Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This section of this Annual Report on Form 10-K generally discusses the years ended December 31, 2019 and 2018 and year-over-year comparisons between the years ended December 31, 2019 and 2018*. Discussions of the periods prior to the year ended* December 31, 2018 that are not included in this Annual Report on Form 10-K are found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018*.*

This Annual Report on Form 10-K 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 Annual Report on Form 10-K are either our registered trademarks or those of our licensors.

DR PEPPER SNAPPLE GROUP, INC. MERGER

On January 29, 2018, DPS entered into a Merger Agreement by and among DPS, Maple and Merger Sub, whereby Merger Sub would be merged with and into Maple, with Maple surviving the DPS Merger as a wholly-owned subsidiary of DPS. The DPS Merger was consummated on July 9, 2018, at which time DPS changed its name to "Keurig Dr Pepper Inc.".

Maple owns Keurig, a leader in specialty coffee and innovative single serve brewing systems. The combined businesses created KDP, a new beverage company of scale with a portfolio of iconic consumer brands and expanded distribution capability to reach virtually every point-of-sale in North America.

See Note 1 and Note 3 of the Notes to our Audited Consolidated Financial Statements for further information related to the DPS Merger.

OVERVIEW

KDP is a leading beverage company in North 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 include Keurig, 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 in North America, with significant consumer awareness levels and long histories that evoke strong emotional connections with consumers. KDP offers more than 125 owned, licensed, partner and allied brands, including the top ten best-selling coffee brands and Dr Pepper as a leading flavored CSD in the U.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.

UNCERTAINTIES AND TRENDS AFFECTING OUR BUSINESS

We believe the North American beverage market is influenced by certain key trends and uncertainties. Some of these items, such as increased health consciousness and changes in consumer preferences and economic factors, have previously created and may continue in the future to create category headwinds for a number of our products. Refer to Item 1A, Risk Factors, of this Annual Report on Form 10-K for information about risks and uncertainties facing us.

We expect net sales growth for the year ending December 31, 2020 to accelerate to 3.0% to 4.0%, versus our merger target of 2.0% to 3.0%. This momentum is expected to be fueled by investments we are planning across the business, including in the areas of innovation, new partnerships, in-store execution, marketing and research and development.

Adjusted diluted EPS growth for the year ending December 31, 2020 is expected to be in the range of 13% to 15%, or $1.38 to $1.40 per diluted share, reflecting the opportunities we are pursuing and the investments it is planning to make to drive accelerated top-line growth. Over the three-year period ending December 31, 2021, we continue to expect to deliver Adjusted diluted EPS growth in the range of 15% to 17%, in line with our merger target.

Supporting this guidance are the following expectations:

•Merger synergies of $200 million for the year ending December 31, 2020, consistent with our long-term merger target for $200 million per year over the 2019-2021 period.
•Adjusted interest expense is expected to be in the range of $530 million to $545 million, reflecting ongoing deleveraging and some benefit from unwinding interest rate swap contracts.
•The Adjusted effective tax rate is expected to be in the range of 24.5% to 25.0%.
•Diluted weighted average shares outstanding are estimated to be approximately 1,425 million.
•Management leverage ratio is expected to be in the range of 3.5x to 3.8x as of December 31, 2020.

SEASONALITY

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 also 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.

SEGMENTS

As of December 31, 2019, we report our business in four operating segments:

•The Coffee Systems segment reflects sales in the U.S. and Canada of the manufacture and distribution of finished goods relating to the Company's single-serve brewing system, K-Cup pods and other coffee products.
•The Packaged Beverages segment reflects sales in the U.S. and Canada from the manufacture and distribution of finished beverages and other products, including sales of the Company's own brands and third-party brands, through our DSD and WD systems.
•The Beverage Concentrates segment reflects sales of the Company's branded concentrates and syrup to third-party bottlers, primarily in the U.S. and Canada. Most of the brands in this segment are CSDs.
•The Latin America Beverages segment reflects sales in Mexico, the Caribbean, and other international markets from the manufacture and distribution of concentrates, syrup and finished beverages.

VOLUME

In evaluating our performance, we consider different volume measures depending on whether we sell beverage concentrates, finished beverages, pods or brewers.

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.

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.

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.

COMPARABLE RESULTS OF OPERATIONS

As a result of the DPS Merger, in order for management to discuss our historical results on a comparable basis, we prepared unaudited pro forma condensed combined financial information to illustrate the estimated effects of the DPS Merger, which was consummated on July 9, 2018, based on the historical results of operations of DPS and Maple. See Supplemental Unaudited Pro Forma Condensed Combined Financial Information section at the end of Management's Discussion and Analysis for further information on the assumptions used in the preparation of the financial information.

Furthermore, 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 for the year ended December 31, 2019, we adjusted certain financial statement captions and metrics for certain items affecting comparability. For the year ended December 31, 2018, we adjusted certain financial statement captions and metrics prepared on a pro forma basis 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.

Presentation of these adjusted financial statement captions and metrics in the tables below compare adjusted financial information for the year ended December 31, 2019 to adjusted pro forma financial information for the year ended December 31, 2018 to provide more meaningful comparisons between years as a result of the DPS Merger.

EXECUTIVE SUMMARY

2019 Financial Overview

The following table details our net income and diluted EPS for the years ended December 31, 2019 and 2018:

For the Year Ended December 31,DollarPercent
(in millions, except per share data)20192018ChangeChange
Net income attributable to KDP$1,254$586$668114.0%
Adjusted net income1,7271,45826918.4%
Diluted EPS0.880.530.3566.0%
Adjusted diluted EPS1.221.040.1817.3%

Net income attributable to KDP increased $668 million to $1,254 million for the year ended December 31, 2019, compared to $586 million for the year ended December 31, 2018, primarily driven by the incremental impact in the current year of the DPS Merger completed in 2018, including the favorable comparison to the $158 million of transaction costs and the $131 million impact of the inventory step-up associated with the DPS Merger recorded in the year ended December 31, 2018. Diluted EPS increased 66.0% to $0.88 as compared to $0.53 in the prior year.

Adjusted net income increased $269 million, or 18.4%, to $1,727 million, compared to Adjusted pro forma net income of $1,458 million in the prior year. This change primarily reflected the growth in Adjusted income from operations, lower adjusted interest expense, driven by deleveraging and the benefit of unwinding several interest rate swap contracts, and a lower effective tax rate due to the TCJA. Additionally, Adjusted net income was impacted by the year ago comparison of the non-operating benefits of a cash distribution from BodyArmor in connection with our unit-holder interest and a gain on our prior equity interest in Core as a result of the Core Acquisition and an increase in our share of losses from our investments in unconsolidated affiliates driven by Bedford. Adjusted diluted EPS increased 17.3% to $1.22, as compared to Adjusted pro form diluted EPS of $1.04 in the prior year.

During the year ended December 31, 2019, we made net repayments of approximately $1,286 million related to our senior notes, our term loans, and commercial paper notes. We additionally made repayments of approximately $531 million of structured payables.

RESULTS OF OPERATIONS

Our results of operations include the following periods, which reflect the results of operations of KDP for:

•the year ended December 31, 2019, and
•the year ended December 31, 2018, which also includes 176 days of the results of operations of DPS subsequent to the DPS Merger, which was completed on July 9, 2018.

We eliminate from our financial results all intercompany transactions between entities included in our consolidated financial statements and the intercompany transactions with our investments in unconsolidated affiliates.

References in the financial tables to percentage changes that are not meaningful are denoted by "NM."

