Keurig Dr Pepper Inc (KDP) 2014 Q2 法說會逐字稿

Good morning, and welcome to Dr Pepper Snapple Group's second-quarter 2014 earnings conference call.

(Operator Instructions)

Today's call is being recorded and includes a slide presentation, which can be accessed at www.DrPepperSnapple.com. The call and slides will also be available for replay and download after the call has ended.

(Operator Instructions)

It is now my pleasure to introduce Heather Catelotti, Vice President, Investor Relations. Heather, you may begin.

Thank you, Jackie. And good morning everyone. Before we begin, I would like to direct your attention to the Safe Harbor statement, and remind you that this conference call contains forward-looking statements, including statements concerning our future financial and operational performance. These forward-looking statements should also be considered in connection with cautionary statements and disclaimers, contained in the Safe Harbor statement, in this morning's earnings press release, and our SEC filings. Our actual performance could differ materially from these statements, and we undertake no duty to update these forward-looking statements.

During this call, we may reference certain non-GAAP financial measures that reflect the way we evaluate the business, and which we believe provide useful information for investors. Reconciliations of those non-GAAP measures to GAAP can be found in our earnings press release, and on the investors page at www.DrPepperSnapple.com. This morning's prepared remarks will be made by Larry Young, Dr Pepper Snapple Group's President and CEO, and Marty Ellen, our CFO. Following our prepared remarks, we will open the call for your questions. With that, let me turn the call over to Larry.

Thank you, Heather, and good morning, everyone. We've had a good first half of the year, in what I've said is the most challenging CSD environment I've ever seen. Despite the headwinds, our teams continued to remain focused against our priorities, and we achieved another solid quarter of results. And as you may have read in this morning's press release, we've raised our full-year EPS guidance by $0.05 to reflect our first-half performance, while remaining cautious on the CSD category over the balance of the year.

For the quarter, bottler case sales increased 1% on roughly 3 points of positive mix and price, with CSDs increasing 2% and non-carbs declining 4%, primarily the result of the 12% decline in Hawaiian Punch. Dr Pepper decreased 1% in the quarter, reflecting sequential improvement from the last quarter. Our core four brands increased 2% in the quarter, led by continued from growth in Canada Dry, both 7UP and Sunkist were flat in the quarter.

As I said, Hawaiian Punch declined 12% on category headwinds, and increased competitive activity. Snapple decreased 3%, as we've strategically de-prioritized our value line. Our Snapple premium business grew by 1% in the quarter. Mott's was flat in the quarter as declines in the sauce business offset growth in juice. Penafiel increased what 25%, as we continue to see strong performance in our mineral water business, and successful innovation that we launched in the third quarter of last year.

All other brands increased by 1% in the quarter. Schweppes experienced strong double-digit growth, reflecting growth in our sparkling waters and positive ginger ale category trends. Clamato grew 8% in the quarter, and our water category increased 4%, on strong growth in both Fiji and Vita Coco, as well as new distribution agreements with [By 5] and Sparkling Fruit2O.

On a year-to-date basis, bottler case sales are flat on 2 points of positive mix and price. Dr Pepper declined 2%, and our Core 4 brands increased 1%. Hawaiian Punch declined 10%, while both Snapple and Mott's decreased 1%. Penafiel increased 22%, and all other brands were flat.

On a currency neutral basis, net sales increased 2% in the quarter on sales volume growth, favorable product and package mix, and pricing. This growth was partially offset by an unfavorable trade discount comparison to last year. Core operating income increased 18% on sales growth, lower cost of goods, a planned decrease in marketing investment, and ongoing productivity improvements. Core EPS increased 26% in the quarter. Year-to-date, currency net sales increased 2%, core income from operations increased 19%, and core EPS increased 31%.

Now through the first half of the year, I thought I'd share a quick update on how we are progressing against our key priorities. Increasing distribution and availability of our key brands and packages continues to be a significant opportunity for us. Year-to-date we've increased distribution in grocery on both key CSD brands and packages, and on Snapple. We've also gained almost 2 points of ACV on Snapple premium in the convenience channel, and just under 2 points of ACV on Mott's in the grocery channel.

We're continuing to expand single-serve availability, while creating new sampling occasions for our brands, with over 20,000 new fountain valves across both local and national accounts. As a result, our fountain food-service business grew 2% in the quarter. We've also re-deploying cold drink equipment assets across our DSD footprint, ensuring that we're maximizing our return.

Our brands are well-loved by consumers, and our equity scores reflect just that. We continue to see gains in our equity scores across the portfolio, with improvements in both brand relevance and brand strength, reinforcing the effectiveness of our marketing programs. As consumers needs and preferences continue to evolve, we're ensuring that we're meeting their needs with a portfolio of products. Our R&D team continues to make progress in the sweetener development area, though we've said before that there is no magic bullet, and this will be an evolution that occurs over time.

