Keurig Dr Pepper Inc.

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Keurig Dr. Pepper's earnings call for the third quarter of 2019. This conference is being recorded, and there will be a question and answer session at the end of the call. I would now like to introduce your host for today's conference, Keurig Dr. Pepper Vice President of Investor Relations, Mr. Tyson Seeley. Mr. Seeley, please go ahead.

Thank you, and hello everyone. Thanks for joining us. Earlier this morning, we issued our press release for the third quarter of 2019. If you need a copy, you can get one on our website at KeurigDrPepper.com in the Investor section. Consistent with previous quarters, today we will be discussing our performance on an adjusted basis, excluding items affecting comparability, and with regard to the year-ago period, our financial performance also takes into account pro forma adjustments due to the merger. The company believes that the adjusted and adjusted pro forma basis provide investors with additional insight into our business and operating performance trends. While these pro forma adjustments and exclusion of items affecting comparability are not in accordance with GAAP, we believe that the adjusted and adjusted pro forma basis provide meaningful comparisons and an appropriate basis for discussion of our performance. Details of the excluded items are included in the reconciliation tables included in our press release and our 10-Q, which will be filed later today. Due to the inability to predict the amount and timing of certain impacts outside of the company's control, we do not reconcile our guidance. Here with me today to discuss our third quarter 2019 results and our outlook for the balance of the year are KDP Chairman and CEO Bob Gamgurt, our CFO, Ozan Dokmeseoglu, and our Chief Corporate Affairs Officer, Maria Sampagursia. And finally, our discussion this morning may include forward-looking statements, which are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially, and the company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the company's filing with the FTC. With that, I'll hand it over

