Keurig Dr Pepper Inc (KDP) — Q4 2018 Earnings Call Transcript

Thank you and hello everyone. Thanks for joining us. Earlier this morning we issued our press release for the fourth quarter and full year of 2018. If you need a copy you can get one on our website at keurigdrpepper.com in the Investors section. As you will recall for the last quarter the discussion of our Q3 performance was largely on an adjusted pro forma basis due to the merger. And our discussion here today will be consistent with that. The company believes that the adjusted pro forma basis provides investors with additional insight into our business and operating performance trends. While these pro forma adjustments and the exclusion of items affecting comparability are not in accordance with GAAP, we believe that the adjusted pro forma basis provides a meaningful comparison in an appropriate basis for discussion of our performance. Details of the excluded items are included in the reconciliation tables included in our press release and are discussed in detail in our 10-K, which will be filed later today. So it was quite an exciting 2018 now in the record books, our attention turns to driving another year of strong performance for KDP in 2019. Here with me today to discuss our results for 2018 and our outlook for 2019 are KDP Chairman and CEO, Bob Gamgort and our CFO, Ozan Dokmecioglu. Also with us today is our recently hired Vice President of IR, Tyson Seeley who some of you already know. Tyson will lead the IR team here at KDP, reporting to me. For those of you who don't already know Tyson I'm certain you will enjoy working with him. And finally our discussion this morning may include forward-looking statements which are subject to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially and the company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the company's filings with the SEC. And with that, I'll hand it over to Bob.

