The Coca-Cola Company — 2018 Q2 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 29, 2018, compared with periods ended June 30, 2017. Coca-Cola sells beverage concentrates and finished products globally and was continuing to refranchise bottling operations. The filing cautions that beverage sales are seasonal and can be affected by weather.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net operating revenues | $8.927B | $9.702B | $16.553B | $18.820B |
| Operating income | $2.727B | $2.037B | $4.538B | $4.000B |
| Net income attributable to Coca-Cola shareowners | $2.316B | $1.371B | $3.684B | $2.553B |
| Diluted earnings per share | $0.54 | $0.32 | $0.86 | $0.59 |
| Gross margin | 63.6% | 62.3% | 63.8% | 61.9% |
| Operating margin | 30.5% | 21.0% | 27.4% | 21.3% |
| Operating cash flow | — | $2.608B | $3.342B |
Reported revenue declined 8% in Q2 and 12% year to date, despite worldwide unit case volume growth of 2% and 3%, respectively. Management attributed much of the revenue decline to bottling divestitures and structural changes; its analysis also identifies favorable pricing/mix and foreign exchange, and a positive revenue presentation effect from adopting ASC 606. Reported profit and margins improved, with lower operating charges and a substantially lower effective tax rate than in 2017 contributing to the comparison. Q2 and six-month continuing-operations effective tax rates were 20.6% and 23.3%, versus 47.7% and 38.1% a year earlier.
Six-month operating cash flow fell 22%, to $2.608B. Capital spending was $612M; management reported capital expenditures net of disposals of $550M. Cash and cash equivalents were $7.975B at quarter-end, with short-term investments of $5.843B and marketable securities of $5.536B. Current assets were $36.024B and current liabilities $31.398B. Loans and notes payable, current maturities of long-term debt, and long-term debt totaled approximately $46.8B, compared with approximately $47.7B at year-end 2017. Interest expense rose 11% year to date to $471M. Dividends paid in the first half were $1.662B; the quarterly dividend was $0.39 per share.
Changes, outlook, risks, and unusual items
- Revenue comparability: Divestitures/refranchising reduced reported revenue growth by an estimated 15 percentage points in Q2 and 21 points for the first half. Adoption of ASC 606 increased reported revenue by $160M for Q2 and $351M for the first half versus the former accounting guidance, while reducing operating income by $47M and $48M, respectively.
- Portfolio changes: Coca-Cola sold its Latin American bottling operations during Q2. It acquired additional interests in bottlers in the UAE and Oman, gaining control of the Oman bottler. Coca-Cola Beverages Africa (CCBA) remained classified as discontinued operations and held for sale; quarter-end assets were $6.681B and liabilities $1.456B. In July, Canadian bottling operations also met held-for-sale criteria; the company expected to refranchise them in Q3 2018.
- Charges and other items: First-half other operating charges were $761M, including $450M of bottling asset impairments and $206M for the productivity and reinvestment program. Other income/loss included pension settlements, refranchising charges, a $52M impairment of an equity-method investee, and gains or losses on investments and foreign currency. First-half net income also included $115M from discontinued operations.
- Management outlook: The company expected 2018 full-year net revenue to be adversely affected by acquisitions and divestitures by approximately 17%. It expected unfavorable currency effects on revenue and operating income through year-end. Management estimated a 21% 2018 effective tax rate before further Tax Reform Act clarifications and unusual items, and forecast approximately $1.7B of full-year capital expenditures. It expected substantial operating cash flow and described near-term business prospects as strong. The productivity program was expected to generate approximately $3.0B of annualized productivity by 2019, with an additional $800M of annualized savings announced in 2017; the filing reports $3.303B of pretax program expenses incurred since inception.
- Tax and other exposure: The IRS transfer-pricing dispute for 2007–2009 involves a claimed potential additional federal tax liability of approximately $3.3B plus interest. The Tax Court trial concluded in May 2018; final post-trial briefs were due by February 2019. Coca-Cola disputes the IRS position, but disclosed that an adverse outcome, or similar adjustments for later years, could materially affect financial position, results, or cash flows. The company also had $627M of third-party debt guarantees, which it did not consider probable to require payment. Management said pending legal matters were not expected to have a material adverse effect overall.
- Tax reform and accounting: Accounting for the Tax Reform Act remained provisional. The company cited a $4.6B estimated one-time transition-tax liability and a $1.6B provisional benefit from deferred-tax remeasurement, subject to further analysis. It also recorded a $2.9B opening retained-earnings adjustment on adopting the intra-entity transfer tax standard. Adoption of the new lease standard in 2019 was expected to significantly increase lease-related assets and liabilities.
- Controls: Management concluded disclosure controls were effective as of June 29, 2018, and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Separate underlying volume and pricing trends from the significant effects of bottling refranchising and ASC 606 on reported revenue and margins.
- Track operating cash flow, working-capital movements, capital spending, and debt maturities; confirm the company’s liquidity and borrowing position as the year progresses.
- Monitor progress and sale terms for CCBA and Canadian bottling operations, including any resulting gains, losses, or changes to continuing operations.
- Follow the Tax Court decision and any developments in the $3.3B IRS dispute, as well as updates to provisional Tax Reform Act estimates.
- Assess whether projected productivity savings, currency assumptions, and the 2018 revenue and capital-spending outlook are being achieved.