Keurig Dr Pepper Inc (KDP) — Q1 2023 Earnings Call Transcript

Thank you, and hello, everyone. Earlier this morning, we issued a press release detailing our first quarter results. Consistent with previous quarters, we will be discussing our performance on an adjusted basis, which reflects constant currency growth rates and excludes items affecting comparability. The company believes that the adjusted basis provides investors with additional insight into our business and operating performance trends. While the exclusion of items affecting comparability and the use of constant currency growth rates are not in accordance with GAAP, we believe that the adjusted basis provides meaningful comparisons and an appropriate basis for discussion of our performance. Details of the excluded items are provided in the reconciliation table included in our press release and our 10-Q, which will be filed later today. Due to the inability to predict the amount and timing of certain impacts outside of the company's control, we do not reconcile our guidance. Beginning this quarter, we will discuss our performance in accordance with our recently redefined business segments, which were described in the 8-K filed last Thursday, April 20. This new segment structure is more consistent with how we evaluate the business internally and provides more visibility to our segment performance in the U.S., which is our largest market. We will also speak about the concept of underlying performance, which removes the impact of nonoperational items in the current and prior years. These items include gains on asset sale leaseback transactions, reimbursement of litigation expenses related to the successful resolution of our BODYARMOR lawsuit, a business interruption insurance recovery, and a change in accounting policy for stock compensation. 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. Here with us today to discuss our results are KDP Chairman and CEO, Bob Gamgort; our Chief Financial Officer, Sudhanshu Priyadarshi; and our Chief Corporate Affairs Officer, Maria Sceppaguercio. I'll now turn it over to Bob.

