At this time, I would like to welcome everyone to The Coca Cola Company's Financial Modeling Call. Today's call is being recorded. If you have any objections, please disconnect at this time. All participants will be on a listen only mode until the formal question and answer portion of the call. Participants will be announced by their name and company.
I would like to remind everyone that the purpose of this call 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. And now I would like to introduce Mr. Tim Leveridge, Vice President and Investor Relations Officer. Mr.
Leverage, you may begin.
Good morning, everyone, and thank you for being with us today. I'm also joined by Lee Coker, our Director of Investor Relations. Before we begin, I'd like to inform you that you can find webcast materials in the Investors section of our company website at www.cocacolacompany.com that support the prepared remarks today. 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 report. Some components of the outlook we will be talking about today are on a non GAAP basis.
Please see the earnings release we filed earlier today and the schedules we posted on our investor page for more information about these measures. Following prepared remarks this morning, we'll turn the call over for your questions. Now let's begin.
The purpose of this call is to go over
the outlook we provided today in more detail to help you better construct your 2017 2018 financial models. We recognize that there are a lot of moving pieces in our business over the near to medium term horizon and we therefore want to be as transparent as we can as to how to help you model out the various elements in your financial models for our company. So we'll plan to cover 2 main points. The first is the timing of the various structural items and then we will do a deeper dive into the impacts they will have on the P and L. We have about 20 minutes of prepared remarks and then Lee and I will open up the lines for your questions.
So turning to Slide 4 on the deck, you all have that in front of you. It will be important to follow along as we are going through the remarks. So I am going to pick back up where we left off from the earnings call earlier today. You'll recall a similar slide from that presentation with the waterfall of the various drivers of EPS. Now we'll be happy to take questions on the overall outlook when we get to Q and A, but the focus for this morning, for the prepared remarks at least will be on the middle column and focusing on the 5 to 6 points of structural headwinds of PBT.
We'll then cover off on implications for 2018, along with some commentary on the balance sheet impacts as we think longer term. So moving to Slide 5, before getting too deep into the numbers, I think it's important to level set on the timing of when the various refranchising transactions will impact our financials. So let's start with the 2 transactions that closed in 2016 that we'll be cycling this year. In May of last year, we merged our German bottling operations with CCE and CCIP to form Coca Cola European Partners. As that transaction closed in the Q2 of 2016, the impact from that transaction will extend through the Q2 of 2017.
In Africa, we merged our South African bottling and canners assets with SABMiller and Savco to form CCBA at the very beginning of Q3 2016. As such, the year over year impact will be seen in the operating results through the Q2 of 2017. On that note, I'd like to reiterate what Kathy mentioned this morning about Coca Cola Beverages Africa. The total outlook we provided today does not include any impact from the transition of ownership of CCBA or the acquisition of any other ABI territories. With that said, we expect these impacts to be minimal as we intend to account for these as discontinued operations, given our intent to refranchise as quickly as possible.
So turning on to the ongoing refranchising in North America. We closed transactions throughout last year and expect to significantly increase the transaction on closings in 2017. But as they will be closing throughout the year, you will see the year over year impact from these transactions extending into 2018. Finally, we announced in the Q4 of last year a definitive agreement to refranchise our company owned bottling operations in China. While this transaction is still pending regulatory approval, we've modeled the transaction to close at the end of the quarter.
Therefore, we would expect the structural impacts to begin in the Q3 of 'seventeen and continue through the first half of 'eighteen. So now let's move on to Slide 6. Let's walk through the consolidated financial impact based on what we've provided in our outlook this morning. We have said it a few times, but as a reminder, this represents our best estimates as of today and therefore the timing is subject to change. For that reason, we are providing the total expected structural impact in both 2017 2018.
Therefore, you can effectively model what any changes in timing this year means for the next year. So said in another way, changes in timing in 'seventeen will have a corresponding impact in 2018. In addition, for most of the guidance we will provide, especially at segment level relative impacts to the overall revenue and PBT ranges. This is to allow you to adjust your assumptions by segment if we ultimately need to update the total structural impacts at both revenue and PBT for the full year as we move through the year. As things move, we'll keep you updated so that you can adjust your models accordingly.
Another clarification to simplify how to look at things, I will sometimes be describing our structural forecast in terms of our operating segments or in terms of geographic segments. For purposes of this conversation, the geographic segment that I'm referring to is simply the combination of our EMEA, Latin America, North American, Asia Pacific and corporate operating segments. Do not worry, we are not creating a new operating segment for your asset model. It's just simply a way to talk about it. These explanations are intended to give you a better now let's turn to Slide 7, starting with the 2017 net revenues.
As we said on the call, we expect an 18 to 19 point headwind from structural items. This headwind is composed of 4 elements. 1st, the largest contributor is the reduction to net revenues in the bottling investment segment or BIG as we refranchise these operations to 3rd parties. 2nd, the reduced revenues in BIG come with a corresponding reduction in eliminations. 3rd, year 1 intercompany profit eliminations will flow through as a benefit in several of the geographic segments and then 4th, sub bottling payments will benefit the North American segment.
