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 second quarter of 2020. This conference call is being recorded and there will be a question and answer session at the end of the call. I would now like to introduce Keurig Dr. Pepper's Chief Corporate Affairs Officer, Ms. Maria Skeppegersio. Ms. Skeppegersio, please go ahead.

Thank you and good morning, everyone. Thanks for joining us. Here with me today to discuss our second quarter 2020 results are KDP Chairman and CEO Bob Gamgort, our CFO, Ozan Dockmahsiyoglu, and Senior Director of Investor Relations, Steve Alexander. Steve is sitting in today for Tyson Seely, our Vice President of Investor Relations, who is home on baby duty, as he and his wife just welcomed their second daughter into the family earlier this week. Our best wishes go out to all of them. I will now hand it over to Steve to cover a few comments.

Thanks, Maria, and hello, everyone. Earlier this morning, we issued two press releases. The first announced that we have entered into a long-term franchise agreement for Polar Shelter and the second was our Q2 press release. If you need a copy of either release, 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. The company believes that the adjusted basis provides investors with additional insight into our business and operating performance trends. While the exclusion of items affecting comparability is not in accordance with GAAP, we believe that the adjusted basis provides 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. 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 on subsequent events. A detailed discussion of these risks and uncertainties is contained in the company's filings with the SEC. With that, I'll hand it over to Bob.