Thanks, Jane, and good morning, everyone. We started 2023 with good momentum. Our overall Q1 performance came in largely as expected and demonstrated the resilience of the modern beverage company we have built. We continue to manage well against a dynamic macro environment with the diversification benefits of KDP's model evident in our results. This morning, we reaffirmed our 2023 outlook, and we are confident in our ability to continue to deliver on our commitments as a company. For the quarter, consolidated net sales advanced a strong 9% versus the prior year, and adjusted EPS grew 3%. Consumer demand remained healthy driven by successful renovation and innovation, increased investment in marketing and modest elasticities across much of our portfolio. A narrowing gap between inflation and pricing, coupled with increased productivity and favorable mix contributed to good flow-through to gross profit, though we continue to work through significant ongoing inflation in transportation, warehousing, and labor costs. We expect the balance between these operating income drivers to turn more favorable in the back half of the year. In U.S. refreshment beverages, which represents nearly 60% of KDP consolidated revenue, our strong performance in Q1 demonstrated the depth of our capabilities across multiple dimensions including brand renovation, marketing, distribution, and in-market execution, as well as our partnership philosophy and successful track record. As discussed previously, we create value in U.S. refreshment beverages in three ways: by driving growth in core brands through marketing and brand renovation, by filling portfolio white spaces via innovation and external partnerships, and by enhancing the effectiveness of our omnichannel selling and distribution system, including our company-owned direct store delivery system. The multiplier effect of all three of these elements working in unison was evident in Q1, where we gained share in categories representing almost 90% of retail sales. With strong momentum in core brands, particularly Dr. Pepper, Crush, and Mott's. On the back of the very successful launch of Dr Pepper Strawberries & Cream, brand Dr Pepper recorded the largest market share gain in the CSD category this quarter. In fact, the brand has become the #1 flavored CSD in syndicated data over the past 13 weeks. For perspective, Strawberries & Cream reached 70% ACV distribution within 5 weeks of launch, quickly gained a full share point in the CSD category, and continues to experience strong momentum. Driving the early success of Strawberries & Cream is KDP's direct store delivery engine and robust consumer insights and marketing support. In Q1, we also began to activate our strategic partnership with Nutrabolt, transitioning C4 energy distribution to our network. Our execution thus far has been smooth and is progressing in line with our plans. As we begin to invest behind the brand, we are securing incremental distribution points and display as well as upgrading placements. Though it is still very early days, our partnership with Nutrabolt is strong and collaborative. We are excited by its potential and look forward to unlocking more value for both KDP and Nutrabolt in the quarters and years ahead. In-market execution underpins the gains we are making across our U.S. refreshment beverages portfolio. The results speak for themselves, but they are even more notable given we and the industry at large continue to work through significant inflation. We have supplemented 2022 carryover pricing with some additional pricing actions to start the year as we protect our profitability and our ability to reinvest for the long term. The limited elasticities this business has experienced so far are a telling reminder of the resilience of the category in general and the KDP portfolio in particular. Our brands remain important and affordable components of our consumers' everyday lives. Still, as recessionary risks persist, we continue to closely monitor consumer health and sentiment. Turning now to U.S. Coffee, which represents roughly 30% of our consolidated revenue. This segment experienced a slower start to the year. The performance in pods, which as you know is our primary focus and profit driver, was as expected, with brewers softer than expected. The pod segment's performance in the first half of the year will be difficult to analyze for longer-term trends. Let me take a step back and explain what we are seeing in the category and in our own business. Growth rates in the at-home coffee category, including the single-serve segment, are being temporarily impacted by changes in mobility relative to the prior year. In Q1, the category lapped the surge of the Omicron variant and lingering pandemic precautions in the year-ago period are expected to continue to affect comparisons through the first half. At the same time, the category is digesting significant cumulative pricing to offset inflation. Importantly, single-serve continues to gain volume share in the at-home coffee category in the U.S., underpinning the strength and resilience of the segment and our long-term growth strategy. We also see the environment for small appliances being impacted by a combination of lower consumer discretionary spending and a challenged specialty retailer environment. Sudhanshu will cover the detailed quarterly performance drivers, but let me say upfront, we expect the second half to reveal a more normalized picture of the health of the single-serve category and our ongoing momentum. We are still planning to add approximately 2 million new households to the Keurig ecosystem in 2023, and we also continue to expect the back half to show strong improvement in segment operating margins. Short-term noise aside, the coffee category is vast and growing in the U.S. and globally. Moving out the volatility of the pandemic period, we are projecting double-digit volume growth for our at-home pods in the U.S. from 2019 to 2023, which translates to a mid-single-digit compound annual growth rate. This is consistent with our previous discussions that eliminating the significant noise over the past three years revealed consistent and healthy long-term trends for at-home single-serve coffee. As the leader in U.S. single-serve, our overarching growth strategy is to continue converting consumers from brewing coffee by the pot to brewing it by the pod, which we pursue through two primary means. First, by driving household penetration for the Keurig system. U.S. single-serve adoption remains significantly below that in more developed single-serve markets in Western Europe and even Canada. And we expect household growth to continue for many years to come as we target adding approximately 2 million new households annually. Second, by increasing revenue and profit growth from our existing 38 million U.S. Keurig households. Ongoing brewer innovation to address new and changing consumer needs and a focus on expanding brand and variety of offerings within the Keurig ecosystem underpin our coffee growth strategy. We have news on both fronts in 2023. When it comes to meeting consumer needs, after an initial successful launch with a single customer last year, in 2023, we are expanding our K-Iced brewer platform as well as dedicated iced pods specifically designed for cold beverages. Both coffee beverages are growing quickly at coffee shops and are over-indexed to younger consumers. Given our ability to deliver a high-quality cold coffee experience at home for a fraction of the price, we see iced coffee as a growth opportunity for the Keurig ecosystem in 2023 and beyond. We also continue to add new and exciting brands to the Keurig ecosystem. Today, we are pleased to announce that Philz Coffee, a super premium brand based in San Francisco, will be available on K-Cup pods beginning this fall. Through the new partnership with Philz, as well as the additions of Intelligentsia and BLK & Bold announced last year, we are building a new super premium segment for K-Cup pods. Our International segment, which represents just above 10% of our consolidated revenue, encompasses both our Canadian coffee and beverages business as well as our LRB businesses in Mexico and Puerto Rico. Our growth strategy for international leverages enterprise-wide insights and capabilities to grow household penetration in coffee and to drive share gains in LRBs through brand innovation and renovation, white space expansion, and strengthening our routes to market. We tailor our approach to local taste and market structures while exporting best practices and ideas across the whole of North America. In Q1, we were pleased to see broad-based momentum across our brands and categories, including in mineral waters, CSDs, and single-serve coffee. Our partnership with Red Bull in Mexico continues to build. And we also remain focused on expanding within the low or no alcohol category, including through our acquisition of Atypique in Canada. Both opportunities leverage our existing portfolio and distribution assets, including our DSD system in Mexico and our alcohol portfolio and expertise in Canada. Wrapping up, we expect the operating environment to remain fluid, and we see KDP as well positioned to continue to deliver strong consolidated performance in 2023. We are reaffirming our 2023 outlook for constant currency net sales growth of 5% and adjusted EPS growth of 6% to 7%. On an underlying basis, this implies adjusted EPS growth that is closer to 9% at the top end of our long-term algorithm. In addition, KDP has a track record of strong free cash flow generation, and we expect to continue to unlock the potential for incremental shareholder returns through strategic capital allocation. We have evolved our capital allocation approach to better fit our development stage as a company and to respond to a higher interest rate environment. We are prioritizing internal investments, partnerships, and M&A, balanced against returning cash to shareholders through our dividend and opportunistic share repurchases, which we undertook this quarter and last quarter. A recent upgrade by Moody's to a stronger investment-grade credit rating recognizes that the inherent portfolio balance of our modern beverage company, along with our capital allocation philosophy and free cash flow profile, all aspects that Sudhanshu will talk more about next.

