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Executives

Carolyn Ross - Vice President of Investor Relations

Larry D. Young - Chief Executive Officer, President, Director, Member of Special Award Committee and Member of Capital Transaction Committee

Martin M. Ellen - Chief Financial Officer and Executive Vice President

Analysts

Wendy Nicholson - Citigroup Inc, Research Division

Judy E. Hong - Goldman Sachs Group Inc., Research Division

John A. Faucher - JP Morgan Chase & Co, Research Division

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Dara W. Mohsenian - Morgan Stanley, Research Division

William Schmitz - Deutsche Bank AG, Research Division

Dr Pepper Snapple Group (DPS) Q3 2013 Earnings Call October 23, 2013 11:00 AM ET

Operator

Good morning, and welcome to Dr Pepper Snapple Group's Third Quarter 2013 Earnings Conference Call. [Operator Instructions] 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.

Carolyn Ross

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 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 will open the call for your questions.

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

Larry D. Young

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 3 points of positive mix and 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. And I'll give you a 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, and our other brands were flat as a double-digit increase in Peñafiel and a high single-digit increase in Schweppes were offset by declines in Crush and other brands.

While 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 we'll 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 brand's 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% through the quarter on 3 percentage points of favorable mix and price that were partially offset by 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, America 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-relevant bundling solutions for consumers' game-day needs. And 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, the #2 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 show in Las Vegas. We also be hosting local GRAMMY street parties in key Hispanic markets. And 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. And since we've become a public company in 2008, we have increased our marketing investments by over $125 million or 35%. We will continue to invest behind our consumer-loved brands to ensure their 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.

Martin M. Ellen

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 2 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 comparison 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. And 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 for Mondelez by $430 million. The net effect was a $33 million noncash increase in net earnings. Additionally, we recorded a $5 million noncash 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 on to 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. And 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 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. And 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 costs, including health and welfare, as we have all year. But 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 report 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.

And 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.

Larry D. Young

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 are doing just that with the TEN platform, and we know it will take time and patience.

We continue to execute against our focused strategy in a very challenging environment, ensuring 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. And finally, we remain committed to returning excess free cash to our shareholders over time.

Operator, we're ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Wendy Nicholson of Citi Research.

Wendy Nicholson - Citigroup Inc, Research Division

I wanted to ask about your comments, Marty, just on the advertising spending line. And 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? And are you spending more on promotional merchandising as an offset to that? So is total marketing still coming down? Or maybe talk a little bit more about that.

Martin M. Ellen

Okay, Wendy. So we're 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 and look at our marketing return on investment, there are simply areas that, right now, we don't see paying back. And 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. And where 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, and that number, initially, right now, is about $2 million, and that number could be a lot greater. 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. So 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.

Wendy Nicholson - Citigroup Inc, Research Division

And do you think -- 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, sort of on a brand-by-brand basis?

Martin M. Ellen

Well, we do actually look at return, by brand. Although it is interesting, because 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, and there is a portfolio impact there. Clearly, this year, Canada Dry has been a big contributor. That's been a really good category and we expect that to continue. And our TEN products have had a positive impact across that whole core. So 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.

Wendy Nicholson - Citigroup Inc, Research Division

Okay. And then, just my last question is on the TEN strategy, specifically. I mean, I think the surprise this summer has been that the diet category has slowed as much as it has. So 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 sort of get rescued because it's a hybrid? Or how do you think about that in the light of what we've seen in the diet category?

Larry D. Young

As you said, I mean, 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 the 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. And I think that TEN will be right there for us. As I mentioned earlier, what we're seeing is 51% of our sales from Nielsen Homescan, are people that have left the category and came back. And that's why we're still very bullish and look at this as long term. If you remember in the beginning when we launched it, it's only been out there about 7, 8 months right now, we said that it takes a long time to change people's consumption habits. And so, we're going to stay behind it and see if we can't kind of pick up some of this decline in diet.

