可口可樂 (KO) 2003 Q2 法說會逐字稿

Good morning. At this time I would like to welcome everyone to the Coca-Cola Company conference call. At the request of Coca-Cola, the conference is being recorded. All participants will be able to listen only until the formal answer and question portion of the call. If you like to question during this time, simply press star one on your touch-tone phone. If you are on a speaker phone, you may need to lift up the telephone hand set. To withdraw your question, press star two. Participants will be announced by their name and company in the order they are received. I would like to remind everyone that the purpose of this conference call is to talk with investors and therefore e questions from the media will not be addressed in this forum. Media participants should contact Coca-Cola media relations department if they have additional questions.

I would like now to introduce Mr. Larry Mark, assistant Vice-President and Director of Investor Relations, who will begin the conference. Mr. Mark, you may begin.

Thank you. Good morning everyone. Thanks for joining us. This morning I'm pleased to be joined by Steven Heyer, our President and Chief Operating Officer and Gary Fayard our Chief Financial Officer. In addition, our senior operating officers, Sandy Allan, Jeffery Dunn, Mary Minnick and Jose Reyes are present and will be available for a Q&A session. Alex Cummings is not able to join us today as he is attending a meeting in Africa. Our prepared comments will provide a high level overview of our performance in the quarter. We intend to leave plenty of time for your Q&A at which time we ask you to be considerate of others and try to limit yourself to one question during your turn. If you want additional questions, please jump back into the queue.

Before we get started, I would like to remind everybody that this conference call may contain forward-looking statements including statements concerning our long term volume and earnings objectives and should be considered in conjunction with cautionary statements that are contained in our earnings release and in exhibit 99.1 of the company's most recent 10-K. In addition, I would like to call to your attention the fact that we have posted a schedule on our company's website at Coca-Cola.com in the investor section with reconciled results reported under U.S. GAAP to certain non-GAAP measures which we may refer to or which our senior executives may use in discussing our results from time to time. With that said, please look at the website for that information and call us if you have questions.

Let me turn this over to Steve.

Thanks a lot, Larry, and thanks to all of you for joining us this morning.

Let me start by covering a few highlights from the quarter. During the second quarter we delivered strong financial results and strong cash flows. We grew our volumes 5% and we picked up momentum as compared to the first quarter, and we continued to increase our share position in key beverage categories around world such as Mexico, China, Great Britain, Spain, India, France, Australia, and Russia. Reported earnings per share per quarter were 55 cent which included a charge of 2 cents relating to streamlining initiatives. For the purpose of comparison with last year, if you excluded this charge, the earnings would be 57 cents versus 49 cents for the prior year, an increase of 16%. Gary will talk about the specifics of our financial performance in a few moments. But in summary, our financial performance reflects 8% underlying operating profit growth, improvement in our equity income, and currency benefits for the first time in many years, and a lower effective tax rate, all leading the strong earnings per share growth.

When we spoke in April, I made it clear that while our results for the first quarter were adequate, we were not satisfied. In the current quarter, we have seen improvements with stronger operating income growth and better leverage of our expenses. We delivered solid underlying operating income growth despite only 1% growth in gallon shipments and product recall costs in Japan. Overall, I'm pleased with the direction that we are headed as we managed our entire portfolio of countries per grow share in profitable categories, improved system profits, and most importantly to deliver earnings growth. But there is still more to do given the opportunities for profitable growth that we see for our business.

Now, as you know, our operating model balances volume and profit across solid brands, packages and channels on a country by country basis. We have made meaningful progress on several cost savings and supply chain initiatives that will continue to free up resources into the future. While still there are a number of economic challenges in front of us, I'm confident we have the strategies and capabilities to continue growing faster than the industry average and to deliver solid financial results. Said another way, we are doing the right things, and we are confident in our ability to execute our strategy.

In the next few minutes, I will try to anticipate some of your questions and give you a sense of how we are doing in our key markets around the world. Let me start with Europe. We are obviously very pleased with Europe in all respects. We achieved growth in all of our key countries driven by strong CSD growth particularly in our most profitable immediate consumption packages and in high profit markets. CSDs grew over 5%. A big benefit coming from innovation in the most profitable brands and packages, especially Coke Light with Lemon, Vanilla Coke, Sprite Ice Cube, and Fanta Berry. The Great Britain trademark Coke grew 9% for the quarter reflecting the successful launch of Vanilla Coke and the continued success of Diet Coke with Lemon. In France our growth came from our most profitable core brands with trademark Coke up 6%, Sprite up 15% and Fanta up 20%. In Spain, volume was up 8% with trademark Coke up over 4%. Our profitable immediate consumption 200 ml refillable package was a key contributor to that growth. In the central Europe and middle east group, volume gains were driven by course CSDs up 6% and immediate consumption packages up 10%, both of which enhanced profitability. Now I know you are interested in Germany so I will spend a little time describing where we are in the business. In Germany, our business has improved considerably with volumes flat in the second quarter versus a 10% decline in Q1. We have adapted quickly to provide the market with refillable packages which is what customers and consumers want and which we are very well positioned to supply. Even though there is some uncertainty as we approach the October 1 deadline for a central clearing system in Germany, we expect to see positive trends in the back half of the year reflecting the successful execution of our strategies. With regard to Europe as a whole, we expect to continue to deliver strong volume and profit growth by focusing on profitable brands and packages, improved concentrate pricing and effective cost management. As I know you can appreciate, we are also praying for a very hot summer and an even weaker dollar. So that's Europe. It was a very strong quarter.