Our TEN platform continues to drive incremental consumer occasions, bringing lapsed users back into the category with its great taste, and full mouth feel, for only 10 calories per can. And we're currently testing natural sweetened CSDs, for consumers who are looking for a lower calorie option without artificial sweeteners. Our naturally sweetened CSDs contain real sugar and stevia, and are 60 calories per 12-ounce can.

RCI continues to drive improvement in all RCI pillars. Safety, quality, delivery, productivity, and growth. And I couldn't be more pleased with the engagement of our people in achieving these results. Marty will provide you more color a little later.

We had a strong programming throughout the first half of the year. And as I look toward our back half calendar, I'm confident that we have strong plans in place to drive engagement and excitement with our consumers, and our customers. Summer is a time for entertaining and refreshment, and I hope you've seen and tried our Dr Pepper Vanilla Float limited time offering. This is currently out in the market.

The PJ Awards is the number one Hispanic youth award program. This summer, Dr Pepper partnered with the PJs for the fifth straight year, and had Romeo Santos, a popular Latin artist, to give away VIP trips to the award shows that aired last week. 7UP has partnered with seven electronic dance music DJs, including world-renowned Tiesto, to make the brand synonymous with the growing EDM culture. Our 7UP Light It UP campaign launch in early summer, and has already delivered millions of targeted impressions with the Hispanic millennial consumer. And our fan base continue to grow on the 7UP Facebook page.

Snapple's partnership with America's Got Talent is in full swing, delivering millions of impressions during the shows, and through our digital specific campaign. And we just announced a three-year sponsorship agreement with the San Francisco Giants last week, which will give Snapple pouring rights in AT&T Park, and bring Snapple teas and juices to thirsty Giants fans.

We are ready to kick off the 2014 college football season with an exciting partnership with ESPN. Dr Pepper is the first official college football championship partner, and presenting sponsor of the new national championship trophy. We'll deliver over 2 billion media impressions across both traditional and digital media platforms, ensuring that we're always on, and our tuition giveaway program will also be integrated with the ESPN properties this year.

And just in time for back-to-school, we're reaching Shopper Mom and supporting schools throughout our participation in the Box Tops for education program with Mott's. I'm sure you'll agree that our plans are stronger than ever. Now let me turn the call over to Marty, to walk you through our financial results, and 2014 guidance.

Thanks Larry, and good morning everyone. For the quarter, reported net sales increased 1%. Package and product mix, combined with pricing, including the impact of the price increase in Mexico to cover the sugar tax, increased net sales by roughly 3 points. This was partially offset by higher discounts, mostly due to an unfavorable comparison of our annual true-up of trade spending, and also 1 point of negative foreign currency.

Reported gross margins were up 120 basis points in the quarter, increasing from 58% last year to 59.2% this year. Lower commodity costs, net of the year-over-year LIFO impact, increased gross margins by 160 basis points. RCI productivity and other cost improvements further increased gross margins by 65 basis points.

Product and package mix, which includes growth in products bought from allied brand partners, reduced gross margins by 60 basis points, and the unfavorable trade discount adjustment I referred to earlier reduced gross margins by about 40 basis points. The net impact of the Mexican sugar tax further reduced gross margins by 45 basis points, as our pricing, as intended, is only a pass-through of the tax.

There were no material mark-to-market commodity gains or losses this quarter. However, we did record a $7 million unrealized mark-to-market loss a year ago, with approximately $5 million recorded in cost of goods, and $2 million reported in SG&A. The net effect on gross margins was a 30 basis point increase.

For the quarter, SG&A excluding depreciation, decreased by $27 million. As we highlighted in our full-year guidance, marketing spend declined $18 million, as we lapped activity on Core 4 TEN last year. Second-quarter marketing spend represented 7.8% of second-quarter sales, slightly ahead of our full-year target of 7.5%. Other favorable SG&A comparisons include $3 million of foreign currency and the unrealized mark to market comparison I just mentioned.

Last year's SG&A included an unclaimed property audit settlement of $4 million. We were able to fairly well offset SG&A labor and other cost inflation, including higher transportation costs from our third-party carriers, by other cost and productivity improvements. Depreciation and amortization was flat at $29 million.

Other operating income was $3 million in the quarter, versus $2 million of expense in the prior year. Driven by the sale of certain warehouses, a direct result of RCI's supply chain improvements. Reported operating income was $348 million, compared to $285 million last year. Core operating margin of 21.3% of net sales was up 290 basis points, from 18.4% in the prior year.

Below the operating line, net interest expense was $27 million, $3 million below last year, reflecting an interest rate swap we entered into in December of last year, and the repayment of senior unsecured notes in May 2013. Our effective tax rate for the quarter was 35.1%, slightly lower than expected.