Thanks, Steve, and good morning, everyone. Let me start by expressing my sincere hope that everyone dialed in continues to be safe and healthy and that your families are well. At KDP, we have worked extraordinarily hard since the onset of the COVID-19 crisis to protect the health and safety of our employees, particularly those frontline employees and our supply chain and out in the trade who play an essential role in ensuring our products are available for our consumers, customers, and communities that rely on them. The results we've reported this morning are a testament to the dedication and commitment of our team, and I can't thank KDP employees enough for all that they are doing day in and day out. As you know, the environment in which we are operating continues to be extremely volatile. With COVID cases spiking again, forcing some regions into a second phase of shutdowns, all of which impacts consumer mobility and beverage consumption behavior. KDP was performing exceptionally well before the crisis. We have delivered well for all stakeholders during the crisis, as evidenced by the results we're discussing today, and we fully expect to emerge as an even stronger company when we get to the other side. Until there is a widely available vaccine or treatment, we believe the macro environment will be bumpy and uncertain, requiring us to continue to be focused, flexible, and responsive. Two years ago this month, we completed the merger that created Keurig Dr. Pepper, which at that time we described as the new challenger in the beverage industry. With the integration complete, we believe we have created a modern beverage company with a broad reaching portfolio of hot and cold beverages, delivered by a diversified route to market network that provides unmatched reach and efficiency, and with highly unique ecosystems in our coffee business and DSD network that leverage partnerships and technology to create value. Equally important, we have built a culture that emphasizes excellence in execution and delivery. The COVID crisis is by no means a windfall for KDP. We have been required to focus resources on the areas of our business that are aligned with changing consumer trends, such as at-home coffee, multi-pack cold beverages, large format retail, and e-commerce, to offset significant weakness in -from-home coffee, on-premise beverage consumption, and convenience stores. The impact of these mixed changes on margin are significant, which has required us to deliver volume and revenue growth while tightly controlling the cost side of our P&L and still investing in our future. Our executional capabilities have certainly been tested by the crisis, and we're proud of how we've performed to date. In the two years since the merger, we have exceeded our merger commitments for net sales growth of 2 to 3 percent, and adjusted diluted EPS growth of 15 to 17 percent. In fact, in the eight quarters since our merger closed, adjusted diluted EPS has grown at an average annual rate of 20 percent. In the second quarter, which we believe will be the most challenging environment we face this year, constant currency net sales advanced nearly 3 percent. Constant currency adjusted operating income grew 11 percent, and adjusted diluted EPS was up 10 percent. Further, we have reduced our management leverage ratio to 4x as compared to the 6x ratio at the time of the merger. Ozon will take you through a more detailed review of our financial results by segment in a few minutes. To bring the concept of a modern beverage company to life, let me use several performance highlights from the latest quarter. The strength of our differentiated portfolio is unprecedented. We were the first company to combine hot and cold beverages at scale, including leading positions in single serve coffee, flavored CSDs, premium water, juices, and mixers. Our cold portfolio was very strong in the quarter, as we gained market share of total liquid refreshment beverages, with gains in the majority of the category segments in which we compete. Specifically in CSDs, we gained 1.2 share points and moved to the number two CSD player in a number of key grocery customers, driven by broad-based core brand strength, strong in-market execution and innovation such as Dr. Pepper and Cream Soda and Canada Dry Bold. In fact, Dr. Pepper and Cream Soda is the best performing innovation in the CSD category so far this year. The Dr. Pepper brand has now delivered 17 consecutive quarters of growth at retail, while Canada Dry has done the same for 13 consecutive years. What's important for our longer-term outlook, however, is the fact that our share expansion of CSDs has been heavily driven by a double-digit increase in new households purchasing many of our brands. We are confident that we will be able to retain a portion of these new households once we emerge from this crisis. In the hot portfolio, we have a commanding leadership position of single serve coffee with a combination of owned, licensed and partner brands. And the Keurig brand is ranked by consumers as one of the most relevant brands in the country, not just in CPG, but among all brands. In the second quarter, our coffee system segment grew pod volume .5% and brewer volume 11.6%. And that's on top of 19% growth in the year ago period. Primarily reflecting new households entering the system. These results reflect significant growth in coffee consumption at home, partially offset by the -from-home channel, particularly our large office coffee business and to a lesser extent our hospitality business, which were down significantly in the quarter. Our share of K-cup pods manufactured by KDP held steady at 82%. And retail pricing for the category increased by 2% as promotional activity lessened and mix shifted towards premium brands. Further, share trends for our portfolio of owned and licensed brands also improved. We've previously discussed our seven distinct routes to market at some length. And today, I think it's relevant to highlight DSD and e-commerce using examples of their contributions in the second quarter to also illustrate our long-term strategy. Our DSD network has served us very well during this crisis by enabling the highest levels of flexibility, speed, and delivery. We have been able to pivot on a granular basis at both the product skew and local marketplace level to react to changes in demand using near real-time data that's simply not available in other distribution systems. We see opportunity to continue to invest to improve our DSD system and look forward to sharing more with you on this topic in the future. As you've seen across many categories, e-commerce has been the real star this year. The COVID crisis has accelerated consumer adoption of e-commerce for food and beverage, and we see no evidence of this trend slowing when the crisis abates. If you recall, at the time of the merger, we emphasized Keurig's first mover advantage in this space, dating back to the launch of Keurig.com 16 years ago and how we plan to leverage that competency across our full portfolio. Today, we believe we are the leader in e-commerce in food and beverage, if not FMCG. E-commerce now represents more than 10% of KDP total retail sales, and it continues to expand rapidly. While our online business is weighted towards brewers and K-cup pods, we also have a strong presence on the cold side, especially