Consolidated Operations

The following table sets forth our consolidated results of operations for the years ended December 31, 2019 and 2018:

For the Year Ended December 31,DollarPercentage
(in millions, except per share amounts)20192018ChangeChange
Net sales$11,120$7,442$3,67849.4%
Cost of sales4,7783,5601,21834.2
Gross profit6,3423,8822,46063.4
Selling, general and administrative expenses3,9622,6351,32750.4
Other operating expense (income), net210(8)NM
Income from operations2,3781,2371,14192.2
Interest expense65440125363.1
Interest expense - related party—51(51)(100.0)
Loss on early extinguishment of debt1113(2)(15.4)
Other expense (income), net19(19)38NM
Income before provision (benefit) for income taxes1,694791903114.2
Provision (benefit) for income taxes440202238117.8
Net income1,254589665112.9
Less: Net income attributable to employee redeemable non-controlling interest and mezzanine equity awards—3(3)(100.0)
Net income attributable to KDP$1,254$586$668114.0%
Earnings per common share:
Basic$0.89$0.54
Diluted0.880.53
Gross margin57.0%52.2%
Operating margin21.4%16.6%
Effective tax rate26.0%25.5%

Net Sales*.* Net sales for the year ended December 31, 2019 increased $3,678 million to $11,120 million compared with net sales of $7,442 million for the year ended December 31, 2018, primarily driven by the incremental impact in the current year of the DPS Merger completed in 2018.

Gross Profit. Gross profit for the year ended December 31, 2019 was $6,342 million, or 57.0% of net sales as compared to $3,882 million, or 52.2% of net sales for the year ended December 31, 2018. The primary driver of the change in gross profit was the incremental impact in the current year of the DPS Merger completed in 2018 including the favorable comparison to the $131 million impact of the inventory step-up associated with the DPS Merger in the third quarter of 2018.

Selling, General and Administrative Expenses. SG&A expenses for the year ended December 31, 2019 increased $1,327 million to $3,962 million compared with the year ended December 31, 2018. The primary driver of the increase in SG&A expenses was the incremental impact in the current year of the DPS Merger completed in 2018, including acquired operating costs, transaction costs and restructuring expenses associated with the integration of DPS and Maple.

Other Operating Expense (Income), Net. Other operating expense (income), net had a favorable change of $8 million for the year ended December 31, 2019 compared with the year ended December 31, 2018. During 2019, the impairment of real estate and equipment was partially offset by a network optimization program gain of $30 million related to the asset sale-leaseback of three manufacturing facilities as compared to unfavorable fair value adjustments on real estate assets held for sale in 2018.

Income from Operations. Income from operations increased $1,141 million to $2,378 million for the year ended December 31, 2019, primarily driven by the incremental impact in the current year of the DPS Merger completed in 2018, with the increase in gross profit, partially offset by an increase in SG&A expenses.

Interest Expense. Interest expense increased $253 million for the year ended December 31, 2019 compared to the year ended December 31, 2018, primarily due to the full year impact of the increased borrowings and the assumption of existing senior unsecured notes as a result of the DPS Merger, as well as the impact of our interest rate derivative instruments, partially offset by the impact of net repayments to our 2019 Notes, our term loans and our commercial paper notes.

Interest Expense - Related Party. Interest expense - related party decreased $51 million for the year ended December 31, 2019 compared to the year ended December 31, 2018 as a result of the capitalization of the related party term loans into additional paid-in capital during the DPS Merger completed in 2018.

Loss on Early Extinguishment of Debt. We recognized $11 million of loss on early extinguishment of debt during the year ended December 31, 2019, related to our prepayments on our term loans, compared to $13 million of loss on early extinguishment of debt for the year ended December 31, 2018 as we paid off the Term Loan A upon the consummation of the DPS Merger in 2018.

Other Expense (Income), net. Other expense (income), net had an unfavorable change of $38 million for the year ended December 31, 2019 compared with the year ended December 31, 2018, driven primarily by an increase in our share of losses from our investments in unconsolidated affiliates, driven by Bedford, as well as the unfavorable comparison to the gain on a cash distribution from BodyArmor in the prior year.

Effective Tax Rate. The effective tax rates for the years ended December 31, 2019 and 2018 were 26.0% and 25.5%, respectively.

Adjusted Results of Operations

The following table sets forth certain consolidated adjusted results of operations for the years ended December 31, 2019 and 2018:

For the Year Ended December 31,DollarPercentage
(in millions, except per share amounts)20192018ChangeChange
Adjusted net sales$11,120$11,024$960.9%
Adjusted income from operations2,8902,62027010.3
Adjusted interest expense553635(82)(12.9)
Adjusted provision for income taxes5915246712.8
Adjusted operating margin26.0%23.8%220 bps
Adjusted effective tax rate25.5%26.4%(90 bps)

Adjusted Net Sales. Adjusted net sales increased $96 million, or 0.9%, to $11,120 million for the year ended December 31, 2019 as compared to Adjusted pro forma net sales of $11,024 million in the prior year. This performance reflected strong underlying net sales growth of 3.2%, driven by higher volume/mix of 2.6% and net price realization of 0.6%, which was partially offset by the expected unfavorable impact related to changes in our allied brands portfolio of 2.1%. Unfavorable foreign currency translation also impacted the year by 0.2%.

Adjusted Income from Operations. Adjusted income from operations increased $270 million, or 10.3%, to $2,890 million for the year ended December 31, 2019 compared to Adjusted pro forma income from operations of $2,620 million in the prior year. This performance primarily reflected the strong productivity and merger synergies, both of which benefitted SG&A and cost of sales, and growth in underlying net sales, partially offset by inflation in input costs, led by packaging, and logistics and the comparison to a $22 million gain from the remeasurement of our equity investment in Big Red. Unfavorable foreign currency translation also impacted the year by 0.2%. Adjusted operating margin grew 220 bps to 26.0% in the year ended December 31, 2019.

*Adjusted Interest Expense.*Adjusted interest expense decreased $82 million, or 12.9%, to $553 million for the year ended December 31, 2019 compared to Adjusted pro forma interest expense of $635 million in the prior year. This change primarily reflected the benefits of lower indebtedness due to continued deleveraging, realized gains associated with the termination of certain interest rate swaps and the benefit of lower interest rates as a result of our existing interest rate swaps.

Adjusted Effective Tax Rate. The Adjusted effective tax rate decreased 90 bps to 25.5% for the year ended December 31, 2019 compared to Adjusted pro forma effective tax rate of 26.4% in the prior year. This decrease in our Adjusted effective tax rate was primarily due to a reduction in the U.S. federal tax rate from 24.5% to 21.0%, partially offset by the loss of tax benefits associated with the U.S. domestic manufacturing deduction in 2019.

Results of Operations by Segment

The following tables set forth net sales and income from operations for our segments for the years ended December 31, 2019 and 2018, as well as the other amounts necessary to reconcile our total segment results to our consolidated results presented in accordance with U.S. GAAP:

(in millions)For the Year Ended December 31,
Segment Results — Net sales20192018
Coffee Systems$4,233$4,114
Packaged Beverages4,9452,415
Beverage Concentrates1,414669
Latin America Beverages528244
Net sales$11,120$7,442
For the Year Ended December 31,
(in millions)20192018
Segment Results — Income from Operations
Coffee Systems$1,219$1,163
Packaged Beverages757257
Beverage Concentrates955430
Latin America Beverages8529
Unallocated corporate costs(638)(642)
Income from operations$2,378$1,237

COFFEE SYSTEMS

The following table provides certain results of operations for our Coffee Systems segment for the years ended December 31, 2019 and 2018:

For the Year Ended December 31,DollarPercentage
(in millions)20192018ChangeChange
Net sales$4,233$4,114$1192.9%
Income from operations1,2191,163564.8%
Operating margin28.8%28.3%50 bps
Adjusted net sales4,2334,1181152.8%
Adjusted income from operations1,4031,327765.7%
Adjusted operating margin33.1%32.2%90 bps

Sales Volume. The Coffee Systems segment recorded strong volume growth reflecting a 9.0% increase in K-Cup pod volume and an 8.2% increase in brewer volume in the year ended December 31, 2019 compared to the prior year.

