The following discussion should be read in conjunction with our audited consolidated financial statements and notes thereto in our Annual Report, as filed onFebruary 27, 2020 . This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, including, in particular, statements about anticipated benefits and expenses of the DPS Merger and other transactions, including estimated synergies, deleveraging and associated cash management, and cost savings, the impact of COVID-19, future events, future financial performance, plans, strategies, expectations, prospects, competitive environment, regulation, labor matters and availability of raw materials. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as "outlook," "guidance," "anticipate," "expect," "believe," "could," "estimate," "feel," "forecast," "intend," "may," "plan," "potential," "project," "should," "target," "will," "would," and similar words, phrases or expressions and variations or negatives of these words in this Quarterly Report on Form 10-Q. We have based these forward-looking statements on our current views with respect to future events and financial performance. Our actual financial performance could differ materially from those projected in the forward-looking statements due to the inherent uncertainty of estimates, forecasts and projections, and our financial performance may be better or worse than anticipated. Given these uncertainties, you should not put undue reliance on any forward-looking statements. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed under "Risk Factors" in Part I, Item 1A of our Annual Report and in Part II, Item 1A of this Quarterly Report on Form 10-Q, as well as our subsequent filings with theSEC . Forward-looking statements represent our estimates and assumptions only as of the date that they were made. We do not undertake any duty to update the forward-looking statements, and the estimates and assumptions associated with them, after the date of this Quarterly Report on Form 10-Q, except to the extent required by applicable securities laws. This Quarterly Report on Form 10-Q contains the names of some of our owned or licensed trademarks, trade names and service marks, which we refer to as our brands. All of the product names included in this Quarterly Report on Form 10-Q are either our registered trademarks or those of our licensors. OVERVIEW KDP is a leading beverage company inNorth America , with a diverse portfolio of flavored (non-cola) CSDs, NCBs, including water (enhanced and flavored), ready-to-drink tea and coffee, juice, juice drinks, mixers and specialty coffee, and is a leading producer of innovative single serve brewing systems. With a wide range of hot and cold beverages that meet virtually any consumer need, KDP key brands includeKeurig, Dr Pepper , Canada Dry,Snapple , Bai, Mott's, Core,Green Mountain and The Original Donut Shop. KDP has some of the most recognized beverage brands inNorth America , with significant consumer awareness levels and long histories that evoke strong emotional connections with consumers. KDP offers more than 125 owned, licensed, and partner brands, including the top ten best-selling coffee brands and Dr Pepper as a leading flavored CSD in theU.S. , according to IRi, available nearly everywhere people shop and consume beverages. KDP operates as an integrated brand owner, manufacturer and distributor. We believe our integrated business model strengthens our route-to-market and provides opportunities for net sales and profit growth through the alignment of the economic interests of our brand ownership and our manufacturing and distribution businesses through both our DSD system and our WD delivery system. KDP markets and sells its products to retailers, including supermarkets, mass merchandisers, club stores, pure-play e-commerce retailers, and office superstores; to restaurants, hotel chains, office product and coffee distributors, and partner brand owners; and directly to consumers through its websites. Our integrated business model enables us to be more flexible and responsive to the changing needs of our large retail customers and allows us to more fully leverage our scale and reduce costs by creating greater geographic manufacturing and distribution coverage. The beverage market is subject to some seasonal variations. Our cold beverage sales are generally higher during the warmer months, while hot beverage sales are generally higher during the cooler months. Overall beverage sales can be influenced by the timing of holidays and weather fluctuations. Sales of brewing systems and related accessories are generally higher during the second half of the year due to the holiday shopping season. COFFEE SYSTEMS Our Coffee Systems segment is primarily a producer of innovative single serve brewing systems and specialty coffee in theU.S. andCanada . Our brewing systems are aimed at changing the way consumers prepare and enjoy coffee and other beverages, both at home and away from home in places such as offices, restaurants, cafeterias, convenience stores and hotels. We develop and sell a variety of Keurig brewers, brewer accessories and other coffee-related equipment. In addition to coffee, we produce and sell a variety of other specialty beverages in K-Cup pods (including hot and iced teas, hot cocoa and other beverages) for use with Keurig brewing systems. We also offer traditional whole bean and ground coffee in other package types, including bags, fractional packages and cans. 29