Thanks, Bob, and good morning, everyone. In kicking off 2023, we made the decision to realign our segment reporting to more closely reflect how we plan, run, and evaluate these businesses internally. The new U.S. coffee segment will also enhance comparability relative to how we speak about our long-term goals, including our 2 million annual U.S. household penetration target. There is also the added benefit of giving you a more refined picture of our operations in the United States, which is by far our largest market. We believe the size, scale, and margin profile of each U.S. segment becomes more visible externally, making it easier for you to track and analyze. U.S. refreshment beverages is an $8 billion-plus revenue business with a 28% adjusted operating margin. The U.S. coffee business is $4.3 billion in revenue, also very large with an adjusted operating margin above 32%. Obviously, both are high-quality CPG businesses with tremendous scale in the U.S. market. At the same time, our fast-growing international segment at approximately $1.7 billion of revenue and a 24% adjusted operating margin is already meaningful and quite profitable. We are pleased that KDP's portfolio delivered overall Q1 results, which were consistent with our going-in expectations even as performance among the segments was varied. Q1 sales advanced 9% driven by strong in-market execution, particularly in U.S. refreshment beverages. Gross profit dollars grew at a similar rate, and we increased marketing investments versus the prior year. At $0.34, our adjusted diluted EPS grew 3% versus Q1 last year. Without a $0.05 headwind from the significant reduction in nonoperational items year-over-year, underlying EPS growth in the quarter was in the high-teens. As discussed on our last earnings call, we are committed to a step function decrease in the use of nonoperational items this year. And as this occurs, the earning powers of the business will become even more visible. Our actions also continued to reflect our revised capital allocation priorities. In Q1, we saw and took advantage of a value opportunity in KDP shares and bought back 6.6 million shares during the quarter. Combined with the share repurchases we undertook in late 2022, we have now returned more than $500 million to shareholders via opportunistic buybacks over the past two quarters. Our high-quality portfolio, consistent results, well-capitalized balance sheet, and flexible capital allocation approach are being increasingly recognized. As Bob mentioned, Moody's upgraded our credit rating earlier this month, which is especially notable in a weaker macro environment. We believe our strong balance sheet and North American focus represents a safe haven in the current tumultuous financial market. Let's now take a closer look at consolidated Q1 results. Consistent with the last couple of quarters, our top line growth was driven by pricing taken to offset inflation and a modest volume/mix decline. Net sales grew 8.9% to $3.4 billion with pricing up approximately 10%. Gross margins were stable at 52.7% and primarily reflected the combined benefits of pricing, productivity gains, and positive mix balanced against considerable input cost inflation. Total SG&A as a percentage of sales deleveraged by about 100 bps versus prior year, reflecting continued elevated transportation, warehousing, and labor costs. Despite these cost headwinds, we increased marketing investment to support our brand momentum. We also lapped an SG&A benefit of $28 million from a stock comp accounting change in the prior year period. Q1 adjusted operating income was $699 million, about 4.5% below a year ago, but representing almost 9% growth on an underlying basis. Adjusted net income grew about 1%, aided by flat interest expense, equity method earnings, and a lower tax rate versus the prior year. Lower diluted shares outstanding helped drive additional leverage in the EPS growth rate. Turning now to segment performance. U.S. refreshment beverages sales grew 12.7%, led by 12.5 percentage points from favorable net price realization. The benefit of pricing was sequentially lower relative to Q4 as we begin to anniversary price increases we took in early 2022 and have not yet captured the full benefit of pricing actions announced earlier this year. Volume mix was slightly positive in the quarter reflecting very limited elasticity impact as well as the contribution from C4 Energy. This volume mix result speaks to resilient consumer demand, modest elasticities in our categories, and a successful slate of renovations and innovations. Segment operating income increased 11.6% as we effectively translated top line momentum to bottom line results despite inflation in packaging, manufacturing, and labor costs. Our U.S. coffee segment represents a single-serve ecosystem in which our brewers create a platform for high-quality coffee experiences through our high-margin consumable K-Cup pods. Simply put, we are in the business of selling pods, not brewers. That said, we recognize that the quarter volatility in brewers can sometimes distort the picture. To help you further contextualize brewer trends, we are introducing two additional disclosures, trailing 12 months brewers sold and associated growth rates. You saw both of these in our press release this morning. Going forward, while we will continue to disclose quarterly brewer sales and shipments in our 10-Q, we will focus our remarks in this forum as well as in the press release on trailing 12 months strength, which we believe to smooth the inherent quarterly volatility of appliances relative to consumables. Let's now get into the results. In U.S. Coffee, Q1 revenue declined 1.3%, with pricing up 5.3%, but volume mix down 6.6%. The involvement for small appliances was more dynamic than we expected, reflecting the combination of softer discretionary spending and a challenged specialty retailer landscape. These factors primarily impacted brewer