with Bi, Core, Mots, and Dr. Pepper. Up front, I mentioned the concept of ecosystems in our DSD and coffee business. Let me explain that important concept further, demonstrate its power in the most recent quarter and for the future, and announce several exciting developments. Our DSD networks, which gives us national reach and the ability to be in retail on a daily basis, is an attractive asset to startup or expanding beverage companies. While we have stated that we have no interest in renting out our system as a distributor, we're willing to partner with beverage brands that fill white space in our portfolio through a range of structures. Recent examples include our long-term partnership with Denone for the Evian brand, our investment with a path to ownership in Ashok Smart Energy, and our licensing agreement with Peet's Coffee for -to-drink beverages. This morning, we announced a long-term franchise agreement with Polar Beverages for their Polar Seltzer brand. Polar Seltzer is the third largest branded flavored sparkling water in the U.S., despite being available in less than 35% of the country. The brand is also the highest velocity sparkling water, where distributed. We currently have a long-standing and successful franchise agreement with Polar Beverages to distribute key KDP brands throughout their network in New England, and we are excited to announce a similar arrangement for their flagship brand to be in our system in expanded geographies. We look forward to rapidly scaling Polar to national distribution. We've also made a seed investment with a path to ownership in Don't Quit, a clean label meal replacement protein drink line created by Jake Steinfeld of Body by Jake. You'll hear more about this partnership in Don't Quit as the brand launches in a couple of weeks. Our coffee ecosystem is built on innovation, technology, and partnership. While common in the technology space, this structure doesn't exist anywhere else in CPG. That means when a consumer makes the conversion from brewing coffee by the pot to coffee by the cup, our branded partners, our retail partners, and we all benefit, which puts us all on the same page with regard to ensuring the Keurig ecosystem remains healthy and growing. In March, we were scheduled to unveil our Keurig innovation pipeline and latest growth strategy during an investor meeting in Texas. While COVID required that meeting to be canceled and the conversation since then has been dominated by the crisis, we have maintained internal focus on progressing our pipeline for launches in the third and fourth quarters and strengthening the Keurig ecosystem to the benefit of all stakeholders. Our lineup of K-Duo brewers launched in late 2019 performed exceptionally well in the quarter, and our K-Slim brewer introduced earlier this year is off to a good start. In August, we are launching the K-Supreme and K-Supreme Plus, filling out our product range at the mid to higher end of our portfolio. These new brewers priced from $139 to $189 feature our new industrial design and most importantly are the first of our next generation of brewers to include multi-stream technology, which increases coffee extraction by using a new five-prong needle system to deliver a more flavorful and aromatic cup. These brewers also offer greater consumer control over strength and temperature. We intend to cascade this technology to more of our brewer lineup over time. Additionally, in the third quarter, we are introducing a limited edition K-Mini brewer created by the renowned home furnishings designer, Jonathan Adler. This brewer represents the first step into a new platform for Keurig with limited edition and or custom designed brewers targeting consumers who are attracted by kitchen style and aesthetics. Look for more to come on this topic in the near future. Retailer interest for these new brewers and across the entire Keurig brewer lineup for the upcoming holiday season is strong and follows a very successful Mother's Day, which experienced a noticeable e-commerce retail shift. In our last earning call, we discussed how we were using real-time points of consumption data through our Keurig connected panel of 10,000 households to guide our decisions during the crisis. Harnessing what is -a-kind technology and CPG, we've been able to navigate the volatility caused by COVID, making near real-time decisions to drive strong in-market execution. We also make connected panel data available to all Keurig partners. Today, I'm pleased to report that our first smart brewer will be available for two consumers on Keurig.com between now and our next earnings call. The K Custom Smart will deliver our most personalized flavorful coffee experience ever, powered by our smartest technology. This brewer represents the next step toward having connected and intelligent brewers across our line. The K Custom Smart is compatible with existing K-Cup pods and has the capability to recognize the specific brand, variety, and roast for any owned, licensed, or partner brand made by Keurig, and brew to the specification of its master roaster to bring out the fullest flavor. The K Custom Smart can be controlled from a smartphone, set to turn on with your morning alarm, and brew your favorite cup of coffee from bed. It can also be customized to consumers' favorite temperature and brew preferences, and can automatically reorder pods, having tracked how many the consumer has brewed since their last order. More specifics will be available in the press release at the time of its official launch. Finally, earlier this month, we began selling McCafe as a Keurig licensed brand in the U.S. across K-Cup pods, bags, and canisters, further emphasizing our ability to create win-win partnerships across the portfolio. We look forward to working with McDonald's to drive growth for the brand in the U.S., as we've done in our partnership with McCafe in Canada, which began earlier this year. Before I turn it over to Ozon, I want to mention three important points regarding sustainability. Again, while most of our conversation over the past four months has focused on the COVID crisis, we've also continued our progress toward delivering our sustainability commitments. First, we're fully on track to convert 100% of our K-Cup pods to be recyclable by year end. As of today, approximately 95% of the K-Cup pods being produced are recyclable. Second, in the next quarter, we are targeting to introduce our first PET bottles made with 100% post-consumer resin. As you'll recall, we are committed to using 30% post-consumer recycled material by the end of 2025, and this is an important first step toward realizing that goal. We also recently announced our founding sponsorship and position as the largest funder of the Recycling Partnerships Polypropylene Coalition. This industry collaboration is designed to increase and improve the recovery and recycling of polypropylene, the plastic used in K-Cup pods, and many other food and consumer products. We have already begun using post-consumer resin in the production of our curing brewers. Finally, we have received the good news that our Spartanburg, South Carolina production facility for K-Cup pods will be LEED certified, making it the largest LEED certified production facility in North America and the second largest LEED facility of any kind. With that, let me hand it over to Ozan.

