Q3 2021 Keurig Dr Pepper Inc Earnings Call
Apology, which delivers a richer more balanced and flavor Cup of coffee.
Our newest Brewer is the keurig Supreme plus smart initially launched on <unk> Dot Com in July and now rolling out to retailers in time for the holidays.
In addition to incorporating multi stream technology. This internet connected Brewer also features our new brew <unk> technology, which recognizes the specific K Cup pod in use and automatically customizes Bruce settings.
The Brewers Smart technology also enhances our successful auto delivery business by utilizing SKU level pod consumption data to automatically replenish consumers via shipments direct to home.
Both our auto delivery and broader e-commerce business continued to expand in the quarter on top of the exceptionally strong growth experienced last year.
We also continue to innovate in parts sustainability and have begun the introduction of easy Peel lids to a recyclable K Cup pods in order to make the recycling process simpler for consumers.
In addition to the good progress we've made in coffee pods sustainability, the accomplishments and our company wide ESG efforts continued to be recognized.
Recently, we received the Reuters responsible business award for the social and human capital category, recognizing our 20 year journey of putting farmers first by improving 1 million lives in our coffee supply.
A top 10% ranking among 350 food and agriculture companies by the World Benchmarking Alliance United Nations affiliated organization that focuses on improving private sector performance against the UN sustainable development goals.
Our number two ranking out of 50 of the largest cpg's and retailers in North America by the nonprofit as you sow and their assessment of plastic usage and packaging sustainability progress.
And LEED gold certification for our new Frisco headquarters.
Before turning it over to ozone I want to highlight the increase in our outlook for 2021 net sales growth to 7% to 8% as communicated in our press release. This morning, we continue.
To expect adjusted diluted EPS growth in the range of 13% to 15% as pricing productivity and revenue growth are being leveraged to offset significant and accelerating industry inflation as ozawa will now discuss in his comments.
Thanks, Bob and good morning, everyone.
Continuing on an adjusted basis.
But he's still a view about four months for the third quarter, which was another strong one for US I will then turn to an outlook for the balance of 2021.
Constant currency net sales increased six 8%.
By higher volume mix of three 2% and favorable net price realization of three 6%.
Importantly.
All four business segments posted growth driven by successful innovation and.
Strong marketing.
And along with continued solid in market execution.
For the first nine months of 2020 one.
Currency net sales grew eight 4% versus a year ago.
And on a two year basis.
One's 13, 3% versus the same period in.
2019.
Adjusted gross margin in the core that advance 50 basis points versus year ago to 56, 4% of net sales.
Reflecting higher pricing and productivity, partially offset by significant and accelerating installation in cost of goods sold.
Adjusted operating income in the quarter grew six 5% versus year ago to $931 million.
Driven by the strong and balanced net sales growth.
And the gross margin expansion.
It has been as productivity and merger synergies in SG&A.
These positive drivers were partially offset.
I see.
On inflation in transportation, and logistics and significantly higher marketing investment.
On a constant currency basis, adjusted operating income increased five 7% versus year ago.
Adjusted operating margin declined 30 basis points, reflecting our decision to reinvest in marketing to drive brand strength.
Excluding the increase in marketing adjusted.
Adjusted operating margin was up versus year ago.
For the first nine months of 2021.
Adjusted operating income increased seven 6% versus year ago.
And on a two year basis, adjusted operating income was up 21% versus the first nine months of 2019.
Adjusted net income in the recorded odd months 13, 3% versus a year ago, two six on the $31 million.
Primarily driven by the growth in adjusted operating income and lower interest expense, largely reflecting lower interest rates stemming from this strategic refinancing completed in the first quarter of 2021.
Lowered outstanding indebtedness and realized gains on interest rate swap contracts.
Also benefiting the growth in adjusted net income was a lower adjusted tax rate.
Adjusted diluted EPS in the quarter grew 12, 8% to 44 cents compared to 49 cents in the year ago period.
For the first nine months of 2021, adjusted diluted EPS at months 13, 9% versus year ago.
And on a two year basis, adjusted diluted EPS was up 32% versus the first nine months of 2019.
Let me take a moment to discuss the inflationary pressures in South Lake chain challenges referenced this morning, that's not impacting the broader economy and our industry.
We are experiencing significantly higher installation this year than we expected at the start of the year reached.
Which vivo managing with pricing.
Activity and accelerated growth.
For perspective, we expect all in inflation this year.
It includes inflation in cost of goods sold.
Transportation.
That housing and logistics and SG&A to be up approximate <unk>, 6% versus a year ago.
This inflation has accelerated in the second half of 2021.
Our updated guidance for 2021 incorporates all of these considerations and we are confident that we have.
The tools and management disciplines in place to deliver our guidance for both revenue and earnings growth.
Let me now turn and talk about segment had four months in the core of that.
Coffee systems constant currency net sales increased four 6% driven by higher volume mix of five 7%.
Partially offset by lower net price realization of one 1%, which continued to moderate as expected.
While you mixed pad four months reflected pod shipment volume growth of six 3% and brewer volume growth of two 2%.
The pod volume growth reflected continued the strong momentum in our at home parts and improve pet four months away from home business. Although returning two offices continues to be slow.
And this business remains well below pre pandemic levels.
