Keurig Dr Pepper Inc (KDP) 2013 Q3 法說會逐字稿

Good morning, and welcome to Dr Pepper Snapple Group's third-quarter 2013 earnings conference call. Your lines have been placed on listen only until the question-and-answer session. Today's call is being recorded and includes a slide presentation which can be accessed at www.DrPepperSnapple.com. The call and slides will also be available for replay and download after the call has ended.

(Operator Instructions)

It is now my pleasure to introduce Carolyn Ross, Vice President, Investor Relations. Carolyn, please go ahead.

Thank you, Maria, and good morning, everyone.

Before we begin, I would like to direct your attention to the Safe Harbor statement and remind you that this conference call contains forward-looking statements, including statements concerning our future financial and operational performance. These forward-looking statements should also be considered in connection with cautionary statements and disclaimers contained in the Safe Harbor statement in this morning's earnings press release and our SEC filings. Our actual performance could differ materially from these statements, and we undertake no duty to update these forward-looking statements.

During this call, we may reference certain non-GAAP financial measures that reflect the way we evaluate the business and which we believe provide useful information for our investors. Reconciliations of those non-GAAP measures to GAAP can be found in our earnings press release and on the Investors page at www.DrPepperSnapple.com.

This morning's prepared remarks will be made by Larry Young, Dr Pepper Snapple Group's President and CEO; and Marty Ellen, our CFO. Following our prepared remarks, we'll open the call for your questions. With that, let me turn the call over to Larry.

Thanks, Carolyn. Good morning, everyone.

I'll start off this morning by saying that we continue to operate in a very challenging environment, not only with macroeconomic pressures, but more importantly, with continued pressures against CSDs. Throughout the quarter, our teams continued to execute our strategy, and we continued to invest behind our brands for the long-term.

Despite the headwinds, we grew volume share while holding dollar share in the highly competitive CSD category. For the quarter, bottler case sales were flat on three points of positive mix in price. Our flagship Dr Pepper brand improved sequentially, with volume down 1% in a very challenging category. Our Core 4 brands were flat, including our TEN products. I'll give you are brief update on TEN in a moment. Canada Dry continued its trend and posted strong growth of 8%, while both 7UP and Sunkist experienced mid single-digit declines. Snapple posted a 4% increase with growth from our launch of SnapTea, and regular Half 'n Half lemonade iced tea and Hawaiian Punch declined 6%. Mott's increased 1%, driven by applesauce growth. Our other brands were flat as a double-digit increase in Penafiel and a high single-digit increase in Schweppes were offset by declines in Crush and other brands.

Though it's still early, the TEN platform is performing in line with our expectations, even though the category is more challenging than we expected. Trial has met our internal target for the year and repeat is very good. We've reached 76% ACV in grocery, which is in line with the average ACV for the base Core 4 brands in this channel. Based on Nielsen Homescan research, we know that 51% of TEN's purchases are incremental to the CSD category, which means we are bringing lapsed consumers and occasions back to the category.

I've said this many times, but it's worth repeating. We believe this platform is critical because it addresses the caloric intake concerns of consumers who prefer regular CSDs but do not want the added calories. We remain committed to the success of this strategic platform and will continue to make it a priority in 2014.

Year to date, bottler case sales declined 2% on 3 percentage points of price mix. Dr Pepper decreased 3%, slightly better than overall category trends. Our Core 4 brands were flat, including the launch of the TEN platform. An 8% increase in Canada Dry was offset by mid single-digit declines in both Sunkist soda and 7UP. Year to date, Hawaiian Punch declined 9% as a result of particular challenges in one major retailer; and Snapple increased 2%, as inclement weather impacted the brands results in the first quarter. Mott's increased 4% year to date, and all other brands declined 2%.

Moving on to our financial results, on a currency neutral basis, net sales increased 1% for the quarter on 3 percentage points of favorable mix and price that were partially offset by a 1% sales volume decline and higher discounts. Core income from operations increased 3% while Core net income increased 8% and Core EPS increased 11%.

As always, we've got an impressive lineup of activities scheduled for the fourth quarter to ensure we continue to build brand awareness with our consumers and give our bottling and retail partners something to get excited about. We've kicked off the college football season stronger than ever with our Dr Pepper Tuition Giveaway program. Through September, we've had over 25,000 tuition video submissions,1.3 million votes, and our digital campaign has delivered over 186 million impressions. Remember that this year, [Amera] gets to decide who competes in the $100,000 halftime throws during the Conference Championship games, and we'll give away over $1 million in tuition throughout the season.

The Core 5 brands are getting in on football action as well, by partnering with MillerCoors and Mission Foods to deliver both shopper and consumer involvement bundling solutions for consumers' game day needs. It won't stop there. Core 5 8-ounce cans will feature color-changing packaging just in time for Halloween trick-or-treating. 7UP once again will be sponsoring the Latin Grammys for the number two-rated show of the night regardless of language. We're again teaming up with crossover megastar Enrique Iglesias in giving consumers the chance to attend a private concert with him and tickets to a show in Las Vegas. We will be hosting local Grammy street parties in key Hispanic markets. Our brands will be front and center during the holiday mixer season, with incremental points of interruption and retail activation around 7UP, Canada Dry, and our Schweppes brand.