North America. Our North America results reflect very solid relative performance when you look at the industry as a whole which has been affected by poor weather and weak consumer retail traffic. We grew our volume 3% in the quarter with our retail going up 5% and food service division down slightly. Excluding the water acquisitions, our volume was flat in the quarter reflecting 1% growth in bottle delivered products offset by negative trends in our warehouse delivered juice business. Although the overall beverage category has been softer than we planned, we have increased our share of shares by .7 share points on a year-to-year basis, and our system remains committed to getting innovative products and packages into the market to achieve price realization.

First let me talk about CSDs. Trademark Coca-Cola continued to pick up share in the cola category with positive year-to-date growth driven by Vanilla Coke, Diet Vanilla Coke, Fridge Pack, and strong growth from Diet Coke. I'm sure you want to hear about Vanilla Coke. Vanilla Coke continues to be a great success. We just completed a 52 week analysis which indicates that more households tried Vanilla Coke than any other new CSD brand. The brand continues to attract new consumers adding approximately half a million new buyers in each of the four recent months. After trying it, consumers are continuing to buy it. With 90% of Vanilla Coke volume in the latest period coming from repeat customers. Research on Diet Vanilla Coke indicates that this brand is leading all other CSD introductions in terms of repeat purchase levels at 47%, suggesting a high level of product satisfaction among consumers. We are very pleased with the success of both brands and have extended Vanilla Coke and or Diet Vanilla Coke to over 30 countries around the world. In addition, we are very excited and pleased with the launch of Sprite Remix. It's exceeding our expectations helping to grow trademark Sprite 12% in the retail division. We are extremely pleased with how Sprite remix is also enhancing Sprite's brand health which remains the CSD lemon lime category leader with over 50% share. We have seen very little impact in Sprite's share position over this past year even as our primary competitor has entered the lemon lime category. Now looking at the second half of the year, we have several important integrated marketing initiatives to keep driving excitement around our great CSD brand portfolio. Fridge Pack is currently available in 50% of the country and will be moving to 80% of the country by year end. And our results in the second half will also benefit from continued growth in Sprite Remix, a strong emphasis on diet CSDs, integrated marketing activities around key holidays and football, and the expansion of our highly profitable 6 pack 24 ounce package.

Now let me move to an area that I know has raised a lot of questions, our water strategy. We have implemented a comprehensive water strategy which has significantly strengthened our position in terms of retail dollar share now making us the largest package water company in the United States based on that measure. Evian continues to play an important role by its positioning as the high end of our tiered strategy. Dasani, our mainstream water brand, has grown 14% year to date and grew 9% in the quarter. A slightly slower trend in the second quarter occurred as the price premium versus other competitors widened. As we have moved to appropriate price premium to other brands, Dasani returned to double digit growth at the end of the second quarter and we expect this trend to continue into the third quarter as the new marketing campaign, "Can't Live Without Dasani continues to gain traction and as we emphasized packaging innovation such as the 6 pack, 24 ounce and 24 ounce sport top bottle. We expect to continue generating strong profits from Dasani for our system. Our water brands from last years' transaction has benefited us in the quarter as we started expanding their distribution to compete directly with other spring water products. Our strategy with Dannon is to continue to be price competitive with other leading spring waters. Our Dannon brands are sold primarily in large, one-half liter multipacks that are principally offered in different package configurations than Dasani. In fact, a recent Nielson household panel study indicates that Dannon is sourcing almost 75% of its growth from category expansion. Growth coming from both new buyers entering the category as well as existing water buyers just purchasing more. 28% of consumers are switching to Dannon from other water brands. And of this group of switchers, only a very small number, about 2% are switching from Dasani. Over 38% of our consumers switching to Dannon are moving away from bulk water and regional spring water brands, which is positive for the category overall. Our water strategy has significantly expanded our presence in all parts of this fast growing category, and we were well positioned to continuing to create more value for the system as we maintain our leadership position in water. Our non-carbonated beverage growth was assisted by PowerAide which was up 15% year to date and should continue to perform very well as we move to the next phase of marketing activities around The Matrix movie series. Other initiatives around non-carbs in the second half include the geographic expansion of Simply Orange and additional marketing support behind our Minute Maid adult refreshment brands such as lemonade, light lemonade and pink lemonade. In the third quarter, our system will begin offering Minute Maid lime aid as a immediate consumption adult refreshment brand and see this flavor has generated in our chilled juice business.

Now moving to food service and our hospitality division. Volume improved compared with the first quarter but still reflected weak overall traffic in restaurants. We are expecting positive growth beginning in the second quarter based on improved second quarter trends and our expectation that consumer confidence and restaurant traffic will improve. As I think about the outlook for North America, we are all very confident that these programs combined with successful execution by our bottling partners should lead to enhanced system profits for both package mix and price realization. We expect our volume growth to be in line with or slightly higher than industry growth, and although it's hard to say how much the industry volume will pick up, we do know that in this environment, our system will remain focused on balancing volume and price to create more value for our system and our customers.

