Keurig Dr Pepper Inc (KDP) 2015 Q2 法說會逐字稿

Good morning and welcome to Dr Pepper Snapple Group's second-quarter 2015 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, Maria, and good morning, everyone. Before we begin, I would like to direct your attention to the Safe Harbor statement and remind you that this conference call contains forward-looking statements, including statements concerning our future financial and operational performance. These forward-looking statements should also be considered in connection with cautionary statements and disclaimers contained in the Safe Harbor statement in this morning's earnings press release and our SEC filings. Our actual performance could differ materially from these statements and we undertake no duty to update these forward-looking statements.

During this call, we may reference certain non-GAAP financial measures that reflect the way we evaluate the business and which we believe provide useful information for investors. Reconciliations of those non-GAAP measures to GAAP can be found in our earnings press release and on the Investors' page at www.drpeppersnapple.com. This morning's prepared remarks will be made by Larry Young, 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.

Thanks, Heather, and good morning, everyone. As you saw in this morning's press release, we've had a good start to the year and I am proud of what our teams have accomplished. We continue to deliver against our key priorities and we drove strong top-line and bottom-line growth in a highly competitive environment. We grew both dollar and volume share at CSDs and shelf-stable juice and expanded or held distribution and availability across our portfolio, and RCI continues to permeate our organization from bottom to top, delivering significant benefits.

For the quarter, bottler case sales increased 1% on two points of positive mix and price. CSD case sales increased 1% and non-carbs increased 3% in the quarter. Brand Dr Pepper increased 1% in the quarter, driven by strong volume growth in our fountain business, regular Dr Pepper increased over 2% in the quarter, while Diet Dr Pepper declined 3% in the quarter, which represents a sequential improvement in the recent diet trend. Our core four brands declined 1% in the quarter, as a 7% increase in Canada Dry was more than offset by mid, single-digit declines in 7Up, Sunkist and A&W. Schweppes increased 8% on growth in sparkling waters and ginger ale and Squirt increased 6%. Penafiel grew 12% on increased promotional activity and distribution gains, while Crush declined 4%. All other CSD brands declined 1% in the quarter.

In non-carbs, Snapple increased 11%, primarily on product innovation. Hawaiian Punch increased 2% and Mott's declined 7% in the quarter, driven primarily by declines in juice. Clamato grew 8% on increased promotional activity and our water category increased 6% on strong growth in Bai5, Fiji and Vita Coco. All other non-carb brands declined 3% in the quarter.

On a year-to-date basis, bottler case sales increased 2% on two percentage points of positive mix and price. CSDs grew 2% while non-carbs increased 4%. Dr Pepper was flat year to date and our core four brands increased 1% as a 10% increase in Canada Dry was partially offset by mid, single-digit declines in 7Up and Sunkist soda and a low, single-digit decrease in A&W. Crush declined 4% and Schweppes grew 8% year to date. Squirt increased 10% and Penafiel increased 15%, while all other brands declined 1% year to date.

In non-carbs, Snapple grew by 8%, partially on growth from innovation and Hawaiian Punch increased 4%. Mott's declined 4%, driven primarily by declines in the juice. Clamato grew 13% and our water category grew 8% on strong growth in Bai5, Fiji and Vita Coco. All other brands declined 2% year to date.

Adjusting for foreign currency translation year over year, net sales increased 3% in the quarter and on 1% increase in shipment volume and favorable product, package and segment mix. Segment operating profit grew 7% in the quarter on a currency-neutral basis. Core operating income increased 7% on net sales growth, ongoing productivity improvements and lower commodity costs. And finally, core EPS increased 9% in the quarter on a currency-neutral basis.

Now that we're halfway through the year, I thought I would share a quick update on how we're progressing against our key priorities for 2015. Increasing distribution and availability of our key brands and packages continues to be a sizeable opportunity for us. Year to date, we've held distribution of CSDs and grew Snapple premium distribution by nearly two points in grocery. We've also gained over one point of distribution across Snapple and convenience, and we've increased distribution of Mott's single-serve juice over 3 points in grocery, which drove a 12% increase in single-serve volumes year to date. Our single-serve distribution gains are the result of an RCI lean track, a great example of how RCI can help drive growth. We've added over 17,000 new fountain valves across both local and national accounts, expanding single-serve availability and creating new sampling occasions for our brands.

We continue to focus our innovation efforts on providing consumers options to meet their evolving needs. This year we expanded our test of naturally sweetened CSDs to three regional markets and we'll continue to monitor how these products perform. We launched Snapple Straight Up Tea nationally, giving tea lovers a product with fresh brewed tea taste in unsweetened and sweetened varieties. We've also entered into arrangements with Bai and other new-age brand owners as a way to supplement our in-house innovation. We expanded distribution of our Canada Dry and Schweppes sparkling waters, introduced Hawaiian Punch pouches for mom looking for on-the-go convenience and finally we're rolling out Penafiel, Mexico's number one mineral water, to key Hispanic markets in the US.

RCI continues to help drive productivity and growth across the business through our lean tracks and business-led RCI. This year we've taken another step forward in embedding RCI into our culture through DPS in ACTION, a framework we'll use to implement lean management across the organization. Marty will provide some additional color on our RCI journey in just a few moments.