Thanks Maria and thanks to everyone for dialing in. We're very pleased with the strong results delivered in Q4 and for the full year 2018, and we are especially proud of the progress we have made in creating our new beverage company. We expect to create sustained shareholder and stakeholder value over the long term. We have largely completed our integration bringing together 25,000 employees under a unified culture and harmonized processes. And we have established a singular focus to capture growth across the majority of beverage occasions in North America. Most importantly, our in-market business momentum never lost a beat while we were in progress of integration. A real testament to the quality of our team members and the strength of our integration program. We drove growth across the majority of our portfolio in 2018 and are on track to deliver our synergy goals and are in position to deliver the overall value creation targets we communicated at the time of the merger, even in an environment that has become much more challenging over the past year. Let's talk specifics for 2018 before we speak to our expectations for the coming year. I will begin with in-market results based on IRi. Retail market performance was strong across most of the business. Our CSD portfolio registered market share growth in both units and dollars with strong dollar performances from both Dr Pepper and Canada Dry and to a lesser extent A&W, Squirt, and Schweppes. Outside of CSDs, we gained share in multiple cold beverage segments such as enhanced flavored still water, premium unflavored still water, ready to drink coffee, apple juice, vegetable juice, and mixers. Our coffee portfolio also delivered strong results in 2018 driven by unit growth approximating 10% for products manufactured by KDP outpacing category growth of approximately 8%. In dollar terms, KDP manufactured pods grew over 4% in a category that advanced approximately 3%. As a result, the dollar market share of pods manufactured by KDP advanced to 82%. Turning to the total company financials on an adjusted pro forma basis, net sales were up 2.3% for the year with strong revenue growth registered for all segments except coffee systems which was up in volume but essentially flat in dollars due to our previously discussed strategic pod pricing investments. Operating income advanced approximately 7% to $2.6 billion with double-digit growth in the second half of the year, more than offsetting flat performance in the first half. For the year, the profit contribution from growth in net sales and continued strong productivity was partially offset by increased inflation and input costs and logistics. Further, the operating gains from changes in the Allied Brands portfolio in 2018 were less than those realized in 2017. Adjusted diluted EPS advanced 22% to $1.04 for the year, squarely in line with our targets. Reflecting the growth in operating income and lower interest expense as well as the benefit of non-operating income recorded in 2018 related to a cash distribution from BODYARMOR and a gain from the acquisition of Core, also benefiting the comparison with the lower effective tax rate in 2018 due to U.S. tax reform. Turning to our segments on an adjusted pro forma basis. I'll start with beverage concentrates which posted strong results for the year. Net sales, which represents our sales of concentrates to bottlers and syrups to fountain customers advanced approximately 4% driven by growth in both net realized pricing and volume mix. The increase in net sales was driven by very strong growth of Dr Pepper and A&W as well as increased sales of Squirt, Schweppes, Big Red, and Canada Dry. Operating income for beverage concentrates advanced 5% for the year reflecting the strong net sales performance and slightly lower marketing spend. Turning to packaged beverages. Packaged beverages delivered 4% growth in net sales for the year reflecting volume mix growth of 5.4% for continuing brands, partially offset by the anticipated unfavorable impact of 1.2% resulting from changes in the Allied Brands portfolio during the year. Pricing for the year was essentially even with a year ago driven by the pricing actions implemented in late Q3 that offset lower net price realization earlier in the year. Driving the net sales momentum with double-digit revenue growth of Canada Dry, reflecting successful innovation. Dr Pepper also registered growth for the year driven by the particular strength of our college football marketing campaign, Standstill, which featured an engaging storyline that played out over the course of the season. Core and Bai also posted very strong growth partially offset by Fiji, Vita Coco, and Hawaiian Punch. Contract manufacturing also contributed to the revenue growth for the year. Operating income in packaged beverages declined approximately 10% for the year primarily due to inflation that was not covered until we took pricing late in the third quarter, as well as the impacted gains recorded from Allied Brands being lower in 2018 than 2017. Partially offsetting these factors were the benefits of net sales growth and productivity. Illustrating the importance of our late year pricing actions, operating income for packaged beverages accelerated in the fourth quarter, growing more than 8%, which Ozan will cover shortly. As we head into spring, we see the benefits from the launch of Diet Canada Dry Ginger Ale Lemonade and the introduction of Canada Dry Ginger Ale and Orangeade, both of which will be supported by marketing investment. In addition, we have continued innovation planned for Dr Pepper and Snapple among other brands. Turning now to Latin American Beverages. Latin American beverages had a strong year with net sales advancing 4% and operating income up 28%. The net sales performance reflected higher net pricing of 5.5% and favorable volume mix of approximately 1%, partially offset by unfavorable foreign currency translation of 2%. Penafiel led the growth in net sales along with Clamato, Squirt, and Mott. Operating income for Latin American Beverages grew 28% to $82 million for the year primarily reflecting the growth in net sales as well as the favorable impact of comparison to a year ago write-off of prepaid resin inventory and to a lesser extent productivity. Now turning to the coffee system segment, coffee systems had a solid year with volume mix up 3.2% driven by strong K-Cup pod volume growth offset by lower net realized pricing of 3.7%, reflecting the previously discussed strategic pod pricing investment, which continues to moderate. K-Cup pod volume grew 7.4% for the year driven by increased household penetration of the Keurig Brewing System, which expanded by 7% and is now approaching 22% on a rolling 52-week basis ending December. Somewhat counterintuitively, brewer volume declined 1.5% despite the growth in household penetration. This is a result of increased brewer quality which has led to consumers holding onto their brewers longer and has also resulted in fewer returns. Brewer sales were also impacted by the discontinuation of select legacy brewer models, partially offset by the success of our recently introduced K-Café and redesigned K-Mini. Since 2016, our entire brewer lineup has been refreshed or replaced with new models. The launch of K-Café, which was supported by the second year of our Brew the Love Campaign featuring James Corden, has been well received in the market. K-Café enables consumers to make lattes and cappuccinos at home using any K-Cup pod. The consumer reviews of the new brewer have been exceptionally strong. In addition, our updated K-Mini brewer platform, which features a modern sleek design and improved coffee quality and temperature, is another example of our robust innovation pipeline designed to drive new household penetration in the Keurig system. Operating income for coffee systems was up a strong 9% for the year primarily reflecting volume growth and strong productivity, partially offset by strategic pod pricing investment, inflation, and higher marketing. As you know, partnerships are a key element of our coffee system strategy and in 2018, we added Tim Hortons, the iconic coffee brand in Canada which was previously unlicensed, and Panera, the well-regarded bakery café brand in the U.S. We've also signed an agreement with Met Café in Canada, previously an unlicensed brand, which we will begin distributing in 2020. We also added and expanded multiple private label partnerships in 2018. And finally, the strong pace of brewer innovation will continue in 2019. While it's too early to share the specifics today, on our next call we will have the opportunity to discuss our 2019 innovation plan which will begin shipping in Q2. We will also be increasing our investment behind Keurig brand marketing this year. Before I turn it over to Ozan to provide more detail on the latest quarter and 2018 full year, I will speak to our 2019 targets. For the full year, we're targeting adjusted pro forma diluted EPS growth in the range of 15% to 17%, representing a $1.20 to $1.22 per share. This growth rate is the same as the long-term target we communicated at the merger announcement over a year ago despite an increasingly challenging operating environment marked by higher inflation and CSD industry volumes that are somewhat pressured by the elasticity impact of pricing. To navigate these pressures, we are strengthening our productivity efforts and investing in innovation, marketing, and retail execution to continue to drive market share gain. With that, I'll hand it off to Ozan.