Two 2% increase in <unk> shipments.
Which is on top of the 44% increase in brewer shipments in the fourth quarter last year.
Fueled by continued strong consumer purchases stemming from successful innovation and a double digit increase in marketing.
During the call that we had.
Pricing in our broad portfolio.
And more recently.
Took pricing on our owned and licensed coffee brands, giving the escalation in coffee commodity pricing.
As a reminder, most of our partner contracts required the partnership to be responsible for coffee beans.
Therefore, the increased commodity costs.
And any pricing they chose to take for these brands does not follow through the KCP profit and loss.
Adjusted operating income.
For coffee systems increased one 1% to $377 million.
Driven by the net sales growth and continued productivity and merger synergies part.
Partially offset by inflation and the double digit increase in marketing investment in the quarter.
This marketing investments supported the launch of our new Keurig Supreme plus smart through it.
Featuring our new grew with I D technology platform.
The campaign was executed nation Ali.
Digital social media.
And was amplified by experiential activations.
On a constant currency basis, adjusted operating income increased 0.5% in the quarter.
Adjusted operating margin in the quarter was 32, 6% compared to 34% in the year ago period.
Lastly, reflecting the significant increase in inflation and marketing investment.
Packaged beverages constant currency net sales grew six 8% in the quarter.
With volume mix growth of one 5%.
And higher net price realization of five 3%, reflecting continued growth in both our company owned DSD operations and warehouse direct business.
The majority of our liquid refreshment beverage portfolio contributed to this growth.
Cst's.
Notably, Dr Pepper, Canada, dry and sunkist.
Particularly out of the strong along with polar <unk>.
While our cocoa and what's driving growth.
Adjusted operating income for packaged beverages increased two 6% in the third quarter.
Two $312 million.
By the strong net sales growth.
Activity and merger synergies.
Partially offset by inflation, particularly in transportation as well as marketing investment and increased operating costs to meet continued strong consumer demand.
On a constant currency basis, adjusted operating income increased two 3% versus a year ago.
Adjusted operating margin for packaged beverages was 22% in Nucor there.
Compared to adjusted operating margin of 21% in the year ago period.
Lastly, reflecting the impact of inflation and higher marketing investment.
Beverage concentrates constant currency net sales increased 10, 8%.
<unk> favorable net price realization of 11.4%, resulting from higher pricing and lower trade expense slightly offset by lower volume mix of 0.6%.
The growth in net sales also reflected a continued recovery in the fountain foodservice business due to increased consumer mobility in the restaurant and hospitality channels.
Brand, Dr Pepper driving the growth.
Offsetting this growth was a decline in bottle can concentrate shipment volume.
Adjusted operating income for beverage concentrates increased 9.1% to $289 million driven by lower net sales growth, partially offset by a strong double digit increase in marketing investment.
This increase reflected investment behind Dr Pepper zero sugar and the Doctor Pepper College football campaign.
On a constant currency basis, adjusted operating income advanced eight 7%.
Adjusted operating margin in the quarter totaled 73, 7% compared to 75, 3% in the year ago period.
Reflecting the impact of significantly higher marketing investment.
Excluding the increase in marketing.
Adjusted operating margin was up versus year ago.
And finally, let.
Latin America beverages constant currency net sales grew 14.5%.
<unk> strong volume mix growth of 10, 5% and favorable net price realization of 4% lease.
Liquid refreshment beverage in market execution in Mexico continued to be strong across all channels.
<unk> drove significant net sales growth for key brands named.
Namely opinion E L M Club model.
Adjusted operating income increased 48% to $37 million and on a constant currency basis, adjusted operating income increased 36%.
This is strong operating income performance reflected the net sales growth and productivity.
Partially offset by significantly higher marketing investment and inflammation.
Adjusted operating margin in the core that advanced 350 basis points to 23, 7% despite the meaningful increase in marketing investment.
Free cash flow in the quarter continued to be strong at $676 million driving year to date free cash flow to $1 6 billion.
This is strong free cash flow at four months for the quarter and year to date periods represented free cash flow conversion ratios of approximate.
107%.
100% respectively.
Drilling nucor there really.
We reduced our outstanding bank debt by $325 million.
Structural payables by $2 million.
We also ended the first quarter that'd be $200 million of unrestricted.
The restricted cash on hand.
Due to all of our growth in earnings and reduction in bank debt.
Improved our management leverage ratio to three two times at the end of the first quarter of 2021.
Since the merger closed in July 2018.
We have reduced our management leverage ratio by two eight times and continue to expect to achieve our management leverage ratio at or below three times at year end.
Let me now move to a lot of outlook for full year 2021.
For the first time this year.
<unk> our guidance for constant currency net sales growth to reflect the significant momentum in the business.
We now expect growth in the range of 7% to 8%.
This compares with our origin of 'twenty or 'twenty, one guidance for constant currency net sales growth of 324%.
And our most recent guidance of 6% to 7%.
We continue to expect adjusted diluted.
Earnings per share growth in the range of 13% to 15%.
And we expect to continue to invest significantly in marketing.
To maintain our topline momentum.
Supporting this guidance, we expect the following.
Adjusted interest expense is now expected in the range of $495 million to $500 million.
Reflecting the realized gains on interest rate swap contracts that benefited the third quarter.