As I look at our calendar for the balance of the year, I am confident we have strong plans in place to build on our first-half momentum and continue driving excitement and engagement with our consumers and with our retail and bottling customers. This summer, brand Dr Pepper is once again partnering with the PJ Awards, America's number one Hispanic youth award program, to celebrate Hispanic millennials' passion for music. We'll offer consumers a chance to win a VIP trip to the awards show in Miami and a private concert featuring Latin music sensation Rameo Santos.

We're also making this the summer of cherry by re-launching our Dr Pepper Cherry line, with a smooth cherry flavor designed to bring consumers into the trademark. And as we look to the fall, we're excited to kick off year 2 of Dr Pepper's partnership with ESPN during college football. And, oh, yes, we're bringing back Larry Culpepper in some new commercial spots this upcoming season. 7Up will team up with two of the world's top electronic dance music DJs, Tiesto and Martin Garrix, to create limited-edition, 16-ounce cans in a unique music collaboration airing on national television. We'll also bring back tropical flavored 7Up for a limited time only and offer consumers a chance to win a VIP weekend in Las Vegas to meet both the DJs. We know that soccer is a passion point for Hispanics, so 7Up will be on the air during the Gold Cup as the official broadcast sponsor on Fox Sports and Univision, and we'll offer consumers a once-in-a-lifetime game experience with soccer stars Tim Howard and Hector Herrera.

Our Born in New York, hashtag love Snapple campaign, is in full swing, with national media featuring everyday people and celebrities from New York sharing why they love Snapple with the rest of America. And our seasonal red raspberry, white peach and blueberry flavored Lady LiberTea is giving tea lovers a refreshing new way to celebrate their American heritage. Mott's has partnered with the blockbuster Minions movie to connect shoppers' mom with her kids, with movie-theme packaging and limited-edition flavors kids are sure to love. And just in time for back to school, Mott's is helping shopper mom support her school through the Box Tops For Education program. 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 2015 guidance.

Thanks, Larry. Good morning, everyone. For the quarter, reported net sales increased almost 1.5% on an increase in sales volume of 1% and favorable product, package and segment mix. Limiting our net-sales growth was two percentage points of unfavorable foreign currency translation, slightly worse than our previous expectations, driven by the further strengthening of the US dollar. While CSD pricing in both our concentrate and DSD businesses added almost a half point of consolidated net-sales improvement, it was partially offset primarily by growth in our pre-priced Venom Energy initiative.

Reported gross margins increased 10 basis points in the quarter, increasing from 59.2% last year to 59.3% this year. Strong productivity benefits, including those from RCI, increased gross margins by 50 basis points, while lower commodity costs and certain other manufacturing cost improvements increased gross margins by another 70 basis points. Product mix, driven primarily by continued growth in our allied water brands, which we purchase as finished goods, and segment mix, collectively reduced gross margins by 50 basis points. Furthermore, foreign currency reduced gross margins in the quarter by 40 basis points as Mexico sources certain input costs in US dollars and finished products sold in Canada are sourced from the US. And finally, the net effect of year-over-year, mark-to-market comparisons decreased reported gross margins by approximately 10 basis points.

Now, moving down the P&L. SG&A for the quarter, excluding depreciation, decreased by $6 million on $9 million of favorable foreign currency translation and a favorable $6 million unrealized mark-to-market comparison. All other SG&A increased by just under 2%. Depreciation and amortization expense declined $3 million in the quarter. Reported operating income was $369 million in the quarter, compared to $348 million last year. Core operating income of $365 million was up 5% year over year and represented 22.1% of net sales, up 80 basis points from 21.3% last year. Below the operating line, net-interest expense was flat in the quarter and our effective tax rate for the quarter was 35.5% compared to 35.1% last year.

Moving on to cash flow, cash from operating activities was $349 million, down $89 million compared to last year, driven primarily by timing of bottler incentive billings, vendor payments and higher 2015 incentive compensation payments made in the first quarter. Capital spending was only $42 million, compared to $71 million last year. Total distributions to our shareholders were $423 million, with $251 million in shares repurchased and $172 million in dividends paid.

Before I update you on our 2015 guidance, let me provide you with a quick update on rapid continuous improvement. Larry mentioned DPS in ACTION, which defines how we work. Its core pillars consist of customer-driven work, employee-led RCI, lean daily management and data-driven solutions. We've also developed an internal scorecard to measure our improvements in these areas over time. These pillars define our RCI-Management process as we seek to make breakthrough change in safety, quality, delivery, productivity and growth.

We break down some of our improvement activities into something we call lean tracks. And as I mentioned last quarter, we've implemented five new tracks this year, targeted at waste elimination in areas such as non-working, marketing spend, ingredients and the customer deductions collection process. We also have tracks focused on driving growth across our Canada Dry brand and through our telesale channel. These tracks are continuing to achieve solid results, and let me just provide a few examples.

