Earnings Call Transcript - KO Q3 2022

Operator, Operator

At this time, I'd like to welcome everyone to The Coca-Cola Company's Third Quarter Earnings Results Conference Call. Today's call is being recorded. If you have any objections, please disconnect at this time. All participants will be on listen-only mode until the formal question-and-answer portion of the call. 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 any questions. I would now like to introduce Mr. Tim Leveridge, Vice President of IR and FP&A. Mr. Leveridge, you may now begin.

Tim Leveridge, Vice President of IR and FP&A

Good morning, and thank you for joining us. I'm here with James Quincey, our Chairman and Chief Executive Officer; and John Murphy, our President and Chief Financial Officer. We posted schedules under Financial Information in the Investors section of our company website at coca-colacompany.com. These schedules reconcile certain non-GAAP financial measures, which may be referred to by our senior executives during this morning's discussion to our results as reported under Generally Accepted Accounting Principles. You can also find schedules in the same section of our website that provide an analysis of our gross and operating margins. In addition, this call may contain forward-looking statements including statements concerning long-term earnings objectives, which should be considered in conjunction with cautionary statements contained in our earnings release and in the company's periodic SEC reports. Following prepared remarks, we will turn the call over for questions. Please limit yourself to one question. If you have more than one, please ask your most pressing first, and then reenter the queue. Now, let me turn the call over to James.

James Quincey, Chairman and Chief Executive Officer

Thanks, Tim, and good morning, everyone. After a strong first half of the year, we continued our momentum in the third quarter with effective execution across our global system despite a macro backdrop that remains challenging. In the face of these pressures, consumers stayed resilient, and we continue to invest behind our loved brands to drive value in the marketplace and growth in our business. Given our strong results year-to-date, and increased visibility into the rest of the year, we are raising our top line and bottom line guidance, while continuing to invest strategically. So this morning, I'll provide a business update and discuss how we are expanding the circumference of what we can control. Then I'll pass to John, and he will discuss financial details for the quarter, our revised guidance for the full year 2022 and some early considerations for 2023. During the third quarter, macroeconomic crosscurrents continued to impact the operating environment. The conflict in Ukraine is ongoing, which creates challenges in that country and beyond. And we saw renewed pandemic-related mobility restrictions in China. Inflationary forces are driving costs, pricing and interest rates higher, resulting in currency volatility in many parts of the world. Against this backdrop, our industry remains healthy and is growing both in value and volume, which continues to include some benefit from cycling COVID-related impacts from the prior year. In the third quarter, we delivered strong organic revenue growth across all operating segments. This was driven by pricing actions and robust volume growth. We had share gains overall and across most categories, as well as within both at-home and away-from-home channels. We accomplished this by investing in our business and providing the right portfolio of brands and packages to retain and add consumers. Notably, we drove revenue growth ahead of transactions growth, which is also ahead of volume growth in the quarter, reflecting the strength of our revenue growth management capabilities. Consumer elasticities in core categories have continued to hold up well. We are leveraging our consumer-centric marketing model and increasingly using digital engagement to link consumption occasions with passion points. Our system has never been stronger, and our global network model is allowing us to leverage the vast experiences of the system's leaders from various parts of the world. We are increasingly sharing learnings and generating faster responses to a changing environment through the right mix of local relevance and scale. Now recapping the third quarter performance across the world, starting with Asia Pacific. In India, we continued to strengthen in the first half of the year as we gained share in sparkling soft drinks. Trademark Coke delivered strong growth through effective execution and occasion-based marketing. Year-to-date, we drove approximately 2.5 billion transactions at affordable price points through the expansion of returnable glass bottles and single-serve PET packages. Sprite has grown to become a $1 billion brand in the market, driven by the success of locally adapted occasion-based global marketing campaigns. In Japan, we continue to strengthen our business amidst an inflationary environment. In China, we grew volume in the quarter and achieved strong growth in sparkling soft drinks. We remain focused on executing RGM strategies to drive outlet expansion and increase key SKU availability. In North America, we drove volume and value share gains through strong core sparkling performance, complemented by robust innovation and music-led experiential marketing despite intermittent supply chain challenges. The Coca-Cola Value Bundle, a collection of core sparkling offerings, is helping to retain and recruit more consumers while creating value for our customers. As we look forward beyond this year, we continue to see great opportunity for our industry. Our innovations have delivered strong results with more than 25% contribution to incremental gross profit year-to-date. Our pipeline is robust and we are excited about their unique consumer propositions. For example, Coca-Cola Creations is providing bold on-trend flavors designed to build both with younger consumers. Our innovations are designed with scalability in mind to further support our growth portfolio. We expect inflationary pressures to continue, so we are leveraging all the levers of RGM at our disposal. Our system is investing to grow our executional footprint, adding to what was already pervasive distribution resulting in availability of our products in nearly 2/3 of all outlets globally. These strong results are clear proof points of what is possible when our alliance system leans forward for growth. Underpinning all of this work is our purpose to refresh the world and make a difference. Sustainability remains an integral part of our business and strategy and is a key driver of future growth and business resilience.