Now, moving onto cash flow. Cash from operating activities for the six months was $438 million, up $143 million, and capital spending was $71 million, compared to $80 million last year. Reported free cash flow was $367 million, compared to $215 million last year. Total distributions to our shareholders year-to-date were $363 million, with $206 million in shares repurchased, and $157 million in dividends.

Before I move on to guidance, let me give you a quick update on RCI. RCI is beginning to become a permanent foundation of our business. Actually, the way we do business, and it continues to drive significant value throughout the organization. We've created lean and leadership tracks, led by senior managers in the company to not only drive meaningful results, but to also create a set of lean leaders and front line excellence throughout the business. I'll share some of the wins we've seen so far this year.

First, we've closed over 4,000 voids on our Snapple business across several markets, achieving sales growth in each of those markets, outperforming national brand results. Second, we've added over 30,000 incremental points of distribution across our single-serve juice portfolio, driving double-digit dollar share growth in the single-serve, multi-pack juice segment. Third, we've even included one of our Dr Pepper distribution partners on an RCI event targeted at increasing our display tie-in rates, and are seeing much improved results in that market. And fourth, we've closed about 650,000 square feet of unnecessary warehouse space this year, and you saw on our financials, realized about $5 million of cash proceeds. These are just a few examples. We continue to believe our runway is long, and we have significant further RCI opportunities.

Now, moving on to 2014 full-year guidance. As you saw in this morning's release, we have now raised our full-year core EPS guidance to a range of $3.43 to $3.51, based on stronger-than-expected first-half performance. While we are very encouraged on many of our key initiatives, as well as our balance of year plans, we are still remaining cautious on the macro and category environments in the US. For the year, we still expect volume to decline roughly 1 point, with CSDs declining slightly, and our non-carb portfolio declining low single digits, although this continues to be a Hawaiian Punch driven issue.

From a CSD standpoint, we do expect concentrate shipments, which have trended ahead of bottler case sales to soften somewhat in the back half. We continue to expect combined price and mix to be up about 2% for the full year. As a reminder, the higher pricing in Mexico, as a result of the sugar tax, will contribute approximately 60 basis points of this positive pricing, but will not contribute earnings growth, as it is simply a pass-through of the tax. Our January 1 concentrate price increase will drive another 40 basis points of growth.

We expect foreign exchange translation to unfavorably impact net sales and operating profit, by approximately 50 basis points each for the full year. As we communicated previously, we expect packaging and ingredients deflation for the year. This is expected to reduce total cost of goods, inclusive of the year-over-year LIFO comparison, by approximately 2% on a constant volume mix basis. However, this deflation will be realized during the first three quarters of the year. Just over 1% inflation is expected in the fourth quarter.

As a reminder, we recorded a $14 million LIFO credit in the fourth quarter last year. Similarly, we booked a LIFO credit of $7 million in the third quarter of last year. We will not have any similar credits this year. Separately, we expect the Mexico sugar tax, which is recorded in cost of goods sold, to increase total cost of goods by approximately 1.6%. After considering all of these items, 2014 gross margins should be flat to slightly better than last year.

Consistent with our previous expectations, higher transportation costs are expected to add $17 million of expense in 2014, and are being incurred evenly throughout the year. People cost inflation of $30 million for the full year, including health and wellness cost increases, will be significantly more pronounced in the third and fourth quarters, as we cycle the benefits of last year's restructuring activity, combined with lapping certain favorable health and wellness cost true-ups in last year's fourth quarter. And we continue to expect marketing spend to be proximately 7.5% of net sales.

Below segment operating profit, net interest expense will be around 4.4% on our $2.5 billion of debt. And our full-year core tax rate is expected to be approximately 35.5%. In terms of cash flow, capital spending will be approximately 3% of net sales, and we are on track to repurchase approximately $375 million to $400 million of our common stock in 2014, subject, of course, to market conditions. With that, let me turn call back over to Larry.

Thanks, Marty. Before we open the lines for questions, let me leave you with these thoughts. Our priorities remain unchanged. We will continue to execute our strategy in a challenging environment, ensuring that we build our brands, while executing with excellence in the marketplace, and driving productivity throughout the business.

We're committed to providing consumers with options to address their evolving needs and lifestyles. We remain focused on managing the business prudently for the long-term, and will continue to invest in our brands and our people, while ensuring we optimize every dollar we spend. RCI continues to drive meaningful improvements in the organization, and importantly, we remain committed to returning excess free cash to our shareholders over time. Operator, we're ready for our first question.

(Operator Instructions)

Our first question is coming from John Faucher with JPMorgan.

