Business context and reporting period
Dr Pepper Snapple Group, Inc. (DPS) filed this unaudited Form 10-Q for the three months ended March 31, 2018, compared with the first quarter of 2017. DPS operated beverage concentrate, packaged beverage, and Latin America beverage businesses. The filing is from before completion of its proposed merger with Keurig Green Mountain’s parent, Maple; the planned combined company was to be named Keurig Dr Pepper Inc.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $1.594 billion | $1.510 billion |
| Gross profit / margin | $913 million / 57.3% | $903 million / 59.8% |
| Income from operations / margin | $259 million / 16.2% | $286 million / 18.9% |
| Net income | $159 million | $177 million |
| Diluted EPS | $0.88 | $0.96 |
| Operating cash flow | $103 million | $97 million |
- Sales grew 6%; volume (bottler case sales) rose 2%. Reported sales growth also reflected Easter timing, initial Canada Dry Lemonade shipments, favorable mix and foreign exchange.
- Gross margin fell 2.5 percentage points. Higher commodity and manufacturing costs and commodity-derivative mark-to-market movements were key pressures.
- Capital expenditures were $41 million; investing cash outflow was $68 million. Financing cash outflow was $73 million, including $104 million of dividends paid. Cash, including restricted cash, ended at $121 million, down from $158 million at year-end; unrestricted cash was $13 million.
- Total current and long-term obligations were $4.518 billion, including $4.212 billion of senior notes carrying value, capital leases and commercial paper. Commercial paper outstanding was $120 million. The $500 million revolver was undrawn, with $380 million available as reported.
- Current assets were $1.246 billion and current liabilities $1.624 billion. DPS reported compliance with debt covenants and believed operating cash flows, cash on hand and available facilities would meet anticipated obligations for the next 12 months.
Changes versus the prior period
- Sales increased $84 million, while gross profit rose only $10 million as cost of sales increased 12%, faster than sales growth.
- Operating income declined 9% and net income declined $18 million. A major comparison factor was the prior-year $28 million gain on the step-acquisition of Bai Brands.
- Reported operating income was $259 million versus $286 million; management’s non-GAAP “core” operating income, adjusted for mark-to-market impacts and specified transaction/integration expenses, was $283 million versus $301 million.
- The effective tax rate declined to 24.7% from 28.6%, primarily reflecting the U.S. Tax Cuts and Jobs Act. DPS had not completed its accounting for the Act’s tax effects.
- Operating cash flow improved modestly, but cash declined as capital spending and dividends used most operating cash. The prior-year investing outflow included $1.548 billion for the Bai acquisition.
Outlook, transaction, risks and unusual items
- No specific earnings or revenue guidance was provided. Management cited seasonal demand, generally stronger in warmer months, and said operating cash flows were expected to cover obligations over the next 12 months.
- The proposed Maple merger remained pending and subject to shareholder, regulatory and other closing conditions. DPS shareholders were to receive a $103.75-per-share special cash dividend at closing; former Maple equityholders were expected to own about 87% of the combined company and DPS shareholders about 13%. The agreement included potential $700 million termination fees in specified circumstances.
- Management expected substantial third-party indebtedness at the combined company. The transaction would trigger a change-of-control provision requiring an offer to repurchase certain notes at 101% of principal if specified credit downgrades occurred within 60 days. Ratings agencies had placed DPS ratings under review/watch for downgrade; DPS anticipated investment-grade ratings would continue.
- Merger-related transaction and integration costs were $12 million in the quarter. A financial-advisor fee was approximately $50 million, with $5 million paid for a fairness opinion and the remaining $45 million contingent on closing. Share repurchases were suspended under the merger agreement.
- Five federal lawsuits and one Delaware action alleged omissions or misrepresentations in the preliminary merger proxy statement; the company intended to contest the claims and did not expect pending legal matters to materially affect results, financial condition or liquidity.
- Other pressures and exposures include commodity costs, logistics and labor costs, foreign exchange, interest rates, seasonal working capital, and customer or supplier disruptions. A 10% foreign-exchange move was estimated to affect annual operating income by about $21 million; a 10% move in unhedged commodity prices was estimated to affect operating income by $18 million for the remainder of 2018.
- ASC 606 adoption reduced opening retained earnings by $35 million, partly offset by a $4 million increase from another accounting adoption; the combined opening retained-earnings reduction was approximately $31 million. DPS expected ASC 606’s ongoing annual net-income impact to be immaterial, but noted interim sales timing effects.
Important facts for investors to verify
- Whether and when the Maple merger closed, the final special dividend and ownership split, and the combined company’s post-close financing and credit ratings.
- Whether volume and sales growth persisted after accounting for Easter timing, product launches, foreign exchange and promotional activity.
- Whether commodity, packaging and logistics costs continued to compress gross margin, and how much mark-to-market volatility affected reported results.
- Cash conversion, working-capital requirements, capital expenditures and dividend affordability, particularly given low unrestricted cash and near-term obligations.
- Resolution and potential financial impact of merger-related litigation, termination-fee provisions and remaining contingent transaction costs.