We will cover each of these 4 topics in more detail as we move through the call. At income before tax for 2017, we expect a 5 to 6 point structural headwind. In addition to what I just described at the top line flowing to operating income, income before tax will be impacted by incremental equity income and the portion of sub bottling payments for our North American businesses that come through the P and L at the interest income line. Building off this base of understanding, let's now take a closer look at how these refranchising impact how these refranchising transactions will impact our P and L. Turning to Slide 8.
Starting first with BIG, probably the simplest to understand is when we divest bottling operations, we'll see a reduction in net revenues and operating income. In the geographic segments, the refranchising transactions will result in tailwinds at revenue and operating income. However, that tailwind in the geographic segments is really driven by 3 components. 1st is sub bottling payments, and we also have intercompany profit elimination benefits. And then finally, the deconsolidation of our canners bottling operation in South Africa.
So let me go through those in a little bit more detail. So the first is on the sub bottling payments. For most of our North America refranchising transactions to date, we've entered into sub bottling payment arrangements for the intangible assets associated with the refranchised territories. These payments are initially flowing through the North America segment at roughly an even split between net revenue and interest income. In addition to sub bottling payments, the geographic segments will see a favorable impact from intercompany profit eliminations at the consolidated basis.
To illustrate this favorable impact, because it's a topic that I understand can be a little confusing, but to better illustrate this favorable impact, it may be helpful to consider our 2010 acquisition of the North American operations of CCE. The benefits we're seeing today are effectively the opposite of the headwinds we experienced at the time we brought CCE onto the books. When CCNA and CCE profit streams were combined, a certain amount of profit was eliminated in the consolidation process. That was because when we sell concentrate to our company owned bottlers, we're not able to recognize the concentrate revenue or profit until the bottling partner has sold the finished products manufactured from the concentrate to a 3rd party. So in effect, the concentrate profit in the bottler inventory must be eliminated for consolidation purposes.
As company owned bottlers are refranchised to 3rd parties, this elimination is no longer needed and therefore it is reversed during the period in which the transaction closes. This reversal results in a one time profit increase in the P and L flowing from revenue down to OI in the relevant geographic segment. Given the number of transaction closings in 2017, this amount will be rather significant, especially in the North America segment as we go through the year. And you will see the impacts in other geographic segments coming from those transactions, albeit to a lesser extent than that of North America given the relative sizes. Finally, the favorability in the geographic segments I've just described is partially offset by the deconsolidation of our canners bottling operation in South Africa.
This operation was previously included in the EMEA operating segment and was contributed to the formation of CCBA upon closing of that transaction. The impact of the Canars deconsolidation will be a reduction to both net revenues and operating income for EMEA through the Q2 of 2017. Finally, the last element to consider is equity income. As you would have seen over the past two quarters, the formation of CCEP and CCBA has resulted in incremental equity income. In addition, the refranchising transaction in North America with Arca Continental Natal will also have a structural impact from an equity income perspective.
This transaction, which includes the refranchising of territories in Texas and parts of certain neighboring states, will result in incremental equity income by virtue of a 20% stake in AC Bovidus, an entity that will encompass Arca's entire beverage business, including its Latin American and U. S. Territories. So now let's move to Slide 9. Now that we've talked you through the various elements across the segment, let's put them together at the total level, starting first with revenue.
What you see on this slide are 2 of the pieces I just referenced, the impact to BIG and the offsetting impact to the geographic segments. It is also important to consider the impact to revenues on eliminations as a result of these transactions. When we have company owned bottlers, the sales of concentrate to those bottlers are booked in the relevant geographic segments, but then removed in consolidations through eliminations, which is presented within the segment P and L. So as you think about modeling the impact of refranchising, you will need to reduce the net revenues of B. I.
G, but you will also need to reduce the amount of eliminations along with it. In terms of correlation between the BIG revenues and the amount of eliminations to model, looking at history will be a helpful approach. Historically, the revenue offset in eliminations has run about 20% to 24% to 25% of B. I. G.
Net revenues. However, this figure over the last few years has been higher than it was prior to the CCR move at the time when BIG primarily composed of bottlers in emerging markets. So it's important to keep this history in mind as you model the structural impact and eliminations. As we complete the refranchise, we'll move back to a bottling investment segment that is primarily composed of bottlers and lower net revenue per case markets and that will impact the amount of eliminations that you model in. Finally, remember that the revenue eliminations aren't offset to consolidated revenues, so a reduction in the amount of eliminations is actually a positive to consolidated net revenues.
The chart presented on Slide 9 helps to show the 18% to 19% decline in net revenues relative to what we just said. In short, the BIG revenues will decline more than the total of 18 and 19 point structural headwind. This will be offset by the reduction in eliminations that I just referenced and to a lesser extent the impact from the intercompany profit eliminations and sub bottling payments. Net net, these factors come together to form the estimated 18 to 19 point headwind. Moving now to the bottom line, let me summarize the comments I made from Slide 8.