to Bob. Thanks, Tyson, and thanks to everyone for dialing in. Before diving into the discussion of the quarter, I wanted to take a moment to share the overall value creation model for KDP that we frequently discuss in our investor meetings. While we always have a number of detailed items that we cover in our quarterly earnings calls, it's helpful to remain focused on the key drivers of value, which are fairly straightforward. We created KDP with the mission of providing consumers with a beverage for every need, whether hot or cold, available everywhere they shop and consume. We set ambitious three-year goals on both top and bottom lines to grow revenue 2-3%, operating income 11-12%, and EPS 15-17%, fueled in part by $600 million of synergies and free cash flow conversion in excess of 100% to enable rapid deleveraging to below three times. In cold beverages, we lead the non-cola CSD segment and have meaningful positions in a number of high-growth and on-trend cold beverage segments. For example, we're the number two player in premium water. We're also one of three companies with near national retail reach through our direct store delivery system. We create value by renovating and innovating our portfolio to leverage that selling and distribution powerhouse, and by partnering with emerging growth brands that offer access to new segments and clear paths to ownership. Productivity provides funding for our brand marketing and innovation. In coffee systems, we create value through expanding Keurig Systems' household adoption by converting drip consumers to single serve. Keurig Brewer and Coffee Innovation, combined with effective system marketing, drives that conversion. Unique to coffee systems, we share productivity with our partners to lower the price of K-Cup pods, further driving consumer growth, while still continuing to expand our margins. Across the enterprise, we drive exceptional free cash flow that enables us to delever and offer shareholder value optionality in the future. With five quarters behind us as an integrated company, we've demonstrated that our value creation model is working, with significant potential still in front of us. With that as perspective, let me now turn to the third quarter results. All four of our segments again registered underlying net sales growth, and we continue to perform well in the marketplace, growing dollar consumption and market share in a number of our key categories. This top-line performance, which was balanced between volume mix growth and positive net price realization, along with synergies and productivity, drove another quarter of strong underlying adjusted ETS growth of 13%, excluding a six percentage point -over-year headwind from laughing one-time gains in Q3 last year, which Ozon will discuss shortly. Our cash flow generation also remained very strong, enabling us to pay down $423 million of structured payables and reduce debt by $71 million in the quarter. To date this year, we have generated over $1.6 billion of free cash flow, with our cash flow conversion at an impressive 130%. We continued to build our roster of brand partnerships during the quarter by agreeing to a long-term master licensing and distribution agreement for Metcalfe packaged coffee in the U.S. You may recall that we agreed to a similar arrangement with Metcalfe in Canada in Q4 of 2018. The U.S. Metcalfe agreement will go into effect during the second half of 2020. While Metcalfe was previously a partner brand in the Keurig system, this new licensing agreement gives us the added responsibilities of coffee sourcing, manufacturing, distribution, selling, and marketing the brand in all forms across all channels. This new agreement is a testament to the strength of the overall Keurig system and KDP's capabilities in coffee. Retail market performance based on IRI was again solid in the quarter. We grew dollar consumption and market share in several of our key categories including CSDs, premium water, shelf-stable fruit drinks, and shelf-stable apple juice. This performance reflected the growth of key brands such as Dr. Pepper in Canada-derived CSDs, Core Hydration, Snapple Juice drinks, and Mopped Apple Juice. As is always the case when managing a broad portfolio, we have a few categories that require additional focus. Falling into that territory are Bye, Snapple Teas, and the ramp-up of new allied brands. We believe we have good line of sight to improve performance across all three of these areas, which I'll speak to in a few minutes. In our U.S. coffee business, volume consumption of single serve pods manufactured by KDP grew approximately 2% as measured by IRI, which we know greatly understates actual growth. As we discussed at a recent conference, what's reported in the tracked channels only represents about half of our total K-Cup pod business, with untracked channels, particularly e-commerce, experiencing higher growth rates. For comparison, our pod shipment growth in the third quarter was 6.1%, and over the past 12 months K-Cup pods have grown 8.6%. These growth rates are more representative of the growth in the broader category. Dollar market share of KDP manufactured pods in tracked channels remains strong at .4% in the latest 52-week period. In terms of high-level financials on an adjusted basis, our underlying net sales, which exclude the movement in and out of our portfolio of allied brands, grew 3.1%. With growth from all four segments. This performance reflected strength of fall mix growth and higher price and net price realization. In addition, we also had a modest benefit from an extra DSD shipping day in our packaged beverages segment. Adjusted operating income grew 8% in the quarter, reflecting the strong underlying net sales growth, productivity and merger synergies, partially offset by inflation, primarily in packaging and logistics. Operating income growth would have been even higher if not for the unfavorable comparison versus year ago of a one-time gain related to the big red acquisition. Ozon will cover the details of that later in the call. The underlying adjusted EPS growth of 13% reflected our balanced top-rank growth and operating income performance, along with the benefits of continued debt reduction and a lower effective tax rate. All key tenets of our three-year merger targets. Turning now to our segments. Starting with coffee systems. Net sales increased 1.1%, fueled by a higher volume mix of 3.1%, partially offset by lower net price realization of .9% and unfavorable foreign currency translation of 0.1%. The higher volume mix for the segment was driven by pod volume growth of 6% and brewer volume growth of 8%. Partially offsetting the growth in volume this quarter was lower POD NICs, reflecting the mixed impact of higher shipments to branded partners for whom we only record a toll-on fee. As we enter the important retail holiday season for brewer sales, our new lineup of K-Duo Brewers is now fully on shelf and performing very well. As you'll recall, the K-Duo lineup of brewers provides consumers the ability to brew a large pot of coffee through a traditional drip system, in addition to a single cup through K-Cup pods. The line is receiving great consumer reviews online, and we are excited about the incremental households that they will unlock. The K-Duo lineup is being supported with increased marketing across traditional and digital media platforms and continues to feature James Corden as our brand ambassador. Consistent with our discussion on our last earnings call, we expected Q3 to be a bit out of sync, which is exactly what transpired. Adjusted operating income declined 3% due to a mismatch this quarter in the timing of pricing, inflation, and brewer investments, including media, market research, and innovation development costs, compared to the positive offsets of productivity and volume. As we discussed consistently, the nature of this business leads to volatility and results from quarter to quarter. But when viewed over a slightly longer timeframe, the growth we continue to drive becomes quite clear. For perspective, on a trailing 12-month basis, K-Cup pod volume advanced 8.6%. Total coffee system's operating income grew nearly 5%, and operating margin expanded 100 basis points. Quarterly results have fluctuated both above and below these numbers, sometimes meaningfully, however we remain focused on the real underlying drivers of growth. Turning to the packaged beverages segment. Reported net sales for packaged beverages were again significantly impacted by the unfavorable impact from the changes in our allied brands portfolio, which amounted to a .8% segment headwind in the third quarter. Excluding this impact, as well as the .6% benefit we had from an extra DSD shipping day, underlying net sales grew a healthy .1% in the quarter, driven by net price realization of .7% and a higher volume mix of 0.4%. As mentioned previously, the impact from allied brands will switch from a headwind to a tailwind in the fourth quarter and represent a top-line driver in 2020. Driving the .1% underlying net sales growth for packaged beverages in the quarter was Dr. Pepper, Canada Dry, and Core Hydration, the latter of which continues to register very strong growth, with an over 30% increase in retail sales in the trailing 52 weeks. In the case of Canada Dry, double-digit net sales growth was driven by successful innovation launched earlier this year, as well as strength in the Core brand. The Vansville College Football campaign behind Dr. Pepper is also in full swing, delivering strong results for our flagship CSD brand. The campaign is resonating well with consumers and is driving additional in-store displays, higher inventory on display, retail dollar growth, and volume performance that continues to outperform the category. As we enter the championship drive with a college football season, the campaign will feature new media content, on-packed consumer offers, strong in-store execution, digital and social media, as well as the return of our college tuition giveaway program. We are also rolling out our Green Bottle campaign with a handful of brands, including Canada Dry, in conjunction with the holidays. This campaign has always well received at retail, and we expected to provide good support behind our brands during a key selling season. Also contributing to underlying sales growth in the quarter were Mott's, SunKissed, and A&W, as well as contract manufacturing. As mentioned earlier, there were a few areas where we see performance trailing our expectations. Buy, Snapple T, and some of the new additions to our allied brands. Buy performed below the category in the quarter, and we are implementing a number of programs to address performance, which we will share with you early in the new year. While we have regained buy distribution that had been lost in Q2 of 2018, we are not experiencing the lift in velocity expected behind our marketing. As we close out this year and head into 2020, our focus behind Snapple T will be on brand renovation. And finally, let me touch briefly on our allied brands portfolio. To refresh everyone's memory, we had significant changes in the allied brands portfolio at the time of the merger, hence our discussion since that time of the concept of underlying net sales. As we said on previous calls, the negative comparison to year ago of allied brands turns to a tailwind in Q4 and is no longer a factor as we enter 2020, which will enable us to drop the discussion of reported versus underlying growth. Our total allied brands portfolio generates approximately $350 million in retail consumption and represents 3% of our cold beverage sales. While not large in the absolute, we expect these brands to provide access to higher growth segments. To that point, the ramp up of the new brands to the allied portfolio is progressing slower than expected. The reasons are slightly different for each brand, but in total, we see a delayed response in realizing the full growth potential of these brands. As a result, we now expect the year over year net changes in the allied brands portfolio to result in a headwind to total KDP net sales of approximately 200 basis points versus 100 basis points forecasted at the beginning of the year. The great news is we expect KDP total underlying net sales growth to approximately reach 3% for the year, which is at the high end of our target driven by very strong growth on our own brands that has been able to offset the slower start on allied brands. We also continue to plant seeds to support future growth, such as A-Shock Smart Energy Drink, which, while still quite early, is performing well in the market. We'll discuss more about that in early 2020. Operating income for packaged beverages in the third quarter advanced a strong 23%, largely reflecting the growth in underlying net sales, strong productivity, and merger synergies, as well as the timing of marketing spending, partially offset by inflation, particularly in packaging, ingredients, and logistics. And finally, we expect to exit the fourth quarter this year with strong sales growth that will fuel our momentum into 2020. Turning now to the beverage concentrates segment, which represents sales of concentrates to bottlers and syrups to fountain customers. Net sales were up nearly 9% in the quarter, driven by both net price realization and volume mix growth. The strong volume performance was driven in part by our fountain food service business, and is reflective of the strength in our core brands such as Dr. Pepper, Canada Dry, Sunkist, and Big Red. Operating income for beverage concentrates advanced a strong 20% in the quarter, primarily reflecting the strong growth in net sales, as well as merger synergies and productivity. And finally, turning to Latin America, beverages, net sales for the segment increased .5% in the third quarter, and operating income of $25 million declined slightly, resulting from higher marketing spending and inflation. With that, I'll hand it over to Ozon. Thanks,

