Keurig Dr Pepper Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are in millions of dollars except per-share data. The DPS merger closed July 9, 2018; reported 2018 results include only 84 days of DPS operations, so comparisons with 2017 are not like-for-like.
Business context and financial performance
KDP combines Keurig’s single-serve coffee business with Dr Pepper Snapple’s beverage brands, manufacturing and distribution. Following the merger, it reported four segments: Beverage Concentrates, Packaged Beverages, Latin America Beverages and Coffee Systems.
| Metric | Q3 2018 | Q3 2017 | First nine months 2018 | First nine months 2017 |
|---|---|---|---|---|
| Net sales | $2,732 | $1,140 | $4,629 | $3,056 |
| Gross profit / margin | $1,361 / 49.8% | $555 / 48.7% | $2,324 / 50.2% | $1,485 / 48.6% |
| Income from operations / margin | $344 / 12.6% | $238 / 20.9% | $690 / 14.9% | $633 / 20.7% |
| Net income attributable to KDP | $148 | $116 | $320 | $235 |
| Diluted EPS | $0.11 | $0.14 | $0.32 | $0.29 |
| Effective tax rate | 23.7% | 28.2% | 25.4% | 30.0% |
Reported sales rose sharply primarily because DPS was consolidated after the merger; reported growth rates therefore do not represent organic or combined-company growth. On a non-GAAP adjusted pro forma basis, Q3 sales increased 2.9% to $2,856, operating income rose 14.3% to $697, and net income rose 39% to $414; adjusted diluted EPS was $0.30 versus $0.21. Pro forma nine-month combined sales were $8,207 versus $7,975, and adjusted net income was $1,039 versus $852. These measures are company-defined and should be considered alongside GAAP results.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $1,063, down from $1,321 in 2017; management attributed the decrease to working-capital changes despite higher net income. Capital expenditures were $104.
- Investing cash outflow was $19,070, mainly reflecting $19,124 of business acquisitions. Financing cash inflow was $18,084, principally from $9,000 of equity proceeds, $8,000 of notes, a $2,700 term loan and $1,386 of commercial paper, partly offset by debt repayments.
- At September 30, cash and cash equivalents were $94; cash including restricted amounts was $122. Current assets were $2,385 and current liabilities $5,967.
- Debt-related obligations included $14,275 of long-term obligations and $1,765 of short-term borrowings and current maturities, including $1,386 of commercial paper. The company had $2,395 available under its revolving facility and was in compliance with its covenants.
- Management said operating cash flows, cash on hand and available financing were expected to cover anticipated obligations for the next twelve months. Moody’s rated debt Baa2 with a negative outlook; S&P rated it BBB with a stable outlook.
Material changes, outlook and notable items
- The July 9 DPS merger was accounted for as a reverse merger, with Maple (Keurig) as accounting acquirer. JAB invested $9 billion; the transaction included a $103.75-per-share special dividend to DPS shareholders. KDP’s preliminary purchase accounting recorded $9,407 of goodwill and $20,404 of acquired intangible assets; allocations remained subject to measurement-period adjustments.
- Big Red was acquired August 31. KDP also agreed to acquire Core Nutrition for enterprise value of $525, expected to close by year-end 2018. In late October, it announced a long-term U.S. distribution agreement for evian.
- Management targeted $600 of annualized merger synergies, with estimated costs to achieve of $750 and program completion expected by 2021. Integration and restructuring charges were $86 for the first nine months; merger transaction expenses were $170.
- Q3 included an approximately $24 gain from a BODYARMOR distribution. Cost of sales also included a purchase-accounting inventory step-up; the filing cites approximately $131 in the acquisition note and $133 in MD&A.
- Management cited input-cost and logistics inflation, foreign-exchange exposure, integration execution and seasonal cash-flow variation as relevant factors. Coffee Systems’ prior-year comparison included an extra shipment week. KDP authorized a quarterly dividend of $0.15 per share, paid October 19, 2018.
- No formal earnings guidance is provided in the supplied filing text. Management noted that TCJA effects were still being evaluated and anticipated adoption of the new lease standard in 2019, with a significant balance-sheet impact expected due to lease commitments.
- Contingencies include the Keurig Proposition 65 coffee-acrylamide litigation, for which loss could not be reasonably estimated, and a Superfund site matter with cleanup costs not yet determined. Management reported disclosure controls effective, while integration of internal controls following the merger remained underway.
Investor facts to verify
- Use merger-adjusted pro forma results for combined-company comparisons; distinguish these non-GAAP measures from reported GAAP results.
- Track debt repayment, commercial-paper usage, refinancing needs and the negative Moody’s outlook, alongside covenant headroom and liquidity.
- Monitor delivery of the $600 annualized synergy target against the stated $750 cost-to-achieve estimate and integration timeline.
- Review final purchase-price allocations, particularly goodwill, acquired brands and intangible-asset assumptions, and the resulting amortization and tax effects.
- Follow Core’s closing and subsequent performance, as well as the outcomes and potential financial exposure of the Prop 65 and environmental matters.