Executives
Thor Erickson - Director, Investor Relations
John F. Brock - Chief Executive Officer, President, Director
William W. Douglas - Chief Financial Officer, Senior Vice President
Terrance M. Marks - President, North American Business Unit
Steve Cahillane - President, European Group
Analysts
Judy Hong - Goldman Sachs
Kaumil Gajrawala - UBS Warburg
Lauren Torres - HSBC
Bill Pecoriello - Morgan Stanley
Christine Farkas - Merrill Lynch
Mark Swatzberg - Stifel Nicolaus
Robert van Brugge - Sanford Bernstein
Bryan Spillane - Banc of America
John Faucher - J. P. Morgan
Coca-Cola Enterprises Inc. (CCE) Q3 2007 Earnings Call October 24, 2007 10:00 AM ET
Operator
Hello and welcome to the Coca-Cola Enterprises third quarter 2007 earnings conference. At the request of Coca-Cola Enterprises, this conference is being recorded for instant replay purposes. At this time, I would like to turn the conference over to Mr. Thor Erickson, Director, Investor Relations. Sir, you may begin.
Thor Erickson
Thank you and good morning, everybody. We appreciate you joining us this morning to discuss our third quarter 2007 results. Before we begin, I would like to remind you all of our cautionary statement. This call will contain forward-looking management comments and other statements reflecting our outlook for 2007, as well as future periods.
These comments should be considered in conjunction with the cautionary language contained in this morning’s earnings release, as well as the detailed cautionary statement found in our third quarter 10-Q.
Our earnings release also contains a reconciliation of the non-GAAP comparable figures referenced during this call. A copy of this information is available on our website at cokecce.com.
This morning’s prepared remarks will be made by John Brock, our CEO, and Bill Douglas, our CFO. Terry Marks. President of North American Group, and Steve Cahillane, President of our European Group, are also with us on the call this morning. Following the prepared remarks, we will open the call for your questions.
Now, I will turn the call over to John.
John F. Brock
Thanks, Thor. We are pleased to be with you today to discuss our third quarter performance, a quarter in which we continued to make important progress against our long-term, strategic objectives, despite working through a combination of operating challenges.
As you read this morning, we achieved comparable third quarter earnings per share of $0.44, comparable operating income of $458 million, which was up 1% versus the year-ago, and comparable net income of $213 million, which was down 1.5%.
We have raised our full-year guidance to a range of $1.31 to $1.36 per share, based on our results to date, as well as an encouraging outlook for the fourth quarter, which includes renewed volume growth in Europe and the continued success of our brand and operating initiatives in North America.
Now, as we look to the third quarter, we believe our progress against our long-term, strategic objectives comes in two areas. First, building our brand portfolio and second, driving higher levels of customer service through improved efficiency and effectiveness.
From example, in North America, we began implementation of significant improvements to our brand portfolio. We began distributing Fuse and Campbell’s beverages, and we reached agreement with the Coca-Cola Company to distribute glacéau brands in the majority of our territory. This progress gives us a very strong portfolio of still brands that can seize increasing opportunities in fast-growing beverage categories.
The glacéau brands, which include Vitamin Water, Smart Water and Vitamin Energy, are powerful additions to our portfolio and we look forward to the opportunity to enhance their success beginning in early November. While there is still work to do to strengthen our portfolio, both in stills and sparkling beverages, these additions demonstrate significant progress towards our goal of being number one, or a strong number two, in every category in which we choose to compete.
We are executing against our second objective, which is driving improved customer service by transforming our go-to-market model and improving efficiency and effectiveness, and we are doing this by quickly moving forward with several key programs in both North America and Europe.
For example, in North America, customer centered excellence is driving both effectiveness and improved customer service, and we are continuing to focus on scheduling, route productivity, warehousing and vending to achieve greater sales -- greater levels of efficiency.
In Europe, we are moving forward with initiatives to restructure components of our operations across our territories, which includes integration of CCE’s European supply chain functions.
These brand and go-to-market improvements, coupled with our commitment to attract, develop, and retain a talented, diverse, workforce are the central elements of our drive to improve operating fundamentals and strengthen our ability to reach our long-term financial targets.
We continue to believe our business can generate revenue growth of 4% to 5%, operating income growth of 5% to 6%, and high single digit earnings per share growth. We look forward to sharing more details about our progress and our outlook for 2008 with you toward the end of this year.
One thing is certain -- reaching these targets consistently is essential to drive shareowner value, which is our single-most important priority.
Now let’s look at the results of the quarter and the short-term challenges and achievements in each of our operating territories.
