Keurig Dr Pepper Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
April 27, 2023

There are 11 speakers on the call.

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Keurig Doctor Pepper's Earnings Call for the Q1 of 2023. This conference call is being recorded and there will be a question and answer session at the end of the call. I would now like to introduce to the company's Vice President of Investor Relations and Strategic Initiatives, Jane Gelfand. Ms.

Operator

Gelfand, please go ahead.

Speaker 1

Thank you, and hello, everyone. Earlier this morning, we issued a press release detailing our Q1 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 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 discussions 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.

Speaker 1

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 an eight 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 non operational items in the current and prior years.

Speaker 1

These items include gains on asset 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 Gamboort Our Chief Financial Officer, Sushantju Priyadarshi and our Chief Corporate Affairs Officer, Maria Scheppagirzio. I'll now turn it over to Bob.

Speaker 2

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.

Speaker 2

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. So 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.

Speaker 2

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 And successful track record. As discussed previously, we create value in U. S.

Speaker 2

Refreshment Beverages in 3 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 omni channel 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. We gained share in categories representing almost 90% of retail sales with strong momentum in core brands such particularly Doctor Pepper, On the back of the very successful launch of Doctor Pepper strawberries and cream, Brand Doctor Pepper recorded the largest market share gain in the CSD category this quarter. In fact, The brand has become the number one flavor CSD in syndicated data over the past 13 weeks. For perspective, strawberries and cream reached 70% ACD distribution within 5 weeks of launch, Quickly gained a full share point in the CSC category and continues to experience strong momentum.

Speaker 2

Driving the early success of Strawberry and Cream is KDP's direct store delivery engine and robust consumer insights and marketing In Q1, we also began to activate our strategic partnership with NutriBolt, Transitioning C4 Energy Distribution to our network. Our execution thus far has been smooth and is progressing in line with our plan. 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 NutriBolt is strong and collaborative. We are excited by its potential and look forward to unlocking more value for both KDP and NutriBul in the quarters and years ahead.

Speaker 2

In market execution underpins the gains we are making across our U. S. Refreshment beverages portfolio. The results speak for themselves, but there 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.

Speaker 2

As we protect our profitability and our ability to reinvest for the long term. 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.

Speaker 2

S. Coffee, which represents roughly 30% of our consolidated revenue. This segment experienced a slower start to the year. The performance in Paz, which as you know is our primary focus and profit driver was as expected with brewers softer than expected. Because this 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.

Speaker 2

Growth rates in the at home coffee category, including the In Q1, the category last the surge of the Omnicom variant and lingering pandemic precautions in the year ago period are expected continue to affect comparisons through the first half. At the same time, the category is digesting significant 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 the combination of lower consumer discretionary spending and a challenged specialty retailer environment. Jananshu 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.

Speaker 2

We're still planning to add approximately 2,000,000 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 category, The coffee category is fast 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.

Speaker 2

S. From 2019 to 2023, which translates to mid single digit compound annual growth rate. This is consistent with our previous discussions that eliminating the significant noise over the past 3 years reveals consistent and healthy long term trends for at home single serve coffee. As the leader in U. S.

Speaker 2

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 2 primary means. 1st, 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.

Speaker 2

And we expect household growth to continue for many years to come as we target adding approximately 2,000,000 new households annually. 2nd, by increasing revenue and profit growth from our existing 38,000,000 U. S. Keurig households. Ongoing brewer innovation to address new and changing consumer needs and a focus on expanding brand and variety offerings within the Keurig ecosystem underpin our coffee growth strategy.

Speaker 2

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 iced brewer platform as well as dedicated iced pods specifically designed for cold beverages. Cold coffee beverages are growing quickly at coffee shops and over index 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.

Speaker 2

Today, we are pleased to Announced that Phil's coffee, a super premium brand based in San Francisco will be available in K Cup pods beginning this fall. Through the new partnership with Phil's, as well as the additions of Intelligentsia and Black and 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.

Speaker 2

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 Atopique 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%.

Speaker 2

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 and A, balanced against Turning cash to shareholders through our dividend and opportunistic share repurchases, which we undertook this quarter last quarter. A recent upgrade by Moody's to a stronger investment grade credit rating recognizes the inherent portfolio balance of our modern beverage company along with our capital allocation philosophy and free cash flow profile, all aspects that Sudanshu will talk more about next.