You've heard me say earlier that we have continued to invest behind our brands for the long-term. Since we've become a public company in 2008, we've increased our market investments by over $125 million or 35%. We will continue to invest behind our consumer-loved brands to ensure that our long-term health.

With that, let me turn the call over to Marty, to provide further information on our financial results and full-year guidance.

Thanks, Larry. Good morning, everyone.

Reported net sales for the third quarter were up 1% and were below our earlier expectations. With CSD category headwinds greater than we expected, both in regular and even more so in diet CSDs, sales volumes declined 1%. This was offset by positive package and product mix and net pricing, aggregating two points in the quarter.

Reported gross margins declined 110 basis points in the quarter, from 59% last year to 57.9% this year. Consistent with last quarter, and based on our current view of input cost inflation and year-end inventory balances, we recorded a $7 million LIFO inventory benefit in the quarter. This compares to a $7 million LIFO inventory charge in the prior year, improving year-over-year gross margin comparisons by 90 basis points.

Changes in certain commodity prices at the end of the quarter caused us to record a $1 million unrealized mark-to-market gain on commodity hedges, all in SG&A. This compares to an $18 million unrealized mark-to-market gain last year, with approximately $15 million included in cost of goods and $3 million in SG&A. This unfavorable comparison reduced reported gross margins by about 90 basis points.

Higher input costs, principally sweeteners, increased cost of goods sold by 2% on a constant volume mix basis and reduced year-over-year gross margins by 85 basis points. We were able to partially offset this by ongoing RCI productivity benefits of about 40 basis points. Finally, package and product mix reduced gross margins by 65 basis points.

Moving down the P&L, SG&A for the quarter, excluding depreciation, increased by $2 million. This comparison includes the unrealized mark-to-market comparison I just mentioned. Additionally, we recorded $7 million of cost associated with certain restructuring actions taken during the quarter. We also recorded a $6 million favorable adjustment to a legal provision which we originally recorded back in 2011. Depreciation and amortization expense decreased this quarter by $1 million.

Reported operating income for the quarter was $300 million, compared to $308 million last year. Excluding items and as shown in the reconciliation table in the press release, Core operating income of $300 million this quarter was up 3% from $290 million in the prior year. Core operating profit margin of 19.4% was up almost 50 basis points.

Moving below the operating line, net interest expense was $29 million, $2 million below last year. If you had a chance to look at our financial statements, you probably noticed that our other income net and tax rate were impacted by certain items. During the third quarter, the IRS concluded their audit of our 2006 to 2008 federal tax returns, which included our spinoff. Based on the results of this audit, we recorded a $463 million tax benefit to decrease our liability, and we eliminated our indemnity receivable from Mondelez by $430 million. The net effect was a $33 million non-cash increase in net earnings. Additionally, we recorded a $5 million non-cash tax charge related to a Mexico court case settlement. Both of these events have been removed from Core earnings. Our Core income tax rate for the quarter was 34.1% in 2013, compared to 36.5% last year.

Moving onto cash flow, year to date, cash from operating activities was $616 million, and capital spending was $111 million. This brings year-to-date reported free cash flow to $505 million on net income of $468 million. Through September, total distributions to our shareholders were $468 million, with $243 million in share repurchases and $225 million in dividends.

Now, before I review our full-year guidance, let me provide you with a brief update on RCI. We're continuing to make great progress against the Core activities within our DSD business, which has been the area of major focus this year. Several of our RCI tracks are showing significant productivity savings, despite the headwinds facing the CSD category. We've eliminated waste by aligning merchandising with customer traffic patterns and by implementing centralized regional ordering for all of our point-of-sale programs, just to name a couple.

At the total Company level, we finished the quarter with the lowest inventory value we have had since we began our RCI journey in February of 2011, proving that changes we are implementing are in fact sustainable. We've also taken significant miles out of the system by enforcing a plant direct delivery methodology, and we've improved safety with a 44% reduction in recorded incidents.

I'm pleased to report that as of the end of the third quarter we've achieved our initial financial goal we set for the first 3 years of our continuous improvement journey, with over $156 million of realized cash productivity. Equally important is the level of engagement and momentum we're building across the organization. This journey, of course, never ends. We'll continue to leverage our RCI capabilities to create flexibility and increase productivity across the business for the long term, and this will enable additional financial improvements.

Now, moving to full-year guidance -- with greater-than-anticipated headwinds in the CSD category, net sales came in below our revised expectations. Despite these challenges, we remain focused on delivering profitable volume while investing prudently in our brands for the long term. Considering our year-to-date results and our current view of the fourth quarter, we now expect net sales to be about flat for the full year, but we are maintaining our Core EPS guidance range of $3.04 to $3.12.