In North America, our cost of goods per case remained high, up some 8.5%, as prices for both sweetener and aluminum continued to affect costs. As we have managed through these high cost increases, we have [made] a real serious ongoing focus on operating expense control.
These efforts have resulted in op-ex growth of 1% for the quarter and a decline of 1% for the first nine months, both on a comparable and currency-neutral basis, and including corporate expense.
Another key is our effort to manage net revenue per case and ensure that we realize the full value of our brand. Net revenue per case grew 6% in the quarter, as North American volume declined 2.5%. Our retail immediate consumption business declined a 0.5% in the quarter.
These results reflect continued volume challenges to our sparkling portfolio, which declined in a mid-single digit range. Although sparkling beverages continue to face obstacles to growth, we have initiatives in place designed to maximize the power of our brand and product, including our Red, Black and Silver execution program. Red, Black and Silver takes advantage of the Coca-Cola trademark and works to take full advantage of the strong consumer acceptance and interest in Coca-Cola Zero.
In fact, with the strength of Coca-Cola Zero, our Diet Coca-Cola trademark brand achieved third quarter growth of 0.5%. Overall, the initiative is performing better than planned and continues to create results that outperform the category.
Our energy drink portfolio also continues to perform well, with the combination of our Full Throttle and Rockstar brands achieving solid growth of more than 25% in the third quarter, as well as the year to date.
North American still beverages grew 2.5% in the quarter, driven by growth in Powerade Sports Drink, Dasani, and teas. Stills already represent about 20% of our North American volume and are continuing to grow. With the addition of the glacéau brand, we believe we are on track to develop the fastest-growing still beverage portfolio and to seize significant opportunities within this fast-growing segment.
Now, let’s turn to Europe, where volume declined 3%. We hurdled strong performance in the same quarter a year ago that was driven by favorable weather, as well as the introduction of Coke Zero in Great Britain and Belgium. This year, weak July sales heavily affected our third quarter results, as Great Britain endured its wettest summer on record, with many parts of the country experiencing major flooding.
Net revenue per case was essentially flat as we implemented strong promotional programs to mitigate soft volume conditions. Since July, we’ve seen improving trends and a return to more normal volume levels with essentially flat volume in August and low, single-digit growth in September.
Our outlook for the remainder of the year is positive and we anticipate a return to growth in the fourth quarter.
Today, I am pleased to note that we are hosting our call from London, where our Board of Directors at CCE has just completed its fall meeting. Both the Board and I have spent time with our European leadership team and in the marketplace. We are very pleased with what we’ve seen with the initiatives in place and with execution at the street level. We now know first-hand as a board that Europe remains strong with significant growth opportunities ahead.
Unquestionably, we are optimistic about the outlook for Europe, which remains profitable and has excellent opportunities for growth in both bills and sparkling drinks. For example, Coca-Cola Zero has continued to perform well, most notably in France, where volume is well above plan since its introduction earlier this year.
As the brand has done in other markets, Coca-Cola Zero in France is attracting new consumers to sparkling beverages, achieving strong repurchase rates and meeting our goals for low cannibalization of other Coca-Cola brands.
In stills, Capri-Sun Juices have performed well since we began distributing the brand earlier this year.
While in London, we’ve also seen excellent examples of our Boost Zone program, which originated in France and was expanded to Great Britain this year. Each boost zone helps create new opportunities for cooler placements and driving cold drink sales. We are also encouraged by the excellent progress in rationalizing our full service vending program, an effort that ultimately will enhance profitability for both our customers and ourselves.
As you can see, we are working very hard to build on our success in Europe, with a number of strong initiatives underway that will leave our business well-positioned for the future. For this positive direction, I want to thank Shaun Higgins, who has provided strong, effective leadership for the European group for several years. Shaun is leaving CCE at the end of the year and we will miss his passion for our business, his commitment, and his leadership. Shaun has effectively guided our European business through many challenges over the past few years and in the process, put together a strong, effective management team. We thank him for his efforts and wish him well in the future.
Replacing Shaun will be Steve Cahillane, who joins us from InBev, where he was Chief Commercial Officer. Steve has 20 years of global experience in the beverage industry, including time reporting to me when he was President of InterBrew in the U.K. Having worked with Steve at InBev, I know that his experience, his leadership, and deep understanding for the unique challenges and opportunities of our European markets make him uniquely qualified to lead our business in Europe. I look forward to working with Steve again.
