可口可樂 (KO) 2006 Q2 法說會逐字稿

Good morning.

My name is Dennis and I will be your conference facilitator.

I would like to welcome everyone to The Coca-Cola Company's second-quarter 2006 earnings results conference call.

All participants will be in a listen-only mode until the formal question-and-answer portion of the call. (OPERATOR INSTRUCTIONS).

I would like to remind everyone that the purpose of this conference is to talk with investors, and therefore, questions from the media will not be addressed.

Media participants should contact Coca-Cola's Media Relations Department if they have questions.

I would like to now introduce Ann Taylor, Vice President and Director of Investor Relations.

Good morning and thank you for being with us today.

I am pleased to be joined by Neville Isdell, our Chairman and Chief Executive Officer, and Gary Fayard, our Chief Financial Officer, and Muhtar Kent, head of our international operations.

Following prepared remarks by Neville and Gary this morning, we will turn the call over for your questions.

Before we get started, I would like to remind you that this conference call may contain forward-looking statements, including statements concerning long-term earnings objectives, and should be considered in conjunction with cautionary statements contained in our earnings release and in the Company's most recent SEC reports.

In addition, I would also like to call your attention to the fact that we have posted schedules on our company website at thecocacolacompany.com in the Investors section which reconcile our results as reported under generally accepted accounting principles to certain non-GAAP measures which may be referred to by our senior executives in our discussion this morning and from time to time in discussing our financial performance.

Please look on our website for this information.

Now let me turn the call over to Neville.

Thank you, Ann, and good morning, everyone.

As is normal, my intention this morning is to make a few initials observations about the quarterly results, and then Gary is going to follow me with an overview of the financials and some additional perspective on 2006 as a whole.

And then that should give us plenty of time for questions to myself and Gary and Muhtar.

I am really pleased to report to you this morning that we delivered another solid quarter.

On the top line, this is now the fifth quarter in a row where we have delivered at least 4% volume growth, demonstrating that this is a great industry with great opportunities.

On the bottom line, we achieved record-level earnings per share of $0.78 in the quarter.

But what I'm particularly encouraged about is the fact that we delivered ongoing currency-neutral operating income growth of 8% in the quarter, with positive performance from key markets more than offsetting weakness in others.

On a year-to-date basis, ongoing currency-neutral operating income growth equaled 7%, even as we continue to make solid investments in our marketing.

As a result of that, I believe that we are in good position to deliver against our full-year objectives as we move into the third and the fourth quarter.

From a top-line perspective, I'm particularly pleased about three important factors.

First, this is a quarter where we lapped our toughest volume comparison for the year.

With 4% volume growth on top of 5% growth in the prior year, our two-year compounded annual growth rate equates to approximately 4.5%, ahead of our long-term growth objectives.

This is an important milestone for our Company as it points to our ability to demonstrate consistency on a year-to-year basis, something that you know we have lacked in the past.

It is also further evidence that our marketing investments in the prior year are starting to pay off.

Second, we achieved balanced growth across categories, with over 3% growth in carbonated beverages and 5% growth in noncarbonated beverages.

Trademark Coke grew 3% on top of 3% growth in the prior year.

And take trademark Sprite -- it delivered 9% international growth and 5% worldwide.

And Trademark Fanta grew by 4%.

So as a result of that, these core brands delivered some 60% of the growth in the quarter.

In noncarbs, we benefited from double-digit growth in water, ready-to-drink juice and POWERADE as we continue to expand our presence.

Finally, our results continue to benefit from the geographic diversity of our business.

The quarter was led by strong unit case growth in key emerging markets in Latin America, in Central and Eastern Europe, and in many parts of Asia, even as they lapped solid results in the prior year.

These results, then, more than offset the volume declines in India and the Philippines, which in fact reduced the consolidated volume growth by 1%.

That's these two countries alone, India and the Philippines.

In fact, if you were to exclude India and the Philippines, worldwide volume would have increased by 5%.

That demonstrates the strength of the numbers.

In addition, and equally encouraging, is the strength of some of our more developed markets.

Now, in Latin America, I want to focus again on the outstanding quarter and the strength of the business, and it was coupled with very strong execution tied to the World Cup, which led to 7% volume growth.

That is lapping growth of 9% in the prior year.

Thanks to marketing, innovation and strong execution in Mexico, Brazil and Argentina, Trademark Coke, Sprite and Fanta grew 7, 8 and 9%, respectively, as we gained carbonated soft drink share in Latin America.

In North America, we again delivered at the top end of our long-term growth expectations.

North America grew volume 2% and delivered solid top- and bottom-line P&L results as innovation in noncarbonated beverages drove the growth.

Importantly, we continued to stabilize our carbonated beverage trends, even as we lapped the launches of diet Coke with Splenda and Coke Zero from last year.