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Our Coffee Systems segment manufactures over 75% of the pods in the single serve K-Cup pod format in theU.S. We manufacture and sell 100% of the K-Cup pods of our own brands, such as Green Mountain Coffee Roasters, The Original Donut Shop, Laughing Man, REVV, and Van Houtte. We have licensing and manufacturing agreements with our partner brands, including brands such as Starbucks,Dunkin' Donuts , Folgers, Newman's Own Organics, McCafé,Peet's Coffee , Caribou Coffee, Eight O'Clock, Maxwell House, andTim Hortons , and private label arrangements. Our Coffee Systems segment also has agreements for manufacturing, distributing, and selling K-Cup pods for tea under brands such asCelestial Seasonings , Lipton and Tazo in addition to K-Cup pods of our own brand,Snapple . We also produce and sell K-Cup pods for cocoa, including through a licensing agreement for the Swiss Miss brand, and hot apple cider. Our Coffee Systems segment manufactures its K-Cup pods in facilities inNorth America that include specialty designed proprietary high-speed packaging lines using freshly roasted and ground coffee as well as tea, cocoa and other products. We offer high-quality coffee including certified single-origin, organic, flavored, limited edition and proprietary blends. We carefully select our coffee beans and appropriately roast the coffees to optimize their taste and flavor differences. We engineer and design most of our single serve brewing systems, where we then utilize third-party contract manufacturers located in various countries inAsia for brewer appliance manufacturing. We distribute our Coffee Systems products using third-party distributors, retail partners and through e-commerce, including our website at www.keurig.com. PACKAGED BEVERAGES Our Packaged Beverages segment is principally a brand ownership, manufacturing and distribution business. In this segment, we primarily manufacture and distribute packaged beverages of our brands. Additionally, in order to maximize the size and scale of our manufacturing and distribution operations, we also distribute packaged beverages for our partner brands and manufacture packaged beverages for other third parties in theU.S. andCanada . Our larger NCB brands in this segment includeSnapple , Mott's, Bai, Clamato, Hawaiian Punch, Core, Yoo-Hoo, ReaLemon,Vita Coco coconut water, evian water, Mr and Mrs T mixers, and Forto Coffee. Our larger CSD brands in this segment include Dr Pepper, Canada Dry, 7UP, A&W, Sunkist soda, Squirt, Big Red, RC Cola, Vernors and A Shoc. Approximately 95% of our 2019 Packaged Beverages net sales came from the manufacturing and distribution of our own brands and the contract manufacturing of certain private label and emerging brand beverages. The remaining portion of our 2019 Packaged Beverages net sales came from the distribution of our partner brands such asVita Coco coconut water, evian water, Neuro drinks, High Brew RTD Coffee, Forto Coffee shots, A Shoc energy drinks, Peet's RTD Coffee and Runa energy drinks. We provide a route-to-market for third party brand owners seeking effective distribution for their new and emerging brands. These brands give us exposure in certain markets to fast growing segments of the beverage industry with minimal capital investment. Our Packaged Beverages products are manufactured in multiple facilities across theU.S. and are sold or distributed to retailers and their warehouses by our own distribution network or by third party distributors. We sell our Packaged Beverages products through our DSD and our WD systems, both of which include sales to all major retail channels, including supermarkets, fountains, mass merchandisers, club stores, e-commerce, vending machines, convenience stores, gas stations, small groceries, drug chains and dollar stores. BEVERAGE CONCENTRATES Our Beverage Concentrates segment is principally a brand ownership business where we manufacture and sell beverage concentrates in theU.S. andCanada . Most of the brands in this segment are CSD brands. Key brands include Dr Pepper, Canada Dry, Crush, Schweppes,Sun Drop , Sunkist soda, A&W, 7UP, Squirt, Big Red, RC Cola and Hawaiian Punch. Almost all of our beverage concentrates are manufactured at our plant inSt. Louis, Missouri . Beverage concentrates are shipped to third party bottlers, as well as to our own manufacturing systems, who combine them with carbonation, water, sweeteners and other ingredients, package the combined product in aluminum cans, PET containers and glass bottles, and sell them as a finished beverage to retailers. Beverage concentrates are also manufactured into syrup, which is shipped to fountain customers, such as fast food restaurants, who mix the syrup with water and carbonation to create a finished beverage at the point of sale to consumers. Dr Pepper represents most of our fountain channel volume. Our Beverage Concentrates brands are sold by our bottlers through all major retail channels including supermarkets, fountains, mass merchandisers, club stores, vending machines, convenience stores, gas stations, small groceries, drug chains and dollar stores.LATIN AMERICA BEVERAGES Our Latin America Beverages segment is a brand ownership, manufacturing and distribution business, with operations inMexico representing approximately 90% of the segment's 2019 net sales. This segment participates mainly in carbonated mineral water, flavored CSD, bottled water and vegetable juice, with particular strength in carbonated mineral water, vegetable juice categories and grapefruit flavored CSDs. The largest brands include Peñafiel, Squirt, Clamato, Aguafiel and Crush. 30
