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Dr Pepper Snapple Group Inc. (NYSE:DPS)

Q4 2013 Earnings Conference Call

February 12, 2014 11:00 a.m. ET

Executives

Carolyn Ross - Vice President of Investor Relations

Larry D. Young - Chief Executive Officer, President

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

Analysts

John A. Faucher - JP Morgan Chase & Co.

Bryan D. Spillane - BofA Merrill Lynch

Judy E. Hong - Goldman Sachs Group Inc.

Brett Cooper - Consumer Edge Research LLC

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

Amit Sharma – BMO Capital Markets

Bill G. Schmitz – Deutsche Bank Securities, Inc.

Bonnie Herzog – Wells Fargo

Jesse A. Reinherz – Stifel Nicolaus

Michael Steib – Credit Suisse

Operator

Good morning, and welcome to Dr Pepper Snapple Group's Fourth Quarter and Full Year 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, you may begin.

Carolyn Ross

Thank you, Brandi, 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. It’s no secret that 2013 was a challenging year. We're up against the toughest CSD category head winds I've seen in my career. And yet, our teams remained focused on delivering against our strategy. And I am proud of what we were able to accomplish.

First, we launched our Core 4 and RC TEN platform nationally, providing regular CSD consumers with an option to enjoy the taste and now feel of a regular CSD but with only 10 calories per 12 ounce can. We launched Snapple regular Half 'n Half Lemonade Iced Tea on the heels of our successful Diet Half 'n Half launch in 2012. We brought Hawaiian Punch to the morning occasions with Aloha Morning, giving moms and kids something to get excited about. The same grade Hawaiian Punch tastes with 40% less sugar. And we continue to expand our reach into the segments leveraging our allied brands.

In the coconut water category, we grew Vita Coco volume 37%. We continue to connect and engage with our consumers through innovative and powerful marketing programs, including our well known and loved Dr Pepper College Football Tuition program and with our strong brand equity scores, we know these programs resonate with our consumers.

From an execution standpoint, we continue to gain distribution and availability of our key brands across key packages with Snapple increasing 3 points in grocery and almost 2 points in convenient and gas, and Mott’s increasing over 3 points in grocery. And our CSDs gained space and convenient gas despite the category headwinds.

We gained over 43,000 new fountain valves, providing thousands of additional sampling opportunities and brand impressions for the Dr. Pepper trademark. RCI continues to be the foundation on which the organization operates, gaining more and more momentum every year. I’m pleased to say that after three years we exceeded our initial financial target with $169 million in annualized cash productivity. But as you’ve heard us say RCI never is. It is simply the way we do business. We returned all of our free cash flow to our shareholders totalling $702 million in 2013. And as further commitment to our shareholders, last week we announced an increase to our quarterly dividend of 7.9%.

Moving onto results for the quarter, bottler case sales declined 2% on 3 points of positive price and mix. Dr. Pepper declined 1% and our Core 4 brands declined 4%, as we continued to face strong category headwinds. Hawaiian Punch declined 8% while Snapple grew 3%. Mott’s and all other brands were flat.

For the year, bottler case sales declined 2% on 3 points of price and mix. Our flagship Dr. Pepper declined 2% for the year and our Core 4 brands, which include our TEN products, declined 1% both outperforming the overall CSD category. Hawaiian Punch declined 9% on lower promotional activity and overall weakness in the juice drink category. Snapple grew 2% for the year and Mott’s grew 3% as we continued to close distribution gaps across both juice and sauce. All other brands declined 1% for the year.

On a currency neutral basis, net sales declined 1% in the quarter. Core operating income increased $30 million or 10% and core EPS increased 18%. For the year, currency neutral net sales were flat. Core income from operations increased $40 million or 4% and core EPS increased $0.28 per share or 10%. Our TEN products are important and strategic priority for us and we will continue to invest behind them in 2014. We believe this is one of the important components of innovation in CSDs to bring regular consumers who either left the category or cut back on the consumption back to the category and to the brands that they know and love.

Our first year results were encouraging. Our recent Nielsen Homescan Study shows that 52% of TEN’s purchases are incremental to the CSD category, proving that we’re bringing back lapsed consumer occasions. The repeat rates on the platform were strong, nearly three times higher than trial rates, telling us that once the consumer tries the product they will come back for more. Based on these learnings we will focus our 2014 efforts on consumer education and awareness to drive trial of products and our new media campaign does just that.

We have teamed up with Chelsea Handler for our anti-solution campaign telling consumers to not give up what they love and drink TEN. Chelsea has been featured on packaging, in-store displays, merchandizing and our digital campaign. We’ll continue to drive sampling with the National FSI and other valuable offers.