For bottling investments, as you look at the total impact to PBT, it really reflects 2 components of divested operating profit that is partially offset by incremental equity income. In the geographic segments, net favorability at income before tax will result from intercompany profit elimination benefits and sub bottling payments, partially offset by the divestment of our in South Africa. In terms of relative size of the structural impacts by segment, we would expect the bottling investments impact to be about 1.3x to 1.5x the consolidated structural outlook we provided at PBT. Prior to moving on to 2018, let me spend just a few minutes highlighting the impacts on gross margin from refranchising for 2017 and beyond. We recognize that gross margin has been a challenge to model in 2016 and has thus complicated the ability to analyze our underlying margin trends.
At CAGNY last year, we talked about how refranchising would yield about 700 basis point improvement in gross margins once we finished refranchising, which makes sense as the bottling businesses we are divesting typically have a gross margin of between 35% to 40% relative to our much higher consolidated gross margin levels. In 2016, we did not see this impact primarily due to the phasing of transactions in terms of distribution rights versus production plants in North America. As we look out to 201720 18, we expect to see much more of a structural benefit to gross margins as the plants in North America should transfer at the same time as the distribution rights. Therefore, as you model the removal of bottler revenue, a 35% to 40% gross margin to pull out along with it is more appropriate. When you model out this impact, this is very important, is not to forget the intercompany sales elimination as this will impact consolidated net revenues but will have no impact on consolidated gross profit.
If eliminations are not taken into account, the resulting reduction to consolidated net revenues will be too high, which would yield implied margin expansion greater than what you should expect. So now let's turn 18 on Slide 11. At this time, we estimate a 16 to 17 point headwind in net revenues and a 1 to 2 point headwind on income before tax. The nature of the structural impacts for 2018 are similar to 2017 in terms of segment and P and L line item impact. A notable exception is the intercompany profit elimination flowing through the geographic segments.
As I mentioned before, the benefit from the reversal of the profit elimination is one time in nature in the period the transaction closes. Therefore, we will lap that benefit in year 2, resulting in a headwind when looking at year over year growth rates. So let's flip to Slide 12. A couple of other points to consider as you model 2018. 1st, based on our current hedging programs on hard currencies that extend into 2018 and assuming no change from today's spot rates, we would expect a low single digit currency headwind on income before tax in 2018.
2nd, given changes to our geographic business mix, the impact of currency and bottling transactions, we're currently forecasting a 2018 underlying effective tax rate of 26%. Similar to our 2017 tax rate forecast, this outlook does not take into account any potential tax reform in the U. S. Or in any of our other taxpaying jurisdictions. Now moving to Slide 13.
Before we move to Q and A, I'd like to give just a few considerations for 2017 balance sheet purposes. At CAGNY, in 2016, we presented a way to think about our capital balance going forward as we progress through refranchising. Specifically, we referenced the impact in terms of the CCR asset base, the China transaction, CCEP and CCBA. Let me provide an update to that perspective through a reminder of what has happened today and what we expect to happen over the next couple of years. For CCEP, that transaction closed in the Q2 of 2016.
As a result of that closing, we recognized a net gain of approximately $1,300,000,000 which was added to our investment in equity affiliates. The CCBA transaction closed at the very beginning of Q3 2016. Upon closing, we recognized a relatively minor net loss. As a reminder, this does not include any impact from the transition of ownership of CCBA or any of the other ABI territories. During 2016, we moved a portion of the CCR asset base off of our books in the closing of refranchising transactions and will continue to do so as we complete the refranchising in North America.
For 2016, we reduced the CCR asset base by approximately $2,500,000,000 This is in addition to the $2,000,000,000 we moved off the books in 2015. It is also important to consider the impact of the Arca transaction on that CCR asset base. As part of this transaction, we will effectively swap our Southwest operating unit assets for a 20% stake in the newly formed AC Babitas, the beverage business of Arca Continental. So while our refranchising of the Southwestern U. S.
Territories to Arca will reduce the CCR asset base, we will be recording an incremental equity investment on the balance sheet in their place, similar to what we did for CCEP and CCBA. This investment will be determined by the market price of Arca's stock at the time of closing. So until the transaction closes, we cannot accurately estimate what the net impact to invested capital will be. However, the best way to think about it is the removal of $12,000,000,000 CCR net assets that we referenced at CAGNY last year will come down by the amount of equity investment we book for AC Bobidas. Moving on, the refranchising of our company owned bottling operations in China will have an impact on the balance sheet and invested capital.
We currently expect these transactions to close in the first half of twenty seventeen depending on regulatory approval. We expect the cash proceeds of this deal to amount to approximately $1,000,000,000 and will be part of the company's cash prioritization process going forward. So prior to opening the lines for Q and A, I'd like to remind you that these slides I've gone through can be found in the Investors section of our company website. Also included in the slide deck posted on the site will be appendix slides that present summary charts of the total outlook we provided for
the
Your first question comes from Vivien Azer from Cowen and Company. Your line is now open. Hi, good morning. Thanks for the question.
Yes. Hey, Vivien.
So as I look at Slide 5, in particular, North America, we're going to have to build out orders, not just for 'seventeen, which we already have, but obviously for 'eighteen as well. Given some of the announcements that we heard in the Q4 where you guys were accelerating some of refranchising in North America, is it fair to say that that should be weighted to the
first half of twenty eighteen?