Thanks, Bob, and good morning, everyone. I will briefly review our performance for the second quarter, which our press release provides in significant detail. The second quarter was another good one for us. On a constant currency basis, net sales increased 2.9%, with growth in three of our four segments. Package beverages and coffee systems were particularly strong in the quarter. On a constant currency basis, adjusted operating income increased .1% in the quarter, driven by revenue growth, productivity, and merger synergies, as well as a significant reduction in discretionary spending. As Bob noted, we believe that we have struck the right balance of continuing to invest in areas such as innovation, technology, and sustainability that provide competitive advantage. Funded in part by reduced marketing, giving the low return on investments in the quarter and dramatically lower travel and entertainment expenses, giving the limitations in travel. These drivers were partially offset by negative segment mix, inflation, higher operating costs associated with increased consumer demand, and certain costs related to COVID-19 that were not treated as items affecting comparability. Let me pause here for a moment to discuss these COVID-19 costs. In the second quarter, pre-tax operating expenses directly related to COVID-19 totaled $75 million. Of these, $63 million were recognized as items affecting comparability and consisted of temporary and unusual compensation increases and incentives for frontline employees, as well as incremental safety and sanitation expenses across our business. The balance of the COVID-19 related costs in the quarter, which totaled $12 million, consisted of inventory write-downs and bed-set expense and have not been treated as items affecting comparability. Therefore, they are included in our adjusted results. Adjusted diluted EPS advanced 10% in the quarter, fueled by the growth in adjusted operating income and an increase in non-operating income in the quarter. These growth drivers were partially offset by increased interest expense due to lapping the benefit of an interest rate swap in the year-ago period and the higher effective tax rate due to lapping favorable discrete tax items in the year-ago period. Turning to our segment performance for the quarter, in coffee systems, constant currency net sales growth of .8% was driven by strong volume mix growth of 8.3%, partially offset by lower net pricing of 2.5%. The volume mix performance reflected higher purchases of K-cup pots and broovers for at-home consumption, partially offset by a significant drop-off in the office coffee and hospitality businesses. Constant currency adjusted operating income increased 10% in the quarter to $363 million. In packaged beverages, constant currency net sales grew .3% due to strong volume mix growth of 6.6%, partially offset by a modestly lower net pricing of 0.3%. This performance reflected increased at-home consumption and market share growth due to strong in-market execution, enabled by excellent supply chain management and exceptional collaboration across our frontline teams during the crisis. This growth was partially offset by a decline in the convenience and gas channels due to limited consumer mobility. Constant currency adjusted operating income increased .6% in the quarter to $269 million. In beverage concentrates, constant currency net sales declined .2% due to a significant drop-off in the fountain food service business, which serves restaurants and hospitality, and lower net price realization of 4.8%. The lower pricing related annual adjustments to prior year customer incentives, partially offset by customary concentrate pricing that we took in January. Importantly, as the second quarter progressed, we saw improving -over-month trends in this business, and those trends have continued into July. Constant currency adjusted operating income decreased .3% in the quarter to $222 million. And finally, in Latin America beverages, constant currency net sales grew 1.4%, reflecting the strong pricing of 6.1%, partially offset by a lower volume mix of .7% due to limited consumer mobility in Mexico. Constant currency adjusted operating income increased 30% to $23 million in the quarter due to continued productivity and lower marketing expense. While the current environment has proven the power of our brands, it has also evidently made the importance of simplification. To meet heightened demand and drive efficiency during the crisis, we focused our production and delivery on the highest priority products, with great success. Through this process, we have performed a detailed review of the offerings in our system to ensure we deliver on our customers' needs, while ensuring we were efficient. We will continue to focus on this as the best practice coming out of this crisis and going forward. In terms of our ongoing productivity and merger synergies, we continue to execute on these opportunities aggressively. In the current environment, we are delaying certain plant value capture projects due to COVID-19 related safety concerns. And in other cases, we are accelerating certain projects to offset delays. We remain committed to delivering our value capture commitments through both productivity and merger synergies, and fully expect to deliver our plant merger synergies of $600 million by the end of 2021. Now moving to cash flow and liquidity. Free cash flow in the quarter was strong at $524 million, translating into an adjusted free cash flow conversion rate of approximately 112%. In the quarter, we reduced bank debt by $274 million and structured payables by $78 million. And we ended the quarter with almost $150 million of unrestricted cash on hand. In terms of leverage, our bank debt to adjusted EBITDA ratio, which we refer to as our management leverage ratio, improved to four times compared to 4.5 times at the end of 2019. This improvement was driven by continued reductions in outstanding debt balances and continued growth in adjusted EBITDA. Since the merger closed, we have reduced our leverage ratio by two full terms. Turning now to capex. We continue to support the business with necessary capex investment, but some projects will be delayed, primarily due to COVID-19. For example, our new Spartanburg pot production facility is delayed approximately six months, resulting from equipment supplier delays. And our new cold beverages production facility in downtown is also delayed about three months for similar reasons. We have always expected both of these facilities to primarily be contributors to our business in 2021. And these minor delays do not significantly change our expectations, which brings us to our guidance. In terms of full year, we continue to have confidence in our ability to manage through what is likely to be a period in the second half, much as we have done today. Our outlook for adjusted diluted EPS growth remains unchanged at 13% to 15%. This outlook reflects our expectation for constant currency net sales growth in the range of three to 4%, continued strong management of the business, while maintaining investment in innovation, technology, and sustainability. Expected higher marketing investment in the second half of the year, relative to the second quarter, giving the expectation for an environment in which consumer receptivity to marketing and marketing return on investment improves. It's important to note that if we experience accelerating growth in our categories in the second half, we would likely increase our brand investment to drive mid to long term growth, while still delivering our adjusted EPS guidance for 2020. We also have confidence in our deleveraging targets and continue to expect our management leverage ratio to be between 3.5 times and 3.8 times at the end of the year.