Marty, I want to follow up on the gross margin guidance, and I understand some of the headwinds in terms of LIFO, et cetera. Can you talk a little bit maybe about Q3 versus Q4, because it seems like with the tougher comp in Q4 the gross margin guidance makes sense, that the gross margin could be down then. But I'm having a real hard time getting Q3 gross margin to where it would need to be, to hit your guidance for the full year. So I know you talked about a little bit in terms of LIFO adjustments, et cetera. But what we missing here that's going to create a pretty seriously down gross margin, given the fact that you're up about 140 basis points year-to-date?

Okay John, thanks for the question. Good morning. So let me try to help guide you on a full-year basis, and for the full-year basis, you can ignore the LIFO. The LIFO has an impact across the quarters over last year, but not on a full-year basis.

So the way we see our margins forming, gross margins forming for the year would be approximately as follows: Our 2% full-year guidance COGS deflation, net of all the LIFO from last year, so working off of last year's cost of goods base is roughly worth 80 basis points of year-over-year improvement. Our concentrate price increase, which for the most part -- leave Mexico's price out of this for a minute, for the most part, is the only real drop-through pricing that we're looking at. So that's worth 40 basis points.

Now the Mexico sugar tax, which is in essence, zero margin revenues because we're just passing the tax through, in terms of the rate of margin, it's probably worth a negative 50 basis points. So you're roughly up 70 and then another potential downside factor is product mix. Packaged beverages is benefiting from the sale of a number of these allied brands Larry mentioned, whether it's Vita Coco, By, et cetera.

We buy these products, we buy finished goods, so the gross margin is not as great. It's good profit per case, but here we're talking about the rate of margin. So somewhere, you're somewhere up on the higher side to 70, 80, maybe a little less, for the full year.

Got it. And then one follow-up on the concentrate price increase, which is, can you talk about the discussions you're having with your bottling partners, in terms of how you're focusing on the reduction in marketing spending, improved efficiencies there, in the context of a concentrate price increase?

What we're doing much more on that John, is showing, just like we said in the first quarter, how we're getting more exposure out there, more GRPs, more activity, more frequency. So we are measuring it much more on the end result than what it cost to get it.

Okay. And you very much.

Ali Dibadj, Bernstein.

I wanted to talk about a couple of things. One is the mention of higher discounts, and if you look at the net pricing at least, negative 2, and beverage concentrate flattish, and packaged beverages. And I understand you are saying look, we're getting 2 overall. I'm trying to get a sense of what your view is of the pricing environment out there, and it feels like you're not following quite as much your competitive set, in terms of pricing in the marketplace being up, from what we saw from Coke and Pepsi, all reported higher than your numbers. Wanted to get a sense of that from you, first please.

Let me start with some numbers, and Larry can comment on market pricing activities. So to clear up beverage concentrates, we do a funding accrual true-up every year, we happen to do it in the second quarter, just to box the numbers. Last year, in beverage concentrates, it actually provided a revenue benefit of $11 million, and this year, it was a charge or reduction of $7 million. So now you can frame that into your model, and of course absent that, there would have been growth in the beverage concentrate segment, so I pass that information out, and Larry can talk about marketplace pricing.

As far as the pricing, we see the pricing being very rational, very disciplined out there right now. We are taking advantage of all that pricing, and if there's any incremental pricing, we'll be watching that on a market-by-market basis. And also remember that the majority of our Dr Pepper is priced by the Coke and Pepsi systems, close to 80% goes through those two systems there, so I would say we're very competitive in all prices that are out there.

I guess I'm trying to understand what you mean by taking advantage of pricing, which is what you just said, because beverage concentrate was down 2%, and pricing, I respect the true-up, but that's the first time in 45 years that's down. Usually up mid-single digits, so trying to get a better handle on that. And then on the finished, it's flat. So I'm trying to understand what you mean by take advantage of, are you not pricing as much as your peers?

Ali, let's just clarify for everybody. Pricing in concentrate, concentrate pricing did go up at the beginning of the year, and it is being realized. So I don't know if your question goes to that, or goes to what's happening in the market place in terms of end consumer pricing?

So when you mean pricing, do you include mix and discounting?

Well, we try to separate those as best we can. That's why I'm saying, I said in my remarks, as I just went through with John on gross margin for the year, other than the concentrate price increase, we don't really see any true pure pricing falling through in the US. Where we are benefiting is mix.

Okay. And you believe your price mix plus discounting is in line with, across your portfolio, your peers?

Absolutely.

Absolutely.

Okay. Thanks.

Steve Powers with UBS.

Maybe taking both those two same topics on, so first margins, and then pricing, but from a slightly different angle. On the margin side, Marty, you gave some good details on the moving parts, both from margin within the quarter, and also in response to John's question, for the balance of the year. But as you step back, could you just maybe frame for us the total benefit from that margins year to date have received from the following three factors: First, commodities deflation. I know you gave it for the quarter, but year-to-date. Second, the lower advertising, again year-to-date.