Thanks Bob and good morning everyone. Let me start with the results of the fourth quarter which was another really good one for KDP. I will then transition to our outlook for 2019, continuing on an adjusted pro forma basis. Net sales for the fourth quarter increased 0.5% to $2.81 billion compared to $2.80 billion in the prior year, which reflected underlying net sales growth of 2.3%. This was difficult, offset by an unfavorable impact of 1.8% from changes in our Allied Brands portfolio which we expected. The underlying 2.3% growth was driven by higher volume mix of 2.7% partially offset by unfavorable foreign currency translation of 0.4%. Net realized pricing in the quarter was flat. Operating income in the quarter increased nearly 14% to $720 million compared to $638 million in the prior year. This past four months primarily reflected strong productivity, lower general and administrative expenses, reduced marketing spending, and the benefit of the net sales growth. Partially offsetting these drivers was inflation in input costs and logistics. On a margin basis, operating income advanced 280 basis points in the quarter to 25.6%. Before turning to a quick review of the segments, it's worth noting the acceleration in performance in the second half of 2018 versus the first half prior to the merger close. Specifically, operating income advanced 13.5% compared to a year ago in the second half, compared to a slight decline in the first six months of 2018. This is a step up in performance lastly reflecting very strong productivity and the benefit of pricing actions in packaged beverages taken in the fourth quarter. In terms of segment performance for the fourth quarter on an unadjusted pro forma basis, net sales for beverage concentrates increased 4.8% to $352 million driven by higher net price realization 2.6%, an increased volume mix of 2.4%, partially offset by unfavorable currency translation of 0.2%. This growth was fueled by sales of Dr Pepper along with increases in 7UP, Big Red, Schweppes, and Sunkist. The shipment volume growth for beverage concentrates was driven by Canada Dry, Dr Pepper, Big Red, and Sunkist. In terms of bottler K sales, beverage concentrates registered growth of nearly 1% in the quarter. Operating income for the beverage concentrates increased more than 14% to $242 million reflecting the benefits of the net sales growth and lower marketing costs offset by inflation. As a percentage of net sales, operating margin advanced 570 basis points versus a year ago to 68.8%. Net sales for our packaged beverages segment but essentially flat to a year ago at $1.18 billion including the unfavorable impact of 4.2% from the changes in our Allied Brands portfolio which we had expected. Excluding this impact, underlying net sales grew 4.3% reflecting favorable volume mix growth of 2.7% and net price realization of 1.7%. Unfavorable foreign currency translation was 0.1% served as a slight offset to the growth. Driving the strong underlying net sales growth were Canada Dry, Core, Dr Pepper, Big Red, and Mott, as well as contract manufacturing. Operating income for packaged beverages increased 8% to $206 million largely reflecting the underlying growth including pricing actions taken late in the fourth quarter, as well as favorable product mix, productivity savings, and lower marketing spending. These factors were partially offset by inflation and the unfavorable comparison against a $21 million gain posted in the fourth quarter of 2017. Net sales for Latin American Beverages increased 1.7% to $120 million compared to $118 million in the prior year. This performance was driven by higher net price realization of 5.8% and favorable volume mix of 0.1% partially offset by unfavorable currency translation of 4.2%. Operating income for Latin American Beverages was up 20% to $18 million reflecting the benefits of the net sales growth and productivity savings, partially offset by inflation. Finally, net sales of our coffee system segment declined 0.5% to $1.16 billion in the quarter. This performance reflected higher volume mix of 2.9% more than offset by lower net price realization of 3% and unfavorable foreign currency translation of 0.4%. The 2.9% volume mix growth for coffee systems was driven by an 8.6% increase in K-Cup product volume, partially offset by an 8.6% decline in brewers during the quarter. This was primarily driven by shipment timing between the third quarter and the fourth quarter. For perspective, brewer sales in the second half were modestly below the year ago. As you know, Q4 is a big brewer selling period for retailers and their purchase of inventory can shift between the third and fourth quarter. Partially offsetting these factors is the recent innovation launches that have been very well received in the marketplace. Operating income for coffee systems advanced approximately 9% to $328 million primarily reflecting strong productivity, partially offset by higher marketing expenses and inflation. Turning to interest, interest expense in the fourth quarter totaled $139 million reflecting a $21 million benefit from unwinding several interest rate swap contracts. Our ongoing deleveraging and the benefit of commercial paper in our debt structure in 2018. You may have also noticed that earlier this month we announced the refinancing of our term loan in an oversubscribed issue that reduced the pricing on our outstanding term loan balance of $2 billion by approximately 30 basis points. The support that we continued to receive from our banking partners speaks to the confidence our lenders place in KDP. Net income for the quarter increased 28% to $423 million driven by strong operating income growth and a lower interest expense reported in the quarter. Taking all of these factors together, our adjusted pro forma diluted EPS in the quarter increased 25% to $0.30 per diluted share compared to $0.24 per diluted share in the prior year. In terms of leverage, we paid down approximately $940 million of bank debt since the merger closed, positioning our bank debt to adjusted EBITDA ratio, which we refer to as our management leverage ratio, by half a turn to 5.4 times. This aggressive pace of deleveraging is consistent with our expectations and we are confident that we will achieve our leverage target in the timeframe previously committed. This rapid debt pay down in the six month period following the merger close was supported by strong free cash flow delivery. In 2019, we expect free cash flow to approximate $2.3 billion to $2.5 billion which will be a significant enabler for our ongoing deleveraging. We remain firmly committed to achieving our targeted leverage below three times in two to three years from the merger closing. And finally in terms of our outlook for 2019, as Bob already mentioned, for the full year we expect adjusted pro forma diluted EPS growth in the range of 15% to 17%, representing $1.20 to $1.22 per share in line with our long-term merger algorithm. Net sales are expected to grow approximately 2%, which is also in line with our long-term merger target of 2% to 3%. Despite the short-term transitory impact we discussed with you last quarter from the changes in our Allied Brands portfolio, we continue to expect merger synergies of $12 million in 2019 consistent with our long-term merger target. There are few items related to changes in the Allied Brands portfolio in 2018 that we do not expect to repeat in 2019. These items totaled $58 million in gains in 2018. Specifically, other operating income in 2019 is expected to be a few million dollars of expense as it will exclude the $22 million gain on Big Red recorded in 2018. Below operating income, other non-operating income and expense is expected to be an expense of $30 million in 2019 as it will exclude the combined $36 million of gains recorded on Core and BODYARMOR in 2018. Interest expense is expected to be in the range of $570 million to $590 million. This reflects our expectation of significant cash flow generation and continued deleveraging during 2019, as well as the benefit from additional unwinding of interest rate swap contracts which is a strategy we use to manage interest rate risk. Our effective tax rate for 2019 is estimated in the range of 25% to 25.5% for the year. We expect our diluted weighted average shares outstanding to approach $1.42 billion in 2019 including the 16.7 million of shares issued in November 2018 for the acquisition of Core. While we are not providing EPS guidance by quarter, we expect EPS growth versus 2018 to be tempered in quarter two and quarter three due to comping the significant gains on Allied Brands in 2018 that we discussed today. With this perspective, you should also keep in mind the following when doing your modeling. We expect our second half synergies to be greater than our first half synergies as our programs build throughout the year. Based on our input cost coverage we expect inflation to be the highest in the first quarter and then moderate over the balance of the year. Finally, the shift in Easter into the second quarter this year from the first quarter in 2018 will likely pressure quarter one net sales and operating income in 2019 by approximately $20 million and $10 million respectively. This said, before taking your questions, I will turn it back to Maria who has some good news to share regarding the IRi data.