And at this time, if you'd like to ask a question, please press star followed by the number one on your telephone keypad. Again, that is star one for any questions. We'll pause for a moment to compile the Q&A roster. Our first question will come from the line up Bonnie Herzog with Goldman Sachs. Please go ahead. All right. Thank you. Good morning,

everyone.

Hi, Bonnie. Hi.

I kind of want to just ask overall, you know, your business has done quite well in the at home economy that we're all experiencing right now. So just hoping you could talk a little bit more about how you expect your business will perform maybe in a more normalized environment. I guess I'm wondering if you see any risk at all in possible pullback in demand for your products, maybe as consumers return to some of their pre-COVID routines. You know, just really how do you think about this and, you know, how sticky do you expect your business to be as maybe things return to normal things?

Yeah, sure. Bonnie, it's a great question, something we think about a lot. I think if we step back at 100,000 feet and then I'll drill down deeper into your points. You know, we look at companies that fall into roughly three buckets. There were those that may not have been doing well prior to the pandemic and are doing really well during the pandemic because suddenly something was off trend became on trend and it would cause you to say, well, what's going to happen when things turn to normal, which is where you're going. There's another set of companies that we're doing really well prior to and are struggling in this environment. And in that case, you kind of have to hope for a return to a future that looks a lot like the past. We're in a very unique situation here and I think there are very few companies in this situation. That is, we're performing very, very well prior to the crisis. So we've said a number of times, we don't see this at all as a windfall for us. We've been able to perform very well since the crisis, but we've had to work really hard to do that. And I think you'll see from the comments that we made earlier that it is quite a mixed management exercise where we've had to push some of our business really hard. But I'll remind you, there are areas of our business that are large and profitable that have taken a significant hit in this crisis that we've had to offset. And if things were to return more to normal, we get the bounce back on those immediately. But we don't expect the future, we don't expect it to continue the way it is indefinitely, but we also don't think that the future is going to look exactly like the past. And so we have the tools and the levers to pull to be able to create a company that does even better in the future. And that's reflective of all of the innovation that we continue to invest in and we're continuing to launch. And we're getting great retailer receptivity on all of that as well because they're bullish about that future as well. So we're confident where we are and we continue to be confident in how we will deliver to the end of the year, as we talked about in our commentary. But we're not planning on a future that returns back to normal. If it did, it would actually be good for us. We're planning on a future that's going to look quite different. And we're navigating the company to be even stronger and stay ahead of the game.

Okay, that makes sense. Thank you very much.

Okay, thank you.

Your next question comes from the line of Bill Chappell with SunTrust.

Thanks. Good morning. Hi, Bill. Morning. Just looking at the kind of the brewer household penetration and is there any way to kind of gauge how much this sticks? And then, you know, I know we don't talk about attachment rate anymore, but certainly the attachment rate is going to a new higher level. Any kind of idea of where that is and where that's a sustainable level? I mean, I imagine a lot of us are dusting off our curing machines and using them all the time, but a certain amount of people have never used them before and will start using them on a regular basis. So just kind of any sense on how the whole platform has changed over the past three, four months?

Yeah. And remember, we have really good insight into this internally because we have this household panel of 10,000 homes where we can see minute by minute consumption. And so we've been able to track the attachment rate change from the very beginning of the crisis. And we haven't talked about attachment rate in the past because, as we said when you guys have tried to model that, it's really steady. So the whole game is really about household penetration. And we've also said that volume growth in the category is a good proxy for penetration because attachment rate is even. We're getting two benefits right now. We're getting new people coming into the system and to answer your question, that sticks. And we've seen that for years now that when somebody decides to move from brewing coffee by the pot to brewing coffee by the cup, or in the case that we have right now, people who weren't making coffee at home, making it at home now using a curing machine, that's incredibly sticky. The dropout rate from the system is very, very low. The attachment rate, as we look forward, our belief is we'll capture some of that increased attachment rate going forward because people who weren't making coffee at home or were making it at a lower frequency recognize that A, it's easy to do, that the quality has improved dramatically over the past couple of years. So for those that had a perception of quality, they're now getting a firsthand experience that the quality is better. You heard from our innovation pipeline that will continue to go up. And I think the third part of it is significant cost benefit to making coffee at home. And I think a lot of people, if you look at the research that we do, but also social media and articles that are written, there are a lot of people saying, I really like this. This is easier than I thought and I'm saving a lot of money on top of it. So we don't model going forward that we're going to keep all of that attachment rate, but we know we'll keep some of it. But the household penetration gains, we're very confident we keep the great, great majority of that.

That's great. And just one follow up on that. Have you seen any real change to trade down the private label or lower price brands as we've been in a quasi recession or is it just kind of too early to tell or see?