Operator

Our next question comes from Judy Hong of Goldman Sachs.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

I guess my question is -- I mean, I think this year, it's certainly encouraging to see you stepping up on getting more cost savings, the LIFO benefits, obviously, helping this year. But I look at your operating profit and it's been pretty stagnant for the last 2, 3 years. And as we look out, 2014, I'd be curious to just kind of 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. So just some of those factors that I'm curious to know, kind of looking out more at 2014.

Martin M. Ellen

Well, Judy, it's Marty. It's a little early for us to talk about 2014. But let me just comment on a few of those points 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. So this year, we recorded a LIFO benefit. Last year, we took a big large LIFO charge, principally related to the higher price for apples that occurred last year as we had the freeze and the price went up. Want everybody to understand that by recording the benefit this year, it's not some sort of non-recurring gain. It simply, adjust the cost of apples to their current pricing. So 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. Look, in terms of managing cost, it's always been a priority and, 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 -- and 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. And I think, as many of you know that, that this is about a culture building a foundation. We're not going to try to overly accelerate things, because RCI itself is a process and we want to build it and sustain it for the long term. Over and above RCI, this quarter, we did do some cost adjustments, and we took a $7 million charge for it. And 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 roll over 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 and, I suspect, you'll see that continue. And 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. And 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. So we're trying to really trim the capital back to also recognize the environment we're in. And when we think about marketing spend, which is a major area of investment, and while we're still spending 8% of 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. And we'll give you some more color on all of this when we talk about 2014 expectations next quarter.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay, that's helpful. And then, 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. So just wanted to get your perspective on your assessment about the current pricing environment, in -- particularly, in the CSD category. And then, as you think about 2014, your ability to continue to deliver positive price mix.

Larry D. Young

Yes. Well, 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. But we're seeing it come back now. We're also hearing from several retailers, there's lots of talk out there that there's 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, but 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. And that's what we'll be looking for.

Operator

Our next question comes from the line of John Faucher of JPMorgan.

John A. Faucher - JP Morgan Chase & Co, Research Division

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

Martin M. Ellen

Okay, John. So it's really product and package, you're right. And there are a lot of moving parts. And 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. So 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, coconut water with Vita Coco. And actually, 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 they, actually -- the dollars have dropped to profit, are actually quite good. So those are always a factor. You know, forever, we talk about Hawaiian Punch. It's been down, it's been down further than we thought. We've had 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 does create -- yes, has a mix effect impact on the top line. And 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 sell more so, around the holidays and with a little lightness, you maybe get some trade-off there against some of the cola drinks. But there's a lot of moving parts to mix, within PB, across the carbonateds to noncarbonateds, and the brands within each one of those. So there's a lot of moving pieces to it.

John A. Faucher - JP Morgan Chase & Co, Research Division

Okay. And 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, more non-CSD brands to the portfolio?

Larry D. Young

Well, John, we look at that constantly. I mean, 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 in to more better-for-you. And then, also, for the CSD is the sweetener, how do we come up with a sweetener? I think the entire industry is working on, to help us eliminate these diet declines. So we're very aware of that. We'll continue to look at it and, I believe, you'll see that will be -- start driving most of our growth in that. We've got our sparkling CSDs and carbonated water is 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.

John A. Faucher - JP Morgan Chase & Co, Research Division

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

Larry D. Young

Absolutely. And we also -- it's not that we don't look at them, but if the right thing would come along, I'd never say never. But 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.

Operator

Our next question comes from the line of Bryan Spillane of Bank of America.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Couple of questions. First, Marty, you talked a little bit about RCI and you've reached to achieve the goals and now there's -- but there's more opportunity, going forward. If you could just talk a little bit about, as you've 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, manufacturing plant versus warehouse and distribution? And where you think maybe more of the efficiencies are out in the future?