Bob, and good morning, everyone. I will start with a review of the financials for the third quarter, which was a good one for KDP. I will then transition to our outlook for the balance of the year. Continuing on an adjusted basis, net sales for the third quarter increased .5% to $2.87 billion, compared to $2.86 billion in the prior year. This performance reflected strong underlying net sales growth of 3.1%, driven by higher volume mix of .5% and favorable net price realization of 1.6%. Also, in the quarter, we had the additional shipping day in our packaged beverages segment, which added .3% of the growth. Partially offsetting the underlying net sales growth and the extra shipping day was the unfavorable impact of .7% from changes in our allied branch portfolio, as well as unfavorable foreign currency transition of 0.2%. On a constant currency basis, underlying net sales increased 3.3%. Operating income in the quarter increased 8% to $754 million, compared to $698 million in the prior year. This increase reflected strong underlying net sales growth and continued productivity and merger synergies in both cost of goods sales and SG&A. These growth drivers were partially offset by inflation, led by packaging and logistics, and the unfavorable comparison versus year ago to the one-time $6 million gain related to the acquisition of Big Red. Operating margin advanced 190 basis points in the quarter to 26.3%. In terms of our segment performance for the third quarter on an adjusted basis, net sales for coffee systems increased .1% to $1.07 billion in the quarter, compared to $1.05 billion in the prior year. This performance reflected higher volume mix of 3.1%, which was partially offset by lower net price realization of 1.9%. The volume mix performance was driven by strong brewer volume growth of 8% and part volume growth of 6.1%. Despite the previously discussed shift of certain pot shipments from the third quarter of 2019 into the second quarter, as Bob discussed earlier, the strong pot volume growth was partially offset by unfavorable mix, reflecting the impact of higher pot shipments to our branded partners in the quarter. Unfavorable foreign currency translation of .1% also impacted net sales in the quarter. Coffee systems operating income was down in the quarter as expected. Specifically, operating income declined .4% to $367 million, compared to $380 million in the prior year, reflecting unfavorable mix, lower pricing, inflation in packaging and logistics, and higher brewer investments including media, market research, and innovation development costs. We are also lapping the timing of certain adjustments in the prior year related to legacy Keurig Green Mountains year-end, including bonus and stock compensation. Partially offsetting these factors were the strong volume growth, as well as continued productivity and merger synergies. Operating margin in the quarter was 34.5%. Moving to package beverages. Net sales for the segment decreased .2% in the quarter to $1.31 billion, compared to $1.34 billion in the prior year. This performance reflected strong underlying net sales growth of 3.1%, driven by the higher net price realization of .7% and increased value mix of 0.4%. Additionally, the extra shipping day in the quarter had a favorable impact of 0.6%. More than offsetting these growth drivers was the unfavorable impact in the quarter of .8% from changes in the Unlight Brands portfolio and unfavorable foreign currency transition of 0.1%. Operating income for package beverages increased .6% to $201 million in the first quarter, compared to $164 million in the year-ago period. The performance largely reflected continued productivity and merger synergies, strong growth in underlying net sales, and the timing of marketing investments. These positive drivers were partially offset by inflation in packaging, ingredients, and logistics. Operating margin advanced 310 basis points versus year-ago to 15.4%, turning to beverage concentrates. Net sales for this segment increased .8% in the quarter to $360 million, compared to $331 million in the prior year. This performance was driven by higher net price realization of 6.5%, combined with favorable volume mix of 2.3%. The strong net sales growth in the quarter was driven by Dr. Pepper, Canada Dry, Big Red, and Sunquist. The shipment volume increase for beverage concentrates was due primarily to Dr. Pepper, Canada Dry, Big Red, and Sunquist. In terms of bottler case sales volume, beverage concentrates increased .1% compared to the year-ago period. Operating income for beverage concentrates increased .6% to $244 million, compared to $204 million in the year-ago period. This performance reflected the benefit of net sales growth, strong merger synergies, and productivity. Operating margin advanced 620 basis points versus year-ago to 67.8%, turning to Latin America beverages. Net sales for this segment increased .5% to $138 million, compared to $136 million in the prior year. This performance was driven by higher net price realization of 5.2%, partial offset by lower volume mix of 1.5%, and unfavorable foreign currency transition of 2.2%. On a constant currency basis, net sales increased 3.7%. Operating income for Latin America beverages totaled $25 million in the second quarter, compared to $27 million in the year-ago period. This performance reflected the net sales growth and productivity, which were more than offset by inflation in logistics and ingredients, as well as increased marketing investment. Turning to interest expense. Interest expense in the first quarter declined $17 million, or 10.5%, to $145 million and was driven by our continued deleveraging. Net income for the quarter increased .2% to $451 million, compared to $417 million in the prior year. This performance was driven by the strong operating income growth, lower interest expense, and a lower effective tax rate compared to the year-ago period. Partially offsetting these favorable drivers was an unfavorable comparison versus the prior year to the $24 million gain from body armor. This gain, along with the previously mentioned $6 million gain related to the acquisition of Becker, collectively reduced the -over-year net income growth rate by approximately 6 percentage points, translating into underlying net income growth of approximately 14%. Taking all of these factors together, our adjusted diluted EPS in the first quarter increased .7% to $0.32, compared to $0.30 in the prior year. On an underlying basis, adjusted diluted EPS advanced 13%. Free cash flow was again strong in the quarter, driven by growth in net income and continued effective working capital management. As a result, in the third quarter, we paid down approximately $423 million of structure tables and reduced net debt by an additional $71 million, for a total of $494 million in payments. This increases the total amount of debt paid down in the first nine months of 2019 to $788 million, as well as a reduction in structure payables of $188 million. For the first nine months of 2019, we generated over $1.6 billion in free cash flow, with a free cash flow conversion rate of 130%, and exited the quarter with $74 million of unrestricted cash on hand. The debt reduction in the quarter, along with our growth in adjusted EBITDA, reduced our debt to adjusted EBITDA ratio, which we refer to as our management leverage ratio to 4.8 times. This aggressive pace of deleveraging continues to be consistent with our expectations. And for perspective, since the merger closed, we have paid down a total of over $1.7 billion of debt. And finally, in terms of our outlook for the balance of 2019, for the full year, we continue to expect adjusted diluted EPS growth in the range of 15% to 17%, representing $1.20 to $1.22 per share. This guidance is in line with our long-term merger target. We continue to expect net sales growth of 1% to 2%, with underlying net sales growth now expected at approximately 3%, the latter of which is at the high end of our long-term merger target of 2% to 3%. This net sales growth reflects higher than expected growth from the core business and the slower ramp of the new allied brands, resulting in an approximate 200 basis point headwind impact from the changes in the allied brands portfolio. We continue to expect merger synergies of $200 million in 2019. This is consistent with our long-term merger target, and we continue to expect these synergies to fully throw through to EPS. We continue to expect interest expense to be in the range of $550 million to $565 million. This reflects our expectation of significant cash flow generation and continued deleveraging, as well as the first half benefit in 2019 totaling $40 million from the unwinding of interest rate swap contracts. We continue to estimate our effective tax rate for 2019 to be in the range of 25% to .5% for the year. We continue to expect our diluted weighted average share outstanding to approach $1.42 billion in 2019. While we do not provide EPS guidance by quarter, we remind you that we expect quarter for EPS growth to be tempered due to comping the significant one-time gains approximating $17 million related to the core acquisition in 2018. We continue to expect our second half synergies to be greater than our first half synergies. We continue to expect inflation to moderate somewhat in the second half. And finally, in 2019, we continue to expect free cash flow to approximate $2.3 to $2.5 billion. With this strong free cash flow generation, we expect our management leverage ratio to be in the range of 4.4 to 4.5 times by the end of 2019. We also remain confident that we will achieve our leverage target of below free times in two to three years from the July 2018 merger closing. And with that, I will hand it back over to the operator to open it up for your questions.