Before I move on, I would like to point out that we are offering consumers many choices in North America. We are, as we said, committed to being a total beverage company, and we feel North America is a great example of offering consumers whatever beverage they desire whether it's Coca-Cola, to Diet Coke to waters, to teas, sports drinks, or juices. This is important to us because it allows us to provide consumers and customers a full range of brands to choose from. Capitalizing on the consumer trends that we are seeing in the marketplace. That's North America.

Now Asia. We grew 4% in the quarter. While this was below the recent trend, we consider this a solid result given the impact of several key events and cycling 14% prior year growth. Growth in the quarter was led by Australia, India, and Thailand offset by the impact of SARS and a product recall in Japan. Understandably, Asia lost unit case sales in China, Hong Kong, Taiwan and Singapore due to SARS. We estimate that the entire group lost perhaps a full 3-points of growth because of SARS which is nearly a one-point impact on the entire company. We took measures early in the quarter to help minimize the impact on profits by redirecting resources and postponing investments until consumer confidence returns, and these measures included redirecting marketing promotions to take home packages and channels where the consumer was shopping and therefore increasing revenue in supermarkets. Shifting brand focus to our juice drink crew which is one of the hottest selling and most profitable SKU's in China. Creating new channels of distribution such as selling product directly off the back of our trucks in densely populated apartment complexes and reducing our operating expenses. Taken together our work in China, this quarter is a great example of our ability to quickly adjust our day to day operations to conditions as we find them. We believe the worst impact from SARS is now over. Volume trends have recently improved with June volume growth turning positive in China and up 12% in Singapore.

Another area which impacted Asia's growth that I know you are interested in is Japan. Volume was down 3% with two primary factors impacting our results. First, since we were cycling last year's highly successful World Cup program, our strategy was to pursue share of revenue dollars by focusing on profitable volume. We saw positive growth in every month of the quarter on our most profitable packages such as small cans and small PET and for our innovative bottle can pack. A second factor impacting results in Japan was a product recall in May that affected our performance in the fast growing functional and wellness drinks category. The product recall related to BOCO, a new fast growing functional water in honey lemon. The overall impact of the recall reduced Japan's second quarter volume by approximately 2 percentage points. The voluntary product recall occurred because of an ingredient suppliers confusion over the government's approval of a proprietary flavor ingredient. The ingredient is widely used in many countries including the U.S. and the EU and it poses no threat to consumers. However, the ingredient supplier didn't identify it as unapproved for Japan. We and other manufacturers pulled products containing this ingredient in May. These two products have been reformulated and are now back in the market. Looking forward for Japan, volumes should be positive in the back half of the year and we still remain very committed to and confident in a strategy that emphasizes profitability. We will get at that through new product innovation in teas, functional beverages, and CSDs by managing margins and focusing on highly profitable products such as increased initiatives around Georgia Coffee and by driving marketing and channel management initiatives such as new Fridge Pack -- new package innovation and the roll out of Fridge Pack and a bundling of the 500 ml bottles. We are focused on driving costs out of the supply chain as you know. The summarize Asia, it's been a challenging quarter in part due to several issues which we feel will not, not impact us going forward. Our strategies are the right ones and we demonstrated our ability to quickly respond to rapid changes in the market.

Moving on to Africa, growth was driven by South Africa. Trademark Coke was up 22% helped by the introduction of the Real campaign, the launch of Vanilla Coke, the rollout of 300 ml returnable glass bottles and superior local execution by our bottling partners. These results were somewhat offset by volume declines in Nigeria where we focused on achieving attractive pricing to improve system profitability. Northern countries such as Morocco, Tunisia, and Algeria were impacted by the war in Iraq. We are encouraged that business there has improved in June indicating that we are not likely experiencing any lingering negative consumer attitudes in this region. As you can imagine, Africa is all about sound business fundamentals in an ever changing environment. We are on it. Our execution is strong.

Lastly, let me touch on Latin America. Latin America benefited from a refreshingly stable economic conditions, we are pleased to report. With continued strong performance in Mexico and improvement in Argentina and Venezuela. Our system in Mexico continues to deliver strong performance even in an intensely competitive environment. Our growth was driven by 4% growth in CSDs. Growth in trademark Coke was aided by the Real marketing platform, continued expansion of our liter refillable PET package, and that's allowing us to compete successfully and profitably. DSDs have benefited from strong growth of Fanta, Sprite, Lift, and Fresca. In addition, Mexico benefited from single serve CL volume growth of almost 20% in the quarter on a constant territory basis. In Venezuela, post general strike, as you will recall, we restored full distribution across our outlets in March with trademark Coke being the first priority which responded with double digit growth in the quarter. In Argentina, our long term strategy to remain close to consumers throughout last year's economic crisis is paying off. As we are seeing 18% growth in unit case volumes nearing the pre-crisis levels. We have come out at the other side of this crisis stronger, just as we promised. Trademark Coca-Cola increased 27% in the quarter through an emphasis on refillable packaging which is the most affordable for consumers and it is the most profitable for our system. Our emphasis here is now being expanded to Fanta and Sprite with similar results. In Brazil, our system is focused on a longer term strategy of increasing profitability. Late last year our bottling partners experienced dramatic increases in raw material costs, largely due to currency devaluation. To offset the cost increases, prices have increased by over 20% versus the prior year. As a result, despite the fact that our volume declined 12% in the quarter, our operating income has improved as we have strengthened our profit position in the market. Although our primary competitor in Brazil did not increase prices until May, the price gap between our products has narrowed and we expect our pricing to hold in the second half of the year. We will be building back profitable volume. Looking ahead, we will continue to capture the great growth opportunities in Latin America focusing on our long term strategy of building our brand, our price, our channel, and our package approach while leading the system profit improvements.