On a total Company basis, we expect net pricing and mix to be up about 2.5% for the full year, consistent with our year-to-date results, with sales volumes down roughly 2%. As a reminder, the fourth quarter will be heavily weighted towards mix as we've cycled the Mott's applesauce pricing actions taken during the third quarter of last year. Consistent with year-to-date results, the concentrate pricing we took in January will continue to contribute about 50 basis points of growth in the fourth quarter. We still expect packaging and ingredients to increase cost of goods sold by about 1.5% on a constant volume mix basis. Since our current purchases of apples are now at more seasonal, historic price levels, we expect a full year LIFO inventory benefit of just over $30 million, or another $8 million benefit in the fourth quarter.

In the fourth quarter, we will continue to experience inflation in our field labor cost, including health and welfare, as we have all year. We now expect these cost increases to be fully offset by savings from the restructuring activities we took in the third quarter. We remain pleased with the early results on our national launch of Core 4 and RC TEN, and we're on track to invest just over $30 million supporting this critical launch with almost $28 million spent through September.

However, with the present weaker overall category performance, we have reduced marketing spend in some areas that we do not believe will yield the previously expected returns. We now expect marketing investments to be up around $5 million, or represent about 8% of net sales for the full year. This will result in a decrease in the fourth quarter, since marketing spend is up $14 million year to date.

With the conclusion of the IRS audit I just mentioned, we will no longer record other income associated with the tax indemnity agreement with Mondelez, and you'll need to adjust your models accordingly. This will also lower our reported tax rate going forward, as we will no longer accrue interest on the liability. Based on these changes, we now expect our full-year Core tax rate to be about 35.5%, and this is a good rate for you to use in your models going forward. Finally, we continue to expect capital spending to be approximately 3% of net sales, and we remain committed to repurchase approximately $375 million to $400 million of our common stock in 2013, subject to market conditions.

With that, let me turn the call back over to Larry.

Thanks, Marty.

Before we open the lines for questions, let me leave you with these thoughts. CSDs are currently facing significant pressures, and it's critical that the industry brings consumers back to the CSD category. We believe we're doing just that with the TEN platform. We know it will take time and patience. We continue to [ex] against our focus strategy in a very challenging environment, insuring that we build our brands and execute with excellence in the marketplace. We remain focused on driving profitable growth and delivering value to our consumers, while continuing to invest wisely behind our well-loved brands for the long-term. RCI is becoming the foundation for how this organization operates on a daily basis and is delivering solid financial improvement. Finally, we remain committed to returning excess free cash to our shareholders over time.

Operator, we're ready for questions.

(Operator Instructions)

Wendy Nicholson, Citi Research.

I wanted to ask about your comments, Marty, just on the advertising spending line. While I guess it makes sense to spend a little bit less if you're not getting the payback for it, is that a permanent change? Do you think we're going to cycle and lap that $30 million on TEN and spend more against TEN specifically next year? Are you spending more on promotional merchandising as an offset to that? Is total marketing still coming down? Maybe talk a little bit more about that. Thanks.

Okay, Wendy. We are very committed to TEN. We'll spend the $30 million this year. We're going to have another significant investment in TEN next year. We'll talk about that when we get to the end of the year, but we're very committed there.

There are a number of areas, as we get better at looking at our marketing return on investment, there is simply areas that, right now, we don't see paying back. I'll tell you, in the whole local media area across a number of our brands, that only works for us if we get the incremental activity at retail. When we don't get it, we don't want to spend the local media. Truthfully eliminating areas of opportunity, some of this coming from RCI, believe it or not, point-of-sale merchandising spending. We've determined that there's been a lot of excess there and simply waste there. That number initially right now is about $2 million, and that number could be a lot greater.

There's some trimming of the Dr Pepper coastal programming. Because, again, while it's an important strategy for us in this environment right now, it doesn't seem to be paying back. I would call these near-term adjustments, but nothing is changing in terms of our strategic point of view, on our major initiatives at all.

There's not a huge amount of variability in terms of the performance of the various brands, 7UP versus A&W, but is there a correlation that you can monitor in terms of what you spend against and what kind of payback you get for it? On a brand-by-brand basis?

We do actually look at return by brand, although it is interesting. When you get to the Core 4, you do have a little bit of portfolio impact. We saw that with Sun Drop a year ago, when we did a national launch. We expected it would probably supplant some other activity in some of the Core brands. There is a portfolio impact there. Clearly this year, Canada Dry has been a big contributor. That's been a really good category. We expect that to continue. Our TEN products have had a positive impact across that whole Core. There's a little bit of inspection of return by brand, but there's also a whole view of how we manage that Core as a portfolio.

Okay. Just my last question is on the TEN strategy specifically. I think the surprise this summer has been that the diet category has slowed as much as it has. It doesn't look like this is just a health and wellness concern because diet has slowed as well. Does that change how you think about TEN at all? Or does TEN get rescued because it's a hybrid? How do you think about that in the light of what we've seen in the diet category?

