Keurig Dr Pepper Inc. (KDP) Earnings Call Transcript & Summary

Okay. Great. So next up at our conference, I'm pleased to welcome Keurig Dr Pepper. 2 years into the merger of Dr Pepper Snapple and Keurig Green Mountain, both the cold and hot value propositions are coming together with share gains across the soft drinks business and quicker-than-anticipated adoption of the brewer pod model for coffee since the start of the COVID-19 crisis. Joining me for a Q&A session to dig a little bit deeper into recent trends and the strategy going forward, we have Chairman and CEO, Bob Gamgort; and CFO, Ozan Dokmecioglu, which I've done before properly. Sorry. Anyways, thank you both for joining us today. But seeing as you had some news out this morning, I wanted to maybe start there.

So Bob, KDP announced that the company is going to be switching its trading platform from the NYSE to NASDAQ. So if you could just help us understand the rationale behind that decision?

Yes. First of all, thank you for hosting us, and welcome to everyone who's joining us right now. Lauren, as you said, 2 years ago, we closed the merger between Dr Pepper Snapple and Keurig Green Mountain, we talked about ourselves being a challenger in the beverage industry. And as we're really done with integration and we move more to activation of this new model, we've been describing ourselves as a modern beverage company. And NASDAQ is home to tech-forward companies and fast-growth companies and we thought that was the neighborhood that we should be in. If you look at our business, we've got a really broad portfolio. As you said, we're the first to combine hot and cold beverages together at scale. But we also have taken very seriously the whole opportunity to use data and technology to drive our business faster. We talked on our last earnings call for the first time about the size of our e-commerce platform, for example, being more than 10% of our sales. We also gave examples of how we were using cutting-edge technology, real-time demand data, for example, to navigate through this crisis. And then we also, on our last earnings call, talked about the launch this quarter of our first connected and smart brewer, which really gives you an indication of where we're going next with that whole platform. And so that's why it seemed like a very good fit. In addition, it gives us an opportunity to enter passive indexes. And that expands our investor reach, it improves our trading dynamics. So if you look at it right now, we would rank about 50 in the NASDAQ 100 Index. So it's a combination of those 2 that made it attractive for us to move, although NYSE was a great partner for these first 2 years.

Okay. And then, of course, the other news of the morning, that your largest shareholder, JAB, is going to be distributing some additional shares to minority partners. So I was just wondering if there's any additional color that you could share on that as well.

Yes. And as you know, there's been a series now of share distributions and some secondaries. JAB -- and they didn't -- they -- people tend to put JAB as one entity. It's really JAB and its partners, we always talk about. Made a substantial investment in KGM about 5 years ago. And they've been great partners, and they've been really supportive of the company. What's happening here is a continued program to provide some liquidity to some of its partners. And so it's standard practice in private equity to do so. What's most important, though, is that the private investors do it in a disciplined manner. And so making sure that they do it at the pace in which the market can accept the additional shares, which is exactly what's been happening here. The other thing I would point out is that -- like today is a share distribution. There have been secondaries. There was a previous share distribution. Some investors put those all in the same bucket, they're really different. The share distributions have lockups on them. And if you think about some of the entities that are getting these shares, BDT, Quadrant, as an example, they intend to be long-term public shareholders. So you'll see them move over to the public shareholder list, and we'll be treating them as among our very largest public shareholders over the long term. And so now this latest move gets our public float up to about 44%, plus Mondelez owns about 12%. And so all of this is good for our journey to go from private to controlled to now widely held. And it reduces volatility, and it allows a number of institutions who haven't been in our stock who have told us directly that the float wasn't big enough. This is all an opportunity for them to get in.

Okay. Great. So back to this regularly scheduled programming in terms of what I'd planned to ask you about today. So first, back -- day back from Labor Day, we're all kind of several cups into home-brewed coffee, so let's talk coffee first, if that's okay.

Sure.