Net Sales. Net sales increased $119 million, or 2.9%, to $4,233 million for the year ended December 31, 2019, compared to $4,114 million in the prior year due to volume/mix growth of 6.1%, which was driven by strong sales volume growth partially offset by unfavorable pod sales mix. This growth was partially offset by lower net price realization of 2.8%. Unfavorable foreign currency translation also impacted the year by 0.4%.

Adjusted Net Sales. Adjusted net sales increased $115 million, or 2.8%, to $4,233 million for the year ended December 31, 2019, compared to $4,118 million in the prior year due to volume/mix growth of 6.1%, which was driven by strong sales volume growth partially offset by unfavorable pod sales mix. This growth was partially offset by lower net price realization of 2.9%. Unfavorable foreign currency translation also impacted the year by 0.4%.

Income from Operations. Income from operations was $1,219 million for the year ended December 31, 2019, compared to $1,163 million in the prior year, driven by the benefits of pod volume growth and strong productivity and merger synergies which were partially offset by lower net price realization, unfavorable pod mix, inflation in input costs, led by packaging, as well as logistics and people costs, expenses associated with productivity projects, and increased marketing investments. Operating margin grew 50 bps to 28.8%.

Adjusted Income from Operations. Adjusted income from operations increased $76 million, or 5.7%, to $1,403 million for the year ended December 31, 2019, compared with Adjusted pro forma income from operations of $1,327 million in the prior year, primarily reflecting strong productivity and merger synergies and strong volume/mix growth, partially offset by lower net price realization, inflation in input costs, led by packaging, as well as logistics and people costs, and increased marketing investments. Adjusted operating margin grew 90 bps to 33.1%.

PACKAGED BEVERAGES

The following table provides certain results of operations for our Packaged Beverages segment for the years ended December 31, 2019 and 2018:

For the Year Ended December 31,DollarPercentage
(in millions)20192018ChangeChange
Net sales$4,945$2,415$2,530NM
Income from operations757257500NM
Operating margin15.3%10.6%470 bps
Adjusted net sales4,9455,069(124)(2.4)%
Adjusted income from operations7836919213.3%
Adjusted operating margin15.8%13.6%220 bps

Sales Volume. Sales volume for the year ended December 31, 2019 increased significantly primarily driven by the incremental impact in the current year from the DPS Merger in the prior year.

Adjusted Sales Volume. Adjusted sales volume for the year ended December 31, 2019 declined 2.9% due to the net unfavorable impact of changes in our allied brands portfolio and lower CSD volume, partially offset by the growth of Core Hydration and contract manufacturing.

Net Sales. Net sales increased $2,530 million to $4,945 million for the year ended December 31, 2019, compared to $2,415 million in the prior year, driven by the incremental impact in the current year from the DPS Merger in the prior year.

Adjusted Net Sales. Adjusted net sales decreased $124 million, or 2.4%, to $4,945 million for the year ended December 31, 2019 compared to $5,069 million in the prior year, reflecting underlying net sales growth of 2.3%, driven by higher net price realization of 1.8% from pricing actions taken late in 2018 and higher volume/mix of 0.5%. More than offsetting the underlying net sales growth was the expected unfavorable impact from changes in the allied brands portfolio totaling 4.7%.

Income from Operations. Income from operations was $757 million for the year ended December 31, 2019, compared to $257 million in the prior year, driven by the incremental impact in the current year from the DPS Merger in the prior year, the favorable comparison to the $105 million impact of the inventory step-up associated with the DPS Merger in the prior year, and strong productivity and merger savings.

Adjusted Income from Operations. Adjusted income from operations increased $92 million, or 13.3%, to $783 million for the year ended December 31, 2019 compared to Adjusted pro forma income from operations of $691 million in the prior year. This performance primarily reflected strong productivity and merger synergies, the incremental margin from Core and Big Red in their first year as owned brands, a network optimization program gain of $30 million related to the asset sale-leaseback of three manufacturing facilities and the growth in underlying net sales. Partially offsetting these growth drivers were inflation in input costs and logistics and the comparison to a $22 million gain from the remeasurement of our equity investment in Big Red. Adjusted operating margin grew 220 bps to 15.8%.

BEVERAGE CONCENTRATES

The following table provides certain results of operations for our Beverage Concentrates segment for the years ended December 31, 2019 and 2018:

For the Year Ended December 31,DollarPercentage
(in millions)20192018ChangeChange
Net sales$1,414$669$745NM
Income from operations955430525NM
Operating margin67.5%64.3%320 bps
Adjusted net sales1,4141,331836.2%
Adjusted income from operations9578619611.1%
Adjusted operating margin67.7%64.7%300 bps

Sales Volume. Sales volume for the year ended December 31, 2019 increased significantly primarily driven by the incremental impact in the current year from the DPS Merger in the prior year.

Adjusted Sales Volume. Adjusted sales volume for the year ended December 31, 2019 increased 0.2% driven by Dr Pepper, Canada Dry and Big Red, partially offset by Crush, 7UP and Schweppes.

Net Sales. Net sales increased $745 million to $1,414 million for the year ended December 31, 2019, compared to $669 million in the prior year, driven by the incremental impact in the current year from the DPS Merger in the prior year.

Adjusted Net Sales. Adjusted net sales increased $83 million, or 6.2%, to $1,414 million for the year ended December 31, 2019 compared to Adjusted pro forma net sales of $1,331 million in the prior year, driven by higher net price realization of 5.3% and higher volume/mix of 1.1%. Unfavorable foreign currency translation also impacted the period by 0.2%.

Income from Operations. Income from operations was $955 million for the year ended December 31, 2019, compared to $430 million in the prior year, driven by the incremental impact in the current year from the DPS Merger in the prior year and the favorable comparison to the $17 million impact of the inventory step-up associated with the DPS Merger in the prior year.

Adjusted Income from Operations. Adjusted income from operations increased $96 million, or 11.1%, to $957 million for the year ended December 31, 2019 compared with Adjusted pro forma income from operations of $861 million in the prior year. This performance primarily reflected the growth in Adjusted net sales as well as productivity and merger synergies. Partially offsetting these growth drivers were inflation in input costs and logistics. Adjusted operating margin grew 300 bps versus the year ago period to 67.7%.

LATIN AMERICA BEVERAGES

The following table provides certain results of operations for our Latin America Beverages segment for the years ended December 31, 2019 and 2018:

For the Year Ended December 31,DollarPercentage
(in millions)20192018ChangeChange
Net sales$528$244$284NM
Income from operations852956NM
Operating margin16.1%11.9%420 bps
Adjusted net sales528506224.3%
Adjusted income from operations8283(1)(1.2)%
Adjusted operating margin15.5%16.4%(90 bps)

Sales Volume. Sales volume for the year ended December 31, 2019 increased significantly primarily driven by the incremental impact in the current year from the DPS Merger in the prior year.

