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Coke's Disclosure Tangles

Apr 19

Written by: Jack Ciesielski
4/19/2005 6:33 AM

Today the SEC and Coca-Cola announced the settlement of antifraud charges in connection with its channel stuffing escapades in Japan. The SEC has been on something of a tear lately: EasyLink, Chancellor, Global Crossing, and now Coca-Cola. The docket is emptying fast.

Between 1997 and 1999, Coca-Cola engaged in what it called "gallon pushing" (a more industry-specific term for "channel stuffing") on its Japanese bottlers. Typically, the amount of concentrate inventory on hand at bottlers matches the expected level of finished product needed at the retail level. Coke enticed the Japanese bottlers to buy more concentrate than they needed, by offering generous credit terms on the products. Instead of the normal eight days of credit, Coke offered bottlers up to thirty days to pay. At the end of 1999, the bottlers' inventory was 62% higher than at the beginning of 1997 its peak the growth in inventories. Comparable sales growth? 11%. That's some gallon pushing.

The products Coke pushed - Georgia Coffee and Coke - were two of the most popular Japanese beverages Coke sold, and two of the most profitable. Coke got the most bang for its gallon pushing buck in terms of meeting earnings estimates by focusing on these two. In the twelve quarters covered by the gallon pushing efforts, the income generated by the practice enabled Coca-Cola to meet consensus earnings in eight of those quarters.

It doesn't take a degree in beverage management science to see the problems Coke created for itself. By employing the flawed practice, the firm started off every quarter with a sales deficit - which could only be cured by more gallon pushing. The practice actually became ingrained into the firm's business plans - but investors couldn't tell. To them, hitting the earnings targets meant business as usual. According to the administrative proceeding, "At no time between 1997 and 1999 did Coca-Cola disclose any information from which investors could determine the existence of gallon pushing, the impact of such gallon pushing on current income, or the likely impact of gallon pushing on future income."

More misleading information: in January 2000, Coca-Cola management had had enough of gallon pushing and embarked on a program to lower worldwide concentrate levels. In an 8-K announcing the decision, management portrayed the decision as the end result of a joint review of inventory levels with its bottlers. It wasn't - it was a unilateral decision by Coke. Furthermore, while the 8-K mentioned the expected earnings impact of $.11 to $.13 in the first half of 2000, it neglected to inform investors that more than $.05 was due to the Japan bottlers - where the gross profit impact was over five times more significant than anywhere else in the world.

Call it what you want - channel stuffing, trade loading, or gallon pushing - it isn't illegal to induce your customers to buy more of what they don't need. (You could argue that inducing customers to buy what they don't need is a tremendously valuable skill practiced in most businesses.) It's not even a genuine accounting gimmick: the sales were genuine and complete. The bottlers had never returned the stuff, nor did they have the right to do so. (Coke is not restating any past financial statements, either.) It's a dumb practice, for sure: avoiding the consequences of a revenue shortfall puts the firm on a treadmill to keep doing more trade loading to maintain the facade of growth; it's borrowing from the future to make today look good, and sooner or later there's a reckoning.

What got Coke into the soup actually wasn't gallon pushing, per se. No, it was the fact that the practice had a significant effect on earnings and future earnings - and they never mentioned it to shareholders even after it was an adopted part of their business practices. That's why the management's discussion and analysis exists in SEC filings. The message to managements: channel stuff if you like. But when you keep your shareholders in the dark about it, that's breaking the law.

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