Keurig Dr Pepper Inc.

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Keurig's Dr. Pepper's earnings call for the fourth quarter and the full year of 2019. 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 our host for today's conference, Keurig's Dr. Pepper's Vice President of Investor Relations, Mr. Tyson Seeley. Mr. Seeley, please go ahead.

Thank you, and hello, everyone. Thanks for joining us. Earlier this morning, we issued two press releases, one announcing that we entered into a long-term strategic agreement with Nestle USA to continue manufacturing Starbucks-branded packaged coffee in K-cup pods in the U.S. and Canada. The second press release we issued was for the fourth quarter and full year 2019 results. If you need copies, the releases are available on our website at kerrydrpepper.com. Consistent with previous quarters, today we will be discussing our performance on an adjusted basis, excluding items affecting comparability and, with regard to the year-ago period for the full fiscal year, our financial performance also takes into account pro forma adjustments due to the merger. The company believes that the adjusted and adjusted pro forma basis provide investors with additional insight into our business and operating performance trends. While these pro forma adjustments comparability are not in accordance with GAAP, we believe that adjusted and adjusted performer basis provide meaningful comparisons and an appropriate basis for discussion of our performance. Details of the excluded items are included in the reconciliation tables included in our press release and our 10-K, 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. Here with me today to discuss our fourth quarter and full year 2019 results and our outlook for 2020, our ADP Chairman and CEO, Bob Gangort, our CFO, Ozan Dogmesioglu, and our Chief Corporate Affairs Officer, Maria Sceper-Gurcio. 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. 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. Before turning it over to Bob, I'd like to share that KDP is hosting a sell-side analyst event on March 19, 2020, which will be webcasted live. As we get closer to the event, we will issue a press release providing more details, but for now, please mark your calendars for a 2 to 4 p.m. Eastern live webcast.