In Africa, I predicted last quarter that we would see the return to growth, and I am pleased to say that we rebounded from our first-quarter results.

And South Africa in particular led the way with a 7% volume growth.

And finally, I'm very pleased with the ongoing progress that is being made in Europe as trends accelerated from the first quarter across every one of our divisions, including Northwest Europe and Germany.

Excellent World Cup activation, and I was in four of the key countries over the World Cup, and I can personally testify to that.

And improving execution drove carbonated beverage growth of 3%.

And with the launch of "The Coke Side of Life" and Coke Zero going on as we speak today, I believe we are starting to turn the corner.

So now, let's discuss Japan.

Clearly, I am disappointed with the results for the quarter.

And as for my expectation that Japan would be positive this quarter, simply put, I got it wrong.

Now, Georgia Coffee did improve, but not as quickly as expected.

However, Trademark Coke was weak, and we did not successfully lap the strong tea launches from the prior year, all of which was impacted by the overall industry -- overall category declines in the industry.

So what are we doing?

As you likely read last week, we've reinforced our management team, reflecting the importance and the unique complexity of the Japanese business.

Dan Sayre, through his marketing and operational experience, will be the perfect complement to Uotani-san, who will continue to play a very important role working with our key bottlers and our customers and in the broader community, a job that is vital to the success of our business in Japan.

Those are more long-term fixes.

On a short-term basis, we are accelerating plans behind Georgia Coffee.

And since the relaunch on May 1, as I mentioned earlier, results have improved, but we're putting additional marketing activity behind the brand, and that began in late June.

For Brand Coke, we're launching a new national summer campaign.

And in the tea category, we're focusing on driving results for Sokenbicha Original, and that was one of our bright spots for the quarter.

It grew 6%.

So we will be putting more weight behind that.

Through these and other efforts, we believe that we are going to be able to improve the trends as we move through to the back half of the year.

Now I know that some of you are frustrated with the results in Japan.

And as you've heard my earlier comment, I am as well.

However, as with other key markets such as North America and Northwest Europe, we have proven that we will aggressively address the issues as they come up and that we will make the correct long-term decisions for the business, leading to improve performance going forward.

I am very confident that Japan will be no different to the other examples that I have just quoted.

In summary, when I look around the world, I am very pleased with nearly every one of our markets.

There are just a few exceptions.

As a result, I believe we are well positioned heading into the back half of the year.

Most importantly, our business is much better positioned today to deliver against our expectations by balancing our portfolio of operations, as demonstrated by the fact that once again, we delivered both top- and bottom-line results aligned with our long-term growth targets.

This gives me confidence that we will achieve our business objectives, and in doing so, create sustained growth and value for the benefit of our shareholders and our stakeholders.

Now let me turn the call over to Gary for some more details on the specific financials of the quarter.

Thanks, Neville, and good morning.

As you saw in the release, we reported earnings per share of $0.78 for the second quarter, an increase of 8%.

That means, on a year-to-date basis, reported earnings per share of $1.25, representing an increase of 11%.

The quarterly results included a net $0.04 benefit primarily related to a gain from the sale of shares in the initial public offering of our Turkish bottler.

Therefore, our adjusted earnings per share for the quarter were $0.74 per share, an increase of 9% over the prior year after considering [IM's] impacting comparability in both years.

At the net revenue line for the quarter, we reported revenue up 3% versus the prior year, but there were a few things specifically impacting that 3% increase.

First was a net negative 2% impact of structural change primarily related to the transfer in Spain of canning rights to our bottlers, which we have discussed in the past.

As a reminder, there is no profit impact from that change.

If you look at price and mix, we did benefit from pricing and mix in many of our markets.

But that was offset by negative 1% impact due to the weak results in Japan.

On operating income, we grew operating income by 3% on a reported basis for the second quarter.

We also had some items impacting comparability in both the current and prior-year quarters.

So after considering those impacts, operating income increased 7%.

We also were impacted by a negative 1% effect from currency.

So on an ongoing currency-neutral basis, we grew operating income 8% in the quarter.

Now within the operating results for the quarter, we estimate that we benefited by approximately $0.02 per share primarily related to the timing of gallons.

And therefore, we would expect that benefit to reverse in the second half of 2006.

In the quarter, we repurchased $666 million of our stock and 1.2 billion for the first half of the year.

As a result, our average shares outstanding for the second quarter were approximately 49 million shares lower than the average in '05.

And that added 2 percentage points to our earnings per share growth in the quarter.

I also wanted to touch on the second-quarter cash flow statement.

You will see a decline in cash from operations, driven by an increase in working capital on a year-over-year basis.

That increase was really driven by two key items that I discussed in the first quarter.

First was the payment of the stepped-up marketing accruals from last year, that payment being made actually in 2006.

That represented about a third of the change in working capital.