Now let me spend a few moments talking about our 2014 priorities and plans. Our fundamental strategy hasn’t changed. We will continue to build our brands and execute with excellence in the marketplace, all underpinned by the principles of RCI. I’ve just said we are committed to the TEN platform and we’ll continue to drive it in 2014. We’re launching some exciting new innovation on several of our key brands ensuring that we’re providing consumers with options to support a balanced lifestyle. And our sweetener development has successfully progressed to the point of enabling us to test all naturally sweetened 60-calorie versions of some of our brands in 2014.

And as we continue to develop and execute consumer programming, we’re sharpening our marketing return on investment capabilities, ensuring we optimize every dollar we spend and actively shifting dollars from low-return vehicles into higher-return vehicles. Execution is key in this business and we’ll continue to strive for excellence through our third party bottling partners and our own DSD, gaining incremental displays and points of interruption while ensuring that we always have the right product in the right package at the right price in every channel.

Living [ph] with the Hispanic consumer is critical. With our strong flavor portfolio and our dedicated Hispanic sales and marketing team that are focused not only on national programs but also on local activation and programming in strategic markets we are poised to win.

From an RCI standpoint, goal deployment is in place across the organization ensuring alignment and focus on our key initiatives. We’re also investing on our strong performing leaders, training them to become stewards of RCI throughout the business.

We’ve got a great starting line-up for programming for 2014. Dr. Pepper returns to the ACMAs showcasing that Diet Dr. Pepper and Rascal Flatts. We’ll give away the VIP experience and private concert with the band and free music downloads on our 20-ounce bottles. Our popular one-of-a-kind campaign features one-of-a-kind individuals like Grammy Award winners, Macklemore and Ryan Lewis and recording artist, Romeo Santos.

7Up is teaming up with Project 7, an organization that makes and sells everyday items and whose sales helped fund seven areas of need around the world. Millennial consumers can make every bottle count by redeeming under the cap quotes on 20-ounce bottles to choose which area need receives the benefit. And 7Up isn’t stopping there. We’re also teaming up with 7 Electronic Dance Music DJs to make the brands anonymous with EDM culture. We’ll have a new media campaign with onsite activation and sampling at key festivals in the strategic markets.

We’re leveraging two of our largest trademarks, Canada Dry and Schweppes to capitalize on the growth in carbonated water category. We’re expanding Canada Dry’s Sparkling Seltzer Waters into new markets as well as launching a new peach mango flavor and we’ll launce a line of Schweppes sparkling waters nationwide.

Moms and kids will love the new Mott’s juice drink line and 3-fold flavors like Wild Grape Surge. The line is made with real fruit juice, has 40% less sugar and no artificial sweeteners. And we’re adding new consumer preferred flavors to our successful line of Snack & Go Applesauce Pouches. Snapple Apple is one of the brand’s most popular single serve flavors. And this year we’ll expand into a take-home packaging. We’ll also add new flavors to the current 64-ounce take-home package.

Consumers have told us they want a less sweet tea. So we’re testing Snapple Straight Up Tea across several markets. Straight Up Tea has a true tea taste and is made from all natural black tea with a touch of real sugar and only 40 calories per serving. And we’ll continue to leverage our allied brands, gaining entry into emerging and growing categories with Vita Coco and Bai, an all natural juice made from coffeefruit.

I’m confident these programs in place, we can drive the business in 2014. Now let me turn the call over to Marty to walk you through some of the financial results and our 2014 guidance.

Martin M. Ellen

Thanks, Larry and good morning, everyone. For the fourth quarter, reported net sales declined 1% in line with our previous guidance, resulting in net sales that were flat for the full year. Sales volume declines of about 3.5% in the quarter and an unfavorable trade comparison to the prior year were partially offset by almost 2 points of package and product mix and just over 1 point of pricing.

Reported gross margins were up 100 basis points in the quarter increasing from 59.2% last year to 60.2% this year. Price mix increased gross margin by approximately 80 basis points but was offset by lower volumes and an unfavorable trade comparison to the prior year.

Based on our year-end inventory balances, which included a higher volume of apples but at significantly lower prices than last year, we recorded a $14 million LIFO inventory benefit in the quarter. This compares to an $11 million LIFO inventory charge in the prior year improving year-over-year gross margin comparison by 170 basis points. This simply means that with respect to apples we benefited this year by lapping the higher cost for apples a year ago as apple prices are now at normal historical prices.

Changes in certain commodity prices at the end of the quarter caused us to record a $3 million unrealized mark-to-market loss on commodity hedges with approximately $4 million recorded in cost of goods, offset by $1 million gain reported in SG&A. This compares to a $1 million unrealized mark-to-market loss a year ago which was all recorded in SG&A. The net effect of these items reduced reported gross margins by approximately 30 basis points.