Our adjusted effective tax rate.
As expected in the range of $23, 5% to 24%.
Diluted.
<unk> shares outstanding are estimated to be approximate $1 4 billion.
And finally, our management leverage ratio is expected to be at or below three times at year end.
Is that net.
I'll hand, it back to Bob for some closing remarks.
Closing out 2021 completes the three year commitments established in January of 2018 at the announcement of the merger clearly a lot has transpired since then and throughout this time. The <unk> team has remained focused flexible and resilient with one quarter left to go we are confident that we will significantly over deliver our net sales commitment.
And achieve our 15% to 17% adjusted EPS commitment.
I will now turn it back to the operator for your questions.
If you would like to ask a question. Please press star one on your telephone keypad.
Again that is star one to ask a question.
Well pause for just a moment to compile the Q&A roster.
Your first question comes from Bonnie Herzog with Goldman Sachs.
Thank you and good morning.
Bonnie.
Marty I wanted to ask about your top line, which you know continues to be much stronger than expected and it is impressive that you guys had taken up your your sales growth guidance, yet again so.
Yeah.
Potentially change your thinking regarding your preliminary outlook for 'twenty. Two I mean is it does it give you any more confident in your ability to deliver on our mid single digit top line growth or possibly above that and if so do you think your initial outlook for mid single digit EPS.
Next year could ultimately prove kind of started can you know given that lever just wanted to get your thoughts on that thanks.
<unk>.
Yeah, we're very happy with the revenue growth that we've seen if you recall when we put the company together, we talked about revenue three year revenue guidance of 2% to 3% and we far exceeded that.
Driven in a really healthy way through a combination of growth across the entire business core business growth in.
And innovation and it's fueled by by Great marketing as well.
Our execution at retail so the drivers behind it are sustainable.
Contributions from our brands and the innovation pipeline is very strong.
As we sit here in during the Investor day in October and we're looking out over the future. We think that mid single digits is the right target remember that everybody is getting some revenue growth off of the pricing that we're putting in place right now so it's hard to look down the road and forecast.
What pricing will be over the next three to five years. So we base it more on what the underlying volume growth is at a normalized pricing environment.
And are comfortable that mid single digits is the right commitment for us to make over the long term obviously the trends that we're seeing right now are stronger than that.
Okay I appreciate that thank you.
Your next question comes from the line of Chris Carey with Wells Fargo Securities.
Hi.
Good morning, Hi.
Hi, Chris.
Hi, there.
Pricing in the packaged beverage business I think was the highest in over a decade unless I'm mistaken clear.
Clearly it makes sense.
This is our <unk>.
Not what they historically have been they are not in any category right now.
Can you just talk about.
Maybe how this pricing evolves over the.
The next.
A year or six quarters.
Yeah, I think <unk> was a little bit.
Forward or to ramp pricing is aggressive as some of your other domestic peers.
When does revenue growth management become.
A bigger dynamic here.
When do you think volumes could potentially be impacted by pricing I imagine that the model will be more pricing driven ahead just.
Again, the concept of higher pricing makes sense, but.
Its historically high of course and.
I just wanted some more perspective on how this evolves over time and where the <unk> comes in relative to list price and just how you're thinking about how this evolves over the next year or so so thanks sure.
The questions that Youre asking here on the minds of everybody in the industry.
The fortunate thing is that we operate in a wonderful industry beverages, and I'm, including coffee in that as well that is incredibly rational.
So the objective is margin protection and what we've all face is an unprecedented level of inflation certainly unprecedented in all of our working careers.
For the for the North American market level of inflation.
There are three ways to offset that pricing and I would include our GM in pricing and I'll talk more about that pricing productivity and then there is another lever which is reinvestment back in the business and so we can pull those levers in different magnitudes based on on the level of inflation and what.
We believe the impact will be on the overall business. What we're seeing right. Now is that there has been a significant amount of pricing across the industry.
We ended by the data that I have doesn't suggest that we were slower than anyone else I think we were right in line.
Different parts of our business realize the pricing faster than others. So for example, our BC business has an immediate impact when you take pricing and hits the P&L. There's a delayed response in some of our other businesses as as it has to reach retail.
And you have to protect some of the promotions in place so that maybe what you're thinking about there, but certainly there has been extensive pricing.
The impact of elasticity has been.
Better than historical and in part it's because of the way we've taken pricing and also the strength of the brands.
And we've been able to find a way uniquely within I think the industry to continue to have positive gross margin in the quarter for example, which gives us the opportunity to reinvest back in our business, which makes pricing even more possible because you continue to invest in your brand strength. So I would suggest that that's the framework we approach 2022 and.
Any prediction I would make in the future about elasticity, what do I think inflation is going to be how do I think pricing will respond to that.
Not productive because it's impossible for anybody including the fed to predict what's happening going forward. What I would say is that we manage this in a very dynamic manner.
When there is more inflation in the industry has put on more pricing.
And we have the other levers that I talked about in terms of productivity and reinvestment to pull to protect margin and that's why we're confident in the guidance that we put out.
October one in an environment as volatile as this we still have the ability to manage our way through that.
Okay. Thanks, so much for the perspective, Okay Chris.
And your next question comes from Bryan Spillane with Bank of America.