With that, I'll hand it over to Bob. Thanks, Tyson, and thanks to everyone for dialing in. Two years ago, we laid out a bold vision and ambitious financial targets for our new company. We saw significant opportunity to create an organization focused exclusively on beverages of all formats by being the first to combine hot and cold beverages at scale. and by harnessing an unrivaled distribution system that can reach nearly all selling outlets, using seven different routes to market, ranging from direct store delivery to e-commerce. Since the announcement, we successfully combined our two legacy companies, uniting nearly 26,000 employees into one forward-looking organization with a common platform and culture. We also delivered financial results that have exceeded our three-year targets, invested in a foundation for long-term sustainable growth, and have upped our game on corporate responsibility and sustainability. In 2019, we delivered very strong financial performance, with underlying net sales growth of 3.2%, adjusted operating income growth of 10%, and adjusted diluted EPS growth of 17%. Importantly, the sales performance reflected growth from all four segments, an in-market performance that remained strong. as we grew dollar consumption and gained market share in nearly all of our key categories. And our free cash flow in 2019 was exceptionally strong at $2.4 billion, enabling us to reduce debt by $1.3 billion. As a result, we reduced our management leverage ratio to 4.5 times at year-end, compared to six times at the July 2018 merger close. The strong free cash flow also enabled us to pay down structured payables by $531 million. In addition to delivering strong and balanced results in 2019, we built a foundation for growth upon which we can drive the business faster and more effectively. And we prioritize investment opportunities during that year that we are now beginning to activate. Therefore, in 2020, we are investing to drive the top line and expect net sales growth to accelerate to 3% to 4%. while still delivering adjusted diluted EPS growth in the range of 13% to 15%. Taking the midpoint of that range would place us directly in the middle of our EPS merger target of 15% to 17% through the first two years, with robust innovation, marketing, and in-store execution driving top-line growth in excess of our merger targets. We will deliver these targets while remaining focused on the key drivers that can create value for our companies. We create value in cold beverages by renovating and innovating our brand portfolio to leverage our selling and distribution powerhouse, and by partnering with emerging growth brands that offer us access to new segments and clear paths to ownership. Productivity provides funding for the continued brand marketing and innovation. In coffee systems, we create value through expanding Keurig systems. Secured brewer and coffee innovation combined with effective system marketing drives that conversion. Unique to coffee systems, we share some of the productivity we generate with our partners to lower the price of take-up pods at retail, further driving consumer growth while still continuing to expand our margins. And across the enterprise, we drive exceptional free cash flow that enables us to de-lever and offer shareholder value optionality in the future. As we've said previously, while these concepts are fairly straightforward and simple to understand, when implemented effectively, they are incredibly powerful drivers of value. With that as backdrop, let me take a few moments to emphasize some of the most important aspects of our 2019 results and highlight the areas of investment in 2020 that will drive the accelerated growth we expect. In 2019, our CSD portfolio expanded retail consumption by more than 3%. and grew market share by 60 basis points, with the majority of the portfolio contributing to this growth. In particular, Dr. Pepper and Canada Dry posted dollar consumption growth in 2019 of 5% and 6% respectively, fueled by innovation and effective marketing. These results are particularly impressive given the context of the strong growth these two brands posted in recent years. We continue to invest in innovation and marketing behind our key brands, and the second year of the Dr. Pepper Fansville campaign, the latter of which drove outside dollar and volume performance for Dr. Pepper during the college football season. New partnerships are also an important element of our growth strategy. For example, we tested Ashok in 2019 with beverage entrepreneur Lance Collins, expanding our presence in the energy drink category. Ashok was introduced regionally in mid-2019 and is now beginning its national rollout. Ashok joined Science Energy Drinks, which we acquired as part of the Big Red acquisition in 2018. Science, while small, continues to post impressive growth. In late 2018, you'll recall that we signed a long-term partnership with Danone to distribute Evian water. The launch of this partnership, combined with Core and Buy, has made KDP the number two premium water company in the United States. And we continue to see areas to build out our presence and drive future growth. In coffee, K-cup pods manufactured by KDP were up approximately 4% for the year in IRI U.S. track channels, which, as we have indicated previously, don't capture the accelerated growth we are driving in untracked channels. In 2019, the untracked channels represented about half of the pods we manufacture, and we would expect that number to continue to grow. Our pod shipment growth of 9% The strong performance of our take-up odds was driven by new households that we brought onto the Keurig platform. Specifically in 2019, we expanded the number of U.S. households regularly using a Keurig brewer by approximately 7%, bringing the total number of U.S. households in the Keurig system to around 30 million at year end, with an additional 3 million households using the Keurig system in Canada. This growth was driven by robust brewer innovation and the Brew the Love marketing campaign featuring James Corden for the third consecutive year. Our most recent brewer innovation, the K-Duo, fills an important need for households that want a single machine that can brew both a single cup and a carafe. K-Duo has been extremely well received by consumers both in terms of units sold and star ratings. And finally, on coffee, the long-term agreement with Nestle announced this morning recognizes the strong partnership we've had with the Starbucks brand for almost a decade. With this agreement completed, along with the long-term master licensing and distribution agreement we recently signed with McCafe in the U.S., we have every major branded player within the Keurig system committed for at least the next five years. In 2019, we launched our Drink Well, Do Good corporate responsibility platform. along with multi-year goals for our supply chain, the environment, health and well-being, and communities. A significant area of environmental focus for both the industry and KDP is plastics, and in late 2019, in partnership with the ABA and industry peers, we launched the Every Bottle Back initiative. We are also on track to make every K-cup pod recyclable this year, after reaching this important milestone in Canada last year. Finally, in 2019, we rolled out our KDP values and competencies to the entire organization, uniting all of our employees under one common culture, fostering an environment in which everyone at KDP operates with shared purpose and common goals. As I mentioned up front, we have a good line of sights of delivering sales growth in 2020 above our long-term target range by investing in a number of platforms across the business. starting within a nation which we expect to be a meaningful growth driver for this year. In CFDs, we plan to support our flagship Dr. Pepper brand with the first quarter launch of regular and diet Dr. Pepper cream soda, which would drive continued growth for the Dr. Pepper and increase frequency and volume to the category. Also launching in the first quarter is Canada Dry Bold, which takes the extremely popular and on-trend Canada Dry ginger ale and dials up the flavor impact. We are also rolling out our new lineup of 10-pack mini cans behind many of our CSD brands, including Dr. Pepper, Canada Dry, Sunkissed, A&W, and 7-Up. These mini cans are consistent with the consumer trend to enjoy carbonated beverages while controlling portion size and caloric intake. While this format has been a significant driver of category growth, until now KDP has not had full representation across its brands. For buy, we are introducing the first flavor innovation behind the brand since it was acquired in 2016, with the introduction of Bing Cherry, rolling out nationwide as we speak. This is just one of many actions we are taking to support the brand this year, and we look forward to sharing additional details during our March 19th webcast. As mentioned previously, A-Shock Energy drinks will roll out nationally in 2020. Also, as you've likely seen, we purchased Limitless, a lineup of lightly caffeinated sparkling waters early this year. Not only do we plan to build that distribution of Limitless as the year progresses, but we also have developed flavor innovations that we plan to introduce as well. While starting from a small scale, both Ashok and Limitless will be solid contributors to growth in 2020. In coffee, we are in the process of launching our next wave of updated brewers, starting with the K-Slim Brewer, which is currently available on Keurig.com, and will be expanded more broadly over the next few months. At just five inches wide, the Caseland Brewer features an impressive 46-ounce reservoir, a simple user interface, and is the first reservoir brewer to feature our next-generation Curie branding and design. We look forward to sharing more brewer innovation with you as the year progresses. All brewer and beverage innovation will be supported by significant marketing investment throughout the year, behind both existing and new campaigns. In 2020, we also have plans for increased investment in our networks. This includes capex spend and expense behind new manufacturing facilities we plan to bring online in 2020, including our Spartanburg, South Carolina facility, which once up and running will be the largest and lowest cost K-cup manufacturing facility anywhere. Also coming online in 2020 is our manufacturing and warehouse facility in Allentown, Pennsylvania, which will produce primarily non-carbonated beverages, Both of these facilities will be significant sources of productivity once they ramp up and will support the future growth of our brands. Investment in our networks also includes improvements in our routes to market, including our company-owned DSD network. We'll elaborate more on this during our webcast in a few weeks, but at a high level, this means investments in sales technology and training for our field team. and the acquisition of select independent distribution territories for incorporation into our company-owned DSD. All of this is to ensure that our retail coverage is as efficient and effective as possible, allowing us to drive maximum value from this important asset. In 2020, we will also continue to geodiversify our brewer supply footprint across Asia. In addition, we have established a center of excellence for brewer R&D and supply chain management, based in Singapore. This center, which started up in late 2019, locates our teams closer to where our appliances are manufactured, allowing us to move faster and more efficiently. And finally, in 2020, we also plan to make investments behind our sustainability initiatives. As you are already aware, all of our K-Cup pods we manufacture will be recyclable by the end of this year. Recyclability has been a large barrier to adoption for many consumers, and we plan to promote this news with stepped-up marketing and in-store support. Also in 2020, we will launch our first 100% post-consumer RPET bottle. We look forward to sharing more information about this later in the year. During 2019, we received many questions from you on what a future KDP looks like once we move beyond 2021. You're beginning to see a robust pipeline of growth platforms across multiple segments, combined with a temporary route to market, and supply chain infrastructure, all of which point to a compelling future for our company. Our 2020 outlook represents a year of accelerating growth behind steps of investments in our brands, network, and people. Some of these investments will produce returns quickly. For example, the innovation of marketing that we are rolling out is expected to translate to accelerated top-line growth in the coming quarters, while other investments will take a little bit longer to show results. For example, Spartanburg and Allentown will be significant sources of productivity and capacity for our business, although benefits won't start to flow through until after this year. Most importantly, these are all critical investments to drive sustained future growth and value creation starting this year. With that, let me now hand it over to Ozan.