shipments, which declined 29% in the quarter. For perspective, Q1 is our seasonally smallest quarter of the year, accounting for less than 20% of brewer shipments. On a trailing 12-month basis, brewer shipments totaled $10.2 million, reflecting a 9.8% decline year-over-year, but a strong growth of 25.6% relative to the pre-pandemic period ending Q1 2019. Our goal of adding an incremental 2 million households in the U.S. in 2023 remains intact. U.S. pod revenues grew 2.9% and pod volumes declined modestly, down 1.9% in Q1. This was influenced by consumer mobility that was meaningfully different versus the same time last year when the Omicron surge led to more time spent at home. There are other factors at play in the category such as some elasticity in response to pricing and mix shifts to a more normalized level of premium versus private label exposure. However, we continue to believe that mobility is the largest driver of at-home coffee category softness over the past few quarters. It follows that pod trends should improve in H2 as mobility differences relative to last year begin to dissipate. We continue to expect U.S. coffee volumes in Q2 to remain under pressure against the year-ago period when we successfully executed our coffee recovery program and rebuilt partner and retail inventories after supply disruptions. Inflation remains a headwind in U.S. Coffee, where segment operating margin contracted 130 basis points in the quarter and segment operating income declined 5.3%. We expect an improvement in the relationship between inflation, pricing, and productivity in the back half, which provides good visibility to a strong margin recovery in the segment, leading to a year-over-year improvement in gross margin in 2023. In particular, we are refocusing on productivity in 2023 after much of 2022 was focused on prioritizing customer service. I want to revert for a minute to Q1 performance as it would have been reported for the former Coffee Systems segment. Constant currency revenue for Coffee Systems grew 1% in Q1, with faster growth in Canada relative to the U.S. Following the segment realignment and reflecting softer-than-expected brewer volume, we now expect U.S. Coffee revenue to grow approximately 1% in 2023, with segment operating income growth of 3% to 4%. This incorporates plans for ongoing marketing reinvestment and the expected back half margin expansion. Our consolidated outlook for KDP in 2023, which I will address in more detail shortly, remains unchanged. Our International segment performance in Q1 was strong and well balanced. Net sales increased 16.7% with net price realization contributing 9 points of growth and volume mix up 7.7% year-over-year. Growth was broad-based and led by LRBs and single-sub-pods. The combination of net price realization and productivity gains helped to offset inflationary headwinds and together led to a strong segment operating income growth of 18%. Turning briefly to cash flow. Free cash flow in Q1 was $16 million. This declined relative to last year, reflecting the lapping of certain discrete benefits in Q1 2022, such as the BODYARMOR litigation settlement gain as well as a use of net working capital this quarter. For the full year, we expect the rate of free cash flow conversion to approach our long-term target. This brings us to our consolidated outlook. With Q1 results largely as expected, we continue to expect constant currency net sales to increase 5% in 2023 and adjusted EPS to grow 6% to 7%. We continue to project currency translation to be a 50 basis point headwind to both top and bottom lines. As Bob said, underlying EPS growth is expected to be closer to 9% at the top end of our high single-digit long-term algorithm. This basis removes the noise from year-over-year differences in nonoperational items, which we still expect to roughly half relative to 2022 levels. Despite the recent news headlines about CPI and PPI easing, we continue to see significant cost inflation. Headwinds across realized raw material costs, transportation, and labor are sticky and persistent, and we still expect mid-single-digit inflation in 2023. We are highly focused on offsetting these pressures through a combination of pricing, revenue growth management, and productivity initiatives, and we expect the gap versus inflation to reverse as the year progresses. Our full-year guidance for below-the-line items remains unchanged. We expect interest expense in a $465 million to $470 million range, which still includes $45 million related to the Nutrabolt investment. Equity method earnings from Nutrabolt of approximately $40 million to $45 million, an effective tax rate of 22% for the year, and approximately 1.42 billion diluted weighted average shares outstanding. As it relates to Q2, EPS is expected to grow in the low- to mid-single-digit range. We still expect to have a gap between inflation and pricing and productivity in the quarter with a more beneficial relationship expected to materialize in the back half. Marketing is also expected to increase in Q2, reflecting incremental investments across both LRBs and coffee, particularly behind the iced platform in U.S. Coffee that Bob highlighted earlier. To wrap up, our overall Q1 performance tracked largely in line with our expectations, and we remain confident in our ability to navigate the balance of 2023, which promises to remain dynamic. Our recast segments better eliminate the scale of our businesses with distinct and clearly defined growth pillars in place for each segment. Our brand portfolio, renovation and innovation activity, and in-market execution remains very strong. We are working diligently to offset inflation and to drive margin improvement later in the year while reinvesting in our brands. And finally, our capital allocation priorities are clear as we look to deploy our strong cash flow against the highest ROI opportunities. I will now turn the call back to Bob for closing comments.