Second was the impact of cash taxes on a year-over-year basis of approximately 250 million, which was primarily related to the tax repatriation in 2005.

We accrued those repatriation expenses, but made a cash payment in the first quarter of this year.

And finally, there was some impact due to the timing of receivables on a year-over-year basis as we continued to grow the business.

As you can see, these items relate more to the timing of payments on items related to last year than any fundamental working capital structure of our operations.

Now let me address some of the factors that we see impacting our outlook for the remainder of this year.

As Neville stated and as we outlined in the release, with the progress to date and the pipeline we have in place, we believe we are on track to deliver against our objectives.

Our read on the macroeconomic outlook for the year remains relatively positive, especially in many of the emerging markets.

The only caveat continues to be some economic trends in Western Europe, where we believe we will have muted growth for the year.

For input costs, we continue to see upward pressure.

But we are actively managing those pressures, and although we do expect to see some increase, we believe it will be within a reasonable range.

SG&A increased 5% in the quarter.

That 5% reflects increased investments in marketing for our four operations, as well as increases in selling expenses within our bottling investment group.

These increases were partially offset by effective management and timing of G&A, general and administrative expenses.

With regard to taxes, we ended up the quarter with an underlying effective tax rate of 24%.

Our best estimate for the remainder of the year is that the rate will continue to be 24%.

Now a couple of comments on currency.

On a comparable basis, we saw a negative impact from currency for the quarter and year to date on operating income of 1 and 2%, respectively.

This is slightly better than our initial expectations, as we were able to benefit from an effective hedging strategy that mitigated some of the overall downside.

We continue to put coverage in place and are effectively covered through the third quarter of this year on the euro and yen and several other currencies.

Based on current spot rates and the expected impact of the coverage in place, the negative impact to operating income would be approximately, we believe, 1% for the full year 2006, including the impact for the first six months.

In terms of flow, we would expect currencies to have a slightly negative impact in the third quarter and slightly positive impact in the fourth quarter.

We also anticipate that our range for share repurchase in 2006 will remain between 2 and 2.5 billion.

That is it for the topics I wanted to cover this morning.

Neville, Muhtar and I are now ready for your questions.

Operator?

(OPERATOR INSTRUCTIONS).

Caroline Levy, UBS.

Just looking at how your currency forecasts have improved, and wondering, then, if -- it looks like you're telling us to take the $0.02 out of the back half of '06 for the overshipment of gallons, but your currency outlook has improved substantially.

So do we really need to do that?

And secondly, why was there an overshipment in the gallons?

Caroline, this is Gary.

A couple of things.

On currency, I would start first -- if you remember, back in December of last year when I told you that what currency looked like, it was going to be a negative 6 at the time.

I said, but I think it is going to be much better than that.

We will see how we do.

And this was one of those times I was able to accurately forecast currency.

I think what we will see is a negative 1 for the full year now, based on where currency rates are today, and that is important, plus the hedge coverage that we have, as I said, through the third quarter.

Relative to your own expectations on currency, I think that depends on each individual and what they have built into their models, because I have looked at models that have more negative and less negative currency built in.

So I think it really depends exactly on specific expectations by individual model.

But relative to the gallons themselves, there are a couple of things.

The $0.02 positive impact in the quarter, where gallons are ahead of cases and ahead of our own expectations for the year, we would expect to reverse in the second half of the year.

It is primarily related to two geographies -- North America and Europe.

In North America, it was literally just the timing of orders coming in from the bottlers as they were ramping up for Fourth of July and the summer selling season.

In the EU, it was more around pipeline fill for Coke Zero.

But again, as you look to the back half, it seems that the estimates should go up in general versus where you were thinking, because of currency.

I think, Caroline, it does come back to what your assumptions were on currency.

So I can't tell you specifically.

It just depends on your assumption.

What I can tell you is that I would expect full year now to be a negative 1.

And that includes the negative two year to date for the first half of this year.

I think, Caroline -- morning, Neville here -- I think the important thing is Gary's indication that we've got a good line of sight now for the balance of the year on what currency is going to be.

You may recall last September, we were talking about a 6% penalty, and then we came down to 4 and 3.

Now we've got a very firm fix on the year.

So we are able to give you that, and then you need to feed that into whatever expectation you have.

Thank you.

Just very quickly, on equity income, it was down.

And I'm just wondering what the problem was there.

There are a couple of things there, Caroline, that are going on.

And without getting into any specifics, because many of the bottlers that we have equity income from are public and have not released yet, but I can tell you there are some one-time items in there.

There is a pension change that had a fairly significant impact on one equity investee.

There were some currency devaluations, which had a pretty big impact on an investee.

And it is those kinds of items, but nothing, I would say, other than those kinds of things.

Everything else is fairly normal.

Bryan Spillane, Banc of America Securities.