Good morning, its peak yellow on for Brian Thanks for taking the question.
I guess just.
On the Bev.
Con.
There's a natural gap between shipment volumes and bottler case volume, but I think.
Bottler case volumes were maybe a little bit lighter than than we had expected and there wasn't a ton of detail around what happened there.
In the press release, so just anything there would be helpful. And then I think it was on just there were some comments, particularly on the bottle and can part of the Bev Con business just how are your franchisees managing inflation.
How is it impacting your ability to serve.
Having to do anything to kind of to accommodate them for their rising costs. Thanks, very much guys. Yeah. Let me, let me kick it off and then I'll turn it over to you.
<unk> between shipments our shipments embolic case volume as always quarter to quarter. Some disconnect to equalize over time there is nothing notable there.
And the best way to look at the underlying health of our business.
And as more of a leading indicator is to look at the consumption numbers, the offtake numbers from IRI or Nielsen because that's the leading indicator of consumer demand that will pull our brands through whether it comes through our system.
Or through another entity system, its still our brand and that is reflected in those numbers as you can see that they are exceptionally strong, particularly on Dr. Pepper, which is the largest brand it flows through multiple system. So.
Everything is very positive there there's nothing to note what was on you want to talk a little bit about the inflationary impact.
On our partners.
And how they offset that.
Of course.
Of course, Bob on particularly on the Bev Con as you were saying about him in Bev can comes in two pieces. One is the bottlers and distributors at the block as well as all of our fountain foodservice business.
And and specific answer to question Pete on the mechanism of our bottlers and distributors pricing.
Most of our bottlers and distributors on on incident pricing.
As you know is it quite a bit sophisticated algorithm.
That's the stuff from the shelf prices then it goes to the bottlers and distributors entities next to us therefore.
This is a best in class in terms of pricing adjustments that take place in the marketplace and then it also includes the sophisticated revenue growth the management of the strategies that we deploy on a consistent basis. Therefore as bubbles. So I alluded a couple of minutes ago the whole sector.
It took us some forms and shapes of our pricing actions either shelf price improvements or are using sophisticated the revenue growth management strategies and as a result of that is and that flow through and it's all about bev can business and given the nature of the Bev can that V.
And sale and transferred the concentrate the increase.
In the pricing in that segment and it reflects in our numbers either way right away, meaning a little earlier than the packaged beverages. For example that takes a little bit the gap between the price improvements to be turned into the finished product ship it and send it across the board so that would be able to liquidate them that to make us.
To realize.
It's very good to margin improvement from pricing in Bev Con.
And your next question comes from the line of Andrea Teixeira with J P. Morgan.
Hey, good morning.
Just wanted to kind of like go back to the supply chain.
That.
I think you kind of manage we do well.
Can you kind of give us an idea of you know how at this point the packaging side, you'll be able to manage and how it positions you.
Into 2022, and Bob I wanted to go back to also just to clarify your point about protecting profitability.
It's early to say and obviously when you gave the 2022 preliminary outlook. It kind of implies that margins are probably going to be.
On a gross margin basis, I don't know, but you know what.
Youre going to have a similar algorithm or protect profitability is that still going to be more of.
Financial deleverage and below the line or you may be able to protect your gross margin. Thank you sure. Good morning, Andrew I'm going to tackle the first one on supply chain and then it was on you want to talk a bit about.
2022.
And margins after I finish that with regard to the supply chain piece like everyone. This is <unk>.
It's been a rolling pattern of challenges. So last time, we talked to you we were having some issues with regard to packaging availability.
Particularly in the area of Snapple on glass, which required us to move faster to ERP conversion and.
And starting up the plant much faster than we expected.
That is largely behind us and as I said youre seeing improvements in those businesses and so at.
At the moment that is less of the issue are bigger challenges and I think consistent with the industry is actually transportation right now customer pickups.
As well as shipments that we make that are not through our own.
Fleet are increasingly challenge, where pickups don't happen as scheduled in.
And transportation is unreliable as well is incredibly costly.
And then again like everybody we are facing some rolling labor issues as well.
That are not adequate from time to time to be able to surface of the man so far.
Our supply chain team.
Has done incredibly well in navigating through all of these as you know we have new supply chain leadership.
And Tony who has joined US made an immediate impact on that and so we're seeing a lot of improvements, but it continues to be incredibly volatile.
I will talk about the margin side.
Exactly of course, Bob.
I'd actually like to expand a little bit because obviously the hold installation and new pricing algorithm you saw interrelate to each other.
As we shared with you and I'm sure you are seeing this every day like everyone else have you are experiencing a significant increase in inflation, particularly in packaging materials.
Labor.
Lately coffee beans, corn in glass, and so forth, which is a broad base of Hawaiian input costs combined with transportation and the latest one.
I've seen pressure on the labor shortage as well as the allied level. It is.
As we also shared with you a little while ago, we expect overall installation rate for 2021 to impact us negatively at one 6%.
And also any inflation has affinity through 2020, one with the second half being higher.
In the first half so what does this mean this means that they've got and heading into 2022.
It's a higher second half run rate. So so we expect that the at least the first couple of quarters of 'twenty two to face tougher comps than the second half of 2020 one.
Except it.
During our Investor Day October one you also shattered issue that all of our long term outlook is for continued adjusted operating margin growth fueled.