Thanks, Sudhanshu. Before moving to Q&A, I want to take a moment to thank Maria, who is retiring in July after a distinguished 40-plus year career. She will remain with KDP as an adviser through year-end. I know that most of you hold Maria in the highest regard, just as we do at KDP, where she has been a valued member of the executive leadership team for the last 5 years. Maria and I have worked together for over a decade, spanning two companies and countless deals, including an IPO. She has built a very strong corporate affairs team for KDP, and we are pleased that she will stay on as an adviser to support the transition to her successor upon hire. We will all miss working with Maria and wish her the very best in this next and well-earned chapter. I'll now turn the call over to the operator for questions.

So I wanted to go back. Bob, you spoke about like the brewer shipments. And then I understand the volatility that allowed you to change the reporting ways and merging the two. I was just wondering, embedded in your commentary as well, you spoke about second quarter still being challenging and all the mobility aspects of the category. So if you can talk about a little bit of what are you seeing as we exit the quarter and as you lap the Omicron or health crisis pandemic benefits for the in-house or at-home consumption? And then at the same time, I understand you don't disclose what is out-of-home, but there is some out-of-home component of the pod, so how should we be thinking about that as well as pantry destocking or retail destocking?

Thanks for your questions, Andrea. There are three main points to discuss, especially concerning brewers. First, I want to emphasize that we do not view brewer sales as a reliable indicator of household penetration, which is our main priority. This perspective remains consistent even during quarters with significant brewer sales increases. Selling small appliances has inherent volatility compared to consumables, making it less useful to assess on a quarter-by-quarter basis. In this quarter, we've seen considerable disruption in retail, including the bankruptcy of one of our key retailers for the Keurig business, contributing to fluctuations in inventory and across retail channels for brewers. However, we believe this does not affect household penetration. We typically sell around 10 million brewers annually, adding about 2 million households, indicating many are upgrades or replacements. It's crucial to discuss brewers using a trailing 12-month basis to filter out some of this noise, although we remain committed to reporting quarterly figures. Regarding mobility, it remains the largest factor driving at-home coffee consumption. As discussed in the previous call, we are observing consistent trends worldwide. Currently, the mobility run rate seems stable, and as we compare to normal year-ago figures later this year, everything appears to be on track. Others in the coffee industry are noting similar trends. The primary factor for home coffee consumption is simply the amount of time people are spending at home. Concerning the away-from-home aspect, the total pod numbers you mentioned combine both at-home and away-from-home data. Many calculate attachment rates by dividing total pod sales by the number of brewers, which includes the away-from-home component that doesn’t directly relate to attachment rates. The at-home business, which saw significant declines during the early COVID period, has rebounded but remains lower than pre-COVID levels, a trend we expect will persist. Currently, the away-from-home segment is stable, though it has negatively impacted business performance in recent years. If we looked at its effect on attachment rates, it could suggest a decline due to the reduced away-from-home contribution.