We've eliminated over 2,000 hours of agency work by implementing standard work across our marketing-creative processes. We've continued to focus on driver check-in and check-out times and this productivity improvement has already taken 30 delivery trucks off the road with absolutely no reduction in deliveries or customer service. To date, we've gained over 7,000 additional points of distribution for Canada Dry and in our Ohio Valley region, as a result of our telesale track, we've driven a 20% increase in volume on our high-margin brands, such as water and energy. Like I've said before, while these wins may appear small individually, taken together and coupled with other RCI initiatives across the Company, they drive a meaningful impact and we have a long runway to go.

Now, moving on to 2015 full-year guidance, as you saw in this morning's release, we have now raised our full-year core EPS guidance by $0.05 to a range of $3.85 to $3.93, based on stronger-than-expected, first-half performance and our view of our balance-of-the-year activities. We now believe our 2015 net sales will be up just over 1%, net of a foreign currency translation headwind of about 2%. While CSD category trends are improving slightly, diets still do remain under pressure. Therefore, with 80% of our volume in CSDs, we believe that total Company sales volume for the year will be up about a half a point. Our volume expectations reflect slight overall CSD declines, offset by growth in our non-carb portfolio and allied brands.

On a total Company basis, we expect combined price and mix to be up about 2.5%. Our January 1st concentrate price increase will drive about 40 basis points of this increase and the remainder will come from expected growth in our higher-priced, non-carb and allied brands. Foreign currency is now expected to be about a two-point headwind on net sales and, inclusive of foreign currency transaction exposure, about a 4% headwind on operating income and EPS. To give you some further insight into our exchange rate assumptions, we are currently planning the Mexican peso at MXN15.75 to the dollar and the Canadian dollar at CAD1.27 for the balance of the year.

Moving on to cost-of-goods, we continue to expect packaging and ingredients deflation, primarily from lower PET, aluminum and apple juice concentrate. However, we now expect this deflation to reduce total cost of goods by approximately 1.5% on a constant volume-mix basis. For modeling purposes, remember that growth from our non-carb portfolio and allied brands which are higher dollar revenue cases will also increase the dollar value of cost of goods. Taken together, these factors should result in a slight increase in gross margins for the year.

Moving to SG&A, though we are still experiencing the higher cost effects of capacity shortages in the transportation industry, recent RCI improvements have reduced our expected transportation exposure to about $10 million for the full year, down $5 million from our previous guidance. And given recent favorable trends, we now expect health and welfare and other insurance costs to increase by about $10 million versus our previously communicated $20 million. As previously communicated, general inflation and field labor will increase total operating expenses by approximately $20 million. That said, RCI productivity benefits will help offset a portion of these increases. We continue to expect marketing spending to be approximately 7.6% of net sales this year, as we continue to hone our return-on-investment capabilities and ensure that we are maximizing every dollar we spend.

Now, moving below segment operating profit, our net interest expense will be around 4.3% on our current debt structure of about $2.6 billion. Our full-year core tax rate is expected to be approximately 35.5% and we continue to expect capital spending to be about 3% of net sales. We expect to repurchase approximately $500 million to $550 million of our common stock this year, subject to market conditions.

Before I turn the call back over to Larry, let me highlight a couple of phasing items that will help you update your models. First, the cost-of-goods deflation of 1.5% will be more pronounced in the back half of the year. Second, the health and welfare and other insurance increases will be predominantly in the third quarter. And third, marketing expenses are expected to increase by over $6 million in the third quarter based on program timing. With that, let me turn the call back over to Larry.

Thanks, Marty. Before we open the lines for questions, let me leave you with these thoughts. Our priorities remain the same. We will continue to execute our strategy in a competitive environment, ensuring that we build awareness and relevance of our brands while executing with excellence in the marketplace. We're committed to providing consumers with options to address their evolving needs and lifestyle. RCI continues to drive both top-line growth and productivity throughout 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 comes from Bryan Spillane of Bank of America Merrill Lynch.

Hey, good morning, guys.

Good morning, Bryan.

I wanted to ask a question just specifically about pricing and I'm going to try not to muddle this, but you've now gone through two holiday periods, Memorial Day and July 4th and I know there's been a lot of focus in the analyst community about price elasticity and the effect of the environment being less promotional. The keys, though, are really how -- I think, how the holiday periods have -- how we perform at the holiday periods. So can you talk at all about whether or not the elasticities have been better than expected or better at the holiday periods themselves or whether it's the sort of off-holiday periods where the industry seems to be getting a little bit better? I hope that's clear.

Yes. I think, if I'm following you, Bryan, I mean, last year we looked at an awful lot of it before the gas prices and the economy started ticking up a little bit, but everything was the first half of the month and was really tailing off towards the end. I think we're seeing a little more consistency right now. We still continue to see tremendous discipline in pricing out there. I thought the pricing was excellent for both holiday seasons, not a lot of load-in, just good promotional activity, which moved some product out there, but I think we're seeing some improvement. Not major, but some.

So gives you some confidence that, that will hold for Memorial -- as we go into the holidays for the balance of the year that nothing to suggest that it would be more -- that it would need to be more promotional or different at, let's say, Labor Day or some of the other holidays?

Nothing at all.

Okay. Great. Thank you.

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

Good morning, guys.

Morning, John.