Higher input costs primarily PET and packaging materials combined with certain higher manufacturing costs reduced year-over-year gross margins by 80 basis points. However, solid RCI productivity improvements enabled us to offset about 40 basis points of this decline.

SG&A for the quarter, excluding depreciation, decreased by $28 million. The unrealized mark-to-market comparison, I just mentioned, reduced SG&A by $2 million. And as we highlighted on our third quarter call, marketing spend declined as expected by $9 million due to this year’s phasing resulting in four-year marketing spend of $5 million or a little over 1%. We also benefited from lower people related costs including favorable health and wellness cost trends.

As you saw in our earnings press release, in the quarter, we recorded a $56 million non-cash charge related to our intent to withdraw from a multi-employer pension plan. This was excluded from core earnings. The paydown of this liability is expected to occur over approximately 36 years at the annual amount similar with the existing funding for this plan.

Depreciation and amortization expense was flat in the quarter at $29 million. Reported operating income for the quarter was $264 million compared to $292 million last year. Core operating income of $323 million, as shown in the reconciliation tables in the press release, was up 10% from $293 million of the prior year with the core operating margin of 240 basis points to 22.1%. For the full year, core operating income of $1.123 billion representing 18.7% of sales was up almost 4% from last year’s $1.083 billion which represented 18.1% of sales.

Below the operating line, net interest expense for the quarter was $28 million, $2 million below last year. Our effective tax rate for the quarter was 34.2% and our core income tax rate was 34.8%. This brings our full year core income tax rate to 35.3%.

Moving onto cash flow. For the year, cash from operating activities was $866 million and capital spending continued to decline to $179 million. This brings full year reported free cash flow to $687 million or 105% of 2013 core net income of $655 million. For the year, total distributions to our shareholders were $702 million with $400 million of share repurchases and $302 million in dividends. Our actual year end outstanding shares have declined below 200 million or 198 million to be more precise.

Since the 2010 inception of our share repurchase program, we have repurchased about 62.5 million shares at an average price of $38.86.

And as Larry mentioned, we remain very committed to returning excess cash to our shareholders over time as we further demonstrated last week with our announcement of a 7.9% increase to our quarterly dividend.

Now, moving onto 2014 full year guidance. As we enter the year the CSD category continues to face significant headwinds with ongoing consumer health and wellness concerns, particularly around artificial sweeteners as well as sugar content and we expect this trend to continue in the near term. We will remain focus on driving our important innovation platforms, including further advances in our sweetener capabilities, to build our brands by providing consumers with a variety of great tasting products to support their balanced lifestyles, drive execution excellence in the marketplace and continue to develop broad organizational RCI capabilities, which we expect will deliver further financial improvements.

Based on the plans we now have in place, we believe our 2014 net sales will be flat to up approximately 1%. With 80% of our volume facing CSD category headwinds and the impact of the one peso per liter sugar tax on our business in Mexico, total company sales volume is expected to decline over 1 point with growth in our non-carb portfolio and allied brands partially offsetting this decline.

On a total company basis, we expect combined price and mix to be up just over 2%. We have raised prices in Mexico as a result of the sugar tax and expect this will contribute approximately 65 basis points of this positive pricing impact. Our January 1 concentrate price increase will drive another 40 basis points of growth and the remainder will be mix from growth in our higher priced non-carb and allied brands.

Moving onto cost of goods sold. Considering our hedged positions and current market prices for our unhedged positions, we expect packaging and ingredient’s deflation primarily from lower sweetener and apple costs. This is expected to reduce total cost of goods inclusive of LIFO by approximately 1.5% on a constant volume mix basis.

Separately, the impact of the Mexico sugar tax, which is levied based on manufactured volume, will increase total cost of goods by approximately 2%. For modelling purposes, remember that growth from our non-carb portfolio will also increase cost of goods dollars. We currently believe that the net effect of all these factors should result in 2014 gross margins consistent with those achieved in 2013. We’re seeing some upward pressure on transportation cost which is expected to add approximately $17 million to our cost base in 2014.

We’re expecting an increase of approximately 10% or $12 million in health and welfare costs due to medical cost inflation and fees we will pay under the Affordable Care Act. General inflation in our field labor costs will also increase total people related costs by approximately 2% or about $20 million. RCI productivity benefits will help offset a portion of these increases.

We’re continuing to enhance our marketing return on investment capability and we’re working harder than ever to ensure that we’re getting the best return we can. We’re shifting marketing dollars across media platforms from traditional to digital and focusing more programs and tie-ins retail activation. In addition, spending across our TEN platform will continue to be approximately $30 million. As a result, we expect marketing spend to be approximately 7.5% of net sales in 2014. Though this is lower than our marketing spend rate in 2013, it is still a very healthy investment level for the business.