Well, to be clear, the announcements that we talked about, a lot of those have to do with signing definitive agreements. The actual impact on the P and L is going to start impacting when we actually close the transactions. And the outlook that we gave today is reflective of our best estimates of the closings of those at this point in time. So said another way, there is not the flow is not different than what we have discussed and what we would expect given the outlook that we gave for the Q1 and then for the full year. Now what we will do as we have been for each quarter, so as we get to the Q1 call and we give outlook for the Q2, we will provide an updated second quarter we will give an updated or give a 2nd quarter outlook on the refranchising impacts and the structural impacts at that point in time.
So you will be able to flow through it. And then if there is any changes to the full year structural impacts, as we get to the quarter, we will update those as well. Does that
make sense? It does make sense. That's perfect and I appreciate the transparency on this going forward. Have you guys provided updated number just in terms of like what percent of North America like you at least have a definitive agreement on?
So right now, we have on the definitive well, all in, if you look at the transactions and we announced this was out in the press release today. So if you look at the territories that have closed that we've signed definitive agreements and LOAs, that amount is roughly about 70% of the territories for CCR. In terms of transactions that have actually closed, it's roughly about 30% of our distribution territories. Sure. Thanks, Vivien.
And our next question comes from Kevin Grundy of Jefferies. Your line is now open.
Hey guys, thanks for the question.
Sure. No problem. Hey, Kevin.
A few from me, if you want. Tim, just going back to the CAGNY slides where you guys sort of grounded us is like 68% gross margins and 34% operating margin. And then given all the moving parts as we're looking out here to 'seventeen and 'eighteen, how should we be thinking about that, I guess, underlying improvements, structural changes, anything that you can sort of help us with there to sort of ground us with those 2 guideposts? And then I have a handful of follow ups.
Yes. So I mean I think the simple way to think about it, the headline on that with the expansion in gross margins and expansion in operating margins said around how North America flowed at that point in time. And so it will really start ramping up as we move through that. If you think about the CAGNY deck, what we gave was a 2015 pro form a as of those numbers. So we have not updated because obviously 2016 moved from the overall consolidated level.
So we have not updated those numbers as of now. But the right way to think about it is the overall magnitude of the change in both gross and operating margins, we would see that continuing to play out in 'seventeen 'eighteen.
Okay. All right. That's helpful. The tax rate, Tim, for 20 18, it's up to 26%, understanding there's a lot of uncertainty with respect to what's going on in Washington. But barring that, is that sort of the right go forward rate?
And what's driving that? Is this just geographic mix in terms of where profitabilities arrive?
That's correct. So the answer to your first question, yes. At this stage, the 26% is a rate that we feel like we can manage moving forward. The reason that it stepped up is, as Kathy said on the call, is it's primarily coming from the geographic mix, predominantly driven by the strength of the dollar. So as our foreign earnings have actually moved down because of the foreign currency translation in U.
S. Dollars, the overall tax U. S. Dollar tax base has shifted to the U. S.
Tax jurisdiction at a higher effective tax rate for the consolidated business. Now we have worked and leveraged strong tax planning strategies that have helped to mitigate some of those. But the cumulative effect of the overall pressure coming from the dollar has and the limitation of those tax planning strategies moving forward is forcing the tax rate up in 'seventeen and then again in 'eighteen.
Okay. One last one for me. Just broader, the industry so you guys are guiding now to the 3% organic. You started off about a year ago down at CAGNY. You guys suggested the industry growth rate was 5%, the guidance was 4% to 5%.
I'm just trying to what is the industry growth rate that is embedded in your guidance for fiscal 'seventeen? Is it 3% is it something sub 3? Because you guys generally have a pretty good track record of gaining market share. I'm just trying to understand how this category growth rate has trended understanding that the macro is difficult, particularly in LatAm where you guys had a lot of leverage. So just some commentary there to help me understand the industry growth rates and what's embedded in terms of market share and how much of the industry growth rate has driven the downward revision?
Is it all of it? Is some of it execution? And that's it for me. Thanks.
Yes. Kevin, great question. And I think number 1, it's important to be really clear about the 3% target for 2017 and recognizing that that is a consolidated number. So it includes both BIG and then our core business. And very similar to 2016 where the consolidated revenue grew 3 and our core business grew 4, we expect in 2017 the core business to outpace the overall consolidated number of 3 again in 2017.
So now if and I think in terms of comparing that from an industry perspective, it's more appropriate and it makes more sense to use the core number because obviously the mix of business and the revenue per case of BIG relative to the rest of our business skews that number. So using the core and looking at that relative to industry growth rates is a more and we expect in 2017 for it to again be in that 4% and we expect in 2017 for it to again be in that 4% range, driven primarily because of the macro environment, especially in developing and emerging markets, especially in developing and emerging markets, that that's how we're going to that's how we see 'seventeen playing out. So embedded in our assumptions is a level of market share expansion, but overall growing in relative to that 4% is the right way to think about it.
Okay. Thanks for the time guys. Appreciate it. Sure. You got it.
And our next question comes from Lauren Lieberman of Barclays. Your line is now open. Thanks. Good morning.