If you would like to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster. Our first question comes from Brian Salane with Bank of America. Your line is now open.

Hey, good morning, everyone. Hi, Brian. Just two questions for me. Just one, on the free cash flow conversion, you know, this year you're over 130%. And, you know, I think what would be implied in terms of getting to the leverage targets, the multi-year leverage targets, that you can maintain a pretty high level of free cash flow conversion. So you can just give us a sense of whether or not where you stand today at converting over 130% is still sustainable or is there some reason why it would be maybe different going forward? And then I've got a follow-up.

Yeah. Good morning, Brian. In short, yes, the answer to your question. Right now, for this year, as we just announced, the conversion ratio is one-third. Of course, there are lots of puts and takes. And as we discussed before, our effective working capital management was the main driver of getting over 100. But we still have a continuation of our program into 2020 as well as 2021. And we are also, as we always do, pursuing new opportunities and explore the new initiatives, which we expect actually our conversion ratio to be very close to around give and take 100% conversion. And if we can do better, of course, we will do better. But the conversion ratio will be high in the upcoming two years.

Okay. Thank you. And then, Bob, just on the brewers, the brewer lineup, I guess, going into the holidays, if you go back to the investor day, you talked about sort of a bridge of, you know, to build household penetration from what was at that point about 20%. And it was quality, modernizing, making it more convenient, variety, value, right? There was a whole sort of cluster of levers, right, that would drive penetration. And it just seems at this point, you've got all the brewers now renovated with the new engines. You've got the duo in the market, which is more convenient. It just seems like you've ticked off a lot of those different levers. So can you just kind of update us on how you're thinking about brewer lineup today, those sort of clusters, and what it might imply for beginning to accelerate household penetration?