Wanted to ask a question -- well, two questions. First off, Larry, you commented on diets and the weaknesses there. Can you talk about two things? One is sort of your view in terms of any updated thoughts on mid-cal as a possibility or is it sort of an all-natural sweetener that needs to happen and kind of how you think the formulations will move going forward. And then a second separate question, which is for Marty, which is about the one offs that you mentioned on the gross margin line, how we should expect those to impact gross margin over the balance of the year, things like transactional FX, et cetera. Thanks.

Yes, I'll start. John, I think it's going to be a combination of diet, mid-cals, natural, the TENs. You take our TEN product, we've got a great consumer base there. You've got people that are maybe happier with a mid-cal if it's natural. We're very excited about seeing our diets kind of bucking the trend out there right now. Diet Dr Pepper was down three and I think a lot of it -- you've heard us talk about it in the first quarter that we were putting some median marketing against Diet Dr Pepper and everything is showing us it's working.

So we're excited about that. We got Dr Pepper back to growth, I mean, so we got a lot of the summer selling season still going. We're seeing that growing, diet looking better. You know, the TEN is still out there serving a purpose. We're testing the mid-cal, the natural in three markets and hopefully in the third quarter, we can give you an update on that. But my answer is it's going to be a combination of all three. This consumer is very different any more.

John, let me talk about gross margins. So a couple factors. Of course, productivity improvements have been strong. We've guided on COGS deflation for the year. FX transaction impacts so, again, because our Mexican business, it's principally resin for them that's US dollar denominated and our warehouse direct products in Canada, which are sourced out of our plants the US. I would say that impact in the back half will be about what it was in the first half. It might be slightly lower, but about what it was, so you can model that. And the other point I want to make for you and everybody is as we continue grow our allied brands, because we buy these, we don't manufacture them ourselves, they come with a higher gross margin -- a lower gross margin because of higher cost, but they're very accretive to the operating profitability.

Okay. So nice price-mix benefit offset at the gross margin line. And I guess the question then would be how do we model the SG&A implications of that, then?

I guess I would model them consistent with sort of where you see our run rate, SG&A, plus overlay the few items I mentioned about transportation and insurance and other factors because we've been -- over time these brands have been growing great. They do have a little different complexion below the line for us, but I think, work off current trends, I think you'll be okay.

Okay. Thank you.

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

Hi, guys. Good morning.

Good morning.

A couple quick ones. On the beverage concentrate, I think you said in the press release there was some commentary about higher discounts. What is that? Your commentary suggested, and all the data suggests, that things are very rational.

Yes, that's -- so our funding, back to our bottling partners, is accrued on a bottler case sales basis and we have stronger flow through the system. We have increased accruals for funding, which in essence means over time it's timing, right? If you believe that case sales over time and shipment volumes over time true up, it's really timing in the periods in which we accrue the funding.

Okay. That makes sense. Was this the one quarter with the timing catch up and it should be sort of normalized the rest of the year, is that kind of the way to look at it?

We like when bottler case sales keep ahead of our shipments. That means people need to replenish, but over time you'd have to expect them to come in line.

Okay. Your balance sheet is in unbelievably good shape and you talked about the gross margin hit from some of these allied brands. Why haven't you been more active maybe trying to buy some of them? I know you made that equity stake in Bai5. Intuitively, it seems like they're good businesses. I know multiples are pretty high, but is that part of your consideration set?

Well, you answered your question, multiples high. Seriously, there are a lot of good things happening, I think, in this space broadly, and we've partnered with a few of them, whether it's Bai or Vita Coco for example, and we're looking at some others. And as Larry said in his prepared remarks, it's a great way for us to use the opportunity, the entrepreneurial passion of these organizations to drive innovation that would admittedly would unlikely come out of this organization and we're not afraid to admit that. So we're okay partnering with these companies.

To acquire them would be just too expensive and we're not sure the right thing to do in terms of the amount of money it would actually take to own all these businesses. They're great partners. We love some of the innovation they have in their pipelines and some of this little bit of equity, for example, that we took in Bai wasn't so much about buying some equity because we're not a PD farm, was as much to help them fund some future innovation which is going to flow through our system.

Okay. That makes total sense. Lastly, it seems like most of the RCI so far has been gross margins, unless I'm wrong. Do you think there's an overhead opportunity? I know it's hard to benchmark a gross company, I've asked this before, but as a percentage of sales, the sort of like the non-transportation/advertising overhead is a little bit higher than some of the peers. Is that going to be an opportunity going forward?

Well, I don't know what peers we're looking at because all of our business models are different. Our complexion across the beverage base -- SG&A, for the most part, is structural. When you compare it across the industry in terms of how much DSD business do you have versus concentrate business. As we've said, I mean, we're applying RCI everywhere. We talked about growth opportunities, Canada Dry. Last year we talked about Snapple on the growth side, tell-sell channel which we think is going to be a big upside opportunity for us to penetrate the [up and down the street] in C stores. And, of course, supply chain, that's where traditional lean is applied.

As we said, marketing spend, non-working marketing spend, there's opportunities everywhere, and I just remember, and those of you on the call that have been involved with us since we began this journey when our margins were in the upper teens and everybody said, gee, can you get to 20%? Well, that's in our rear-view mirror right now. I don't think I would have predicted this back then, okay? I don't know where we can go, but I'll tell you, we see opportunity everywhere, and you can tell we're confident about it.

