The Coca-Cola Company — Q1 2020 Form 10-Q
Reporting period: Three months ended March 27, 2020, compared with the three months ended March 29, 2019. Unaudited results. The quarter began to reflect COVID-19 disruption; management cautioned that results are not necessarily indicative of the full year.
Financial performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net operating revenue | $8.601 billion | $8.694 billion | Down 1% |
| Gross profit / margin | $5.230 billion / 60.8% | $5.329 billion / 61.3% | Margin down 0.5 percentage points |
| Operating income / margin | $2.380 billion / 27.7% | $2.435 billion / 28.0% | Income down 2% |
| Net income attributable to Coca-Cola shareowners | $2.775 billion | $1.678 billion | Up 65% |
| Diluted earnings per share | $0.64 | $0.39 | Up $0.25 |
| Operating cash flow | $556 million | $788 million | Down 29% |
Net income and EPS benefited substantially from a one-time $902 million pretax gain on remeasuring Coca-Cola’s previously held fairlife interest when it acquired the remaining stake. The reported increase in earnings therefore does not reflect underlying operating growth alone. Other income also included a $392 million net loss on investment securities and a $57 million loss from economic hedging activities. The effective tax rate was 7.2%, versus 23.5% a year earlier; Q1 2020 included a $40 million tax benefit associated with the fairlife gain and other discrete tax items.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $13.561 billion; short-term investments were $1.713 billion and marketable securities were $2.392 billion. Together these totaled $17.666 billion.
- Total current assets were $28.234 billion versus current liabilities of $32.397 billion.
- Loans and notes payable, current maturities of long-term debt and long-term debt totaled approximately $50.393 billion at quarter-end, compared with $42.763 billion at December 31, 2019.
- The company issued $5.0 billion of long-term notes in March, with maturities from 2025 through 2050 and fixed rates of 2.950% to 4.200%. Financing cash flow was $7.810 billion, reflecting significant net debt issuance.
- Management reported $8.9 billion of unused credit lines and described liquidity as strong. On April 6, after quarter-end, the company entered into agreements providing access to $3.0 billion in term loans, subject to the stated election period.
- Cash dividends were not paid during the quarter; the first-quarter dividend was paid in early April. The board approved a $0.41-per-share quarterly dividend payable July 1, 2020.
Material changes and operating trends
- Worldwide unit case volume declined 1%; concentrate sales volume was flat. Management said concentrate shipments were about one point ahead of unit case sales, partly because bottlers built inventory amid COVID-19 uncertainty.
- Revenue was affected by a 2% adverse foreign-currency impact, offset in part by acquisitions and divestitures. Gross margin declined primarily due to currency effects.
- Regional unit case trends varied: North America grew 3%, Europe, Middle East and Africa and Latin America were flat, Asia Pacific declined 7%, and Global Ventures declined 2%.
- North America operating income fell to $387 million from $586 million, partly reflecting a $152 million trademark impairment. Global Ventures operating income fell to $19 million from $66 million, with Costa store closures cited as a COVID-19 factor.
- Other operating charges rose to $202 million from $127 million. Q1 2020 charges included the $152 million trademark impairment, $39 million for the productivity program and $11 million for fairlife contingent-consideration remeasurement.
- Fairlife acquisition cash consideration was approximately $979 million, net of cash acquired; the company also recorded an estimated $270 million liability for contingent milestone payments, which is subject to quarterly remeasurement.
Outlook, commentary and risks
- Management reported global volume declines of approximately 25% from the beginning of April, with nearly all of the decline in away-from-home channels. It expected the COVID-19 impact on Q2 volume to be material; the duration and full-year impact were unknown.
- The filing provides no specific full-year revenue, earnings or volume guidance. Management expected 2020 foreign-currency movements to weigh on revenue, operating income and operating cash flow. Its estimated 2020 effective tax rate was 19.5% before significant operating or nonoperating items.
- Management was reducing or reassessing marketing, travel, third-party and other spending, reviewing capital projects, prioritizing the dividend, and stated it had no current intention to repurchase shares or pursue significant M&A during the remainder of 2020.
- COVID-19 risks include continued away-from-home demand weakness, lower-margin channel and product mix, customer closures, supply and distribution disruptions, currency and borrowing-cost pressure, possible impairment charges, and effects on bottlers and suppliers. The company reported no material manufacturing or distribution impact as of the filing date.
- A longstanding IRS transfer-pricing dispute concerning tax years 2007–2009 remained in Tax Court. The IRS’s notice asserted approximately $3.3 billion of potential additional federal tax, plus interest; the company strongly disputed the claim. An unfavorable outcome could be material, and similar adjustments could be proposed for later years.
- The company stated that pending legal proceedings in aggregate were not expected to have a material adverse effect, but noted that outcomes in tax matters remain uncertain.
Important facts for investors to verify
- How much of reported earnings growth was attributable to the nonrecurring fairlife remeasurement gain, and how underlying operating results evolve.
- Whether the sharp post-quarter decline in global volume persists, particularly in away-from-home channels, and its effect on mix, margins and cash flow.
- Debt levels, refinancing needs, borrowing costs and liquidity as pandemic-related credit-market conditions develop.
- Potential asset impairments and contingent fairlife milestone payments, including changes in the underlying assumptions and valuations.
- The status and potential financial exposure of the IRS transfer-pricing litigation, including possible effects on subsequent tax years.