Adjusted Sales Volume. Adjusted sales volume for the year ended December 31, 2019 declined 3.7%, as Aguafiel decreased 4.3% primarily due to the exit of our low margin bulk water business, partially offset by a 0.6% increase in the balance of the portfolio.

Net Sales. Net sales increased $284 million to $528 million for the year ended December 31, 2019, compared to $244 million in the prior year, driven by the incremental impact in the current year from the DPS Merger in the prior year.

Adjusted Net Sales. Adjusted net sales increased $22 million, or 4.3%, to $528 million for the year ended December 31, 2019 compared to Adjusted pro forma net sales of $506 million in the prior year, driven by higher net price realization of 4.5%. Unfavorable foreign currency translation also impacted the period by 0.2%.

Income from Operations. Income from operations was $85 million for the year ended December 31, 2019, compared to $29 million in the prior year, driven by the incremental impact in the current year from the DPS Merger in the prior year including the favorable comparison to the $9 million impact of the inventory step-up associated with the DPS Merger in the prior year and productivity savings.

Adjusted Income from Operations. Adjusted income from operations decreased $1 million, or 1.2%, to $82 million for the year ended December 31, 2019, compared to Adjusted pro forma income from operations of $83 million in the prior year. This performance reflected net sales growth and productivity savings, partially offset by inflation in input costs, energy and logistics, higher general and administrative expenses and unfavorable foreign currency transaction. Additionally, the change reflected the unfavorable comparison to a $6 million benefit related to a previous reimbursement by a resin supplier in the prior year. Adjusted operating margin declined 90 bps from the prior year to 15.5%.

LIQUIDITY AND CAPITAL RESOURCES

Trends and Uncertainties Affecting Liquidity

Customer and consumer demand for our products may be impacted by all risk factors discussed in Item 1A, "Risk Factors" that could have a material effect on production, delivery and consumption of our products in the U.S., Mexico and the Caribbean or Canada, which could result in a reduction in our sales volume. Similarly, disruptions in financial and credit markets may impact our ability to manage normal commercial relationships with our customers, suppliers and creditors. These disruptions could have a negative impact on the ability of our customers to timely pay their obligations to us, thus reducing our cash flow, or the ability of our vendors to timely supply materials.

We believe that the following events, trends and uncertainties may also impact liquidity:

•our intention to drive significant cash flow generation to enable rapid deleveraging within two to three years from the DPS Merger;
•our ability to issue unsecured commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $2,400 million;
•our ability to access our other financing arrangements, including the KDP Revolver and 364-Day Credit Agreement, which have availability of $3,150 million as of December 31, 2019;
•our continued optimization of our operations;
•a significant downgrade in our credit ratings could impact our accounts payable program and may reduce flexibility of our business to engage in certain transactions, such as the execution and renewal of certain leases;
•our continued capital expenditures;
•our continued payment of dividends;
•seasonality of our operating cash flows, which could impact short-term liquidity;
•fluctuations in our tax obligations;
•future equity investments; and
•future mergers or acquisitions of brand ownership companies, regional bottling companies, distributors and/or distribution rights to further extend our geographic coverage.

Financing Arrangements

Refer to Note 9 of the Notes to our Audited Consolidated Financial Statements for management's discussion of financing arrangements.

LIBOR CONSIDERATIONS

In 2017, the U.K. Financial Conduct Authority announced that LIBOR will no longer be published after 2021. In the U.S., the Alternative Reference Rates Committee selected the Secured Overnight Financing Rate as the preferred alternative reference rate to LIBOR.

We have a number of financing arrangements which incorporate LIBOR as a benchmark rate and which extend past 2021, including the 2019 KDP Term Loan Agreement and the KDP Revolver. The agreements related to such financing arrangements contain provisions for alternative reference rates, and we do not expect a significant change to our cost of debt as a result of the transition from LIBOR to an alternative reference rate.

Liquidity

Based on our current and anticipated level of operations, we believe that our operating cash flows will be sufficient to meet our anticipated obligations for the next twelve months. To the extent that our operating cash flows are not sufficient to meet our liquidity needs, we may utilize cash on hand or amounts available under our financing arrangements, if necessary.

The following table summarizes our cash activity for the Periods:

Year Ended December 31,Three Months Ended December 31,Fiscal Year Ended September 30,
(in millions)2019201820172017
Net cash provided by operating activities$2,474$1,613$385$1,749
Net cash (used in) provided by investing activities(150)(19,131)(18)180
Net cash provided by (used in) financing activities(2,364)17,577(620)(2,026)

NET CASH PROVIDED BY OPERATING ACTIVITIES

Net cash provided by operating activities increased $861 million for the year ended December 31, 2019 as compared to year ended December 31, 2018, primarily due to additional cash flows from operations generated as a result of the DPS Merger. The increase in net cash provided by operating activities was driven by the increase in net income adjusted for non-cash items and the improvement in working capital primarily driven by extended payment terms with our suppliers, partially offset by the payment and deferral of customer incentives.

As of December 31, 2019, the Company deferred estimated tax payments of $59 million, which were paid in January 2020, as compared to no deferral of estimated tax payments as of December 31, 2018.

Cash Conversion Cycle

Our cash conversion cycle is defined as DIO and DSO less DPO. The calculation of each component of the cash conversion cycle is provided below:

ComponentCalculation (on a trailing twelve month basis)
DIO(Average inventory divided by cost of sales) * Number of days in the period
DSO(Accounts receivable divided by net sales) * Number of days in the period
DPO(Accounts payable * Number of days in the period) divided by cost of sales and SG&A expenses

Our cash conversion cycle increased 1 day to approximately (46) days as of December 31, 2019 as compared to (47) days as of December 31, 2018. The following table summarizes our cash conversion cycle:

December 31,
20192018
DIO5252
DSO3537
DPO133136
Cash conversion cycle(46)(47)

In future periods, DPO is expected to have a positive impact on our cash conversion cycle as a result of our supplier terms initiative, which has set our customary terms as we integrate our legacy businesses.

Accounts payable program

As part of our ongoing efforts to improve our cash flow and related liquidity, we work with our suppliers to optimize our terms and conditions, which include the extension of payment terms. Excluding our suppliers who require cash at date of purchase or sale, our current payment terms with our suppliers generally range from 10 to 360 days. We also entered into an agreement with a third party administrator to allow participating suppliers to track payment obligations from us, and if voluntarily elected by the supplier, sell payment obligations from us to financial institutions. Suppliers can sell one or more of our payment obligations at their sole discretion and our rights and obligations to our suppliers are not impacted. We have no economic interest in a supplier’s decision to enter into these agreements and no direct financial relationship with the financial institutions. Our obligations to our suppliers, including amounts due and scheduled payment terms, are not impacted. As of December 31, 2019 and December 31, 2018, $2,097 million and $1,438 million, respectively, of our outstanding payment obligations were voluntarily elected by the supplier and sold to financial institutions. The amounts settled through the program and paid to the financial institutions were $1,745 million and $1,477 million for the years ended December 31, 2019 and 2018, respectively.

NET CASH USED IN INVESTING ACTIVITIES

Cash used in investing activities for the year ended December 31, 2019 was primarily driven by our purchases of property, plant and equipment of $330 million partially offset by proceeds of $247 million from sales of property, plant and equipment, primarily driven by our asset sale-leaseback transactions. Other drivers of cash used investing activities included $35 million for purchases of intangible assets, primarily the reacquisition of distribution rights, and advances of $32 million to Bedford under its line of credit with us.

Cash used in investing activities for the year ended December 31, 2018 consisted primarily of our business acquisitions of the DPS Merger, the Big Red Acquisition and the Core Acquisition of $19,114 million, net of cash acquired of $169 million, and purchases of property, plant and equipment of $180 million.