And then, really the total productivity. And here I'm talking about both direct RCI benefits plus any other productivity that you have been able to realize and pull through. I realize that there are other factors involved in the margin, but I'm trying to isolate on those three, and especially the third bucket, that productivity bucket, as a feel for what the total run rate is on gross productivity, in the business right now. Thanks.

Thanks, Steve. Okay, let me handle those. So let me start with commodities and LIFO. You really need, for your purpose, in terms of trying to understand margin structure of the business, which I think is where the question goes to, let's not worry too much about what happened with LIFO last year, because on a full-year basis, it simply negated the cost inflation we took the year before, when the apple prices went up.

So as I have said, the net effect of that in the quarter was 160 basis points, and as I just told John, if you think about that deflation for the year, it's up 80 basis points. So the way we would think about it is, when you look at current costs as they sit today, you add 80 basis points last year's margin, that creates, at least with respect to that item, a new baseline margin. When it comes to, as I said in the quarter, about 65 basis points of productivity, some of that's RCI, but actually a large portion of that came from some renegotiated vendor and supplier agreements, and that's good news, because of course those will, in fact, continue over the duration of those agreements. Steve, am I missing a third part of that?

I mean I think you said A&P was down $17 million or $18 million in the quarter. What was it down for the first half?

That was $25 million for the first half. Remember that this was planned, don't forget that we are lapping the introduction a year ago of the Core TEN products. And I said in my prepared remarks, we still spent 7.8% of sales this quarter, a year ago. With that program, it was 9.1%. So we're tracking where we want to be, and I'm here to tell you, and Larry will tell you, based on what we've seen in terms of our activities and program, the A&M we're going to roll out in the fourth quarter that I think is going to be -- going to hit somewhat head on what's happening in the diet category, when you see our new college football championship trophy program that's tied to Dr Pepper we're feeling good about our spend, and we don't think we need to spend any more, and we continue to apply the rigor were trying to get better at, in terms of marketing ROI, and trying to find every dollar that's not working for us, to work somewhere else.

That's very helpful. And just on the pricing side of things, as you say, Larry, things are rational, we've heard that from your peers as well, which is great to hear. But the skeptic in me says it's rational in an environment where commodities really aren't a factor, retailers are actively promoting the category, and right now, volumes are trending better than a lot of folks, I think when we spoke in March, you were looking at category volumes down maybe two or three, and we're obviously a lot better than that so far this year.

So how do you feel about the rationale of your pricing over time, if any of those factors get a bit worse? You have confidence that rationality will hold? And if not, what contingency plans does DPS have in place?

I feel very confident it will hold, and if you look at what we've experienced in the last 18 months, I mean, going through this year and last year, when there was discounting, Steve, there wasn't the volume pick up. I think everyone's learned some great lessons from that, not just the bottling community, our competitors and peers, but also the customer. And so, we're seeing -- most of our growth we're seeing is in the sugar products. And as everyone knows, the diets are what's really hitting us now, and to Marty's point, we think we have some programs put together for later this year that are going to take that head on.

Okay, thanks.

Dara Mohsenian with Morgan Stanley.

Marty, the gross margin clarity was helpful, but I'm still struggling to understand why you weren't flowing through more of the earnings upside we saw in the first half of the year to full-year guidance, because it seems like volume is coming in a bit better than expected so far this year, or maybe worse, in line with your original expectations, the pricing environment looks rational in the US, as you indicated. Mexico top line results have come in much better than expected, commodities are more favorable, RCI savings and productivity have ramped up, so I guess I'm just struggling to figure out what the offset is to these positives that you limit you to only a modest positive full-year earnings revision, versus the first half upside that we saw from an earnings standpoint.

Thanks. I think you summarized it well, and so I'll respond with simply one word. We're midyear, and we want to be cautious. You are correct. Mexico outperforming our expectations coming into the year, given the uncertainty of the tax, US business performing better on the top line than we thought, and we've got some cost increases I called out, we're going to lap some things in the fourth quarter that were really one-time. Health and wellness, an adjustment from last year, we're going to have some other inflation. But when I still put all that together, I give you a one word answer. At this point, to the middle of the year, we want to remain somewhat cautious.

Okay. That's helpful. And then on the advertising spending line, it sounds like the ROI payback that you are getting, and the efficiencies you are realizing there, that's more of a continuous program that will last beyond the efficiencies we've seen, the last few quarters here. Is that the fair way to look at it, in that you don't need to reboost spending after the declines this year, just because it's more based on efficiency and productivity, in terms of marketing spending?