Yeah, I'll talk about both sides. On the cold side of the business, no, we're seeing actually pricing on average up as promotions less than, and we're seeing no move away from brands to private label. In fact, in many cases you're seeing the larger brands benefit and clearly we've benefited significantly from a share of total liquor refreshment beverage. And then we gained, as I said in the prepared remarks, 1.2 share points in CSD. So the brands that are brands in particular are doing very well in this environment. On the coffee side of the business, you're actually seeing a skew towards more premium brands in this environment. And I believe that's because as people trade off from making or purchasing coffee outside of the home to making it in home, they want to take their brands with them and the coffee shop brands that they can get now in our system skew towards the premium end. So that's very bullish. And the other point that's worth emphasizing is that the cost of pods today in general, whether it's at the premium mid price or the value or entry level price point, are all down significantly versus where they were three, four, five years ago. And that's intentional. That was part of our strategy that we talked about. We set off with the ambition of lowering the price of pods to increase household penetration and attachment rate. And that's exactly what we're seeing. So I would have thought actually that given some of the financial strain, you might see some trade down, which I would emphasize we're okay with because we produce a great majority of private label as well. But we're actually seeing the reverse right now. And although I can't predict anything in the future, it makes sense to me with the change in behavior from out of home to in home.

Great. Thank you so much for the color. Okay.

Thanks, Bill.

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

Hey, guys. Good morning. It's actually Pete Galba for Brian. Thanks very much for taking the question. Hi, Pete. Good morning. Bob and I just wanted to dig in a little bit on beverage concentrate. Obviously, Bob, you kind of mentioned it seems like you're through the worst of it or through the trough. And in July, trends improving. But also just wanted to touch on your concentrate volumes were pretty significantly behind bottler cases in the first half. I think it's something like 350 basis points. Just how should we think about catch up there in the second half of the year? And I have followed up as well.

Yeah. Let me start it. And then, Ozan, feel free to jump in at the end if you have something you want to add to this. The BC area is where you see the fountain and food service business that's servicing restaurants. And clearly that's been impaired. But it's improved throughout the quarter. And so I think that the gap that you're talking about between shipment sometimes and concentrate shipments and bottle or case sales, that happens from quarter to quarter. So there's always a catch up. But we are seeing great improvement in the FFS business throughout the quarter due to a rebound in restaurants. And I'd emphasize that we're particularly strong in QSRs. And in fact, Dr. Pepper Brand is the number one most available CSD in QSRs. And so as the drive-through business seems to be improving in particular, that's very bullish for us going forward. But you're seeing in the BC segment the hit that came from restaurants shutting down, especially in the early part of the quarter. Ozan, anything to add to BC?

No. I mean, actually you covered all the points. I mean, there is always a gap and lack between our shipments to our distributors and the bottlers and their shipments to the retailers. And as Bob said, always and always, even a timeframe catches up.

Got it. Now that's helpful. And maybe Ozan, just a quick one. You detailed some of the COVID costs for 2Q. Anything we should be expecting kind of in the back half of the year that you call out at this point?

Well, I mean, maybe I can use this opportunity to expand a little bit on the FX as well. And as you have heard in our prepared remarks, first of all, the costs, the excluded from adjusted results are unique and temporary impacts resulting from the crisis. So they are not normal ongoing cost of business. This is consistent with our long-term standing treatment of extraordinary and one-time costs. So I mean, these costs are clearly and not only defined as the significant expenses to provide temporary financial incentives to frontline employees, which represented more than 70% of the cost and the balance for the extraordinary measures that we undertook to protect employee health and safety, including obviously enhanced benefits for them and their families. And we also said there were a portion, approximately $12 million of COVID-related expenses that we did not add back and we kept in our adjusted results. Therefore, first and foremost, the health and well-being safety of our employees come as number one. Therefore, depending on the crisis and depending on how the pandemic is going to evolve, we will adjust our programs accordingly. Having said that, we also believe CoreCAD 2 was the highest in terms of us incurring the COVID expenses. Obviously, time is going to show us what will be the reality, but that's our expectations at this point in time.

Great. Thanks very much.

The next question will come from the line of Robert from the line of

Robert. Hi,

this is actually you Tom Drell on for Robert. Thanks for taking my question. Morning. So you mentioned a new product called Don't Quit. Could you just talk about what gets you excited about that brand? How does retail interest look and how are you thinking about sales and profit potential?

Yeah, so we're just giving you a teaser on that today and there will be appropriate press release from them because we're investing in this business in the next couple of weeks because it's already keyed up to go for sale in August. It's going to be available on right now it's about 2,500 retail outlets and growing traditional retailers as you might imagine as well as the e-commerce. What's exciting for us, big white space in our portfolio, protein drinks. We don't want to launch a me too protein drink out there and so this one we think is highly unique. It's targeted to a baby boomer population which is growing and underserved in this space and we think that all the new entries are going for a much younger population. We saw this as very unique with a very unique person behind it who speaks to that group uniquely. The structure is unique in the marketplace but not for us. It's very similar to the deal that we did with A-Shock where we put a relatively modest seed investment up front. We help them with this business although this business won't initially go through our DSD network. It'll go through warehouse direct and as it proves itself out we will put it in our DSD network where it's appropriate and it's got a pre-negotiated path to ownership so we have the option to buy it at a point in time in the future if we choose at a multiple that makes sense. It's the combination of all of those things that has us excited. As we said when we did the A-Shock deal we would like to do more of these. We see this as again part of this ecosystem that we've created where we can create these win-win structures, help entrepreneurs and startup companies get up and running and buy an option on them for the future and get rewarded for the help that we're able to provide to make them successful. More to come on that.

