The Coca-Cola Company — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended July 1, 2011; unaudited. Comparisons are with periods ended July 2, 2010. The October 2010 acquisition of Coca-Cola Enterprises’ North American business materially changed the company’s mix and scale, limiting direct comparability, particularly for North American revenue and margins.
Financial performance
| Metric (USD millions, except per-share data) | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net operating revenues | 12,737 | 8,674 | 23,254 | 16,199 |
| Gross profit | 7,748 | 5,719 | 14,316 | 10,703 |
| Operating income | 3,174 | 2,763 | 5,453 | 4,946 |
| Net income attributable to Coca-Cola shareowners | 2,797 | 2,369 | 4,697 | 3,983 |
| Diluted EPS | $1.20 | $1.02 | $2.02 | $1.71 |
| Dividends per share | $0.47 | $0.44 | $0.94 | $0.88 |
- Revenue rose 47% in Q2 and 44% year to date; management attributed much of the increase to the CCE North American acquisition and related structural changes. Worldwide unit case volume increased 6% in both periods.
- Gross margin fell to 60.8% from 65.9% in Q2 and to 61.6% from 66.1% year to date. Consolidated operating margin was 24.9% versus 31.9% in Q2 and 23.5% versus 30.5% year to date. The company cited the shift to lower-margin finished-products and bottling operations following CCE, as well as higher commodity costs.
- Q2 other income included a $418 million gain from the Arca–Contal merger; six-month other income also included a $102 million gain on the Embonor investment sale. These gains, partly offset by a $38 million investment impairment and other items, materially affected reported nonoperating income. Treat earnings growth with these unusual items in mind.
- Income tax expense was $990 million in Q2 and $1,588 million year to date; the corresponding effective rates were 26.1% and 25.2%. Management estimated a 24% full-year 2011 tax rate excluding unusual or infrequent items.
Cash flow, liquidity and debt
- Six-month operating cash flow was $3.642 billion, down 15% from $4.310 billion. Management cited larger pension contributions, a longer cash conversion cycle after CCE, restructuring payments and extended customer terms in Japan; lower tax payments partly offset these factors. Capital expenditure purchases were $1.190 billion.
- Cash and cash equivalents were $10.166 billion, and short-term investments were $3.705 billion at July 1, for combined cash and short-term investments of $13.871 billion. The company reported $4.557 billion of unused availability under $4.825 billion of credit lines.
- Loans and notes payable were $12.326 billion, current maturities of long-term debt were $2.486 billion, and long-term debt was $11.373 billion. The increase in short-term borrowings primarily reflected higher commercial paper balances; long-term debt declined partly because of repayments and reclassification to current maturities.
- Financing activities provided $30 million of net cash. The company paid $2.143 billion in dividends and repurchased $1.114 billion of shares under its repurchase plan during the first half. It planned at least $2.5 billion of share repurchases for 2011.
Material changes and management outlook
- The CCE acquisition made North America predominantly a finished-products operation, increasing reported revenue, distribution expense and commodity exposure while reducing margins. Integration and purchase-accounting effects also influence comparisons.
- Management expected full-year gross margin to remain below 2010 levels and estimated an approximately $700 million unfavorable full-year impact from higher commodity costs. North American retail pricing was expected to increase 2%–3% for 2011.
- CCE integration was expected to deliver at least $350 million of annual operational synergies when fully integrated; management expected $140 million–$150 million of net cost synergies in 2011. It estimated total integration costs of approximately $425 million. Separately, the company targeted $500 million in annualized productivity savings by year-end 2011, with approximately $500 million of total initiative costs.
- Expected 2011 capital expenditures were $3.0 billion–$3.2 billion. Management anticipated substantial operating cash generation and expected operating cash flow to benefit in the second half as North American finished-products operations’ seasonal working-capital pattern changed.
- Management expected foreign exchange to provide a mid-single-digit positive impact on full-year operating income, based on current forecasts and hedges.
- The Japan earthquake and tsunami resulted in $83 million of charges in the first half. The company estimated a $0.03–$0.05 reduction in 2011 diluted EPS, primarily in the second half; it had recorded no insurance recovery because a recovery was not yet considered probable.
Risks, contingencies and other items
- Risks include commodity-price and foreign-exchange volatility, seasonal demand and weather, integration execution, and economic, political and currency constraints in emerging markets. Venezuela’s bolivar exchange controls and hyperinflationary accounting remain exposures; the subsidiary held approximately $225 million of net monetary assets.
- The company reported $693 million of contingent guarantees of third-party indebtedness, including $337 million related to variable interest entities, and stated that payment was not considered probable.
- Aqua-Chem asbestos litigation remained unresolved. Coca-Cola said it could not estimate its potential loss; it cited insurance coverage but noted ongoing litigation with insurers. The CCE shareowner litigation settlement was approved and the cases were dismissed with prejudice.
- Management stated disclosure controls were effective as of July 1, 2011, with no material change in internal control over financial reporting during the quarter. The CCE business was still being integrated into the company’s control processes.
- The filing cautions that interim results are not necessarily indicative of full-year results; beverage sales are seasonal, with the second and third quarters typically strongest.
Most important facts for investors to verify
- How much of reported revenue and earnings growth reflects the CCE acquisition, rather than comparable underlying growth, and how margins evolve as integration proceeds.
- Whether the projected $140 million–$150 million of 2011 CCE synergies and the $500 million productivity-savings target are achieved, and what related costs remain.
- Whether commodity inflation approaches the estimated $700 million full-year headwind and whether pricing and hedging offset it.
- Whether operating cash flow improves in the second half as management expected, given pension funding, working capital and Japan-related credit terms.
- Progress against the $3.0 billion–$3.2 billion capital expenditure and at-least-$2.5 billion share-repurchase plans, alongside commercial paper balances and upcoming debt maturities.
- Developments in Japan, Venezuela and the Aqua-Chem matter, including any insurance recoveries or changes in estimated exposure.