NET CASH USED IN (PROVIDED BY) FINANCING ACTIVITIES

Cash used in financing activities for year ended December 31, 2019 consisted primarily of the voluntary and mandatory repayments on the 2018 KDP Term Loan and 2019 KDP Term Loan of $1,203 million, dividend payments of $844 million, repayments of structured payables of $531 million and the repayment of the 2019 Notes of $250 million. These cash outflows from financing activities were partially offset by net issuance of commercial paper notes of $167 million and proceeds from structured payables of $330 million.

Net cash provided by financing activities for year ended December 31, 2018 consisted primarily of proceeds from the issuance of common stock of $9,000 million, issuance of unsecured notes of $8,000 million, proceeds from the 2018 KDP Term Loan of $2,700 million and net issuance of commercial paper notes of $1,080 million. These cash inflows from financing activities were partially offset by repayments on the 2018 KDP Term Loan of $3,447 million. These activities were used to accommodate the DPS Merger and reflect subsequent repayments since the DPS Merger.

Debt Ratings

As of December 31, 2019, our credit ratings were as follows:

Rating AgencyLong-Term Debt RatingCommercial Paper RatingOutlookDate of Last Change
Moody'sBaa2P-2NegativeMay 11, 2018
S&PBBBA-2StableMay 14, 2018

These debt and commercial paper ratings impact the interest we pay on our financing arrangements. A downgrade of one or both of our debt and commercial paper ratings could increase our interest expense and decrease the cash available to fund anticipated obligations.

Capital Expenditures

Capital expenditures were $330 million and $180 million for the years ended December 31, 2019 and 2018, respectively.

Capital expenditures for the year ended December 31, 2019 primarily related to manufacturing equipment, our continued investment in the construction of our new Spartanburg facility in South Carolina and information technology infrastructure.

Capital expenditures for the year ended December 31, 2018 were primarily related to machinery and equipment, information technology infrastructure, logistics equipment and replacement of existing cold drink equipment.

Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents

Cash, cash equivalents, restricted cash and restricted cash equivalents decreased $28 million to $111 million as of December 31, 2019 compared to $139 million as of December 31, 2018.

Our cash balances are used to fund working capital requirements, scheduled debt and interest payments, capital expenditures, income tax obligations, dividend payments and business combinations. Cash generated by our foreign operations is generally repatriated to the U.S. periodically as working capital funding requirements in those jurisdictions allow. Foreign cash balances were $70 million and $59 million as of December 31, 2019 and December 31, 2018, respectively. We accrue tax costs for repatriation, as applicable, as cash is generated in those foreign jurisdictions.

Contractual Commitments and Obligations

We enter into various contractual obligations that impact, or could impact, our liquidity. Based on our current and anticipated level of operations, we believe that our proceeds from operating cash flows will be sufficient to meet our anticipated obligations. To the extent that our operating cash flows are not sufficient to meet our liquidity needs, we may utilize cash on hand or amounts available under our financing arrangements, if necessary.

The following table summarizes our contractual obligations and contingencies as of December 31, 2019:

Payments Due in Year
(in millions)Total20202021202220232024After 2024
Long-term obligations(1)$13,355$350$2,350$350$3,580$—$6,725
Interest payments4,7315084724253532942,679
Finance leases(2)3355546413734122
Operating leases(3)6277774635552306
Purchase obligations(4)1,6831,194125105918385
Total$20,731$2,184$3,067$984$4,116$463$9,917
(1)Amounts represent payments for the senior unsecured notes issued by us and the term loan credit agreement. Please refer to Note 9 of the Notes to our Audited Consolidated Financial Statements for additional information.
(2)Amounts represent our contractual payment obligations for our lease arrangements classified as finance leases. These amounts exclude renewal options, which were not yet executed but were included in the lease term to determine finance lease obligation as the lease imposes a penalty on us in such amount that the renewal appeared reasonably assured at lease inception. Refer to Note 4 for additional information.
(3)Amounts represent minimum rental commitments under our non-cancelable operating leases. Refer to Note 4 for additional information
(4)Amounts represent payments under agreements to purchase goods or services that are legally binding and that specify all significant terms, including capital obligations and long-term contractual obligations.

Amounts excluded from our table

As of December 31, 2019, we had $56 million of non-current unrecognized tax benefits, related interest and penalties classified as a long-term liability. The table above does not reflect any payments related to these amounts as it is not possible to make a reasonable estimate of the amount or timing of the payment. Refer to Note 7 of the Notes to our Audited Consolidated Financial Statements for further information.

The total accrued benefit liability representing the underfunded position for pension recognized as of December 31, 2019 was approximately $22 million. This amount is impacted by, among other items, funding levels, plan amendments, changes in plan assumptions and the investment return on plan assets. We did not include estimated payments related to our total accrued benefit liability in the table above.The Pension Protection Act of 2006 was enacted in August 2006 and established, among other things, new standards for funding of U.S. defined benefit pension plans. We generally expect to fund all future contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. We did not include our estimated contributions to our various single employer plans in the table above.

We have a deferred compensation plan where the assets are maintained in a rabbi trust and the corresponding liability related to the plan is recorded in other non-current liabilities. We did not include estimated payments related to the deferred compensation liability as the timing and payment of these amounts are determined by the participants and outside our control.

In general, we are covered under conventional insurance programs with high deductibles or are self-insured for large portions of many different types of claims. Our accrued liabilities for our losses related to these programs are estimated through actuarial procedures of the insurance industry and by using industry assumptions, adjusted for our specific expectations based on our claim history. As of December 31, 2019, our accrued liabilities for our losses related to these programs totaled approximately $105 million.

CRITICAL ACCOUNTING ESTIMATES

The process of preparing our consolidated financial statements in conformity with U.S. GAAP requires the use of estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. Critical accounting estimates are both fundamental to the portrayal of a company’s financial condition and results and require difficult, subjective or complex estimates and assessments. These estimates and judgments are based on historical experience, future expectations and other factors and assumptions we believe to be reasonable under the circumstances. The most significant estimates and judgments are reviewed on an ongoing basis and revised when necessary. We have not made any material changes in the accounting methodology we use to assess or measure our critical accounting estimates. We have identified the items described below as our critical accounting estimates. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use in our critical accounting estimates. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to gains or losses that could be material to our consolidated financial statements. See Note 2 of the Notes to our Audited Consolidated Financial Statements for a discussion of these and other accounting policies.