Okay perfect thank you. Your next question comes from the line of Kevin Grundy with Jeffries.

Hey good morning everyone and congratulations. Hey good morning Bob and congrats on a great first half year so far. Thank you. So Bob question on M&A which is going to become an increasingly I think for investors a bigger part of the story particularly as we sort of look out to next year. Can you talk a little bit about the M&A philosophy maybe share some of the governors around areas of interest fully understanding you don't want to front run anything that you're potentially looking at you know looking out we totally get that but maybe put some governors around where the board and where you're going to be looking and maybe even just comment you know there's some increasing discussion about another company in the beverage space looking in non-alcohol that is looking in hard seltzer category maybe you can comment on the company's openness to moving outside of non-alcohol as well and that'll do it for me.

Thanks. Yeah we look at white space in our portfolio and we could define white space very broadly and again I don't want to tip our hand in any way on that front but just like you heard us talk about energy in the past with A-Shock we just talked about don't quit in protein I'm just using those examples although they're relatively small at this point that we're very clear as to where we have white space in our portfolio and I think we're very creative in thinking through how do we access that white space in a way that's a win-win meaning we don't want to just be a distributor we've said that multiple times and so when you look at the arrangement that we have with Evian which was a space that we couldn't access on our own and then you look at the deal that we announced today on Polar which is very significant because it's a big category rapid growth white space we could try to invent it ourselves we could try to acquire somebody in that space but look Polar is a family-owned business it's a great brand it's not for sale and to be able to sit down with with them who we've had a long and successful relationship with and come up with this win-win scenario says that we can move forward in these spaces without having to necessarily buy something outright and we get all the benefits from it and then if you take a Polar they get the benefits of maintaining ownership from the brand and experiencing now what will be a national brand for them and with regard to specifically M&A just a couple more things that we've talked about before that I would emphasize we are very wary of acquisitions of highly developed businesses or rapidly growing businesses that have reached threshold that are at very high multiples we've said this before we've studied every one of these we cannot find one that has created value in the industry it's happened within our own house right we've talked about it when I'm on buy it's good learning for the future we love the brand but the multiples don't make sense and so we are not going to to fall into that trap and so we look at the the possibility of filling our white space through the arrangements that we talked about earlier which are seed investments long-term partnerships franchise agreements we also look at M&A but I would tell you what's off the table is going out there and and you know making a very large acquisition a huge multiple because the those values always get written down in the in the future.

Thanks for the caller. Good luck. Okay. Thank you.

Your next question comes from the line of Peter from with JP Morgan.

Hey good morning everyone. So just a couple questions on the on that sales guidance so first maybe you know a bit more of housekeeping but could you maybe break out what we should expect in terms of the benefit from McCafe but also player in the back half and then second I know the environment continues to evolve but as you mentioned Q2 is hopefully going to be most difficult but so the extent that you are willing to share kind of what are the underlying assumptions embedded in the guidance for the back half from an operating standpoint you know do you expect a continued reopening reopening sequentially is it kind of based on where we are now just anything around that topic would be helpful.

Thanks. Yeah yeah with regard to McCafe that was announced in the beginning of the year so that was always part of our 2020 guidance and I would say that everything is on track there so no new news so that's embedded in the guidance. Polar is something that will be up and going but it's really a benefit towards 2021 rather than 2020. You know both McCafe as well as Polar there are investments that are that are required in the first you know six months to a year so that there's almost no profit impact on either of those and again we said that before on McCafe so I look at those as much more of a 2021 impact and the story that comes out of that is we are managing our way through the COVID crisis really well and holding on the guidance and we're doing that with what we have right in hand but we're continuing to invest in innovation and new partnerships and we talked about a lot of innovation today as well as these new partnerships which really set us up for continued growth. This is not a short-term phenomenon this is something that we will invest in over the long term. Your question about the back half of the year is a really important one because we're one of the few companies that has provided guidance and we do not think for a second that we can predict a future better than anyone else and if you look at the feds comments yesterday and they have better access to the economy than we do in terms of the data they put a lot of caution out there on the second half so I think the important thing for you to take away from this is that we're not operating off of a single point forecast. We tested our second half plans against a number of macro scenarios and despite the fact that we think it's going to be bumpy and volatile we feel like with that testing that we've been able to put out there that we have confidence in our ability to continue to deliver really strong revenue and EPS growth so it's not just a matter of holding on to guidance I'd like to point out to people it's guidance for 13 to 15 percent EPS growth and three to four revenue growth for the year in a year that is is unprecedented in terms of its challenges it's because we're working against a range and not a single point.