Martin M. Ellen

Sure. I'll do best I can, Bryan. So 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. And before I talk of that, I want to remind everybody that when we did, we first focused on our Warehouse Direct business, just focused on the logistics side of that business. We took a -- we have a dramatic reduction in our logistics cost per case, I mean, very dramatic. And actually, that's actually allowed our Warehouse Direct channels, actually, raise its profits, albeit on lower sales, again, led by, principally, by Hawaiian Punch. So it's been a great driver of improved productivity and profitability for our Warehouse Direct business. We shifted over to DSD, and I'll remind everybody that, we had the first area of focus was what we call our Pull Replenishment process. And that's moving our manufacturing plants, their production scheduling, closer to the market-rated 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. So you pull, 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 amongst 15 beverage and CPG companies, we have the highest level of inventory turns of any of them. So now, we move to the functions of DSD in warehousing and delivery. And as you heard in my prepared remarks, a lot of it is there's a complete track around merchandising. Think about merchandising, it's a very important function to our retailer. And you look at the process and, in fact, now you overlay the activities of merchandising, for example, in an environment that's changing. We're now seeing consumer traffic pattern bearing throughout the month. Some people call this the "paycheck effect." When people spend and when they don't. Yet 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 plant. I'll give 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. Same thing in Houston, but with a number of their branches around that plant, and elsewhere throughout the country. So 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 every one of these tracks, but 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. And we're making great progress. You see it in some of our -- 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.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

And so, 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 backup through the supply chain, is that fair?

Martin M. Ellen

That's fair. And 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, it doesn't appear to us that there's been real meaningful step change, and we think we have the opportunity to do that. But whatever we do, we're going to do it in a way -- no big bang fixes, no big bang restructuring, because we don't think that's the way to do it, is to do it with process and make sure that when we're done, it's very sustainable. And so far, it's been good.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

Okay. And then just maybe for Larry and for you, Marty, the school of thought out there that -- with EBIT being flattish or growing modestly that you can boost -- companies could boost shareholder returns by buying back more stock, and you've got other -- there are other companies in your peer group that have even used their balance sheet to buy back stocks. So could you just think about or update us on your thinking about returning cash to shareholders. And 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.

Martin M. Ellen

Okay, Bryan, it's Marty. I think 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. And I've said to many of you, as I've visited with you, that when it comes to the distribution of free cash flow, between those 2, that we like our payout ratio. But that said, we think that we have room to move it up over time, meaning to grow it, at maybe a faster rate than growth in EPS. And that's something our board takes up every year, they'll take it 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. And 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. And in essence, we're returning our total yield. I think it was recently, last year, if you look at our yield plus the net reduction in shares, the net effect to buyback put us around 7.2%, which is where our free cash yield is. So we're -- our model today is to give our holders what we would consider sort of 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.

Operator

Our next question comes from the line of Bonnie Herzog of Wells Fargo.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

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

Larry D. Young

Yes, Bonnie, I think what I'm seeing, I'll just tell you personally is, I'm out in the trade and I talk with consumers and customers, I think a lot it 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, but you have people talking about it causing Alzheimer's, it's causing -- makes you want to eat more, will increase obesity. Social media has stepped it up even more than what it was before. And so 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, with -- 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, that it's going to be something that will 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. So it is a concern. As we look at it, I mean, we kind of went through our numbers, I mean our regular, especially with Dr Pepper, was looking really good. The diets' what effected the most of the decline. So it will be a major focus for us. I talked earlier about how we're looking at other non-carbs and the sweeteners, but 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 continue to invest behind the brands.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Okay. And then, could you actually just touch on the distribution of your Core 4 TEN platform, I guess, versus DP TEN. Given your ability to possibly better control placements of these brands, do you see greater incremental gains for the Core 4 over the long term?