Speaker 2

Thanks, Paul, and

Speaker 3

good morning, everyone. In kicking off 23, 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 $2,000,000 annual U.

Speaker 3

S. Household 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.

Speaker 3

U. S. Refreshment Beverages is an $8,000,000,000 plus revenue business with a 28% adjusted operating margin. The U. S.

Speaker 3

Coffee business is $4,300,000,000 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 $1,700,000,000 of revenue and a 24% adjusted operating margin is already meaningful and quite profitable.

Speaker 3

We are pleased that KDP's portfolio delivered over all Q1 results, which were consistent with our going in expectations even as performance among the segments was varied. Q1 sales advanced 9% driven by a strong in market execution, particularly in U. S. Refreshment beverages. Gross profit dollars grew at a similar rate and we increased marketing investments versus prior year.

Speaker 3

At $0.34 our adjusted diluted EPS grew 3% versus Q1 last year. Without a $0.05 headwind from the significant reduction in non operational 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 non operational 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.

Speaker 3

In Q1, We saw and took advantage of a value opportunity in KDP shares and bought back 6,600,000 shares during the quarter. Combined with the share repurchases we undertook in late 2022, we have now returned more than $500,000,000 to shareholders We are opportunistic buybacks over the past 2 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.

Speaker 3

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 the modest volume mix decline. Net sales grew 8.9% to 3,400,000,000 with pricing up approximately 10%. Gross margins were stable at 52.7% and it primarily reflected the combined benefits of pricing, productivity gains and positive mix balanced against considerable input cost inflation. Total SG and A as a percentage of sales deleveraged by about 100 bps versus prior year, reflecting continued elevated transportation, warehousing and labor costs.

Speaker 3

Despite these cost headwinds, we increased marketing investment to support our brand momentum. We also lapped an SG and A benefit of $28,000,000 from a stock comp accounting change in the prior year period. Q1 adjusted operating income was $699,000,000 about 4.5% below 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.

Speaker 3

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 began to anniversary price increases we took in early 2022 and have not yet captured the full benefit of pricing actions announced earlier this year.

Speaker 3

Volumemix was slightly positive in the quarter, reflecting very limited elasticity impact as well as the contribution from Seaport Energy. This volume mix result speaks to resilient consumer demand, modest elasticities in our categories and a successful slate of innovations 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.

Speaker 3

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 brewer's. That said, we recognize that the quarter volatility in brewer's can sometimes distort the picture. To help you further contextualize brewer trends, we are introducing 2 additional disclosures, Trailing 12 months brewer sold and associated growth rates. You saw both of these in our press release this morning.

Speaker 3

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 month 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%.

Speaker 3

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 months basis, brewer shipments totaled $10,200,000 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 2,000,000 households In the U.

Speaker 3

S, in 2023 remains intact. U. S. Port revenues 2.9% and forward volumes declined modestly, down 1.9% in quarter 1. 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.

Speaker 3

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 power trends should improve in H2 2, as mobility differences relative to last year begin to dissipate. We continue to expect U. S.

Speaker 3

Coffee volumes in quarter 2 to remain under pressure against a year ago period when we successfully executed Our coffee recovery program and rebuilt partner and retail inventories after supply disruptions. Inflation remains the 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.

Speaker 3

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 system segment. Constant currency revenue for coffee systems grew 1% in quarter 1 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.

Speaker 3

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.

Speaker 3

Net sales increased 16.7 percent 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 LRVs and single subparts. The combination of net price realization and productivity gains helped to offset inflationary headwinds and together led to the strong segment operating income growth of 18%. Turning briefly to cash flow. Free cash flow in Q1 was 16,000,000 This declined relative to last year, reflecting the lapping of certain discrete benefits in Q1 2022, such as the body armor litigation settlement gain as well as a use of net working capital this quarter.

Speaker 3

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.

Speaker 3

This basis removes the noise from year over year differences in non operational items, which we still expect to roughly have 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 GAAP versus inflation to reverse as the year progresses. Our full year guidance for below the line items remains unchanged.

Speaker 3

We expect interest expense in a $465,000,000 to $470,000,000 range, which still includes $45,000,000 related to the NutriVault investment, equity method earnings from NutriVault of approximately $40,000,000 to $45,000,000 an effective tax rate of 22% for the year and approximately 1,420,000,000 diluted weighted average shares outstanding. As it relates to quarter 2, 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 quarter 2, reflecting incremental investments across Both LRBs and coffee, particularly behind the ice platform in U. S.