Right. Yeah, sure. You're referring to the waterfall that we showed in the investor day where we identified the opportunity to convert households in the range of about 69 households that could still be converted. And then we built on that and showed the research as to why people who theoretically should be in a single serve coffee system weren't. And then we redesigned our brewers and our marketing plans to specifically go after those barriers. So job one, if you go back a couple years, job one was to increase the quality of the brewers, hit the right price points, and then begin to add features. And as you accurately point out, we've been ticking off many of those opportunities, modernizing the look, going into specialty beverages with the K Cafe, and now very importantly, going after one of the biggest barriers is the ability to produce a large batch of coffee with K Duo. So I would say as we figure today, the quality of the brewers is up significantly. You don't have to take my word for it. You can just look at the star ratings online. We've been able to fill out a lot of the basics, hitting the lower end price points. We're now moving higher end as well and then filling out most of the functionality that we've talked about. And so we're really happy and that's what's driving the strong household penetration that we continue to experience. But we've got a great pipeline still ahead. There is still a lot of white space to fill in between all of those. And there are new features and benefits that we can add to existing brewers to make them even more interesting that we'll share with you in the coming months. So we feel like we've got the basics in place, but a lot of upsides still left. And then I would also remind you that there are drivers of household penetration that aren't directly connected to the brewers. And one of the biggest is having a recyclable pot. And so that's being implemented as we speak and will be completed by the end of 2020. And just to give you one final point, we get a lot of questions of, well, you've launched that brewer. So you've got everybody who you are going to get based on that as a system. It takes time. People don't typically replace their brewer until their current brewer breaks. And so you have to layer in lots of different features and benefits to get people. And it really is a slower build than one might think. But it's all moving in that direction that gives us line of sight to growing household penetration for quite a long term.

All

right. Thank you.

Our next question comes from Lauren Lieberman with Barclays. Your line is now open. Great.

Thanks. Good morning. Good morning. I wanted to ask a little bit about the allied brands. So assuming, you know, kind of the slower ramp is about the market performance of what you already have in the portfolio, not our matter of attracting more. I'm sure it's a different story for, you know, different brands. But anything you can offer, is it sort of the health of the brand, the established brands that you've brought in-house? Is it noise in sort of the newer segments that you've been entering? And I know this is a short time period, but is this performance sort of impacting at all your thinking about portfolio composition for that allied piece as you go forward?

Yeah. Let me give you a couple thoughts on that, Lauren. I think first of all, you know, as I mentioned, the total allied portfolio now is about $350 million in sales. So it's important, but it's not as large as it once was. That number may be surprising because you might think, well, I thought the number was much larger than that. And the reality is it was, but if you recall, we acquired some of those businesses. So if you look at the core and the big red businesses that we acquired in the past year, they're actually larger than the remaining allied brand portfolio that we have left. So it's still a good opportunity for us to access different segments and different levels of growth. But in its absolute, it's not as important as it once was. We talked about the net change in allied brands with Fiji and Body Armor coming out and some of the new ones coming in, Evian, Peets, and Porto. We said that was about 100-bip headwind, and now we're saying it's about 200-bip headwind. Look, if you pick a rounding that's involved in that, you know, slightly more than that rounded down to 100 and slightly less than that rounded up to 200, what we're talking about here is a delay in sales versus our expectations of about $50 million. So it has an impact on our growth rate for sure. But the good news, as I emphasized before, is that we've been able to offset that with really good strength in our core owned businesses, which speaks to the health of that portfolio. As we sit here today, and to answer part of your question, and we look at those new brands, we think it is primarily just a delay. It's just a slower startup. We're getting the distribution. The velocity is building. It's just not at the rate that we thought it would be. And it's a combination of things when you're looking at a new brand. Sometimes it's hard to forecast. Evian is a good example. If you look at the latest 13 weeks, we're growing Evian at about 8%. That's below the category because that category is really strong. That category is growing at like 12%, 13%. But 8% is not too bad, and it's up significantly. So we're seeing traction. It's just taking longer to get there, and it really doesn't affect the way that we think about allied brands going forward. And as I remind you, we're also continuing to put new partnerships in place like A-Shock that will continue to fill that pipeline. So I think this is well contained and well defined and really doesn't change our outlook going forward.

Okay. I think that's super helpful. Thanks a

lot.

Great.

Our next question comes from Steve Powers of Deutsche Bank. Your line is now open.

Hey, thanks. Good morning. I wondered if the drill into beverage concentrates affected? The performance there was really strong this quarter, and price realization seems to be the key driver of both sales and segment margins. Is there anything you're doing differently in that business this year, perhaps with respect to promotional depth or breadth, to drive that kind of price realization seemingly without any real degradation of volume? And if so, what's the runway on that source of profit growth continuing? I think is this a one-year step up that we're seeing in 2019 with more normalized growth to resume in the year ahead, or do you see more incremental opportunity available to you in 2020 and beyond?

Well, it's hard to know what pricing, price realization going forward is going to be, to be honest with you. I mean, that's very much driven by the industry in total and other factors like inflation. So that's still to be determined. What you're pointing out, though, is very important is the strength of our brands that are sold in the beverage concentrates segment allow the pricing to be put in, and yet the volume holds up nicely. And remember, these are the sales primarily of brands like Dr. Pepper and Canada Dry, and then we've got others, Crush, etc., Schwest, that go through and are sold via either Cope or Pepsi, but also through a very important channel of fountain and food service, which is restaurants. And as we point out a number of times, Dr. Pepper is actually the most available brand in the country in fountain and food service. So the brands, it's a concentrated portfolio of brands with incredible strength. That's why we continue to invest so heavily in marketing behind these brands. They're able to withstand the pricing, and what you're seeing in the quarter is that pricing flowing through that was taken. And sometimes there's a bit of a delay to get that pricing, and you're seeing that matched up against the benefits of productivity and synergies across the entire business as a result of the integration. And that's why you're getting such powerful profit increase during the quarter. But we have a very robust business, and to your point about pricing, we'll say we take every opportunity we get going forward, but it's hard to have a forward-looking position on industry pricing.