Great. Thanks. I appreciate your time, guys.

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

Thank you. Good morning.

Good morning.

Good morning, Judy.

My first question is just on your price mix, and I think we've talked about this in the past, but just the way we see your price mix seems a little bit more modest than some of your peers. Can you -- I know you talked about a little bit of the Venom issue in the Q2, but can you just talk broadly about how you see that kind of playing out in the back half of the year as you think about -- I think in the past, you've talked about maybe increasing the capability on the packaging mix side, so should we see some of that contributing more to the mixed side of the equation as you look out 6 to 12 months?

Okay, Judy, it's Marty. Yes. If you simply look at the -- I assume you're referring to CSDs only -- and you look at the implied price mix coming out of the Nielsens, yes, we look lower than our two competitors and we know one of our competitors particularly, although both, but one in particular, has an abundance of different package sizes, smaller package sizes, which you know we do participate in, in those markets where they have brand Dr Pepper.

We, too, are moving down that pathway. I doubt you'll see us have as many packages. We're not sure that that added complexity makes sense for our operating model, but does make sense at the top line and for our consumers, and so you're going to see us moving down a little bit. They're advantaged in terms of price per equivalent ounce that they can capture. But in terms of our underlying pricing, as I said, we really, if you look at our pricing, pure pricing in CSDs, and strip out some of the things offset, it was about -- it added about 1% of our CSD business about a half a point across the total Company revenue, because we don't, really break out our CSD sales in our DSD business.

The offsets were -- we've been growing Venom. We decided to take advantage of the opportunity in that category. It's pre-priced cans, $0.99. We've got some new flavors, and we're actually getting a pretty good take. It's small, but it was enough to partially offset the increase I just said. And truthfully, there was another offset. As part of our Snapple strategy, we introduced three variations of Straight Tea, sweetened, lightly sweetened, unsweetened. We previously had a lightly sweetened tea in the Snapple traditional glass bottle. These new ones are an 18.5-ounce PET.

So we sold off, at discounted prices, the old inventory, the old product and we've deemphasized and more or less discontinued our Snapple value gallons, because we're focused on premium and we decided to go ahead and sell off some of that inventory at lower prices. So those two offset. But underlying our pure pricing on our CSDs would be about 1%.

Okay. That's helpful. Marty, just on your guidance, so if I sort of take all the changes that you've called out today, the more favorable transportation costs, the health and welfare costs, and then partly offsetting that was, I guess, more adverse FX, I still come up with a number that's maybe about $0.10 higher than your prior guidance? I know we may be splitting hairs, maybe it's a range. But is there anything that you can kind of point to where maybe I'm missing something here just in terms of that bridge?

No. Well, Judy, that's a couple -- let me overlay a couple considerations. First of all, let's talk about Mexico. We don't talk a lot about Mexico on these calls, but it's becoming an increasingly important part of our business and obviously the results are actually fantastic. This last quarter, on a currency-neutral bases, sales up 5% in dollars and operating profit up 29%. A lot of growth down there in Penafiel. We've done a great job with brand Penafiel and, including penetrating of the largest C-store chain in Mexico, OXXO, we're going to start lapping some of that in the second half.

Now, that's built into our growth guidance for the balance of the year, but I want to point that out to everybody. And built in is still some conservative view. Maybe not conservative, but just view on where CSDs are going relative to where we've been in CSDs and not attempting to get too optimistic just yet on what can happen in that category as it relates to us. We want to be a little conservative. That's about all I can say, Judy. I think you guys can tumble the numbers and we took our guidance up to a level that we're very comfortable with, and so I'll leave that with you.

Okay. And then marketing as a percentage of sales. You said it's unchanged, but in the second quarter, did you give us that number, how much marketing was up in the second quarter?

I didn't give it to you, but I will tell you it's up $1 million. Just coincidentally that for the first half of the year, actually, marketing spending came in at 7.6% of sales. We've said it's going to be 7.6% for the year. So if I remember my mathematics correctly, it sounds like it should be 7.6% in the second half.

Got it. Yes. Thank you.

Our next question comes from the line of Amit Sharma of BMO Capital Markets.

Good morning, everyone.

Good morning.

Marty, just talking about -- you were talking about Mexico and a question on that. Clearly margins are up pretty big in the first half. Is this simply a larger payoff from the distribution gains you had last year and earlier this year as well, or is there more incremental -- or incremental productivity that you're finding there?

I would tell you that in Mexico we've done some great innovation and coupled with RCI, and that includes sort of changes in certain product formulations and other things that have added value to the products while being able to improve the gross margins on those products. When you talk about distribution in Mexico, I think many of you know this, we are actually not very well distributed throughout the country at all. We're concentrated in the middle part of the country, Mexico City, Guadalajara, to the north a little bit. There's actually lots of white space for us in Mexico and we think that's a good runway, but over the last few years, we've wanted to make sure our business down there had a solid foundation, the house was in order. We believe that's critically important to establish that foundation for growth. This business -- the margins now are in the low-double digits and I remember when they were in the single digits. This is a textbook case of classic improvement up and down the business, solid teams, solid foundation and we've got some growth opportunity there.