As you said, we are shocked at how we've seen the diets decline, but I think it encourages us even more on what we can do with the TEN platform. I think that TEN answers a lot of the questions that people have out there especially whenever they want better for you, but they don't necessarily care for the mouth feel of a diet or maybe the aftertaste of a diet. I think that TEN will be right there for us. I mentioned earlier, we're seeing 51% of our sales from Nielsen Homescan are people that have left the category and came back. That's why we're still very bullish and look at this as long-term. As you remember in the beginning when we launched, it's only been out there about seven, eight months right now. We said that it takes a long time to change people's consumption habits. We're going to stay behind it and see if we can't kind of pickup some of this decline in diet.

Got it. Okay. Thank you very much.

Judy Hong, Goldman Sachs.

Thanks. Good morning. My question is this year it's certainly encouraging to see you stepping up on getting more cost savings. The LIFO benefits are obviously helping this year, but as I look at your operating profit and it's been pretty stagnant for the last two, three years. As we look out 2014, I'd be curious to just get your perspective on your confidence level in really growing operating profit, in light of the category challenges that you're seeing. Is there some sense of urgency to really get further cost savings from the business? Is there something you can do further from a capital allocation perspective to really drive better earnings growth? Just some of those factors that I'm curious to know, looking more at 2014.

Judy, it's Marty. It's a little early for us for to talk about 2014. Let me just comment on a few of those points that you raised. Let me make sure everybody is grounded on LIFO. I saw a lot of conversation in some pre-call notes that were published this morning, just so we're all grounded. This year recorded a LIFO benefit. Last year, we took a big LIFO charge, principally related to the higher price for apples that occurred last year, as we had the freeze and the price went up. What I want everybody to understand is that by recording the benefit this year, it's not some sort of non-recurring gain. It's simply an adjust the cost of apples to their current pricing. It's nothing that we'll have to lap next year. In essence the cost anomaly, if you will, occurred last year by accelerating those higher-priced apples through our P&L last year. In essence, that gets neutralized out this year. So, we don't have to lap that next year.

In terms of managing cost, it's always been a priority. Of course, it takes on more importance in this top line environment. I mentioned a few of our RCI wins. We've got a lot more opportunity there. I have not framed a new goal, a new financial goal for us, but I can tell you that everywhere we look in the Company we see enormous, enormous opportunity for productivity improvement. As many of you know, this is about a culture building a foundation. We're not going to try to overly accelerate things, because RCI itself is a process. We want to build it and sustain it for the long-term.

Over and above RCI this quarter, we did do some cost adjustments. We took a $7 million charge for it. As I said in my prepared remarks, that at least enables us in the fourth quarter to offset some of the cost inflation headwinds. We'll get some rollover benefit from that next year. Capital allocation, we've taken our capital spending, in terms of that element of capital, down dramatically over the years. I suspect you'll see that continue. In essence, we don't have to have the same level of investment in cold drink equipment, for example, that we've had in the past. That's partly because we've gotten to the point of penetrating the market where we need to be, and it's also partly due to the fact that even in the single-serve category, the cold drink category, we're seeing some declines there. We're trying to really trim the capital back to also recognize the environment we're in.

When we think about marketing spend, which is a major area of investment, and while we're still spending 8% on sales, I think you'll see us increasingly think about what the right approach is in our CSD categories, where to invest in innovation in TEN, where this environment might cause us to rethink some of the historic activities and programs we might have otherwise done, and attempt to shift some of those funds to better growth opportunities. We'll give you some more color on all of this when we talk about 2014 expectations next quarter.

Okay. That's helpful. Larry, just on the pricing environment, obviously there's been a lot of chatter about the heightened promotional activity that we saw over the Labor Day weekend. It sounds like in the fourth quarter you still are expecting positive price mix, but more skewed towards the mix component. I just wanted to get your perspective on your assessment about the current pricing environment, particularly within the CSD category, and then as you think about 2014, your ability to continue to deliver positive price mix.

Yes, you're right, Judy. We saw some pretty aggressive pricing, primarily in September. The balance of the quarter was very rational. We didn't see a lot of change until right there at the end. We decided not to follow some of that out there. Some was very deep. We're seeing it come back now. We're also hearing from several retailers. There's been lots of talk out there that there some price increase letters coming out and things like that. We'll watch that closely. I wouldn't always bank on that. I look at it as, we will do what's right for our brands to continue to deliver value and what the market will take. As Marty mentioned, 2014, still a little early for that. I can tell you this, we will remain very rational on our pricing. As I've said since we went public, part of our strategy is we pursue profitable volume. That's what we'll be looking for.

Great. Thank you.

John Faucher, JPMorgan.

I was wondering, as you talk about the mix piece taking a bigger piece, it seems as though what you're probably talking about is packaged beverages taking over from a growth standpoint relative to CSDs. Can you talk a little bit about how we should look of that from a gross margin standpoint, and then also a profit per case standpoint? Can you walk us through some of the mix impacts? Thanks.