Now moving below segment operating profit. Our net interest expense will be around 4.4% on our $2.5 billion of debt and our full year core tax rate is expected to be at approximately 35.5%. We expect capital spending to be approximately 3% of net sales and we expect to repurchase approximately $375 million to $400 million of our common stock in 2014 subject to market conditions. Considering all of these items, we expect full year core earnings per share to be in the $3.38 to $3.46 range.

Before I turn the call back over to Larry, let me highlight a couple of phasing items that will help you update your models. First, the packaging and ingredients deflation will be skewed towards the first three quarters of the year. Second, the transportation cost increases will be spread fairly evenly across the year. Third, people cost inflation including the health and wellness increases will be more pronounced in the third and fourth quarters. And finally, remember, that we are no longer recording other income associated with our former tax indemnity agreement with Mondelez. So you will need to remove these from your models.

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. We continued to execute our strategy in a very challenging environment, ensuring that we build our brands while executing with excellence in the marketplace. We have been and will continue to launch new innovations that offers consumers options to help them lead balanced lifestyles. We remain focused on managing the business prudently for the long term as reflected in our full year results. We’ll continue to invest in our brands and our people while ensuring we optimize every dollar we spend. RCI is the foundation of our business and it will continue to drive improvements and provide financial flexibility. And finally, we remain committed to returning excess free cash to our shareholders over time.

Operator, we are ready for our first question.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is coming from John Faucher from JP Morgan.

John A. Faucher - JP Morgan Chase & Co.

Thanks. One quick question, sort of a housekeeping question which is on sort of where corporate came in for the quarter. You have the segment operating profit numbers, but I’m assuming we have to make some adjustments for the pension charge. So that will be the first question. And then secondly, can you talk about sort of the underlying pricing dynamic in the North American CSD category? Cott just actually talked about it may be getting a little bit better in the first half of the year, but what are you expecting and building in as we get closer to the summer selling season? Thanks.

Martin M. Ellen

John, good morning, it’s Marty. Let me take care of the housekeeping on the numbers. The $56 million non-cash pension charge in the segment table is actually included in packaged beverages, not in corporate.

John A. Faucher - JP Morgan Chase & Co.

Great, thank you.

Larry D. Young

And John in pricing, we think the pricing for the year is going to be still reasonable. We saw a little activity towards the end of the year for the holidays, but so far this year it’s looking good. I think everybody would be looking at what we can do bond market opportunistically but we’re not planning a lot of pricing on our plan and we think where the prices are at now, we can do quite well with that.

John A. Faucher - JP Morgan Chase & Co.

Right.

Operator

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

Bryan D. Spillane - BofA Merrill Lynch

Hi, good morning.

Larry D. Young

Good morning Bryan.

Bryan D. Spillane - BofA Merrill Lynch

Just a couple of questions regarding the outlook. I think and Marty, just want to make sure I’m understanding, you’re building a bridge for operating income for ’14. Just kind of backing into some of the other items you’ve given in terms of the guidance, operating income will be up somewhere in the 5 or 6% range. And with revenues flat to plus 1, gross margins flat, it means the SG&A leverage is going to drive I guess about 4 points of that. And so as we look at that SG&A leverage, how much of it is just the marketing expense coming down and how much of it is mix or RCI? I’m just trying to get a better understanding of kind of what the drivers are of that and like how visible that is, how variable that might be.

Martin M. Ellen

Okay. I think, yeah Bryan, I think you have it. As we’ve guided, flat to up 1 on the top line constant gross margins as a result of sort of the pluses and minuses that I went through in my script. We’re really pleased with our SG&A productivity. This year we measured about $16 million in year-over-year operating income improvement as a result of RCI initiatives and we’re expecting as I said in my remarks, notwithstanding some of the inflationary items, whether they be healthcare, whether they be transportation costs, we’re going to beat back a big chunk of those with planned RCI improvement.

Bryan D. Spillane - BofA Merrill Lynch

Okay.

Martin M. Ellen

So SG&A is going to be a big contributor. As I said in my remarks, we’re going to spend 7.5% of net sales on marketing, a little lower than this year, but if you look back historically, sort of in the range where we’ve been and I’ll repeat what I’ve said to many of you as I’ve travelled that our learnings from our MROI developing capabilities is giving us some insight into where the – where we should money and where we shouldn’t spend money. And we’re really comfortable with that. We’re funding as Larry said, all of the important initiatives next year including our rolling out some test products that we think will be squarely within the crosshairs what consumers are going to be looking at for naturally sweet and beverages and reduced calories and that’s where we settled on the marketing budget for next year.

Bryan D. Spillane - BofA Merrill Lynch

Okay, thanks for that clarity. And just Larry, maybe if you could just give us maybe a first impression, any first impression that you’ve seen in terms of how consumers have responded in Mexico to the higher prices and how the market has – or how the industry has sort of dealt with it. If you could give any color at all in terms of how that’s gone so far, that’d be helpful.