Okay. Just to clarify then, so this is reflective of true list price increases that you've taken versus change in the promotional cadence, or is it a little bit both?

Well, when you're selling in the concentrate segment, the answer is a little both, but when you take a look at the concentrate segment, when you think about pricing, it's different than the way you would think about it in our package beverages segment, where we're actively involved in the promotions. Remember, we're selling to somebody else who turns around and resells our products in the beverage concentrate segment. So that's why it's more of a combination, but it's really more about the absolute pricing that we're giving than it is timing or a level of discounting, as you might see in a retail environment.

Okay.

Thank you.

Our next question comes from Nick Mahdy with RBC. Your line is now open.

Thanks. Good morning, everyone.

Good

morning, Mark. So, good morning. The question, I have two quick ones. On buy, what happened, I guess, was the question. What do you think is really causing some of the weakness and the fact that it's been lagging your expectations? So that would be the first one. And then the second one, Bob, is just, look, I think you guys have obviously done a very good job of integrating at a time where a lot of big mergers have not really gone that well. And I'm just kind of thinking about future layers of value creation and thinking about what's been going on between Coke and Pepsi and refranchising and how it's really worked for Coke. And I just wonder, you know, is this an opportunity for KDP longer term? Just wanted to get your thoughts on that.

Sure. I think buy, I think it's pretty straightforward, which was it was a pioneer in the category. It became the number one player by far. And there's a lot of competition. That's CPG, you know, issues that happen every day. What do we need to do? We need to refresh the brand and drive it to the next level with innovation that will keep it ahead of the game. From a poor perspective, when we talk about weakness and buy, it's still a business that's about a half a billion dollars in sales. And on a 52 week basis, according to IRI, grew about 3%. So it's not as if the brand is falling off the edge. It's just not growing at the level that we believe it has the potential to grow. And so it's going to be a combination of renovation on the brand and some innovation that will continue to drive. And again, we'll be happy to share that with you in early 2020. With regard to your question about M&A more broadly, we've been very focused on taking the portfolio that we have today and making it work. And you're seeing there's a significant amount of upside potential for the foreseeable future. There will be a point in time where we'll start thinking about M&A differently. You're also talking about the route to market side of the business, refranchising and driving that. There's nothing that we would talk about at this point in time. But one of the big value drivers is for us to optimize the distribution system that we have today. And what that really means in the near term is running it more effectively, which is actually showing up in a lot of our numbers. And also on the margins, bringing in routes from independent distributors, for example, where we see an opportunity to combine them with our own routes and get more scale. We'll be doing that on the margins. But I look at that as more fine tuning on top of running the fundamental distribution system we have right now better rather than a big strategic move like the one that you're referring to.

Great. Helpful. Thank you.

Sure.

Our next question comes from Sean King with UBS. Your line is now open.

Hi. Thank you. Given the pod volume strength Q2 and then this quarter despite the rebound, are there any, I guess, tail inventory considerations into Q4? And is there potentially any upsides against the full year outlook?

If you look at our pod volume over the long term, it's been really solid. So just to remind everybody, in 2018, pod volume was up about 7.5%. We're running .5% on a -to-date basis. And on a 12-month basis, we're running about the same, about 8.5%. What we called out in the last call was the fact that we knew that we shift ahead of consumption in the second quarter 100% driven by partners who wanted to take volume earlier. To that, we were up 12.8%. We said that we're going to get a reaction to that in our numbers in Q3. We did. We're up 6%, which is below our long-term trend. Our assumption is when you look at Q4 is that all reverts back to the mean and that there's nothing notable to call out on that. And I think part of the learning over the past 18 months or so, if you look at this business, is it's a challenging business to try to forecast quarter to quarter if you're outside of the company. But when you take a broader view, and you don't even have to go much longer than six months, but certainly if you go nine months or a year, it's a really steady and dependable business with some quarterly fluctuations. And so our assumption in any situation that unless there's something notable that we would call out, you should assume that it just reverts back to the mean. Thank you. Okay.

Our next question comes from Trevin Grundy with Jefferies. Your line is now open.

Hey, thanks. Good morning. And congratulations on the strong result. A question really for both of you if you want to touch on this. So far so good with the Synergy delivery and credit to you and your team for doing that. And you're still targeting the $600 million. But kind of take a step back and look at, you know, it's been closing in on two years since the deal was announced. You've obviously had a much, much closer look at the different areas of Synergy. So a couple different questions. And they always on what do you see as potential upside, if any, to that initial target? And then Bob, for you, the target was a number that you expected to fully flow through to earnings. But, you know, we had this conversation on the call and Bogg needs some attention and Snapple needs some attention. And it's going to be a slower ramp for the allied brand. So there's an argument to be made that maybe investment levels need to move higher. Does that give you any pause with the $600 million target? Maybe you do need to invest some of it and it should not potentially flow through to earnings.