Okay. John, it's really product and package. You're right. There are a lot of moving parts. When you focus on packaged beverages, where you tend to get this as opposed to the concentrate business, you have a lot of factors to consider. I'll start with the allied brands can have a big impact, which we're doing quite well in, particularly in the water category with Fiji, and coconut water with Vita Coco. They're very good on the profit line. Some of them are not so good on a percentage basis on the gross margin line, but actually the dollars of drop through profit are actually quite good. Those are always a factor.

Forever we've talk about Hawaiian Punch. It's been down. It's been down further than we thought. We've got a problem with one big customer. It seems to get a lot of visibility on the top line, but I'm here to tell you it doesn't do much, in terms of gross margin or operating margin, for that matter, in terms of packaged beverages. But it has a mix effect impact on the top line. Across the CSD portfolio, it's really about our view of package mix around the holidays and the larger bulky packages that we tend to tell more so around the holidays. With a little lightness, you maybe get some trade-off there against some of the cola drinks. There's a lot of moving parts to mix within [PB] across the carbonated, the non-carbonated, and the brand within each one of those. There's a lot of moving pieces to it.

Thanks. Then, just a follow-up on that, going back to the capital allocation piece. If we look at CSDs, continuing to decline more than people thought, maybe not at this current rate, how does that make you think about the need to add more non-carbs and more non-CSD brands to the portfolio?

John, we look at that constantly. We know we're skewed heavily, 80/20 CSDs. I can tell you this, on our R&D team and on the pipeline for innovation, the major focus there is how do we get into more non-carbs, how do we get into more better for you. For the CSDs, the sweetener, how do we come up with a sweetener? I think the entire industry's working on to help us eliminate these diet declines. We're very aware of that. We'll continue to look at it. I believe you'll see that we'll start driving most of our growth in that. We've got our sparkling CSDs and carbonated waters coming out after the first of the year. We think that's going to do a lot for us. We see that category doing well, but we will stay very focused on it.

Okay. It sounds like more of a build versus buy type of bias at this point?

Absolutely. It's not that we don't look at them, but if the right thing would come along, never say never. We just stay focused on what we have and we think with the 58 brands out there, we have a lot of things we can build off of.

Okay. Great. Thank you very much.

Bryan Spillane, Bank of America.

A couple of questions. First, Marty, you talked a little about RCI and you've reached, achieved the goals, but there's more opportunity going forward. If you could just talk a little bit about as you applied it more towards -- in packaged beverages, towards your Company-owned bottling operations, can you talk a little bit about just where the savings so far have been found, meaning the manufacturing plant versus warehouse and distribution, and where you think maybe more of the efficiencies are out in the future?

Sure. I'll do the best I can. Let me give you a quick update. This year, our focus switched to DSD and the Core activities within DSD, which is really warehousing and delivery. Before I talk about that, I want to remind everybody that when we first focused on our warehouse direct business, just focused on the logistics side of that business, we had a dramatic reduction in our logistics cost per case, very dramatic. Actually, that's actually allowed our warehouse direct channels to raise its profits, albeit on lower sales led by principally Hawaiian Punch. It's been a great driver of improved productivity and profitability for warehouse direct business.

We shifted over to DSD and I'll remind everybody that where the first area of focus was what we call our [poll] replenishment process. That's moving our manufacturing plants, their production scheduling, closer to the market rate of demand. You just don't build inventory to fill up warehouses. You don't run plants to maximize absorption. That is a no-no in a lean world. You pull to demand. We've pretty much accomplished that, and you see the inventory results on our balance sheet. Somebody showed me a slide yesterday that among 15 beverages in CPG companies, we have the highest level of inventory turns of any of them.

Now, we move to the functions of DSD in warehousing and delivery. As you heard in my prepared remarks, a lot is a complete track around merchandising. Think about merchandising, it's a very important function to our retailer. You look at the process. In fact, now you overlay the activities of merchandising, for example, in an environment that's changing. We're now seeing consumer traffic patterns varying throughout the month. Some people call this the paycheck effect, when people spend and when they don't. Traditionally, people that have done merchandising haven't changed their model to reflect that. We're making those changes right now.

I mentioned direct delivery from plants. I'll give you an example right here in our backyard, between Irving, Texas, and Fort Worth, they're not too far away. We've always had a branch in Fort Worth, yet we realize we can deliver to many customers direct out of Irving. It's the same thing in Houston with a number of their branches around that plant and elsewhere throughout the country. We've got a number of tracks going on.

Warehousing, we have a lot of excess square footage in our warehouses now, due to the inventory reduction. The challenge there will be monetizing that. We can't exactly cut a warehouse in half and sell the half we're not using, so we're going to have to figure out over time how to actually reduce the physical footprint. We're working on that right now.

We've got senior people leading everyone of these tracks. What I'll tell you is whatever opportunities we find in a location, we simply don't cookie-cutter across the network. It's not the process we've elected to go through. Every location puts a team together. They take the findings from other areas as a learning, but then make sure based on their customer mix, their product mix, any nuances of their geography, that we actually do very specific kaizen projects to come up with solutions that best work for those locations. We're making great progress. We've expanded operating margins this quarter. I talked about 40 basis points of productivity at supply chain. That's not a small number. It is clearly providing us a bottom line benefit that's helping enormously, given the top line challenges.