Yes, Dara. We're 7.5% -- if you go back historically, leave last year out, you would say we were between 7.5% and 8% over the years, the ROI program, the analytics behind the program we're really pleased with, but I'm also going to tell you, just like RCI, we're in the early stages of really developing the rigor and discipline, but we're working at it really hard, and we have seen some payback.

The other thing I remind everybody all the time is that to some degree, your ability to spend and therefore implement marketing programs, has to still find its way through the funnel of your sales teams, in terms of what they can, how much they can execute during a given time frame, not just inside the Company, but actually asking customers to do at the same time. You can't bring them too many things all at once. It's just not possible, so there is a little bit of a governor, if you will, on that, which people really ever talk about. And you don't follow that governor, what happens is, you throw a lot of money in marketing, and then your wonder why you're not getting the payback, and you realize because you asked your sales force do 10 things, instead of 5 things really well. And we pay a lot of attention to that.

Okay. Thanks.

Judy Hong with Goldman Sachs.

Larry, I just wanted to get your assessment about the Dr Pepper brand performance. Sequentially, a little bit better, down 4 in Q1, down 1 in second quarter, but maybe lagging some of your other CSD brands here. Just maybe give us a little bit more perspective on where you think the brand stands? I think you've shown some relevance scores that still shows improvement, but where do you think there may be more work to do, here, in terms of really rejuvenating the brand Dr Pepper volume?

Judy, and as you said I mean it was a great improvement from Q1, minus 4, to minus 1. We feel very confident with Dr Pepper. Our issue, Judy, is diet. Diet is taking us down.

As I mentioned earlier, we have -- and we're all over it, we're really digging deep into it, and we have programs for the second half that we think are really going to take this on. We have some specific programming we're doing, but also tying our diets into our football program. The team is very confident, our bottling partners are very confident that Dr Pepper, the brand strengths are good, the fountain food service numbers are good, and as we address this diet situation, we'll be able to get her Dr Pepper volume's back up where they're used to.

Okay. Marty, if I could just follow up on the margin, just maybe ask it a little bit differently. So in the fourth quarter of this year, why do you think the commodity trends will turn inflationary? What are some of the drivers of going from deflation to inflation? And then thinking about just specifically for packaged beverages, because it seems like that's where you really saw pretty significant margin expansion, in the second quarter at least, so the impact in terms of their product mix that's having on the margin, and how that flows through in the back half of the year?

Okay Judy, let me start with packaged beverages. Yes, they had a nice operating income improvement in the second quarter, and they did receive the bulk of the commodity deflation in their cost of goods. They also benefited from, at the operating income line, from some of the increases in the allied brands, Larry mentioned a number of them, Vita Coco, et cetera, and they also had productivity gains.

As I said, we didn't really in packaged beverages, realize any true pricing drop through, so theirs was a mix story, a commodity deflation story, and a little bit of a productivity story. Your first question, in terms of the Q4 guidance and margins is simply the timing, okay, of our current cost trends. We are fairly well hedged now for the year, not completely, but fairly well hedged, and well into the 90% range in some of our key input items. And it's just the comparison against last year. So it's just that's just the timing, the way it flowed through the quarters.

Okay. Can you just remind me how much of your volume is now in the allied brands? Volume or sales, whatever metric you look at?

I do know. Maybe 3, maybe a tad more

Okay. Great, thank you.

Robert Ottenstein with ISI Group.

I was wondering if you could give us a little bit more detail, in terms of Snapple. What percentage of your volume you characterize as value, what percent premium, and what efforts you see over the next 12 months or so to reignite that brand? And what the competitive environment looks like.

Yes, if you look at the Snapple, let's start with the value. I mean we went out to the value brand specifically for some strategic reasons two years ago. If you remember, we always say that we pursue profitable volume, profitable channels, and packages. We accomplished what we wanted to do with the value.

Snapple is a premium tea. We will always consider it a premium tea. That's where we want to put our focus, that's where we want to get our growth. We have a lot of great innovation coming along with Snapple, you heard some of the things we're doing with marketing and some of our sponsorships. We've got some LTOs that were looking at for later in the year next year.

Plus, continued R&D on looking at different ways, different sweeteners, different types of teas. Keeping the excitement, that the Snapple consumer is used to having a variety. And so we feel very good with the plans we have in place for Snapple. We just want to emphasize the value piece of it, and it's really only about 10% of our total, I don't know the exact number, but that's roughly a correct number. 10% of the total.

Great. That's very helpful. And then some of your competitors are making a very large effort to drive mix through smaller pack sizes. Just wondering what you think about those efforts, and what your plans are?

Especially with Dr Pepper, we participate in those plans, any packages they have, we have our Pepper and Diet Pepper in them, so we think they're good plans. We do a wide range of different packaging. That's where Marty talked about it, we really try to balance not only price but our mix. Where can we get a better margin on a certain package? And I think the biggest thing is giving our consumer choice. They have a broad choice of the packages, and it also helps in the calorie intake.