So Bob, channel closures, consumers staying home more, working from home has accelerated the coffee system story. Household penetration for brewers, I think -- for Keurig brewers to be clear, I think was at 23% at the end of '19. I know the plan is to update us on that number annually. But I was still curious, just your insights work and what it's telling you, if there's a quicker path to get to that 30% to 50% target that you've cited historically as the long-term opportunity. And how much kind of brewer innovation plays a role in driving that further?

Yes. As you know, we did our Investor Day at the launch of KDP back in March of 2018. We talked about our line of sight to getting beyond 50% of U.S. households and provided the road map to get us there. It was a combination of innovation, and we've seen a significant amount of innovation in the past 2 years, new features, new benefits, better aesthetics, improved sustainability, which continues to drive household penetration. You've seen good marketing. The improvement in quality, both the brewers and the coffee, and the fact that the cost per cup, which I know in the early days of this, created some angst among the analysts and investor community. It was all part of the strategy to increase household penetration. And we've been increasing household penetration at about a rate of 7% per year, which is -- there aren't many businesses in the CPG world that have line of sight for real growth of 7% per year for a very long period of time. So we look at it as very much a long-term play. If you want to look at what's happened during the crisis, yes, it's had a positive impact on our at-home business. As I always emphasize, it had a major negative effect on our away-from-home coffee business. So we had to navigate that mix issue, but driving the at-home business, there's no question that our household penetration has been positively impacted by that. People are working from home. We've seen a lot of current Keurig consumers upgrade their machines. If you take a look at sales of brewers, and we've talked many times, brewers sales aren't necessarily a direct correlation. It's kind of a supportive metric. You're seeing that Keurig machines are outselling coffeemakers by a significant margin. And so it's not just that everybody is moving to at home and buying coffee, they're buying Keurig machines on top of it. But I think it's worth just going through the math for a minute because I don't want people to get ahead of us here. If we grow household penetration at 7% a year, we're adding about 2 million, 2.1 million households per year into the system. And we said before, it's very sticky once they come in. If we were to take that household penetration, let's say, from 7% to 10%, that's a fairly modest number, that then -- that goes up to 3 million households. That delta in brewers would mean that our brewer growth rate would more than double in a year. Because we have such a large installed base that when you add that incremental 1 million households that I'm using as just being illustrative on top of our normal growth rate, you see brewer household, the brewer growth rates more than double. And so my conclusion on that is the pandemic has been a nice bump up, but it's the long-term trends that really matter. And the installed base is so large and the inherent growth is so big, that it's a nice plus up, but it's not a game changer on here. It's all part of this ongoing path.

Okay. As just kind of closer in, though, also as consumer mobility has increased, coffee shops have begun to reopen. I think we're not quite where we can bring on true on-premise coffee back into the conversation with offices and so on. But are you seeing any kind of slowdown in the attachment rate or just in layman's term, how much coffee each brewer is making right now?

So we're seeing -- this is the area we're seeing the opposite of that. We've seen a significant increase in attachment rate. And remember, we have a connected panel. So we have about 10,000 households that have been connected to smart machines for about 3 years, and we get real-time consumption data minute by minute, and you can go back and look at this first days of the shutdown and see the attachment rate spike. So that is not something that we believe -- that level that we've seen is not something we believe will continue post-pandemic. Although we think there's an element that will be elevated because of people discovering how easy it is and how much the quality has improved. There's another factor, too, which is, let's say, there's a recession coming out of this. That's actually a positive for us because the cost differential versus away-from-home coffee is substantial in our favor.

Okay. Great. Let's switch to the cold side of the business. So Bob, there too, KDP has seen very positive share growth in CSDs and tracked channels. And that's -- these share gains, it's not just Dr Pepper and Canada Dry, right? It's been pretty broad-based. So could you just talk a little bit about what's enabling such broad performance? And how sustainable do you expect it to be?