Let me talk about the second one first and then Ozon can talk about, you know, where the $600 million is coming from and to your point now that we're into it, what's our level of confidence? Well, as you point out, we put these ambitious targets out just about two years ago. A lot has changed over that time. We've had to compensate for significant inflation increases. We've seen pricing in the industry, which has had a negative impact on volume. The points about Buy or Snapple or all those, that's business as usual. You always have a brand that are performing well or above plan. Look at the strength and core hydration, for example, doing incredibly well. And you always have brands that you can you need to fix. And so on balance, there are no conclusions that you should take from that. That means there's an overall increase in spending or investment required to address those. It's more just being very frank with you guys about where things are working and where they're not and keeping you in the loop about where our management attention is. So I think that the most important takeaway for you and any of our investors is that we put out a long term algorithm. And the critical parts of long term algorithm is top line growth of 2 to 3 percent and EPS growth of 15 to 17 percent. And as I say frequently, what you pay us to do is to manage through all the changes in the environment and competition and all the noise that's out there and deliver that. And we're going to have levers that we can pull that were a positive versus our original expectations. And we use those to offset some of the negative surprises. And I just say in balance, you should take away nothing different other than our original algorithm of the 2 to 3 and the 15 to 17 is intact. And the integration is going remarkably well, which supports that. But specifically your question on synergies, let me turn that over to Ozon in terms of how we now think about that as we're into the integration and also the broader concept of value capture, which is synergies and productivity in the way that we think about it internally.

Sure. So we are on track with our expectations to deliver $200 million in 2019 as we have guided several times, which also makes us to stay 100 percent behind $600 million of delivery over three years, starting 2019 through 2021. So that is a rock solid commitment and we have great plans to achieve it. As a matter of fact, we also expect the synergy number to flow through fully in EPS. And we started to deliver the synergies initially in SG&A, then procurement and logistics following. Obviously, we have several initiatives that are fueling these deliveries, but I just given the big buckets of the areas of the delivery. And as Bob also said, besides the deal synergies, we also have several base productivity programs, as we call them internally, which is nothing to do with the deal synergies in both businesses that we have all built in our algorithm. And we are also happy to share that we have been executing very nicely behind those initiatives as well.

That's great. If I could just follow up with one. Bob, maybe just touch on, you guys decided to make a small tweet to the guidance in early September and then another one today. What happened, I guess, in the month of September that you felt, you know, incrementally more cautious on the impact from the allied brands, but then incrementally better on the underlying portfolio, presumably, you know, as you move through September? If you could just comment on that, I'll pass it on. Thank you.

Yeah, sure. I mean, we thought that the 1 to 2 percent that we talked about back in September at an industry conference was clarification of a position that was well known. People were struggling with trying to do the math on what the fourth quarter might look like. And so we just decided to clarify. If you recall, when we said, just to clarify, our reported net sales will be in the range of 1 to 2 percent, consensus was around 1.4. So we saw that as a non-event that surprised us that people thought that was an event. What we are seeing right now, which I think is important to point out, is this is about the time period where the new allied brands should have kicked in at a higher level than they are. And I just put the size of that on an annual basis. It's about $50 million. But again, the good news is that we're seeing real strength in our core business, and that's been able to offset that. So balance, it puts us in a position where we have confidence in a 3 percent underlying net sales growth for the year, which is a very strong number. And it's just a tweak between the allied brand and core, which I think is a net positive. And as I said earlier, I really think the allied brand number is more about timing than it is anything else. But when we get around to 2020, we'll talk more specifically about that.

Thank you very much. Good luck.

Our next question comes from Amit Sharma with BMO Castle. Your line is now open.

Hi. Good morning, everyone. Good morning. Bob, wanted to go back to your response to Steve's question on the sustainability of beverage concentrate segment. And I want to broaden it to not just beverage content, but package beverage as well. Is it fair to read from your statement that these are good sustainable margin structure for these businesses as we go into 2020 and beyond?

Well, yeah, I mean, if you think about what we've been consistent in saying, which is 2 to 3 percent top line, 15 to 17 percent EPS growth. And yes, implied in all of that is the margin structure that we have in place is solid, it's sustainable, and will benefit from the growth that we're talking about. So, you know, in any integration, you get a boost from synergies. And there's those I just talked about. We also look at ongoing productivity that's above and beyond the synergies, which helps fuel those margins. But you do get a point where the margins benefit from the synergies and then you are driving the business based on growth. And the top line growth that we're pointing out to you is accelerating. It's driven by an underlying performance that's about 3 percent. It's driven by strength in our core brands. And that will continue to drive our total profit as our margins are, we believe, very sustainable.

And just to follow up on that, like if you look at historically legacy Dr. Pepper portfolio versus your competition in North America, that portfolio performed on an operating profit basis, right? And now obviously expectations for both Cog and WebC are much higher. Is that performance gap you expect to continue? Like legacy Dr. Pepper portfolio should still be outperforming those two companies in terms of their North American performance,

right? Well, we don't spend a lot of time thinking about our performance relative and operating profit relative to our peer set. We look at our business and we look at the upside that we have. We see a lot of upside on our business in the absolute. As I point out to many people, our portfolio in many cases is not in direct competition with Cog or WebC, particularly on the CSD side where our strength is in the non-COLA segment with Dr. Pepper and Canada Drive leading the way. So I don't think that has changed at all. And to answer your question, all of our upside that we believe is in the business in total is reflected in the long-term targets that we set forth.

All right. Thank you so much.

Our next question comes from Laurent Grandet with Guggenheim. Your line is open.

Hey, good morning, everyone. Good morning. Hey, good morning. Two questions. I mean the first one on Mac Cafe. Craft Ice has indicated that Mac Cafe will hit their ABA debt by about $100 million in over 12 months. Should we think, I mean, you will gain that $100 million in your ABA debt from mid-next year to mid-21? And could you tell us what's your plan for that brand that now you will carry?