Speaker 3

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 opportunity.

Speaker 3

I will now turn the call back to Bob for closing comments.

Speaker 2

Thanks, Sudanshu. Before moving to Q and 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 advisor 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. Marie and I have worked together for over a decade spanning 2 companies and countless deals including an IPO.

Speaker 2

She has built a very strong corporate affairs team for KDP and we are pleased that she will stay on as an advisor to support the transition to 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.

Operator

We will now begin the question and answer session. Our first question comes from Andrea Teixeira from JPMorgan. Please go ahead.

Speaker 4

Thank you, everyone, and good morning. So I wanted to go back. Bob, you spoke about like the brewer shipments and then I understand the volatility that led you to change the reporting ways and merging the 2. I was just wondering Embedded in your commentary as well, you spoke about 2nd 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 the 2 pandemic benefits for the in house or at home consumption.

Speaker 4

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? Thank you.

Speaker 2

Okay, Andrea. Thanks for your questions. It's really 3 components quickly on brewers, then I'll talk about mobility related deposit. And then I'll add in the last point about what is the away from home business impact on our pod business. So first one brewers, I always need to go back and say what we Essentially every quarter is, we don't see brewer sales as a good predictor of household penetration and our primary focus is driving household penetration.

Speaker 2

And just so we're clear, we said that in quarters where brewers were plus 60% or plus 35%. We felt the same way. There is an inherent volatility in selling small appliances that is fundamentally different than selling consumables. And that's why looking it out on a quarter by quarter basis makes that metric even less helpful. And if you look at this quarter in particular, you're seeing a lot of disruption in retail.

Speaker 2

And One of our original retailers for the Keurig business actually went bankrupt. So there's movement in inventory. There's movement across retail channels On the brewer side, so it's particularly volatile. Having said that, we don't believe it impacts household penetration. We sell about 10,000,000 brewers per year and we add 2,000,000 households.

Speaker 2

So there's a significant difference there that is representative of upgrades or replacements. And that's the piece that I think people always forget. The reason that we're talking about brewers on a rolling 12 month basis, trailing 12 month basis, because that's At least take some of the noise out of it and gives an accurate picture, but of course, we didn't change the metric. We're just talking about that and we're still reporting the quarterly metric well, so we'll give you both. With regard to mobility, that has been the single biggest driver of at home Coffee consumption and as we've talked about on the last call and still true today, we're seeing the exact same trend globally.

Speaker 2

As it stands right now, mobility, the run rate, if you want to think about it that way on mobility is pretty steady. And what's happening now is we begin to lap year ago numbers that also are more normal. That will happen in the back half of the year. And we've been saying that for a while. Everything seems to be on track for that and other people around the globe or in the coffee business are seeing the same So I think there's a common view of what's happening with the consumer.

Speaker 2

The biggest driver of Consumption of coffee at home is time spent at home. It's that simple. And so that's what we're seeing happening right now. And with regard to away from home, When you see the total pod number as you point out, it's a combination of at home and away from home and a lot of people do that calculation for attachment rate And they divide the total pot number, divided by the number of brewers that embeds the away from home number, which is really nothing to do with an attachment rate. That at home business, which was down almost gone in the early days of COVID has rebounded, But we think it is lower, it is clearly lower than pre COVID, and we think that's the way it's going to stay for a while.

Speaker 2

So I don't think there's good news come on the way from home, I also don't think there's bad news to come. I think it's pretty stable right now, but it has been a significant drag on the business over the past couple of years. But It is on a if you were to calculate that and its impact on the attachment rate I described, it would give the impression that attachment rate is down just simply because away from home in total is smaller than it once

Operator

The next question comes from Bryan Spillane from Bank of America. Please go ahead.

Speaker 5

Thanks, operator. Good morning, everybody. And Maria, congratulations. It's been a pleasure working with you. You'll definitely be missed.

Speaker 1

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

Speaker 5

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

Speaker 2

We'll wait for that.

Speaker 5

You teed it up. So actually my question is for Sudhanthu and just Around your comments around cash flow, the payables working capital was a pretty negative Swing in the Q1. And I think it's if you can clarify for this that this is partly just reducing the size of your factoring program. So A, if you can confirm that. And then the second is just How you get to approaching, I guess, 100% free cash flow conversion because you're starting from a pretty big hole in the Q1.