If you buy a problem out of the three things productivity mix and overhead leverage while we continue to invest in a lot of product brands to continue to drive strong growth. Therefore are at this point in time, our 2022 outlook is our best estimate based on the Zain.
Your assumptions, which is very important to articulate then this is how we have been managing the enterprise for a while which is a balance between the installation.
Pricing productivity and business investments, obviously, the motive you know our.
We will update you on the timing of that update would be drilling a lot February 2022 eh call that'd be able announce a lot quarter four and full year results.
In summary, we believe in the strength of our plan and the algorithm that we put in front of you that daily.
They live in over time.
Okay. Thank you very much.
And your next question comes from Kevin Grundy with Jefferies.
Great. Thanks, Good morning, everyone and congratulations on another strong result, Hey, Bob.
Bob I wanted to kind of zoom out a little bit of a more strategic question for you. This morning, just as it pertains to your distribution assets and the potential to move into alcohol. Following pepsico's announcement with hard mountain Dew.
I mean as you know the legacy Dr. Pepper company has long viewed its bottling assets are strategic I think there's been some questions over the years about potentially taking a look at doing something more strategic spinning them off refranchising et cetera, but it was.
It's something the board so I've never made a lot of sense you mentioned the Vita Coco investment there it's been a long term relationship as part of the Allied strategy. The polar deal that you guys entered into you made a lot of sense as well.
So my question is I'm sure. The Pepsico announcement is in no way lost on you I. Just wanted you to comment this morning on the potential for.
For keurig, Dr Pepper to move into the alcohol space to take a look at your own distribution assets is that something that you're entertaining is that something that you think makes a lot of.
Yeah.
Okay.
Okay, I think we lost a lot of us.
Of it but let me let me give you a point of view on this space here.
On alcohol in particular.
He is an area that we look at that's very similar to the way we looked at beverages in total so as we said when we put the other coffee with cold beverages that we thought there was an opportunity to look at beverages Holistically, it's the same with alcohol.
Now the complexity of distribution is one that has been pointed out by many including US and I think that what you referenced with regard to Pepsi is very interesting and how theyre being creative around that what youre seeing is really the intersection of two opportunities one is portfolio expansion into new territories.
As well as consolidation.
In the distribution assets to make sure that they are at scale and therefore more efficient and so we look at both of those opportunities and the one that you pointed out is there is some overlap. So it's an area that we continue to study as we had pointed out on the Investor day, we participate in alcohol in a variety of ways that I think with some.
So the people we talked about the business, we have in Canada, where the distribution environment is very different the fact that we do licensing and the alcohol space and we think that our brands can play in alcohol nicely.
The fact that we're the number one mix our company.
Which has us participating in alcohol consumption occasions at a much higher rate and.
And we put all of that knowledge and objective together to think about that so I think in short there's a lot of complexity to do this in the U S. It's interesting to see how others are looking at it we look at beverages Holistically and so it's certainly on our radar screen.
It will be something in the broadest sense that we'll be talking about in the future.
Very good thanks, Bob Good luck alright.
And your next question comes from the line of Brett Cooper with men Sumer age research.
Yeah.
Good morning, Hi, Brett.
Hi.
But the leadership team that you brought in comes more from outside of non alcoholic beverages, which versus what we typically see in this space. So I was just hoping three years into the deal you can talk about where you see the state of your aftermarket business. Your observations on what the accepted view of operations was versus how you as a team we're seeing it and then how you look at managing evolutions in the.
Industry, whether those e-commerce, the ryzen penetration of electric vehicles to altering convenient store purchases.
And or the ryzen non ready to drink beverages. Thanks, Yeah, well first of all I'll start with the team. We're really we're really proud and pleased with the team that we have in place right. Now we continue to build capabilities. If you look at where we have drawn team members, especially at the most senior levels and you see it at the Yale executive team level, but.
I would also say at the level of direct reports to the executive team. It is very similar wide range of packaged goods experience with a focus on beverages wed like to pull people from all elements of beverages. So we have not alcohol as well as alcohol experience and we have a number of people who in that individual have experience in both.
We also have people who have a number of experiences both within North America as well as the international experience and we think that.
This combination of skills experience and backgrounds and style make us much stronger as a team and we will continue to to add talented team as well as promote and upgrade talent from within as we have done so.
It is a critical part for our ongoing success to make sure that we've got the management team who can two can really lead the business of the future. So let's talk about some of the future looking comments or questions that you ask right. There again, we go back to our original thesis for putting the two companies together is that beverages, historically had been managing silos and we thought.
If we took a look at it from a consumer perspective.
That we would be better off and it's exactly what we've seen is that consumers don't think about beverages and formats via silos, they think about needs and occasions and they use multiple beverage formats brands products et cetera to satisfy those needs. So by taking a consumer first need based approach. It has really informed our innovation pipeline.
Both on the cold and hot side to Great success as you say, it's driven our marketing programs and it helps us think about partnerships going forward, whether that's a partnership.
Like polar there with our most recent one in which we have a long term franchise agreement with them, but not ownership or partnerships, where we have seen investment or ultimately acquire the business as we've done with others. When you think about our distribution assets, which is another area that you point to we put the company together in 2018 and talked about seven.