Larry D. Young

Yes, I see greater gains there. It's always -- things are always easier when you have control of it. And we've been able to do that with the core. But we also has some great programs put together for our DP TEN. Jim Johnston and his team have programs out there to help us kind of get it reignited. It's been out there a little over twice as long as the Core TEN and we see some opportunities there. But when you look at the Core, with us just being out there, I think our full national launch was in March, already had 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. So again, going back to the sweeteners, we've got to let people know that these products are good, they're safe and they're also fun.

Operator

Our next question comes from the line of Mark Swartzberg of Stifel.

Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Two questions. Marty, one, I wanted to inquire a bit more on Bryan's question and this leverage number is in the neighborhood of 2, a little bit shy of 2. And can you just help us understand, relative to EBITDA, can you 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. So can you help us understand why that is, this threshold? And 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?

Martin M. Ellen

Yes, sure, Mark. So let's go back to teeing off Bryan's question. There's nothing magic about the leverage ratio at roughly 2. We talked early on about targeting actually 2.25x EBITDA, but there was nothing solely magical about that. It does triangulate for us, with respect to our long-term, our BBB rating with the rating agencies, BBB+. So we want to always pay some attention to that. We're not -- 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 to -- I assume your question goes to significant leverage, we can always do some marginal things but to add significant leverage solely for the purpose of buying back shares, and would that be for real value accretiveness or simply to stairstep 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 it in the past. We're focused on organic growth. There could be opportunities out there to use our balance sheet and we would not want to foreclose on that. I'm not suggesting that we're going to do that, but the one thing -- 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 2 systems are. And that gives us a great view of opportunities and some of those could come with some investment for us. So we think, right now, the sort of distribution policy around free cash flow, maintaining balance sheet flexibility has worked for us. And so, 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 costs in there, the mark-to-market comparison was sort of a negative -- $3 million. And 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, and we've been able to adjust that down based on some settlements by about $6 million. And those are some of the non-recurring type items that flowed through SG&A this year versus last year.

Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

But even if I'm looking at the right numbers, I think on a comparable core basis, it was down quite significantly. And I believe marketing spend was up in the period. So can you help us a little bit more there?

Martin M. Ellen

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

Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

And bonus accruals, can you -- is that a component there as well?

Martin M. Ellen

Not at all.

Operator

Our next question comes from the line of Ali Dibadj of Bernstein.

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Wanted to get a better sense, still, of the ROI you see on the spending on TEN, and kind of the level of your commitment. Because the Core 4 volumes remain relatively flat despite all this investment. And really, only Canada Dry was up, while the other 3 were down, with or even a little bit worse than the category, from a volume perspective. So I'm trying to get underneath what gives you the confidence that you actually spend even more on the TEN franchise? And I ask that purely in the context of what you're 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. And look, aspartame is in TEN, it's got Ace-K and HFCS in it, too. But it's in there. So I'm trying to get a sense of how to tie all that with a sense of -- is it the right thing to do, to incrementally spend on this business, given the results you've seen?

Martin M. Ellen

Ali, it's Marty. Let me talk to that. So when we went into TEN, it was clear to us, and it's still pretty clear to us, although I would say there's been a little bit of change on the diet front, but 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, right, that the aspartame, which is in TEN is becoming an increased area of focus, but there's still a lot population of people that simply do not want all the calories in a regular product, but still want the taste of a regular product. And I'm -- 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 9 months, we done over 14 million cases. Now, okay, in the larger scheme of things in the entire CSD category, that may sound small. Not so small to us, and if we accept the Nielsen Homescan data that 51% are coming from outside the category. I mean, this isn't cannibalization of our own brands, we know there's some, we've probably cannibalized some, both regular and Diet Dr Peppers, say in the case of DP TEN and with the other brands as well. But I'll tell you, for 1 year, not even a year in on the Core TEN, and okay, maybe we're going on 2 years now on Dr Pepper TEN, give or take, it is way too -- 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, but we'll talk about our investment spending on this next year. I haven't quoted a number yet, but this is -- in terms of, as Larry has said, developing consumer awareness, getting people to know what this product is, I mean, we've got repeat purchase rates that are 4 times the rate of trial, this is very good. So we got to get more people to try it. So 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, and we're not seeing that data today, no.