Thanks, Bob, and good morning, everyone. Since our press release provides significant details on our performance, I will touch on our fourth quarter results very quickly, and then turn to the larger drivers in our 2019 performance, along with our 2020 guidance. At a high level, the fourth quarter was another solid one for us. Excluding the prior year sales of body armor in October last year and foreign exchange impacts, Net sales increased 4.6% in the quarter, with contributions from all four segments. The sales growth, along with strong productivity, synergies, and network optimization, low operating income growth in the quarter of 13%, and operating margin expansion of 210 basis points. We delivered adjusted diluted EPS growth of 17% in the quarter, fueled by the growth in operating income and the lower effective tax rate, partially offset by higher interest expense, due to comping last year's benefit of interest rate swaps in the fourth quarter last year. Turning to full year results. free cash flow in 2019 was exceptionally strong at approximately $2.4 billion. This translated into an adjusted free cash flow conversion rate of nearly 140%. We also ended the year with $75 million of unrestricted cash on hand. In terms of leverage, we reduced our outstanding bank debt by approximately $1.3 billion in 2019. As a result, our bank debt to adjusted EBITDA ratio, which we refer to as our management leverage ratio, improved by nearly a full turn to 4.5 times versus 5.4 times at the end of 2018. Since the merger closed in July 2018, we have reduced our leverage ratio by 1.5 turns. In addition, we also paid down $531 million of structured payables during 2019, resulting in total payments between debt and the structured payables of $1.8 billion. In terms of synergies, 2019 was the first year of our three-year program. As you will recall, when we announced the merger two years ago, we committed to $600 million of synergies, with $200 million per year between 2019 and 2021. We delivered synergies of slightly more than $200 million, and we expect to deliver our commitments in each of the next two years. And finally, before turning to 2020 guidance, let me provide some details on our synergy, productivity, and network optimization programs. And they will continue to be important sources of growth and value creation in the coming years. As we shared at our investor day in March 2018, a key part of our strategy is to execute untapped opportunities to drive profitability and cash flow, which enable us to reduce debt and provide optionality for the business. Our value creation program, which includes synergies, productivity, and network optimization, is an important aspect of this. Examples of progress across these programs that we have already made include the following. The consolidation of warehouses between our two legacy companies, the integration into one-phase organization, the organizational alignment of the two legacy companies, including the consolidation of certain corporate functions and elimination of duplicative roles. Simultaneously, reducing the cost and improving the quality of our brewers through engineering redesign and the harmonization of brewer parts and platforms. Optimizing procurement practices, utilizing economies of scale, and driving manufacturing efficiencies across the combined network. Utilizing asset sale respects on certain facilities, which we will continue to pursue opportunistically. And optimizing our DSD system, our accounts across the country. All of these actions have enabled us to unlock significant efficiencies and value in our network, with many opportunities yet to come. We have a long runway of value creation in this area, and we look forward to sharing these with you in the coming quarters. Let me now move on to our outlook for 2020. As you saw in our pre-release, we expect net sales growth to be between 3% and 4% in 2020, nicely above our three-year target range. We have confidence in our expectations, given the high-quality areas in which we are making investments. As I will discuss in a minute, there's a timing component of these investments. Given these investments, we expect adjusted diluted EPS growth to be in the range of 13 to 15% in 2020, representing $1.38 to $1.40 per diluted share. Importantly, over the two-year period ending 2020, we expect it to remain in line with our merger target for average annual growth of 15 to 17% and continue to have confidence in achieving our target EPS growth over the three-year merger target period ending 2021. Adjusted interest expense is expected to be in the range of $530 million to $545 million. This reflects expectation for continued deleveraging in 2020 giving the significant cash flow we expect to generate in the year, as well as the expectation of a modest benefit from the opportunistic unwinding of our remaining interest rate swaps. Our management leverage ratio is expected to be in the range of 3.5 to 3.8 times at the end of 2020. Cash outlay for capital projects is expected to step up, as previously communicated, to approximately $550 to $600 million in 2020, giving the ongoing projects we have underway to support future growth in our business. Importantly, 2020 represents the peak cash out a year in the three years following the merger. We currently expect CapEx over the three-year period to be in the range of $1.4 to $1.5 billion. While we are not providing guidance by quarter, we do expect net sales growth and adjusted EPS growth versus 2019 to be tempered in the first half of 2020 due to several factors. Specifically, the investments we are making this year that Bob mentioned previously will be weighted to the first half versus the second half. Productivity and synergies are expected to be lower in the first half versus the second half as programs build throughout the year. Based on our current input cost coverage, we expect inflation to be the highest in the first half of the year, specifically in the first quarter, and then moderate over the balance of the year. Partial offsetting these timing factors is a gain of $39 million, we realized in January of 2020, related to additional asset sale defects of four properties. Consistent with the value creation framework I laid out earlier, this gain primarily affects packaged beverages, with the remaining benefit in coffee systems. In addition, in coffee systems, we are anticipating the highest tariffs in the first quarter and marketing investment is also expected to be elevated. Coffee will also be lapping the full launch of the highly successful K Mini Brewer in Q1 2019. In beverage concentrates, the timing of synergy culture and volume initiatives are weighted toward the back half of the year. Giving these discrete segment impacts, while we do expect and beverage concentrates in 2020, they will start slowly and ramp up as the year progresses, particularly coffee systems. And with that, I will hand it back over to Bob for some closing remarks before we open it up to your questions.