DescriptionJudgments and UncertaintiesEffect if Actual Results Differ from Assumptions
Goodwill and Other Indefinite Lived Intangible Assets
For goodwill and other indefinite lived intangible assets, we conduct tests for impairment annually, as of October 1, or more frequently if events or circumstances indicate the carrying amount may not be recoverable. We use present value and other valuation techniques to make this assessment. If the carrying amount of goodwill or an intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. For purposes of impairment testing we assign goodwill to the reporting unit that benefits from the synergies arising from each business combination and also assign indefinite lived intangible assets to our reporting units. We define our six reporting units (in italics below) as the following: Packaged Beverages - DSD - WD Coffee Systems - US - Canada Beverage Concentrates Latin America Beverages For both goodwill and other indefinite lived intangible assets, we have the option to first assess qualitative factors to determine whether the fair value of either the reporting unit or indefinite lived intangible asset is not "more likely than not" less than its carrying value ("Step 0"). If a quantitative analysis is required, the following would be required: - The impairment test for indefinite lived intangible assets encompasses calculating a fair value of an indefinite lived intangible asset and comparing the fair value to its carrying value. If the carrying value exceeds the estimated fair value, impairment is recorded. - The impairment tests for goodwill include comparing a fair value of the respective reporting unit with its carrying value, including goodwill and considering any indefinite lived intangible asset impairment charges.For our detailed impairment analysis, we used an income based approach to determine the fair value of our assets, as well as an overall consideration of market capitalization and our enterprise value. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry and economic factors and the profitability of future business strategies. These assumptions could be negatively impacted by various risks discussed in "Risk Factors" in this Annual Report on Form 10-K. Critical assumptions for quantitative analyses include revenue growth and profit performance, including the achievability of synergies, over the next six year period, as well as an appropriate discount rate, long term growth rate and royalty rates, as applicable. Discount rates are based on a weighted average cost of equity and cost of debt, adjusted with various risk premiums. For 2019, such discount rates ranged from 7.25% to 13.00%. Long term growth rates are based on the long-term inflation forecast, industry growth and the long-term economic growth potential. For 2019, the long term growth rates ranged from 0.0% to 2.5%. Royalty rates are based on observable market participant information. For 2019, such royalty rate used in the impairment analysis of trade names ranged from 7.5% to 10.0%.The carrying values of goodwill and indefinite lived intangible assets as of December 31, 2019, were $20,172 million and $22,565 million, respectively. We have not identified any impairments in goodwill or indefinite lived intangible assets during the Periods presented. For goodwill, holding all other assumptions in the analysis constant, including the revenue and profit performance assumption, the effect of a 0.50% increase in the discount rate used to determine the fair value of the reporting units as of October 1, 2019 would not change our conclusion. For the indefinite-lived brands, holding all other assumptions in the analysis constant, including the revenue and profit performance assumption, the effect of a 0.50% increase in the discount rate used to determine the fair value of our brands as of October 1, 2019 would impact the amount of headroom over the carrying value of our brands as follows (in millions):
Fair ValueCarrying Value
Headroom PercentageResult+0.50%Result+0.50%
Potential impairment$—$1,100$—$1,110
0 - 25%7,25110,5226,3569,253
26 - 50%17,30311,41212,3198,532
In excess of 50%1,9881,5541,188968
$26,542$24,588$19,863$19,863
For the indefinite-lived trade names, holding all other assumptions in the analysis constant, including the revenue and profit performance assumption, the effect of a 0.50% increase in the discount rate used to determine the fair value of our trade names as of October 1, 2019 would impact the amount of headroom over the carrying value of our trade names as follows (in millions):
Fair ValueCarrying Value
Headroom PercentageResult+0.50%Result+0.50%
0 - 25%$—$—$—$—
26 - 50%————
In excess of 50%6,6506,1102,4792,479
$6,650$6,110$2,479$2,479
DescriptionJudgments and UncertaintiesEffect if Actual Results Differ from Assumptions
Revenue Recognition
We recognize revenue when performance obligations under the terms of a contract with the customer are satisfied. Accruals for customer incentives, sales returns and marketing programs are established for the expected payout based on contractual terms, volume-based metrics and/or historical trends.Our customer incentives, sales returns and marketing accrual methodology contains uncertainties because it requires management to make assumptions and to apply judgment regarding our contractual terms in order to estimate our customer participation and volume performance levels which impact the expense recognition. Our estimates are based primarily on a combination of known or historical transaction experiences. Differences between estimated expenses and actual costs are normally insignificant and are recognized to earnings in the period differences are determined. Further judgment is required to ensure the classification of the spend is correctly recorded as either a reduction from gross sales or advertising and marketing expense, which is a component of our SG&A expenses.A 10% change in the accrual for our customer incentives, sales returns and marketing programs as of December 31, 2019, would have affected our income from operations by $36 million for the year ended December 31, 2019.
Income Taxes
We establish income tax liabilities to remove some or all of the income tax benefit of any of our income tax positions based upon one of the following: (1) the tax position is not “more likely than not” to be sustained, (2) the tax position is “more likely than not” to be sustained, but for a lesser amount, or (3) the tax position is “more likely than not” to be sustained , but not in the financial period in which the tax position was originally taken. We assess the likelihood of realizing our deferred tax assets. Valuation allowances reduce deferred tax assets to the amount more likely than not to be realized.Our liability for uncertain tax positions contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various tax positions. We base our judgment of the recoverability of our deferred tax assets primarily on historical earnings, our estimate of current and expected future earnings and prudent and feasible tax planning strategies.Our income tax returns, like those of most companies, are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our tax positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. As these audits progress, events may occur that cause us to change our liability for uncertain tax positions. To the extent we prevail in matters for which a liability for uncertain tax positions has been established, or are required to pay amounts in excess of our established liability, our effective tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement generally would require use of our cash and may result in an increase in our effective tax rate in the period of resolution. A favorable tax settlement may be recognized as a reduction in our effective tax rate in the period of resolution. If results differ from our assumptions, a valuation allowance against deferred tax assets may be increased or decreased which would impact our effective tax rate.
Business Combinations
We record acquisitions using the purchase method of accounting. All of the assets acquired and liabilities assumed are recorded at fair value as of the acquisition date. The excess of the purchase price over the estimated fair values of the net tangible and intangible assets acquired is recorded as goodwill.The application of the purchase method of accounting for business combinations requires management to make significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed, in order to properly allocate purchase price consideration between assets that are depreciated and amortized from goodwill. The fair value assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques. Significant assumptions and estimates include, but are not limited to, the cash flows that an asset is expected to generate in the future, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset, if applicable.If the actual results differ from the estimates and judgments used in these estimates, the amounts recorded in the financial statements may be exposed to potential impairment of the intangible assets and goodwill, as discussed in the Goodwill and Other Indefinite Lived Intangible Assets critical accounting estimate section.

OFF-BALANCE SHEET ARRANGEMENTS

We currently participate in three multi-employer pension plans. In the event that we withdraw from participation in one of these plans, the plan will ultimately assess us a withdrawal liability for exiting the plan, and U.S. GAAP would require us to record the withdrawal charge as an expense in our consolidated statements of income and as a liability on our consolidated balance sheets once the multi-employer pension withdrawal charge is probable and estimable. Refer to Note 8 of the Notes to our Audited Consolidated Financial Statements for additional information regarding our multi-employer pension plans.

There are no other off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our results of operations, financial condition, liquidity, capital expenditures or capital resources other than letters of credit outstanding. Refer to Note 9 of the Notes to our Audited Consolidated Financial Statements for additional information regarding outstanding letters of credit.

EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS

Refer to Note 2 of the Notes to our Audited Consolidated Financial Statements for a discussion of recently issued accounting standards and recently adopted provisions of U.S. GAAP.

SUPPLEMENTAL UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION AND NON-GAAP FINANCIAL MEASURES

Supplemental Unaudited Pro Forma Combined Financial Information

The following unaudited pro forma combined financial information is presented to illustrate the estimated effects of the DPS Merger, which was consummated on July 9, 2018, for the year ended December 31, 2018 based on the historical results of operations of DPS and Maple. See Notes 1 and 3 of our Notes to our Audited Consolidated Financial Statements for additional information on the DPS Merger.

The following unaudited pro forma combined statements of income for the year ended December 31, 2018 are based on the historical financial statements of DPS and Maple after giving effect to the DPS Merger, related equity investments, and the assumptions and adjustments described in the accompanying notes to these unaudited pro forma combined statements of income. The KDP (Maple) statement of income information for the year ended December 31, 2018 was derived from the audited consolidated financial statements included elsewhere in this Form 10-K.