Maria, congratulations. It's been a pleasure working with you. You'll definitely be missed.

That's so nice, Bryan. Look forward to seeing you soon.

Okay. I guess you stayed for more than just a cup of coffee.

We'll wait for that.

My question is for Sudhanshu regarding your comments on cash flow. The working capital showed a significant negative change in the first quarter. Can you clarify if this is partly due to reducing the size of your factoring program? Additionally, how do you plan to achieve close to 100% free cash flow conversion, considering the challenges presented by the first quarter? Could you also provide insights on how you envision progress towards the long-term target throughout the year, especially given the impact on cash from operations in the first quarter?

Bryan, it's a great question. So you see Q1 operating cash flow is down versus a year ago, but last year, we had a lot of one-off items. So it's lower, mainly driven by those things, but also there is some timing of supply chain financing, we call it factoring. And this program was great in the beginning when interest rates were low, but we have a lot of options for our cash. You saw our leverage target is 2x to 2.5x. So we make the right optimal financial decision, whether it's interest rate, factoring also takes care of some interest rate's impact on our P&L. So we're making a lot of those decisions. Those are dynamic. But when I sit today, I still expect that we should be pretty close to our long-term target of cash conversion. I don't see an issue here right now, but we will be making these like dynamic trade-off decisions every month, every quarter, and we will update you more if we see something different.

Very much appreciate the conversation I'm trying to effectively almost smooth out the conversation on brewer sales in particular and also on pods across multiple quarters. But I was wondering why the comparison is being made to trailing 12 months ending the March quarter of '19 because that's basically comparing to 2018? I wouldn't think that with the pandemic starting as it did that there was any big real acceleration in shipments. There may have been takeaway at retail, but shipments wouldn't have changed very much in those last weeks of March 2020. So why compare it to effectively 2018 rather than to 2019?

Lauren, this is Sudhanshu. The reason we did it was to provide you with a clearer picture. In the first quarter of 2020, China began implementing lockdowns, and we noticed some retail activity late in March. This was primarily meant to give you visibility, as there was more noise in Q1 2020. We wanted to present a pre-COVID number. However, we will continue to show you a trailing 12-month decline. As you've observed, this time we declined by 9.8%. You'll always have these metrics, but we aimed for a cleaner comparison due to the noise in Q1 2020.

Certainly. To build on that, we expect brewer sales in 2023 to show a significant increase compared to 2019 and even earlier years, during which we added over 2 million households. One key point is that many upgrades and replacements were expedited during the pandemic, as people spent more time at home and invested in their living spaces, along with support from government subsidies. Ultimately, brewer sales are largely driven by household penetration. Looking back at the numbers from 2019, 2018, and 2017, it’s clear that the figures for 2023 will indeed be higher than those years, during which we also added 2 million households. That’s the main point we want to emphasize.

Can you just comment on the coffee margin in the quarter, just given the volume decline? I actually think it came in a little bit better? What are some of the drivers? What are you seeing from commodity inflation? What are you seeing from transportation? What are you seeing from volume deleverage in the quarter? And then also, what are you seeing from a productivity standpoint? This is a key kind of debate for investors. And again, I just want to understand some of the components that came in, in Q1 and maybe helping build confidence on what you expect for the full year, including the back half recovery?

So Chris, there are three things that impacted Q1. One was there's a narrowed gap between pricing and inflation. There was a mix between pod and also the brewer sales. If you see brewer declined 29%, so it helps the margin and productivity benefit was there too, but that will ramp up more towards the second half. So if you look at our U.S. Coffee guidance, we said roughly 1% top-line growth and 3% to 4% profit growth. So you're seeing those leverage will come more. It will be more second half, but we believe that the margin improvement driven by relationship improving between inflation and pricing, productivity, and mix will help us deliver the full year number. So Q1, all those things impacted, but you will see this benefit move in the second half.