John Murphy, President and Chief Financial Officer

Thank you, James, and good morning, everyone. Today, I'll comment on our third quarter performance and provide considerations for our updated guidance for this year. We are encouraged with the continued momentum of our business, and we delivered another set of strong results in the third quarter. We grew organic revenue 16%, unit cases grew 4%, with broad-based growth across most operating segments and targeted investments in the marketplace. Concentrate sales were in line with unit cases for the quarter. Our price/mix of 12% was driven primarily by pricing actions across operating segments, along with revenue growth management initiatives. Comparable gross margin for the quarter was down approximately 190 basis points versus the prior year. The underlying margin compression was approximately 60 basis points, with the rest of the impact coming from currency headwinds. We significantly stepped up our consumer and customer-facing investments to support our robust marketing agenda and strong innovation pipeline. Notwithstanding higher costs and continued investments in the marketplace, we expanded underlying operating margin by approximately 100 basis points, driven by strong top line growth. All in, third quarter comparable EPS of $0.69 grew 7% year-over-year. We continue to expect to generate approximately $10.5 billion of free cash flow for 2022, through approximately $12 billion in cash from operations, less about $1.5 billion in capital investments. The environment remains volatile, and while we are preparing for many futures in 2023, we did want to share some early considerations for next year based on what we know today. We are pleased with our results so far and have the visibility to deliver on our updated guidance, creating value for our shareholders through strong top line growth.

Bryan Spillane, Analyst

So I guess, John, I wanted to just pick up on your commentary about '23. We've got this question a bunch this morning about dollar earnings growth next year. So I just want to clarify, in your comments on those three objectives, does that apply to next year kind of based on where you sit now?

John Murphy, President and Chief Financial Officer

Thanks, Bryan. Yes, those comments were very much related to next year. We do see a path to generating U.S. dollar EPS growth next year. The cost outlook does remain more elevated than we are used to. But we've got a higher revenue, higher cost algorithm that we're looking to manage going into next year. We are very focused on finishing the year strong, starting fast and being able to deliver on those three objectives.

Dara Mohsenian, Analyst

So obviously, another set of strong top line results in the quarter. You also mentioned the underlying top line momentum. So just wanted to get a bit of an update, given the external environment, there's obviously a lot of concerns around weaker consumer spending and some of the pressure points out there.

James Quincey, Chairman and Chief Executive Officer

Yes. Thanks, Dara. The short answer is yes. We're seeing some changes in consumer behavior. Overall, in the third quarter, consumers remained pretty resilient and elasticities were at the better end of the spectrum. Clearly, there are some changes in consumer behavior going on. The pressure comes on purchasing power, and they tend to squeeze down the basket size per trip and look in some categories to perhaps trade down to some private label or smaller packages. You can clearly see that happening in a number of places. Our focus and confidence in our year-to-go and going into next year is about the momentum we've created in our business over the years.

Lauren Lieberman, Analyst

You'd mentioned the ability for the company to adapt more quickly than in the past. And I was intrigued by the example you gave of the value packs in North America that you've started to roll out. So I was curious if you could tell us a bit more about kind of how broad-based those are, the degree to which that's something that's being explored for other markets?

James Quincey, Chairman and Chief Executive Officer

Yes, absolutely. Ensuring affordability for the consumer is one of the core pieces of RGM. Around the world, that's what we're pursuing, whether it's in the U.S., having smaller bottles or smaller multipacks or in Japan, where we took the 500 ml and split it into 350 and 700. Those returnable bottles that we refill are a way of bringing the price points down and keeping the consumer in the category.

Steve Powers, Analyst

I guess just to drill a little bit further into the path to dollar-based EPS growth next year. Clearly, as we stand here today, there are a number of headwinds to overcome, and you've outlined and quantified some of them.

James Quincey, Chairman and Chief Executive Officer

The simple answer, Steve, is we're very dependent on top line momentum. We are going to continue to invest for the long-term health of the business and that's going to drive top line growth. Preserving and sustaining top line momentum is actually the key starting point.

Nik Modi, Analyst

If you can provide some context on other markets in terms of organizational priorities, whether it be some of your larger markets like in Japan or in Western Europe or Latin America. Maybe you can just share some thoughts on how you're thinking about some of the key initiatives in those regions.

James Quincey, Chairman and Chief Executive Officer

In Japan, we're very focused on marketing and innovation. It tends to be a market that's very driven by engagement with the consumer. Also, importantly in Japan, we've taken price on large packs in the third quarter. Our strategy is to invest in marketing, innovation, leveraging RGM and driving in-store execution and value for retailers.

John Murphy, President and Chief Financial Officer

Yes, as you know, we manage our funding with a focus on liquidity risk and a long-term perspective, and we have been doing this for many years.

Bonnie Herzog, Analyst

I have a question on your commodity inflation. John, you touched on this, but hoping you could help frame the commodity inflation expectation next year. And then I guess I'm asking in the context of the pricing environment.

John Murphy, President and Chief Financial Officer

When I think about the cost environment, not just the commodity environment, I think about both our commodities and the non-commodity pressures that we have. As we look at '23 on the commodity front, we are rolling off some very favorable hedges that we were fortunate to have this year.

James Quincey, Chairman and Chief Executive Officer

Yes, clearly, it's likely that next year price/mix will run ahead of volume in a similar way it has this year. Our long-term growth algorithm has assumed a relative balance between price and mix.

Andrea Teixeira, Analyst

Is that the way we should be thinking of next year, to a more muted EPS growth? Or you still think you can grow above low single next year in EPS?

John Murphy, President and Chief Financial Officer

The key takeaway is that as we sit here, we do see a path to generating U.S. dollar EPS growth in 2023. As I said earlier, there's many variables to bring that path to fruition.

James Quincey, Chairman and Chief Executive Officer

It's been driven by the work we've done as a system and the transformation we've undergone over the last few years. We are a more resilient business, and we're committed to delivering long-term value for our shareholders and stakeholders.

Operator, Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the call back over to James Quincey for any closing remarks.

James Quincey, Chairman and Chief Executive Officer

Thank you, operator. So just in summary, third quarter results exemplify how we're executing and winning in the marketplace. Thank you for your interest, your investment in our company and for joining us this morning.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.