Speaker 5

So I guess if you can kind of clarify how close you think you get to the long term target and again just kind of how that evolves over the course of the year given the impact on cash from operations in the Q1?

Speaker 3

So hi, Brian. This is a great question. So you see Q1 operating cash flow is down versus 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.

Speaker 3

And this program was great in the beginning when interest rate was low, But we have a lot of options of 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, it impacts our P and L. So We're making a lot of those decisions. Those are dynamic.

Speaker 3

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.

Operator

The next question comes from Lauren Lieberman from Barclays. Please go ahead.

Speaker 6

Great. Thanks. Good morning. Very much appreciate the conversation on trying to effectively 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 2019 because that's basically comparing to 2018.

Speaker 6

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 2 weeks of March of 2020. So why compare to effectively 2018 rather than to 2019? Thanks.

Speaker 3

So Lauren, this is Sudhan Shul. The reason we did it, to give you more clear picture, in Q1 2020, you'll see that China started having lockdown. And then we saw the late March, there was some retail. So it was more to give you the The visibility, but we that's the reason we did it. It's more because Q1 2020 had more noise.

Speaker 3

So we just wanted to have Peak COVID number, but we'll continue to give you trailing 12 months decline. As you can see, this time, we declined 9.8%. So you will always have these metrics, But that's the reason because Q1 2020 had some noise. So we just wanted to be more pleased.

Speaker 2

Yes. And just to build on that one, but One of the points is, if you take a look at how we're expecting sales for brewers to play out in 2023, It's going to be up nicely versus 2019 or you could pick a date prior to 2019, all of which were years in which we added 2,000,000 or more households. So one of the points we're trying to make on this is, there were a number of upgrades and replacements So we're accelerated during the pandemic cycle. We had people spending more time at home, people were spending money on their home and also there was government subsidies as well. But if you're if in the end we sell brewers as part of household penetration, actually the household penetration is what drives brewer sales primarily.

Speaker 2

And if you go back and you start to 2019, 2018, 2017, the 2023 numbers, no matter how you look at it, are going to be up nicely versus that and we added 2,000,000 households in all And that's the point we're trying to make.

Operator

The next question comes from Chris Carey from Wells Fargo. Please go ahead.

Speaker 2

Hi, good morning. Good morning. 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?

Speaker 2

What are you seeing from volume deleverage in the quarter? And then also what are you seeing from productivity standpoint? This is a key kind of debate for investors. And again, I just I 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. Thanks.

Speaker 3

So Chris, there are 3 things that impacted in Q1. One was there was narrowed gap between pricing and inflation. There was mix between pot and also the brewer sales. If you see brewer decline 29%, 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.

Speaker 3

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 second half.

Operator

The next question comes from Steve Powers from Deutsche Bank. Please go ahead.

Speaker 7

Great. Good morning. Thank you. So on the resegmentation, I think I definitely appreciate the simplicity of it. And I think over time, it will become shorthand for all of us.

Speaker 7

And I think The incremental disclosures you spoke to on and have been speaking to on coffee systems, pods versus brewers will help. I guess, as I'm thinking about it, my question is really On the refreshment beverages side, because the historical I mean, it was just the economic differences, Both revenue mix implications and margin mix implications of the former beverage concentrates versus packaged beverages business. I think there's a big spread there. So as you're talking about that business going forward, we're thinking about Forecasting that business going forward, how should we think about that? What information may be in the Qs and Ks going forward that will help Kind of tease out those potential mix implications.

Speaker 7

It's really I'm just trying to think through that. And also on Refresh and Beverages, because I don't know you're going to give this or not, but just the NutriBullet contribution to growth in

Speaker 2

the quarter and expected over the year just

Speaker 7

so we can frame sort of the underlying versus The all in revenue growth. Thank you.

Speaker 3

So Steve, this is Hanshu. The region we did is re segmentation. We didn't do it since we merged. When we merged, we were running the business the same way. But internally, this is our 2nd chapter of KDP growth and we run the business U.

Speaker 3

S. Retrenchment Beverages, U. S. Coffee And international. So that's the reason we require to report results to you the way we run the business.

Speaker 3

We also feel That U. S. Coffee will give people will get lot more visibility because we talk about 2,000,000 households. People look at IRI and channel data. So it will help more clarification and people can relate to what internal numbers and external numbers are.