Thanks, Ozan. We've covered quite a bit of territory in our remarks today and look forward to providing more details during our March 19th webcast. We are excited about the progress we've made in the past 18 months to build a foundation for our company that we can now leverage to drive accelerated growth beginning this year. The strong results we have delivered since the merger closed demonstrate the strength of our strategy and team, and we are confident in our 2020 guidance and remain committed to delivering the three-year merger targets we established more than two years ago. I will now hand it back over to the operator to open it up for your questions.

Thank you. Ladies and gentlemen, at this time, if you would like to ask a question, please press star, then the number one on your telephone keypad. Again, that is star one to ask a question. If you would like to withdraw your question, press the pound key. Please hold while we compile the Q&A roster. Your first question is from the line of Brian Spillane with Bank of America.

Hey, guys. Good morning. It's actually Pete Gabel on for Brian. Thank you for taking the question.

Good morning.

Bob, I just wanted to get your thoughts around supply chain, particularly coming out of China with a lot of the disruption we've seen at ports and how you're thinking about that in terms of brewer growth, particularly maybe at the first half of the year.

Yep. So, I mean, first of all, you're talking about the supply chain. I think it's important to talk about there is no demand impact on our business because – The great majority of our business, nearly all of our business, is U.S., Canada, and Mexico. That's why you get to the supply chain side. We've done a couple of things that have served us well. The first thing that we did was geodiversified our supply chain for our brewers outside of China. Our original catalyst for doing so was tariffs, but that served us well in this current situation. We just came out of our peak selling season during the holiday with spectacular selling results. And as we go into this year, we're in a lower seasonality period, which allows us to build some inventory. And so we really, at this point in time, we're in really good shape from a supply standpoint. We'll watch it very carefully, but we don't anticipate any disruption at all.

Got it, got it. That's helpful. And then maybe just on free cash flow, you know, obviously very impressive in 2019, the $2.4 billion increase. Just want to get some thoughts around sustainability of that in 2020 and 2021.

Sure. I mean, I believe we have demonstrated quite a bit of ability to drive outsized cash flow from a variety of sources. For example, we have, and as we just announced, our free cash flow conversion ratio to net income was 140%. And it would be, obviously, we will continue our programs in order to generate still outsized cash flow. For example, our business is quite highly cash generated. Second, we have strong working capital management programs in place. As well as, we tap into other initiatives if we see opportunity in order to unlock the cash generation using our asset base. For example, assets, say, Lisbeck was one of the initiatives. Therefore, we do expect to generate outsized cash flow and turn our free cash in excess of 100% in the upcoming few more years.

Great. Thank you. Your next question is from the line of Peter Brum with J.P. Morgan.

Hey. Good morning, everyone. So I just wanted to ask a couple questions on the revenue outlook. First, I guess, would it be possible to break out your expectation for what is organic in the 3% to 4% target for 2020? As I know you guys get a benefit from McCafe in the back half of the year. And then just more broadly, you reiterated your long-term EPS guide this morning but didn't mention anything around long-term net sales growth. And, you know, maybe I'm reading too much into this, but should we expect faster growth beyond 2020 as a result of this increased investment? Thanks. Thanks.

