01—Abstract
Summary
Summary of the 10-K filed March 29, 1999. Cited figures are marked; the original filing is the authoritative source.
The Coca-Cola Company's 1998 Form 10-K shows a company that still earns extraordinary returns on a concentrate-based model, but with clear signs of slowing earnings momentum.
Net operating revenues were essentially flat at $18.8 billiona (versus $18.9 billion in 1997), and unit case volume grew 6% to 15.8 billion cases, helped by emerging-market expansion. Gross margin rose to 70% from 68% largely because the company sold previously consolidated bottling operations in Italy and shifted toward higher-margin concentrate sales. However, operating income was roughly flat at $4.97 billion, and net income fell about 14% to $3.53 billion ($1.42 diluted EPS) as 1997 included large one-time gains on bottler stock issuances and asset sales that did not repeat.
The stronger U.S. dollar reduced operating income by about 9%. Balance sheet and cash flow trends warrant attention. Free cash flow fell sharply to $1.27 billionb from $3.53 billion, as operating cash flow declined 15% and investment spending rose to $2.16 billion, including acquisitions of Indian and Russian bottlers.
Total debt climbed to $5.1 billionc from $3.9 billion, pushing net debt to $3.3 billion from $2.0 billion and the net debt-to-net capital ratio to 28% from 22%. Management still returned about $1.6 billion through share repurchases and raised the quarterly dividend to $0.16, while signaling a long-term intent to lower the payout ratio to 30% to free cash for reinvestment. Equity method investments in bottlers, notably Coca-Cola Enterprises (about 42% owned, with a fair value roughly $5.5 billion above carrying value), represent a significant hidden asset base.
Pending transactions could reshape the portfolio. The $1.85 billiond Cadbury Schweppes brand acquisition, the roughly $890 million Orangina purchase in France, and the Japanese Coca-Cola West Japan anchor bottler formation are all subject to regulatory approvals.
Year 2000 remediation costs are estimated at $130 to $160 million, and the company reports that it expects no material impact from the Euro conversion. The Brazilian excise tax assessment, roughly $530 million including interest and penalties, was dismissed at the first level but remains subject to a pending appeal, and management does not consider it material to the company's financial condition.
02—Key points
Key Highlights
- Net operating revenues were flat at $18.8 billion, while unit case volume grew 6% to 15.8 billion cases, with growth driven by emerging markets and the expansion of the bottling system.
- Gross margin expanded to 70% (from 68%) mainly due to the divestiture of consolidated bottling operations in Italy, shifting revenue mix toward high-margin concentrate sales.
- Net income declined 14% to $3.53 billion ($1.42 diluted EPS) as 1997 benefited from roughly $508 million in gains on bottler asset sales and $363 million in gains on equity investee stock issuances that did not recur.
- Free cash flow dropped to $1.27 billion from $3.53 billion, as operating cash flow fell 15% and investing outflows rose to $2.16 billion, including acquisitions of bottlers in India and Russia.
- Net debt increased to $3.3 billion from $2.0 billion (net debt-to-net capital of 28% vs. 22%), and the company repurchased $1.6 billion of stock while raising the quarterly dividend to $0.16.
- Pending acquisitions include the $1.85 billion Cadbury Schweppes beverage brands purchase and the ~$890 million Orangina acquisition in France, both subject to regulatory approval.
- Equity stakes in bottlers, especially Coca-Cola Enterprises (~42% owned), carry an estimated market value substantially above book value, with the company's listed equity investees showing roughly $6.4 billion of aggregate excess fair value over carrying value.
03—Questions
Frequently Asked Questions
Why did Coca-Cola's net income decline in 1998 even though gross margins improved?
The 1997 results included large nonrecurring gains of about $508 million from sales of bottling interests and about $363 million from equity investees issuing stock. In 1998, comparable gains were much smaller (about $27 million from stock issuance and roughly $230 million in other income, mostly from the Italian bottler sale). The stronger U.S. dollar also reduced operating income by about 9%, offsetting the margin improvement.
Why did free cash flow fall so sharply, and is it a concern?
Free cash flow (operating cash flow minus investing outflows) fell to $1.27 billion from $3.53 billion. Operating cash flow declined 15% to $3.4 billion due to a larger use of cash for working capital, while investing outflows rose to $2.2 billion from $0.5 billion because of acquisitions and investments in bottlers. Much of the investment is discretionary and aimed at long-term volume growth, but investors should monitor whether these returns materialize, particularly given the higher debt load.
How much debt does Coca-Cola carry, and is the balance sheet still strong?
Total debt rose to $5.1 billion from $3.9 billion, and net debt increased to $3.3 billion. Coca-Cola's long-term credit ratings remain strong at AA- from Standard & Poor's and Aa3 from Moody's, and interest coverage was a healthy 19 times. Current liabilities exceed current assets, which management describes as a normal consequence of its debt and share repurchase policies.
What is the company's dividend policy and how much does it return to shareholders?
The quarterly dividend was raised to $0.16 per share in February 1999, equal to an annual rate of $0.64, the 37th consecutive annual increase. Dividends paid in 1998 were $0.60 per share, a 42% payout ratio. Management intends to gradually reduce the payout ratio to 30% over time to free up cash for reinvestment in the high-return beverage business. In addition, the company repurchased about $1.6 billion of stock in 1998.
What are the main legal and regulatory risks disclosed in the filing?
The principal disclosed legal matter is a Brazilian excise tax assessment against subsidiary Recofarma totaling about $530 million including interest and penalties. The assessment was dismissed by a Rio de Janeiro branch in September 1997, but the dismissal is subject to a pending ex officio appeal. Management believes the outcome will not have a material adverse effect. Other risks include the pending regulatory approvals for the Cadbury Schweppes and Orangina acquisitions, Year 2000 remediation costs of $130 to $160 million, and currency and emerging-market exposure.
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