A question for Neville and Muhtar -- just on the Philippines, the volumes are down pretty substantially still.

And I know San Miguel has made some comments publicly about talks that they are having with you in terms of structure.

Can you just talk a bit about where you stand in those talks and whether or not it is going to require buying San Miguel out completely, or is the potential just to buy the majority stake in order to turn that around?

Well, there is nothing definitive in terms of any signed agreements or anything of that nature at this point in time.

You have seen the releases that have come out from San Miguel, that we are in talks about potentially restructuring it.

That is still very much work in progress.

It is very clear from the results, as you've mentioned yourself, Bryan, that the business is in bad shape at the moment, that the route to market is not working.

And therefore, we are having very, very strong discussions.

And one of the potential outcomes is that we will increase our ownership and that we will take management control.

But that is not defined yet and not agreed yet.

But it is certainly very high on our agenda.

And Muhtar, in fact, has been in there very recently in terms of leading those discussions himself.

And as you have gone through this negotiation, I guess, has there been any effort to improve the route to market yet, or are we just seeing sort of a standstill at this point until you work out a structure?

There is no change in the route to market system at this point in time.

William Pecoriello, Morgan Stanley.

I was just focusing on the underlying operating profit.

You had talked about the 8% when you adjusted for foreign currency.

But that of course benefited on the $0.02 from the timing of the gallons and the G&A.

So if you back that -- that's about 3 points of profit growth.

So I back that out, I get about 5% in the quarter.

So looking to the back half of the year, what I am trying to understand is if Japan is going to continue to be a drag versus original budget, and you've talked about additional market spending in Japan to turn it around, what do you see as the offsets in the portfolio on the underlying profit growth?

Is it the rebound in Europe and continued strength in Latin America?

So I'm just trying to get comfort on that back-half-of-year underlying profit outlook.

Short answer is yes.

And I will let Gary go into detail.

Bill -- I guess it's okay if I say Bill and not William, as the operator did -- Bill, a couple of things.

First, on the $0.02 in the current quarter that we benefited, if you go back to last year's second quarter, there was also a $0.02 timing benefit.

So if you take that out as well, we are still at that 8% increase.

So we feel very comfortable with our operating income increase -- in fact, at the high end of our range and operating income of what we would expect.

So we feel very good there, and year to date at 7%, feel very good about it.

A couple of things I would say.

Japan will continue to be somewhat of a drag in the second half of the year.

And I will switch to Muhtar on that in just a second.

But the other thing as well -- we are not only seeing very strong growth in the emerging markets, but we are seeing a rebound in northwest Europe, particularly in Great Britain.

Germany was a little softer than I think some of you expected.

But it is right in line with what we thought would happen.

We did put through a needed price increase in Germany just in front of the World Cup.

And I think that was the right thing to do for the long term.

But we feel actually very comfortable and confident going into the second half of the year.

Neville, Muhtar?

Let me make a comment before I pass it on to Muhtar on Japan, picking up on Germany as an example.

You know, this is not a sprint, this is a marathon in terms of everything we are doing.

And I continue to emphasize that we are going to do the right thing for the long term.

So if you take Germany, a number of you have been in Germany.

You know that the pricing generally in Germany is very low compared to the rest of Europe.

So we took the opportunity to rectify that in some of the take-home packages in Germany just ahead of the World Cup.

So that was the right overall decision for Germany.

At the same time, we are getting very strong double-digit growth in our immediate consumption packages, which is where we are focusing -- I think you saw that when you were there.

That is around 20% growth.

That, therefore, is a much more profitable business, as you know.

So it is part of a long-term view of doing the right thing.

If you go to India, it is exactly the same story.

We have taken actions to reduce credit.

We are collecting receivables.

We are tightening up on a number of controls.

You see the benefits of that actually coming through in terms of profitability in the bottler investment group, which is our sort of hospital ward for bottlers that are not performing.

And so there is a balance there in terms of the profitability.

But we took the volume hit.

We think, by the way, you will certainly see some significant improvement in the back half in India in terms of volume because that action is behind us.

But we are willing to take the pain in order to do the right thing.

And that is part of what you have seen in some of the areas that maybe were a little softer than you had thought.

And then I just want to hand over to Muhtar about Japan, the actions in Japan and then what we're doing.

Muhtar?

You mentioned Japan being a possible drag in the second half.

And what I would just like to say is certainly there is going to be -- I have every confidence that there is going to be an improving trend in the second half in Japan.

Q3 will clearly be better than Q2, and Q4 will be better than Q3, based on some of the actions that we have already taken and some of the other actions in the pipeline.

You mentioned increased marketing -- actually, there is going to be -- we have taken every action to ensure that the marketing is going to become more effective in Japan.

