recording in the third quarter of 2000 of approximately $94 million in charges as previously discussed under the heading, "Other Operating Charges." Operating income and operating margin for the nine months ended September 30, 2001 were $4,104 million and 27.1 percent, respectively, compared to $2,852 million and 18.8 percent for the nine months ended September 30, 2000. The increases in operating income and operating margin for the first nine months of 2001 reflect the recording of approximately $965 million in charges in 2000 as previously discussed under the heading, "Other Operating Charges," the effect of the planned reduction of concentrate inventory by certain bottlers within the Coca-Cola system in 2000, and the decrease in selling, administrative and general expenses in 2001 as previously discussed. Operating income and operating margin for the third quarter of 2001 and for the first nine months of 2001 were also negatively impacted by a stronger U.S. dollar.
Interest Income and Interest Expense Interest income decreased to $68 million for the third quarter of 2001 and to $227 million year to date at September 30, 2001, from $92 million and $257 million, respectively, for the comparable periods in 2000, due primarily to lower interest rates. Interest expense decreased 45 percent to $66 million in the third quarter of 2001 relative to the comparable period in 2000, and by approximately 31 percent to $234 million year to date at September 30, 2001, due to both a decrease in average commercial paper debt balances and lower interest rates. Interest income exceeded interest expense for the third quarter of 2001. Interest income benefited from cash invested in locations outside the United States earning higher rates of interest than can be obtained within the United States. Our interest expense is primarily incurred on borrowings within the United States.
RESULTS OF OPERATIONS (Continued)
Equity Income - Our Company's share of income from equity method investments for the third quarter of 2001 totaled $104 million, compared to $63 million in the third quarter of 2000. For the first nine months of 2001, our Company's share of income from equity method investments totaled $167 million, compared to equity income of $49 million for the comparable period in 2000. The increase in our Company's share of income from equity method investments was due primarily to the continued improvement in operating performance by the majority of our equity investees.
Other Income - Net Other income - net decreased to $26 million income for the third quarter of 2001, compared to $121 million income for the third quarter of 2000. Other income - net decreased to $23 million income for the first nine months of 2001 compared to $102 million income for the comparable period in 2000. The reductions in other income - net in both periods were due primarily to the Company recognizing a tax free noncash gain of $118 million in the third quarter of 2000 from the merger of Coca-Cola Beverages plc and Hellenic Bottling Company
S.A.
Issuances of Stock by Equity Investee - In July 2001, CCE completed its acquisition of Herb Coca-Cola. The transaction was valued at approximately $1.4 billion, with approximately 30 percent of the transaction funded with the issuance of approximately 25 million shares of CCE common stock, and the remaining portion funded through debt and assumed debt. The issuance of shares resulted in a one-time noncash pretax gain for our Company of approximately $91 million. We provided deferred taxes of approximately $36 million on this gain. This transaction resulted in our Company's 40 percent ownership interest in CCE being diluted to 38 percent.
RESULTS OF OPERATIONS (Continued)
Income Taxes Our effective tax rate was 30 percent for the third quarter of 2001 compared to 28.1 percent for the third quarter of 2000. The increase in our effective tax rate for the third quarter of 2001 compared with the third quarter of 2000 was due primarily to the recognition in the third quarter of 2000 of a tax free gain of approximately $118 million upon the merger of Coca-Cola Beverages plc and Hellenic Bottling Company S.A., partially offset by the noncash gain recorded in the third quarter of 2001 related to CCE's acquisition of Herb Coca-Cola. The effective tax rate was 30 percent for the first nine months of 2001 compared to 33.8 percent for the first nine months of 2000. The decrease in our effective tax rate for the first nine months of 2001 compared with the first nine months of 2000 was due primarily to the first quarter of 2000 including other operating charges of approximately $405 million related to asset impairments for which no tax benefit was recognized. Excluding the impact of these impairment charges, the effective tax rate on operations for the first nine months of 2000 was 30.8 percent. Our effective tax rate of 30 percent for the three and nine months ended September 30, 2001, reflects tax benefits derived from significant operations outside the United States, which are taxed at rates lower than the U.S. statutory rate of 35 percent.
Recent Developments - In February 2001, our Company and The Procter & Gamble Company announced plans to create a stand-alone enterprise to develop and market juices and salted snacks. In September 2001, the two companies announced that they will independently pursue opportunities to grow their respective businesses, instead of pursuing a joint business as previously announced.