Now to wrap up before I turn it over to Gary, let me say we have confidence in what we are doing. Throughout our system, our execution is solid and it continues to improve. As we work with the team all around the world, we were encouraged by the intensity and the focus that we have to keep driving profitable growth and create value for our entire system. While we still have challenges remaining for the second half of the year, our clear focus will be on execution and delivering very solid profitability.

Now let me turn things over to Gary.

Thanks, Steve.

I would like to discuss our financial performance in the quarter. Our results were driven by the underlying performance from our operating groups, the continued strength of our equity income and lower effective tax rate. First and most importantly, under lying performance of our operations was strong. As you heard from Steve, we achieved positive results by balancing our performance across our entire portfolio. Reported operating income increased 3% in the second quarter which included a $70 million charge from streamlining initiatives and a $13 million increase in stock base compensation expense. If you were to back out those two items, the remaining operating income increased 8% versus the prior year. This increase is based on gallon shipments increasing only 1% in the quarter, improved concentrate pricing, and effective management of operating expenses. In addition, operating income benefited for the first time in 7 years by approximately 3% due to positive currency trends. The second factor was improved equity income which continues to demonstrate our commitment to the overall profitability of the Coca-Cola system. Our strategies of working closely with our bottling partners to drive the most profitable products are clearly paying off. And third, our effective tax rate was lower than we have previously indicated. In the second quarter, the underlying effective tax rate declined to 22.8% versus the rate of 26.5% that was communicated in our first quarter release. This reduction improved earnings in the current quarter by little less than 3 cents per share. The decrease in the underlying effective tax rate is due to effective tax planning, improved earnings from equity investees and stronger profit contributions in 2003 from lower tax locations where currencies are also having a favorable impact primarily related to the strength of the Euro. For the remainder of this year, we expect to maintain an effective tax rate on operations of 22.8%. Therefore, we expect that earnings per share for the third and fourth quarters will benefit from the lower tax rate.

Looking into 2004 and future years, we expect the company's effective tax rate on operations to be a longer term rate of 25.5% so a decrease of a full percentage point from what we had earlier indicated. Therefore, for any of you that are modeling next year, we would expect our earnings per share to benefit next year and beyond to reflect the anticipated lower tax rate. This lower effective tax rate for the year in the future represents real economic benefit to the company as lower tax payments directly improve future cash flows and returns on capital. We are pleased that our tax planning strategies are having a favorable impact on our earnings, and this benefit is being enhanced by the currency trends. The estimated lower taxes should directly increase our earnings for this year and the next several years, and you should apply these rates to your estimates of underlying operating results.

Moving on, in addition to our strong earnings growth, our cash flow also remains very strong. Cash from operations for the first six months was $2.1 billion. And we expect strong cash flow to continue in the future. If you were to exclude the Japan tax settlement from the first quarter of the prior year, our remaining cash from operations was up double digits. During the first six months, we spent approximately $470 million on share repurchase, and we intend to spend an additional $1 billion in share buybacks between now and the end of the year. And that's on top of a 10% dividend increase in 2003 which was the 41st consecutive annual increase in our dividend, making our anticipated total dividend payout this year in excess of $2.1 billion. When you combine share repurchase and dividend payments, we expect to return at least $3.6 billion of cash from operations to share owners this year.

Let me address currency. As many of you know, we have been negatively impacted by currencies for seven straight years. This is a first quarter in a long time and I hope not the last of which we actually had some positive benefits from currencies. In the quarter, operating income benefited about 3% from currency and year to date results benefited about 1%. As we look to the remainder of the year, we continue to expect a slight positive impact from currency.

One more subject I would like to address is gallon shipments. Gallons were behind unit cases in the quarter, and they are also slightly behind on a year to date basis. For the full year unit casing and gallon growth should be approximately the same. Therefore in the back half of this year we expect gallons to be up slightly ahead of unit cases and this should benefit our results.

As for our outlook for operations throughout the rest of this year, hopefully our comments are provided helpful insight into our business. We do have some challenging markets, but in summary, we expect continued strong performance from Europe. We expect Asia to improve, but we do still face some challenges in Japan. We expect that Latin America and Africa will remain solid. We expect that North America will perform at least in line with the industry with a strong focus on creating value for the Coca-Cola Company and the entire system. And we expect our financial fundamentals to remain very good as we deliver results in the back half of the year.

Now I would like to turn things back over to Steve for a few final comments before we take your questions.

Thanks, Gary.