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InMexico , we manufacture and distribute our products through our bottling operations and third party bottlers and distributors. We sell our finished beverages through all major Mexican retail channels, including small outlets, supermarkets, hypermarkets, convenience stores and on-premise channels. In theCaribbean , we distribute our products through third party bottlers and distributors. We have also begun to distribute certain products in other international jurisdictions through various third party bottlers and distributors. VOLUME In evaluating our performance, we consider different volume measures depending on whether we sell beverage concentrates, finished beverages, K-Cup pods or brewers. Beverage Concentrates Sales Volume In our Beverage Concentrates segment, we measure our sales volume as concentrate case sales. The unit of measurement for concentrate case sales equals 288 fluid ounces of finished beverage, the equivalent of 24 twelve ounce servings. Concentrate case sales represent units of measurement for concentrates sold by us to our bottlers and distributors. A concentrate case is the amount of concentrate needed to make one case of 288 fluid ounces of finished beverage. It does not include any other component of the finished beverage other than concentrate. Our net sales in our concentrate businesses are based on our sales of concentrate cases. Packaged Beverages and Latin America Beverages Sales Volume In our Packaged Beverages and Latin America Beverages segments, we measure volume as case sales to customers. A case sale represents a unit of measurement equal to 288 fluid ounces of packaged beverage sold by us. Case sales include both our owned brands and certain brands licensed to and/or distributed by us. Coffee Systems K-Cup Pod and Appliance Sales Volume In our Coffee Systems segments, we measure our sales volume as the number of appliances and the number of individual K-Cup pods sold to our customers. COMPARABLE RESULTS OF OPERATIONS Management believes that there are certain non-GAAP financial measures that allow management to evaluate our results, trends and ongoing performance on a comparable basis. In order to derive the adjusted financial information, we adjust certain financial statement captions and metrics prepared underU.S. GAAP for certain items affecting comparability. See Non-GAAP Financial Measures for further information on the certain items affecting comparability used in the preparation of the financial information. These items are referred to within this Management's Discussion and Analysis discussion as Adjusted income from operations, Adjusted interest expense, Adjusted provision for income taxes, Adjusted net income and Adjusted diluted EPS. EXECUTIVE SUMMARY Impact of COVID-19 on our Financial Statements The impact of COVID-19 on our third quarter net sales performance presented both headwinds and tailwinds across the business and within the segments, requiring strong portfolio, package and channel mix management to optimize overall performance. The diversity of the Company's broad portfolio and extensive route to market network enabled it to successfully navigate these mix impacts posed by the pandemic to drive overall performance and deliver a strong third quarter compared to the prior year period. • Coffee Systems experienced growth in K-Cup coffee pods for at-home
consumption and strong double-digit growth in brewers, which more than
offset the continued significant decline in away-from-home consumption due
to weaknesses in the office coffee channel, as elevated work-from-home
trends persisted throughout the quarter. Sales in the e-commerce channel
were again very strong, as consumers continue to shift purchases to the on-line channel, including at the Keurig.com retail site. • Packaged Beverages experienced a net benefit from strong in-market
execution, driven by net sales and market share growth in the majority of
the segment's beverage portfolio. Performance in large-format channels
continued to be strong across multi-pack and take-home packages, and performance in the convenience and gas channels improved during the quarter, as consumer mobility increased. • Beverage Concentrates experienced a decline due to the fountain foodservice component of the business, which services restaurants and hospitality, as a result of the impact of shutdowns and reductions in occupant capacity, which improved throughout the quarter, reflecting a modest reopening of quick-serve and other fast-casual restaurants.
• Latin America Beverages experienced a modest decline in sales volumes
driven by limited consumer mobility inMexico . 31
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The current environment has increased operating costs, requiring us to take deliberate action. In addition to strong portfolio, package and channel mix management to optimize overall net sales performance, we maintained our strong cost discipline, which included the following: • Reduced marketing expense, given the current COVID-19 landscape which has reduced the effectiveness and return on these marketing investments; and
• Significantly reduced all other discretionary costs, such as travel and
entertainment expenses, within the business.