Terrific. Thank you very much.

Amit Sharma BMO Capital Markets.

Marty, looking at the constant beverage concentrate volume trends for the back half, especially if you look at the fourth quarter, much easier comps, here should we assume that the flattish volume in the back half is doable?

Well, I don't want to go into specific segment expectations, but only to remind you that when you go back and look at trends and look at the first half, don't forget we had a big benefit in the first quarter. We talked about, we thought was volume that we didn't get in December of the prior quarter. Whether it was bottlers lowering inventories, whether was them waiting for us to put at our new higher yield concentrate, so we had a big upside in Q1, and that would not be expected to continue. Beyond that, I don't really want to comment too much on specific quarterly trends, other than my prepared remarks, where we said, when we look at trends in the first half, and we think about what I just said, and you take that out and look where bottler case sales are, our cautiousness is to view that volume softening in the second half.

All right. In and looking at LA, Latin America volumes, pretty solid volume growth there, as well. Have you recovered, or are you seeing positive volume trends in your sugar portfolio, or is it all still being driven by a non-sugar portfolio?

Actually, it's not, so the sugared portion is actually declining somewhat, as we predicted, given the higher pricing. All the growth is in innovation, although one of the really strong pockets of innovation happens to still be a sugared beverage, and is subject to the tax. It's some flavor extensions in the Penafiel line, but our mineral water business is doing really well. And obviously, they have had great growth the first half of the year.

All right, and then final one, and you talked about the allied brands or the co-pack brand, are they good margin business for you?

Yes, okay? And they are relatively higher dollar value cases and they are good dollar profit cases. The way though, to think about, and they're really important to us, and they're growing.

And strategically it speaks to our ability to either seek out or have others seek us out, entrepreneurs who create these products, that will probably end up creating these products somewhat better than larger companies would, not that we can't, and we have the opportunity, as we've said in the past, to see every one of these when they are looking for distribution. And these are the partners we've signed up, whether its Vita Coco we've had for a while, Larry talked about By, many of you have probably seen that product in the market. The Fruit2O. One of our strengths and advantages, is offering up our DSD system to take advantage of growing categories and growing products that are created by these partners. And it is very good business for us.

Thank you.

Kevin Grundy with Jefferies.

Wanted to come back to the marketing, but more like from a different angle, and even a bit theoretical. So obviously down this year some 30 million but some efficiency moving up. But this, within the context of all of your competitors seem to be taking up marketing levels in North America, but yet it doesn't seem to be hurting your market share position.

At least as of yet. So if you could discuss a little bit about monitoring of brand health and your share of voice, currently, and I guess, just give a level of comfort that there's not some risk maybe that catches up over time with respect to your brands, as you're cutting levels now.

I think you said it right there with the -- we monitor it very closely, and all of our brand scores are increasing. They're becoming stronger. We've also -- we've not lost any share, and I'll go back to what I said a moment ago. We measure what we are getting in activation, and what the deliverable is, instead of just what a cost is. If you remember fourth and first quarter both, we talked about, we moved some from national, that we were able to put national media into local that we could activate, and activate not only with our bottlers, but with specific customers. Very account-specific marketing.

So if you take out the TEN from last year, we're not spending any less, but we're also not driving a TEN. We're also going much more to digital. The digital is, I think, one that we're all in the process of trying to learn more about, but it's also being very successful for us. So we don't really have any concerns at all on what we're spending, I think Marty has said it probably a dozen times. We've not said no to anything. If we need to spend on something, we will, but we're not seeing that need. We're delivering our plans, we're delivering what we said we would do, and getting better results than we expected.

Okay. Two more brief ones for me. Just on Hawaiian Punch. Any update there? Do you plan on doing anything differently, as volumes continue to be under a bit of pressure, and understanding that's a lower margin brand for you.

No. I mean like you said, it's big on volume but on the top line, but it doesn't do a lot for the bottom line, so it helps a lot on our mix. It's still a very important brand to us, a very important brand to our customers. We will constantly look at it and make sure we have it in the right package and everything like that, but as far as putting in any specific programs, if you look at the Nielsens and you look at the category, it's not just Hawaiian Punch. It's a category issue. We've got some peers and some competitors in there that are suffering the same way, so that's something we don't want to throw money after, that we don't think would turn it around.

Okay. And one last one for me. Just the bottler case sale volumes in CSDs seem to be stronger than the syndicated data in the quarter. Any color on that?

Kevin, that includes Penafiel. That includes our CSD business in Mexico.

Okay. Okay. Fair enough. Thank you.

Bryan Spillane with Bank of America -- Merrill Lynch.