Ways that we went to market we range from direct store delivery to wholesale direct to franchise, our fountain and foodservice, which is our on premise business, but the other one that we talked about that time with E. Commerce and there was very little appreciation for e-commerce, particularly in beverage in 2018, and that's changed dramatically.
<unk>, we have seen the percentage of our E Commerce business grow we've talked to you before that its north of 10% its higher on our coffee business. It grew significantly faster than our average business and we are in position to be the market leader of the category leader in this space driven by the historical strength of Keurig and now with.
Keurig, where theres always been a substantial ecommerce business. The fact that we are selling brewers that are smart brewers that can recognize the pod.
That can trigger in order direct to consumer based on actual SKU level consumption suggests that we are thinking way ahead in terms of what the net next steps are in terms of distribution routes as well as our efficiency and my last point is it ties back to the question that Kevin asked in addition to portfolio white space and finding new.
Points of distribution, we think our DSD asset is a competitive advantage, but we also believe in consolidation and distribution in the industry and we will look for ways to continue to consolidate distribution.
And drive more efficiency and effectiveness through that really important asset to us. So I think I covered all of your forward looking point of if theres anything else on there or anything I missed let me know.
No that's great. Thanks, alright. Thanks.
Your next question comes from the line of Lauren Lieberman with Barclays.
Great. Thanks, good morning.
Sure.
I was wondering if you could just talk a little bit about polar I know, it's still relatively early but it had been expanding distribution and I was just curious if you could talk about some of the uptake youre seeing and what Youre doing also too.
And build awareness of that brand because it's one thing to put it on the shelf another for people outside of the northeast to pick it up off that shelf. Thanks sure.
As you know polar.
<unk> continues to be responsible for the brand in their territories and we've expanded outside of the northeast for them right now we're at 60% ACB distribution.
The territories for which we're responsible we're happy with that it continues to grow.
We've achieved now just under a four share of that category, which is a sizable and growing category.
And we're happy with the trajectory that we're on I was out just recently doing retail.
And a number of markets across the country and I was really pleased with the level of distribution and display activity that we're getting and in.
In stores in which we haven't gotten it fully slotted onto the shelf yet because of timing I saw a lot of off shelf display pressure, which will continue to grow the brand. The polar team is responsible for marketing the brand and that's something that we work with in conjunction with them on.
I agree with you that as this distribution base continues to build and we have great push activity behind it needs.
Needs to be supported with an increasing amount of consumer pull activity.
That's something that we're continuing to work with them on but I think that the foundation is in place to be able to activate that and overall, we're just really pleased with how that business is trending.
Great. Thank you.
Your next question comes from Sean King with UBS.
Hey, good morning.
Yes first of all I'm glad to see you're starting to move pricing higher on the parts side for the owned and licensed brands.
But first off do you expect that where are you seeing the partner brands. Following on price at retail and then second over overtime can you get pricing on the partner brand manufacturing contracts given the higher cost Youre, saying Oh, Yeah. Let me let me, let me talk a little bit about just pricing in total and pods and then OS that much to pick up on the.
On the partner agreements and potential pricing there.
Pricing is always an interesting conversation in the context of K Cup pods, because we have intentionally been lowering the price.
Although I know for analysts and investors that was always something of concern we always point out that that was an intentional strategy.
As continue to drive household penetration and we knew that the price was too high and we're able to back up those price investments.
With strong levels of productivity because as the price came down we were able to expand margin.
That's certainly a proof point that it was intentional and we had that well under control. We are seeing an increase in the underlying price of coffee.
And while that is a lesser component of a finished K cup pod than somebody who's selling roasting ground coffee is still is of a magnitude where we we know that pricing is appropriate and required. So we pass it on immediately in the form of pricing in our owned and licensed.
Brands and we do think that's the right thing to do given the inflation, but it's a little more complex than the partner situation as well as private label I think it was a monster, but did you talk that through because it's a good opportunity to remind everyone. How our contracts work and what they are likely to see inside and outside of the Katy P. P&L.
Sure sure and as we say the use of genetic code and partners and obviously be included branded partners that you have as it is.
Private label, it's one group put us and as we shared with you know the.
Specifics, but in general terms our partner contracts.
For long term duration. So they are not for the short term and in the contracts, obviously specify OLED pays in terms of the working relationship.
Let me do the double click if you also see that a.
V S. K D P VR not responsible to source the coffee beans for the most of our partner group. So what does this mean this means that any fluctuation plus or minus in the coffee bean.
The procurement at least.
Once the ability of the profit and loss management.
For the year, but by itself to either your product label or Mercury with Dunkin' or honestly Starbucks. Thank you yes.
Yes, good morning, Laura you want to pick that up.
Absolutely.
Moving on to Israel first of all I mean, he had not at that position to disclose all the details relationship between us and our partner as I'm sure you will not finish it but if I want to make a let's say of an old Gen and all statement on that one.
If you always look to seven O pieces is it kind of basket.
Between that one from the manufacturing perspective that includes some of the input cost.
As you said and as I said, if you are not responsible for the most part from the coffee beans, but there are some other elements as you say, but that's why we have all that overall productivity programs and that's why we always look for further efficiencies in our business in order first of all to help us.
To improve our margins as we have been doing is Venice.