So in closing, let me review a couple of key points; first, I am very encouraged by the direction we’ve taken with regard to strengthening our brand portfolio, most notably in North America, as well as the strong commitment of the Coca-Cola Company to meaningfully expand our brand and package portfolio. The addition of glacéau brands first in the United States with the potential for expansion into Europe, affords us the opportunity to compete fully in a fast-growing category and it creates additional flexibility in working to strengthen each of our brands.
Of course, there is much more work to be done, with needs including a significantly stronger tea portfolio in North America and a water strategy in Great Britain. But we have made good progress and I’m confident that together, we and the Coca-Cola Company are on the right path.
We look forward to continuing to work together in the years ahead as we further enhance our brand portfolio.
The second point is I continue to be impressed by the skill and dedication of our people as we work to create the strong, consistent results that will enable us to drive long-term shareowner value. We are working through a difficult period in 2007, with short-term operating challenges such as high North American costs, coupled with overall soft volume trends.
Yet despite these challenges, our team has moved forward quickly to implement important changes in the way we work. We’ve implemented programs such as customer centered excellence in North America and in Europe, we’ve restructured our full service vending program to improve service and enhance profitability.
These have not been easy steps and we’ve accomplished them through the skill and dedication of our employees. This work is impressive and I look forward to creating even more improvement in the months ahead.
Thank you for your time and attention, and now I’ll turn it over to Bill to give more details on our financial results and our outlook for the remainder of 2007.
William W. Douglas
Thanks, John. In the third quarter, we achieved earnings per share of $0.44, excluding $0.11 for the net impact of items affecting comparability. These items included a $0.04 charge for restructuring, land disposition gains of $0.03, $0.02 of benefit related to termination of a distribution agreement, and $0.10 for net favorable tax items.
Our results for the quarter reflect the combination of necessary pricing actions in North America, challenging operating conditions in Europe, and the continued success of our operating expense initiative, including the initial benefit from our restructuring efforts.
Operating expenses grew 3% on a reported basis. On a comparable, currency-neutral basis, operating expenses grew 0.5% in the quarter and are flat year-to-date.
Currency contributed approximately $0.03 to third quarter earnings per share growth and approximately $0.06 year-to-date. On a comparable basis, operating income was up 1% for the quarter, as North American operating income grew 4.5% while operating income in Europe declined 8% and corporate expenses declined 8%.
Revenue for the quarter grew 3.5%, with a revenue increase of 4.5% in Europe and 3.5% in North America. As John discussed, European volume declined 3% with flat, net pricing per case, while North American volume declined 2.5%. Net pricing per case in North America grew 6%, primarily due to higher rates as increases from the sale of finished goods, such as Campbell’s and Fuse, were offset by multi-pack water volume growth.
With a stable and rational pricing environment in North America, we continue to expect North American pricing growth for the year in a mid-single digit range, with volume down in a low single digit range. In Europe, we believe we will return to volume growth in the fourth quarter, with low single digit volume and pricing growth for the quarter and full year.
High North American pricing levels reflect the ongoing impact of the cost of goods environment. Cost of goods per case increased 8.5% in North America, driven by strong increases for both aluminum and sweetener. As we have discussed with you over the past year, these cost levels have created a very difficult operating environment in North America, with higher than normal pricing limiting our volume performance. Despite these challenges, we remain encouraged by our operating performance during the first nine months of this year.
Our operating expense controls are working and our restructuring initiatives are creating savings and enhancing service to our customers. In addition, our relationship with the Coca-Cola Company is enabling us to make meaningful additions to our brand portfolio. For example, we are seeing the benefits of our vending program in Europe, while in North America we are becoming more efficient and improving service to our customers through our customer centered excellence program.
In brands, we’re adding glacéau and building on the strength of Coca-Cola Zero in all of our markets.
These and other efforts demonstrate positive momentum that is reflected in our outlook for the fourth quarter, enabling us to raise our comparable EPS guidance for the full year to a range of $1.31 to $1.36. This includes a full year currency benefit of approximately $0.07 per share. This range excludes restructuring costs, which we continue to believe will total approximately $300 million, with most of this cost recognized in 2007 and 2008.
We continue to expect strong free cash flow and our current estimate is more than $675 million for 2007.
Over the past several years, we have used our free cash flow primarily as a means to reduce debt, enabling us to bring our debt level below $10 billion at the end of the third quarter.
This success, coupled with our long-term outlook, leaves us in our best position in several years to increase cash returns to shareowners. We are currently developing plans to accomplish this and look forward to sharing more details with you in the near future.
Now I would like to look ahead to 2008. While it is too early to provide specific guidance for next year, we do know that we will have the full year benefits of the addition of the glacéau, Campbell’s, and Fuse beverages. These products will have a significant impact, generating increased revenue while creating higher costs on a per case basis because of the mix benefit, or mix impact; however, adding meaningfully more gross profit.