Larry D. Young

Not really Bryan, it’s still so early with it just coming out and a lot of it’s got some carryover and it’s just not completely across the market. We’re seeing it, there is an impact but the size of it, I’d be afraid to even try and dimentionalize that right now.

Bryan D. Spillane - BofA Merrill Lynch

Do you sense that consumers might have bought ahead of the increase, like there was any sort of pantry loading ?

Larry D. Young

We didn’t notice it in December.

Bryan D. Spillane - BofA Merrill Lynch

Okay.

Larry D. Young

Our clients stayed pretty steady through December.

Bryan D. Spillane - BofA Merrill Lynch

Okay, thank you.

Larry D. Young

You’re welcome.

Operator

Your next question comes from the line of Judy Hong of Goldman Sachs.

Judy E. Hong - Goldman Sachs Group Inc.

Thanks. Good morning.

Larry D. Young

Good morning Judy.

Judy E. Hong - Goldman Sachs Group Inc.

So it’s really admirable that you’re doing really well on the costs side and done – and growing profit in the context of a challenged volume situation. I guess my question is just really thinking about the industry and your business over time, what can we really look forward to get volume growth again? And I guess in the context of the marketing spending coming down and I hear you really want to find the right opportunity to spend money, but just really want to understand how you’re thinking about the growth opportunity for some of your core brands. And I think the industry is challenged but just beyond that, can you do more to really accelerate the top line growth?

Larry D. Young

Well, rest assured, Judy, we never stop looking at that. As I said in my prepared remarks, we expect the headwinds to continue in ’14. I love how the year started so far. The weather has been so wonderful, kind of ties right into the soft drink business. But I’m bullish on how we’ve started the year, even with the weather. We will never stop looking at ways to grow, but we want to make sure that all that growth is profitable. As I mentioned, we’re going to be testing in select markets across the U.S. here in not too long a time, a 60 calorie natural sweetened CSD in some of our top brands and we feel good about that. Also, TEN, we’re still getting new distribution of TEN. We just got some new authorizations on the West Coast and so we’re still bullish on that and we’ll continue to spend behind it. As far as the marketing front, we’re not concerned at all at where the dollars are coming in. We don’t really worry that much what the dollars are. It’s what we get in relevance and activation and we’re finding that we’ve got programs that are working better for us. As Marty mentioned, we’re going to continue to spend 30 million on TEN and we think we have every one of our brands where we can continue to build and grow them as we get down the road and get past some of these headwinds.

Judy E. Hong - Goldman Sachs Group Inc.

Okay. And then Larry, I just wanted to get your thoughts on the announcement between Coke and Green Mountain, the partnership that they’ve announced, whether you think that that could potentially help the category, bringing some excitement into the category. You’ve got a Snapple brand in the Keurig system. Is there some opportunity to expand your brand offering with the likes of Green Mountain? And then just in terms of the potential on that could have on your bottlers?

Larry D. Young

Well I think it was a great move for Coke and Green Mountain both, news to the category is always good. I think we all have a lot of work to do on how do we do this as partners with our bottlers. They’ve got franchises out there that my job is to make sure that we protect their equity and that we’ve also got to look at it and make sure we’re doing the right things for the future on growth and we may have to do some things different. So we look at all these things like with the K-Cup and now we’ve got Amazon coming out and Wal-Mart.com and there are changes to our industry. It’s a different way of going to market than we’ve had before and I think all of us in the industry are sitting down, figuring out how do we do this the right way where it’s a win-win for everybody.

Judy E. Hong - Goldman Sachs Group Inc.

Okay, thank you.

Larry D. Young

You’re welcome.

Operator

Your next question comes from the line of Brett Cooper of Consumer Edge.

Brett Cooper - Consumer Edge Research LLC

Good morning guys. A quick question, in ’13 you reached most of your pricing – by 3.5% or so. It appears that you reduced it by another 150 basis points, increased marketing by 5 million and it seems that retail prices for CSDs are up a fraction, about three-tenths of percent. And given that we on the outside don’t have all the information, it would be great to hear any insights you have on this relationship as it seems that 2014 is setting up for something similar. I’m just trying to get an understanding of how sustainable this is as a source of growth for you guys in the coming years.

Martin M. Ellen

Yeah, it’s Marty. I’ll deal with some of that. I’m not sure I can connect all the dots there for you. I’m not sure I recognize all the numbers you have there either. So I’ll tell you, our concentrate price increase is net of funding, we paid bottlers in money that we put aside for our bottlers to fund products. In 2013, it probably is at 2% but we may have been netted a little less and that’s going to be sort of where the number lands in 2014. And I would only tell you, concentrate costs is a pretty small portion of the total package costs to our bottlers.