It is not increased, but it is reallocation of marketing behind the brands that are performing, like Sokenbicha, like the diets category that has already been very positive even in the first half, and also behind very specific activities around Trademark Coca-Cola, Brand Coca-Cola, specifically, in the season, in the peak season now, going forward, as well as the early indications from the restage of Georgia, certainly, are showing very good results, particularly with the flagship Emerald Mountain coming forward.

Every month was better than the other.

In fact, in the month, the very profitable canned coffee actually had showed a positive share gain in the last month of the quarter.

So we certainly are expecting good -- better results coming out of Japan, and also particularly to your question, the issue of reallocation of marketing and making marketing more effective.

Robert van Brugge, Sanford Bernstein.

I have a question for Gary about the flow of corporate expenses throughout the year.

It appears that in the fourth quarter of last year you had a big step up.

Should we expect it to be kind of a normal base case, or should it provide for an easier comparison in the back half of the year?

Robert, I would say on expenses, there was a slight benefit in that $0.02 that I talked about in the second quarter, primarily in G&A corporate expenses.

I would expect that to turn around in the third and fourth quarter.

But based on what we are cycling, I would say that we are containing to focus on expenses to get leverage out of the G&A line.

We have done that year to date pretty well and will continue to focus on that.

I would expect the first half to be slightly lower than the second half, but not significantly different.

Robert, Neville here.

I just want to reemphasize the real focus that we do have on that SG&A line.

You see that we continue to invest in marketing.

That allows us to be able to do that.

And we get the right leverage out of that.

So you're going to see a strong focus on the SG&A line coming through in the many quarters ahead.

I guess, let me add one thing, too, just for full transparency as well.

And you will see it in some of the detail in the 10-Q.

But you'll also see that sales and service is included in that SG&A line, which is volume variable to volume in the bottler investments group.

And you will see that continuing to grow as the bottling investment group continues to improve their results and continues to grow volume.

So you are going to see different growth rates in the three different categories -- marketing, sales and service and G&A within that line.

Lauren Torres, HSBC.

First, I was hoping you could update us on the consolidation of the bottlers in Germany, if there's any new news there.

And secondly, on your Northwest Europe, you had a stabilization there that we've seen over the last couple quarters -- has that been most attributable to the World Cup, new products, things like that?

Or are we just -- how are we seeing market improvements, just better execution, things like that, that are somewhat more sustainable?

Okay, let me make a comment on the bottler group, because that is one that I've been handling.

Neville here.

The discussions are continuing.

In fact, around the World Cup, I met with the bottlers.

We, obviously, we absorbed Bremen as part of consolidation.

I would make two points on where we are with the consolidation.

First, I would say that the discussions continue to move forward successfully.

There are still a few outstanding issues, but we are continuing to make good progress.

I think, more importantly, we are working in a very collaborative way with the bottlers.

I think what you see in the results is that we're not letting the discussions interfere with the business.

In fact, the bottlers have undertaken to work as if we had finalized the discussions and we were moving together as a consolidated entity.

So some of the issues that we had in the past regarding promotions on a German-wide basis, etc., those issues are not ones that we're concerned about at the moment.

So the overall atmospherics, if you want to put it that way, are actually very good.

I am not predicting that we will definitely be able to conclude, but we're certainly moving in the right direction.

And I am going to hand over to Muhtar for the balance of your question.

I think what we are really seeing in the first half is the benefits of some of the key strategies we have implemented across the EU, across Northwest Europe.

Across the EU, Trademark Coke was up 4% with very good World Cup activation, of course, but also very, very powerful immediate consumption measures and strategies implemented across all the countries.

And we've seen very strong diet and light growth across the EU, across the key markets, also double-digit POWERade and Minute Maid growth in the EU.

All of this will continue with strong innovation and marketing plans for the remainder of the year based on a very powerful, very, very powerful Coke Zero launch, "Coke Side of Life" being launched, our new campaign, accelerating route-to-market improvements in key markets like Italy, like France, like Great Britain, which will again benefit a focus on revenue growth management and benefiting the entire system.

And we will certainly drive CSDs -- continue to drive CSDs with a focus on diet as well as light for the balance of the year.

So, I mean, the Coke Zero is the most powerful launch in Germany since 1983, has really excited the system in a country like Germany and providing real focus and energy behind our system.

Let me just reflect on the Zero launch as an example of what is happening.

The first launch outside of the U.S. was into Australia, and you know the great success of that.

And that was repeated in New Zealand.

And we were down as a management team in Australia in the first quarter, Muhtar, Dominique, myself, everyone down there, looking at what had happened.

And we saw the tremendous power of Zero.

The Zero launch was actually not in our plans for any of the European markets that we are launching into now.

And in March, we took the decision to go into the market, and we are in the market right now.

We are launching, as we speak, it is out in all of the key markets that we've mentioned -- Germany, UK, France, etc.