Thanks Ozan. I know tracking KDP manufactured pod performance is challenging for you using the existing syndicated reporting. I'm pleased to share that in addition to their regular reporting, IRi has developed a KDP manufactured sales trends report for single-serve coffee that encompasses all of the K-Cup pods manufactured by KDP, whether owned, licensed, partner, or private label. This new report will be available directly from IRi beginning in March, I hope you find it useful. With that, I'll turn it back to the operator for questions.

Great, thanks, good morning. I know you guys went through some of the data points on brewer sales and the dynamics of the replacement cycle, but I think there might be a bit of confusion this morning around results from the coffee segments. If you could just talk again a little bit about how you were thinking about the role of brewers, brewer sales, brewer profitability, how that may have changed in the long-term plan. And also anything around Pods as you see it as being indicative of kind of consumer uptake, adoption rates, things like that because I think what I'm getting from people this morning is just questions around that coffee segment and does this mean that my long-standing concerns about the legacy KGM business are coming to fruition, so I would just love your perspective on that? Thanks.

Yeah, thanks Lauren, happy to answer that. I mean from our perspective, the metrics across the board on the coffee system are all flashing green. I think our understanding is that sometimes it is a complicated business that requires some thought from our perspective to tell you why we feel that way, and it's consistent with what we talked about in the March a year ago Investor Day as well as the follow-up Analyst Meeting that we had. So let me start at a higher level about those metrics that really matter on this business from a management perspective, and then I want to drill specifically into household penetration, brewer sales, and a little bit on what we see on pods. So the way that we run this business is the four metrics that matter are household penetration of the system, hot volume growth, KDP manufactured pod share, and coffee system profitability. Every single one of those metrics is going in the right direction in a very significant way. Household penetration is up 7% in the past year to about 22% of households; there are now 28 million households in the United States that are using a Keurig brewer on a regular basis. And we still believe there's another 67 million households left for us to target. But at 7% growth in household penetration up to 28 million households is significant. Pod volume growth is up significantly. If you take a look at the K-Cup pod category in IRi, it's plus 10% for the year, incredibly robust. KDP manufactured share is up a point to 82% as we talked about, and we gave you a list of partners that we've added over the past year, some of them are very significant, and several of them were unlicensed parties and we haven't lost anyone in the past year. So that speaks to the forward-looking confidence we have in that. And then finally, coffee profitability—I get to brewer sales because then people are concerned that brewer sales have zero correlation in the short-term between household penetration and brewer sales. We're going to give you the example of that right now. But also things like mix and pricing. We also look at coffee systems, even with the investment in pricing, grew margin in the fourth quarter by 240 basis points and for the year by 290 basis points, which tells you that we also have incredible line of sight to productivity that we use to protect the pricing investment that we made. So, those are the metrics that matter. Some of those are easier for you to get than others, but we're disclosing household penetration on an annual basis as we did today, and as Maria said, there's now a report available through IRi that will allow you to measure KDP manufactured pod shares. So, those are all pointing in the right direction so that you can see the business the way that we do. Let me just talk about brewer sales for a minute. At a very high level, we've talked in the past kind of theoretically that you can have a situation where brewer sales were up significantly but had little impact on household penetration because they were all replacements. Similarly, we talked about theoretical scenarios where brewers could be down significantly, and household penetration was up because the replacement cycle was different and they were all going to new households. A little more toward that in 2018 and the last quarter which were, brewer sales were down but household penetration was way up. The reason underlying that is actually really good news: a higher percentage of the brewers sold went to new households versus replacement households. Why is that? Because the quality of the brewers is up significantly. You can see that by going online on Amazon or Walmart or anywhere else and look at the star ratings of the brewers and how much higher they were than those in the past. We also see it because we see significantly lower returns and significantly lower warranty claims. Those are really good for the P&L in addition to speaking towards a better mix of new users versus replacement users. And the other part is we know as one of the metrics that we track internally is that consumers are happier with their brewers; they don't break, and as a result they're holding on to their brewers for longer. So we are in sort of this virtuous situation; it is the opposite I think of being concerned. We're actually very bullish. Because of the quality of our brewers, we're driving household penetration, and ironically it means that we're going to have some lower brewer sales in situations like we did for the fourth quarter because fewer people are buying to replace a broken brewer. That means happier consumers in the end. So net-net we see this as all flashing green from that standpoint. Then the last thing I'll say on this point, and apologies for the very long answer but I think it's a really important question. In the past when the company lost a significant amount of money on brewers, everybody wanted to model brewer sales because the more you sold, the bigger the negative impact on profitability. Similarly, if we made a lot of money on brewers you'd want to know that because there would be a direct correlation to sales going up and down our profitability. We are about breakeven as we talked about. So, to be honest with you, brewer revenue going up or down has zero impact on the profitability on our P&L, and the only thing that you guys would care about it for is a proxy for household penetration. As I just went through in great detail it's actually a poor proxy for household penetration. So short answers, brewer revenue is really a meaningless metric in terms of our P&L as well as in indicating the health of the system.

