Keurig Dr Pepper Inc. (then Dr Pepper Snapple Group, Inc.) — Q2 2018 Form 10-Q
Business context and reporting period. The filing reports DPS’s standalone, unaudited results for the quarter and six months ended June 30, 2018; it excludes Keurig and the Maple transaction. The merger closed July 9, 2018, and DPS was renamed Keurig Dr Pepper Inc. Because the transaction is accounted for as a reverse acquisition, Maple is the accounting acquirer and KDP’s future historical financial statements will be those of Maple for periods before closing.
Financial performance
- Q2 revenue and earnings: Net sales were $1.886 billion, up 5% from $1.797 billion. Net income was $235 million versus $188 million; diluted EPS was $1.30 versus $1.02. Income from operations declined 3% to $362 million.
- First-half results: Net sales were $3.480 billion, up 5%; net income was $394 million versus $365 million; diluted EPS was $2.17 versus $1.98. Operating income fell 6% to $621 million.
- Margins: Gross margin declined to 58.1% from 60.0% in Q2 and to 57.7% from 59.9% for the first half. Operating margin was 19.2% versus 20.9% in Q2 and 17.8% versus 20.0% for the first half.
- Cash flow and investment: First-half operating cash flow was $418 million, compared with $410 million. Investing used $179 million, including $79 million of capital expenditures, $73 million paid in connection with Bai, and an $18 million investment in Core. Financing used $296 million, primarily reflecting $209 million of dividends and $66 million of net commercial-paper repayments.
- Debt and liquidity at June 30: Long-term obligations were $4.126 billion, with $264 million of short-term borrowings and current maturities; cash was $64 million and restricted cash was $37 million. The $500 million revolving facility was undrawn and available at quarter-end, but was terminated when the merger closed. Current liabilities of $1.526 billion exceeded current assets of $1.416 billion.
- Segments: Q2 sales rose 4% in Beverage Concentrates and 6% in Packaged Beverages, while Latin America Beverages sales fell 2%. Packaged Beverages segment operating profit fell 24% to $148 million, despite higher sales; higher commodity, logistics, marketing and personnel costs weighed on profitability.
Changes, unusual items and management commentary
- Sales growth reflected favorable product/package and segment mix, higher volume, and increased contract manufacturing. Overall volume (BCS) rose 1% in Q2 and in the first half; branded non-carbonated beverage volume grew while carbonated beverage volume was flat or lower, depending on the period.
- Management attributed lower margins mainly to higher commodity costs, especially packaging, and an unfavorable LIFO provision; operating expenses also reflected logistics, marketing and people-cost increases. Management cited productivity improvements as a partial offset.
- Net income comparisons benefited from a lower effective tax rate following the 2017 U.S. tax law change: 25.9% versus 33.2% in Q2 and 25.4% versus 31.1% for the first half. The 2017 comparative period included a $49 million early-debt-extinguishment loss. First-half 2017 also included a $28 million gain on the Bai step acquisition, making operating-income comparisons less favorable in 2018.
- Q2 other operating income included a $16 million remeasurement gain on DPS’s Big Red investment. On July 9, KDP agreed to acquire Big Red for an estimated $300 million.
- The merger consideration included a $103.75-per-share special cash dividend, payable July 10, funded primarily by a $9 billion equity contribution, $8 billion of Maple notes, and cash on hand. Former Maple holders own approximately 87% of KDP on a fully diluted basis. DPS’s unvested awards vested at closing; the filing says associated compensation costs would be accelerated.
- At closing DPS assumed Maple financing arrangements including a $2.7 billion term loan and a $2.4 billion revolving facility, and assumed $8 billion of Maple senior notes. The filing does not provide a completed purchase-price allocation or a full post-merger pro forma balance sheet.
- Outlook and risks: No numerical earnings or sales guidance is provided. Management said operating cash flows should meet anticipated obligations over the next 12 months. Risks discussed include substantial post-merger debt, commodity and foreign-exchange exposure, seasonality, customer demand, and access to credit. Moody’s and S&P had downgraded DPS’s ratings in May, though they remained investment grade; management expected the combined company to remain investment grade and avoid a change-of-control repurchase offer.
- Five merger-related proxy disclosure lawsuits were pending; a separate Delaware appraisal-rights case was decided in DPS’s favor, with the appeal period expired. Management did not expect pending legal matters to have a material adverse effect. Management reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- Post-merger debt, interest expense, refinancing plans, credit ratings and available liquidity, including the effect of the special dividend and assumed Maple financing.
- The purchase-price allocation, goodwill and intangible-asset valuations, and resulting amortization once finalized.
- Whether sales growth can offset commodity, logistics, marketing and labor cost pressures, particularly in Packaged Beverages.
- The effect of the reverse-acquisition accounting on future reported comparisons, and the timing-related revenue effects of adopting ASC 606.
- Execution and cost of the Big Red acquisition, remaining merger-related expenses, and resolution of pending merger-related litigation.