Great. And then your BCS volume, as you said, were running a little bit ahead of your concentrate shipments. Is that something that concentrate shipments will cap up in the back half or do a we continue to see a little bit of lag there?

I can't -- it's hard to predict the BCS volumes by themselves, but you would expect a catch up.

Okay, got it. And then, Larry, a question for you. In most beverage and food categories that we cover, pricing tends to be more rational when commodities environment is challenging and discounting levels tend to rise when commodities are favorable and we've seen quite the opposite here in the CSD category, right? So the question is, when commodities do turn, and they will, would you expect to lose some of the discipline as companies trying to scramble to hold share at that point or do you expect this behavior to continue even if commodities environment change?

No, I'd expect it to continue and probably even more so if commodities increased. I think we'd see everybody more taking some price. I don't think it would be an issue of the share, but I feel very confident going forward. I think you're right. I mean, commodities aren't going to stay like this forever, but we're hoping they get back to more of a normal, where the algorithms that we can look at as commodities a couple percentage here and just go on from that. But if they do, we'll definitely have pricing that will capture it.

Got it. Thank you very much.

Our next question come from the line of Vivien Azer of Cowen and Company.

Hi, good morning.

Good morning.

My one question has to do with the Dr the Dr Pepper brand. Clearly, the improvement is encouraging and seemingly the improvement in diets is certainly helping. But it also feels like the underlying Dr Pepper brand itself is looking a little bit healthier. So can you talk to that a little bit? Is it benefiting from a halo around the increased media? Anything you can offer on that would be helpful. Thank you.

Yes. As I mentioned in my prepared remarks, our fountain food service volume was up very strong, so we were excited about that. We've got a bunch more new accounts coming on, especially taking on diet, which is also helping our diet. I think with our marketing campaign, again, that we did on diets to help kind of turn that around, our fast food partners out there are picking up on that, liking that, seeing people coming in and do it. Also, we just continue to focus on our priority brand execution out there with our partners.

We've -- I think everyone is excited when they see Dr Pepper back to growth, and then look at it and say we're coming into -- not only are we back at growth now, but we're coming into Dr Pepper's time of year with college football. I mean, as we get coming in with that and we got the right momentum with the diets, we feel very, very good and so do our partners that Dr Pepper will continue to be a strong brand.

Terrific. Thank you very much.

Our next question comes from the line of Nik Modi of RBC Capital Market.

Good morning, everyone.

Good morning.

The quick question I had was really around the diet portfolio. Larry, I was curious if you could comment on Pepsi reformulating. Have you thought about potentially testing a diet version with a different sweetener? Any help around that would be useful.

No. I mean, we watch everything that's out there. I mean, we're very satisfied with our Diet Dr Pepper and with the aspartame, the taste, I mean, that's the profile. Our customer, our consumers love it. We have a lot of products out there that -- our Diet Rite is sweetened with Splenda. We have different sweeteners across the portfolio. But as far as our core four and our Dr Pepper, our base business, we'll be watching everything, but we're very pleased with where we're at right now.

Great. Thanks so much.

Our next question comes from the line of [Dharma Finian] of Morgan Stanley.

Hi, guys.

Good morning.

Wanted to get an update on your thoughts around returning cash to shareholders. Fundamental outlook looks like it has improved here over the last year or two with US CSD pricing turning more rational on the limited demand elasticity. Your Mexican business is performing well. Would love to get your perspective on if improved fundamentals give you more comfort going forward that you can increase your payout ratio or your dividend going forward or take on more debt leverage than the two times level you're at here?

It's Marty. We do return all of our cash and so your question goes to allocation on the one hand between dividends and share repurchase. Our pay-out ratio is about a 50/50 split right now. We've always said that if we were to lean one way or another, we would lean into the dividends more so and tick the payout ratio up. That's still our point of view. That's an annual consideration by our board every February.

In terms of using leverage, we're about two times. We've said early on we're targeting 2.25 times. That's come down a little bit as our EBITDA has gone up. We're not looking to materially change the capital structure of the Company. It's just, our point of view is that's not necessarily the way we ought to create value, and so we sort of like the mix and like the profile today.

Okay, thanks.

Our next question comes from the line of Kevin Grundy of Jefferies.

Thanks. Good morning, guys. First one for Marty. The question is on long-term profit growth for DPS. I guess this goes back -- so you guys decided to take the 3% to 5% sales growth off the table, I guess, a few years, a couple years ago now, but the irony is you've exceeded the old high-single-digit EPS growth target for a couple years. I understand that commodities are favorable, but, Marty, I guess based on kind of how -- and Larry too, how you see the environment with greater pricing discipline. You've talked about the long runway for productivity. Again, understanding commodities can be a wild card, are you thinking high-single-digit sort of EPS growth is sustainable now going forward for DPS?

It's an interesting question because when we saw this quarter's numbers and thought about where we had been in the past and our years ago talking 3% to 5% top line -- I know Steve Powers is probably on the call. He would ask me forever, when are you going to take that number down as the world was changing on us? it is interesting that when we look at FX-neutral, translation-neutral results this quarter being up 3[%] and having the leverage at the operating line up 7[%] and as you said, EPS up 9[%], that was in essence our model then, and I think the financial construct of the Company and the cost structure of the Company sort of indicates that this is achievable if we can get the top line. But the business is competitive, the business is challenging. We think we're doing some good things.