That's great, thank you so much.

Thank you and good morning everyone. So I guess the other sort of question or concern that I'm hearing from investors is 2019 guidance and I know it's in line with your long-term target in terms of EPS guidance, but if I sort of take the implied EBIT growth in 2019, it looks like it's around 10% versus the 11% to 12% EBITDA growth that you had given previously. So first just wanted to confirm that this is in fact sort of what you're guiding to for 2019 just from an EBIT growth perspective, and if so is this reflective of some of the challenges that you called out particularly on I guess the CFT side, and does that imply that you're going to be putting more investments to deal with some of the operating environment getting tougher?

Hi Judy, this is Ozan. Our guidance, as we have communicated just now, is on the EPS which is in line with our long term merger target that we put out there of 15% to 17% and on net sales of 2% to 3%. And as you pointed out, we did also provide significant details with regards to the makeup of the P&L hoping it will make your jobs easier to model it out. And you are right, we put the 11% to 12% operating income guidance back then, but as you said it's a long term algorithm. And it wouldn't be right to make specific comments on a year basis. What matters is how we are managing the overall results delivery over the long term as the name entitles. Sometimes there are plusses or minuses here and there, but what matters is that we are 100% committed to delivering the bottom line of the company as well as the cash deleveraging to reduce our bank debt and overall to get to a lower multiple. On your second part of the question, as Bob explained, we always look at the business from a holistic basis, cold and hot. We make the investments whenever it is necessary, and when we look at the brewer side of the equation we've been investing in our campaigns in order to improve the household penetration numbers and came in at a 7% growth which was a very robust number. And whenever it is needed, as we have been doing, we will make all the trade-offs and the necessary investments in our cold side of the portfolio, which included a couple of brand acquisitions that we did in the second half of 2018.

Well, I would like to just add that. I think our role as managers and also, as we said a number of times we have a significant amount of our personal investment in the company as well. So we're aligned in creating wealth, and it's to make sure that we do it over the long term. So I think what you really want us to do as leaders is navigate really difficult environments, and make sure that we're delivering the commitments that we have, which we are, right in line with the targets that we gave a year ago despite the environment that everyone else has talked about. But also doing it in a high-quality way. So, we're getting to these numbers that we talked about while still investing more in the marketing and innovation side of our business. And what's the evidence of that? The evidence of that is that we grew share across the great majority of our portfolio in 2018. Actually, if you take away IRi in the first quarter of 2019 we grew share in every single segment of our business. So to be able to grow our business, invest in innovation and marketing, deliver the EPS targets while absorbing inflation that is significantly higher than it was at the time of the merger a year ago, I think is pretty good management and good navigation of the complexity, and that's what you want out of us.

Yeah, and I guess just to follow up on that, just wanted to be clear just in terms of the forward commentary because Bob you alluded to sort of the price elasticity pressure on CSD. Obviously, you have touched these investing pretty significantly in their beverage business this year, so if that's obviously is kind of driving maybe some of the caution as we think about 2019 from an operating standpoint, why are you sort of managing to get into that long-term target?

Yeah, let me give some stats on that, right. So as one of the offsets but not the only offset to this significant inflation that the industry has faced, we've all taken pricing. And I think it's a victory; the good news is it's a very rational industry. When you take a look at the final quarter of 2018, for example, the category pricing was up 5.6%, volume was down 4%, so that's the elasticity impact of the price that you see in the category. For KDP in the fourth quarter, our pricing was up 5.9% and these are all in IRi, by the way, but what's interesting is our volume was down 2.2%. So the elasticity impact of our pricing actions is lower, is more muted than you'd see for the industry in total, and that speaks to the quality of the brand marketing and the innovation pipeline, which means consumers are effectively willing to pay more for some of our brands as a result of all the innovation and the market behind it. So that's why we say we have to be really balanced as management to make sure that we're offsetting inflation with pricing and productivity but we're also on the other side of the equation investing in our brands to continue to drive growth. And we're talking forward-looking, but all you've got to do is look at the last quarter for evidence of it working.

Got it, that's helpful. Thank you.

Hi, thanks for the question. Can you expand on any benefits from green coffee coming down, is that yet to come or is that sort of being absorbed in the pricing investments?

Sure, obviously we do have certain coverage positions, actually not only in coffee but our crossover commodities that impact both categories. And on the base of that, we have great visibility in terms of our cost structure in line with the price structure at the same time. It is true that coffee beans have been in the declining mode 18 to 24 months and we take all the opportunities on the basis of the positions that we do have. And all the pluses or minuses have been configured and included in our 2019 guidance.