Is it fair to think that if the opportunities going forward are more at the front-end of the business, so in the merchandising, selling, and delivery, and less back up through the supply chain? Is that fair?

That's fair. That's where most of your cost is, right? It's selling. It's warehousing. It's delivery. That's where a huge opportunity is, and we still maintain that there hasn't been, across the industry, doesn't appear to us that there's been real, meaningful step change and we think we have the opportunity to do that. Whatever we do, we're going to do it in a way -- no big bang fixes, no big bang restructurings -- we don't think that's the way to do it, to do it with process and make sure that when we're done, it's very sustainable. So far, it's been good.

Okay. Just maybe for Larry, and for you, Marty. The school of thought out there, that with EBIT being flattish or growing modestly, that companies could boost shareholder returns by buying back more stock. There are other companies in your peer group that have even used their balance sheet to buy back stock. Can you just think about or update us on your thinking about returning cash to shareholders, maybe more specifically, just your thoughts around, or update us on your thoughts around, using the balance sheet to return even more cash to shareholders?

Brian, it's Marty. I'll take that question. Everybody knows our distribution model right now. Our model is to distribute all of our free cash flow to our investors. You know the mix of dividends and share repurchases. I've said that to many of you, as I visited with you, that when it comes to the distribution of free cash flow between those two, we like our payout ratio. That said, we think we have room to move it up over time, meaning to grow at maybe a faster rate than growth in EPS. It's something our Board takes up every year and will take up again, I believe, in February.

Otherwise, in terms of just limiting our share repurchases now to free cash flow and not using leverage to enhance it, we think it's the right thing for us to do right now. For the time being, we're going to stick with it. We have a strong balance sheet. We want to keep that strong balance sheet. I've looked at our total returns for new dividends and share repurchases across, again, a broad-based group of a number of food and beverage companies. In essence, we're returning our total yield. Recently, last year, if you look at our yield plus the net reduction in shares, the net effect of buybacks put us around 7.2%, which is where our free cash flow yield is. Our model today is to give our holders what we would consider a full cash-on-cash return, distributed the way I just indicated, and don't see the need right now to want to enhance that.

Thank you.

Bonnie Herzog, Wells Fargo.

Hello. I just wanted to go back to diets and the trends that we're seeing. I was actually hoping you could talk a little bit more about what you think has been driving the slowdown in diets and in the low calorie CSD category. What you think is driving the trend? Where do you think these consumers are going? Finally, do you think a natural sweetener blend will be enough to stem some of these declines, based on what you're seeing from consumer behavior right now?

Bonnie, I like what I'm seeing. I will just say, personally, as I'm out in the trade and I talk with consumers and customers. I think a lot of this is just a misperception of aspartame. Aspartame is one of the most tested sweeteners on the market, and there's never been anything found on it. The FDA has proven that there's nothing wrong. You have people talking about it causing Alzheimer's. It makes you want to eat more, will increase obesity. Social media has stepped it up even more than what it was before. I think that's the headwind we have to fight there. We've got to do a better job of educating people with the facts, with the science, instead of hearsay. So, that's why I mentioned earlier we stay very, very committed to that.

I think TEN, especially on our Core TEN, the Core 4 with what we're seeing with our early days, it's going to be something that'll help us with that to get those that have a concern over the full diets that they can come to something with 10 calories and a more mouth feel, a more taste of a sugared product. It is a concern. As we look at it, we went through our numbers. Our regulars, especially with Dr Pepper, was looking really good. The diets is what affected the most of the decline. It will be a major focus for us. I talked earlier about how we're looking at other non-carbs and the sweeteners. Don't ever get me wrong. This team never gives up on CSDs. We believe in them. We think we can get this thing moving, especially with TEN, and that's why we'll will continue to invest behind the brands.

Okay. Could you just actually touch on the distribution of your Core 4 TEN platform versus DP10, given your ability to possibly better control placements? These brands, do see greater incremental gains for the Core 4 over the long-term?

Yes. I see greater gains there. Things are always easier when you have control of it. We've been able to do that with the Core. But we also have some great programs put together for our DP10. Jim Johnston and his team have programs out there to help us reignite it. It's been out there a little over twice as long as the Core 10, and we see some opportunities there.

When you look at the Core, with this just being out there, I think our full national launch was in March, it's already at a 76% ACV in grocery. We're very, very pleased with that. We've got to keep getting more activity, getting people to understand what it is. The messaging is everything on that. Again, going back to the sweeteners, we've got to let people know that these products are good. They're safe. They're also fun.

Okay, thank you.

Mark Swartzberg, Stifel.

Two questions. Marty, one, I wanted to inquire a bit more on Brian's question, and this leverage number is in the neighborhood of 2, a little bit shy of 2. Can you just help us understand relative to EBITDA, help us understand a bit more why that is a sacred number? It seems like there's an opportunity when you look at your peer set to have a higher number and yet it sounds like that really is the right number in your mind. Can you help us understand why that is the threshold? Then, the second question is just SG&A was down in the quarter. Can you give us a little more detail on the components of that decline?