So that is the speed with which we have been able to move.

And it is also the way that we have managed to address really reenergizing the system, as Muhtar has indicated.

And we have both been wearing out shoe leather walking around the streets and getting a feel for where things are.

So even though the category in Great Britain is down, we believe that Zero is going to help turn that around.

But it really is the increased speed with which we are able to do things, the fact that the system, together -- because we're talking about the bottlers being fleet of foot as well -- the speed with which we are able to do things, which I find very encouraging, as well as the overall results that Muhtar has just talked about.

Christine Farkas, Merrill Lynch.

A question on margins, specifically in North America and Latin America.

We saw margins based on underlying, excluding [some] eliminations, down year over year.

And I'm just wondering if you can comment either on the product mix impact or the timing of G&A or anything like that which can explain some of the shortfall?

Christine, a couple of things on margin.

I think on a reported basis, gross margin was up 140 basis points.

There were some comparability items in there, particularly the Spain canning rights and that sort of thing.

But even with that, gross margin on a comparable basis increased 40 basis points.

There are a couple of things that are driving margins, though.

One is that there have been some increases in input costs, particularly in North America, I would say particularly around orange juice.

And orange juice itself is up fairly significantly.

And then just the percentage of finished products within our portfolio in North America, particularly where we own a lot of finished product business, as well as the impact of the bottling investment group, which is going to, as they continue to increase, they will have a lower margin.

But overall, I would say, relative to margin, we are fairly comfortable where we are.

And even with some pressure on input costs, I would say we are in pretty good shape.

Gary, can you comment on Latin America as well, in terms of costs and margins being a bit lighter than a year ago?

Yes, let me see, because I had not focused specifically on Latin America.

Your growth of water or certain products that would have brought down that number?

Well, on Latin America, we've got revenues up ongoing -- you know, 18, operating income up 16.

A lot of the difference there is actually in the marketing, where we continue to invest in marketing in Latin America.

There's nothing relative to margins in Latin America of any concern at all.

In fact, if anything, the volume in Latin America is very much skewed to CSDs, and very strong performance there.

So other than there's been a little bit of weakening in currency in the peso in Mexico, nothing of any significance or any concern that I have at all in Latin America.

It is a business that is performing extremely well and is actually -- we are continuing to invest in it and continue to see results pay off from those investments.

Is it front-loaded marketing spend, or this is the kind of pace that we can expect to see for the rest of the year?

This is Muhtar.

Two things -- I think first, as Gary said, it's a very strong performance from all the key markets, led by Mexico.

The marketing is basically a spread on the curve.

But certainly, there has been a lot of very major marketing activity in the first half, particularly in the second quarter around the World Cup across all countries, which really has yielded also very positive results both on the image indicators as well as in the volume.

Carlos Laboy, Bear, Stearns.

Mexico and Brazil aside, to stay with that thought for a minute, you saw great growth in CSDs.

But water aside, still no long-term agreement with bottlers on certain noncarbs like juices, for example, for the traditional trade.

Could you speak to that, expand on that?

And is there any likelihood that you and the bottlers could go separate ways on certain noncarbs like juices?

Carlos, this is Muhtar.

Good morning.

Firstly, I want to just say that we have very good alignment with our bottling partners across the region in Latin America, have fairly extensive discussions going around the alignment in terms of how we go forward, and a very good relationship.

The current-quarter results in Mexico and Brazil demonstrate the power of the system.

And I think you will see us being more active in the noncarbonated beverage arena going forward.

We are working with each of the bottlers, including FEMSA, Coca-Cola FEMSA, to develop our long-term plans to capture the opportunities in the marketplace.

You will see us certainly being more active in the area of noncarbonated beverages going forward.

To take the one piece of your question -- any likelihood that ourselves and the bottlers are going to go separate ways -- I would answer no.

Cheryl Gedvila, Prudential Equity Group.

My question is also on your Latin American operations.

And I was just wondering if you could give a little more color on how pricing is working throughout the region versus what the impact of FX was in the quarter?

Cheryl, this is Gary.

A couple of things I would say relative to Latin America.

Number one, in Latin America, we are on incidence pricing, and so -- meaning that our concentrate revenues are calculated as a percentage of the net wholesale of what the bottler sells.

So we get an increase in pricing, positive pricing, as the bottler gets pricing in Latin America.

And it was built that way years ago because of back when those markets were hyperinflationary.

So it is a method where we and the bottlers work very effectively around pricing.

And this is where you really see revenue growth management working.

And it is working extremely well in Latin America, probably the leading region for us in the world around revenue growth management, where that is really around getting the best mix by channel, product package by channel, and that is what you are seeing.

FEMSA has been doing an outstanding job starting in Argentina, then Mexico and Brazil, and all of the bottlers are rolling out very sophisticated revenue growth management ability across their entire organization to drive the positive mix.