And the other thing just to build on that, Sean, is compared to what I would say traditional coffee companies, the percentage that coffee represents in the total cost of goods sold in a Keurig system is significantly lower than you would see for somebody who's producing traditional roasting ground coffee. Because there's a lot of value add that comes in this single-serve format in the delivery of that. So it has a benefit or a negative if we go the other direction. We're well covered so it never is a short-term impact for us. We like to be able to plan going forward so we have good visibility for the year. But any movement, as you think about coffee in the future, any movement up or down is less of a direct impact on our P&L than it is for sort of a lower value-added coffee scenario than K-Cups.

Got it, thank you.

Thanks, good morning everyone. Bob, I apologize if I missed this, but I want, from a quantitative perspective, all the color on the courage side is very, very helpful. But specifically part of the long-term guidance beginning 2019 was that the courage side of business was going to get back to 2% to 3% revenue growth. Are you still confident in that? Maybe you could touch a little bit on that? Then touch up, Bob, the composition of pricing and volume. I think the hope was that the price investment was going to tail off after this year and stabilize. Are you comfortable with where pricing is, should we still expect negative pricing as well? So maybe if you could talk a little bit about the composition as well? Thank you for that.

It's a great question, thank you. Over the last couple of years, we decided to invest in pricing significantly for two main reasons: to bring all of our partners and unlicensed players into the system and to extend agreements with our partners, which has been successful. Additionally, this was the biggest barrier to consumer adoption of the system. We achieved benefits for both consumers and partners, but we also needed to maintain visibility into productivity, which our margin expansion indicates we have well under control. Now, let me discuss pricing. In the last three quarters of 2018, the average KDP manufactured pod sold for $0.53, remaining relatively stable during that time. The pricing breaks down into expected tiers: premium at $0.68, mainstream at $0.49, which is an important metric, and private label at $0.33. All these prices are within the thresholds we discussed earlier, with almost every American considering $0.30 as no longer expensive and many saying it's a bargain. We're aligned with the pricing structure we envisioned, and we're also seeing positive volume trends and a moderation in pricing changes. While we will continue to see some negative pricing, we're comfortable with the revenue growth of Keurig moving forward, as everything is progressing according to plan.

Okay, thank you guys, good luck.

Hey good morning, this is actually Graham on for Bill. Just a quick question on the Dr Pepper side, as you guys have done a little bit more visibility into that business now, maybe looked at some more cost-cutting initiatives kind of beyond just the synergy realization, have you found more opportunity here going forward, to me it brings more structure to that system and kind of following on that also, is there a bigger opportunity on working capital from that business and maybe they've seen in the past? Thank you.

Yes, sure. Let me do it first right now; I will ask Ozan to do the working capital part of that question. From our standpoint, we've got the base Keurig productivity programs and the ones that we're investing in significantly like the new plants in Spartanburg and the whole reinvention of our pod supply. We have the synergies that we talked about at length and the good news is we're very much on track for that. And then we always look at what are the opportunities to drive productivity above and beyond that, and we see lots of opportunities in that space. And again with evidence of that, evidence of the fact that we've been able to find more productivity is the fact that we've been able to stay right on track with the guidance that we gave a year ago despite a significant uptick in inflation while at the same time upping the investment in our brands. That tells you that we've been able to find more efficiency within the system that we've been able to deliver a really nice balance forecast for 2019 that delivers the commitments while still investing in the long term health of the business. So, Ozan, you want to talk about the working capital side of things?

Sure, as we mentioned, we had long-term guidance between 2019 and 2021 regarding working capital delivery and improvements. With better visibility into the legacy DPS business, we're pleased to report that our findings matched or exceeded our prior forecasts. This has strengthened our confidence in meeting our deleveraging commitments stated over 12 months ago. We are satisfied with the progress in working capital, and you can expect to see improvements on our balance sheet from 2019 onward.

Hi, good morning everyone. Two questions Bob and Ozan, can you just provide us a little bit update on the new capacity for K-Cups? How far along are we and once it is up and running, what does it do to your cost structure? And the second one Bob and that's something that we're hearing today as well. I mean at least if you look at 2019 EPS growth, the bulk of that is coming from cost energies, from the merger, and interest savings. And in the context of what happened to the packaged foods space last week and questions are like once those factors talk to moderate, do we have enough visibility that the Base Business is able to continue to grow at this level of EPS growth once you are last on these benefits?

Well let me start with the last part first. In the last part it is, I think in this environment the fact that we're able to deliver 15% to 17% EPS growth while investing in our business and the fact that we're growing across every single segment, growing share gives us a ton of confidence in the sustainability and health of this business. In terms of visibility, I mean we've given visibility at the time of the merger announcement for three plus years. And we're only nine months into a little less than nine months since we've closed on the business, six months from a financial reporting perspective. So, we're in the really early days of that. We've got the visibility that we've communicated and again, the fact that we're here today saying despite all these changes in the environment, we're right on track since we have the flexibility to navigate to the right answer. And we will worry about what happens after three years from now when we get closer to it because we have no idea what the environment is. But in the fact that we have that kind of visibility I think puts us in good position versus most of the world. With regard to the pod supply chain, all of the savings, all of the pricing, and everything else is all built into the long-term targets that we've given you. So to start pulling those all apart actually isn't really constructive. That's how we're able to do what we talked about. A lot of the concerns about brewer sales and pricing – my counter to that is volume up and accelerating household penetration growing very healthy, consumers returning brewers at a lower rate and holding on to them longer because they like them, and margins for coffee systems up almost 300 basis points for the year. We get there by the combination of all the things we talked about.