We plan to reinvest a portion of these profits in our core business and in building our overall capabilities. This will strengthen our ability to reach our long-term growth targets beginning in 2008. As a reminder, these targets include annual revenue growth of 4% to 5%, operating income growth of 5% to 6%, with high single digit EPS growth and a 30-basis point improvement in return on invested capital.
We do have confidence in our ability to reach these targets, given the success of our operating and brand initiatives and our overall long-term directions. I look forward to sharing with you our 2008 outlook later this year and discussing the specific factors that will drive our performance.
So to summarize, we believe we have created positive momentum in our business, despite a difficult year, and that we are poised to achieve levels of growth next year in lie with these long-term targets.
Thank you for joining us today and Operator, now we’ll be happy to open the line up for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from Judy Hong of Goldman Sachs.
Judy Hong - Goldman Sachs
Good morning, everyone. My first question is just in terms of the pricing strategy in North America, looking out into 2008. I think last year you started to take prices up in the fourth quarter by about 3% to 4%. Are you starting to do that this year? And given just the potential for better cost outlook next year, would you emphasize more volume at the expense of pricing?
John F. Brock
Judy, I would suggest that Terry Marks address that question.
Terrance M. Marks
We’d said that as we took pricing last year in the fourth quarter, it was our intent to take enough pricing that we would be able to get through all of 2007 without taking another increase, and therefore would put us on an annual cycle where we would be moving in the first quarter. And we’ve been successful in doing that, so like you’ll see our net pricing for 2007 higher, as you did see it higher in the beginning of the year and it moderates as the year goes on, and that’s because of the fact that we are cycling this period now where we took it last year without an increase this year.
So we don’t anticipate taking any pricing at all in the fourth quarter and we do anticipate taking our 2008 increase midway through the second quarter.
Judy Hong - Goldman Sachs
Okay, and then Bill --
Terrance M. Marks
I’m sorry, Judy. First quarter.
Judy Hong - Goldman Sachs
Okay, and then Bill, just in terms of any preliminary comment about the cost outlook for 2008? I mean, Coke talked about, as a system, costs being flattish for next year. Can you just talk about more [specifics that you see] next year?
William W. Douglas
Yes, in some generalities, if you look at North America, our costs per case were up 8.5% in the quarter and we said previously that we expect full year to be 9% or so. That’s still the case, driven principally by aluminum and sweetener. As we look to ’08, the big drivers are going to continue to be aluminum and sweetener; however, the year-on-year increase will not be nearly as significant in ’08 as it was in ’07. However, I do think it will be somewhat higher for our business than historical norms of 2% to 3%.
In Europe, the situation is a little bit different. Our package mix is not as heavily skewed towards cans and we have a different sweetener system, with the HSDF in North America and Europe. It’s beet sugar and the overall cost environment in Europe would be a little bit less than historical norms of circa 2% to 3%. So overall, that’s what we see today and we have covered a part of our commodities for both corn and aluminum in 2008, so I think the variability of our forecast will be pretty accurate once we get towards the end of December and early January.
Judy Hong - Goldman Sachs
Thank you.
Operator
Kaumil Gajrawala of UBS, you may ask your question.
Kaumil Gajrawala - UBS Warburg
Thank you. Can you -- you’re taking on a lot of incremental volume in the next few months. Can you talk about what incremental costs you might -- particularly if there’s going to be any CapEx related, if glacéau keeps putting up these growth rates?
John F. Brock
Again, I’ll ask Terry to comment on that one.
Terrance M. Marks
We don’t anticipate any incremental capital spending in 2007 as a result of taking on these SKUs. We are very busy looking at alternatives from a supply chain standpoint more holistically as we move into 2008, and we’ve actually already begun that work in earnest.
With the increase in SKUs that we are experiencing now that are really coming to a head in the fourth quarter, it’s not a single event, as you know. I think it’s something that we’re going to have to learn how to thrive in as a way of life, so we are dealing with that pretty aggressively from a supply chain standpoint. But that said, I don’t see any material impact to capital spending in 2007.
Kaumil Gajrawala - UBS Warburg
That’s useful, thank you. And then, if I could ask a little bit, if you could provide a few more details on the boost zones and the rollout of the boost zones in Great Britain, and what maybe you’ve learned at France that you can transition easily over?