Yes. This has been an area that's been a real positive for us as we talk about this mix management that we've been able to accelerate our at-home beverage business. So if you take a look at total LRBs, we've grown share of LRB, we've grown share in 90% of our retail base. Every category, except for one in which we compete, we've expanded share. If you take a look at CSDs underneath LRBs, it's been a real star within there. In the past 13 weeks, we've gained 1.5 share points of CSDs, and every single one of our CSD brands has grown share. What's driving all of that is household penetration growth. So we break it down. Is it, our current consumer is drinking more? Or is it new households entering our franchise? The numbers are convincingly in the direction of new households entering our brands, which is very promising for the future, being able to hold onto those franchises as they rediscover our products or discover them for the first time versus a temporary blip because people are at home and they just drink more. So that's very positive. If I go down a level further to your question and say, what's driving the household penetration? Why are we doing so well in that? It's a combination of innovation. So we've got an innovation out before the pandemic hit and items like Canada Dry Bold, and Dr Pepper & Cream Soda right here, which is the #1 CSD innovation this year, have been a big contributor. Marketing has been strong. So yes, we backed off of some marketing like everyone did, and that's the appropriate thing to do during the pandemic. But our relative spend is still very robust, and that's showing up in the share numbers that you see. And then our in-store execution has been terrific. It had -- company-owned DSD has shown its true value. We have centrally controlled company-owned DSD, which is a real differentiator, performed incredibly well. We focused on core SKUs. I talked about the data that we had access to that's informed which products we should distribute in which stores. We've adjusted our promotion schedule. And so when you add that all up, it's always a number of things that are brought together, but there's no question that the execution has been a big driver of this as well.

And so to that point, the distribution network has clearly been a pretty major asset and -- particularly in the last couple of months. But you have also talked about optimizing route to market. You're leveraging your network to also address white space opportunities, partnering with strong and emerging brands like Polar and evian, then you've got A Shoc and now plant-based protein. So there's a lot that's going on that really, I guess, looks to leverage what you've already got but also make it even better. So maybe we could just, I guess, first, I'd love to start with the Polar and evian pieces. They're both big and established brands. So could you help us understand how these relationships are something more than just like renting out your distribution system? Kind of differences in your level of involvement with the 2 brands? And how you might tie that back to what the old Allied Brands model looks like versus what you're trying to build going forward?

Yes. That's a good question. So we got this base of distribution. We're proving that we can execute very well. I think it's surprising to a number of people in the industry how strong the KDP company-owned DSD network combined with our independents to cover the space, the part of the geography that we don't cover, how well that's performed. So we can continue to enhance that and improve it. But it also works really well if we take new brands and put it through that existing system, which is what you're referring to. And we said that we wanted to change the Allied Brands strategy going forward. So we can do it in 4 ways: we can develop products on our own, but we've mainly done that through -- use that tool for innovation and renovation. We can acquire straight up as we did with Core, but we're really sensitive to paying high multiples. We say this all the time that all of those big deals in the industry that we can study have all destroyed value. And so we do not think that, that's our primary way to go forward. You talked about seed investment with path to ownership. That's A Shoc and Don't Quit, which is our latest example. But if we're in categories where there's white space in our portfolio where we know we can drive growth, and unsweetened flavored sparkling water is one of those examples, and we can go through and buy something, we can do it on our own. We could try to do a seed investment. And we've got a 30-year partner in Polar who's got the highest velocity brand in the category, but is only 1/3 of the country. Then we're willing to enter into a partnership because we can't own the brand. The family is not willing to sell the brand. We can enter into a really unique partnership that mimics ownership, but gives us both what we want. So we're able to take this brand national. We're going to do the manufacturing and the distribution in the territory that we're in. They get to keep the brand within the family, and we get to leapfrog competition by taking this high-velocity business nationally. As -- and we studied every other group on that category. I can tell you we studied all of those paths and decided this was by far the best path. And these are very long-term relationships that are very difficult for either side to get out. So I say they mimic ownership. It's everything but the ownership and that's same with evian.

Okay. Okay. And then in terms of optimizing the distribution network. I mean I think we were going -- my guess is you're going to talk a bit about this at the Investor Day in March. So I don't really know how to ask the question because I was excited to spend a couple of hours hearing about it. But maybe what you could offer? You've already made a few moves. But as you think about this optimization in a better way, maybe through specific examples of changes you've already made? Or at a high level, if that's a better way to kind of get at the conversation?