Before we move to Q&A, I would like to address one more item. There are been a number of media stories that have raised questions regarding financial and legal matters, investigations and our relationship with Burger King. Let me be very clear. We take all allegations of any inappropriate conduct very, very seriously. We feel strongly that our financial statements properly reflect the financial performance of our company, and we do not believe based on exhaustive internal analysis that there are any material misstatements in our results. Further, as we have investigated all of the allegations raised by Mr. Whitly, we have found nothing material that requires a restatement of our financial statements or we would be doing that right now. As you know, our senior management signs a letter certifying our financial statements on a quarterly basis. We have found nothing that would lead us to believe that our certification is inappropriate. As we reported on June 17th, we did identify several small items that required adjustments. As such, we included a $9 million write off in our second quarter results. We have always prided ourselves on the quality of our people and our actions. As we go about our daily activities, we will always act with integrity. Each of our associates is responsible for upholding our integrity and earning the trust of our consumers our bottling partners and our fellow employees. We will continue to take the steps necessary to ensure our reputation as an upstanding quality employer and trusted business partner continues well into the future. Also, let me assure you that we are very focused on running our business and we will ensure that our senior operating officers remain focused on running each of their operations around the world to continue satisfying more and more consumers every day. Our associates in food service are focused and motivated. As I hope you can appreciate, we will not be discussing any of the specific allegations during this conference call nor can we comment on specific customer relationships. However, we would like to take the next minutes to answer your questions about our operations around the world.

So with that said, let's move to your questions.

At this time, I would like to remind everyone if you would like to ask a question, please press star then the number one on your telephone key pad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Marc Cohen of Goldman Sachs.

Hi guys. Have I two questions and they may be answered by either of you, Steve and Gary. The first is pricing flexibility. I wonder if you could talk a little bit about some of the things you are looking at as you assess the company's own pricing flexibility looking forward into say later this year when you will be setting price plans for next year? Obviously you made moves here in Brazil that you talked about a year ago almost at this time. But what are you looking at that could give you more confidence to maybe make a decision to accelerate your own price growth and where do you think you are in terms of being in the position to do that? And then the second question is operating margins. Clearly, despite North America and Japan being weak, you held expenses down. Talk a little bit about your confidence and being able to continue to show positive operating margin behavior from here.

Let me try to answer your question. This is Steve. I think I understand what you are getting at, and if I'm missing the essence of your question, please stop me. Obviously we look market by market, country by country at where we think we sit relative to system health, relative to other competitors in the category, and what we know the underlying demand is for our products. And when we go through that drill, we are pretty optimistic about pricing opportunity across Europe. We were optimistic about price opportunity in parts of Latin America and some key markets in Asia. Taken together, we think we have got some meaningful upside. When you blend the rate opportunity with the opportunity we have through package innovation to continue to adjust mix, our ability to get price goes up rather dramatically. And that's really the primary opportunity we see in addition to adjustments in markets where the markets are just robust enough that we believe we can take the absolute rate up as well. Taken together, that, of course, gives us confidence in margin expansion, and when coupled with supply chain initiatives and the cost reduction activities, we have under way, and lay on top of that the innovation programs that we have which we believe downstream will generate some additional premium price opportunities taken together we see growth.

Where do you feel you are in terms of getting to the point where that can start to come into your P&L. This year it's been a one or two percent price mix factor that's been building in the business more or less with geographies constant. Do you think that we were at a point where these factors can come together and accelerate now? Or is this something that's two or three years out?

I think it's closer than two or three years. I think we will gradually take the performance of the business up. I think we have done some of that in this quarter. We expect to do more of that in the second half and beyond.

Thanks.

Your next question is from Bill Pecoriello from Morgan Stanley.

Good morning, everyone. On the emphasis on profitability, when you're talking about the supply chain management programs globally, where would you say you are now? Are you just getting started? Are the bottlers on board? And is there a cultural change with Coke in terms of making this continuous and how Coke is going to participate in those systems savings? And I just wanted to follow up on the concentrate pricing. As you have say a slower growth market like North America where the bottlers are getting pricing with lower volume growth, is Coke going to participate in that in the concentrate pricing as well?

I will let everybody speak for their own marketplace. I think with differing degrees supply chain improvement is a priority everywhere in the world and we are making a lot of progress. Why don't we start, Mary, with you? Talk about where we are with Japan. And I know you have interesting work going on in China and then we can move across the world.

Hi, as we talked before in Japan, bottlers are on board with it. The details are pretty much 90% there and we have in April signed a letter of understanding in terms of forming the supply chain management company in Japan and we expect it to be operational by the end of this year. As I said a number of times, the knock-on benefits of starting with production and procurement are substantial. Further down the line in sales and distribution line we also feel there are significant savings there. There is no problem with terms of bottler buy in and understanding. In China, we have replicated what we did in Japan on supply chain management in the non-carb side of our business. They are co-investing and building a non-carb infrastructure. They are fully on board. It's an operational entity with a general manager and a full staff.

Good morning, Bill. As you know in Europe, I have three bottlers that account for almost 70% of the volume. These bottlers have been very active over the past two to three years in taking costs out of their respective systems. We will follow and improve that with the 10 countries that are going to join the European union in May of next year because that means that frontiers are going to come down, and that will allow the bottlers, particularly, [Helinik], to really get at significant supply chain savings through plant closures and streamlining the logistics.

