COCA COLA CO quarterly report, Q2 FY2017

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Business context and reporting period

The Coca-Cola Company’s unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared with periods ended July 1, 2016. The company continued shifting from company-owned bottling operations toward a refranchised system; this structural change materially affected reported revenue and segment results. Unless noted otherwise, figures are in U.S. dollars.

Financial performance and position

MetricQ2 2017Q2 2016First half 2017First half 2016
Net operating revenues$9.702B$11.539B$18.820B$21.821B
Operating income$2.078B$2.859B$4.060B$5.000B
Net income attributable to shareowners$1.371B$3.448B$2.553B$4.931B
Diluted EPS$0.32$0.79$0.59$1.13
Operating margin21.4%24.8%21.6%22.9%
Gross margin62.3%61.3%61.9%60.9%
  • Q2 revenue declined 16% year over year and first-half revenue declined 14%. Management attributed the decline principally to acquisitions and divestitures, with a 3% favorable contribution from price, product and geographic mix and adverse currency effects.
  • Worldwide unit case volume was flat in Q2 and the first half; concentrate sales volume was flat in Q2 and down 1% in the first half. Favorable price/mix and lower commodity costs supported gross margin, but were offset in operating results by refranchising effects, impairments and currency headwinds.
  • First-half cash provided by operating activities was $3.391B, down 11% from $3.820B. Investing activities used $1.224B; financing activities provided $797M. Cash and cash equivalents ended the period at $11.718B.
  • At June 30, cash, cash equivalents and short-term investments totaled $22.734B; current assets were $38.961B and current liabilities $28.830B. Interest-bearing debt totaled approximately $49.638B, comprising $14.355B of loans and notes payable, $3.478B of current long-term debt and $31.805B of long-term debt.
  • Dividends were $0.37 per share in Q2, versus $0.35 a year earlier. First-half dividends declared were $0.74 per share. The company repurchased 50.8M shares in the first half for $2.189B.

Material changes versus the prior comparable period

  • The 2017 revenue decline reflects a major change in bottling-system scope, including North America and China refranchising; it should not be read as equivalent to a decline in consumer demand. The Bottling Investments segment’s Q2 unit case volume fell 46%, primarily due to divestitures and deconsolidation, including a 51% decline at CCR.
  • Bottling Investments reported a Q2 operating loss of $652M, versus operating income of $216M a year earlier; first-half operating loss was $762M, versus income of $98M. CCR-related impairment charges were a key factor.
  • Q2 other operating charges rose to $823M from $297M, including $653M of CCR asset impairments. First-half charges were $1.131B, including $737M of CCR impairments and $226M for productivity and reinvestment initiatives.
  • Other income, net, was $203M in Q2 2017, versus $1.133B in Q2 2016, which included a substantial gain on deconsolidating German bottling operations. First-half other income, net, changed to a loss of $351M from income of $791M; 2017 included North America refranchising losses and related charges, partly offset by a $445M gain on the combination of Japanese bottlers CCW and CCEJ.
  • Interest expense increased to $231M in Q2 and $423M in the first half, versus $162M and $303M, respectively; management cited higher rates on the debt portfolio and a $38M debt-extinguishment charge.

Outlook, management commentary and risks

  • Management said it expected substantial operating cash flow in 2017 and considered liquidity strong. It forecast an 18%–19% adverse full-year revenue impact from acquisitions and divestitures and expected currencies to weigh on revenue and operating income through year-end.
  • The company expected 2017 capital expenditures, net of disposals, of $2.0B–$2.5B, and approximately $2.0B of 2017 share repurchases, net of proceeds from employee stock-option exercises. It expected a 24% full-year effective tax rate before significant operating and nonoperating items; actual interim rates were 47.7% for Q2 and 38.1% for the first half.
  • The company planned to refranchise all U.S. company-owned bottling operations by year-end 2017. It also expected to complete the transition of ABI’s interest in CCBA and other agreed bottling transactions by year-end, subject to regulatory and minority approvals.
  • Productivity initiatives were expected to generate approximately $3.0B in annualized productivity by 2019; an April 2017 expansion targeted an additional $800M in annualized savings by 2019. These are targets, not reported results.
  • The IRS is seeking approximately $3.3B of additional federal tax for 2007–2009, plus interest, in a transfer-pricing dispute; the IRS has indicated it may assert penalties. Coca-Cola disputes the claim and says it expects no material impact, but notes an adverse outcome could materially affect results, financial position or cash flows. A Tax Court trial was set for March 5, 2018.
  • Other risks include foreign exchange exposure, political and economic instability in emerging markets, potential further asset impairments, seasonal and weather-related demand variation, and execution of bottling-system changes. Venezuela-related impairment charges were $14M in Q2 and $34M in the first half; the carrying value of related U.S.-dollar intangible assets was reduced to zero.

Important facts for investors to verify

  1. How much reported revenue and profit movement reflects refranchising and other structural changes versus underlying volume, price/mix and currency.
  2. Whether the remaining North America bottling refranchising proceeds and contingent payments support management’s expected recovery of transferred intangible value, and whether additional refranchising losses arise.
  3. Progress toward the 2017 revenue, currency, capital expenditure, repurchase and productivity outlook, alongside the effect of higher interest costs and debt levels.
  4. Developments in the IRS transfer-pricing case, including potential interest or penalties and the March 2018 trial schedule.
  5. Whether cash generation and available liquidity remain sufficient to fund dividends, debt maturities, investment plans and strategic transactions.