Yeah, let's start with 2019 for a second, right? If you look at, there was a lot of noise in 19, as we talked about numerous times, about the ins and outs of allied brands. I am very happy to say that's all behind us as we go into 2020, so there is no concept of underlying net sales as we go into 2020. But if you go back and look at 2019, our underlying net sales was 3.2%. In the fourth quarter, it was 4.6%. And one of the discount underlying reported was 4.3%. So you saw an acceleration throughout the year in 2019. And that continuation into 2020 is why we have the confidence of taking our revenue targets up for 2020. With regard to organic versus additional, really the only thing that wouldn't be organic in your definition would be McCafe, as you point out. And a couple of points on McCafe. I mean, one, We participate in revenue of McAfee now because we produce the pods. And so we're picking up some incremental difference, particularly on the premium bag business. But we already participate in the revenue on pods. So there's not much change there. It's a partial year impact. And a lot of the reports out there that quote numbers that I've seen are really looking at retail numbers, not manufacturer sale numbers. So to answer your question, The great majority of what we're talking about on the increased revenue in 2020 is, by your definition, organic. In terms of sustainability of that beyond 2020, which is where I think you're getting at, clearly we're not going to sit here and guide beyond 2020. But you can see the investments that we're making are not short-term in nature. They're very much long-term in nature, both in terms of the foundation that we're building that drives our business day in and day out, renovation of our existing brands, launch of new businesses, whether we're doing it completely on our own or in partnership with others. And all of that combined suggests that we have a lot of runway in front of us as we talk from the very beginning to improve the operations of our business and fill in significant white space in our portfolio. And that's why we're giving the outlook that we are today.

Thanks. That was very helpful. Pass it on. Okay.

Your next question is from the line of Lauren at Laberman with Barclays.

Hi. Good morning. Good morning. So I just wanted to talk a little bit about maybe opportunities that you have uncovered since closing the deal for now a full year in. But just, you know, two years in. But vis-a-vis, like, particularly the network optimization program and some of the things that you started to hint at and promise us we'll hear more in a few weeks. But I was just curious kind of what is sort of incremental discovery as you've gotten closer and deeper into the business versus things that you maybe contemplated, you know, when the merger first came together? Thanks.

Sure. I'm going to break them into three buckets of areas that we've learned. I'm going to talk about portfolio expansion in the white space. I'll talk about our selling and distribution capabilities. And then I'll ask Ozan to talk about the cost side of the business and also some cash I think would be important, right? Because you go in, as you point out, you go into these mergers with a hypothesis and a merger thesis, but the reality is how can you deliver against that once you're up and running? And so now 18 months into running this business, what have we learned? I think our ability to fill in white space in our portfolio and expand into higher growth segments is very much intact and is evidenced by the fact that we're taking up our target on growth. And you can see where we're targeting to fill in our white space. Water, premium water, is a very attractive segment. We're now the number two premium water company. And through a combination of the buy business that was there, the partnership that we have with Denone on Evian, the acquisition of Core at the end of 2018, which we really were able to accelerate in 2019, the recent acquisition of Limitless, which is small but will ramp up this year, and some of the other opportunities that we take a look at in water, we see significant growth coming out of that segment, and we see more opportunity to fill in additional white space within water. Energy is another one. And energy, as we talked about, you have to be more thoughtful about how you want to approach that segment because some of the big players that exist, But a combination of business that we acquired along with Big Red Science now growing rapidly and the partnership that we're scaling up with Lance Collins on Ashok are all good examples of how we're able to access some of these very large and attractive segments in unique ways. The one point I would make on top of that is that's all important as long as your foundation, your core business continues to grow. And that is 100% what's happened. What's interesting that hasn't really come up and I've seen a number of the reports is, again, KDP outpaced the CSD market. We were up 3.2% for the year. The market was up 2.5%. And Dr. Pepper just had his 15th straight year of growth and outpacing the CSD category with growth of nearly 5% and Canada's dry at 6%. So being able to add all of these new segments on top of a really strong and robust core is the key to our success. On the route to market side, there are a number of things that we're doing. And, again, it's hard to cover it on a call, so we'll just say we're previewing that for our discussion in March when we have you all in. But it's a combination of investing in technology, investing in our people, but also being very targeted and going after some of these independent distributor markets where we think we can do a better job through our own company-owned DSD. We've already begun to do that, which we'll show you when we get together, and we have plans to do more of that. And what we're seeing is part of the strength in our core is not only coming from marketing and renovation, it's coming from strength in our selling and distribution capabilities. And so both sides of that are not only intact, but we feel stronger about them than we did going into it, which is, again, why we're taking up our growth outlook. Sure.

On the cost side, let me start with the value capture. As we did define and share with you as well, it comes in two pieces, which we call as base productivity programs as well as the synergies. And as we guided and announced several times, we had the target of delivering $600 million of these synergies starting over three years, starting 2019 through 2021.

And we just also announced that we topped off actually both of the metrics. In fact, on the deal synergy side, we delivered a little bit more than our original plans.