Relative to North America, there's two key things going on. One, obviously the formation of CCB by the bottlers and the movement of procurement. We have just about are complete in moving the procurement resources in there. That team will do procurement for the system as we move into next year's planning and execution. And then obviously CCB will continue to leverage up over time as we add activities into it separately in terms of Coca-Cola North America, we have integrated to bring our supply chain organizations together, and that team is up and running, and we look to get savings out of that in terms of the elements in the supply chain we directly manage. So I would say both those things are moving forward. To answer your pricing question, we have a philosophical agreement with the bottlers relative to SGI or the majority of the bottlers that signed SGI that set volume and price plans going forward and we will participate in that. We won't take price ahead of their ability to get into the market, but will plan that pricing action together based on rate and mix activities that allow us to get price realization.

As you know in Mexico, supply chain activities have been in place quite some time. The Mexican bottlers have done a good job of trying to take advantage of those opportunities. And we are experiencing the same results throughout Latin America. Added by the fact that Coca-Cola being integrated makes it even more easier to accomplish.

Bill, the only thing I would say, I say two things in summary to your question as well, which is as you may know we have implemented sessions a couple times a year that we call top-to-top meetings with the CEOs and our COO with the our largest bottlers around the world. And we've undertaken a series of initiatives working together to capture system benefits that you can only get on a global basis. I'm thinking about activities around IT procurement and quality. All of which promise rather substantial benefits. We have seen some the benefits in the bottler performance this year. We expect to see a continued roll through the system, and needless to say as their results are improved, not only do we have price opportunity down the road, but we see improvements in our equity income.

Thank you very much.

Our next question comes from Mike Branca of Lehman Brothers.

Thank you and good morning everyone. I have two questions. First on the marketing spending per case, particularly for umbrella Coca-Cola brand outside of the U.S. and specifically as you shifted spending to let's call it new Cola news around new products like Vanilla Coke and Coke Light with Lemon, I want to know how has that marketing spend -- what kind of incremental list have you seen from that new activity, particularly when you compare that to a couple of years ago when you dramatically stepped up your marketing spending for core Coca-Cola Classic and if you can help us understand how that should translate as you roll on extension beyond the trademark colas elsewhere. And then a second question and a follow-up on the bottler pool procurement share manufacturing and shared administrative services, as we all know close to 60% of bottler expenses are parallel across the entire system globally, and we recognize the initiatives you are doing with the three quarters of the bottling that goes through the big bottlers. Can you articulate how that will make its way to the other quarter of the volume through the smaller bottlers where we are likely to see the greatest level of savings on a per case base and along those lines your participation in those initiatives?

Let me deal with the second one first because I think your first question can best be answered by each operator on a market by market basis. We have -- we have been working with the big bottlers to set in motion these initiatives. There has been a huge amount of work in this area. We have basically gotten to the stage now where we aren't driving it. The bottler management teams are very engaged and we are just a participant in it, which is a much healthier way for us to go forward given that in many ways it's their cost, their bottom line, and we don't want to be glib about decisions we make for their operations. We want to be facilitators and helpful in bringing together the system to do a better job against areas where there is big scale benefit. Now that we have that foundation in place, we are reaching out to bottler consortiums, bottler co-ops on a region by region and some cases country by country basis allowing them to participate. For instance, the Japanese bottler co-op, none of whom are part of the top to top are linked in to the top to top initiatives. We are doing that with other bottlers around the world. Because you a right, there are big savings there and we want the entire system to benefit from these initiatives. With regard to your first question, who wants to start? Mary is raising her hand enthusiastically.

Thank you. In a number of markets and we have launched Vanilla Coke and Diet Coke with Lemon everywhere pretty much, Hong Kong, Australia, Japan. The exciting thing about investing in Cola new products as you call them is they do three things. Number one, they can bring in new users to the Cola franchise. Number two, they can increase frequency of purchase among existing users, and number three, they tend to reduce experimental switching to competitive brands. And so in many cases these are extremely incremental products and they reflect the tone and imagery Coke trademark in general. None of the positioning of these new Cola extensions have taken the brand into inconsistent directions with the trademark. So all in all, it's a win and it's a very effective spend per case.

Let me build on that. That's not only true for Coca-Cola but we were seeing that same effect relative to Sprite [vis-a-vi] Remix and Sprite Zero, and Sprite Ice Cube. I think you are seeing that effect on these big brands across the trademarks.

I might add from a European perspective. We believe that giving consumers choice is what we are all about. And as consumers' tastes vary and trends, for example, diet trends assert themselves strongly in developed country, I think it's a responsibility for us to meet these consumer demands. It is a win-win situation because many of our brands, particularly light brands are more profitable for our system than Coke Classic by itself. So that's a trend that we see as being very positive, not only for consumers meeting their demands but also from our overall profitability.

Steve, if I could make one follow-up on your comments on the bottler cost side. Would you care to -- obviously it's the bottler's savings. Would you care to give us a ballpark idea for look out over the next three to five years of the magnitude of the cost saves that you see from all of the pool procurement manufacturing services?

The fast answer to that question is, no.

That's shocker.