Sure, Mark. Let's go back to teeing off Brian's questions. There's nothing magic about the leverage ratio at roughly 2. We talked early on about targeting actually 2.25 times EBITDA, but there's nothing solely magical about that. It does triangulate for us with respect to our long-term BBB rating with the rating agency, BBB+. We always want to pay attention to that. I'm not here to say we're managing solely for a debt rating. That's not the purpose, but it just happens to fit that ratings matrix. The real question is, is it the right strategy for the Company right now. I assume your question goes to significant leverage. We could always do some marginal things, but to add significant leverage solely for the purpose of buying back shares. Would that be for real value accretiveness or simply to stair-step EPS all in one year, and then just reset the bar from where we are today?

Balance sheet flexibility is important to us. We've talked about, in the past, we're focused on organic growth. There could be opportunities out there to use our balance sheet. We would not want to [foreclose on] that. I'm not suggesting that we're going to do that, but the one good thing about our distribution system is we've got great coverage across the country. We see lots of opportunities with new entrants into the beverage space that need distribution. Our system is maybe more open to new products and brands than maybe the other two systems are. That gives us a great view of opportunities. Some of those could come with some investment for us. We think right now the distribution policy around free cash flow, maintaining balance sheet flexibility, has worked for us. For the time being, we're going to stick with that.

SG&A, your other question went to, I guess, the SG&A comparison, and as I said in my prepared remarks, and I guess if you're looking at the reported SG&A, we had $7 million of restructuring cost in there. The mark-to-market comparison was a negative $3 million. Offsetting that, again, on a reported basis, not on a Core basis we had a litigation accrual that we booked back at year-end 2011. We've been able to adjust that down based on some settlements by about $6 million. Those are some of the non-recurring type items that flow through SG&A this year versus last year.

Even if I'm looking at the right numbers, I think on a comparable Core basis, it was down quite significantly. I believe marketing spend was up in the period. Can you help us a little bit more there?

Yes, we reduced cost. That's what we've been doing. I don't necessarily bridge that for you. Between the cost reductions that we've been achieving through RCI and some of the additional actions we took, yes, we've lowered cost.

Bonus accruals, is that a component in there as well?

Not at all.

Not at all, okay. Thanks, Marty.

Ali Dibadj, Bernstein.

Hi, guys. I wanted to get a better sense still of the ROI you see on the spending on TEN and the level of your commitment. The Core 4 volumes remained relatively flat despite all this investment and really only Canada Dry was up, while the other three were down with or even a little bit worse than the category from a volume perspective. I'm trying to get underneath of what gives you the confidence that you actually spend even more on the TEN franchise. I ask that in the context of what you were saying before, that at least the way we see it, which is very much in line with how you're seeing it, that the health and wellness is shifting from caloric intake more to artificiality and aspartame. Aspartame is in TEN. It's got Ace K and HFCS in it, too, but it's in there. I'm trying to get a sense of how to tie all that with the sense of, is this the right thing to do to incrementally spend on this business, given the results you see?

Ali, it's Marty. Let me talk to that. When we went into TEN, it was clear to us, and it's still pretty clear to us, although I'd say there's been a little bit of change in the diet front. There's still this huge segment of consumers that want caloric intake reduction and they really don't care. It's a second-order question to them about the sweetener. You're correct. More recently, it appears that the aspartame, which is in TEN, is becoming an increased area of focus. But there's still a large population of people that simply do not want all the calories in a regular product, but still want the taste of a regular product.

We don't normally quote too many numbers by brand, but I'm here to tell you that if you actually, through the third quarter, if you actually look at the Core TEN and I'll throw Dr Pepper TEN in there, even though that was launched a year ago, for the first nine months, we sold over 14 million cases. Okay, in the larger scheme of things in the entire CSD category that may sound small, not so small to us. If we except the Nielsen Homescan data, that 51% are coming from outside the category, this isn't cannibalization of our own brands. We know there's some. We've probably cannibalized some, both regular and diet Dr Pepper, say in the case of DP TEN, and with the other brands as well. Not even a year in on the Core TEN, maybe we're going on two years on Dr Pepper TEN, give or take, there's too much positive data here to say that we should somehow pull back.

You're right. We have to now be somewhat concerned about whether the aspartame issue is going to have a more negative impact on the TEN expectations for us. We'll talk about our investment spending next year. I haven't quoted a number yet. In terms as Larry has said, developing consumer awareness, getting people to know what this product is, we've got repeat purchase rates that are four times the rate of trial. This is very good. We've got to get more people to try it. It's way too early to be having these conversations. We're committed to making this work, unless and until we see the data that would cause us to think differently. We're not seeing that data today.

No.

Still a lot of room on that caloric intake dimension, based on raising trial for TEN is another way to say what you just said, I think?

Sure.