Therefore, the things went well in those two packets in terms of delivering overall value capture and topping off those numbers, which in fact gives us the unique opportunity, as Bob laid out a couple of minutes ago, to continue to invest behind our business from either the brand investment side or the distribution routes or our manufacturing capability that will further fuel and satisfy our growth as well as further drive the base productivity as well as the synergies. Therefore, there's no surprise. In fact, we have maybe a little bit positive surprise in those two buckets which are unlocking the investments that we have laid out. On the cash flow side, absolutely there's no surprise. We laid out a deleveraging program and we are 18 months into it and definitely have delivered exactly what we said we would. We did deliver outside cash flow in 2019 and we have very solid programs intact and in place both 2020 and 2021 that will get us to the deleverage targets that we put out there. And the more opportunities we find, definitely we will put into service as we have been doing.

So I think the net of all of that is we were really confident going into this merger. 18 months later, we're even more confident with what we know. And the one thing we didn't mention in any of that was we did everything we just talked about on top of delivering a home run of the year for coffee systems. And our outlook on that is as robust as ever. We're sitting here 18 months into this feeling good, as you can tell.

That's great. Thank you so much.

Your next question is from the line of Steve Powers with Deutsche Bank.

Hey, great. Good morning. Two questions, if I could. I guess the first one, just building a quick cleanup for ozone. It looks like outside of a couple hundred million dollars in asset sales in the fourth quarter, your free cash flow would have actually come in a little light of the full-year target. And I guess that was probably planned on your part, but I guess can you just give us a little bit more insight into what was sold? And as we think about the path, the future of free cash flow, is that a driver there? Is there a line of sight to similar sales in the future?

Well, first of all, I mean, we deliver $2.4 billion of free cash flow, and that equates to 140% of the cash conversion percent free cash flow to net income, which is best in class and best in our industry. It's an obvious number. Therefore, we did plan potential asset sales. In fact, we did plan during the deal time. of those numbers, because we always look to our opportunities in a very holistic manner. And therefore, we just delivered a mid-pack of our guidance that we put out there. Therefore, probably it would be a little bit unfair to say that we are short in absence of those, let's say, a couple of asset sales that we did. In fact, once we release our 10-K today, you will find further details. The asset sales which we did run as such, by the way, in 2019 was on the three manufacturing units that we had. And obviously, we have very long-term lease contracts in place, even the options on us to be able to renew two terms further after the first expiry of this period. Therefore, that was within our algorithm, and whenever we find opportunities to unlock either on the profit side or the cash side, definitely we will go after. So what matters is if we take a holistic look to our cash flow generating, again, we have very solid programs in place with regards to continuing expanding our working capital.

This business, including our EBITDA generation, is very cash generative, and there are ample other opportunities that will enable us to continue to deliver outsized cash flow.

The one thing that I would add in all of that, this is Maria, is that if you look at our results for the year, there's a fair amount of noise in it. And any time you put two large companies together, you're going to have that. There are things that are positive and things that are negative. What I would venture to say, if you look at 2018 and 2019 and you make a list of them and the vast majority of that stuff is disclosed, you will see that we had more benefit in 2018 than we did in 2019. So on a year-over-year basis, our growth – if you strip all the noise out, would actually be higher than what we reported. It would be north of 17%. So there is some work that has to be done to kind of get to that, but the reality is that the underlying performance was really good.

Okay. Yeah, that's helpful. Thanks for the clarity. I guess the second question, if I could, for Bob, and I guess this builds on what you were just discussing in response to Lauren's question, your ability to leverage legacy data DPS distribution platform assets to expand, accelerate new brands. That's always been a big part of your longer-term strategy and the industrial logic of taking on DPS in the first place. But I guess are you removed from the merger 18 months or so? As strong as legacy Keurig and core DPS have been, it looks like that part of the value proposition – Maybe a little bit just lagging, if I could. Clearly you're excited about 2020, but you've spoken in the past about some of buy's challenges and the slower ramp of allied brands. I think allied brands, you know, contributions were supposed to turn positive in the quarter. I'm not sure that that happened. So I guess just can you give us a little bit more clarity or color on how you're thinking about it and the system's ability to develop smaller under-penetrated brands in the future? Sure. And as it relates to, and maybe some of that relates to your comments about plans to acquire new territory, because that too seems like an evolution from some of your comments in the past. So just some further wrap-up there would be great. Thanks.

Yeah, I think you're referring to our PB segment, which is where our company-owned distribution resides. I mean, first of all, just to reiterate, because I know there's complexity around our routes to market. but we have the ability to reach 100% of the U.S. with direct store delivery. Approximately 75% of that is through company-owned DSD, and the remainder is through long-term partnerships with independent distributors. So we have the ability to take any new brand and get it to every store in the U.S. through a DSD system, which is really powerful. I mean, you know, there are only a few companies that can do that. Within the PD segment, you have to remember, from Marie's point on noise, That is the noisiest segment with regard to the movement in and out of allied brands. And that was disruptive, but I think we managed through it really well. And if I just take a look at the quarterly trends on the PB segment, in the first half of the year, our underlying growth was around 1% to 1.5%. In Q3, it was plus 3%. In Q4, it was plus 4%. So you're seeing an acceleration after – cleaning up some of the noise of the allied brands through our own company-owned DSD system. And, yeah, the allied brands, some of them were a little bit slower to ramp up than we talked about before. And there are always brands that you have to work on. We talked about Buy. We talked about Snapple Tea. But everybody who has a big portfolio always has a group that is growing rapidly, a group that's growing nicely, and a group you have to work on. The key is you have to balance right. And, again, our total company growth in the fourth quarter underlying was 4.6%, and our PB segment was plus 4%. So, yeah, we feel great about where we are with this one. We just always have a few things we have to work on that you can pick out, but net-net, everything's going in the right direction, and that's reflective in the targets we put out there for 2020. Okay.