RESULTS OF OPERATIONS (Continued)
Recent Developments (Continued) -
The Company has concluded negotiations regarding the terms of a proposed Control and Profit and Loss (CPL) agreement with certain other shareholders of Coca-Cola Erfrischungsgetraenke AG (CCEAG), a bottler in Germany in which the Company owns approximately a 41 percent ownership interest. Under the terms of the proposed CPL agreement, the Company would obtain management control of CCEAG for a period of up to five years, commencing January 1, 2002. In return for the management control of CCEAG, the Company would guarantee minimum annual dividend payments by CCEAG (or the equivalent) to all other CCEAG shareholders. Additionally, all CCEAG shareholders have agreed to enter into either a put or a put/call option agreement with the Company, exercisable at the end of the term of the CPL agreement at previously agreed prices. The CPL agreement and other related proposed agreements are subject to final execution of definitive agreements and are further subject to CCEAG shareholder, supervisory board and European Union regulatory approval. If the CPL agreement and the related agreements are executed and receive the requisite approvals, the transfer of management control of CCEAG would require the Company to consolidate CCEAG in its financial statements beginning January 1, 2002. The consolidation of CCEAG effective Janaury 1, 2002 would be expected to increase the Company's assets and decrease the Company's 2002 gross margin and operating margin, but would not be expected to have a material effect on the Company's 2002 operating income, net income or earnings per share.
FINANCIAL CONDITION
Net Cash Provided by Operations After Reinvestment In the first nine months of 2001, net cash provided by operations after reinvestment totaled $2,213 million compared to $1,643 million for the comparable period in 2000.
Net cash provided by operating activities in the first nine months of 2001 amounted to $3,053 million, a $474 million increase compared to the first nine months of 2000. The increase was due primarily to the first nine months of 2000 being unfavorably impacted by the previously mentioned planned inventory reduction by certain bottlers, cash payments made to separated employees under the Realignment, as well as additional Japanese tax payments made pursuant to the terms of an Advance Pricing Agreement (APA) entered into by the United States and Japan taxing authorities, referred to in Note 14 to the Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000.
Net cash used in investing activities totaled $840 million for the first nine months of 2001, compared to $936 million for the first nine months of 2000. The decrease was due primarily to (i) a reduction in purchases of property, plant and equipment; (ii) proceeds received from the sale of our vending operations in Japan; offset by (iii) the consolidation of the Nordic bottling operations and other investing activities.
Financing Activities Our financing activities include net borrowings, dividend payments and share issuances and repurchases. Net cash used in financing activities totaled $1,526 million for the first nine months of 2001, compared to $223 million for the first nine months of 2000. Our Company reduced its cash borrowings by $565 million in the first nine months of 2001 compared to a net increase in cash borrowings of $505 million for the comparable period in 2000. In 2000, the Company increased its borrowings due to the impact on cash from the reduction of concentrate inventory by certain bottlers, costs associated with the Realignment and the satisfaction of tax obligations pursuant to the terms of the APA.
Cash used to purchase common stock for treasury was $219 million for the first nine months of 2001, compared to $130 million for the first nine months of 2000. The Company repurchased approximately 4,050,000 shares of common stock during the first nine months of 2001 at an average cost of $48.76 per share. During the first nine months of 2000, our Company did not repurchase any common stock under the stock repurchase plan. Treasury stock repurchases in 2000 were due primarily to the repurchase of shares from employees pursuant to the provisions of the Company's Stock Option and Restricted Stock Award Plans.
FINANCIAL CONDITION (Continued)
Financial Position The increase in current prepaid expenses and other assets during the first nine months of 2001 was due primarily to the change in the carrying value of derivatives and hedging instruments as reported under SFAS No. 133 and an increase in prepaid marketing.
Total current and non-current debt decreased by $371 million during the first nine months of 2001. The increase in non-current debt was due primarily to the Company's issuance in March 2001 of $500 million in 10-year global notes. This amount, together with cash generated from operations, was used to reduce current debt.
Euro Conversion - In January 1999, certain member countries of the European Union established irrevocable, fixed conversion rates between their existing currencies and the European Union's common currency (the Euro).