The follow-up reason why is that there is a lot of work under way, and by the way, the Coca-Cola Company is a partial beneficiary in these activities as well. It's not all bottler benefit. But we don't want to get locked into a number because it requires a system coming together and while we are making progress, I don't want to give you guys a target number that -- except to say that it's large and very meaningful.

Great. Thank you.

Our next question comes from Andrew Conway of CSFB.

Good morning, Steve and the group. The question, Steve, on your expectations on whether you anticipate country mix improving second half of the year from the first half and which regions or countries do you anticipate to see perhaps the largest rate of improvement or largest delta? And then as a follow-up, I really value Mary's insights in Japan just in terms of her second to third quarter consumer insight. In particular March was a very difficult month in the first quarter. How has the nonalcoholic category responded competition, dollar share of category growth across the spectrum? How are Coke branch performing in light of the consumer shifts?

Andrew, I think we do expect to see country mix improve. You need to understand that most of the world is doing just fine. As a matter of fact, better than just fine. There are only a couple of markets where we really found that the marketplace or the economy has had a bit of a chilling effect on our results which we have talked about. We believe that Germany and Japan will have improved second halves. And we are hopeful. As far as other operations are concerned, we are running on pretty much all cylinders. Mexico can't do much better than it's doing. We expect it will continue. Brazil we expect to see some upside in the second half. China we expect to see upside in the second half. Because the SARS issue has dissipated. So country mix will be enhanced. To put this in perspective, again, let me say, most of the world is doing better than fine.

Great. On the Japanese consumer currently?

Andrew, as you know we don't expect the economy to improve in Japan, but we did have some one-time unplanned events that we don't think will affect us in the second half, and we do expect to see improved trends in the second half for Japan. And as I said in the last conference call, when you are faced with industry growth of zero to minus 1% and that's essentially what's going on, with a lot of share movement within that stagnant category from competitor to competitor, you have three strategies you can pursue. You can grow share volume. You can innovate to stimulate growth and you can go after share of dollars. The latter two is definitely our emphasis for the second half of this year. We will innovate aggressively and around a couple of key high margin areas. Roll out Fridge Pack in supermarkets. There are still huge upside to the availability expansion of the bottle can product. Functional drinks as you know are a big consumer trend right now. We will have a new functional drink in August. Vanilla Coke is doing well. We will expand that to all channels and packs. We will launch another nonsugar tea and we will launch some CSD innovations in the second half of this year. From Canada Dry, we can stimulate carbonated soft drink growth among consumers. In terms of share of dollars, we have an agressive campaign for Georgia Coffee in the second half. We'll have a whole new advertising campaign. We saw another has done really well but it's time to move on to that. We will have a two month consumer promotion. We have a strategy with our bottler and we're putting Georgia in Fridge Packs. In terms of the longer picture in Japan and most people are keen to understand that we have two things going for us. One is certainly not the economy. It's innovation and its supply chain management. Next year we think pseudo pharmaceuticals, functional drinks, carbonated soft drinks and a whole new line of Georgia Coffee can help stimulate growth. It's worth pointing out that we will not participate in the excessive price discounting that's going on in large PET in supermarkets, particularly around the tea area. We don't think that makes sense. It's moving share from one competitor to another. Our focus is innovation and share of dollars.

Great. So in the interim area with the category up up to flat to down slightly, you believe you can continue or to execute the value and profit strategy in local currency successfully?

Yes, we do. There are huge variability in our margins in Japan and we understand which levers to push to pursue share of dollars. We know which levers to push to pursue share of dollars -- or, volume and, of course, we know how to innovate.

Thank you.

Our next question comes from Caroline Levy of UBS Warburg.

Good morning. Can you hear me?

Yes, go ahead.

Have I two quick questions. On innovation, it just seems to me that the lapping of Vanilla Coke, if you look at the data they are showing the base brand down a lot, and you have a face that of the third quarter. You did address that, Steve. I know that the trial repeat looks very good versus other things. The implication is you will need another major CSD innovation, and I'm wondering if you have come to that conclusion and we could expect something soon? The second thing I would love, could Sandy paint a picture of a best case scenario in Germany? I think a lot of the restructuring benefits you expect to see you will put back into the market. What kind of margin expansion can we look for out of the bottling operation there under a best case scenario?

Carolyn, Jeff. I guess you are talking about lapping of Vanilla Coke in the U.S.

Yes.

Number one, we have just launched Sprite Remix which is running ahead of plan. That's going to help us cycle. We have got in the third quarter un-cycled Diet Vanilla Coke and a major diet emphasis period coming up. That's going to help us cycle. We have another 30% of the country coming on Fridge Pack. That's going to help us cycle. And then the rest of our marketing programs across the other brand portfolio. So there has been a lot made of climbing vanilla mountain, but effectively I think we have the programs in place in the third quarter to do that. In context of another major CSD innovation, we will look for constant innovation across our product and packages, and we will see. I don't think looking for it as a function of lapping, you know, a previous innovation is a good strategy. It has to be based on consumer insight and what will expand the category in our brand.

