Keurig Dr Pepper Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and comparability
KDP operates four reportable segments: Coffee Systems, Packaged Beverages, Beverage Concentrates and Latin America Beverages. The Dr Pepper Snapple Group merger closed July 9, 2018. Accordingly, 2019 results include the merged business, while reported 2018 results generally do not. Year-over-year comparisons of GAAP totals are therefore not like-for-like; management’s adjusted comparisons use pro forma 2018 results.
Financial performance
| Metric | Q2 2019 | Comparable Q2 2018 | First six months 2019 | Comparable first six months 2018 |
|---|---|---|---|---|
| Net sales | $2,812 | $2,822 adjusted pro forma | $5,316 | $5,355 adjusted pro forma |
| GAAP net income attributable to KDP | $314 | $83 reported; $323 pro forma | $544 | $171 reported; $534 pro forma |
| GAAP diluted EPS | $0.22 | $0.10 reported | $0.38 | $0.21 reported |
| Adjusted net income | $423 | $356 adjusted pro forma | $785 | $612 adjusted pro forma |
| Adjusted diluted EPS | $0.30 | $0.26 adjusted pro forma | $0.55 | $0.44 adjusted pro forma |
Q2 reported gross margin was 57.8%, versus 51.7% in the pre-merger comparison; adjusted operating margin was 25.0%, up 230 basis points from 22.7% pro forma. Adjusted Q2 operating income rose 9.7% to $702, while adjusted net sales declined 0.4%. For the first six months, adjusted operating income increased 10.1% to $1,323 and adjusted operating margin rose 250 basis points to 24.9%.
Management attributed adjusted operating growth primarily to productivity and merger synergies, partly offset by inflation in packaging, other inputs and logistics. Adjusted net sales reflected underlying growth of 2.6% in Q2 and 2.4% for the six months, more than offset by the expected effects of changes in the Allied Brands portfolio and, for the six-month period, unfavorable foreign exchange.
- Segment trends, Q2 adjusted comparisons: Coffee Systems sales increased 4.3% as reported; pod volume rose 12.8% and brewer volume 19.4%. Packaged Beverages adjusted sales fell 4.9%, mainly from Allied Brands portfolio changes, while adjusted operating income rose 18.0%. Beverage Concentrates adjusted sales rose 3.1% on pricing despite lower volume; adjusted operating income rose 4.2%. Latin America Beverages adjusted sales rose 3.7%, but adjusted operating income fell 23.1%, with lower volume and input/logistics inflation weighing on results.
- Q2 GAAP interest expense was $170, up $119 from reported Q2 2018, primarily reflecting merger-related debt. Adjusted interest expense was $138, down 21.1% from pro forma 2018, reflecting deleveraging and interest-rate swap gains.
- Q2 effective tax rate was 24.5%, compared with 13.3% in reported 2018, which included a tax-reform-related benefit. First-half effective tax rate was 25.6%, versus 26.9% reported in 2018.
Cash flow, debt and liquidity
- First-half operating cash flow was $1,203, versus $578 in 2018; investing cash outflow was $114, including $118 of property and equipment purchases. Financing cash outflow was $1,080, including $848 of term-loan repayments, $250 of note repayment and $423 of dividends.
- Cash, cash equivalents and restricted cash totaled $160 at June 30, 2019. Current assets were $2,221 and current liabilities $6,695.
- Short-term borrowings and current maturities were $1,806; long-term obligations were $13,164. The company reported $1,461 of commercial paper outstanding. It had $2,400 available under its revolving facility and an unused $750 364-day credit commitment; management stated total availability under these facilities was $3,150.
- Management said operating cash flows, cash on hand and available facilities should meet anticipated obligations for the next 12 months. It intends to use cash generation to deleverage rapidly within two to three years of the merger. Moody’s rating was Baa2 with a negative outlook; S&P’s was BBB with a stable outlook. KDP reported compliance with financial covenants.
Outlook, commentary and notable risks
- No specific quarterly or full-year earnings or revenue guidance is provided in the supplied filing text. The merger integration program targets $600 of synergies over three years, expects completion by 2021 and anticipates total cash expenditures of $750, including capital expenditures and expenses. Cumulative pre-tax integration-program charges were approximately $247 through June 30, 2019.
- Management cited seasonality, input-cost and logistics inflation, foreign-exchange exposure, supplier/customer credit conditions, continued merger integration, capital spending and dividends as factors relevant to operations and liquidity.
- The filing identifies exposure to coffee, packaging, aluminum, fuel, sweeteners and other commodities. A 10% exchange-rate change was estimated to affect annual operating income by approximately $32; a 1% interest-rate change was estimated to affect annual interest expense by $27.
- Keurig faces California Proposition 65 litigation concerning acrylamide warnings on coffee. The company could not reasonably estimate potential loss; significant penalties or warning requirements could be imposed. KDP also disclosed a dispute over early termination of a BA Sports Nutrition distribution contract; outcome and potential recovery were uncertain.
- The filing notes a February 2019 malware incident affecting Coffee Systems operations; related costs are excluded from management’s adjusted measures. The amount of the incident’s total operational impact is not clearly stated in the supplied text.
- Management concluded disclosure controls were effective as of June 30, 2019, while noting merger-integration work was reasonably likely to materially affect internal controls during 2019.
Important facts for investors to verify
- Use pro forma adjusted comparisons when assessing growth; reported GAAP year-over-year changes are substantially affected by the July 2018 merger.
- Track progress toward the $600 synergy target against integration spending, current charges and the 2021 completion timetable.
- Assess debt reduction, commercial-paper reliance, refinancing capacity and the negative Moody’s outlook alongside the company’s low cash balance and current-liability position.
- Monitor segment volume and pricing trends, especially Allied Brands changes, Coffee Systems mix, and Latin America Beverages margins.
- Follow outcomes and potential financial effects of the Proposition 65 and BA litigation, and any further disclosure about the malware incident.