To where these type of nonpersistent or persistent inflation I D.
In light of minutes. Therefore, it wouldn't be right just to look to one piece of a lemon and try to make sense out of it but rather we need to look holistically and that's how it would be worth the money gene not only coffee, but all segments of Hawaiian business.
On the basis of the relationship that pricing the inflation.
The productivity as well as the business investments and as.
As we also spoke we also improved our pricing on the owned and licensed that it will be impacting.
Our numbers and you will see in the data as well as snap Inc. Quarter four onwards, and as we also said that we are very pleased that both on the coffee beverages, there's been as cold beverages that the sector is very rational and very responsible to manage the inflation and the pricing relationship that vote. We are very pleased though it onto our algorithm and a lot of walking.
She showed with our partners in the old pieces off the Ottomans yeah.
Just to build on that as I said before just to reemphasize.
Our objective is margin protection.
Our leavers to pull or a combination of pricing productivity and reinvestment and we have different mechanisms and different contracts to be able to protect margin against that.
That entire basket and in the case of coffee, which has been the most inflationary item within that.
Within the manufacturing and delivery of our K Cup pod.
As we said, we're not responsible for it for most of our partners and in the case of our own brands, where we are we immediately took pricing which by the way as you can see it didn't really show up at all in Q3.
Based on the timing of the pricing and the lag on that so that's the actual pricing that we put in place.
And we've seen across the industry is more to come.
Thank you gentlemen, I appreciate it.
Thanks.
Your next question comes from the line of Dara machine with Morgan Stanley.
Hey, guys. Good morning, good morning, Dara So good morning, Justin.
Just to follow up on that.
Look obviously the guidance for 2022.
Is below your long term algorithm because of the cost pressure. So clearly there is.
Some ability not to fully priced away those commodity costs.
Erratically with the conversations we've been having today heritage Dps is in good shape to do that you talked about some pricing on your owned and licensed brands. So just to be very clear I assume the gap for 2022 is that the.
Cost pressures, you're seeing on the manufacturing side for your partner brands understanding you're not responsible for the for the coffee grounds themselves, but youre not fully getting the pricing to offset that so.
A is that the case just to be explicit about it it seems clear, but just to be explicit and b is that more just.
A lack of ability to sort of respond short term and you can make up for that in future years. As you think about it or is it more just the contracts are set the way they are in terms of pricing and the way the relationships work, it's more of a sort of a standard pricing over time as opposed to responsiveness to commodity costs.
It'd be helpful. Just to clear that up sure first of all I think youre connecting things that arent connected right now so you're you're looking at our 2022 guidance, which was our initial guidance that we were in a position to.
I think really we felt obligated to provide some guidance in October four to five months in advance of when we normally would and as we've shown since the very beginning we take our guidance and our commitment is really seriously we were pretty much the only company that help on the guidance during COVID-19. So when we put a number out there we treat it as a commitment and an obligation and so when we're sitting there.
In October operating an incredibly volatile environment that nobody can predict.
We feel that it was important to set expectations for 2022 that was friendly to investors so that they could plan appropriately so.
Connecting coffee contracts.
And our ability to price or not which I think we just explained in great detail over the last two questions to our guidance for 2022 I think it is.
Not appropriate.
He said all of that I'm going to say, what we said a couple of times today inflation is one input cost we are managing around a range of inflation.
One of the pieces that I think is not well understood as soon as we talk about inflation immediately I see reports jumped to commodities and hedging let's be clear the inflation that the industry is seeing right now is way beyond commodities. It's commodities, it's packaging its labor transportation. Some if not most of those cannot be hedged.
Possible to forecast.
So everybody is getting exposed to a high level of inflation, we're exiting 2021 at the highest run rate of the year.
Nobody can fully predict how that's going to flow through in 2022, but if you are entering the year at the highest level of the previous year.
That would cause you to say, okay, there's going to be increasing pressure and we're gonna have to offset that through a range of pricing productivity and reinvestment.
Last point I would make as you think about 2022 as we were really clear. We are marketing is up in 2021 versus 'twenty, we intend to put our marketing to be up in 2022 as well the industry took down our marketing in 2020 versus 2019 reluctantly, but the whole industry did it.
Our objective is to build it back because we think investment in our brands behind innovation is the most important thing and it's fueling the top line. So there was an assumption in 2022 that we're going to reinvest and you can figure that into the to the.
Estimates as well.
So that's our outlook for 2022, it's early we're going to provide a lot more information when were in our normal position of doing so in early February.
We take our commitments seriously and we're really pleased with the growth of our business and believe that the right thing for us over the long term is to continue to invest in growth and not cut marketing spend to be able to offset any margin pressures.
And can I just follow up with one question.
So if you see.
Manufacturing costs continued to move up on the on the partner side and coffee.
Do you think you can get incremental pricing over time, how do you think about just that piece of it I understand there are a lot of moving pieces and you are still delivering solid growth for next year, but I'm just trying to understand that one piece of it obviously, we're seeing a lot of responsiveness to the costs on the heritage Dps side right, a very strong pricing this quarter. So I'm just trying to undo.
Stand at one piece of it. Thanks, Yeah. There are a variety of mechanisms for us to recover inflation on the parts side of the business pricing is one of them productivity is another my last point on this one is.