John F. Brock
We’ve learned that they work, which is the most important thing and we are very pleased with the IC business that is generated from this approach. And over the past year, we have walked the streets in Paris and other markets where we’ve had boost zones where typically one account manager will have anywhere from 180 to 200 plus accounts, and really get to know them and build on them with everything from coolers and immediate consumption equipment to other kinds of activities in that operation. And we’re finding that the business benefits are very meaningful.
So we’ve taken that same concept, we’ve done it now this summer. In Great Britain, we have 30 of them up and running and we have plans to put substantially more than that in Great Britain in 2008. So it’s an excellent program which you’ll see us continuing to expand. In France, I should say, we’ll continue to make them work harder and stronger. We’ve had a lot of learning and what we are realizing is you move from year one into year two, there is still more ground that you can cover in terms of just exploiting them even further.
So we are pretty excited about that.
Kaumil Gajrawala - UBS Warburg
Thanks, John.
Operator
Lauren Torres of HSBC, you may ask your question.
Lauren Torres - HSBC
Good morning. A few quick questions or clarifications on the U.S. in the quarter. You mentioned that your sparkling portfolio was down what, mid single digits?
John F. Brock
Yes.
Lauren Torres - HSBC
Okay, and could you talk about too, immediate consumption? I think you touched upon that at retail, but what we saw in immediate versus take-home in the quarter?
John F. Brock
Immediate versus take-home for the quarter -- Terry, do you want to -- I’m not sure I understand the question.
Lauren Torres - HSBC
As far as the performance of the, the volume performance or decline. I think you said in the immediate consumption channel, we saw it down 0.5% at retail -- that’s the number you gave us?
John F. Brock
Yes, well, full service was down meaningfully more than that because again, the total sparkling categories, we said was down mid-single digits.
Lauren Torres - HSBC
Right, but as far as looking at the future consumption channel, quarter over quarter, what are you seeing? Are the trends getting a bit tougher, or any signs of improvement there?
John F. Brock
Terry will take that.
Terrance M. Marks
Yes, I’m happy to take that. As we said, immediate consumption at retail was down about a half a point. We saw a significantly larger decline in future consumption, but remember future consumption is a much bigger part of the overall business, so it doesn’t have to be down much more than the total number to influence the total number.
What we saw was -- it was principally early in the quarter. The year-over-year performance in the month of July was really very soft for us in large stores. I can tell you that that’s not a trend that we saw continue through the quarter. Our business through the quarter, both actually from an immediate and future consumption standpoint, improved materially into August and continued to improve in September.
The early part of the quarter was particularly difficult. It was particularly difficult from a future consumption, large store standpoint, and there were a myriad of reasons -- everything from weather patterns in certain key markets for us to simply year-over-year promotional activity that had shifted out of the month and into other times of the year through a fairly lengthy list of a lot of other contributing factors.
But net net, the pattern did not play out through the balance of the quarter at all.
Lauren Torres - HSBC
Also too, you made comments with respect to the fourth quarter, seeing an improvement in Europe. Once again you’re cycling a tough comparison. Can you give us a sense so far in the fourth quarter what you are seeing that makes you a bit more comfortable that we’re going to see that improvement in the fourth quarter?
John F. Brock
First of all, the tough comparisons we had in Europe really were the third quarter, particularly because we had an excellent weather summer last year and we had World Cup activation and we had the launch of Coke Zero, so we had some -- and then this year, we’ve had the wettest summer in Great Britain in history.
The fourth quarter -- well, first of all, as we’ve moved into the end of the third quarter, our business throughout Europe began to pick up, and as we’ve moved now into October, it’s continued to pick up. As we look at the comparables for the fourth quarter, combined with our overall programs, we are confident that we are in a good position and that we will -- you know the fourth quarter should be much more like the first quarter.
Lauren Torres - HSBC
Thank you.
Operator
Bill Pecoriello of Morgan Stanley, you may ask your question.
Bill Pecoriello - Morgan Stanley
Good morning, everybody. Bill, I just wanted to cycle back on the COGS outlook for ’08. On the last conference call, you were a little bit more specific. You were saying above the two to three, you were looking in the three-and-a-half to four range, excluding the mix impact on glacéau. Is that the kind of levels you are thinking about still for ’08? And then, recognizing that you are still under negotiation with Coke on [inaudible] and concentrate, would you expect those negotiations to result in any material difference to that kind of three-and-a-half to four overall range?
William W. Douglas
I would say at this juncture, 4%-ish for commodities, excluding the impact from glacéau, plus/minus. That’s still what we’re seeing. And with respect to concentrate, we are in the final stages of 2008 planning. I don’t have a specific number yet but the concentrate price in both Europe and North America, we would expect to be below that number, roughly in line with inflation.