Great. I appreciate the simplicity of the resegmentation, and I believe it will become common terminology for us over time. The additional disclosures regarding Coffee Systems pods versus brewers will be helpful. My question is primarily about the restructuring of the beverage side, especially considering the economic differences in revenue and margin mixes between the former beverage concentrates and packaged beverages. There's a significant disparity there. As you discuss this business moving forward, what should we consider when forecasting? What information will be included in future reports that can clarify these potential mix implications? I’m also curious about the neutral contribution to growth in refreshment beverages for the quarter and the remainder of the year, as this would help us understand the underlying revenue growth compared to total revenue growth.

So Steve, this is Sudhanshu. The reason we resegmented is that we haven’t made changes since our merger. Initially, we operated the business in the same manner. Now, we are in our second phase of KDP growth, managing it through U.S. refreshment beverages, U.S. Coffee, and International, which reflects how we report results. We believe that U.S. Coffee will provide greater visibility, as we reference around 2 million households and data from IRI and channels. This will clarify our internal and external numbers. In terms of refreshment beverages, you can review the three-year margin and sales data to see that we will continue to disclose the key performance drivers. Our business approach is U.S.-focused, and we are managing fluctuations from foreign exchange, which were previously impacted by the Canada and U.S. combination. These changes will help simplify things, and we are here to assist with any questions as you build your model. Nutrabolt contributed minimally this quarter, but for the year, depending on interest rates and cost, the effect will be marginal. We expect to see better improvement or an increase in our EPS in 2024.

Congrats to Maria as well. A question for you on distribution systems. There's been a lot of change in the marketplace. And I think you're in a unique position given that your nondistributed volume goes through Coke, close to Pepsi route to market. And given that perspective, I was hoping you could offer your thoughts on the potential for distribution relationships and partnerships as a means to enhance scale capabilities and economics and then obviously, ultimately, brand performance in the years to come?

Yes. Brett, just to clarify for everyone, a portion of our Dr Pepper volume goes through Coke and Pepsi as well as our own trucks and then some other brands like Schweppes and Crush. Outside of those brands, everything goes through our distribution system, and we cover about 75% of the U.S. population. And then the rest of that is covered by a network of independent operators, most of whom we've had long-term relationships with. And so we have always stated that we want to be a catalyst for consolidation on the distribution side of the business. We think it is what retailers are going to want over time. We believe it's highly cost efficient. We also think from an environmental impact, taking miles off the road is a smart thing to do. Our way of doing that has been to consolidate overlapping territories where our company-owned routes match up against independent operators. And we've done about 25 transactions over the past couple of years to make that happen. We think that consolidation will continue over time. We think that there are all the macro drivers that we just talked about, and we stand ready and are driving our role as a catalyst to continue to make that happen. So, a lot more to come there.

Great. I want to send my congratulations to Maria as well. I want to come back to Nutrabolt, and the C4 brand, Bob, you said it pretty bullish, both near term and long term. A few questions related to that. Just 1 maybe comment on how quickly you think you can ramp that brand from a distribution perspective? Some color on the spring, shelf space resets and where you think that brand is possibly gaining share? And then Sudhanshu, to follow up on Steve's question, I think there would be some interest in the revenue contribution. I think the guidance for equity earnings is helpful, but the revenue contribution on the distribution agreement that would have gone through the PB segment, is that something you want to provide with respect both to the quarter and to the full year in terms of what's embedded in your outlook?

We are in the early stages with C4 and are currently transitioning from their existing distribution system to ours. This process has been going very smoothly. The syndicated data shows an increase in points of distribution, which aligns with our initial objectives. Furthermore, it's not just about the increase in quantity; there's also a notable improvement in the quality of placements and merchandising. Everything is progressing as planned, and the positive news is that you will be able to track our advancements in both distribution gains and velocity through syndicated data. Would you like to discuss the growth contribution?

Yes, Kevin. The C4 has contributed to the volume of U.S. refreshment beverages in the first quarter, and we expect this to continue throughout the year. However, similar to other distribution partnerships, we are not providing a specific figure for its contribution to revenue. As Bob mentioned, we will highlight this as a driver, and you can monitor our performance through scanner data. Although it represents a very small portion of our $8 billion U.S. refreshment beverages, we will identify it as a driver for you. Once it grows to a size that significantly impacts our revenue and profit, we will consider how to disclose it.