Carolyn, Germany. Steve told you earlier we were flat in volume in Germany in the second quarter versus 10% down. As you know, the poor performance in the first quarter was caused by the imposition of mandated deposit. We are uniquely placed in Germany for refillable packaging. No other supplier in Germany has the refillable production capacity that we have. And so in one way the imposition of the mandatory deposit has benefited our system in Germany. Give you an example. Our bottler which we control there, CCAG which accounts for 70% of the volume, recorded its highest profits ever in the month of June. And as we look forward, we still have some uncertainties what's going to happen with mandatory deposits, that's a critical date on October the 1st when the industry is meant to put in a centralized take back system. That isn't not going to happen. What we were seeing in the marketplace in Germany that more customers are delisting returnable -- nonreturnable packaging. We are adjusting our system as we can to cater for that possibility and therefore as we look forward to the back half of the year, I'm confident that we will see in Germany both growth in volume and also growth in profitability.

And Sandy, I want to be clear, the savings you get from restructuring, will any of that serve the bottom line?

No, we need to use that to invest in the marketplace. We have underinvested in marketing Germany for many years. But now that we have control of CCAG, the major bottler, then it is absolutely imperative that we take these savings and invest in the market.

Thanks.

Operator, we have time for two more questions. I apologize we won't get to everybody's questions this morning. Our board meeting actually is starting in just a minute. We will take time for two more questions and then we will have to wrap it up and I will be glad to take other questions throughout the day today.

Thank you, sir. Your next question comes from John Faucher of JP Morgan.

Good morning, everyone. Just sort of wanted to can a couple of comments out of the CCE call yesterday and a comment related that Mary made today which is, as you look at -- we talked about volumes but not long-term targets for volumes. Can you give us an idea given the fact that North American CSD growth comes in sluggish and the bottlers are committed to pricing and Mary mentioned the fact that the category in Japan can be expected to grow 0 to minus one. Given those changes maybe in the growth rates, and I don't know if Mary's is a change, but if you rethought in terms of your long-term volume target needs to be? And using this in the context of whether or not the categories can grow that fast and sort of how that changes your algorhythm if you have looked at it?

John, Jeff. Let me take the U.S. business model. We are not considering changing the business model. What we see is a couple of things. The first half CSD sluggishness. We had a terrible winter and spring. There are factors in there that I think impacted the sluggishness. Number two, in terms of pricing, we were committed to value and price realization with the bottlers. We have got to continue to work on packaging innovation and the mix aspect and being surgical in the pricing. The fact of the matter is that all pricing is not created equal, and we have to continue to work with the bottles to put product and package innovation, and again Japan is a good evidence of that. When you get innovation in, you can grow these categories and we have seen it in Europe as well. No change to the model. It's about surgical pricing. It's about innovation allowing us to capture that, and I don't think the first half of this year is indicative of the potential.

Okay. So we should -- I'm not sure where you are from a guidance standpoint. Are you guiding to a 5 to 6 target?

That's the long term model, yes.

Is that an average number? Or a peak number? Should we expect when things are going well, that's where it will be? I'm assuming that's the better way to look at it?

That's right.

Thank you.

Your last question comes from Marc Greenberg of Deutsche Banc.

Good morning. Just wanted to pick up on a couple of pieces on the innovation conversation. Wanted to get a sense from you, first, Jeff, on what you think the prospective rate of change in innovation might be over the back half of the year and out over the next few years. And if there is anything you considered by way of package or product that might specifically address weakness in single serve business. On the second part of the innovation conversation, Mary, you talked some about the way you could go in terms of the levers. We were getting a little bit of a faint look at potentially modest price inflation in Japan? I don't know if that's a trend yet. How might that impact your packaging strategy? Anything you can do to drive volumes up?

Mark, Jeff. Let me talk about rate of change. Rate of change is hard to talk about in the back half. Let me talk about it in a multi-horizon. I only think we have gotten our heads wrapped around innovation if terms of the U.S. as a key driver. Whether that's package or product innovation in the last two years. I would see the rate of change in innovation accelerating in not only terms of quality of innovation but the hit rate. In terms of the focus on that, we said as we went into this year, we continue to focus on product innovation, but I think package innovation and especially single serve. We have Fridge this year and multi-pack innovation, but single serve innovation could be a key volume drive for us and the bottlers go forward. Not only in terms of the packaging and sales to how people interact and purchase them, vending, things like that. I think it's a major focus going forward. We are relying basically on one package called 20 ounce which we introduced eight years ago. It has done a great job. I think there is a lot more question do in that area.

And in terms of pricing trends, let's take each channel. Let's take vending, for example. There is a higher degree of variability in pricing in vending. We are anywhere from 100 to 160 in our machines. Overall that adds up to a stable price picture in vending. In convenience stores, fairly stable pricing and the highly profitable single serve package there. In supermarkets, we still continue to see deflation at around 5% range on large 2 liter PET, particularly in the tea category. We have aren't getting any indication of inflation there. There are things we can do to help minimize that. Two key strategies are our Fridge Pack. Particularly on Georgia Coffee which is fairly profitable. And secondly, bundling a 500 ml. Multi-packing if you will of that more profitable single serve package. You know, I do think that we are approaching the bottom on pricing in supermarkets. And wouldn't expect that trend to accelerate in the next year.

Thanks, everybody. Want to appreciate you taking the time to spend with us this morning. We have a board meeting to attend but we do appreciate you being with us. Have a great day. Thanks.

Thank you for participating in today's conference call.