And we had about 8 points of positive price mix in the second quarter in Latin America -- 9 points year to date.

And then there was some negative -- positive currency of 4 points.

Matthew Riley, Morningstar.

I was hoping to get an update on the overall performance of innovations over the past couple of years -- kind of what is under-, over-performed expectations, whether you have a sense as to why, and how your whole innovation strategy has evolved over that time.

Well, I think you have seen -- you say the last couple of years, let's take the last -- it is probably the last 18 months -- and you've got to look at a very broad background of how we are looking at the business differently.

We're looking at the different deed states as opposed to just the normal categorized segmentation.

And as we do that, we are bringing forward innovations in -- really, I would put it in three buckets -- innovations in carbonated soft drinks.

And you have seen that with regard to Splenda and Zero.

And we have managed to cycle, if you take the U.S., we have managed to cycle now into the second year of Splenda and Zero successfully.

And therefore, we see that rolling out globally.

I have just commented about that.

We think that that is still a major opportunity with diets.

And I just also want to make a comment there about innovation is not just product-led.

It is also package-led.

Again, I talked about the strong growth of Fanta.

That is driven by a new package.

The whole new design of that bottle has been very successful.

And very often, we have seen major growth spurts around packaging.

So that has been part of it.

If we take -- again, I will go with a North American example here, but if we take energy drinks, just 18 months ago, we were hardly in the category with less than 1% share.

We're looking at almost -- it depends which measure you look at, but we're very close to being number two in energy drinks from nowhere.

So that is very encouraging.

Some of the line extensions have come and gone in carbonated soft drinks.

That is something that we do anticipate.

But some -- Coke with Lime, for example, was not as successful as we had anticipated.

But those are really to add some interest into the category.

But DASANI Flavors, those have worked well.

Aquarius in Spain, which we are starting to expand into other markets, has been extremely successful as well.

And you are seeing the growth that we have with POWERADE.

The bucket that we have that I want to focus on is the one which is really niche, small volume, but high margin.

So here you talk about a Tab Energy, I guess the Full Throttles are in there as well -- I commented on energy drinks earlier -- but also on the likes of Coke Blak.

A little early still to judge it, but we are certain -- the main launch was in France in March, and we are ahead of our budgeted plan in France.

A number of other markets are looking at it as well.

So that is that second bucket.

And then the third one is, of course, expanding the noncarb portfolio.

Part of that is also acquisition driven.

And you have seen us with two very important announcements in Europe with the acquisition of Traficante in Italy and of Apollinaris in Germany, which again widens out that portfolio.

And you're going to see more of that.

I'm going back to CSDs -- the Vault rollout, by the way, is looking very strong as well.

So in general terms, our hit rate is actually higher than I would have anticipated, and remembering the innovation pipeline is one that was pretty empty.

And we have only had 18 months of filling it.

So there is more to come.

But on the negative side -- Muhtar has already mentioned it -- what we did in Japan in terms of repositioning Georgia Coffee would be one that we're not terribly happy with.

And obviously, we -- Hajime, the green tea in Japan, which we have been unable to cycle the initial very successful launch there, would be ones that you could point to that have not been as successful.

So that's sort of a broad trip around innovation and the success of it.

John Faucher, JPMorgan.

Gary, I wanted to follow up on your commentary on sort of the margin changes, because you have so many puts and takes in the P&L this quarter.

If I adjusted for, staying on the top line, gallons on the top line, gallons on the operating profit line and currency on the operating profit line, I came up with operating margin expansion of somewhere around 60 basis points.

Does that seem right, first of all?

And if that is right, is that something we can use sort of going forward over the balance of the year in terms of a margin number?

Yes, John, thanks for the question.

A couple of things.

I'll kind of give you some of the puts and takes and tell you what I think the number is.

On a reported basis, margins increased 140 basis points.

That was from about 66% to 67.4, and this is gross margin in the quarter.

If you look at items impacting comparability in both years, the increase goes from 140 up to 220 basis points.

But then if you net the structural change out, that is a negative probably 210 basis points.

The bottler acquisitions helped by 40.

So my net-net on gross margin, I would say margins increased on a comparable basis about 40.

You are coming up 60;

I am up at about 40 basis points.

Going from 67.4 to 67.8 is the way we would calculate it.

And that is even with the decline in Japan of 6% and unit case volume in the quarter.

So I will put it this way -- as Muhtar said, you are going to see an improving trend in Japan.

And therefore, my expectation on margin should be that we will hold what we've got or it should improve.

Gary, I was actually looking at the operating margin line.

Well, you should have stopped me before I went through all that detail.

I didn't want to be impolite here.

But I thought I was doing such a great job at the gross margin level.

It was -- it just wasn't exactly what I was looking for.

Isn't that the way you're supposed to answer these questions?

