Coca-Cola Bottling Co. Consolidated — Q3 2018 Form 10-Q
Business context and period. The company distributes, markets and manufactures nonalcoholic beverages across 14 states and the District of Columbia. It is the largest independent Coca-Cola bottler in the United States. This unaudited filing covers the 13 weeks ended September 30, 2018 and the first 39 weeks of fiscal 2018; comparisons are with the corresponding 2017 periods. Financial amounts below are in U.S. dollars; rounded to millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | First 3 quarters 2018 | First 3 quarters 2017 |
|---|---|---|---|---|
| Net sales | $1,211.7m | $1,162.5m | $3,511.0m | $3,197.5m |
| Gross profit / margin | $420.3m / 34.7% | $410.3m / 35.3% | $1,197.3m / 34.1% | $1,157.5m / 36.2% |
| Operating income / margin | $44.4m / 3.7% | $37.5m / 3.2% | $45.1m / 1.3% | $101.1m / 3.2% |
| Net income attributable to company | $25.2m | $17.3m | $7.0m | $18.6m |
| Basic earnings per share | $2.69 | $1.86 | $0.75 | $2.00 |
| Operating cash flow | Not separately reported for quarter | $26.0m | $202.4m |
- Q3 net sales grew 4.2%; bottle/can sales volume was nearly flat at 86.7 million physical cases versus 86.8 million. Organic case volume declined 0.4%, while organic net bottle/can sales rose 4.3%.
- For the first three quarters, sales increased 9.8% and bottle/can volume increased 5.9%, including substantial contributions from the 2017 territory acquisitions. Organic case volume grew 0.3%.
- Q3 operating income increased 18.5%, helped by $10.2m in exchange-transaction gains and lower system-transformation expense. First-three-quarter operating income fell 55.4%; attributable net income fell 62.1%.
- Q3 selling, delivery and administrative expense was $375.9m, up 0.8%; it declined to 31.0% of sales from 32.1%. For the first three quarters, expense rose 9.1% to $1,152.2m but eased as a share of sales to 32.8% from 33.0%.
- Cash from operations declined to $26.0m from $202.4m, largely reflecting the absence of the $87.1m Territory Conversion Fee received in 2017 and a $120.4m cash use from changes in current assets and liabilities. Investing used $106.0m, including $113.1m of capital expenditures; financing provided $72.5m. Cash decreased $7.6m to $9.3m.
- At September 30, current assets were $845.2m and current liabilities $558.6m, with net working capital of $286.6m. Long-term debt was $1,194.1m; capital lease obligations were $37.3m. Net debt and capital lease obligations were $1,222.1m, up from $1,114.6m at year-end 2017. Interest expense rose 22.9% year to date to $37.6m.
- Quarterly dividends were $0.25 per share for both common classes, unchanged from 2017; year-to-date dividends were $0.75 per share.
Material changes and unusual items
- 2017 system-transformation acquisitions contributed $308.8m of Q3 sales and $11.9m of Q3 operating income; year-to-date contributions were $896.2m and $14.6m, respectively. Comparisons also reflect 2017 divestitures.
- Pricing and mix lifted Q3 sales, but higher commodities, a shift toward lower-margin still products, and lower margins in acquired territories reduced gross margin by 60 basis points year over year. Management reported sequential margin improvement from the first half.
- Q3 included a $10.2m net gain from final post-closing adjustments to system-transformation exchanges. Year-to-date results also included $32.7m of system-transformation costs, $4.8m of workforce optimization costs, and $3.1m of unfavorable commodity-hedge mark-to-market adjustments.
- Reported year-to-date earnings are also affected by comparability items in 2017, including divestiture earnings and a $23.1m unfavorable fair-value adjustment to contingent consideration. Management presents non-GAAP adjusted results; these should be distinguished from GAAP results.
- The company’s $363.8m acquisition-related contingent-consideration liability is a Level 3 fair-value estimate tied to future sub-bottling payments. Management estimates annual payments of $25m to $47m; changes in discount-rate assumptions and projected territory results can materially alter noncash gains or expenses.
Outlook, risks and contingencies
- Management did not provide full-year revenue or earnings guidance. It expected $6m to $8m of system-transformation expense and $25m to $35m of capital spending in Q4 2018, with transformation costs expected to decline over subsequent quarters. It expected to begin distributing BodyArmor in part of its territory in Q4; management did not expect a material 2018 impact.
- Management said pricing actions and supply-chain efficiencies were priorities in addressing rising input costs. It cited mid-week July 4 timing as shifting volume between Q2 and Q3, and said Hurricane Florence’s identified incremental costs were immaterial. Territory integration, revenue management, product expansion, distribution costs and productivity remained priorities.
- The company had $330m of unused capacity under its $500m revolving credit facility, which matures in June 2023. It intended to refinance amounts due within the next 12 months, including $110m of 7% notes due April 2019, and said it had capacity to do so. It was in compliance with debt covenants. S&P rated the company BBB with a negative outlook; Moody’s rated it Baa2 with a stable outlook.
- A 1 percentage-point increase in average interest rates would raise estimated next-12-month interest expense by about $4.6m, assuming no change in capital structure. A 10% increase in relevant commodity prices could add approximately $56.5m to costs over 12 months, assuming unchanged volume.
- Other exposures include a $23.9m guarantee of South Atlantic Canners debt, with maximum exposure including the investment of $32.1m; $160.0m of future marketing-contract payments; and concentration in major customers, which represented about 26% of year-to-date net sales. Management did not expect ordinary-course litigation to have a material effect and reported no material change in risk factors from the 2017 Form 10-K.
- The company expected adoption of the new lease standard in fiscal 2019 to have a material balance-sheet impact; the income-statement impact was still under evaluation. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether pricing and cost-management actions can sustain revenue growth and recover gross margin as commodity, transportation and acquired-territory costs evolve.
- How much of reported sales growth reflects acquired territories versus organic performance, particularly after acquisition comparisons normalize.
- Whether operating cash flow improves after working-capital pressure and the nonrecurrence of the 2017 Territory Conversion Fee; monitor inventory and receivables.
- Refinancing and repayment plans for the 2019 notes and term-loan principal, alongside rising net debt, interest expense and the negative S&P outlook.
- The assumptions behind the contingent-consideration liability and expected annual payments, as well as commodity, pension and other contractual exposures.
- Execution and remaining costs of territory and CONA-system integration, planned capital spending, and the commercial contribution from BodyArmor.