Where are we on one of the big projects within our pod supply chain reinvention Spartanburg, the building is under construction, lines have been tested at the manufacturer, they're ready to be installed once the building is done. Things are moving along nicely on that and it's all part of the long-term plan that we put out there before. You got them all.

Hi, good morning, this is Craig for Laurent. If we could just go back to coffee real fast, I think in the scanner data we continue to see that you're losing share to private label, and you touched on the pricing which is really helpful. But could you talk about the interaction of your branded portfolio with private label and then how you sort of reconcile that performance with the fact that you're the third-party manufacturer for the majority of private label offerings? And then related to that just how are you looking at the composition of your current branded coffee portfolio especially given sort of the recent press that our major brand could be on the block? And even more broadly than that how are you thinking about potential opportunistic M&A across the portfolio given the constrained balance sheet and that doesn't have to just be coffee and it could be sparkling water for example. So I know there's a lot there but anything you can offer would be helpful? Thanks.

I will begin, and you might need to remind me in a couple of weeks regarding this. We should address everything. I want to clarify some points about share since there seems to be a lot of confusion. First, we produce most private label pods currently available. As I mentioned before, 82% of the dollars spent on pods through the Keurig system are made by us, which is a point increase from a year ago. This is one of the four metrics we closely monitor. Within that 82%, we have a mix of our own brands, recognized partner brands, and some private label brands. The margin difference among these has significantly decreased, so we are fairly indifferent about the mix. Our primary concern is whether we manufacture the pod and if household penetration is increasing, which would lead to higher pod volume. Again, the reason for our optimism today is that the number of households adopting the Keurig system last year increased to 28 million users, marking a 7% growth in household penetration to 22%. Pod volumes and IRi are also up by 10%, with our KDP manufactured share increasing to 82%, a one-point rise. These metrics are crucial for the system's performance, explaining the strong profitability of our coffee systems in 2018. The mix is less of a concern, and there seems to be confusion between private label and unlicensed pods. We hold the majority of private label, and the margins we achieve are quite respectable. Lastly, regarding our owned-in-license portfolio, these are brands we manufacture and own, like Green Mountain Donut Shop. Historically, they aimed for a 100% share of the system. As more brands have been introduced, our share of owned and licensed pods has decreased. Currently, at the end of 2018, our share stands at 24, down about 0.5% from a year ago. This reduction is reflected in the numbers we have discussed and what we anticipate moving forward. We see this as a natural evolution as the system grows; the biggest advantage for consumers is the variety of brands. We aim to have every coffee brand on this system and to manufacture those pods. This strategic approach explains our confidence in the coffee system and its offerings.

On the M&A?

M&A, we don't talk about M&A on any side. I would tell you on the cold beverage side there's still a significant amount of white space in our portfolio. We have filled in that white space through a combination of brands we've acquired like Core, new partnerships that we've entered into like Evian and Peets, and other things that we're contemplating in the future, including organic development of brands on our own or segments on our own. But the fact that we have available white space in the cold side of the portfolio is a real positive for the future of this business because it tells you we have many avenues for growth that haven't been pursued yet.

And you also mentioned that our multiple, this can be a limiting factor. In fact, it is the opposite, as we have shown and proven with the Core acquisition. We are always more than welcome to use our shares, you know that, to buy the right targets for us if they do exist as well. So there's no constraint in terms of the balance sheet and we're still 100% committed to our deleveraging commitment at the same time.

Okay, thanks for the comments.

Hey, good morning everyone, thanks for taking the question. So I just wanted to kind of follow up on your last comment, trying to get your thoughts on the Allied Brands portfolio. So maybe could you provide a little bit more color on how it's performing versus your expectations? And then any commentary you'd be willing to offer on the pipeline of new Allied Brands and then aside from organic beverages, are there any particular categories you're looking to become more involved in? Thanks.