Speaker 3

Regarding refreshment beverages, you have the 3 year margin in So you can see from there and we will continue to disclose the key drivers of that performance, but that's the way we run the business is U. S. Focused. We're also taking noise from ForEx, we're taking noise from before it was Canada and U. S.

Speaker 3

Combined. So a lot of those things will help you simplify it, and we will aid you if you have any questions On building your model, a neutral bolt, this quarter was minimum, it did help us. But for the year, as we say, Depending on the interest rate we pay, interest cost and also the equity pickup we will take, it is marginal. It will see More improvement or accretion to our EPS in 2024.

Operator

The next question comes from Brett Cooper from Consumer Edge Research. Please go

Speaker 5

ahead. Good morning and congrats to Maria as well. Thanks, Brad. Question for you on distribution system. 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 And given that perspective, I was hoping you could offer your thoughts on the potential for distribution relationships Shifts as a means to enhance scale capabilities in economics and then obviously ultimately brand performance in the years to come.

Speaker 5

Thanks.

Speaker 2

Yes. Brett, just to clarify for everyone, the a portion of our Doctor 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 And we cover about 75% of the U. S. Population.

Speaker 2

And then the rest of that is covered by a network 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 with where our company owned routes match up against independent operators.

Speaker 2

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 is 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.

Operator

Our next question comes from Kevin Grundy from Jefferies. Please go ahead.

Speaker 8

Great. Thanks. Good morning, everyone. And I want to extend my congratulations to you as well. I want to come back to NutriBullet And the C4 brand, Bob, you sounded pretty bullish both near term and long term.

Speaker 8

A few questions related to that. Just one, 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 to answer, to follow-up on Steve's question, I think there'd be some interest in the revenue contribution. I think the guidance for equity earnings is helpful, but the revenue contribution on the distribution That would have gone through the OPB 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?

Speaker 8

So thanks for all that.

Speaker 2

Sure. Early days on C4, we're in the mode of transitioning From the current distribution system into ours, I can tell you that that's gone very smoothly so far. And if you look at the syndicated data, You can see that the points of distribution are on the rise, which is really what our initial objective is. And it's more than just The quantitative increase in distribution is also the qualitative increase in terms of quality of placement, distribution, I mean on merchandising and placement. So all of that is very much going on track.

Speaker 2

And the good news is you'll be able to track our progress on both The distribution gains and you'll be able to monitor velocities through syndicated data. So you'll be able to track our progress. You want to talk about the growth contribution?

Speaker 3

Yes, Kevin. So the C4 contributed to volume in U. S. Subtractive Beverages in Q1, which we expect to continue for the full year. With a similar to other distribution partnership, we are not quantifying the top line contribution.

Speaker 3

As Bob said, we will call this out as a driver And you can track our performance in this Canada data. It's a very small if you look at our $8,000,000,000 U. S. Refreshment beverages, it's a very small, But we'll call that as a driver for you. And then once it becomes big enough to really meaningfully impact our revenue and profit, We will start thinking and how do we disclose it.

Operator

Our next question comes from Bonnie Herzog from Goldman Sachs. Please go ahead.

Speaker 9

Thank you. Good morning, everyone.

Speaker 2

Good morning, Bonnie.

Speaker 9

Good morning. 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 for your top line as well as impact On margin since they're just slightly profitable. So how should we think about brewers volumes for the year, Especially given how elevated your inventory levels still are.

Speaker 9

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. Thanks.

Speaker 2

Sure. So on our last call, we set the expectation that for 2023 that brewers would be down modestly. When you take a look at it on a trailing 12 month basis, you see those kind of trends that we described here down 9.8%. This quarter, as we said in the prepared remarks, was softer than expected. And I don't take a look at any one of these quarters and project it As a long term trend and there's a lot of volatility in this quarter compared to a normal quarter, which is brewers, which is which has volatility.

Speaker 2

And part of that as we talked about is retail disruption with regard to some of the specialty retailers being really challenging, one of them going bankrupt. Having said that, other retailers will pick up the consumer slack and the consumer demand and we will certainly be there in all those retailers. We have distribution everywhere And a lot of this is moving online where we are very, very strong. And so as I said before, just like in quarters where we're plus 60%, We should don't project this quarter out anywhere. That's the inherent volatility.