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

So still a lot of room on the caloric intake dimension based on raising trial for TEN, is another way to say what you just said, I think.

Martin M. Ellen

Sure.

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And moving more towards kind of the overall top line, I mean, you certainly -- as you mentioned took down the top line guidance from 2 to flat, which suggests a pretty decent deceleration in Q4. Would love a little bit more explanation about that, you touched on it. But want to get a little bit underneath that. Particularly in the context of what, Coke, as an example, insists time and time and time again, over the past couple of weeks, at least, that they're going to raise prices pretty significantly in cities [ph] in North America. And again, you and I will both believe it when we see it. We'd like that happen. But what's driving the deceleration, in particular, in the short term, given your Q4 guidance?

Martin M. Ellen

Well, Ali, I would just tell you that our guidance for Q4, what we see in Q4, is we're seeing a continuation of the more recent trends. So that, I don't think that, sort of 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 many of you also see in terms of category performance. I want to come back, though, and it comes back to -- because this question is sort of, John sort of was talking it, about the impact of carbs and non-carbs. Because 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. So 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 operating profitability. This is where the opportunities in non-carbs in our portfolio today, where brands that have, on a relative basis, small volumes, contribute a lot of profit. We have a saying, we could actually make more selling less cases. And that's true, okay. And we see this clearly in the Warehouse Direct business. They suffer hugely from the loss of top line from Hawaiian Punch, but as they sell more Mott's and applesauce, Clamato, which has done reasonably well, they make a lot of money. And so, the challenge for us is going to be within, say, the non-carb category, where, as Larry has said, focusing on profitable volume. And we've talked to many of you about, bulk water is not in the cards but making money with Fiji, making money with Vita Coco is good for us. Snapple, in the tea category, and growing it at the premium level. The whole Mott's category, it's where we're really focused. The question for us is doing the things that grow operating profit.

Operator

Our next question comes from the line of Dara Mohsenian of Morgan Stanley.

Dara W. Mohsenian - Morgan Stanley, Research Division

So 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 you think the weakness is from this year, in CSDs, as we look out to 2014 and beyond? And then, also, can you comment on how close you think you are to cracking the innovation code and commercializing a product with a natural sweetener?

Larry D. Young

Well, I think, 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, I mean, it's -- this is a new thing that's came up. I think with the right facts out there, we can help turn that back around. We do that, that can get us back into positive territory again. As far as adjusting my numbers, I mean, we look at it and we're going to go after every case we can get. As we get to the fourth quarter and get a little better view of what we think is out there for 2014, we'll update everybody. The trends definitely told us that we needed to say we were going to be flat, basically flat for this year. But again, I'll go back to what Marty said, I mean, 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.

Operator

Our next question comes from Bill Schmitz from Deutsche Bank.

William Schmitz - Deutsche Bank AG, Research Division

How do you feel about the distribution of your structure given how sluggish volumes have been? I mean, sort of, my broader question is, obviously, Coke's doing refranchising, Pepsi's going to talk about what they're going to do in February. But it just seems intuitively logical for me to try to get more consolidation even across the brands on the distribution side. So maybe anything you're kind of working on, on that front? And I realize that might be competitively sensitive.

Larry D. Young

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

Dara W. Mohsenian - Morgan Stanley, Research Division

Because, I mean, the reason I asked is just because, obviously, capacity utilization is probably pressured right now. And I'm just wondering, like longer term, do you think there's sort of a need to have a white system?

Larry D. Young

Yes, you're going to have to always have a white system. If you just look at the -- I think people sometimes forget that 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. But 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, of the startups that Marty mentioned a while ago, would have nowhere to go. So I think it's going to be -- it's sustainable and it'll be here long term.

Operator

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

Larry D. Young

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

Operator

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

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