The unaudited pro forma combined statements of income set forth below primarily give effect to the following assumptions and adjustments:

•Application of the acquisition method of accounting;
•The issuance of Maple common stock to JAB in connection with the equity investments;
•The conversion of Maple Parent Corporation into KDP shares in accordance with the Merger Agreement;
•The pre-closing Maple share conversion;
•The exchange of one share of KDP common stock for each share of DPS common stock;
•The change in year-end for Maple; and
•The alignment of accounting policies.

The unaudited pro forma combined financial information was prepared using the acquisition method of accounting, which requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the completion of the acquisition. We utilized estimated fair values at the Merger Date for the preliminary allocation of consideration to the net tangible and intangible assets acquired and liabilities assumed.

The unaudited pro forma combined financial information has been prepared and presented in a form consistent with SEC Regulation S-X Article 11 and is not necessarily indicative of the results of operations that would have been realized had the transactions been completed as of the dates indicated, nor are they meant to be indicative of our anticipated combined future results. In addition, the accompanying unaudited pro forma combined statements of income do not reflect any anticipated synergies, operating efficiencies, cost savings or any integration costs that may result from the DPS Merger.

The historical consolidated financial information has been adjusted in the accompanying unaudited pro forma combined statements of income to give effect to unaudited pro forma events that are (1) directly attributable to the DPS Merger, (2) factually supportable and (3) are expected to have a continuing impact on the results of operations of KDP. As a result, under SEC Regulation S-X Article 11, certain expenses such as transaction costs and costs associated with the impact of the step-up of inventory related to the DPS Merger are eliminated from pro forma results in all periods presented. In contrast, under the U.S. GAAP presentation in Note 3, Acquisitions and Investments in Unconsolidated Subsidiaries, these expenses are required to be included in prior year pro forma results. See Note 3 of the Notes to our Audited Consolidated Financial Statements for additional information.

The unaudited pro forma combined financial information, including the related notes, should be read in conjunction with the historical consolidated financial statements and related notes of DPS, and with our Audited Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.

Keurig Dr Pepper Inc.

Pro Forma Condensed Combined Statement of Income

For the Year Ended December 31, 2018

(Unaudited)

(in millions, except per share data)Reported KDP**(1)**DPS January 1 - July 8, 2018**(2)**Pro Forma Adjustments**(3)**Pro Forma Combined
Net sales$7,442$3,605$(27)$11,020
Cost of sales3,5601,529(156)4,933
Gross profit3,8822,0761296,087
Selling, general and administrative expenses2,6351,639(361)3,913
Other operating expense (income), net10(14)2(2)
Income from operations1,2374514882,176
Interest expense40188182671
Interest expense - related party51—(51)—
Loss on early extinguishment of debt13——13
Other expense (income), net(19)514—
Income before provision for income taxes7913583431,492
Provision for income taxes20282109393
Net income5892762341,099
Net income attributable to employee redeemable non-controlling interest and mezzanine equity awards3—(3)—
Net income attributable to KDP$586$276$237$1,099
Earnings per common share:
Basic$0.54$0.79
Diluted0.530.78
Weighted average common shares outstanding:
Basic1,086.3303.51,389.8
Diluted1,097.6303.51,401.1
(1)Refer to the Statements of Income, which includes DPS activity subsequent to the Merger Date.
(2)Refers to DPS activity during the year ended December 31, 2018 prior to the Merger Date.
(3)Refer to Summary of Pro Forma Adjustments.

Keurig Dr Pepper Inc.

Reconciliation of Pro Forma Segment Information

(Unaudited)

(in millions)Reported KDP**(1)**DPS January 1 - July 8, 2018**(2)**Pro Forma Adjustments**(3)**Pro Forma Combined
For the Year Ended December 31, 2018
Net Sales
Coffee Systems$4,114$—$—$4,114
Packaged Beverages2,4152,654—5,069
Beverage Concentrates669689(27)1,331
Latin America Beverages244262—506
Total net sales$7,442$3,605$(27)$11,020
Income from Operations
Coffee Systems$1,163$—$(2)$1,161
Packaged Beverages257299124680
Beverage Concentrates430436(10)856
Latin America Beverages2942980
Unallocated Corporate(642)(326)367(601)
Total income from operations$1,237$451$488$2,176
(1)Refer to the Statements of Income, which includes DPS activity subsequent to the Merger Date.
(2)Refers to DPS activity during the year ended December 31, 2018 prior to the Merger Date.
(3)Refer to Summary of Pro Forma Adjustments.

Summary of Pro Forma Adjustments

Pro forma adjustments included in the Pro Forma Combined Statements of Income for the year ended December 31, 2018 are as follows:

a.A decrease in Net sales to remove the historical deferred revenue associated with DPS' arrangements with PepsiCo and Coca-Cola, which were eliminated in the fair value adjustments for DPS as part of purchase price accounting.
b.An increase in Net sales to remove the historical amortization of certain capitalized upfront customer incentive program payments. These were eliminated in the fair value adjustments for DPS as these upfront payments were revalued within the customer relationship intangible assets recorded in purchase price accounting.
c.Adjustment to remove the impact of the step-up of inventory recorded in purchase price accounting.
d.Adjustments to SG&A expenses due to changes in amortization as a result of the fair value adjustments for DPS' intangible assets with definite lives as part of purchase price accounting.
e.Adjustments to SG&A expenses due to changes in depreciation as a result of the fair value adjustments for DPS' property, plant and equipment as part of purchase price accounting.
f.A decrease to SG&A expenses for both DPS and Maple to remove non-recurring transaction costs as a result of the DPS Merger.
g.Removal of the Interest expense - related party caption for Maple, as the related party debt was capitalized into Additional paid-in capital immediately prior to the DPS Merger.
h.Adjustments to Interest expense to remove the historical amortization of deferred debt issuance costs, discounts and premiums and to record incremental amortization as a result of the fair value adjustments for DPS' senior unsecured notes as part of purchase price accounting.
i.Adjustments to Interest expense to record incremental interest expense and amortization of deferred debt issuance costs for borrowings related to the DPS Merger.
j.Removal of the Net income attributable to employee redeemable NCI and mezzanine equity awards caption as the Maple non-controlling interest was eliminated to reflect the capital structure of KDP.

Non-GAAP Financial Measures

To supplement the consolidated financial statements presented in accordance with U.S. GAAP, we have presented in this report selected unaudited pro forma combined financial information for the year ended December 31, 2018. We also present (i) Adjusted pro forma net sales, (ii) Adjusted pro forma income from operations, (iii) Adjusted pro forma net income and (iv) Adjusted pro forma diluted EPS, which are considered non-GAAP financial measures. This pro forma financial information and non-GAAP financial measures provided should be viewed in addition to, and not as an alternative for, results prepared in accordance with U.S. GAAP. The non-GAAP financial measures presented may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures in the same way. The adjusted measures are not substitutes for their comparable U.S. GAAP financial measures, such as net sales, income from operations, net income, diluted EPS, or other measures prescribed by U.S. GAAP, and there are limitations to using non-GAAP financial measures.

For the year ended December 31, 2019, we define our Adjusted non-GAAP financial measures as certain financial statement captions and metrics adjusted for certain items affecting comparability, while for the year ended December 31, 2018, we define our Adjusted non-GAAP financial measures as certain pro forma financial statement captions and metrics adjusted for certain items affecting comparability. The items affecting comparability are defined below.