Brett Cooper - Consumer Edge Research LLC

Okay. I mean my understanding was your beverage concentrate business price mix was up 5 and so if you had 2% on the net, right, I mean is the other 3 points to reduce discounts? How do you get to – can you bride the 5 for me?

Martin M. Ellen

I can – there is a factor in our beverage concentrate business this year that actually relates to our fountain business, it has nothing to do with our bottle and can business. We have increasingly and to our advantage, are producing more fountain syrup in our system, taking some of that away from some of our bottlers. And the syrup price per case, the revenue per case is higher than simply selling the concentrate to them to make the syrup. So we’ve been shifting some more fountain business in house, it raises the revenues, it’s good – it also raises the transportation costs. Now we’re shifting syrup but still good margins. It’s not a factor we’ve talked much about this year but it’s had a little bit of impact on the beverage concentrate numbers.

Brett Cooper - Consumer Edge Research LLC

Okay, that’s great. Thank you.

Operator

Your next question comes from the line of Ali Dibadj of Sanford Bernstein.

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

Hey guys, how are you?

Larry D. Young

Good.

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

So I wanted to focus in on first, just on the beverage concentrate margin, it makes sense that the pension prepayment or withdrawal I guess is in there. I want to understanding whether there would be there’d be ongoing benefits. And if you endeavor to strip that out for us, can you talk a little bit about the RCI impact on that business unit in particular – sorry, packaged beverages on that piece of the business in particular especially from the opportunity within the DSP system that you have?

Martin M. Ellen

It’s Marty, I’ll take it. You mentioned beverage concentrate but you corrected the packaged beverages. I want everybody to understand that on a reported basis, the pension charge, the 56 million on a segment basis is in packages beverages. Of course we’ve taken it out on a core basis, but we don’t provide core reconciliations by segment. So that’s out and I just want to make sure everybody understands the pension liability. As I said in my prepared remarks, from a cash funding point of view, which is what’s really important here for us, next 36 years, we’ll be making contributions to this plan more or less in line with what we’ve been paying, so no impact there. Okay, in terms of packaged beverages, you have to mount -- I mean, RCI, of course, we’ve had probably biggest impact – in fact, in beverages it’s had a big impact in Mexico as well. And we made a lot of great progress in 2013, I’ve talked before about lean practice in warehousing and delivery and selling. And the better part of the roughly $16 million of year-over-year cost improvement we’ve had this year, it’s been in – I quoted earlier – as describable to RCI has been in packet beverages, so it’s helped them quite a bit.

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

That’s helpful. And so if you try to piece that together with the volume deleverage that you’re getting, is there any way to quantify really just that rate of volume deleverage that you’re seeing given the volumes in that segment in particular and kind of how you’re offsetting that with RCI, in terms if you are just sort of comment to how much that you are offsetting?

Martin M. Ellen

Ali, here is what I would tell you about the economics of packet beverages, as you think about it first and foremost in terms of declines in volume vis-à-vis, which of course hits them in terms of cost absorption. Where they are actually – and where we are actually making improvement besides just productivity through RCI is mix shift in our non-carb portfolio. So, whether you’re talking about, you know, Bai the Coco [ph] – Larry mentioned 37%, our recent announcements on product like, Bai and Fruit2O and all of these allied brands, as we call them, that are becoming very important in our portfolio that have reasonably good growth prospects particularly in the near-term as we see it, is actually helping packaged beverages quite a bit. Don’t forget too that the – one of their 800-pound guerilla product is Hawaiian Punch. Now, we talked a lot about Hawaiian Punch and the fact that it hurts their top line when volumes are down but does not have such a meaningful impact on the operating profit line. So, you see the volume decline, you don’t see it on the operating profit line. Yes, CSDs are down but we claw back with non-carb product, by the way Mott’s – we shouldn’t forget Mott’s did well this year, both, in sauce and in juice. These products shift the margin up in PB reasonably importantly.

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

Yeah. Okay. And then last question is, what would core focus our CB in term of volume growth without can? And I guess how does that – what does that suggest about your still 3% to 5% long-term top line target that frankly I’m not going to believe and I don’t wonder how you guys do so too? So kind of two questions that, one, just the TEN and then one long-term. Thanks.

Larry D. Young

Labels have been down. I mean, the core forward have been down greater but I think still above the industry. That’s one of the reasons we’re staying so focused on, is that we see that we’re bringing people back to the category that have less CSDs and then getting greater CSD occasions. So, yeah, they would have been down more but I think still above what we would have seen in the category.