Thank you. Sure. Sure.

Your next question is from the line of Robert Eisenstein with Evercore ISI.

Great. Thank you very much, and congratulations on a strong year. Two questions. First, you talked, and it went fast, but it looked like you were going to be pushing minicans much harder in the past, and it's obvious why you would do that. But that does represent a change in strategy, certainly from prior management. And if I recall, and correct me if I'm wrong, I think it may have been a change in strategy from your initial views on the business due to supply chain costs and complexities. Is that correct? And how are you thinking about dealing with those changes to the supply chain to execute on that effectively? So that's question number one. And question number two, obviously getting some really nice share in the cold drink segment. Can you say what channels that you're seeing those share gains, or is that pretty broad? Thank you very much.

Sure. So we keep talking about why we're so bullish on our business going forward is the amount of opportunity we still have in front of us that we haven't yet accessed. We talked a lot about segments that we're entering that we didn't have great participation in. that we are now able to access. Minicans falls into that same category. You know it's been a big growth driver for the industry. It's not only a driver of revenue growth, but it's good profit as well. And we just haven't participated in it for a number of reasons. There's no change in our thesis on this. We've always wanted to do it. It's just a matter of gearing up our supply chain and getting the can supply to be able to do that. And now we're able to do that in a broad way, in a big way, going into 2020, which is another source of incremental growth and profitability. The industry has accessed that. We're underdeveloped. We'll be able to close that gap because we need to make sure that our brands are available in a format that consumers want. With regard to where are we seeing share gains, it's really across the board. It's no particular channel. and every channel, and when we're able to drive growth and share gains through great marketing, through innovation or renovation, or through new segments, we get the benefit of that across every single channel.

Terrific. Thank you very much.

Okay.

Your next question is from the line of Kevin Grundy with Jefferies.

Hey, good morning, everyone, and congratulations on the strong year. Thanks. Bob, can we pick up on coffee systems? So the household penetration was up nicely this year and then also reflective and strong brewer volume growth of 8%, which is great. Can you put some context again on just revisit where you think household penetration can go? I think there's been some context around mid-60% household penetration in parts of Europe. Maybe just some updates on your targets here and then how quickly you think you can achieve them and then what that potentially means as we think about growth in this segment.

Yeah, let me just give the real headline numbers on how we see the coffee systems number in 2019 because, as you know, there's a lot of When it comes to reporting, I think there's still an over-reliance on the IRI numbers because they're available, but they don't really tell the whole story. When I look at the key metrics for 2019 coffee systems, we see household penetration of 7%. We see pod shipments of 9%. We've always said over time shipments and household penetration will equal each other. We see brewer shipments of 8%, but if you take a look at NPD, which is a good source of brewer sales, they were up 9.5% for the year. And then the fourth quarter, which benefited from the introduction of the K-Duo launch in NPD, was up 15.5%. So that's why I said it's a home run of a year on coffee, and not to mention we expanded our margin by 90 basis points at the same time we did all of that. In terms of household penetration, we're sitting at around 23% household penetration. All of the work that we've done going back to the – launch of the merger. And we showed you in our first investor day, we said that we believe that household penetration should be north of 50%. There is every piece of evidence that suggests that that number is still very much the target, something north of 50%. And we're just chipping away at it every year. And at a pace that we're looking at, you know, growing that at 7%, you could do the math and figure out when we would get to 50%. But the good news is it's a long way off. And so that speaks to our ability to continue for the foreseeable future.

Okay, that's helpful. And then just to follow up to Robert's question, so specifically around beverage concentrates, so the volume number there has been strong, and it's been strong for the past two quarters. So, Bob, maybe just talk about the disconnect between what we're seeing in the Nielsen data. You alluded to some stronger growth in tract channels and non-tract channels, excuse me. I'm just trying to understand the sustainability of the wide gap that we're seeing between the Nielsen data and then what we're seeing in volume growth in beverage concentrates. Talk about the emphasis in non-track channels, but specifically I think it would be helpful that the magnitude of the gap that we're seeing, is this just sort of the first half? You picked up distribution in the first half of 20. We should see that gap close, or you think this is sustainably we should see this gap higher and it's so wide?

So I think if you're talking about, just for clarification, are you talking about in the month of January, February, or are you talking about fourth quarter?

I'm talking about fourth quarter, Bob, and I'm also talking about third quarter. So if you look over time, there's been a tighter gap between the volume numbers in beverage concentrates versus what we see in the Nielsen data, and that gap has widened in 3Q and 4Q. So the question is sort of premised on that.