Items affecting comparability: Defined as certain items that are excluded for comparison to prior year periods, adjusted for the tax impact as applicable. Tax impact is determined based upon an approximate rate for each item. For each period, management adjusts for (i) the unrealized mark-to-market impact of derivative instruments not designated as hedges in accordance with U.S. GAAP and do not have an offsetting risk reflected within the financial results; (ii) the amortization associated with definite-lived intangible assets; (iii) the amortization of the deferred financing costs associated with the DPS Merger and the Keurig Acquisition; (iv) the amortization of the fair value adjustment of the senior unsecured notes obtained as a result of the DPS Merger; (v) stock compensation expense attributable to the matching awards made to employees who made an initial investment in the EOP or the Keurig Dr Pepper Omnibus Incentive Plan of 2009; and (vi) other certain items that are excluded for comparison purposes to prior year periods.

For the year ended December 31, 2019, the other certain items excluded for comparison purposes include (i) restructuring and integration expenses related to the DPS Merger and the Keurig Acquisition; (ii) productivity expenses; (iii) transaction costs for significant business combinations (completed or abandoned) excluding the DPS Merger; (iv) provision for legal settlements; (v) the impact of the step-up of acquired inventory not associated with the DPS Merger (vi) the loss on early extinguishment of debt related to the redemption of debt and (vii) the loss related to the February 2019 organized malware attack on our business operation networks in the Coffee Systems segment, as discussed in our 2018 Annual Report on Form 10-K.

For the year ended December 31, 2018, the other certain items excluded for comparison purposes include (i) restructuring and integration expenses related to the DPS Merger and the Keurig Acquisition; (ii) productivity expenses; (iii) provisions for legal settlements; (iv) the loss on early extinguishment of debt related to the redemption of debt; and (v) tax reform associated with the TCJA.

For the year ended December 31, 2019, the supplemental financial data set forth below includes reconciliations of Adjusted net sales, Adjusted income from operations, Adjusted net income and Adjusted diluted EPS to the applicable financial measure presented in the unaudited condensed consolidated financial statement for the same period. For the year ended December 31, 2018, the supplemental financial data set forth below includes reconciliations of Adjusted pro forma net sales, Adjusted pro forma income from operations, Adjusted pro forma net income and Adjusted pro forma diluted EPS to the applicable financial measure presented in the unaudited pro forma condensed combined financial statements for the same period. For a reconciliation of the applicable financial measure presented in the unaudited pro forma condensed combined financial statement for the year ended December 31, 2018 to the applicable historical financial measure presented in accordance with U.S. GAAP, please see "Supplemental Unaudited Pro Forma Condensed Combined Financial Information" above.

KEURIG DR PEPPER INC.

RECONCILIATION OF CERTAIN REPORTED ITEMS TO CERTAIN NON-GAAP ADJUSTED ITEMS

For the Year Ended December 31, 2019

(Unaudited, in millions, except per share data)

Cost of salesGross profitGross marginSelling, general and administrative expensesOther operating expense (income), netIncome from operationsOperating margin
Reported$4,778$6,34257.0%$3,962$2$2,37821.4%
Items Affecting Comparability:
Mark to market35(35)10—(45)
Amortization of intangibles——(126)—126
Stock compensation——(24)—24
Restructuring and integration costs(1)1(216)(25)242
Productivity(15)15(60)(22)97
Transaction costs——(9)—9
Inventory step-up(3)3——3
Provision for legal settlements——(48)—48
Malware Incident(2)2(6)—8
Adjusted GAAP$4,792$6,32857.0%$3,483$(45)$2,89026.0%
Interest expenseLoss on early extinguishment of debtIncome before provision for income taxesProvision for income taxesEffective tax rateNet incomeWeighted Average Diluted sharesDiluted earnings per share
Reported$654$11$1,694$44026.0%$1,2541,419.1$0.88
Items Affecting Comparability:
Mark to market(47)—2(1)3—
Amortization of intangibles——12634920.06
Amortization of deferred financing costs(13)—13490.01
Amortization of fair value debt adjustment(26)—266200.01
Stock compensation——246180.01
Restructuring and integration costs1—241551860.13
Productivity——9724730.05
Transaction costs(16)—257180.01
Loss on early extinguishment of debt—(11)11290.01
Inventory step-up——312—
Provision for legal settlements——4811370.02
Malware Incident——826—
Adjusted GAAP$553$—$2,318$59125.5%$1,7271,419.1$1.22

Diluted EPS may not foot due to rounding.

KEURIG DR PEPPER INC.

RECONCILIATION OF CERTAIN REPORTED ITEMS TO CERTAIN NON-GAAP ADJUSTED ITEMS

For the Year Ended December 31, 2018

(Unaudited, in millions, except per share data)

Net salesCost of salesGross profitGross marginSelling, general and administrative expensesOther operating expense (income), netIncome from operationsOperating margin
Pro Forma$11,020$4,933$6,08755.2%$3,913$(2)$2,17619.7%
Items Affecting Comparability:
Mark to market—(53)53(19)—72
Amortization of intangibles———(121)—121
Stock compensation———(21)—21
Restructuring and integration costs—(2)2(160)(8)170
Productivity—(12)12(14)(6)32
Transaction costs———(4)—4
Provision for legal settlements4—4(18)—22
Inventory step-up—(2)2——2
Adjusted Pro Forma$11,024$4,864$6,16055.9%$3,556$(16)$2,62023.8%
Interest expenseLoss on early extinguishment of debtOther expense (income), netIncome before provision for income taxesProvision for income taxesEffective tax rateNet incomeWeighted Average Diluted sharesDiluted earnings per share
Pro Forma$671$13$—$1,492$39326.3%$1,0991,401.1$0.78
Items Affecting Comparability:
Mark to market(3)—37216560.04
Amortization of intangibles———12131900.06
Amortization of deferred financing costs(9)——936—
Amortization of fair value debt adjustment(22)——226160.01
Stock compensation———214170.01
Restructuring and integration costs———170431270.09
Productivity2——309210.01
Transaction costs(4)——835—
Loss on early extinguishment of debt—(13)—133100.01
Provision for legal settlements———226160.01
Inventory step-up———2—2—
Tax reform————7(7)—
Adjusted Pro Forma$635$—$3$1,982$52426.4%$1,4581,401.1$1.04

Numbers may not foot due to rounding.

KEURIG DR PEPPER INC.

RECONCILIATION OF SEGMENT ITEMS TO CERTAIN NON-GAAP ADJUSTED SEGMENT ITEMS

(Unaudited)

(in millions)ReportedItems Affecting ComparabilityAdjusted GAAP
For the Year Ended December 31, 2019
Net Sales
Coffee Systems$4,233$—$4,233
Packaged Beverages4,945—4,945
Beverage Concentrates1,414—1,414
Latin America Beverages528—528
Total net sales$11,120$—$11,120
Income from Operations
Coffee Systems$1,219$184$1,403
Packaged Beverages75726783
Beverage Concentrates9552957
Latin America Beverages85(3)82
Unallocated corporate costs(638)303(335)
Total income from operations$2,378$512$2,890
(in millions)Pro FormaItems Affecting ComparabilityAdjusted Pro Forma
For the Year Ended December 31, 2018
Net Sales
Coffee Systems$4,114$4$4,118
Packaged Beverages5,069—5,069
Beverage Concentrates1,331—1,331
Latin America Beverages506—506
Total net sales$11,020$4$11,024
Income from Operations
Coffee Systems$1,161$166$1,327
Packaged Beverages68011691
Beverage Concentrates8565861
Latin America Beverages80383
Unallocated corporate costs(601)259(342)
Total income from operations$2,176$444$2,620

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