On a comparable basis, operating margin for the quarter we would say are up 70 basis points.

You are at 60; we are in 70.

We are pretty close.

Now, does that include the benefit from the extra gallon shipments, though?

But remember that there was a benefit in the prior-year second quarter as well.

So it is the same thing.

If you adjust it out, you also -- there's some that adjust out of the second quarter of last year.

So we still say about 70 basis points.

You are at 60, so we are in the right ballpark, John.

And that is fair looking forward?

Yes.

John, Neville here.

Gary mentioned Japan.

I mean, I think that is where we really are encouraged in terms of our ability to absorb such a strong negative quarter in Japan.

That does give us great encouragement looking forward.

I just wanted to reemphasize that, John.

Marc Chin [sic], Merrill Lynch.

It is Marc Cohen.

Neville, I am struck by the repeated comments you have made about 2% volume growth in North America being at the high end, in light of the fact that many people expect the whole LRB industry in volume terms to grow 2 or 3%.

So we hear a lot about how the system is underperforming.

And indeed, it seems like at the surface, at least, you are planning around volume share losses.

So I guess the question is -- the questions are, is that true?

And if so, can you explain the strategic thinking and the competitive and financial ramifications of that?

Well, we are talking about our long-term growth targets.

And you, I think, are focusing on maybe a narrower timeframe.

And I also want to point out that as you try and do an analysis with some of our competitors, we're looking at different periods.

But it is clear I'm still not satisfied with the level of growth that we have in North America.

But I am also very encouraged that we're improving the trends.

And I think you and I have talked about that.

And I think that you see that happening.

We are also improving the execution capability.

And John Brock and I have been talking, if we go specifically to CCE, about the things that he is focusing on to continue to do better in terms of execution.

They have identified that, and of course the management team there has commented before.

We have great confidence in the new management team in North America to do that.

But with regard to overall shares, we are stable in share with regard to carbonated soft drinks.

And again, we've got June in here.

So that may be different from some of the other data that you may be looking at.

And that is even lapping the launches of Splenda and Zero last year.

So CSDs are looking good.

We actually have gained share in energy drinks.

I have commented on that earlier.

We have gained some share in water.

That is within the overall industry.

We've lost share in sports drinks, and that is something that, even with the strong growth, that does concern us.

So we want to highlight that.

In warehouse juice, delivered juice, we have gained, but the other categories where we have been weak, juice drinks, but also specifically tea and coffee ready to drink.

And with regard to that, although the formal announcements aren't out, you know we've got two very strong launches in tea coming up -- all the reports about Gold Peak moving out in North America.

So there is innovation in tea coming out, which will, we believe, address that.

To your broader issue, we are trying to stabilize the business here.

One of the reasons I said it's not a sprint, it is a marathon -- I am not committing to moving out of the band that we are in at the moment.

I think that is what we are able to achieve.

But clearly, our overall goal is to grow share.

We have grown share five out of the last six quarters overall in NA RTD.

I anticipate that continuing.

And therefore, if industry growth continues and doesn't get slowed by fuel pricing, etc., we would expect to participate in that.

So just to be clear, I mean, you look at the North American ready-to-drink market, and I was talking longer term, really, rather than shorter term -- is it that -- you are looking at 1 to 2, and many people talk about 2 to 3 in volume terms.

Are those numbers comparable, or do you see a different growth rate for the industry longer term?

And is the difference in thinking here one between volume and value?

That is a very good point.

Our 1 to 2 is based on believing the industry is going to grow at 1 to 2.

So that is one point of difference.

And then your second point is the value issue.

And that is where I was talking about some of the niches, and that is where your Tab Energy, your Coke Blaks, the like come in.

And that gives us the margin expansion -- the energy drinks with the margin expansion.

So I think you have to look at the overall profitability that we are managing to put into the system.

And I emphasize system, because we are obviously very cognizant of the fact that CCE still doesn't have a positive return on invested capital.

So there is a broad focus on the overall health.

And I think if you'd look at the strong profit growth in North America over the quarter and over the six months, you'll see that reflected as well.

So we are trying to balance the two.

And then I got back to the fact that our view is therefore within that, the industry is going to be 1 to 2% growth.

I hope I am wrong.

Thank you very much, everyone, Gary and Muhtar as well.

I just wanted to say that we do believe that this quarter demonstrates that we have got consistency and that the plans are clearly in place for the balance of the year to continue to reflect that.

Execution is going to continue to be critical in our path going forward.

But again, we are seeing sequential improvements in execution as we move ahead.

So I look forward to speaking to you again in the third-quarter call in October, once again, share with you our progress.

Thanks very much indeed, everyone.

Ladies and gentlemen, this concludes The Coca-Cola Company's second-quarter 2006 earnings results conference call.

You may now disconnect.