Martin M. Ellen

Ali, it’s Marty. Look I took the 3% to 5% off the table last year sometime, clearly – because, look, the environment, as everybody on this call knows, is different today than it was three or four years ago. We understand better what’s happening with consumer on the health and wellness front. Everybody sees how the CSD category has performed, you know, we talked last year a lot about particularly the big reductions in diets, which was a relatively new factor versus two years ago and the consumer and what’s happening to the consumer’s discretionary income, you know, whether it’s higher taxes, whether it could be impact of food stamp reduction. So, the world has changed but we believe what we’re going to demonstrate is that even on lower volumes we can make more money.

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

Look forward to a healthy and a strong result. Thanks, guys.

Larry D. Young

Thank you.

Operator

Your next question is from the line of Amit Sharma of BMO Capital.

Amit Sharma – BMO Capital Markets

Hi, good morning, everyone.

Larry D. Young

Good morning.

Amit Sharma – BMO Capital Markets

Larry, you talked about artificial sweet – but not artificial, the natural sweetener soda and yet you’re starting to bring it to the consumer. Can you provide just a little bit more color in terms of what’s the platform that you’re using for that, what kind of incremental marketing spend we are looking behind that product and what is the internal expectation?

Larry D. Young

We are not going to give a whole lot because, you know, for competitive reasons, but we’ve worked – our R&D team has put together proprietary blend with Stevia and sugar that we’ve been very pleased with. One thing that we’ve been working on a while, but we will not sacrifice the taste of our brands. And this will be a very limited test in certain markets that we’ll go out and the biggest thing for this is to get the consumer insights. We’re working with some national retail partner so that we can both look at the data. We hear what people are telling us, they want natural but we want to see if they buy the natural and where should we put the natural so it’s going to be a test that we’re excited about but I want to emphasize it is a test for, you know, we’ll decide later what type of rollout we’ll do on it.

Amit Sharma – BMO Capital Markets

And the expectation is that this will stay but then Dr. Pepper Bottling System will not go to your bottling partners?

Larry D. Young

Well, right now, we’re just doing the test. I mean, it’s within our system and then we get the data points, that’s when we share with our bottlers. And I think, you know, we have talked to some of them already, they’re very excited about it. Everyone is excited about finding something natural but we want tot be able to share the facts with them on what it does in these markets.

Amit Sharma – BMO Capital Markets

Got it. And one more, your private level competitor on the juice side indicated that they will probably spending a little bit more in the juice category and then you talk about apple sauce being, you know, one of the failing commodities, is there expectation that you will also spend a little bit more to get volumes going in that segment?

Larry D. Young

No, we’re happy with what our volumes doing right now. We’ve got plans in place that we put together last year. We will stay with those. We’ve also got innovation coming in with our new lineup of Mott’s fruit flavors. We’ve got more Mott’s pouches coming out with different flavors and so we’re very happy where we’re at in the category right now.

Amit Sharma – BMO Capital Markets

Great. Thank you.

Operator

Your next question comes from the line of Bill Schmitz with Deutsche Bank.

Bill G. Schmitz – Deutsche Bank Securities, Inc.

Hey, you know, all the speak in your private level competitors calls, I mean, everyone has been sort of lamenting the capacity situation in the U.S., so do you think there is room for a broader restructuring as you kind of look at your global manufacturing footprint and obviously to previous question, you talked about, you know, the 3% to 5% no longer being realistic, so is room incrementally for maybe a bigger, broader restructuring on the cost of goods sold side?

Martin M. Ellen

Well, I guess Dr. – look, as industry volumes go down, of course, that’s going to yield excess capacity and everybody is going to have to decide how they want to deal with that. Some of our RCI is getting after us but it’s going to be an industry issue for everybody depending upon what they’re making in those plants. Obviously, we see the Nielson data, we’re not really in the private label business in any degree and obviously those volumes have taken a much, much greater hit than branded volumes, so of course it’s going to put pressure on manufacturing capacity and what to do with that capacity. [Multiple Speakers]

Martin M. Ellen

So, there’s a trend in business, in manufacturing too which is you can look at your footprint of manufacturing plants on the one hand, decide whether you need them all or not but on the other hand you have to deal with transportation, you still got to get the product to the customer and fuel prices today are a lot higher they were than 30 years ago when a lot of this manufacturing footprint was constructed.

Bill G. Schmitz – Deutsche Bank Securities, Inc.

Got you. That makes total sense. And then, just in terms of the advertising spending and going back to historical levels, I mean, what is the money going to be spend – I know you said you’re going to move a lot of stuff from conventional to digital but do you still kind of think that maybe the coastal strategy is on a hold and then maybe, you know, kind of we’re using the – what the brands report besides TEN.