That's very helpful thank you best of luck. All right thank you.

Your next question will come from the line of Avivia Nazer with Cowen.

Hi

thank you good

morning. Good morning. I would like to understand a little bit on your outlook for polar and the sparkling water category more broadly it's certainly been outperforming still water pretty considerably for a couple of years well more than a couple of years now so where do you see the share today where do you see it going forward and are there any international benchmarks that you're using to inform that? Thank you.

Yeah I don't there's unfortunately in this category there's not an international benchmark that's very helpful I think what you're seeing is that people love carbonated soft drinks I put that in the broadest category people like bubbles and there are full calorie versions of them there are low or no calorie versions of them using a variety of sweeteners and then there are unsweetened flavored varieties in there and we're seeing growth right now across all of them but the area that's really emerged in recent years and continues to be strong through the crisis has been this unsweetened flavored sparkling water and I don't see any signs of that slowing down because it's representative of a shift in consumer preferences towards healthier but also just less flavor less sweetness in general and we see that in in a number of categories. I don't know how high is high but again when you're looking at growth rates polar in the you know in the past six months grew at like 25 percent you're seeing explosive growth and we as I said before could have come at this by an acquisition we could have come at it by trying to develop our own brand and we thought this was the best way to go this is the highest velocity brand in the category they have one challenge and that is they're only in about a year and a half. So I think that brand in partnership with them and making it national is the best way for us to leapfrog in this category and end up in a leadership position and I would also point out that we've got some other smaller positions in this category Canada Dry and Schweppes are in there Canada Dry by the way in the northeast corridor is a very strong brand in unsweetened flavored sparkling water but we really are emphasizing Canada Dry in its ginger ale credentials and you see that it has had 13 years of growth with a lot of innovation behind it and so that's always going to be the focus on Canada Dry we're not going to pivot that to a sparkling water brand and we made an acquisition last year that we didn't talk a lot about of Limitless which is more of a functional sparkling water and I would just say more to come on that one we haven't really put our game plan in play on that and we'll be happy to share that with you in the future and we think that like many large and growing categories the best way to access them is through multiple plays but be clear the polar play is our lead one and we couldn't be more excited to partner with with the fastest selling brand in that category.

Thank you. Our final question will come from the line of Sean King with UBS.

Hi, good morning. A question for you on the strong brewer number. Is there any kind of color you can provide on the cadence of that through the quarter like by month and could that number have actually been higher given the closure of a lot of the traditional retail channels through the quarter?

Yeah, very good question. That has been strong and steady with no signs of slowing throughout the quarter so it's not an issue like we saw in some of the other categories like Fountain and Food Service where it was incredibly weak in April and we saw a recovery by July. This has been strong from the start and persistently strong. We're happy to report. In terms of your point which is very true which is a lot of the traditional brick and mortar retailers were impaired. We saw a very significant shift to e-commerce during the quarter and that's a combination of traditional e-commerce players. The brick and mortar retailers that you refer to, some of them did a fantastic job of pivoting to e-com and then of course we have curig.com and in the case of our e-commerce capabilities which I will point out again, e-commerce now represents more than 10% of our total company retail sales. We have such strong capabilities there that we were able to step in and actually fulfill shipments for e-commerce retailers who weren't able to catch up with demand. So think about the pressure they were under in the early parts of this crisis. Our brewer sales could have been higher in the early stages if they were able to fulfill. So we actually stepped in and in a large number of cases fulfilled on their behalf and were able satisfy the consumer demand that was there and continues to be there. The last point I make on this is nobody knew what Mother's Day was going to be like. It's one of those classic holidays and we always think do we play in this one? We had a very strong Mother's Day. It was an e-commerce shift. People shifted towards things that they could get through e-com and also that were predictable, reliable. They knew that they were safe in terms of people would like them and also there was a shift towards more functional gifting. I think you're going to see the same thing at Christmas. Whenever there's a situation like this and people are also feeling financial stress, they tend to move away from gifting that's more extravagant to that which is more known and functional. The fact that we're going to be out there with a full lineup of our best lineup we ever had and some really good innovation on top of it is the reason why I said in my comments that retail or receptivity around our innovation pipeline and total lineup for Q3 and Q4 has been remarkably strong.

Great. Thanks for the call. Best of luck.

All right. Thank you.

I'll now turn the call back over to management.

Thank you very much. This is Steve. The IR team is around all day. If you have any questions, please reach out to us and we'll follow up with you. Thanks so much for joining today.

Ladies and gentlemen, that will conclude today's call. Thank you all for joining and you may now disconnect.