Hey, good morning, Lauren.
Just want to ask the phasing of productivity, if you can provide any color on remaining, what's remaining and how to think about that over the next 3 years and also reinvestment rates of that savings?
Sure. So if you look at what we've announced to date, and Muhtar referenced that, is we have about, call it, we did a little bit more than $500,000,000 in 'fourteen, $600,000,000 in 'fifteen, another $600,000,000 last year. So that gets you to a little over more than $1,700,000,000 on our $3,000,000,000 program. So that gives you kind of call it $1,200,000,000 1 point $3,000,000,000 remainder for the balance of the next 3 years. So you are talking a run rate of about $400,000,000 a year.
That's what we expect and built in as we think about 2017. In terms of reinvestment rates, obviously, we have talked a lot about the step up in marketing we did from 'fourteen through 'sixteen. We feel like we are now at a space where we do not need to drive incremental marketing moving forward against our base level. And therefore, you are going to see more of the productivity in 2017 drop to the bottom line and that's built into our overall guidance as you think about our outlook for 'seventeen, because probably the simplest way to think about it is you take that net revenue number and drop it down to an OI growth rate that is now we guided to 7 to 8 PBT, but recognized in that PBT number was a couple of points of headwind below the OI line. So probably the most effective way the best way to think about OI growing, call it, 9% to 10%.
So you have got 3 points of net revenue driving roughly 9 points to 10 points of OI. And so you are seeing a lot of that productivity flow to the bottom line.
Okay. And then Kathy had mentioned also that overhead, the sort of the structural excuse me, the stranded overhead that's being worked on concurrently. Correct. So that's like another $200,000,000 incremental to that $400,000,000 We should think about another, I think you said what, 200 basis points of benefits here?
Yes, the $400,000,000 that I just referenced does not include the $200,000,000 of stranded cost removal.
Okay. Okay. Great.
But in terms of I just want to be abundantly clear, not just for you, but for everyone on the call. The 9% to 10% OI growth that I referenced would include the couple of points of stranded cost removal as well. Just I just for abundance of transparency.
Okay, great. And then on the 34%, again grounding at 34%,
just to make sure I
was clear on your explanation there. So one is that, that was off of a different base that didn't include any kind of margin progress or productivity benefits experienced since. So when you meant rate of change, it was sort of apples to apples 15 to today, but I should theoretically adjust that higher for any kind of operating margin progress you've seen outside of structural?
Yes, that's correct. You also have to factor in FX into that assumption as well because FX, as you know, has been putting a lot of pressure on margins because of the differential of our international versus North America operating margins. But the fundamental point of what you said is accurate in that when I said the magnitude of change, meaning the magnitude is, again, the CAGNY presentation was assuming we took the business as of 2015 and pulled out the businesses we were selling. So that was a base so that base number, if you will, is going to continue to grow at an underlying you've got to factor in currency and all of that within that, but you're still going to be see a significant step up in operating and gross margins as we pull the rest of those businesses out.
Okay. And then last thing, sorry, if I was grounding myself to that 34% and then also knowing all the things you said that I then need to go back and adjust for, if you will, would I be thinking about that end state now being at the end of 'eighteen or is it kind of like mid 'nineteen because there's still flow through impacts of structural just given the timing of closures in 'seventeen?
No. The right way to think about it is, is that we intend to be done with the refranchising as the end of 'seventeen. So starting at 'eighteen, the operating margins are going to be on that steady state basis. The year over year growth rates are going to be are going to continue to be impacted, but the margins are going to be at the steady state in 2018.
Okay. So my full year 2018 can ground to 34?
Yes.
Okay. All right. Thank you so much.
Got it.
Okay. Your next question comes from Carolyn Levy of CLSA. Your line is now open.
Thanks. Good morning. Hey, Carolyn. Hi, thanks. Can you tell me what the gain in 2017 will be from the writing up of the concentrate inventories?
So it's the simple answer is it's about a it's a couple of points that are going to flow through at the consolidated level.
A couple of points of earnings growth, operating growth?
Yes, of operating income growth.
Okay. And that's
And as I mentioned on the call, that's primarily going to flow through the North America segment.
So it will be multiples of that in North America?
Yes, exactly. That's exactly right. And that's one of the reasons, frankly, we wanted to call it out because as this starts playing out, you are going to see growth rates in North America at the OI and PBT level much higher than the run rate has been. And so we just wanted to ground people to expect that. So because we knew eventually we're going to have to explain it.
So we wanted to take the time to explain it upfront.
And there are no other markets like China or South Africa, whatever, where you'd have the same thing?
There are. You'll see it in China and it will flow through in China. It's going to be much smaller because obviously the relative size of the transactions are much different. In the other territories, you will see it. Africa is a bit unusual because the benefit you would have seen is offset by the Canners deconsolidation or is more than offset by Canners.
And then for CCEP and yes, for CCEP, that's actually already happened. That was booked in 2016. Now we didn't get onto this in detail on the script because it gets even a little bit more confusing. But in the case of CCEP, not only did we did benefit from the Germany refranchising, but it was more than offset by having to do a similar type of elimination for all of CCEP because you basically have to do the same thing for equity investees. And so the benefit from Germany was offset by the overall impact for CCEP.