As a result of these items, COVID-19 is impacting our results, both positively and negatively, and should be taken into account when reviewing this Management's Discussion and Analysis. Refer to the section Uncertainties and Trends Affecting our Business - COVID-19 Pandemic Disclosures below for further information. The following table sets forth our reconciliation of significant COVID-19-related expenses. Employee compensation expense and employee protection costs, which impact our SG&A expenses and cost of sales, are included as the COVID-19 item affecting comparability and is excluded in our Adjusted financial measures. In addition, reported amounts underU.S. GAAP also include additional costs, not included as the COVID-19 item affecting comparability, as presented in tables below. Items Affecting Comparability(1) Employee Allowances for Employee Compensation Protection Expected Credit (in millions) Expense(2) Costs(3) Losses(4) Inventory Write-Downs(5) Total For the third quarter of 2020: Coffee Systems $ 7 $ 5 $ - $ -$ 12 Packaged Beverages 32 4 - - 36 Beverage Concentrates - - - - - Latin America Beverages - 1 - - 1 Total $ 39 $ 10 $ - $ -$ 49 For the first nine months of 2020: Coffee Systems $ 14 $ 7 $ 2 $ 8$ 31 Packaged Beverages 73 22 8 - 103 Beverage Concentrates - - 4 - 4 Latin America Beverages - 1 - - 1 Total $ 87 $ 30 $ 14 $ 8$ 139 (1) Employee compensation expense and employee protection costs are both included as the COVID-19 items affecting comparability in the reconciliation of our Adjusted Non-GAAP financial measures.
(2) Reflects temporary incremental frontline incentive pay and the associated
taxes in order to maintain essential operations during the COVID-19 pandemic. Impacts both cost of sales and SG&A expenses. Beginning inmid-September 2020 , we have discontinued the incremental frontline incentive pay program.
(3) Includes costs associated with personal protective equipment, temperature
scans, cleaning and other sanitization services. Impacts both cost of sales and SG&A expenses.
(4) Allowances reflect the expected impact of the economic uncertainty caused
by COVID-19, leveraging estimates of credit worthiness, default and recovery rates for certain of our customers. Impacts SG&A expenses. (5) Inventory write-downs include obsolescence charges of$8 million for the first nine months of 2020. Impacts cost of sales.
Financial Overview
• Net sales increased
quarter of 2020 compared with
This performance reflected higher volume/mix of 6.6%, partially offset by
lower net price realization of 0.8% and unfavorable FX translation of 0.6%, primarily in our Latin America Beverages segment.
• Net income increased
2020 as compared to
strong growth in income from operations, driven primarily by the continued
benefit of productivity and merger synergies, lower marketing expense and
higher volume/mix, partially offset by
expenses associated with COVID-19. Other favorable drivers included lower
interest expense due to continued deleveraging and the impact of a lower
effective tax rate, partially offset by a non-cash impairment on an equity
investment. 32
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• Adjusted net income increased
quarter of 2020 as compared to Adjusted net income of
prior year period, reflecting the continued benefit of productivity and
merger synergies, lower marketing expense and volume/mix growth, which
were partially offset by lower net price realization and higher
manufacturing and operating costs associated with increased consumer
retail demand for our products. Other drivers included lower interest
expense due to continued deleveraging and the impact of a lower effective
tax rate. • Diluted EPS increased 47.6% to$0.31 per diluted share as compared to$0.21 in the prior year period. • Adjusted diluted EPS increased 21.9% to$0.39 per diluted share as compared to Adjusted diluted EPS of$0.32 per diluted share in the prior year period. • During the first nine months of 2020, we made net repayments of$541
million related to our commercial paper notes, KDP Revolver, 2019 KDP Term
Loan and our Notes. Additionally, we repaid$290 million and added$128 million of structured payables during the first nine months of 2020. • InJuly 2020 , we entered into a long-term franchise agreement with Polar
Beverages to manufacture and distribute Polar Seltzer sparkling seltzer
waters. The manufacture and distribution of
launch in early markets in the fourth quarter of 2020 and is anticipated
to reach nationwide distribution throughout our DSD network in the first
half of 2021.
• Effective
be listed on the
following business day, our common stock began trading on Nasdaq's Global
Select Market at market open. Our stock ticker remains "KDP".
• Effective
• On
and distribute certain KDP brands in 18 counties inNew York andNew Jersey . Honickman is selling these rights to a third party and we will enter into a simultaneous transaction with the third-party to gain
long-term access to these rights in exchange for the payment of an annual
fee. RESULTS OF OPERATIONS We eliminate from our financial results all intercompany transactions between entities included in our consolidated financial statements and the intercompany transactions with our equity method investees. References in the financial tables to percentage changes that are not meaningful are denoted by "NM". See Uncertainties and Trends Affecting our Business - COVID-19 Pandemic Disclosures for more information about the specific costs related to COVID-19. Non-GAAP financial measures are provided in addition toU.S. GAAP measures. Such non-GAAP financial measures are excluded from the Results of Operations by Segment when there is no difference between the non-GAAP and the correspondingU.S. GAAP measure. See Non-GAAP Financial Measures for more information, including reconciliations to the correspondingU.S. GAAP measures. 33
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