I just had a couple of questions on your U.S. Coffee segment. Bob, I understand your point about brewer volumes versus household penetration. But I guess I'm trying to understand your expectations for brewer volume this year, especially that's a pretty big driver of your top line as well as impacts on margins since they're just slightly profitable. So how should we think about brewer volumes for the year, especially given how elevated your inventory levels still are? I mean is it fair to assume your volumes will likely now be down more than you originally thought? And then, I guess, if so, is that also a key driver of why you're expecting margin expansion in the second half? Any color there would be appreciated.

Sure. On our last call, we indicated that we expected brewers to decline modestly in 2023. Looking at the trailing 12-month figures, we see a decline of 9.8%. This quarter was softer than anticipated, and I don't project any single quarter as indicative of long-term trends. There’s considerable volatility this quarter compared to a typical quarter, which already has its own fluctuations. One contributing factor is the retail disruption, particularly with some specialty retailers facing significant challenges, including one bankruptcy. Nevertheless, other retailers will meet consumer demand, and we are well-positioned with distribution across various channels. A lot of sales are shifting online, where we are very strong. As I mentioned before, we have seen increases of over 60% in some quarters, and I advise against projecting this quarter forward due to its inherent volatility. Regarding brewers, inventory management is under control from our perspective, so it’s not a concern. Additionally, the expected reduction in brewers will not impact our margin expectations for the second half of the year.

Maria, congrats as well. Maybe just two questions on coffee, maybe one just housekeeping. Bob, you mentioned Bed Bath & Beyond, how impactful is that to the business? I'm assuming it's embedded in the outlook, but just wanted to understand if there's something we need to think through as we model the growth from here? And then I guess I just wanted to follow up on Chris' earlier question around operating margin in coffee, but more from a long-term recovery perspective. I understand you expect improvement in the back half of the year. But how would you frame the long-term opportunity? And maybe more specifically, how quickly can you get back to operating margin in kind of the mid- to high 30% range?

The disruption caused by any specific retailer is not a significant concern in the long term. Consumer demand persists; it simply shifts to different retailers. We have strong relationships and reliable availability, including in e-commerce. We consistently collaborate with retailers, even during their challenges. In a particular quarter, there may have been some shipment disruptions compared to last year, but this does not affect household penetration or our long-term and annual outlook. Regarding margins, the reasons for our positive trajectory have already been shared. As we look ahead, there are a couple of contributing factors. One is the reduction in pricing compared to inflation, which we discussed concerning our contracts with partners. We have long-term contracts and have mentioned before that there is a lag in aligning prices with inflation, but this will improve over time. The other factor is productivity. A year ago, during our supply chain rebuild phase, productivity was not a focus as we concentrated on getting supplies out for inventory rebuilding. Now that our manufacturing is in a stronger position, we can prioritize productivity. Additionally, we have major structural productivity initiatives like Spartanburg, which have faced delays in the past year but represent deferred productivity gains yet to come. Overall, this is about optimizing our cost structure, where inflation minus productivity trends favorably against pricing as we advance.

First, just a point of clarification, then my real question. The clarification is, I just want to make sure I heard it right, that the pod sales in the second quarter will be affected by Omicron last year? And please remind me on the guidance on that. And then the main question is, wondering if you could give us an update on your digital initiatives and e-commerce?

Sure. To clarify the discussion about pod sales, the main factor influencing pod volume is mobility. As previously mentioned, time spent at home directly affects coffee consumption, which isn't surprising. The trend we’re noticing in mobility has been stable over the last few months, and we anticipate this to continue. When comparing to the previous year, the situation will look more neutral or favorable as we reach the second half of the year. Therefore, we expect that all types of adult coffee will see better volume performance in the latter half. Additionally, when we look back at Q2, it’s important to consider that we were rebuilding our inventory following supply chain challenges in the fourth quarter and the first quarter. Last year, we shipped more than we should have in Q2 due to this inventory rebuild. As a result, comparing Q2 this year is challenging due to the combination of mobility rebound and this unique inventory situation. Regarding digital initiatives, we don't have much time to delve into that right now, but that's a conversation for another day. We have various initiatives in place to optimize our operations and consumer marketing. In terms of direct-to-consumer sales, we believe we are leading in the food and beverage sector. The technology we are developing, particularly with our connected brewers that allow for real-time consumption tracking and smart auto reorder capabilities, is very promising as we expand the number of households with smart brewers. We’ll have more discussions on this topic in the future, and I appreciate your question.

Thank you, Jason, and thank you, everyone, for joining us on a busy morning. The IR team is available to answer any questions you may have. So please do reach out. Thank you again.