A couple questions, or actually just related to bottling. And if you look at, I guess, where Coke and Pepsi have headed directionally, in terms of business model in North America, Pepsi seems content to continue to go on with an integrated model and Coke is seemingly wanting to move into a more -- into a more franchise model. So I guess, from your perspective, at first, how do you see that affecting your business, if the Coke system moves into more of a franchise business, potentially you'd have more, I guess, potentially franchise customers to sell into, versus a more consolidated Pepsi system. And then second, just Larry, maybe your views on just which one you think is the optimal for this market.

I probably won't answer that one for you. I couple other people you just that. If you look at, I think that both are great systems. You look at us, you can tell we like them both. I mean we have 40% that's company-owned, 40% third-party, 10% fountain food service and 10% that is warehouse direct. So we're happy with our system.

We see no changes, I mean, with Coke franchising more, the people they're franchising territories to are current customers now. And they do a very nice job for us. We cover them at headquarters, and at their locations, and so we look at it and say it's a win-win for us. We don't see any downfall.

Does it add more complexity to your business, just simply because there's simply more people to call on, or the business, I guess this is probably more related to just Dr Pepper but does it add any --

Not really. Because I mean even with the size of Pepsi, we still call on their BUs and their market units and their business units, and so, we still have the people out there. On the Coke side, we do our annual sales meetings where we have the same plans. We meet with the team so the Coke system knows the team, the Pepsi system knows the team, and our independent system knows the team and the plan for that year. So we don't really see any more complexity.

We all tend to kind a look at it from a investment angle, or what would be the most efficient or yield the greatest returns, but from your perspective, if you flipped it and looked at it from a retailers lens, do you think they would rather have a consolidated model, maybe more flexibility in terms of how the product comes into them, whether it's two-step DSD, DSD warehouse? Do you think they have a view on that? Or have you heard?

I do have a view. They love DSD. I mean, that's been proven over and over. Especially with the velocity and weight of our products. I think a few years ago, you would have heard a different story from our retail partners out there.

Today, I think all three of us do a very good job speaking with one voice. I think we're aligned well with our bottlers. We can go in and quickly speak with one voice and have a program for a national retailer. And so, I applaud the work we've all done on working that together and realizing the changing landscape of the retail environment. So, I don't think our retailers would see that big of a difference.

All right. And Marty, you did a more effective job defending your gross margin guidance than Tim Howard did in the World Cup.

I hope that's a compliment.

Have a good day.

Bill Schmitz with Deutsche Bank.

I just want to take a bigger picture. Have you targeted what do you think your SG&A ratio could go down to, because I know it's a different commodity environment, but if went back all the way to 2008, obviously your G&A costs are most lower as a percentage of sales. Advertising was higher, you made great progress the last three or four years. But do you think they're an ongoing opportunity to get back to where you were before?

Bill, I'll say what I've always said. There's huge opportunity. There's a lot of waste in a lot of processes, there's huge opportunity for improvement, but the way we're going to get is through RCI, through kaizen events. We don't cookie-cutter things, we have found great opportunities already, and so I never really have boxed it. I know it's been frustrating for some, but I don't know that I actually can. I'd probably underestimate it if I did.

And I'll tell you, there are some structural things were doing. Bryan just mentioned about, where do beer distributors fit in the model? We actually have done this in certain of our lower-scale markets, but it's our way of saying, we know RCI can improve a lot, but sometimes in lower scale markets, maybe we need structural change. We've actually done that in a few markets, we haven't realized all that potential yet, but some of the numbers I've seen have suggested that there's probably $3 million to $5 million through incremental profitability, and a lot of that is taking out of the G&A. So we're enthusiastic about what those opportunities are. I simply can't frame it for you.

Got you. Do you know what caused the bloat the last five or six years? Because it seems like it was up, and then it went -- it was down and went up, the costs, and then they started to come down again, so is there a way to maybe just undo what happened there?

I don't have any data in front of me, and we'll spent too much time looking backward.

Okay got you, and then just very quickly. Have you change your tune on acquisitions? I know you talked about some of these great allied brands that you love the growth profile, you love the revenue per case, and obviously the balance sheet is fairly under-levered right now. So have you changed your view on doing deals?

We look at all of them, Bill. And as I have said many times, we remain committed to two things. One being very shareholder friendly, and number two, we're not going to overpay for something. Some of these multiples that are out there are ridiculous, and I love these young entrepreneurs, but they all want to have the next [Glasso] deal and will be very prudent in what we do with them, and we're very happy on being a distributor, and can also pick up some equity stakes in them, and we'll continue to do that going forward.

Great, thank you very much.

Thank you and I want to thank everyone for joining the call today, and for your continued interest and investment in Dr Pepper Snapple Group. Thank you.

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