So that's why you didn't see it really hit the P and L at a significant level when you look back at the 20 16 numbers for EMEA.
Okay. Just to clarify, with Arca, will you be at 27.5 percent ownership or 20 0.5 percent ownership total?
So we'll have a 20% ownership in AC Bavidas and we'll still continue with our existing ownership at the parent company level, which is 8%.
Okay. And then, could you just break out interest expense, which moved up a lot even though there is some income from the butter sub payments. So what happened in the quarter so that we can understand what to expect going forward? And what should we look for interest expense net in 2017?
Hey, Caroline, it's Lee. Yes, I think if you look at Q4, I don't think that's a good number to use as sort of a run rate for 2017 on quarterly net interest expense. Part of what you saw in the 4th quarter was, for lack of a better word, sort of a one time impact related to some hedging activity and swaptions. So, I think going forward, I'd look at it's hard to say exactly what the interest expense is going to be. It will be definitely be a couple points of headwind or I'd say 1 to 2 points of headwind.
But I would not look at the Q4 as a good proxy for next year. I'd say maybe looking at about half of that was one time and half of it was sort of ongoing interest expense.
And that 1% to
2% headwind in interest expense is net of going forward would be net of the sub bottling payments coming in there?
Yes, that is a no, excuse me, to be clear. So the 2 point headwind and this is what I talked about when we got to the differential between the 7 to 8 PBTX structural number and we said there's about 2 points from below the line coming from net interest and the all other line item. So as Lee mentioned, call it, a payments in the period that they come in. That is in structural impacts, which we just walked through on the call. So in the 5 to 6 point overall PBT headwind, there is a benefit from the sub bottling payments in the year that they come in.
Now the growth, once they're in the base and they keep growing, that does impact the underlying net interest number. But the one time step up is actually flowing through structural impact.
Thank you so much.
You got it.
And our next question comes from Amit Sharma of BMO Capital. Your line is now open.
Hi, good morning everyone.
Hey Amit, how are you?
Good, thanks. Just a couple of quick questions. As we are looking at 2018 and perhaps even beyond that, what should the revenue we should be modeling for the B. I. G.
Division once all of the 3 franchising has completed in North America and in China as well?
We haven't broken that out because obviously those base businesses are going to be growing between now and 20, let's call it 2019 as we get to year over year. But I think we have given you enough at the structural impact line at the headline numbers to get to a pretty good ballpark range. So I think if you take the structural impacts we've given plus the incremental details we gave on the call with the fact that obviously the B. I. G.
Segment impact is going to be above in 'seventeen, it's going to be above the 18% to 19% impact. It's going to be more than that. And then you factor in another impact in 'eighteen, that will get you to a pretty good that should get you in the ballpark of what the number should be.
That makes sense. And then if I'm thinking the OI margin for BIG, is the elimination of the North America business, does that depress that margin structure even more or should I still be looking at a relatively flat margin sale?
Yes. I mean, I think probably the better way to think about it is what's going to be left. So you are going to have primarily India as the biggest driver in that and then Southeast Asia. And you would imagine in territories where we are in a growth mode overall, that margins are going to look different than they are in more developed territories as they are reinvesting in the business and growing it for the future.
Got it. And then one just on the call, James sort of talked about trying to overcome the strong dollar. What should we read from that statement? Is that something you're going to do something differently if we are in a structurally stronger dollar environment?
Yes. It's a great question. And I think the simple answer is that what James the fundamental message that James was saying is that we obviously ultimately have to drive U. S. Dollar EPS growth or comparable EPS growth.
That is what we are valued against and ultimately what our PE is set against. So his point was, we certainly need to manage our business for the long term and that includes having those to manage at the local level, recognizing that we compete with local players. And therefore, we have to keep in mind what local inflation levels are that sometimes move with U. S. Dollar currency and sometimes don't.
So we have got to factor that in. And then when we see a period of such long term U. S. Dollar currency growth and we have to take other corporate actions to drive and manage the business accordingly. So without going in and saying we are going to do X, Y and Z specifically, what I can say and what he is clear on is that he understands that in the face of headwinds that may be out of our control.
We need to do everything within our control to help offset that.
And without asking you for details on it, would that include changing your marketing spend in some of those markets or at a consolidated level along with corporate actions or
corporate expense volume?
Yes. I think, I mean, certainly, we're taking a hard look at every dollar we spend. And so as James referenced in terms of decisions, even in I mean the probably simplest example is to think of the Q4, although those were really more around end marketplace spend against pricing initiatives, it still holds true from a marketing perspective as well as where we do not think that we are going to get a return on our investment in the near or medium term associated with that, then we'll make decisions to either redeploy into other markets where we think we can get a better return. And if we don't see that opportunity, then that would drop to the bottom line and then look for opportunities in the future as macros get better or situations and dynamics in the marketplace change.
And just one more for Mike, Tim. You earlier talked about maybe the incremental spending between 14% and 16% on marketing that's sort of like gone away and the base is steady. I mean, if I think about all the statements about one brand strategy and is that now in the base? So if we think that you push a little bit harder on the one brand strategy, that's not going to lead to any incremental spend?