So, let's do a quick refresher just for everybody. The Allied Brand portfolio as we sit here today has been transformed versus where we're sitting a year ago, and I think a year ago there was a lot of concern about what was going to happen. And I say again, fast forward to a year later and you say, while we got a really good stable partner brands, and that provides a source of growth for us going forward. So the new brands we added were Evian, Peets, and Forto; the brands we acquired were Core and Big Red; the brands that left were FIJI and BODYARMOR; and the brands that continued on with us were Bai, Coco, High Brew, and Neuro. So we like that lineup and we've got a lot of opportunity in front of us to really now drive Evian, Peets, and Forto which are new brands. It is just getting started in this quarter. There were minimal sales of those businesses in the fourth quarter of last year; that's now ramping up in the first quarter and will accelerate throughout the year as we pick up distribution. And that's exactly where we track as a management team is are we getting the distribution, the build that we committed to with our partners? Are we getting the pricing and the merchandising performance? So all of that is nicely on track. Again, having said all that, you've got to remember that when you take out two brands like FIJI and BODYARMOR and you add these new ones which are in emerging stages, we took quite a hit in the fourth quarter and in the beginning part of this year on revenue because those brands were gone and the new ones weren't in yet. And that's now more of a tailwind for us going forward because as we build it, we're able to get the revenue and profit growth over those businesses that we absorbed. But I repeat myself, as I said a couple of things, despite that hit we didn't miss a beat in terms of profit delivery or a commitment to our algorithm. I think we put ourselves in a really nice position to grow. So where are we, the future on Allied Brands? We are taking a very disciplined approach to this, something we talked about before. There's a lot of interest in brand owners to work with us and through our system as we've all talked about, and we now realize firsthand. Distribution, DFT distribution into small outlets and cold cases in particular is a scarce resource. And we're one of the partners, and it is a really good opportunity for them given that we have so much white space. But we've been really disciplined about the terms of how we will work with somebody, and it either has to be a situation where if we can't own the brand in the future like Evian, then we need a really rock solid long-term equitable agreement. And by the way, the other side wants that as well; but it's a brand that we can own. We want to have an equity stake in that upfront and we want to have a path to ownership, which means for the most part, we've pre-negotiated the terms that exit in the future. What we won't do is just quickly jump into a distribution agreement and make the brand successful and then have a negotiation with them about what the value of that brand is. That's not something that we're repeating. So short summary on that one is we're really bullish about the brands we have in our portfolio and it's all upside, and a lot of work to do to get that distribution. Lots of interest but also it's matched with a lot of discipline on our part to make sure that we're entering into this in the right way.

Great, thanks.

Hey good morning, this is Brendan Metrano for Robert. Had a quick question on marketing spend. So the third quarter you guys had called out the timing of the marketing spend, it was a benefit to operating profit performance and indicated that it can be put towards investments against the holiday seasons. So again we're kind of calling marketing as a benefit to the fourth quarter, and so was wondering are you spending the right level or are there puts and takes on that?

Let me clarify that. You will get a chance to go through the K; but the only comment we made on marketing spend was on the beverage concentrate business, not in the other sections of the business. And we're investing heavily both in the Keurig system as well as the cold system. And then the other that you have, and this is a little more nuance but it's really important to understand when you put two companies together, one of the synergies that you create is more purchasing power on media. And we've got a significant increase in scaling capabilities on our media side now. And what that means is that you're able to get the same reach and quality at a lower cost. So in that situation, you could actually spend the same dollars and have a fairly significant increase in the effective reach of those dollars because you bought that media at a better price because of your consolidation. So there's a lot of that all working together, but what you need to take away from this is we're not using marketing as a source of profitability at all. As tempting as that would have been given the world of inflation right now, and in fact are doing the opposite and investing more behind our total business.

Great, thanks.

Good morning, congratulations on a great 2018. Bob, your comments on the Keurig machines and household penetration make a lot of sense. But I'm just curious, do you actually have enough information to precisely know whether your Keurig machine is a replacement machine versus a new household?

We do; it's a great question. I mean we use multiple sources internally to get at household penetration and then we are able to get sort of qualitative data below that in terms of how are they feeling about their product, how long have they had it, etc., etc. We also know when somebody drops out of the system, why they dropped out of the system. We also see it as an ongoing data source that is proprietary to us that we have that’s been consistent for years. So we're able to test that backwards against the history to make sure that it's accurate and it's very good. In addition to that, we also have metrics on return rates which we get from our customers and also warranty claims and those are really hard numbers and we've seen a significant improvement in those numbers. To give you an example, it's only put the warranty claim in or the return that actually boosts brewer sales. So if you send people back out there to rebuy a brewer that they turned in warranty, perversely that increases the revenue of brewers. I would argue that's a terrible situation. So the fact that we're getting fewer warranty claims and fewer turns is a profit positive to us; it also means happier, more satisfied consumers, but it also has a negative impact on revenue. And quite frankly we don't care about that because there’s no profit or loss impact resulting in that. So sort of a long answer, but we really have a ton of data. The other thing that we haven't talked about but I just want to mention is we have a household panel that's statistically significant. It's about 12,000 to 15,000 connected brewers out there, and we provide that data to our partners. So if you're in the Keurig system, you get exclusive access to this. And it literally captures points of consumption data meaning when somebody brews a cup in this panel we know what they brewed, what brand, what size, what strength, and we feed that live to our partners, and you get a lot of data in terms of the quality of household penetration around that. So we feel really good about those numbers. We want to give — we want to give them to you on an annual basis. You can get a proxy for this by looking at household penetration of PAS through IRi. The caution on that is it's volatile for no good reason, but over time it's a good proxy. But that's why we're going to give you household penetration.

Thanks, that is very helpful. And then I think did you comment at all about your pricing expectations for CSDs in 2019?

I can't forecast it. It's like I said it's a rational industry and it's going to depend on inflation. But the numbers that you can see it on a weekly basis through the syndicated data, and as I said before, in the 13-week ending December, the category was up between 5% and 6%, which is pretty robust pricing in a CPG environment. So it's all going to depend on what inflation looks like going forward.

Thanks.

Thank you. Thank you all for listening in today. As always, we are around, so if you have any follow-up questions and you want to talk to us, just give us a call. Take care, have a good day everyone.