Bill Pecoriello - Morgan Stanley
And just on the revenue per case, as you are investing back against the portfolio, reinvesting some of those glacéau benefits you talked about, would you expect the revenue per case to lag those cost of goods sold increases in ’08?
John F. Brock
I’ll let Terry comment on the pricing.
Terrance M. Marks
On a per case basis, specifically within the sparkling category, we would expect to see pricing up in the low single digit range, modestly trailing the increases that we are seeing on a per-case basis in commodities.
Bill Pecoriello - Morgan Stanley
Thank you.
Operator
Christine Farkas of Merrill Lynch, you may ask your question.
Christine Farkas - Merrill Lynch
Thanks very much. Good morning. Terry, I’m wondering if you can follow-up a little bit on the pricing. You had some helpful comments on immediate consumption versus take home. I’m wondering how the pricing played out with respect to rate versus mix, as well as the immediate consumption pricing versus the take home pricing?
Terrance M. Marks
The majority of the pricing increase that we’ve experienced in the third quarter and for most of the year has been principally rate driven more than it’s been mix driven. And remember, we took pricing last year in the fourth quarter in October, so we -- as the year went on, we saw a higher year-over-year rates of pricing increase. We’ll continue to see that moderate as the year goes on, now that we’re lapping it going into the fourth quarter.
But the pricing, although it varies slightly from region to region within the country, and we plan it that way, it was relatively consistent in both future and immediate consumption.
Christine Farkas - Merrill Lynch
Okay, great. And you competitor talked about light traffic in C-stores. It doesn’t sound to me, based on your immediate consumption volume, that that was necessarily the case for you. Can you comment a little bit about that channel performance?
Terrance M. Marks
I think in fairness, we experienced pretty significantly light traffic in the convenience retail channel early in the third quarter. I think it was almost a tale of two quarters within the third quarter. The early part of the quarter was particularly difficult and we saw it most acutely in the convenience retail channel. That really did moderate, though, as the quarter went on and we ended the quarter really with a fair bit of momentum, which appears to be carrying over.
Christine Farkas - Merrill Lynch
Okay, and last question on Europe, if I might. There was a commentary about teas begin weaker this quarter year over year. I just want to understand if there is an underlying trend there or we’re just simply looking at tough comps from a year ago in that segment. Thanks.
John F. Brock
I don’t think there’s an underlying issue there. The tea category, we’re just off a little bit relative to a year ago.
Christine Farkas - Merrill Lynch
All right. Thanks so much.
Operator
Mark Swatzberg of Stifel Nicolaus, you may ask your question.
Mark Swatzberg - Stifel Nicolaus
Thanks. Good morning, guys. John, to what extent did the shift of this negotiation you had back in August in terms of shifting volume of glacéau over to you guys, to what extent did that allow you to kind of accelerate the conversation you are having now with Coke regarding their role in your performance next year -- the concentrate, marketing support -- do you go into ’08 with a little more visibility at this point in the year than you had because of that conversation?
John F. Brock
Well, it accelerated some of our conversations, yeah, it did. But we are still in the process of finalizing the ’08 business plan, so we sat down and I think had a very healthy, productive set of discussions on what moving glacéau into our system would look like and signed an agreement and we’re very pleased with the way it’s come out.
I think the way we would characterize that is we have a continually improving relationship with the Coca-Cola Company in terms of the fact that they’ve made some major moves in the brand portfolio in North America and as a result, we’re working with them across a whole series of arenas. We also have some things that we are working on in the sparkling category that we believe will be some helpful moves to our business in 2008.
So still a lot more work to be done, more planning to be worked out, but I would say that move did accelerate some of our discussions.
Mark Swatzberg - Stifel Nicolaus
And on that comment about sparkling, can you talk about Coke Zero? There’s obviously been different views about the level of channel representation you’ve gotten for that brand at this stage in its life. How much opportunity do you see for that brand here in North America?
John F. Brock
I’ll ask Terry to give you a little more color commentary, but the fact is we think Coke Zero is a big, big part of our success. It is a key part of the Red, Black and Silver strategy and our availability plan with Coke Zero is everywhere that we sell Coke, Coke Classic, we expect to sell Coke Zero. It’s really that simply and certainly as our theme throughout - well, actually throughout our entire business but I think you are specifically talking about the U.S., we are very optimistic about the way it’s going and plan to have it in all channels.