Well, I mean, don't forget, we've significantly increased our marketing spend over the last 3 years. And so that is now in our base dollar spend. And so it's about how do we effectively deploy that against all of our brands in our portfolio. I mean, we stepped up and we significantly supported our when I say one brand, there's 2 elements of that, obviously. There is the one brand that has to do a little bit more with the visual identity and moving the brands together and then there's the actual Taste the Feeling campaign launch.
And so the Taste the Feeling campaign launch in 2016 was supported by a very robust marketing platform across the board. And then as we continue to drive that campaign as well as look to roll out the 1 brand strategy in other markets, we'll pull all the levers and look to understand what is the best use of those dollars. But the point being is we have a good strong marketing base as of now. It's now then comes down to marketplace by marketplace decisions on how to best deploy against the portfolio of brands.
And our next question comes from Brett Cooper of Consumer Edge Research. Your line is now open.
Hey, guys. A few from the side. Stranded overhead costs, where do they sit today?
Well, they are in the BIG segment.
Okay. Any way that you can quantify or give us a sense of sub bottler payments, how much they are, so we can understand the moving pieces?
We are the simple answer is we're not breaking those out specifically. We've given you the total offsetting impact to PBT of all of those elements. But we are not breaking them out specifically because obviously then that has impacts on because it's against multiple bottlers that are involved. And so starting to give individual sub bottling payment estimates is not in the best interest. But you have enough at the consolidated level to know how to plan out the overall PBT impacts.
Okay. Last one from my side. For 'seventeen, you're saying 9% to 10% OI growth includes 2 points of stranded overhead, 2 points of write up and then some piece of roughly 4 point productivity benefit. And then we're talking about org sales up 3%. I think you guys said earlier more price than mix and flattish commodities.
Why is there not more leverage in the model?
So, I mean, in terms of if you think let's start first with the 3, all right. So we talked 3 top line revenue. That is going to drive some level of operating margin expansion associated with it and we saw it this year as well to your point about there's pricing associated with that built into it. You layer on 4 points. So let's assume that it's a couple points.
You layer on another 4 points of productivity. You are at that point in time, you are at 9% to 10% OI growth. There is a little bit of reinvestment taking place in the business and that gets you back down when you take the 9% to 10%, you back off the couple of points of stranded cost removal, you get that flowing through. So you are seeing the combination of both even if you back off a couple of points, you get to 7% to 8%, you Even if you back off a couple of points, you get to 7 to 8. You are still seeing 4 to 5 points flow through between the combination of pricing and then the productivity flowing down to
the bottom line. But
don't I always take also take out the 2 points from the write up of inventory?
No, no. That is in the structural that's an offset to the structural impact number.
So that will not be in your underlying number. So when you say 7% to 8%, that's not with the write up?
Yes, exactly. And thank you for asking that question because that's very important to clarify. That 2 point benefit of the intercompany profit benefit that we talked about on the call, that is netting against the overall 5 to 6 point structural headwind.
All right, perfect. Thanks. That makes a lot more sense.
Okay. Okay, got it.
Our next question comes from Steve Powers of UBS. Your line is now open.
Hey, good afternoon.
Hi, Steve.
So I just have one. And you've done a great job, I think, of clarifying the P and L moving parts. But on cash flow, when you presented at CAGNY last year and talked about the transition to future state coke, In addition to calling out the $800,000,000 of structural impacts to EBIT, you also said free cash flow would be more minimally impacted, I think only about 400,000,000 dollars And yet this past year in 'sixteen, free cash flow fell by $1,000,000,000 more than that, if my numbers are correct. So I'd just like some clarification on what's going on there in 2016? And should we expect free cash flow to recover back to or above that $8,000,000,000 level over the next few years?
And if not, why not?
Yes. So I think number 1, it's probably important to break out and talk about 'sixteen because there's elements of 'sixteen that on the base business that have an impact. Number 1 is we had a significant impact from currency flow through that in 2016. And then we also had some pretty significant pension payments that were made in 'sixteen that flowed through operating cash flow that impacted that number overall. So there were some offsets to that number that were not tied to the refranchising specifically.
And then as you think about it going forward, the overall premise of the fact that the free cash flow is going to reduce at a lower level than the OI still holds. So that's still the right way to think about it. And importantly, it's also I mean, from my perspective, the way I think about it is we're going to see not only a significant increase in the operating margins, we'll see a significant increase in the free cash flow margins because the other element that you have to play into that number is the CapEx. Now as we think about 2017, the overall CapEx guidance is still somewhat elevated versus what we talked about at CAGNY and that's simply because of the timing of the refranchising, especially in the plant. So we'll still have a certain base level of CapEx that's going to play through and that's why that CapEx number for 'seventeen is still higher.