Martin M. Ellen

No, we – Bill, I think we talked in the last quarter, the quarter before, about some reduction in the coastal program, not because we don’t think there is opportunity there but we just couldn’t see the – get the activation that would have made the spend most affective, so there’s been a lot of that in our – a lot of those kinds of adjustments in our total marketing plan. You know, as I said, at TEN we’re still investing and Larry talked about it, it’s early, it’s important. So, we made the adjustments, we think are the right adjustments to make given what’s happening in this environment and making sure that they are really aligned with what our field teams are doing in terms of execution at retail.

Bill G. Schmitz – Deutsche Bank Securities, Inc.

Got you. And then how it adds out – and if so, things do becoming a little better, obviously the weather comps are pretty undemanding. I mean, will you let that flow to the bottom line or you take some of the incremental savings and put it back into the marketing line?

Martin M. Ellen

No, I’ve said this to everybody, we spend on that which gives us a return at what we think we should do and it’s not a function of spending top line – you know, unexpected top line margin dollars just to spend. And I don’t think anybody would do that anyway but –

Bill G. Schmitz – Deutsche Bank Securities, Inc.

Beneath the price.

Martin M. Ellen

Yeah. And somewhat – and the decision with us, it’s first and foremost is driven by the analysis of data we’re presented with on the project.

Bill G. Schmitz – Deutsche Bank Securities, Inc.

Great. Thanks very much.

Martin M. Ellen

You’re welcome.

Operator

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

Bonnie Herzog – Wells Fargo

Good morning.

Larry D. Young

Good morning, Bonnie.

Bonnie Herzog – Wells Fargo

I was hoping you could give a little more color on your beverage concentrate business. Typically this business, you know, it’s outperformed your packaged beverage business but this quarter your volume was down quite a bit so could you drill down a little more on what some of the main drivers of this were, and then really how we should think about this business going forward?

Martin M. Ellen

Bonnie, it’s Marty, good morning. I’ll take this initially. I would tell you their volumes were a little weaker in December than we thought and we’ll see what happens in January whether or not certain bottlers decided they’re not to buy concentrated before yearend or not. We have at least some bottlers who just want to keep their inventory levels lower. And I’ll also encourage you to think about beverage concentrate versus packaged beverages. Don’t forget beverage concentrate is pretty much all reliant on CSDs.

Bonnie Herzog – Wells Fargo

Okay.

Martin M. Ellen

Alright. So, they don’t – were versus, as I just said, packaged beverages is starting to put more emphasis on having greater success in the non-carbs. And, of course, you know within beverage concentrates it’s reliant very much on brand Dr. Pepper. So, like I said, December was a little lighter than we thought. I know we’ve also made a change in the concentrated, we’ve got some high yield concentrated, so it’s a more effective package to ship because it has less water in it and I think some bottlers waited for us to put that product out and buy it in January instead of December.

Bonnie Herzog – Wells Fargo

So, just to clarify, you’re already seeing the business improve from December?

Martin M. Ellen

I’d say, we see signs in January and there may be some purchases that would have otherwise happened in December may have happened in the first half of January.

Bonnie Herzog – Wells Fargo

Okay. Thank you.

Operator

Your next question comes from the line of Mark Swartzberg at Stifel Nicolaus.

Jesse A. Reinherz – Stifel Nicolaus

Hey, good morning. This is Jesse Reinherz in for Mark. Just a quick follow-up to Bill’s question. Given the pressure we’ve seen in the CO2 volumes and the excess capacity that you guys mentioned, have you ever explored getting into the private label business or just perhaps seeking out additional co-packing arrangements or they just really going to be business as usual going forward, thank you?

Larry D. Young

We’ve always done a little bit of contract pack, you see that in our numbers. We do it very opportunistically. We do it where we have capacity. We make sure that we’re in the right shipping lanes because as Marty mentioned earlier transportation gets very expensive on that. But as far as wanting to get into it, that’s not what we do, we build and enhance leading brands and we will continue to do that.

Jesse A. Reinherz – Stifel Nicolaus

Okay. Great. Thanks a lot.

Operator

And your final question this morning comes from the line of Michael Steib with Credit Suisse.

Michael Steib – Credit Suisse

Good morning. Just a follow-up question on the SG&A line in the quarter. I think you mentioned that of the $28 million reduction some $9 million was due to phasing of marketing spend, my question is you know what’s the remainder – where is the remainder coming from? Are these RCI savings and are these going to be going forward into the next year, thank you?

Martin M. Ellen

Now, Michael, it’s a combination. We said, we have some favorability in health and wellness cost but I’ll also tell you that all of the RCI initiatives that are being deployed particularly in our DSB business all of that is showing up as productivity improvement in SG&A.

Michael Steib – Credit Suisse

Okay. Great. Thank you very much.

Larry D. Young

Well, thanks again for joining us on the call today and for your continued interest and investment in Dr. Pepper Snapple.

Operator

Thank you. This concludes today’s Fourth Quarter 2013 Earnings Call. You may now disconnect.

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