Just to be clear, I’m speaking about this from a Coca-Cola Enterprise standpoint, not from a Coke system standpoint. I think there are probably some places and bottlers in the U.S. where you might find it’s not quite as well represented as it is in our system. Terry, do you want to --
Terrance M. Marks
I think the only thing I would add to is that we are into year three now of Coke Zero in North America and the business is stronger than its ever been. We’ve posted growth of 50% in the most recent quarter, and so it is an integral part of our plans and sparkling now and in the future -- if anything, it’s gaining momentum.
From a channel representation standpoint, I think the big gap is probably in the whole area of food service and that’s really a question for the Coca-Cola Company. I mean, they have I think a very good strategy for what they do with their valves, but it’s just a very different game because you’ve got a limited number of valves and so therefore, clearly Coke Zero is not as ubiquitous in fountain as it is in bottle cans, but that’s to be expected and I think that may change over time.
Mark Swatzberg - Stifel Nicolaus
Great, thank you, guys and quickly, Bill, on restructuring, target is still 3,500 in terms of headcount reduction -- can you give us an update on where you are and when you get to that 3,500?
William W. Douglas
Yes, Mark, the overall objective is still a net reduction of approximately 3,500 associates. By the end of 2007, we expect to have achieved a net reduction of about 2,000, so well over halfway to the overall objective, with the vast majority of the ’07 reductions coming from North America, and a fair amount of those are through attrition as well.
Mark Swatzberg - Stifel Nicolaus
Excellent. Thank you, gentlemen.
Operator
Robert van Brugge of Sanford Bernstein, you may ask your question.
Robert van Brugge - Sanford Bernstein
Good morning. I have a question about the impact of glacéau on your 2008 business plan. How much cannibalization do you think there is going to be if you’re adjusting immediate consumption business as you roll out Vitamin Water in more and more channels? What will be the impact on your margin? For example, are you better off or worse off if you sell a 20-ounce Vitamin Water compared to a 20-ounce Coke?
John F. Brock
We’ll ask Terry to do both of those.
Terrance M. Marks
From a cannibalization standpoint, I can tell you that one of the things that is occupying a great deal of the time of everybody at Coca-Cola Enterprises right now is providing very clear channel segmentation direction to our field organization. It becomes more and more important as the scope of our portfolio continues to expand.
So we are taking very careful steps to give our organization direction on where and how to merchandise glacéau in such a manner that it does not create any operational cannibalization of sparkling soft drink. That’s for a variety of reasons. First and foremost, we believe that there is a role for sparkling soft drink. We believe that it is a big and vibrant category and an important category for us. But there is also the very near-term economic impact, which you’ve identified in your question, and the answer to that is yeah, it’s a transaction of a 20-ounce Coca-Cola Classic is significantly more profitable to us on a per unit basis than is a transaction of a bottle of Vitamin Water.
That said, they are both accretive to our total margin, but clearly sparkling soft drinks on a per case basis, the 20-ounce pack remains our most profitable pack.
Robert van Brugge - Sanford Bernstein
Thanks.
Operator
Bryan Spillane of Banc of America, you may ask your question.
Bryan Spillane - Banc of America
Good morning. Just two questions, one quick one, Bill, on your debt balances -- did you pay down some commercial paper in the quarter?
William W. Douglas
Yeah, we did have a net reduction. We have issued another refinancing of -- I think it was about $300 million in the quarter and we got some more that will probably be refinancing as well of our overall balance, but the net debt definitely increased in the quarter and we expect it to in Q4 as well.
Bryan Spillane - Banc of America
Okay, and so is the -- is the switch-out of commercial coming at a higher interest rate or is it not having much of an impact at all?
William W. Douglas
It’s not having a significant impact. Our weighted average cost of debt has crept up slightly year over year, I believe from 5.9% to 6.1%. Our current mix is about 81% fixed and 19% floating.
Bryan Spillane - Banc of America
Okay, and I know you’ll probably want to talk more about this when you are ready to talk about ’08, but when we are thinking about your interest expense heading into ’08, assuming that maybe the rate of debt reduction may not be at the same pace as it’s been, there shouldn’t be anything -- is there anything in the mix of your current debt and maybe the change of that that might influence rates up a little bit?
William W. Douglas
I think our current thinking, and it’s obviously depending on what the overall credit [rate] would do with our weighted average cost of debt creeping the level that it is at 6.1%, at this juncture, we don’t see a significant change year over year in that weighted average cost of debt. I think the main difference in our interest expense year over year will be a reduction in net debt balance. But we’ll give more guidance on specifics as we head into ’09.