Yes. I mean, first of all, the way that we look at this move of Mac Cafe into the security system really speaks to the value of the security system. It's a vote of confidence. And I would remind everybody that if you look at all of our branded partners, all of them, nearly all of them at this point in time as the contracts have expired, have extended for a longer period of time than they ever have before. So this is just, yes, one more vote of confidence that partnering with Curie is good for everybody in the ecosystem. We transitioned that over to us in mid-2020. There are upfront investments that are involved with that. And we'll talk when we talk about 2020, we'll talk about how that impacts our guidance in 2020. But remember, before you take off, you have to take the puts and the takes together. We don't know what the tariff environment is going to be in 2020. That would be a negative. So we've got positives and negatives. And as I said before, it's our job to navigate all of those and be able to look at long-term guidance. I have not seen the number that you're referring to. All I would suggest, though, is that it's about $300 million in retail sales, not wholesale. I did not get to a number nearly that big based on a retail business of $300 million. And I honestly haven't seen that one. But we'll provide more clarity when we talk about 2020 and how that may impact our results at that time.

Yes, Ruo? I just want to remind you, Maria, is that we already had McCaffey in the system. So as you think about incrementality and what it might mean for the business, it was already in. This is a different relationship. It's broader, as I'm sure you know. But it's not wholly incremental. And I think that's important to keep in mind. Yeah, that's

a good point. Just thank you for bringing that up. I think to put a finer point on that one is we already participated in the financials of McCaffey to a level through the K-Cup business that we had. So it's not an unlicensed business that came in. But, Ned, this is all incredibly positive for us. We just don't – I think the number you put out there would be very big and not necessarily incremental. So that's why we're clarifying this.

Okay, thank you. And a quick one, again, on the concentrated business, as it's so profitable for you, so that has some implication about the next quarter and the future. So either – I mean, your volume and your sales and volume were very strong in the quarter. Could you tell us the level of inventory at Bartholomew's level? I did see that there is a disconnect in performance versus what we are seeing in the Nix and Java.

Well, I don't know how you could see that, Dad, to be honest with you. A lot of this goes through restaurants and places that they're different. We have no ability to – all I would suggest is that this quarter is not a disconnect between our sales and what we believe is consumption out there at all. But we were really candid on K-Cups when we shifted ahead of consumption calling that out. So we'd be the first ones to call that out. This is reflective, as I said before, of a couple of things. You've got really good volume going. Our business is very healthy across those channels, and we specifically call that fountain and food service where our brands continue to be in great demand. This is also reflective of pricing that was put in place, and there's always a delay on pricing flowing through. And when you have a combination of pricing starting to flow through combined with volume that holds up in the face of that, yeah, you're going to see some very good numbers. And there's only a little bit of what was exactly this quarter a year ago, but there's nothing extraordinary in that number that should cause you to be concerned.

Okay. Thank you very much, Chypa Cetel. Thank you.

Our next question comes from Peter Groome with J.P. Oregon. Your line is now open.

Hey. Good morning, everyone. Good morning. I appreciate the color on the track versus on-track performance in pods. I mean, is there anything you can share in terms of the price versus volume relationship kind of for the on-track channel versus what we see in the track? And then the second part, while we are on the coffee business, I appreciate, you know, the color on the Q4 pod volume, but, you know, brewer volume is cycling a very easy comparison. You know, how are you thinking about brewership and volume next quarter? Thanks.

Yeah. So, I'll start with the brewership and volume. And again, we minimize the impact of brewership and volume. Our objective is to grow household penetration, and I think we have some credibility on this. We had that conversation when there was a quarter year ago that you referred to as an easy compare that caused a lot of concern. And we're way ahead since then. I mean, we're running at like a .5% growth since that time period. You haven't heard us for a second refer to that number, nor have we used that as a predictor of household penetration because we don't believe it's a predictor of household penetration. So, I would suggest that the fourth quarter of this year, again, household penetration based on the volume that you're seeing is growing mid single digits. You're seeing brewer growth so far year to date of above 10%. That would suggest that we shift brewers for the holidays earlier than we have. And that's part of the strategy for our customers. So, I think that back to my comment I sent on pods, reversion to the mean, I think the same rule applies on brewers. Over time, it's a very steady number. The fact that we shift some earlier is not a good thing because it means we forward position the product to get early merchandising for the holiday season. But in the end, we think this is very little, is very weak indicator of performance for our pod business, whether it's up or down. We don't spend a lot of time talking about that for that reason. Having said that, let me talk about pods. As you refer to, it's getting increasingly difficult for you guys to track this business using IRI or Nielsen because track channels are now representing about 50% of our total sales. And the on track channels, which are driven by club and e-commerce, largely and some other channels, are in total growing faster than the track channels. And that separation is accelerating, as you can imagine, with the adoption of e-commerce. We believe our e-commerce business is 2 to 3X the size of a typical CPG business. So the trend that you're seeing with us is really the leading edge of where you're going to see the rest of CPG go over time. When we take a look at our business in the on track channels, it's growing faster. But if you're asking about the composition of volume and mix, it's not materially different than what you see in the track channels. Our KDP manufactured share and our owned and licensed share, we believe, when we look at our on track channels, is slightly higher than it is in the track channels. Like, for example, away from home offices are in there and our share in offices of our own brands is higher. But it's not material enough for you to put too much thought in there. It's just the knowledge that you're only looking at half the market. And unfortunately, for modeling purposes, the other half of the market is not transparent to you and growing at a faster rate, which we continue to see accelerating. It's good for the business in total. It's just harder to observe from the outside.

Thanks. I appreciate the call.

Okay.

Thank you. That concludes our question and answer session today. I'll now turn the call back over to management for closing remarks.

Thanks, everyone, for joining the call today. I know we went a bit over and it's a busy day for everyone, but the IR team is around today for any follow-up questions. Thank you.

This concludes today's conference call. You may now disconnect. Thank you.