Speaker 2

I'm saying the same thing about this quarter. With regard to brewers, I mean inventory, it's not an issue from our standpoint. We manage that very, very well. So it's not a negative. And with regard to second half margins, expected reduction is not a driver of our margin assumptions in the back half of the year.

Speaker 2

That's not built into any of our assumptions.

Operator

The next question comes from Peter Grom from UBS. Please go ahead.

Speaker 10

Thanks, operator, and good morning, everyone, and Maria, congrats as well. Maybe just two questions On coffee, maybe one just housekeeping. Bob, you mentioned Bed Bath and 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.

Speaker 10

And then I guess I just wanted to follow-up on Chris's earlier question around operating margin And 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 Long term opportunity and maybe more specifically, how quickly can you get back to operating margin in kind of the mid- to high-thirty percent range? Thanks.

Speaker 2

Yes. I mean the disruption from any particular retailer is not a major factor over the long term. The consumer demand remains. They just shift Their demand to other retailers, as I said before, we have great relationships and great availability across the board, including e commerce. We always try to work with retailers even when they're challenged.

Speaker 2

And so in a given quarter, it causes some disruption based on shipments versus year ago, etcetera. But like I said, it has no impact on household penetration nor does it have any impact on the long term outlook that we have or even the annual outlook that we have. With regard to margins, Suneet you gave you the reasons why margin was on the right trajectory. If you continue to look forward, I'll give you a couple of factors. One is the narrowing of pricing versus inflation as we talked about on our contracts with our partners.

Speaker 2

We have long term contracts, we said a number of times that there is a lag in being able to secure the pricing versus inflation. So as time goes forward, we're able to do that. And the other part that we talked about is productivity. Productivity a year ago when we were in a supply chain Rebuild mode was a very, very low focus for us. In fact, it was no focus.

Speaker 2

We were just trying to get supply out there to rebuild inventory. Now that we're way ahead of the game from a manufacturing standpoint, it allows us to focus on productivity. And then of course, we've talked about big structural productivity projects like Spartanburg and we said that we view that. It's been a delay, which has been challenging in the past 12 months and currently. But as you look forward, think of that one as deferred productivity still to come.

Speaker 2

So again, this is all about the narrowing of Our cost structure, which is inflation minus productivity versus pricing, and they continue to get more favorable as we move forward.

Operator

Our last question comes from Rob Ottenstein from Evercore. Please go ahead.

Speaker 7

Great. Thank you very much. First, just a point of clarification to my real question. The clarification is I just want to make sure I heard it right that The pod sales in the 2nd 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?

Speaker 7

Thank you.

Speaker 2

Sure. On the just to clarify the pod Conversation. The primary driver of pod volume is the mobility and it's what I've as I said before, time spent at home is Biggest driver of coffee consumed at home. No big surprise there, but it's a very direct relationship there. The run rate that we're seeing on mobility is relatively stable over the past couple of months and we continue to expect that going forward.

Speaker 2

It's the last versus year ago that becomes more neutralfavorable as you get to the second half of the year. And that's why we're saying the second half of the year For all forms of Idaho coffee, would look better on a volume perspective. The unique element in your comparison to Q2 In addition to the mobility comparison is we were rebuilding inventory after the late Q4, Q1 supply chain issue. So we outshipped ourselves in the Q2 of last year and we were really clear when that happened that that was the rebuild of inventory. So that's why when we talk about Q2 being more challenged on a comparison basis.

Speaker 2

It's the combination of still the rebound in the mobility versus a year ago with this unique situation in Q2, which is the inventory build. With regard to digital, we don't have a lot of time to talk about that right now. I mean, I think it's a conversation for another day. We have initiatives across the board in terms of the way that we plan and run the business As well as the way that we identify and optimize our consumer marketing. With regard to direct to consumers, we are We've talked before that we believe we are one of if not the leader in certainly in the food and beverage world in terms of direct to consumer sales.

Speaker 2

And the technology that we continue to build on the Keurig side of the business, which is the connected brewers with the ability to understand consumption on a real time basis, translating that into a smart auto reorder program is very exciting as we continue to move forward and build the number of households That have a smart brewer. So a lot more conversations on that point to come. I can't really do it justice in this period of time, but appreciate the question.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Jane Gelfin for any closing remarks.

Speaker 1

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.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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Earnings Conference Call
Keurig Dr Pepper Q1 2023
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