But if you were to tell me we could be at these levels of revenue growth, could we drop sort of mid or so improvements in operating profitability and a little higher in EPS? Absolutely. The question is, over the long term can we achieve this level of revenue improvement. But the model will work.

Very good. That's helpful. And then a quick one for Larry. Just on Coke's refranchised bottlers, as they're in the process of continuing that, have you seen any difference? Do you expect to see any difference in terms of execution there in those regions? Thank you.

No. We've -- we're very familiar with all these bottlers. They handle our Dr Pepper right now. I think the refranchising is going very well, very smooth and our bottling partners are excited to be picking up more territory.

Very good. Thanks, guys.

Thank you.

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

Hey, guys. I have a few questions but I want to focus maybe on two things. One is, if you can unpack and maybe quantify a little bit more the SG&A drivers? You talked a little bit about distribution, health and welfare going forward, but in the quarter, if you could talk a little bit more about that. And then if you lower marketing as well, at least in this quarter as a percent of sales. And in that, if you could talk about the effect of allied brands. I think I get it on the gross margin line, but what the kind of effect would be on the SG&A line. If that becomes a bigger and bigger piece of your business, does that just continue to be a tailwind for you going forward? First on SG&A.

Ali, let me take it. It's Marty. Good morning. Let's cover SG&A in Q2. Let's get grounded on what happened in Q2. As I said in my prepared remarks, so foreign currency reduced dollar-reported expense levels by $9 million. Our mark-to-market adjustments on commodities, so in SG&A that's where our fuel contracts occur. That actually year over year net reduced dollar-reported SG&A by $6 million, so you had a $15 million decline there. We took up about $3 million in higher incentive compensation accruals, given where our results are first half of the year. And then just everything else was sort of just, as I said, some general inflation, okay, which we said was less than 2%, so we're pleased there.

Look, on the allied brands, the real issue -- so you understand the gross margin impact, these go right to our distribution centers. They really go right on the truck. So in essence there's very little -- when we look at it, we don't really add anything incrementally, so it's more about, call it, variable drop here or contribution margin. There's no real incremental cost. There's some, but it's really at the margin, and so we get a nice profit drop through.

Okay. And one -- sorry. One thing you didn't mention, and this is RCI specifically, is SG&A and that's kind of the cost reduction you guys are doing. For what it's worth, we're starting to hear a little bit of squirming from your employees and former employees, and, of course, you always have to take that with a grain of salt, but about, gosh, maybe it's going a little too far in some areas. Is there any kind of reasonable reason why folks would be nervous or concerned that perhaps it's going a little bit too far in some areas?

Ali, the answer is no and I find it interesting that we're probably the only company in our space that's not been aggressively restructuring and taking loads of people out. I'll tell -- our people don't walk around this Company looking over their shoulder, worrying whether they're going to have a job come next week. That's very healthy for our organization. And that's what I'll say. I don't think -- we don't -- we don't necessarily run thin. We don't underpay our people. We look at this all the time, and so I think -- I don't think we think much to it.

And I'll tell you everywhere Larry and I travel in this Company, for the people who work for this Company, they're thrilled. And not just what we're getting done, but the way we're getting it done, the fact that we're listening to them. We say change is led by our employees, not by Management. They love that, they love participating and that's why we can grow -- we can grow and grow profitability, and last time I looked, you can't find restructuring charges in our numbers because we don't feel we need to go that way.

Okay. That's helpful. And last question, kind of a bigger picture question, you guys were part of a bigger company. Actually, Larry and Marty, you came after, but were certainly part of a bigger company and now you're on your own and clearly doing quite well. Is there a time in the future where you would be better off as part of a bigger company, and is that just too far away for investable time frame to think about or are there milestones where you say, gosh, at this point we need international exposure or we need being part of a bigger distribution system? At what point, if ever, do you think it might actually be worthwhile to be, again, part of a bigger company?

The answer is no.

So you'd never think that there would be a benefit.

We can operate the way we're operating, the way we have, the behaviors, the culture. Whenever people ask us about why don't we buy some of these new allied brands and these startups, I mean, we look top heavy whenever you look at them how fast they can move and why we don't want to go in and mess them up. As Marty has said, especially with RCI and what we look at in distribution and availability, our runway is very, very long, and we've got a strategy, we've got a tactical plan in place and we're going to continue to work it, drive our priorities and we're very, very happy with the size we are and what we're capable of doing.

Thanks very much, guys.

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

Thanks. Good morning, guys.

Hi, Mark.

Larry, a question on the core four. We saw a slowdown in that portion of the portfolios bottler case sales performance. I was wondering if you could speak a little bit more to your outlook for that component of the portfolio. I think there's going to be a pickup in spend against 7Up here in the second half. I think the 10-calorie laps are going to ease at some point over the next few quarters. Just help us understand what's really going on under the hood there and what your plans are to improve performance there.

You're exactly right, Mark. I mean, for the year we're up 1%. We're very happy with that. We were lapping some heavier activity in Q2 to last year, so we were not too concerned about it.

