Coca-Cola Bottling Co. Consolidated — Q2 2018 Form 10-Q
Business context and reporting period
The company distributes, markets and manufactures nonalcoholic beverages across 14 states and the District of Columbia, and describes itself as the largest independent Coca-Cola bottler in the United States. This unaudited filing covers the 13 weeks ended July 1, 2018, and the first 26 weeks of fiscal 2018; comparisons are to the corresponding 2017 periods.
Financial performance and liquidity
- Second quarter: Net sales rose 5.0% to $1.227 billion. Gross profit was $412.0 million, down 0.8%; gross margin fell to 33.6% from 35.5%. Operating income declined 59.6% to $19.7 million. The company recorded a $2.7 million net loss, or a $3.9 million loss attributable to the company; loss per share was $0.42.
- First half: Net sales rose 13.0% to $2.299 billion. Gross profit increased 4.0% to $776.9 million, while operating income fell to $0.7 million from $63.6 million. The company recorded a $16.3 million net loss, or a $18.1 million loss attributable to the company; loss per share was $1.94.
- Sales and volume: First-half bottle/can sales increased 11.6% to $1.911 billion. Reported physical case volume grew 9.4% in the first half, mainly reflecting acquired territories; organic volume rose 0.7%. In Q2, reported volume grew 1.8%, while organic volume declined 0.6%. Still-beverage bottle/can sales grew faster than sparkling sales in the first half.
- Cash flow: First-half operating cash flow was $57.2 million, versus $179.0 million a year earlier. Investing used $75.8 million, including $85.3 million of capital expenditures; financing provided $21.3 million. Cash ended the period at $19.7 million. The operating cash-flow comparison was affected by the prior-year $87.1 million Territory Conversion Fee and working-capital movements.
- Debt and liquidity: Long-term debt was $1.131 billion and capital lease obligations were $39.3 million at July 1. Net debt and capital leases, a company-defined non-GAAP measure, totaled $1.151 billion. Working capital was $180.0 million. The $500 million revolving facility had $100 million drawn; the company reported compliance with its debt covenants and said it had capital sources to meet needs for at least 12 months. The company intends to refinance principal due within the next year.
- Other metrics: Q2 interest expense rose 22.1% to $12.7 million. First-half dividends were $0.50 per share. First-half income tax benefit was $13.1 million; management cited nondeductible expenses, repeal of the manufacturing deduction and low pretax results as factors affecting the effective tax rate.
Material changes, outlook and risks
- Reported sales growth reflects the 2017 territory and facility acquisitions, as well as pricing, product mix and volume. Acquisitions contributed $312.9 million of Q2 sales and $587.4 million of first-half sales. Management cautions that acquired territories generally have lower margins and higher operating costs than legacy territories.
- Management attributed margin pressure primarily to rising commodity costs, a shift toward still beverages, lower margins in acquired territories and higher transportation costs. Pricing actions affected about one-third of Q2 sales volume; additional actions early in Q3 were expected to support margins. Management expected commodity and transportation pressures to continue through 2018.
- The company recorded $9.8 million of Q2 and $22.3 million of first-half System Transformation expenses, mainly IT-related. It expected another $20–$25 million in the second half, with substantial completion of system work in late 2018 and early 2019 and potential future cost synergies. It also recorded $4.8 million of Q2 severance and outplacement costs and estimated annual savings of $25–$30 million from workforce changes.
- Management estimated second-half 2018 capital expenditures of $75–$95 million and pension contributions of $10–$20 million for the year. Potential annual sub-bottling payments tied to acquired territories were estimated at $25–$47 million.
- Commodity exposure is significant: the company estimated that a 10% increase in relevant commodity prices would add about $56.2 million to costs over the next 12 months, assuming unchanged volume. A 1% increase in average interest rates was estimated to raise next-12-month interest expense by about $4.0 million.
- Acquisition-related contingent consideration was a $374.5 million liability, valued using significant unobservable assumptions; changes in forecasts or discount rates could materially affect reported noncash expense. The company also had $17.8 million of guaranteed cooperative debt, with maximum exposure including its investment of $31.3 million. Management said ordinary-course litigation was not expected to have a material adverse effect.
- Standard & Poor’s affirmed the company’s BBB rating but changed its outlook from stable to negative; Moody’s outlook was stable. The company reported no material change in risk factors from its 2017 Form 10-K. Disclosure controls were concluded effective as of July 1, 2018.
Important facts for investors to verify
- How much of future sales and volume growth is organic rather than attributable to acquired territories, and whether reported growth translates into improved operating profit.
- Whether pricing offsets commodity, transportation and acquired-territory cost pressures, and whether management achieves the projected workforce savings and future system-related synergies.
- Cash generation after working-capital needs and planned capital expenditures, alongside debt refinancing needs and the negative S&P outlook.
- Final post-closing adjustments for the 2017 transactions, and the sensitivity of the $374.5 million contingent-consideration liability and its future payments to assumptions.
- Exposure to commodity-price increases, customer concentration (the three largest customers accounted for approximately 25% of first-half net sales), and related-party arrangements with The Coca-Cola Company.