Yeah, I think there's a couple things. I think one is you don't see everything in the Nielsen IRI data. So, for example, you know, a big part of our business that shows up in beverage concentrates is what we call found in food service. So that is our sales to restaurants across the board. And remember, Dr. Pepper is the most available soft drink across all restaurant formats. And so that's an area where we continue to see very strong growth behind demand in our brands. And what's the demand driven by? Great marketing because those are really the core brands' limited number of SKUs. And so that's when you see core Dr. Pepper or Canada Dry doing really well in those segments behind good marketing. That probably explains the biggest difference in the gap there. The other thing I thought you were alluding to is when you take a look at the IRI or Nielsen numbers that's been reported, you see somewhat of a slowdown in the fourth quarter and a little bit into this year. That's really a category-driven piece that comes in from lapping of pricing in the fourth quarter in the previous year. Our differential performance, KDP versus the category, though, has held up really nicely. So the category slowed down, as would be expected when you lap pretty aggressive pricing. You're seeing the price impact being lower, but the volume impact higher. But most importantly, we continue to outperform the category, and that hasn't slowed down at all. Does that get at your question?

I think so. I mean, the way I'm – just not to put words in your mouth, but it seems like you picked up some distribution in food service. That's what's driving the disconnect in 3Q and 4Q, which would suggest that that gap remains the same or roughly the same in the first half of 2020, but then maybe normalizes in the back half of 2020. Is that fair? Yeah.

I wouldn't take it all the way on the 20 because it's more than just picking up distribution. We're seeing an increase in velocity on our brands in same stores in the Fountainhead Food Service channel. It's not just we picked up a different number of new outlets. Because the reality of it is if we are the most available beverage out there, there aren't many more places we can go. So really this is driven by velocity. And if you take a look at, again, the really strong marketing behind our flagship brands, Dr. Pepper in particular, You see it in the retail channels and you see it in the pound and food service channels. We're getting good velocity increases on that brand.

Okay. Thanks, Bob. I'll pass it on.

Okay.

Your next question is from the line of Brett Cooper with Consumer Edge Research.

Good morning. At the outset of the deal, you guys said you wanted to get pod pricing to about $0.50, and I think you ended 2019 at $0.49 to measure channels. You also said that consumers found $0.30 pod pricing a bargain. I think private label pricing is in the mid-30s in measure channels. So, first, I'm just wondering if you see any, I guess, change in volume pricing as you go forward now that you've gotten those targets, and is it possible with the South Carolina plan to get a partner to 30-cent pod pricing? Thanks.

Yeah, I think, look, part of what we've talked about along the way is you're looking at IRI pricing. So, remember, when you take a look at IRI pricing, it reflects partners and or retailers who can choose to compress their margins if they wish because – it's still a very attractive segment from a growth and profitability standpoint. And so some of them choose to compress margins, and obviously that has no impact on us, nor do we control that. With regard to what we said back at the deal launch, I think that's a good place to start. If you go back to the March 2018 investor day that we had here in Burlington, we talked to you guys about the current situation on coffee. And as you point out, at that point in time, pricing was coming down. Volume was growing, but it wasn't enough to offset the pricing. And we saw negative revenue. And what we projected at that time is that volume would accelerate, pricing would moderate, and margin would continue to expand. And we said that revenue would grow to somewhere between 2% to 3% by the combination of all of those factors. That has come 100% true. You're seeing ARK pricing. Forget about IRI for the reasons I talked about. Look at ARK. pricing that's in our 10K, you'll see that it's still declining but moderating over time. Our net sales, which were negative in 2017, were flat in 2018, up slightly. Remember I said 2% to 3%? Our revenue was 2.8% up in 2019, so right on where we forecasted it back almost two years ago to be. And the most important part of it that I think is far more important than pricing, which everybody on the outside tends to focus on, is our margin continues to expand. So we were up 90 basis points in 2019, despite making those investments. And what that tells you is that, as we've said all along, we have line of sight to strong productivity, and there's still a lot of productivity left to come. And you just pointed out one of those examples, which is Spartanburg coming online, which will be another step change in the pricing of our pods. I can't totally forecast where pricing is going to go, although we continue to see it moderating. But we do have line of sight to the increased growth on our business and our increased operating income margin. And we feel good about both of those. And I think those are actually the most important metrics.

Your final question is from the line of Sean King with EBS.

Hi. Thanks for the question. Can you elaborate on any implications, I guess, if any, of the Starbucks agreement in terms of margins versus dollar revenue or dollar profit reporting? Or is the real value of this agreement just locking in a powerful brand for years to come?

It's really the latter to us. I mean, it is a really important brand for the system. It's now the number one brand within the system, and it brings a premiumness to it. to the overall category and our business in total. Obviously, we're really important to them. If you look at how big K-Cup's Starbucks business is and the profitability behind that, we're important to each other, and I think that's reflective in the fact that we entered into a long-term agreement with them because it's a win for both of us. So I think it's really about that and not a material impact on anything other than we continue to grow the household penetration of the system, and Starbucks continues to participate in that growth with us. Great. Thanks a lot. Okay.

That's all the time we have for questions. I will hand the call back over to management for final remarks.

Thanks, everyone. This is Tyson. I know you all have busy days today, but the IR team is around to take your questions, so feel free to give myself or Steve a call, and we'll talk to you later. Thanks.

This concludes today's earnings call. Thank you for your participation. You may now disconnect.