The introduction of the Euro is scheduled to be phased in over a period ending January 1, 2002, when Euro notes and coins will come into circulation. The existing currencies are due to be completely removed from circulation on February 28, 2002. Our Company has been preparing for the introduction of the Euro for several years. The timing of our phasing out all uses of the existing currencies will comply with the legal requirements and also be scheduled to facilitate optimal coordination with the plans of our vendors, distributors and customers. Our work related to the introduction of the Euro and the phasing out of the other currencies includes converting information technology systems; recalculating currency risk; recalibrating derivatives and other financial instruments; evaluating and taking action, if needed, regarding the continuity of contracts; and modifying our processes for preparing tax, accounting, payroll and customer records.
Based on our work to date, we believe the Euro replacing the other currencies will not have a material impact on our operations or our Consolidated Financial Statements.
FINANCIAL CONDITION (Continued)
Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and government actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments and to fluctuations in foreign currencies.
Due to our global operations, we use approximately 65 functional currencies. Weaknesses in some of these currencies are often offset by strengths in others. In the third quarter of 2001, the U.S. dollar was approximately 9 percent stronger as a weighted average of all of our functional currencies, compared to the third quarter of 2000. This does not include the effects of our hedging activities and, therefore, does not reflect the actual impact of fluctuations in exchange rates on our operating results. Our foreign currency management program mitigates over time a portion of the impact of exchange on net income and earnings per share. The amount of foreign currency exposure we hedge at any point in time varies based on our hedging strategy and market conditions. The impact of a stronger U.S. dollar reduced our operating income by approximately 3 percent for the third quarter 2001, and by approximately 5 percent for the first nine months of 2001, led by movements in the Euro and the Brazilian Real.
The Company will continue to manage its foreign currency exposures to mitigate over time a portion of the impact of exchange on net income and earnings per share. Our Company conducts business in nearly 200 countries around the world, and we manage foreign currency exposures through the portfolio effect of the basket of functional currencies in which we do business.
FORWARD-LOOKING STATEMENTS
Certain written and oral statements made by our Company and subsidiaries or with the approval of an authorized executive officer of our Company may constitute "forward-looking statements" as defined under the Private Securities Litigation Reform Act of 1995, including statements made in this report and other filings with the Securities and Exchange Commission. Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "project," "will" and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future including statements relating to volume growth, share of sales and earnings per share growth and statements expressing general optimism about future operating results are forward-looking statements. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our Company's historical experience and our present expectations or projections. As and when made, management believes that these forward-looking statements are reasonable. However, caution should be taken not to place undue reliance on any such forward-looking statements since such statements speak only as of the date when made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following are some of the factors that could cause our Company's actual results to differ materially from the expected results described in or underlying our Company's forward-looking statements:
- Our ability to generate sufficient cash flows to support capital expansion plans, share repurchase programs and general operating activities.
- Changes in the nonalcoholic beverages business environment. These include, without limitation, competitive product and pricing pressures and our ability to gain or maintain share of sales in the global market as a result of actions by competitors. While we believe our opportunities for sustained, profitable growth are considerable, factors such as these could impact our earnings, share of sales and volume growth.
- Changes in laws and regulations, including changes in accounting standards, taxation requirements (including tax rate changes, new tax laws and revised tax law interpretations) and environmental laws in domestic or foreign jurisdictions.
- Fluctuations in the cost and availability of raw materials and the ability to maintain favorable supplier arrangements and relationships.
FORWARD-LOOKING STATEMENTS (Continued)
- Our ability to achieve earnings forecasts, which are generated based on projected volumes and sales of many product types, some of which are more profitable than others. There can be no assurance that we will achieve the projected level or mix of product sales.
- Interest rate fluctuations and other capital market conditions, including foreign currency rate fluctuations. Most of our exposures to capital markets, including interest and foreign currency, are managed on a consolidated basis, which allows us to net certain exposures and, thus, take advantage of any natural offsets. We use derivative financial instruments to reduce our net exposure to financial risks. There can be no assurance, however, that our financial risk management program will be successful in reducing foreign currency exposures.
- Economic and political conditions, especially in international markets, including civil unrest, governmental changes and restrictions on the ability to transfer capital across borders.
- Our ability to penetrate developing and emerging markets, which also depends on economic and political conditions, and how well we are able to acquire or form strategic business alliances with local bottlers and make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Moreover, the supply of products in developing markets must match the customers' demand for those products, and due to product price and cultural differences, there can be no assurance of product acceptance in any particular market.
- The effectiveness of our advertising, marketing and promotional programs.
- The uncertainties of litigation, as well as other risks and uncertainties detailed from time to time in our Company's Securities and Exchange Commission filings.
- Adverse weather conditions, which could reduce demand for Company products.
The foregoing list of important factors is not exclusive.
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