But ultimately, as we move to 'eighteen and we've completely refranchised, that CapEx number is going to come down pretty significantly from there. And therefore, you're going to see the free cash flow number move up accordingly. So that's why 'seventeen is a little bit hard to look at just in and of itself and it's better to think about where we're going to be post 'eighteen or in 'eighteen and beyond. And then at that point in time, you're going to a business with a very strong free cash flow margin. And then as we drive top line growth against that and knock on wood and anything else I can get hold of, a dollar that stops moving against us at the rate it has been, it's going to be a highly cash generative business that's going to flow through.
Okay. That's helpful. And so the getting back to 90% to 100% free cash flow conversion is something we should expect, right? This 2016 was an aberration in that regard?
Yes. I mean, there were certainly with the pension payment alone, I would say that's not going to continue. We'll have pension payments from time to time, but that's not something that you would model in at that level into 'seventeen.
Okay. And then just one last thing. So as I think about the moving parts, so I get the CapEx comes out, but you also lose a good deal of depreciation and you're replacing some operating profit with equity income, which doesn't necessarily come carry with it cash. So where do we make up the difference? Is it just better working capital is going to plug a hole as we transition?
Yes, there's an element of working capital in that. Yes, I didn't obviously the CapEx number is going to come down. There obviously depreciation, D and A goes down, comes out with it as you mentioned. And so but the free the working capital number is one of it. And then, I mean, at the end of the day, there's is with the guidance that we gave, you are still going to flat see free cash flow coming out of the P and L and that's what we talked about at CAGNY and you are going to see that for sure.
But again, I don't want anyone to lose sight of the whole reason why we did this was not to end up with higher margin business is to, number 1, get back to the core of what we do well and then drive accelerated top line growth through the combination of the bottlers being in the hands of those that we are refranchising to, putting focus against that and then separately us focusing on what we do best, which is driving our consumer centric portfolio. So all of that put together drives an overall better cash flow outlook.
Okay. Great. Thank you very much.
You got it.
And our next question comes from Bill Chappell of SunTrust. Your line is now open, sir.
Hey, thanks. Hey, Bill. Good afternoon.
Good afternoon, yes.
Just a simple if I look at the 30% of the unsigned territories, what's the timeframe from LOA to a close? And then is there any chance that some of this falls into 2018?
So as of now, the outlook in the U. S. Is that we would intend to have all of those closed by the end of 'seventeen. So now the timing between DA and closing is going to vary. So there's not a standard number just to give you.
And the 30% so the 30% has been closed, but again, we have a lot that have reached the DA stage. And so there's just a matter of moving to the close. And then we obviously have to manage the timing of those relative to the overall pace and change for the year, the seasonality of the business, etcetera. But the teams, the Gantt charts that the teams have in front of them are, as you can imagine, number 1, very detailed and number 2, they are very comprehensive and everything as of now is pointing to a successful close by 'seventeen. Is there a chance it slips to 'eighteen?
I mean, of course, there's always a chance, but the team has the right plans in place and we're at this stage confident that that's going to happen.
And just going back to Vivien's question, I mean, I think what you're saying is there's very little chance of me or being able to model this quarterly in 'seventeen?
I think it would be very tough. I think probably the best thing to do is to have a full year number and then wait for us to give you guidance on the next quarter.
Got it. Just want to
make sure we're on the same page. Thank you.
And our last question comes from Bill Schmidt from Deutsche Bank.
Hey, just a very quick question. How much flexibility are the bottlers going to have on retail pricing once everything is closed? And I know it's sort of nascent to your question, but I asked because it seems like once this is done, you guys have no commodity exposure and sort of they kind of bear the brunt of it. So as you get changes in sort of like oil based commodities and things like that, are they going to be able to pass it through? Or are you guys still going to have like pretty good control and say over the retail price points?
Yes. No, I won't want to be crystal clear that we do not dictate retail pricing and this is how and this is how it works across multiple territories is, I mean that's part of the franchise process as we work together to define where and what the overall consumer outlook is. We work together to think about the right price pack architecture and then make recommendations to the bottlers. But ultimately, it's their decision to implement those and take pricing to the retailer per those agreements that they reach. Now in the U.
S, as we have talked about before, we do have arrangements where we have a national customer approach and that allows us to think about holistically about how we are working with our customers at Okay
Okay. That's super helpful. Actually, I lied. Just one on do you have any sense for what the pro form a cost of goods sold is going to look like? I'm trying to figure out what you guys are going to buy now that all the sort of volatile stuff seems like it's off your P and L.
Yes. So if you factor in at this stage, I think we have the updated slide in our investor overview. So our overall raw material impact for COGS, I'll have to double check. I want to say it's $4,000,000,000 but I need to reference that. But it is on our website.
I can get back to you on that, Bill. But it's around that range.
Okay. That's super helpful. Thank you, guys.
You got it.
All right. Bye bye.
All right. Thanks, Phil.
And now I would like to turn the call back to Tim for your closing remarks.
Yes, you got it. And I know there may be other questions. Do not hesitate to call us post the call. So that will conclude the call. We hope the content has been beneficial and helpful for you as you think about the models.
As always, as I mentioned, please don't hesitate to give us a call. We will be happy to help. Thank you for your continued interest, your investment in our company and joining us today. Thank you very much.
That concludes today's financial modeling call. You may disconnect at this time and have a good day.