I've said this for the past three years.
At the focus on pricing on coffee.
While it makes sense from a traditional CPG perspective makes no sense in the coffee pod business. When the company is intentionally trying to lower prices and even in an inflationary environment, we're trying to keep prices down where only passing on the coffee costs because they are excessively.
Hi, with regard to the rest of our business, we have a significant amount of productivity and mechanisms to take more pricing, if we choose going forward, but remember our overarching strategy.
Is to try to keep prices down.
Even in the placed in the face of inflation and protect our margins through a combination of productivity and pricing in this business, we have leaned on productivity because it's available to us much more than pricing because it's the right thing to do for the ecosystem of keurig are.
I recognize that concept is very different concept than traditional CPG.
Also say, it's the beauty of the keurig system because it truly is an ecosystem, that's an overused phrase, but it's true in the case of <unk> and Thats. What makes this thing work over the long term you can't focus on one metric because if you do you run the risk of damaging the long term growth of the system and you can see that if anything we are accelerating the growth of the system, which really drives.
Everything so thanks for all the questions and the opportunity to clarify the surety business.
Thanks.
And your final question comes from the line of Robert Orange, Spain with Evercore.
Great. Thank you very much and just want to follow up on a couple of questions.
<unk> covered a lot of ground. So just just one.
As you look at their growth opportunities in the M&A.
How does international expansion rank.
In terms of priority is that something that you see as natural particularly maybe in Mexico or particularly in areas, where you have the brand in the U S, but maybe not overseas or you can use your expertise in other areas. So that's that's the first question and then second.
As you look at these commodities.
I mean, theres, a traditional hedging playbook right.
You guys have traditionally used but you've got prices now at unprecedented levels with a steepness in the curves you know like aluminum that I know think any of us have ever seen.
Does that change your strategy in terms of the duration of the hedges. Thank you.
Thanks Robert.
I'm going to let me, let me hit the first one and then also on you want to talk about hedging and duration of our positions and how we think about that.
On the international side.
With regard to M&A specifically.
As we talked about in our Investor day that we're really excited about.
Being able to use our high levels of discretionary free cash flow to look beyond debt reduction as we're just about to reach our long term leverage targets.
And we talked about the capacity to $20 billion worth of M&A. There are four areas that we talked about in that portfolio of white space.
Distribution and consolidation within distribution, adding capabilities to our business and then we also talked about market expansion our international.
So it's one of the top priority I don't want to I don't want to rank them, because it's going to be dependent upon not just our needs and our opportunities, but what is available and what kind of partners or on the other side, we've got really nice business in Mexico, we hadn't talked about it very much.
And we were proud to share with you the business that we built in Mexico at Investor Day.
Similarly in Canada.
We have a nice business there that that we have really driven nicely and we believe that both of those markets are we've got a position there with management infrastructure capabilities that are scalable and so we see opportunities in those two markets and then I really don't Wanna talk beyond that because our objective is to make sure that we leverage the investments that we already have.
In place and scale them before we look at completely open territory, although that's not off the table.
And see a lot of exciting opportunities across all of North America, not just in the U S.
Im going to talk about the hedging in our commodity positions.
Absolutely, absolutely and I would like to expand a little bit on this because this is a very important topic and it's and it's changing especially all lead times of Colby to prove how vigilant and flexible and adaptive we need to be first of all when we look to the sources of the installation.
You would see that that is across the board.
Includes as you were saying bump the main commodities that we buy that they become seven O.
So office vacated hedging strategies and techniques that we apply but that is not all that on other elements of the cost of goods sold is that being increase as part of the agenda that was information that includes transportation, then housing which is have to being able to hedge for example, and even some parts of our portfolio in your pocket.
Like polypropylene, which is the main materiality using the K Cup.
The hedging taken additional hedging techniques.
But having said that what is important for us at the money, which is again very basket that even basis by looking to say that all scenarios.
And assumptions and of course, if we do change our hedging strategy and the policies on the basis of the expectations as well as.
Taking a very different blends of.
Positions again, depending on each segment of our business, but beyond that have you had also very active to protect ourselves.
Because the information that comes will be seen as an increase surprise, but the allied abilities also important therefore that we have been very active of trying to find alternative suppliers and beyond that alternative. So players also diversifying geographically these.
The sources of the input.
To fulfill.
Our business requirements. Therefore, when we say hedging it summarizes quite a bit by the snow with old and are centered on next to hobby manage the overall cost of goods sold.
Walmart Costco Cuso's base of the company that includes the something that relationship that includes the diversification.
And that includes the geographical.
Diversification at the same time therefore.
It's a it's a very vigilant part of Hawaiian business that the VR.
All of it and spending a huge amount of time to get it right.
With my test at the end of the day that we manage this complex situation on the basis of the commodities assumptions and still continue to deliver it again successfully delivered against our financial commitments.
We have been doing a little bit more than three years I think the model that would be.
Adopted has proven to be successful and we will continue to act.
As such.
Terrific. Thank you very much.
Alright, thank you.
I would now like to hand, the conference over to management for closing remark.
Thank you very much for joining us today, our teams around all day. So if you have any questions feel free to reach out to us here. Thank you.
This does conclude today's conference call. Thank you for your participation you may now disconnect your lines.
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