Okay. Moving more toward the overall top line, as you mentioned, took down the top line guidance from 2% to flat, which suggests a pretty decent deceleration in Q4, we would love a little bit more explanation about that. You touched on it, but I want to get a little bit underneath that, particularly in the context of Coke, as an example, insists time and time again over the past couple of weeks at least, that they're going to raise prices significantly in CSDs in North America. You and I will both believe it when we see it, and we'd like that to happen. What's driving the deceleration, particularly in the short term, given your Q4 guidance?

Ali, I would just tell you that our guidance for Q4, what we see in Q4, we're seeing a continuation of the more recent trend. I don't think that's talking about flattish revenue performance in the quarter should be a surprise to anybody, given where we ended Q3 and given what we see, and what many of you also see, in terms of category performance. I want to come back though. This question, John was talking about it, about the impact of carbs and non-carbs. We understand the headwinds in carbonated. We've talked about our strategies to deal with that. In non-carb, we keep talking about Hawaiian Punch, and I'm here to tell you it makes no significant difference on the bottom line.

For us, the growth challenge, which is always talked about in terms of the top line, we're here to tell you that our focus is turning that into, how do we grow our operating profitability? This is where the opportunities in non-carbs in our portfolio today were brands that have, on a relative basis, small volumes, contribute a lot of profit. We have a saying, we could make more selling less cases, and that's true. We see it as clearly in the warehouse direct business. They suffered hugely from the loss of top line from Hawaiian Punch, but it's based on more Mott's and applesauce and Clamato, which has done reasonably well. They make a lot of money. The challenge for us is going to be within the non-carb category, as Larry said, focusing on profitable volume. We talked to many of you about bulk water is not in the carbs, but making money with Fiji, making money with Vita Coco is good for us. Snapple and the tea category and growing it at the premium level, the whole Mott's category, it's where we're really focused. The good question for us, is doing the things that grow operating profit.

Okay. Thanks for much.

Dara Mohsenian, Morgan Stanley.

Good morning, guys. Larry, following up on Bonnie's question, given the diet struggles and some of the weak CSD trends, do you think at some point you may need to adjust your long-term sales growth outlook? And how sustainable do think the weakness is from this year in CSDs as we look out to 2014 and beyond? Also, can you comment on how close you think you are to cracking the innovation code and commercializing a product with a natural sweetener?

Well, number one, if I had that crystal ball that could tell us where this thing's going to be, I wouldn't have to be doing this. Visibility, as everyone knows, is probably the worst I've ever seen. As I mentioned earlier, we believe in CSDs. We think we can stay on this. We think TEN is the platform that will help us. We're going to stay very focused on it. The diets, this is a new thing that's that come up. I think with the right facts out there, we can help turn that back around. If we do that, that can get us back into the positive territory again.

As far as adjusting my numbers, we look at it. We're going to go after every case we can get. As we get through the fourth quarter and get a little better view of what we think is out there for 2014, we'll update everybody. The trend's definitely told us that we needed to say we were going to be basically flat for this year. But again, I'll go back to what Marty said. We focus on profitable volume growth, operating income, and I think you can see where we're going to stay after that to start bringing that trend up better.

Okay. Thanks.

Bill Schmitz, Deutsche Bank.

How do you feel about the distribution infrastructure, given how sluggish volumes have been? My broader question is obviously Coke's doing re-franchising. Pepsi's going to talk about what they're going to do in February. It seems intuitively logical for me to try to get more consolidation even across the brands on the distribution side. Is there anything you're working on, on that front? I realize it might be competitively sensitive.

Yes, I think if you look at what we have here, the way our model is set up, we're basically 40% Company-owned, 40% our bottling partners,10% warehouse direct, and 10% fountain food service. We're very pleased with that. We think our system works well. We watch what our competitors are doing out there. Always remember, our competitors today are also our partners and our customers, and they're very good partners. We get learnings from them. I think they pick up some ideas from us. I think we'll stay with where we're at and I think -- I can't comment on what Coke or Pepsi are going to do. I really don't know. We've stayed our course. We like it. It works well for us, and I think it'll pay us dividends in the future.

Got you. The reason I ask is because obviously capacity utilization is probably pressured right now. I'm just wondering, longer-term do think there's a need to have a [white] system?

You're going to always have to have a white system. I think people sometimes forget the number of brands that are in that white system, and you take in a large percentage of our non-carbs go through that white system. A lot of our CSDs, other than just Dr Pepper, a lot of our brands go through the Coke and Pepsi systems. A lot of them are the independent Coke and Pepsi bottlers. I don't think you'd ever see where there would not be a third player out there in this market. So many of these small brands, the start-ups that Marty mentioned awhile ago, would have nowhere to go. I think it's sustainable and it'll be here long-term.

Great. Thanks so much, guys.

Thank you. I would like to turn the floor back over to Larry Young for any closing remarks.

All right. I'd like to thank everybody for joining us today and your continued interest in investment in the Dr Pepper Snapple Group. Thank you very much.

Thank you. This concludes today's third quarter 2013 earnings call. You may now disconnect.