Our activation plans and marketing plans for 7Up in the third and fourth quarter, you heard me in my prepared remarks, we've got a lot of things going on there, not only with the electronic -- I don't know what this music is called, but all that flashing and everything, but also the World Cup -- or the Gold Cup on soccer, which is going to really drive us a bunch out there. We've got some LTOs for this summer that we'll come back in with. So we think that the core is going to look good, but the biggest thing on Q2 is just lapping some heavier activity last year.

Is it fair to think that these 10-calorie laps have been an issue and they become less of an -- A, is it fair to consider them an issue in the quarter that we just saw here? And B, when in your opinion do they become less of an issue from a lapping perspective?

I think it was a slight issue on lapping those. I mean, it's -- you're exactly right, it's starting to trend off. They're still a sizeable piece of our business and we have a good consumer base that likes those brands. So it's kind of settling into where it's going to be in the lineup, but it's not that big of an impact.

Got it. Got it. Okay. And then if I could also, Marty, just kind of a subcomponent, if you will, of RCI, this focus on the distinction within your marketing dollars between working and nonworking. I think you're looking for something on the order of about a $5 million improvement in the nonworking number, but could you just give us a little more color on how that's going? If it's possible, even that split as you see it, what portion of your dollars presently do you think are nonworking on a percentage of total marketing spend basis?

Mark, you're right, we did target this year. That team targeted a $5 million savings, and nonworking dollars are not insignificant in terms of the whole, so it's a good number to go after, a lot of waste. Obviously we want zero nonworking dollars. We want every one of our dollars to work towards our brand. As I said in my prepared remarks, here's a classic one, just basic standard work. We use outside creative agencies to do work for us. They can only do the work based on the specs we give them. And when you get into the process you realize there are iterations through these specs, they go back and forth and that is just rework. Those are defects and they need to be eliminated.

When we talk standard work, we mean standard work. We mean we are creating a process, a step-by-step process that everyone will adhere to, to eliminate all that. That principle you can sort of apply anywhere in the Company. Standard work on any process, get rid of defects, get rid of iterations and rework and so far so good. I mean, as I've said, they've eliminated 2,000 hours of cost per hour with outside agencies is not an insignificant sum of money. So there you have it.

Yes. And last one is on the input comment. Can you give us any help as we -- we all obviously have models that go beyond calendar 2015, and you've made the comment about deflation being more beneficial, if you will, in the second half, and we all know what the spot markets are. So it just seems reasonable to think that the 1.5 becomes an even bigger benefit, if you will, in calendar 2016 if things stay, if the spot markets for the various inputs stay where they are presently. Is that a fair way to think about our models for calendar 2016?

It's just too early for me. I haven't seen enough. I know we're -- I've seen where commodities are hedged through, and we've got some decent coverages already into 2016. But in terms of the total impact to next year's COGs, I need a few months here as we begin in the fall in the planning process to see where it all shakes out. Needless to say, we feel good about our hedged positions and, oh, by the way, the open positions right now are not too bad because most of the things that are important to us have softened.

Yes Got it. Great. Okay. Thank you, guys.

Your final question this morning comes from the line of Rob Ottenstein with Evercore.

Great. Thank you very much. I was wondering if you could give us a little bit more detail on Diet Dr Pepper, which had a strong quarter. How sustainable is that reduced decline, which is doing better than a lot of your peers, and what amount of that improvement had to do with increased distribution?

I think the majority of it is from our marketing, the media that we've put behind it that was -- before, whenever we started going down, our media was basically Pepper, Diet Pepper and Pepper TEN together and we broke this out with little sweet that is Diet Dr Pepper completely, so I'm going to give the majority of that turnaround to my marketing department and our media partners that were able to put that together for us.

Sustainable? Very sustainable. I'm very excited about how we can use that through college football, that we can continue this momentum. And as far as added availability, I mean, Pepper, Diet Pepper, is basically everywhere. It's good ACV out there, so maybe a little more tie-in rates because of us being able to do the media, because we can show a lesser decline that we may be on a track to grow again, helps with our bottling partners and our retail partners out there.

Great. And then as a follow-up on 7Up, I know the majority of the marketing and promotion is in the second half of the year, and you went through that, but as I recollect, and correct me if I'm wrong, you did a lot of that last year and I would have thought you would see some benefit in the first half. Can you give us any more sense in terms of why the first half was so weak for 7Up?

Yes. We had a good first quarter and year to date we're up one with our core out there right now. I think with what we have coming up especially -- the third trimester is always the biggest time for the green bottle, 7Up, Canada Dry and everything for the holidays and the mixers, so we're not concerned with what happened in the second quarter. Everything we're showing is that we've got the right plans in place, just a little less activity this year in Q2 than we had last year. Third quarter is going to look good for it.

Terrific. Thank you very much.

I'll end by saying again that we're pleased with our first-half performance and feel confident in our commitments for the remainder of the year. Thanks for joining the call today and for your continued interest and investment in Dr Pepper Snapple Group.

Thank you, ladies and gentlemen. This concludes today's second-quarter 2015 earnings conference call. You may now disconnect and have a wonderful day.