Bryan Spillane - Banc of America
Okay, great, and then one more, if I could, for Terry; I guess it sounds like you are more than halfway through the restructuring program and I think, thinking back to when you first announced this, one of the -- I guess one of the questions that was raised was just, especially in terms of how it affected the way that you face the customer, was there a risk that there might be some sort of lapse in execution or some sort of negative response from customers, so if you could just talk a little bit about how much of the restructuring you’ve done so far has been at that frontline level. And if I recall it correctly, it was moving more customers to [tell sell].
Second, as you are setting up for ’08, is that part of the restructuring effectively done and just how you feel about where the organization is at this point.
Terrance M. Marks
It’s a massive initiative and it is something that -- we call it customer centered excellence. It is about that 26 -- actually a little bit more than that -- work streams that we’ve organized, again under this banner, customer centered excellence. And the focal point of the entire initiative is to remove waste from the business so that we can do two things concurrently; one, when waste is removed, customer service is improved, and so that by definition draws the top line. And when waste is removed, then costs are saved as well, and so that obviously contributes.
The combination of those two things creates or provides us with a fuel for reinvestment in the business. That’s the premise. It’s not a unique premise but it’s really a fundamentally sound one, and we are about halfway through.
You’re absolutely right. The work that we are doing now is in our sales center, so it’s really all of our customer-facing people are involved in this work, and you may recall I’ve talked in the past about how we staged the work in such a way that it was sequential. We effectively reorganized the business down to that customer-facing level first, so that we’d have the platform to go ahead and continue the work through to the customer, which is what we are doing now.
I guess the -- to make a long store short, we have some very specific metrics, both quantitative and qualitative. I mean, before we go into a market unit and we have 41 market units across the U.S., the process is an 11-week process per market unit for this transition of the changes we’re implementing. We do a pretty detailed customer survey before and after, from a qualitative standpoint, and then we have a number of metrics where we measure our performance from a quantitative standpoint.
All of that said, we are about halfway through, almost exactly halfway through the work and the returns, both from a productivity improvement standpoint, which have exceeded expectations modestly, and from a customer service standpoint, have been terrific.
The customers have received it very well. The only time that we’ve had a hiccup is when we have had problems communicating the intent of the initiative up front to a customer, and that’s simply a factor of the thousands of customers we have and relying on a lot of people to communicate the message. Occasionally the message is garbled and we’ll have to go back a second or third time.
But really, those are the exceptions, so net net, very successful, both quantitatively and qualitatively, and about halfway through.
Bryan Spillane - Banc of America
And do you expect to have most of the rest of these markets done before the summer selling season next year?
Terrance M. Marks
Just about the beginning of the summer selling season, yeah, we expect to wrap up right around the end of the second quarter.
Bryan Spillane - Banc of America
Okay, great. Thanks, guys.
John F. Brock
Operator, let’s plan to take one more question.
Operator
Our last question comes from John Faucher of J. P. Morgan.
John Faucher - J. P. Morgan
Good morning, everyone. Quick question on your guidance for ’08; if we take a look at the puts and takes you guys have talked about in terms of the benefits from the other brands and potentially from returning some cash to shareholders, and then you throw in the restructuring, if I marry that up with the comments about pricing being up less than COGS, it sounds as though you guys are planning on your core operating profit on your North American business to be down next year, but making up for it in some other ways. Is that the right way to read it? And do you think that gives you a competitive advantage as you head into ’08, where you don’t need to price as much as your COGS are going up?
John F. Brock
Just to make sure I understand your question, when you say profit down, are you talking about on our sparkling business?
John Faucher - J. P. Morgan
I guess that would be the case, yeah. I mean, if you look at your discussion of the algorithm in terms of getting up to the target with all these benefits you have, and then you look at the commentary on pricing being up less than cost of goods sold per case, if we strip out the other products, if we strip out restructuring, it sounds like you guys are thinking you might have a little bit of a core operating profit decline. And I guess what are the competitive implications of that? Does that make sense?
John F. Brock
Well, it depends again on what you’re defining as core. We clearly don’t plan to have an operating profit decline in North America in our total beverage business. We expect to have a -- and we will provide you a lot more info on this as we go forward, but if you are talking explicitly, specifically on sparkling, I think your premise is probably broadly right, yeah. But not on our total business --
John Faucher - J. P. Morgan
That’s fine.
John F. Brock
-- glacéau and the rest of the still piece, and it’s a very different picture.
John Faucher - J. P. Morgan
Okay, that’s pretty much exactly what I’m looking for. Okay. Thanks.
John F. Brock
Okay, well, thanks to all of you for joining us today. We are pleased that you took the time to listen to our conference call and wish everyone a very good day. Thank you. Take care.
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